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India

Author(s):
International Monetary Fund
Published Date:
February 2008
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Executive Summary

India’s dream run of strong growth and macroeconomic stability is a tribute to its sound macroeconomic policies and past structural reforms. The economy expanded at an average rate of about 8½ percent for four years running, on the back of rising productivity and investment. After rising sharply in early 2007, inflation has ebbed, and the current account deficit is moderate. India’s bright prospects have attracted record capital inflows amidst heightened global uncertainties and slowing U.S. growth.

Swelling capital inflows have highlighted the key policy challenges: managing financial globalization and tackling the supply constraints to growth.

  • Large capital inflows are exacerbating tensions in the monetary policy framework among exchange rate management, monetary independence, and financial openness. The RBI’s stance of accommodating increased exchange rate volatility, actively managing liquidity, and liberalizing outflows is appropriate. However, the use of capital controls could dampen investment, raise doubts about the government’s commitment to fuller capital account convertibility, and pose questions about the exit strategy from new controls. Strengthened monetary operations and communications along with greater exchange rate flexibility could be a better way to increase monetary policy effectiveness and deal with uncertainty in global financial markets.
  • Sizeable cross-border movements of capital require broader and deeper financial markets to channel capital to its most productive use, accommodate higher exchange rate volatility, and support financial stability. In this regard, a domestic corporate bond market will provide an important alternative source of funds, while better-developed onshore derivatives markets will enable corporations to better manage the risks associated with India’s financial integration.
  • Further fiscal consolidation is important for sustaining growth as well as managing financial globalization. Despite impressive revenue performance, fiscal consolidation has stalled and public debt remains high, squeezing the fiscal space needed for public investment in physical and social infrastructure. Both expenditure and revenue measures are needed, including rationalizing subsidies, cutting tax exemptions, enhancing tax administration, and broadening the tax base. A tighter fiscal stance could also limit the inflationary impact of capital inflows.
  • Structural reforms can ease real sector rigidities, boost competitiveness, and ensure that the benefits of growth are widely shared. The government’s “inclusive growth” agenda has rightly identified as top priorities: bridging infrastructure gaps (through active private sector participation), ensuring access to social services, and promoting a competitive environment that supports private sector investment and job creation.

I. Economic and Political Context

1. India’s macroeconomic performance is impressive, the result of sound macroeconomic policies and steady reforms since 1991. Growth averaged about 8½ percent in the four years through 2006/07, and is set to record 8¾ percent this year, making India one of the world’s fastest-growing economies. The poverty rate fell from 36 percent in 1993/94 to under 28 percent in 2004/05. The productivity-driven growth boom and India’s increasing financial integration have attracted record capital inflows. With global portfolio weights on India rising, the inflows appear set to continue.

India: Global Financial Integration

(Gross foreign assets and liabilities in percent of GDP)

Source: Lane, Philip R. and Gian Maria Milesi-Ferretti (2005).

2. However, capital inflows are raising the tensions of the “impossible trinity.” Inflows have put upward pressure on the exchange rate. Concerns about competitiveness have arisen, and the authorities have intervened in the foreign exchange market. The expansion in domestic liquidity required monetary tightening, which in turn has maintained a wide interest-rate differential.

India: Capital Flows and International Reserves

(In billions of U.S. Dollars)

Sources: Reserve Bank of India; and Fund staff calculations.

3. Supply constraints are the critical challenge to sustained growth with stability. Rapid growth is worsening already serious shortages of infrastructure (especially electricity) and skilled labor. Pressures on skilled wages are widening income inequality, potentially eroding support for growth-oriented reforms (Box 1).1 Reforms are needed to spur job-intensive growth, further alleviate poverty, absorb the growing working-age population, and sustain the reduction in public debt, as well as to manage appreciation pressures by bolstering productivity.

4. The authorities have been successful at maintaining macroeconomic stability but critical structural reforms have lagged. Fiscal consolidation and monetary stability are cornerstones of macroeconomic policy. In recent years, the budget deficit has fallen, thanks to strong growth and the Fiscal Responsibility and Budget Management Act (FRBMA), and price stability has been maintained. To cope with capital inflows, the authorities have allowed greater flexibility in the rupee, enhanced prudential measures, tightened selected capital controls, and hiked reserve requirements. The 11th Plan envisions significant hikes in infrastructure and education spending, along with labor market reforms. However, coalition politics complicate reforms, with initiatives by the coalition-leader Congress Party resisted by its partners on the left.

Box 1.Inclusive Growth

Rapid growth has reduced poverty, but inequality has risen although it is still low by international standards. The share of the population living below the poverty line fell from 45 percent in 1983, to 36 percent in 1993/94, and then to 27½ percent in 2004/05.1/ However, inequality began to rise in the 1990s. Between 1993/94 and 2004/05, the gap between average monthly per capita consumption in rural and urban India widened. The increase in income and wealth inequality is potentially much larger, as the prices of major sources of wealth, held by a small segment of the population, have risen sharply.

The shift in consumption growth is particularly notable and suggests that growth has become less inclusive. From 1983 to 1993/94, growth in per capita consumption at the bottom of the income distribution outpaced growth at the top. During the 1990s, the shape of the growth incidence curve reversed, with much faster growth at the top—particularly in urban India, reflecting the pickup in manufacturing and services compared with agriculture. In the 1990s, despite faster growth, the bottom 50 percent of India’s population, experienced slower consumption growth than in the previous decade.

India: Consumption Inequality

Sources: NSSO, 38th, 50th and 61st rounds; and staff estimates.

Consumption Inequality Around the World

India: Growth Incidence Curve

Sources: NSSO, 38th, 50th, and 61st rounds; and staff estimates.

1/An alternative measure of consumption that uses different recall periods places India’s poverty rate at 21 percent in 2004/05, down from 26 percent in 1999/2000. Comparable estimates for earlier years are unavailable under this measure.

5. The 2007 Article IV consultation discussions focused on policies needed to manage financial globalization and tackle supply constraints to sustained growth Discussions centered on macroeconomic policies (monetary, exchange rate, fiscal), capital account policy, financial stability, and structural reform.

II. Economic Backdrop

6. Growth remains strong, led by investment and productivity (Figure 1). During July-September 2007, real GDP rose by 8.9 percent y/y. Capacity utilization and business confidence remain high. Total factor productivity growth has averaged about 3⅓ percent in recent years, within Asia exceeded only by China. High-frequency data point to a recent deceleration in consumption, but investment indicators remain strong, fed by robust corporate profits.

India: Real GDP Growth

(In percent)

Source: IMF, World Economic Outlook.

1/ Includes Hong Kong SAR, Indonesia, Korea, Malaysia, the Philippines, Singapore, Taiwan Province of China and Thailand.

Figure 1.India: Growth

Sources: Data provided by the Indian authorities; CEIC Data Company Ltd; NCAER; and Fund staff projections.

7. Headline WPI inflation has ebbed from about 6¾ percent y/y earlier this year to about 3½ percent y/y partly due to decelerating food and manufacturing prices and appropriate monetary tightening. Core inflation (excluding food and energy) has eased to about 4¾ percent y/y. CPI inflation exceeds WPI inflation by over 2 percentage points, reflecting the CPI’s higher weight on food.

8. Capital inflows are swelling (Figure 2). Capital inflows reached a record $45 billion in 2006/07, and (as in other emerging markets) accelerated this fiscal year (Box 2). Portfolio inflows from foreign institutional investors (FIIs) rose appreciably but accounted for less than a quarter of inflows. Capital inflows more than finance the current account deficit (projected at about 1½ percent of GDP in 2007/08, versus a capital account surplus of 9½ percent of GDP). Export growth remains robust at over 20 percent y/y in U.S. dollar value, but buoyant imports (led by raw materials and capital goods) have pushed up the trade deficit.

Figure 2.India: External Sector

Sources: Data provided by the Indian authorities; CEIC Data Company Ltd; and IMF, WEO.

1/ Customs data; based on U.S. dollar values, up to September 2007.

Box 2.Comparing BRICs: Exchange Rate, Capital Flows, and Macroeconomic Policy

Rising capital inflows have put upward pressure on currencies in Brazil, Russia, India and China (the BRICs). This box discusses the experience in the BRICs, including how policies have adapted.

Since the start of 2007, the BRICs (Brazil, Russia, India, and China) have experienced significant REER appreciation. Most of the real appreciation in 2007 for India and Brazil came from nominal appreciation, whereas China and Russia had inflation-led appreciation. In China and India, the appreciation is a recent phenomenon, while in Brazil and Russia, the exchange rate appreciation in 2007 comes on top of sharp rises in 2005–06.

BRICs: Exchange Rate Appreciation
Average y/y Change
Dec. 2006–Aug. 20072005–2006
LC/USDREERNEERREERNEER
(In percent change)
India-8.67.17.51.4-0.7
Brazil-8.59.08.317.514.9
China-3.25.32.20.91.4
Russia-2.54.90.39.11.7
Source: INS
Source: INS

India is not unique with respect to the size of inflows over the past two years, but stands out as the only one in the group with a current account deficit. All BRICs have had rising balance of payment inflows. For India Brazil and (in 2007) Russia, it has been mostly from capital inflows, and for China, mostly from the current account surplus (Table). High commodity prices supported inflows through the trade balance in Russia and Brazil. Brazil experienced the largest increase in portfolio inflows in percent of GDP, followed by India. Net portfolio inflows were smaller in both China and Russia, partly reflecting outward investment. The Indian corporate sector and Russian banks and corporations increased overseas borrowing. In the second half of 2007, the pace of capital inflows appears to have picked up more in India than the in other countries, as suggested by the more rapid reserve accumulation (chart).

