UN Web Site   |   UN Website Locator Home     Site Map     Contact    
Home » Country Notes

India

Briefing Notes for the Launch in New Delhi, March 2008

India moved on to a new phase of high growth but inflationary concerns remain

  • The economy of India appears to have moved on to a new phase of high growth, with an average growth rate of 8.8% over the last five years as investment in the economy has risen sharply. India’s 9.6% GDP growth rate for 2006 reflected double-digit growth in the industrial and services sectors. India’s continued high growth in 2007, estimated at 8.7%, resulted from steady gains in the rate of savings and investment, consumption demand, addition of new capacity and the more intensive and efficient use of existing capacity. Strong growth in the industrial and services sectors supported the high overall rate, more than compensating for an agricultural slowdown.
  • GDP growth for India over the next few years is projected to remain at between 8.5% and 9.5%. Concerns have been expressed about whether the country is growing beyond its growth potential thereby straining its labour force and capital stock, and creating inflationary instabilities. The government’s strategy for maintaining high growth while keeping prices fairly stable is to increase productivity, ameliorate skills shortages and add capacity through investments. Monetary policy will continue to play a critical role in maintaining price stability. But the sustainability of high economic growth with moderate inflation will depend critically on fiscal prudence and high investment levels. India could achieve and sustain a 10% growth rate by further improving the country’s business environment, by developing its physical infrastructure and human capital.
  • Inflation in India, as measured by the consumer price index for industrial workers, rose from 4.4% in 2005 to 6.7% in 2006. The increase mainly reflected higher food prices, with demand-supply gaps in the domestic production of major food grains and oilseeds amid rising global prices. But 2006 also led to other inflationary pressures on the demand side, including elevated asset prices, high investment and consumption demand and strong growth in credit and monetary aggregates. To contain inflation the government adopted a tight monetary policy and took various fiscal and supply-side measures in 2006. Inflation in India is estimated at 5.5% for 2007, slowing somewhat from its 2006 rate. But inflationary pressures could persist as international commodity prices, in particular oil prices, further increase. A continuous vigil by all concerned – with appropriate policy actions – would be needed to stabilize prices and anchor inflationary expectations in a sustained fashion.
  • The Indian central government’s fiscal deficit fell in 2006, to 3.7% of GDP and further to 3.1% in 2007. Essentially revenue-led, the government’s deficit reduction strategy focuses on improving the efficiencies in allocating public spending. Its policy of reprioritizing expenditure has led to higher outlays for the social sector.
  • In India both exports and imports continued to grow strongly. Imports increased more than exports, deepening the trade deficit. But thanks to continuing buoyancy in the net invisible surplus, India’s current account deficit in fiscal 2006 was 1.1% of GDP. Net capital inflow to India remained buoyant in 2006, at 4.9% of GDP, far more than the country’s current account deficit. Higher capital inflows for 2006 were attributable to strengthening macroeconomic fundamentals, greater investor confidence and ample global liquidity. Net FDI inflows in 2006 reached $19.4 billion. For 2007, both exports and imports are estimated to have grown by more than 20%. Foreign exchange reserves stood at $267 billion at the end of December 2007, and the Indian rupee had appreciated sharply against the United States dollar.
  • The main challenge for countries in South Asia is to sustain their growth momentum in the face of high oil prices. Should oil prices remain very high, they will compromise economic growth while putting pressure on budgets, inflation rates and the balance of payments in countries throughout the sub-region. So, some measures must be taken to hedge the risk of continued high oil prices and – more importantly – to contain oil imports through selective energy conservation measures.