BRICs: Intervention and International Reserve Accumulation, 2007

(Billions of US Dollars)

The BRICs’ policy responses put different emphases on inflation, exchange rates, and the capital account.

  • Intervention: Regardless of their exchange rate regimes, all of the BRICs intervened heavily in foreign exchange markets: Brazil is an independent floater, India and Russia are managed floaters with no predetermined path, and China maintains a crawling peg.
  • Sterilization: Both India and China partially sterilize their foreign exchange intervention, but India does so at a higher rate than China. In Brazil, intervention is fully sterilized consistent with its inflation target. In Russia, sterilization is limited to the oil-fund related inflows.
  • Monetary policy: India and Brazil put greater emphasis on containing inflation, as indicated by larger contributions of NEER changes to real appreciation. Russia’s monetary policy is accommodative with base money growth accelerating to about 40 percent. China has attempted to absorb liquidity mainly through increases in reserve requirements and administrative measures to curb credit growth.
  • Capital account: India has liberalized outflows, and selectively restricted inflows. In recent years (mostly through mid-2006), Brazil increased outflows by expediting external debt repayments, and then liberalized some outflows. China restricts capital inflows other than FDI, but has also liberalized outflows.
  • Supporting the export sector: Brazil and India provided some incentives to selected sectors, including through import tariff exemptions and subsidized credit (India).
  • Fiscal policy: In India, staff expect higher revenues to be fully spent, while Brazil and China are taking advantage of revenue over-performance to achieve better-than-budgeted fiscal balances. In Russia, the government has spent more of its oil-revenues since 2005, with a decline in the non-oil fiscal balance.
BRICs: Balance of Payments
IndiaBrazilChinaRussia
20062007 1H20062007 1H20062007 1H20062007 1H
(In billions of USD)
Current-9.4-2.113.64.6341.4162.996.139.0
Capital and financial37.832.416.060.049.090.23.961.2
FDI, net7.82.5-9.424.391.250.97.41.9
FDI, in17.510.218.820.9115.458.330.527.9
FDI out-9.7-7.7-28.23.5-24.2-7.4-23.2-26.0
Portfolio, net9.59.39.624.0-96.8-4.815.45.4
Other, net 1/20.420.615.811.654.544.1-18.853.9
Overall29.431.730.661.6369.1266.1107.598.5
(In percent of GDP)
Current-1.2-0.51.30.813.011.89.77.2
Capital and financial4.76.91.510.01.96.50.411.2
FDI, net1.00.5-0.94.03.53.70.70.3
FDI, in2.22.21.83.54.44.23.15.1
FDI out-1.2-1.6-2.60.6-0.9-0.5-2.3-4.8
Portfolio, net1.22.00.94.0-3.7-0.31.61.0
Other, net 1/2.64.41.51.92.13.2-1.99.9
Overall3.76.72.910.214.019.210.918.1
Sources: IFS, CEIC, EMED, and staff calculation.

Calculated as residual in capital and financial account.

Sources: IFS, CEIC, EMED, and staff calculation.

Calculated as residual in capital and financial account.

9. Capital inflows have lifted financial markets. Overseas investors bought a net $18.8 billion of stocks and bonds during January-November 2007, compared to the previous record of $9.5 billion in the same period in 2006. Equity markets recovered quickly from the subprime crisis. Long-term interest rates range around 8 percent. Real estate markets have been buoyant, although cooling recently.

10. Strong capital inflows have put upward pressure on the rupee (Figure 2). After remaining roughly stable since 2000, the rupee appreciated by 7 percent in real effective terms and by 7½ percent in nominal effective terms between December 2006 and August 2007, with most of this appreciation occurring between March and May 2007. This REER appreciation was exceeded only by the Canadian dollar (8½ percent) and Brazilian real (9 percent). The RBI accrued $65 billion in reserves (purchasing foreign currency) between end-May and end-November, when intervention picked up amid growing concerns about competitiveness after the sharp rise in the rupee. Rupee flexibility is roughly comparable to that of other large emerging-markets currencies and the yen (see Figure 3).

India: Effective Exchange Rates (2000=100)

Source: Fund staff estimates.

Figure 3.India: Exchange Rate Highlights

Sources: Data provided by the Indian authorities; CEIC Data Company Ltd; Bloomberg LP; and Fund staff estimates.

1/ The index is calculated by dividing the standard deviation of exchange rate movements by an index of exchange market pressure (the sum of exchange rate volatility and volatility in reserves, normalized by lagged base money). It takes values from zero to one. A lower value signifies relative inflexibility, with zero indicating a peg or a high commitment to inflation targeting.

2/ Positive number implies markets assigning a greater probability (or premium) to INR depreciating than to appreciating against U.S. dollar.

11. In addition to the exchange rate appreciation, several steps were taken since October 2006 to tighten monetary conditions. The cash reserve ratio has risen 200 bps, while the repo (lending) rate was hiked twice by 25 bps (the last time in April). With WPI inflation ebbing and real estate prices and credit growth slowing, the RBI left policy rates on hold at its October 2007 policy meeting, but raised the cash reserve ratio (CRR) by 50 basis points to 7.5 percent.

12. Fiscal consolidation slowed in 2006/07. Including off-budget bond issuance, the general government deficit held steady at about 7¼ percent of GDP.2 The central government deficit remained at 4½ percent of GDP, with buoyant tax revenue offset by higher expenditure. The states’ aggregate fiscal deficit rose marginally to 2¾ percent of GDP. Revenues performed well, though expenditure rose faster on the back of rising public investment. Public debt remains high, at roughly 80 percent of GDP in March 2007.

India: General Government Fiscal Deficit 1/

(In percent of GDP)

Sources: Ministry of Finance, India; and Fund staff estimates.

1/ Includes off-budget bond issuances.

13. Banks are profitable and liquid (Table 8). At end-March 2007, the aggregate capital adequacy ratio (CAR) stood at 12.4 percent, remaining stable above the regulatory rate of 9.0 percent (Box 3). Amid strong credit growth, the ratio of scheduled commercial banks’ gross non-performing loans (NPLs) to advances has fallen to 2.7 percent from 10.4 percent at March 2002, even as prudential norms have been tightened, in part because rising real estate prices have facilitated repayment of problem loans. However, NPL provisioning averaged 56 percent over the last year-well below the 150 percent and higher in comparable emerging market countries. At the same time, there are concerns about the sharp past rise in real-estate prices and sub-standard loans. In addition, delinquencies on unsecured retail loans (which account for about 10 percent of all loans, and which require 100 percent provisioning) are rising for some banks.

Banking Sector Performance and Soundness (2006-2007)(In percent)
Return on AssetsGross NPL 1/Provisioning 2/
India0.92.556.1
Emerging Markets
Brazil2.14.0153.0
Korea1.10.8177.7
South Africa1.41.164.3
Mature Markets
Australia1.60.2204.5
Japan0.42.530.3
U.S.1.20.8129.9
Sources: IMF, Global Financial Stability Report (2007); and Fund staff estimates, RBI, Report on Trends and Progress of Banking in India (2007).

Ratio of gross non-performing loans to gross advances.

Provisions to non-performing loans ratio (NPL).

Sources: IMF, Global Financial Stability Report (2007); and Fund staff estimates, RBI, Report on Trends and Progress of Banking in India (2007).

Ratio of gross non-performing loans to gross advances.

Provisions to non-performing loans ratio (NPL).

III. Outlook and Risks

14. Staff expects growth to moderate toward potential in the near term. Weaker external demand will moderate exports. Consumption growth may slow due to the past rise in real interest rates, but investment should remain brisk—supported by robust business confidence, high capacity utilization in the capital goods sector, and buoyant corporate profits. A favorable monsoon should deliver above-average agricultural growth. GDP growth would moderate to 8¾ percent in FY2007/08 and further to 8¼ percent in FY2008/09, with inflationary pressures contained. The current account deficit should register around 2 percent of GDP, as growing services and remittances offset a widening trade deficit.

15. Near-term risks are on both sides:

  • Risks to growth are broadly balanced. A sharper-than-expected slowdown in developed economies could dampen exports, although increasing export diversification to fast-growing Asian and Gulf economies limits this risk. Moreover, investment could surprise on the upside, given strong corporate profits and domestic savings.
  • Inflation risks are to the upside. Domestic liquidity remains ample (owing in part to intervention), capacity remains constrained, skilled wages are rising sharply, and continued rapid growth could increasingly expose the infrastructure deficit. Also, soaring international food and fuel prices could stoke domestic price pressures.3
  • On financial risks, reflecting the past boom in retail credit, some increase in NPLs may be in prospect. However, banks’ sizeable capital buffers indicate that the credit cycle is likely to be manageable, and risk measures have improved (Box 3)4. Corporate leverage is rising but remains low.
  • Fiscal consolidation is subject to downside risks. Soaring global commodity prices will boost food, fuel, and fertilizer subsidies, while public compensation may rise significantly during FY 2008/09. In addition, tax collections may slow as growth eases.
  • The external position is sustainable and robust to significant shocks (Figure 4 and Table 9). Capital inflows could moderate as global liquidity eases, especially if risk aversion increases or if the growth outlook disappoints. However, given India’s vibrant baseline outlook and sizeable capital demands, inflows will likely remain strong, consistent with the experience in other Asian countries around growth takeoffs. Any volatility in flows is unlikely to generate external instability: external debt is low; external commercial borrowings (ECBs) are subject to restrictions on end-use, maturity, and amount; and the projected medium-term current account is consistent with debt sustainability. Reserves are ample, exceeding total external debt.

Capital Flows in Select Asian Countries 1/

(Net flows in U.S. dollars in percent of GDP)

Sources: IMF, World Economic Outlook; and Fund staff calculations.

1/ Countries or country-groups are assumed to have taken off in period “t”.

2/ Average of Indonesia, Malaysia, Philippines and Thailand.

Figure 4.India: External Debt Sustainability: Bound Tests 1/

(External debt, in percent of GDP)

Sources: IMF, country desk data and staff estimates.

1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.

2/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.

3/ One-time real depreciation of 30 percent occurs in 2007/08.

Figure 5.India: Asset Market

Sources: Data provided by the Indian authorities; and Bloomberg LP.

1/ Average spread of Indonesia, Korea, Malaysia, Philippines and Thailand.

2/ Non deliverable forwards.

3/ Semi-annually fixed rate versus 3 month U.S. Dollar LIBIOR.

Figure 6.India: Money and Inflation

Sources: Data provided by the Indian authorities; CEIC Data Company Ltd; and Fund staff projections.

1/ Deflated by the WPI.

2/ Average of daily weighted call money borrowing rates.

Figure 7.India: Fiscal Trends

Sources: Data provided by the Indian authorities; and Fund staff projections.

1/ Includes off-budget bond issuance.

2/ Excludes off-budget subsidy related bonds.

3/ Augmented definition includes off-budget subsidy related bond issuance. For 2007/08, excludes a non-recurrent dividend from the Reserve Bank of India amounting to 0.7 percent of GDP.

Box 3.Sensitivity Analysis of Banking System Credit Risk

Sensitivity analysis of the ten largest banks reveals modest credit risk exposure at current capital levels. The impact of higher default rates on capital adequacy ratios (CAR) is estimated by assuming that impaired loans are fully provisioned, and reducing risk-weighted assets and capital at a rate equivalent to the increase of the NPL ratio. The effects of various increases in NPLs are assessed.

A sizeable increase in NPLs would be needed to reduce the weakest bank’s capital adequacy below the regulatory threshold (figure below). The capitalization of the lowest quartile of banks drops below the regulatory CAR threshold of nine percent (the solid black line) if impaired loans rise to more than twice the current gross NPL ratio. Thus the least capitalized bank, representing eight percent of total loans, can withstand more than a doubling of current NPLs before breaching statutory capital requirements. Similarly, the average and median capitalization of the banking system remains well above the existing CAR even if NPLs double in magnitude. However, once Basel II takes effect, the regulatory threshold for capital would rise to 10 percent, and a 75 percent increase in NPLs would push the weakest bank below that threshold.

India: CAR Adjusted for an Increase in Impaired Loans, 10 Largest Commercial Banks (end-June 2007)

Source: Bank Scope, Bloomberg, Moody’s KMV, unconsolidated financial statements as of June 30, 2007.

1/ with a 100 percent provisioning for impaired loans.

2/ with a 20 percent provisioning for impaired loans. Note: 20 percent provisioning is required for uncollateralized loans classified as substandard.

Market data indicate that bank risk has declined and the largest banks have a low implied probability of default. That said, the range has increased in recent months, and India’s bank risk is at the higher end of the range for Asian markets.

Sources: Data provided by Indian authorities, Moody’s KMV Credit Edge Plus; and Fund staff estimates.

1/ Estimates show the implied risk-neutral default probability based on the adapted Black-Scholes-Merton (BSM) framework.

2/ Estimates show the implied risk-neutral default probability (by quartile) based on the adapted Black-Scholes-Merton (BSM) framework.

3/ The chart shows the cumulative, one-year implied probability of default (PD) of all 70 publicly listed banks. Banks are ordered by market share. For example, 98 percent of all banks (total bank assets) have a probability of less than five percent to default within the next year.

16. Medium-term prospects are for sustained growth, contained inflation, and continued economic and financial stability. GDP growth would moderate to 8 percent, staff’s estimated potential growth.5 Inflation should range around 4 percent. The current account deficit would remain around 2 percent of GDP, comfortably financed by private capital inflows, and at a level consistent with a broadly unchanged net external debt position. Strong growth would help reduce the general government deficit to about 4½percent of GDP.

India: Summary of Medium-term Projection(In percent of GDP unless otherwise indicated)
2004/052005/062006/072007/082008/092009/102010/112010/1122012/13
Real GDP growth at factor costs (% change)7.59.09.48.78.38.28.28.18.0
Agriculture (% change)0.06.02.73.32.62.62.72.72.7
Industry (% change)9.89.610.99.48.98.88.88.88.8
Services (% change)9.69.811.010.29.89.59.49.19.0
WPI (% change)6.54.45.53.63.63.93.93.93.9
CPI (% change)3.84.46.75.94.33.93.93.93.9
(In percent of GDP)
Central government balance - authorities 1/-4.0-4.1-3.5-3.3-3.0-3.0-3.0-3.0-3.0
Central government balance - augmented 2/-4.2-4.4-4.4-4.5-3.9-3.3-3.2-3.2-3.1
General government balance-augmented 2/-7.3-7.1-7.2-6.8-6.4-5.8-5.4-5.0-4.6
General government debt85.782.979.075.272.469.566.864.161.4
Current account balance-0.4-1.1-1.1-1.5-1.9-1.9-1.9-1.9-1.8
Trade balance-4.8-6.4-7.1-7.4-8.3-8.4-8.5-8.6-8.6
Capital account balance4.13.05.19.55.44.84.44.23.9
FDI (net)0.50.60.92.01.71.71.61.61.6
Portfolio flows (net)1.31.60.82.61.81.31.01.00.8
ECB (net)0.70.31.81.40.70.70.80.80.7
Memodandum items
External debt stock (In billions of USD)124128156210237267299333369
External debt stock (In percent of GDP)17.815.817.117.918.318.518.718.919.0
Source: Fund staff estimates.

Divestment is treated as financing from 2006/07 onwards; excludes off-budget bond issuance.

Divestment is treated as financing; includes off-budget bond issuance.

Source: Fund staff estimates.

Divestment is treated as financing from 2006/07 onwards; excludes off-budget bond issuance.

Divestment is treated as financing; includes off-budget bond issuance.

IV. Policy Discussions

17. Discussions focused on how the policy framework should evolve to maintain India’s impressive macroeconomic performance and stability in the face of sustained inflows:

  • Monetary and exchange rate policy calibrated to increasing financial openness;
  • Deepening and broadening capital markets—while maintaining financial stability—to intermediate capital inflows smoothly and finance infrastructure;
  • Fiscal consolidation to facilitate inclusive growth and cope with appreciation pressures; and
  • Structural reforms to enhance economic flexibility and productivity.

18. The mission outlined the preferred approach to dealing with capital inflows in the current favorable growth conjecture. This included a package of measures comprising consistent monetary policy actions to address the impossible trinity, more ambitious fiscal consolidation, continued liberalization of outflows, financial sector reforms to prepare for a more open capital account, and structural reforms to increase the absorptive capacity of the economy (each described in detail in the sections below). The authorities generally agreed on the broad objectives of policies. However, given uncertainties in the global economic and financial environment and the constraints on reforms imposed by coalition politics, staff’s view is that the current eclectic approach was likely to continue.

A. Calibrating Monetary and Exchange Rate Policy to Financial Globalization

Background and Staff Views

19. With the balance of inflation risks tilted to the upside, vigilance is warranted. WPI inflation—the RBI’s preferred measure—is set to remain below the RBI’s end-year forecast of 5 percent this fiscal year. The mission agreed that it was appropriate to leave policy rates unchanged for now, in view of conflicting signals about prices (from the CPI) and demand growth. If money and economic activity did not slow as expected, the mission saw a case for further rate hikes to moderate credit expansion and anchor inflation expectations.

India: Policy Rates Corridor

(In percent)

Source: CEIC Data Company Ltd.

20. The mission assessed the rupee as in line with fundamentals (Box 4). So far, the rupee’s rise has not broadly hampered competitiveness, with the level of the rupee appropriate from a medium-term perspective, and exports and profits remaining strong. While selected industries are affected, the appropriate response could be targeted, time-bound support—e.g., offering affected workers training and temporary financial assistance—to facilitate adjustment. In addition, enhanced labor market flexibility, improvements in power and transport infrastructure, and removal of small scale reservations would reduce business costs and increase economic flexibility. Benefits of appreciation (e.g., lower inflation and cheaper imports) also need to be better communicated.

21. Large capital inflows are complicating the conduct of monetary policy, creating excess liquidity and pressuring the rupee. Partially sterilized intervention to smooth volatility has maintained a wide interest differential, which in turn has aggravated inflows, thereby placing further pressure on the exchange rate. More generally, inflows are exacerbating tensions in the policy framework among exchange rate stability, monetary independence, and financial openness—the “impossible trinity.”

India: Exchange Rate and Central Bank Intervention

Sources: Reserve Bank of India, Bloomberg LP; and Fund staff calculations.

22. Further rupee flexibility would be the most effective way to address the “trinity.” The stated policy of a managed but market determined exchange rate with no target path, and intervention only to curb short-term volatility remains appropriate. Within this framework and in light of the large net inflows faced by India and other large emerging markets, the mission noted that avoiding large and prolonged foreign currency purchases would reduce the need for costly sterilization and limit the potential buildup of speculative inflows.6 Moreover, a more flexible rupee, along with better-developed derivatives markets, would encourage private entities to hedge.7

Box 4.Competitiveness

The recent rupee appreciation has fueled concerns about competitiveness. During January-November 2007, the rupee rose over 11 percent against the U.S. dollar. On a REER basis, the rupee is now outside of the ±5 percent range observed since the early 1990s. Sharp appreciation has led to strong calls to support the export sector.