Fiscal deficit and public debt sustainability in South Asia

  • Despite improvements in recent years, public debt remains a serious problem for most countries in South Asia. While domestic public debt is becoming a larger component of total public debt, it has received relatively less attention despite its serious economic implications. Excessive reliance on debt, whether domestic or external, carries macroeconomic risks that may hinder economic and social development. High domestic public debt pushes up interest rates and crowds out private investment, which is much needed to promote economic growth.
  • When most government revenues are devoted to debt servicing, fiscal policy cannot be used to provide basic services, such as education, health, safe drinking water and housing. When public debt level reaches a very high level, a larger fiscal deficit becomes unavoidable. As a result, inflation starts climbing, pushing domestic interest rates and raises the cost of debt servicing. Therefore, countries should pursue vigorous macroeconomic policies to contain public debt, including domestic public debt before they become totally unmanageable.
  • In India, high fiscal deficits increased the combined debt of the central and state governments from about 70% of GDP in 1990 to about 87% over 2002-2004. Public debt, on the decline more recently, is estimated at 82% for fiscal 2006. The central government share in public debt is much higher than that of state governments. The real burden of public debt is in its servicing. In India, interest payments alone consumed more than 28% of the revenue of the central and state governments in 2005, more if repayments of principal are included.
  • Policymakers may find lessons useful in their efforts to contain public debt. The sustainability of debt is crucially dependent on the size of the economy. Moreover, past experience suggests that it is difficult to bring public debt ratios down without robust economic growth. Therefore, policies promoting GDP growth should be vigorously pursued.
  • As budget deficits are a major cause of public debt, every effort should be made to maintain a primary surplus in the budget. India under its Fiscal Responsibility and Budget Management Act has been able to bring down budget deficit in recent years. The pace of government revenue growth through the strengthening of tax administration and broadening of the tax base must continue to rise so that the country’s debt-carrying capacity can increase. Debt sustainability becomes an issue of growing concern when the growth of government interest payments exceeds that of government revenues.
  • Strengthening tax administration is crucial. Tax rates are not low in South Asia, but inefficient tax systems and corruption keeps revenues low. A simpler tax system, with fewer exemptions, less discretion and better compliance, should be a focus of policy. Improving documentation of the economy will also help. Greater use of information technology could strengthen tax administration.
  • Widespread poverty and lack of basic services mean that demand for public spending is high. The challenge for governments is to contain wasteful public spending and orient it towards priority sectors. Public expenditure should promote pro-poor growth; basic services, such as education, health, sanitation and housing, should be a priority.

Addressing the neglect of agriculture – two-pronged approach needed

  • The rural poor account for around 70% of the poor in the Asia-Pacific region, and agriculture is their main livelihood. Another worrisome trend is the widening gap between the rich and the poor because the benefits of growth are not shared equally by different sectors, regions or income groups. Agriculture appears neglected, even though it still provides jobs for 60% of the working population and generates about a quarter of the region’s GDP. Growth and productivity in agriculture are slowing, and the green revolution has bypassed millions. In South Asia, growth in agriculture output dropped from 3.6% in the 1980s to 3.0% in 2000-2003.
  • Agricultural labour productivity has a significant impact on poverty reduction. ESCAP estimates show that a 1% increase in agricultural productivity would lead to a 0.37% drop in poverty in the Asia-Pacific region. Given the large agriculture productivity gaps among countries in the region, the potential gains appear substantial. Raising the region’s average agricultural productivity to that in Thailand can take 218 million people out of poverty, roughly a third of total poor in the region. Large gains in poverty are also possible through comprehensive liberalization of global agriculture trade, which could lift another 48 million people out of poverty in the region.
  • Therefore, a policy priority should be to revitalize agriculture. Revitalizing agriculture requires connecting the poor to markets through improvements to rural infrastructure, the availability and management of water, agricultural technology, increasing the capacity to adapt technologies, and speeding up diversification and commercialization. It also requires improving the distribution of land and the access to agricultural credit and extension - and making macroeconomic policy friendlier to agriculture, all enabling the poor to make a dent on poverty by themselves.
  • While agriculture growth will help in reducing poverty particularly in rural areas, yet some poor will shift from agriculture to industry and services, which offer them a better chance of escaping poverty. Policies should be put in place to make this transformation easy. Public policy could thus adopt a two-pronged approach, taking both aspects into account; revitalizing agriculture while facilitating the migration of excess labour from agriculture to industry and services. Farmers can leave agriculture for non-farm activities in rural areas or for work in urban areas. This requires creating opportunities in the non-farm sector as well as urban planning. Both require better opportunities for skills development and strategies for raising overall economic growth.