Real Effective Exchange Rate and Exports

(2000 = 100, in percent changes of 4 quarter sum)

At the same time, the September 2007 CGER exercise puts the rupee “close to equilibrium.”1/ India’s cyclically adjusted medium-term current account deficit is close to its fundamental level (3 percent of GDP), as downward pressure on the deficit from favorable demographic trends are broadly offset by fiscal deficits and strong growth. Strong growth also supports a sustainable net foreign liabilities position, allowing India to comfortably run current account deficits.

Total Factor Productivity: China, India, Japan, and the United States

(1992=100)

Source: WEO (April 2007).

Equilibrium rupee appreciation is also supported by rapid productivity growth. India’s total factor productivity (TFP) growth averaged about 3¼ percent in recent years, compared with peak decade averages of 2⅓ percent for Japan or newly industrialized countries in the past four decades.2/ Consistent with buoyant productivity, India’s share in world exports of goods and services has risen about ½ percentage point since 2000.

However, some industries are clearly making losses and have led the public call for action by the authorities to stem exchange rate appreciation or to offer some form of protection. The recent upward movement in the exchange rate highlights an interesting pattern in export growth. In general, industries experiencing the lowest export growth are those with low import content, and high labor intensity (and thus covered by the rigid labor laws or by small scale industry reservations). These industries have had significant protection over the years and have faced little incentive to become efficient and to raise productivity. In contrast, services exports and more capital intensive manufacturing exports have been expanding more briskly, and gaining market share globally. The key is to pursue labor market reforms and upgrade infrastructure to bolster productivity and lower costs for labor intensive sectors so that they too can adjust to the stronger currency.

India: Export Growth, by Major Commodity

(Annual average growth in percent, in USD terms, 2000/01–2006/07)
1/Using data from August 22 to September 19.2/World Economic Outlook, September 2006, “Asia Rising.”

23. The mission welcomed steps taken to liberalize capital outflows in 2006 and 2007 (Box 2 discusses international experiences with capital flows). Continuing to liberalize outflows—including by large domestic institutional investors—would signal the commitment to fuller capital account convertibility. While local investors may not initially take full advantage of broader opportunities to invest overseas, over time outflows will rise as part of portfolio diversification, reducing net inflows.

24. However, using capital controls for macroeconomic management could affect investment and growth adversely. These risks were demonstrated by the recent experience with tightening restrictions on external commercial borrowings, which have not curbed overall flows, but have raised concerns about investment financing. Such restrictions are likely to be effective only temporarily. Moreover, further restrictions on capital inflows could foster uncertainty about the government’s commitment to fuller capital account convertibility and about the authorities’ “exit strategy.”

25. The temporary space provided by existing controls should be used to prepare for a more open capital account. In particular, the flexibility and effectiveness of monetary policy would be enhanced by strengthening the monetary framework.8

  • On monetary operations, the mission welcomed the heightened use of market sterilization instruments in 2007 and urged further reliance on open market operations (OMOs), with a broad range of maturities, rather than the CRR—which taxes banks.
  • On communications, the mission welcomed improvements—such as the 2005 shift from annual to quarterly reviews and the increasingly forward-looking analysis in policy documents. Further increasing the frequency of policy meetings would reduce the need for inter-meeting measures. Monetary policy reviews could elaborate further on the inflation and demand-supply outlook, including through eventual publication of the inflation expectations survey, to guide expectations.9 In addition, focusing policy on a broad-based CPI would orient policy around a clearer measure of the cost of living.

Authorities’ Plans and Views

26. The authorities saw the current conjuncture and outlook as favorable. While demand pressures remained strong, the supply response had helped allay concerns about overheating and credit growth to sectors such as real estate had moderated, owing to the prudential measures taken in 2006/07. However, they remain vigilant, given abundant liquidity and high international oil and wheat prices. They also reiterated their preference for a multiple-indicators approach to formulating monetary policy, in light of ongoing structural change in the economy and the RBI’s mandate for financial stability as well as price stability. On inflation measures, officials noted that given India’s economic diversity, it is not possible to construct a meaningful single CPI. The survey of inflation expectations is in the pilot-testing stage, with no timetable for its release.

27. The stance of monetary policy remains unchanged and focused on domestic concerns. The RBI reiterated its policy of withdrawing monetary accommodation through active liquidity management. They noted that their approach of using varied instruments to sterilize was aimed at distributing costs among the RBI, the banking system (through the CRR) and the budget (interest on the stabilization bonds). The authorities agreed that, with inflation signals mixed, cutting policy rates would be premature.

28. On the approach to exchange rate management, the RBI reiterated that intervention aims at smoothing volatility. The focus was not on the real effective exchange rate, but on maintaining orderly conditions in the bilateral U.S. dollar/rupee market, particularly in response to externally-induced volatility. Over the past year, intervention had been one-way (purchases of foreign exchange) because there had been no net capital outflows since May 2006. With risks to capital flows on both the upside and downside, the rupee could weaken as well as strengthen; in this connection, they stressed that the rupee had been on a weakening trend as recently as 2006. For the medium term, the authorities agreed that higher exchange rate flexibility could help India adjust to increasingly globalized financial markets.

29. The authorities did not dispute the staff’s assessment that the exchange rate appears to be in line with its medium-term equilibrium value but noted that it is too early to assess the effects of the recent appreciation. Notwithstanding the small current account deficit, the authorities see the sizable trade deficit as a potential sign of loss of competitiveness due to exchange rate appreciation. At the same time, when providing assistance to the sectors worst affected by appreciation, the authorities have publicly stressed the need for Indian companies to adapt to a stronger rupee, by strengthening productivity.

30. The authorities stressed that formulating a response to rapid capital inflows was difficult given the present global environment. The authorities saw the current monetary framework and communications as adequate to maintain price and financial stability. They noted that costs of sterilized intervention had to be weighed against the benefits of financial stability and smoothing exchange rate volatility given limited real-sector flexibility. On communications, the RBI viewed its approach as well understood in markets, and noted its efforts to increase transparency. The authorities also considered the current frequency of policy meetings, with the Committee of the Central Board meeting weekly, alongside its quarterly reviews, to be adequate. On capital flows, the RBI considered that excessive inflows had resulted from the “unusual heightened global uncertainties” surrounding the disruption in global credit markets, and in particular, the policy response by major-country central banks to the credit turbulence. They saw the surge in FII inflows since September in the aftermath of the sub-prime crisis as temporary, with India (among other countries) becoming a haven for capital flows. These massive capital inflows—far in excess of the economy’s absorptive capacity—were complicating monetary management. Continued inflows could create financial sector vulnerabilities, and restrictions on selected capital inflows had helped to preserve a favorable macroeconomic environment. They did not consider liberalizing outflows as an adequate solution as such steps would only attract more inflows while not resulting in significant balancing outflows. In light of these risks, they stated that all possible options for maintaining stability would be considered, including non-monetary measures such as active capital account management (capital controls).

31. In the medium term, the government’s intent remains to move toward fuller capital account convertibility. The approach would remain gradual, with a hierarchy of preferences according to stability of flows (with FDI and equity first), and, as noted above, some role for existing controls to preserve financial stability. At the same time, the government shared staff’s doubts about the long-term effectiveness of controls and concerns about the impact of ECB restrictions on investment. On outflows, they noted that ceilings on overseas investments of corporates, mutual funds, and individuals had been increased, but so far these measures had not resulted in significant outflows.

B. Strengthening the Financial System

Background and Staff Views

32. India’s financial globalization necessitates development of broader and deeper financial markets, as well as increased efficiency and continued stability in the financial system. Better developed financial markets would help to intermediate capital inflows, expand risk management toolkits, and finance India’s large investment needs. In the financial system, continued deregulation, with appropriate strengthening of prudential rules, can improve the efficiency of intermediation while preserving stability.10

Financial markets

33. The priorities are developing India’s government debt, corporate bond, and derivatives markets. A more liquid government debt market would provide a better foundation for pricing financial instruments (and would strengthen the monetary transmission mechanism). A robust, rupee-denominated corporate debt market would allow corporations to avoid currency mismatches while providing a venue for infrastructure finance (the banking system lacks the balance-sheet capacity to provide it). Well-developed derivatives markets would provide financial institutions and corporations with tools needed to manage risks accompanying financial globalization.

34. The government yield curve is illiquid, undercutting its role as a pricing benchmark. The turnover ratio of government debt is about 70 percent—lower than in Indonesia and Vietnam, and about half that in countries such as Thailand and Malaysia. Only four issues are traded more than four times a week. Reasons include (i) a narrow investor base; (ii) stringent short selling rules (positions may remain open for no more than five days; failure to deliver faces harsh penalties, including banning from trading); and (iii) the Statutory Liquidity Ratio (SLR) requires banks to maintain in cash, gold, or government and other approved securities at least 25 percent of demand and time deposits.11

35. The corporate debt market is underdeveloped, amounting to less than 5 percent of GDP, compared with over 20 percent of GDP in Thailand, Chile and Mexico, and 50-100 percent of GDP in more advanced economies. Impediments to a vibrant market include quantitative limits on institutional investors such as pension funds and FIIs;12 restrictive issuance procedures (including a requirement for two investment-grade ratings); tax deduction at source and stamp duties; the lack of a repo market; and low price transparency (with most trading OTC).

Government Bond Turnover Ratio 1/

Sources: Country authorities and Bond Market Assocations, Bank for International Settlements, World Federation of Exchanges, Asian Bonds Online, Bloomberg LP.; and Fund staff estimates.

1/ Based on a scaled measure of trading volume (sales in local currency units) divided by year-end local currency value of outstanding bonds.

Corporate Bond Turnover Ratio 1/

Sources: Country authorities and Bond Market Associations, Bank for International Settlements, World Federation of Exchanges, AsianBondsOnline, Bloomberg LP.; and Fund staff estimates.

1/ Based on annual trading volume (sales amount in local currency) divided by year-end local currency value of outstanding bonds.

36. Augmented exchange-traded interest-rate and foreign-exchange derivatives would complement growing OTC markets.13 While OTC markets turnover has risen threefold during 2004–2007 to over $8 billion per day, OTC markets lack the centralized risk management and inherent transparency of exchanges. In addition, legal uncertainty exists about settlement in OTC markets, particularly closeout netting (which limits the risk that a defaulting counterparty will demand payment on contracts that are in his favor while refusing to pay those on which he owes money). However, attempts to introduce exchange-traded interest-rate contracts had limited success, partly due to imperfect contract design and restricted participation, while currency futures are presently disallowed.

Financial efficiency and stability

37. The main risks to financial stability—rapid growth in credit and strong capital inflows—appear to be manageable at present, but warrant close monitoring. Financial soundness indicators are in prudent ranges, and overall credit growth is decelerating. However, growth in credit to real estate remains elevated, at almost 70 percent y/y, and is concentrated in new private sector banks (accounting for more than 30 percent of their loan books). Also, the rapidly growing retail segment is relatively new to Indian banks. In addition, Indian corporates’ foreign currency borrowing has risen, and data on the extent of hedging are unavailable but anecdotes suggest that it is far from complete. In this environment, close supervisory attention would be needed to banks’ careful management of retail credit portfolios, and to their exposure to corporates that have unhedged foreign exchange exposures.14 Going forward, stress tests of banks’ exposures, and strengthened supervision under Basel II, will help to maintain the stability of the banking system.

38. There is also scope to improve the efficiency of the banking system. Public ownership accounts for about 70 percent of scheduled commercial bank assets. The banking system is fragmented, including 82 commercial banks. Return on assets of domestic banks is low compared with other emerging and developed markets. Impediments to greater efficiency include credit targets to “priority sectors” (including agriculture, small scale industries, self employed); these loans tend to be small (thus costly to administer), with higher default rates than other loans.15 Rates on savings deposits and small loans, short-term agricultural loans, and export credits are regulated. In addition, the CRR taxes banks. Foreign ownership, which could boost competition and introduce new products and technologies, is subject to limits (to be reviewed in 2009).

Authorities’ Plans and Views

Financial market development

39. The authorities agree on the need for a more liquid government securities yield curve. They have been gradually consolidating benchmark issues to reduce fragmentation, through swaps and buybacks, and by concentrating issues on benchmark maturities. In addition, the Government Securities Act of 2006, which came into force on December 1, 2007, allows inter alia stripping and reconstitution of government securities.

40. Steps are underway to develop corporate bond markets. The fixed-income industry group (FIMMDA) has developed a trade-reporting platform to improve price transparency. In addition, the RBI would introduce corporate bond repos once an efficient and safe settlement system based on delivery versus payment and electronic straight-through processing is implemented. Meanwhile, the Securities and Exchange Board of India has introduced smaller lot sizes for trading, and in December 2007 reduced the number of required ratings to one and allowed sub-investment grade debt.16

41. The RBI has clarified the regulatory environment for derivatives. Comprehensive guidelines on derivatives (April 2007) stipulated eligibility criteria for participation as either market-maker or end-user, broad principles (including sound risk management), permissible instruments, documentation, and prudential limits. Draft guidelines on credit default swaps (May 2007) specified permitted structures, eligible counterparties, prudential norms, and risk management, accounting, and reporting requirements.

42. Work is underway to expand derivatives markets. On currency derivatives, the RBI’s October 2007 mid-term policy review proposed to permit authorized dealers to run options books and allow corporates to buy and write covered options. A November 2007 report of the RBI’s Internal Working Group on Currency Futures recommended creation of a dedicated exchange, with participation initially limited to residents. Meanwhile, a sub-group of the RBI Technical Advisory Committee on Markets is considering how to reactivate the interest rate futures market, and whether to expand foreign participation.

Financial efficiency and stability

43. The RBI made the following points in response to staff comments. They noted that bank efficiency had improved over time, including for the public banks, while NPLs have fallen over time. Going forward, however, banks would need to raise capital, particularly to meet the enhanced demands of Basel II (for foreign banks and Indian banks with foreign activities from March 2008), which would require an increase in capital equivalent to about one percent of risk-weighted assets. Foreign ownership of banks would be reviewed in 2009 as earlier planned; one option being considered could be to grant subsidiaries of foreign banks the same treatment as Indian banks. The RBI’s roadmap for foreign bank participation is consistent with India’s WTO commitments, and it has proposed that foreign participation go beyond the existing WTO commitment of 12 branches per year. Regulations on priority-sector lending were defined broadly, and formulated to promote financial inclusion.

44. The RBI is carefully monitoring bank risk exposures. Including in the context of its Supervisory Review Process, in which banks with substantial exposures to sensitive sectors are subject to special scrutiny, it frequently inspects banks’ credit and market risk books, cognizant that banks have not experienced a full retail credit cycle. It has found no basis for concern, with rising income levels supporting retail credit quality; in the real estate sector, rapid growth has partly reflected the low initial base. In addition, banks have been advised to monitor the unhedged currency exposures of their corporate clients, and the RBI is working to put in place a supervisory process for globally-active bank-led conglomerates. More generally, the pending move to Basel II will provide an opportunity to further strengthen risks management and the supervisory review process. The RBI has also worked with banks to strengthen stress testing, including credit risk in derivatives books, and closely watches banks’ derivatives exposures.

45. A Committee on Financial Sector Assessment is undertaking a self-assessment of financial stability and development. Four advisory panels are addressing financial stability and stress testing; financial regulation and supervision; institutions and market structure; and transparency standards, and will issue separate reports. The first group will conduct macro-prudential surveillance, including system-wide stress tests, and make recommendations for strengthening the financial system. The other groups will undertake assessments of relevant standards and codes and suggest measures to bridge identified gaps. The Committee is expected to complete its work by March 2008.

C. Achieving Debt Reduction While Financing Priorities

Background and Staff Views

46. Progress in consolidation has been mixed, with significant revenue gains eroded by expenditure overruns. Tax performance has been underpinned by rapid economic growth, high corporate profits, base broadening, and improved administration. States’ VATs (now in all states but Uttar Pradesh) have bolstered revenues, supplemented by higher central government transfers. But revenue gains have been offset by sharp increases in subsidies and higher-than-budgeted interest payments, reflecting soaring commodity prices and rising sterilization costs respectively. Overall fiscal consolidation has therefore stalled; on staff’s definition (including off-budget bond issuance), the general government deficit has hovered at just over 7 percent of GDP since 2004/05.

India: Recent Budgetary Performance(In percent of GDP)
2006/072007/08
Official budget 1/
Authorities-3.5-3.3
Staff-3.5-3.3
Augmented budget 2/-4.4-4.5
o/w: Off-budget subsidies-1.0-1.2
States-2.7-2.4
General government (augmented) 2/-7.2-6.8
Sources: Data provided by the Indian authorities; and Fund staff estimates and projections

Uses authorities’ definition: excludes off-budget bonds.

Staff definition: includes off-budget bonds as quasi-fiscal expenditure.

Sources: Data provided by the Indian authorities; and Fund staff estimates and projections

Uses authorities’ definition: excludes off-budget bonds.

Staff definition: includes off-budget bonds as quasi-fiscal expenditure.

47. The central government’s deficit target for this year—3.3 percent of GDP—is likely to be met. Tax revenue is likely to overperform the budget target by a wide margin, but expenditure is also expected to overshoot due to above-budget subsidy and interest costs. Including off-budget quasi-fiscal expenditure, staff projects the augmented deficit at 4½ percent of GDP, about the same as last year.17 Looking to 2008/09, the FRBMA sets the challenging objective of revenue balance (and reduction of the overall deficit to 3 percent of GDP). Based on the staff’s augmented definition of the budget deficit, achieving revenue balance would require consolidation of 2¾ percentage points of GDP (and about 1½percentage points of GDP to achieve an overall deficit of 3 percent of GDP).18 As discussed in Annex I, the staff baseline assumes that off-budget subsidy-related bond issuance will be phased out gradually, suggesting that achievement of current balance will be delayed by a few years.

India: Fiscal Impulse 1/

(In percent of GDP)

Source: Fund staff estimates.

1/ Calculated using staff definition of the augmented fiscal balance (including off-budget bond issuance).

48. Given the rapid growth in revenue, fiscal consolidation could have been more ambitious. This would not only have accelerated debt reduction, but also increased the contribution of fiscal policy to absorbing the inflationary impact of capital inflows, a burden which has been borne disproportionately by monetary policy (given the positive fiscal impulse).19

49. There are risks to this baseline. Spending risks include the persistence of high fertilizer and fuel subsidy costs (given the global commodity price outlook) and increased government wages and pensions from the Sixth Pay Commission (SPC) award.20 Recent wage hikes and past cost of living increases would limit the rise in salary costs and phasing in pay increases would ease the fiscal burden. On revenues, rapid growth since 2004/05 (averaging 23 percent annually) largely reflects corporate profits, which are already slowing. Moreover, tax losses from Special Economic Zones, which grant full income tax exemption for five years (and 50 percent exemption for the following five years), could rise to 1½percent of GDP per year.

50. On a longer view, fiscal consolidation remains important for achieving India’s inclusive growth objectives and coping with financial globalization. Debt servicing costs (over 5 percent of GDP) absorb fiscal space needed for priority social and infrastructure projects. Consolidation would also reduce the risks of crowding out and set the stage for further financial openness.

Interest Costs in Selected Countries - 2006

(General government, in percent of GDP)

Sources: IMF, World Economic Outlook; and Fund staff estimates.

51. Bold expenditure reforms are needed to make space for social spending. Revamping subsidies is a key priority: they are expensive and poorly targeted.21 A phased re-alignment of domestic fuel prices to international levels, paired with a shift to a rule-based pricing and burden-sharing mechanism for petrol and diesel, would reduce the fiscal burden and improve transparency. Staff welcomed the government’s plans to improve targeting and reduce diversion of food and fuel subsidies and other social assistance, as well as efforts to broaden the social safety net (including extending social insurance to informal-sector workers and old-age pensions to the poor).22

52. Revenue reforms are needed as well. In 2006/07, foregone revenue from exemptions amounted to 5.7 percent of GDP (roughly half of actual tax collections). The authorities’ GST (planned for April 2010) would streamline the tax structure and bolster revenue in the medium term. Early announcement of a roadmap—including a timetable for merging VAT-like taxes and broadening the services tax—would help taxpayers prepare. A single point of collection (as in most federal OECD countries) would be easier to administer than a dual-tier system. On non-tax revenue, there is considerable potential to raise collections from user fees, but this will require significantly improved service delivery.

53. The FRBMA should be supplemented by an explicit framework for medium-term debt reduction. The Act implicitly targets further debt reduction beyond March 2009, which staff sees as achievable (staff projects general government debt to fall to 62 percent of GDP by 2012, a decline of almost 20 percentage points (see Annex I)). Adoption of an explicit, ambitious medium-term debt reduction target could bolster the government’s commitment to debt reduction, guide public expectations about fiscal policy, and relieve appreciation pressures.23 The target should encompass the consolidated government, including non-financial public enterprises.

General Government Gross Debt

(In percent of GDP)

Source: IMF, World Economic Outlook.

54. Aggregate state finances are sound.24 Thanks to fiscal responsibility legislation (adopted in all but two states), as well as high transfers and debt forgiveness by the central government, fiscal consolidation targets set out under the 12th Finance Commission are likely to be met ahead of schedule. Going forward, however, several risks exist:

  • The anticipated slowdown in central government tax collections (which are shared with the states) requires states to enhance revenues, particularly given potential SPC costs.
  • With education and health spending (primarily a state responsibility) expected to rise, constraints on implementation and ensuring the quality of spending could become more acute. Monitoring and evaluation need improvement.
  • State liquidity management could be improved further; cash-rich states could use excess revenue to consolidate debt more quickly.

Authorities’ Plans and Views

55. The authorities remain committed to FRBMA targets. This year, significant revenue overperformance (especially by corporate taxes) was expected to offset higher-than-budgeted interest payments and subsidies, thus allowing the central government deficit target to be met.25 The authorities acknowledged that achieving revenue balance by March 2009 would be challenging, given persistent expenditure pressures.

56. At the same time, the government plans to ramp up priority spending significantly in coming years, with a particular focus on the social sector. Under the 11th Plan (2007–2012), spending on education and health is set to triple to 6 percent and 9 percent of GDP, respectively, mostly coming from the public sector. Total infrastructure investment is targeted to rise from about 5¾ percent of GDP to 9 percent of GDP, with an increased private-sector share. To avoid undermining fiscal consolidation, the government aims to contain non-priority spending growth. Relatedly, Planning Commission officials expressed concern that pushing for revenue balance by March 2009 would constrain priority spending, thereby jeopardizing inclusive growth objectives.26

57. The Ministry of Finance shared the staff’s view that reforms are needed to secure lasting fiscal consolidation. The government is committed to reducing the subsidy bill and is evaluating reform options; but the timing of these politically-difficult reforms is unclear. On revenues, they agreed that tax buoyancy would moderate as growth eased, but noted the contribution of ongoing compliance improvements and base-broadening.

58. The authorities were cautiously optimistic about the outlook for state finances. while recognizing the significant recent improvement in states’ fiscal balances, they highlighted the large role of central government transfers and the need for states to strengthen their own revenue-raising capabilities. Expenditure may have been consolidated too quickly in some cases, with critical labor shortages in education and health resulting from across-the-board hiring freezes. Looking forward, improving service delivery at state and local levels will be critical for inclusive growth.

59. On medium-term fiscal issues:

  • The recently appointed 13th Finance Commission is preparing a road map for GST introduction (a dual-tier system with a common tax base would be the likely outcome) and will make recommendations for medium-term fiscal policy.
  • The authorities downplayed concerns about SPC expenditure risks, noting that the award was unlikely to be as high as in 1997 because cost-of-living hikes have been granted more frequently in recent years. Increases would likely be phased in, and the states ’improved fiscal positions would help them absorb the costs.
  • On financing infrastructure, the government plans to increase significantly the role of public-private partnerships.

D. Addressing Supply Constraints to Sustain Growth

Background and Staff Views

60. Strong and more inclusive growth is the basis for India’s economic stability. Productivity needs to be bolstered in order to maintain competitiveness in the face of appreciation pressures. Strong growth is also needed to support fiscal sustainability, currently riding on buoyant revenues. Inclusive growth will also be essential to build political consensus for growth-oriented reforms, given growing perceptions of rising inequalities and the lack of a well-functioning social safety net.

61. Education and labor-market reforms can both accelerate growth and ensure that its benefits are distributed widely. Skill premia, and correspondingly consumption inequality, are growing, especially in urban areas. India registered one of the highest increases in skilled wages in the world; wages of managerial and supervisory staff rose 16 percent during 2007, with a similar increase expected in 2008. Yet, unemployment rates among the young rise steeply with educational achievement, suggesting serious mismatches between education provision and market needs.27 More flexible labor regulations could increase formal sector employment, which has stagnated even as employment in the informal sector grows. The reallocation of labor from weaker performing to stronger sectors in the economy could generate substantial productivity gains, while allowing a larger share of the population to enjoy the benefits of growth.

India: Employment Growth

(Annual growth, 5-year moving average)

Source: OECD, 2007 Economic Review - India.

62. Major shortcomings exist in infrastructure, which are estimated to reduce GDP growth by 1 percent per annum. Power shortages are acute and growing: the average firm reports power outages on 85 days per year, and the peak deficit reached a 10-year high of 14½ percent this year. The government estimates that some $500 billion in infrastructure investment will be needed over the medium term in power and other sectors. A prerequisite for private investment in the power sector is a more predictable and transparent regulatory framework (particularly for pricing and payment collections). Streamlining FDI regulations, developing a corporate bond market and tapping global capital markets (including by limiting restrictions on ECBs) would help mobilize the financing needed.

Infrastructure Stocks in India and China

Source: World Development Indicators.

63. The mission encouraged the authorities to continue with gradual trade liberalization. The overall average tariff has come down from 32.3 percent in 2002 to 15.8 percent in 2006, although average agricultural tariffs stand at 40.8 percent. In the 2007/08 budget, the government announced a further reduction of the peak nonagricultural rate from 12.5 percent to 10 percent (subject to certain exemptions).

Authorities’ Plans and Views

64. “Faster and more inclusive growth” is the guiding objective of the 11th Plan. Priorities include ensuring access to social services, augmenting physical infrastructure, and promoting a competitive environment that supports private sector investment and job creation, including in agriculture.

65. The Plan envisions enhanced education and labor market flexibility. In particular, a stronger focus on secondary, higher and technical education would better align the skills of graduates with market needs, and limit widening income disparities. The 11th Plan envisages a tripling of public spending on education to 6 percent of GDP, with further private sector involvement. The government is well aware of the need for a greater emphasis on quality of services provision, with enhanced monitoring, evaluation and accountability. Allowing FDI in the education sector is under consideration. The authorities recognize that rigid labor regulations stifle organized-sector employment, and the 11th Plan includes, for the first time, recommendations to make labor regulations more flexible, though their political feasibility remains unclear.

66. The government is relying on public-private partnerships (PPPs) to help bridge infrastructure gaps. So far, progress in PPPs has varied across sectors, with telecom, ports and road sectors attracting the bulk of private investment. In the power sector, regulatory hurdles regarding payment mechanisms remain the biggest obstacle. Model concession agreements in key infrastructure sectors are moving towards allocating a greater share of the risk to the public sector. The authorities also plan to increase public investment significantly.

67. The authorities remain committed to multilateral trade liberalization. Tariff reductions have lowered the costs of key capital goods and raw materials, and in tandem with complementary structural reforms, have spurred domestic competition, pushing firms in India to align their cost structures with firms globally. While the government plans to reduce tariffs to ASEAN levels by 2009, domestic concerns and corresponding tariffs and non-tariff barriers of major trading partners may influence the degree of reductions. The authorities were hopeful for progress in the Doha Development round, though they expressed concern that the focus on development was fading. In the meantime, India is pursuing further trade liberalization through FTAs with key nations.

V. Staff Appraisal

68. India’s impressive macroeconomic performance pays tribute to its sound macroeconomic policies and steady structural reforms over the past 16 years. Growth has brought further reductions in poverty while prudent macroeconomic policies have supported financial and economic stability.

69. Sustaining this performance requires tackling two challenges. First, rapid capital inflows are bringing out tensions in the policy framework associated with the “impossible trinity.” Resolving these tensions will require an evolution of monetary policy, further exchange rate flexibility, and deeper and broader capital markets. Second, sustained, inclusive growth is needed to maintain economic stability. The necessary structural reforms will both underpin growth and increase economic flexibility and competitiveness.

70. Monetary operations and communications are adapting to financial globalization, and this process can usefully be stepped up. The RBI has managed liquidity more actively, improved communication, and accommodated increased exchange rate volatility. Greater use of open market operations would enhance the flexibility and effectiveness of monetary policy and decrease reliance on the tax of the CRR. Meanwhile, further elaboration on the inflation outlook in more frequent monetary policy reviews would help guide expectations.

71. Staff judge rupee appreciation as an equilibrium phenomenon, reflecting strong economic fundamentals. The rupee is appropriately valued from a medium-term perspective. A market-determined rupee, and the policy of a managed float with some intervention to curb volatility but no target or preannounced path, remain appropriate. Looking ahead, further exchange rate flexibility will give monetary policy greater room to focus on containing inflation, and reduce the costs of exchange rate management. In combination with better-developed derivatives markets, a more flexible rupee would encourage hedging and avoid a buildup of speculative inflows.

72. The use of capital controls for macroeconomic management should be avoided, as they could affect investment adversely. These risks are demonstrated by the recent experience with tightening ECBs restrictions, which have not curbed overall flows but have raised concerns about investment financing. Moreover, while the government remains committed to fuller capital account convertibility, imposing further restrictions on inflows may create confusion about that commitment and about the authorities’ “exit strategy.” A preferable strategy would be to make capital account liberalization a deliberate process. The temporary space provided by existing restrictions should be used to prepare for a more open capital account. Steps taken to liberalize capital outflows in 2006 and 2007 are welcome, and further bolder steps would be warranted, to reduce net inflows over time.

73. Broader and deeper financial markets could better intermediate capital inflows, accommodate adjustments in the exchange rate, and finance India’s large investment requirements. Developing the corporate bond and derivatives markets onshore will be crucial to funding massive infrastructure investment needs and providing corporations with the tools they need to manage the risks associated with India’s financial globalization. Another priority is developing exchange-traded currency and interest rate derivatives markets to complement the growing OTC markets.

74. The efficiency of financial institutions can be enhanced. Key steps would include opening up further to foreign banks, phasing out directed lending, further loosening interest rate restrictions, and reducing the CRR. In addition, further liberalizing FDI in financial services would spur competition and bring innovation and advanced financial technologies.

75. The RBI appropriately maintains a strong focus on preserving financial stability. Thanks to the RBI’s close scrutiny of banks’ credit portfolios and its efforts to improve bank risk management, the risks posed by a turn in the credit cycle are likely to be manageable. In addition, the pending adoption of Basel II will further strengthen bank risk management. The ongoing review of financial stability and development appropriately emphasizes macro-prudential surveillance, including system-level stress testing, and staff looks forward to publication of the report in March 2008.

76. Further fiscal consolidation is essential to sustain inclusive growth and cope with financial globalization. The interest costs of high public debt absorb fiscal space needed for priority social and infrastructure spending. Consolidation would also reduce the risks of crowding out and set the stage for further financial openness. Finally, a tight fiscal stance can shoulder some of the burden of adjusting to the inflationary impact of capital inflows.

77. Measures are needed on both spending and revenues. On spending, the authorities are rightly concerned about the growing fuel subsidy burden. A phased reduction in fuel subsidies and a gradual alignment of domestic prices to international levels is warranted, and a more rule-based pricing and burden-sharing mechanism would improve transparency. Meanwhile, food and fertilizer subsidies can be better targeted. On revenues, cutting exemptions would substantially boost the tax take. Plans to introduce the GST are welcome; early announcement of a roadmap would help taxpayers to prepare. Collections from user fees could be raised, but will require significantly improved service delivery.

78. State’s aggregate fiscal performance remains impressive, providing fiscal space to raise social spending. Fiscal responsibility laws, large central government transfers, and introduction of the VAT have spurred rapid deficit reduction. However, liquidity management could be improved further. Looking ahead, a priority is to improve the quality and quantity of state social spending.

79. The FRBMA could be augmented to provide an explicit framework for future debt reduction. An explicit medium-term debt reduction target for consolidated government could bolster the commitment to further debt reduction.

80. Structural reforms to make the economy more flexible will be key to competitiveness and inclusive growth. Sustained productivity growth will be essential to maintain competitiveness. Meanwhile, widening disparities reflect rapid growth in skilled wages owing to skills shortages, which in turn reflect gaps in education. In addition, infrastructure gaps and labor market rigidities will increasingly constrain growth. In the power sector, a more predictable regulatory environment is warranted to mobilize private sector funding. Higher—and more effective—public spending on education is also essential. FDI in education could play a supportive role, with a clearer regulatory regime. More flexible labor regulations can facilitate the reallocation of labor to stronger sectors.

81. Further trade liberalization can facilitate growth. Tariff reductions have reduced the costs of key capital goods and raw materials, and in tandem with complementary structural reforms, have spurred domestic competition. Accordingly, staff supports the aim to reduce tariffs to ASEAN levels and welcomes the authorities’ commitment to multilateral trade liberalization.

Table 1.India: Millennium Development Goals, 1990–2006 1/
19901995200120042006
Eradicate extreme poverty and hunger 2/
Income share held by lowest 20 percent8.1
Malnutrition prevalence, weight for age (percent of children under 5)63.9
Poverty gap at $1 a day (PPP) (percent)10.77.9
Poverty headcount ratio at $1 a day (PPP) (percent of population)41.834.3
Poverty headcount ratio at national poverty line (percent of population)36.028.6
Prevalence of undernourishment (percent of population)25.020.0
Achieve universal primary education 3/
Literacy rate, youth total (percent of people ages 15–24)64.376.4
Persistence to grade 5, total (percent of cohort)61.478.9
Primary completion rate, total (percent of relevant age group)68.277.175.888.5
School enrollment, primary (percent net)81.489.7
Promote gender equality 4/
Proportion of seats held by women in national parliament (percent)5.09.09.08.3
Ratio of girls to boys in primary and secondary education (percent)69.577.586.9
Ratio of young literate females to males (percent ages 15–24)73.980.5
Women employed in the nonagricultural sector (percent of total nonagricultural employment)12.714.416.817.3
Reduce child mortality 5/
Immunization, measles (percent of children ages 12–23 months)56.072.058.058.058.0
Mortality rate, infant (per 1,000 live births)80.074.066.061.656.0
Mortality rate, under-5 (per 1,000)123.0104.094.074.0
Improved maternal health 6/
Births attended by skilled health staff (percent of total)34.242.5
Maternal mortality ratio (modeled estimate, per 100,000 live births)
Combat HIV/AIDS, malaria, and other diseases 7/
Children orphaned by HIV/AIDS
Contraceptive prevalence (percent of women ages 15–49)44.947.0
Incidence of tuberculosis (per 100,000 people)167.8
Prevalence of HIV, female (percent ages 15–24)
Prevalence of HIV, total (percent of population ages 15–49)0.90.9
Tuberculosis cases detected under DOTS (percent)0.323.857.161.3
Ensure environmental sustainability 8/
CO2 emissions (metric tons per capita)0.81.01.11.2
Forest area (percent of land area)21.522.722.8
GDP per unit of energy use (constant 2000 PPP $ per kg of oil equivalent)4.04.35.05.5
Improved sanitation facilities (percent of population with access)14.033.0
Improved water source (percent of population with access)70.086.0
Nationally protected areas (percent of total land area)
Develop a global partnership for development 9/
Aid per capita (current US$)1.61.91.60.61.6
Debt service (PPG and IMF only, percent of exports of G&S, excl. workers’ remittances)
Fixed line and mobile phone subscribers (per 1,000 people)6.012.943.684.5127.7
Internet users (per 1,000 people)0.00.36.832.454.8
Personal computers (per 1,000 people)0.31.35.812.115.5
Total debt service (percent of exports of goods, services and income)31.929.714.719.1
Unemployment, youth female (percent of female labor force ages 15–24)8.010.210.8
Unemployment, youth male (percent of male labor force ages 15–24)8.410.110.4
Unemployment, youth total (percent of total labor force ages 15–24)8.310.110.5
General indicators
Fertility rate, total (births per woman)3.83.43.12.92.8
GNI per capita, Atlas method (current US$)390.0380.0460.0630.0730.0
GNI, Atlas method (current US$) (billions)330.6349.6478.7680.4804.1
Gross capital formation (percent of GDP)24.126.524.531.033.4
Life expectancy at birth, total (years)59.161.462.963.463.5
Literacy rate, adult total (percent of people ages 15 and above)49.361.0
Population, total (millions)849.5932.21,032.51,079.71,094.6
Trade (percent of GDP)15.723.227.640.144.7
Source: World Development Indicators, April 2007.

In some cases the data are for earlier or later years than those stated.

Halve, between 1990 and 2015, the proportion of people whose income is less than one dollar a day.

Ensure that, by 2015, children everywhere, boys and girls alike, will be able to complete a full course of primary schooling.

Eliminate gender disparity in primary and secondary education preferably by 2005 and to all levels of education no later than 2015.

Reduce by two-thirds, between 1990 and 2015, the under-five mortality rate.

Reduce by three-quarters, between 1990 and 2015, the maternal mortality ratio.

Have halted by 2015, and begun to reverse, the spread of HIV/AIDS. Have halted by 2015, and begun to reverse, the incidence of malaria and other major diseases.

Integrate the principles of sustainable development into country policies and programs and reverse the loss of environmental resources. Halve, by 2015, the proportion of people without sustainable access to safe drinking water. By 2020, to have achieved a significant improvement in the lives of at least 100 million slum dwellers.

Develop further an open, rule-based, predictable, non-discriminatory trading and financial system. Address the Special Needs of the Least Developed Countries. Address the Special Needs of landlocked countries and small island developing states. Deal comprehensively with the debt problems of developing countries through national and international measures in order to make debt sustainable in the long term. In cooperation with developing countries, develop and implement strategies for decent and productive work for youth. In cooperation with pharmaceutical companies, provide access to affordable, essential drugs in developing countries. In cooperation with the private sector, make available the benefits of new technologies, especially information and communications.

Source: World Development Indicators, April 2007.

In some cases the data are for earlier or later years than those stated.

Halve, between 1990 and 2015, the proportion of people whose income is less than one dollar a day.

Ensure that, by 2015, children everywhere, boys and girls alike, will be able to complete a full course of primary schooling.

Eliminate gender disparity in primary and secondary education preferably by 2005 and to all levels of education no later than 2015.

Reduce by two-thirds, between 1990 and 2015, the under-five mortality rate.

Reduce by three-quarters, between 1990 and 2015, the maternal mortality ratio.

Have halted by 2015, and begun to reverse, the spread of HIV/AIDS. Have halted by 2015, and begun to reverse, the incidence of malaria and other major diseases.

Integrate the principles of sustainable development into country policies and programs and reverse the loss of environmental resources. Halve, by 2015, the proportion of people without sustainable access to safe drinking water. By 2020, to have achieved a significant improvement in the lives of at least 100 million slum dwellers.

Develop further an open, rule-based, predictable, non-discriminatory trading and financial system. Address the Special Needs of the Least Developed Countries. Address the Special Needs of landlocked countries and small island developing states. Deal comprehensively with the debt problems of developing countries through national and international measures in order to make debt sustainable in the long term. In cooperation with developing countries, develop and implement strategies for decent and productive work for youth. In cooperation with pharmaceutical companies, provide access to affordable, essential drugs in developing countries. In cooperation with the private sector, make available the benefits of new technologies, especially information and communications.

Table 2.India: Selected Economic Indicators, 2003/04–2007/08 1/
Nominal GDP (2006/07): US$912 billion
Population (2006/07): 1.13 billion
GDP per capita (2006/07): US$809
Quota: SDR 4,158.2 million
2003/042004/052005/062006/072007/08 2/2007/08
Prov.Proj.Apr.MayJun.Jul.Aug.Sep.Oct.Nov. 3/
Growth (y/y percent change)
Real GDP (at factor cost)8.57.59.09.48.7
Industrial production7.08.48.211.311.310.68.98.310.76.811.8
Prices (y/y percent change, period average for annual data)
Wholesale prices (1993/94 weights)5.46.54.45.53.66.05.24.54.73.93.43.03.7
Consumer prices - industrial workers (2001 weights)3.93.84.46.75.96.76.65.76.57.36.45.5
Saving and investment (percent of GDP)
Gross saving 4/30.431.232.634.235.6
Gross investment28.031.533.835.337.0
Fiscal position (percent of GDP)
Central government balance - authorities 5/-4.5-4.0-1-3.5-3.3-0.6-1.4-1.7-2.0-1.5-1.0-1.1
Central government balance - staff 6/-5.1-4.2-4.4-4.4-4.5
General government balance - staff 6/-9.1-7.3-7.1-7.2-6.8
General government debt85.785.782.979.075.2
Money and credit (y/y percent change, end-period)
Broad money16.712.321.221.319.819.721.621.820.721.022.522.8
Credit to commercial sector13.026.032.225.424.923.622.521.922.720.521.221.7
Financial indicators (percent, end-period)
91-day treasury bill yield4.25.36.18.07.47.17.26.26.97.17.27.5
10-year government bond yield5.16.77.58.08.28.18.27.87.97.97.87.9
Stock market (y/y percent change, end-period)83.416.173.715.915.239.938.144.730.938.853.041.4
External trade 7/
Exports of goods (US$ billions)66.385.2105.212.81154.411.012.51211.912.512.712.813.3
y/y percent change23.328.523.420.921.514.1121.914.118.518.919.335.6
Imports of goods (US$ billions)80.0118.9157.0192.0241.917.819.219.217.519.617.220.8
y/y percent change24.148.632.062.326.041.834.436.720.432.62.324.3
Net oil imports (US$ billions)17.022.932.341.350.32.32.53.65.06.05.56.1
Balance of payments (US$ billions)
Current account balance14.1-2.5-9.2-9.6-17.4
(in percent of GDP)2.3-0.4-1.1-1.1-1.5
Foreign direct investment, net2.43.74.78.423.51.62.11.20.70.8
Portfolio investment, net (equity and debt)11.49.312.57.130.61.81.30.35.5-1.84.65.7-1.5
Overall balance31.426.215.136.693.9
External indicators
Gross reserves (US$ billions end-period)113.0141.5151.6199.2296.1204.1208.4213.5227.1228.9247.3262.5273.5
(In months of imports) 8/9.28.77.67.89.86.56.77.07.67.88.79.49.9
External debt (percent of GDP, end-period) 9/18.517.815.817.117.9
Of which: short-term debt 10/1.83.12.02.12.9
Ratio of gross reserves to short-term debt (end-period)10.76.59.510.512.28.48.68.89.39.410.210.811.2
Gross reserves to broad money (percent; end-period)24.627.524.826.325.325.425.726.627.027.528.629.5
Debt service ratio 11/16.06.09.75.15.5
Real effective exchange rate
(y/y percent change, period average for annual data)1.02.24.4-2.25.311.712.012.912.09.77.96.3
Exchange rate (rupee/US$, end-period)43.643.744.643.541.240.640.740.440.939.839.339.6
Memorandum items (in percent of GDP):
Off-budget subsidy related bonds 12/0.00.00.31.01.2
Sources: Data provided by the Indian authorities; CEIC Data Company Ltd.; and Fund staff estimates and projections.

Data are for April-March fiscal years.

Current staff projections.

Latest available figures.

Differ from official data due to revisions in the current account.

Divestment proceeds are treated as revenue until 2005/06 (included); excludes off-budget bond issuance.

Divestment is treated as financing; includes off-budget bond issuance.

Monthly data are on a customs basis; annual data are on a projected balance of payments basis.

Imports of goods and services projected over the following twelve months.

Data are reported relative to staff’s estimated annual GDP.

Residual maturity basis, except contracted maturity basis for medium and long-term non-resident Indian accounts.

In percent of current account receipts excluding grants.

Issued by the central government to FCI, the state-owned oil refining/distribution companies, and fertilizer companies as compensation for losses incurred from the provision of price subsidies.

Sources: Data provided by the Indian authorities; CEIC Data Company Ltd.; and Fund staff estimates and projections.

Data are for April-March fiscal years.

Current staff projections.

Latest available figures.

Differ from official data due to revisions in the current account.

Divestment proceeds are treated as revenue until 2005/06 (included); excludes off-budget bond issuance.

Divestment is treated as financing; includes off-budget bond issuance.

Monthly data are on a customs basis; annual data are on a projected balance of payments basis.

Imports of goods and services projected over the following twelve months.

Data are reported relative to staff’s estimated annual GDP.

Residual maturity basis, except contracted maturity basis for medium and long-term non-resident Indian accounts.

In percent of current account receipts excluding grants.

Issued by the central government to FCI, the state-owned oil refining/distribution companies, and fertilizer companies as compensation for losses incurred from the provision of price subsidies.

Table 3.India: Balance of Payments, 2003/04–2007/08 1/(In billions of U.S. dollars)
2003/042004/052005/062006/072007/08
Prov.Proj.
Current account balance14.1-2.5-9.2-9.6-17.4
Merchandise trade balance-13.7-33.7-51.8-64.9-87.5
Merchandise exports66.385.2105.2127.1154.4
Merchandise imports80.0118.9157.0192.0241.9
Oil20.629.944.057.371.0
Non-oil59.489.0113.0134.7170.9
Of which: customs based 2/57.776.8105.2124.1
Non-factor services balance10.115.423.932.740.0
Receipts26.943.261.481.3103.3
Of which: software services12.817.223.613.0
Payments16.727.837.548.663.2
Income, net-4.5-5.0-5.5-4.8-5.4
Transfers, net22.220.824.327.435.4
Capital account balance16.728.023.444.9110.7
Direct investment, net2.43.74.78.423.5
Of which: direct investment in India4.36.07.719.435.3
Portfolio investment, net11.49.312.57.130.6
Government borrowing, net-2.91.91.71.82.6
Commercial borrowing, net-2.95.22.716.116.5
Short-term credit, net1.43.81.73.312.1
NRI deposits, net3.6-1.02.83.910.6
Rupee debt-0.4-0.4-0.6-0.2-0.2
Other capital, net 3/4.15.5-2.24.615.0
Errors and omissions0.60.60.81.30.6
Overall balance31.426.215.136.693.9
Valuation change5.42.4-5.011.03.0
Increase in gross reserves (-)-36.9-28.5-10.1-47.6-96.9
Memorandum items:
Change in forex reserves (includes valuation)36.928.510.147.696.9
Foreign exchange reserves113.0141.5151.6199.2296.1
In months of next year’s imports (goods and service)9.28.77.67.89.8
Current account balance (percent of GDP)2.3-0.4-1.1-1.1-1.5
Merchandise trade balance (percent of GDP)-2.3-4.8-6.4-7.1-7.4
Overall balance (percent of GDP)5.23.81.94.08.0
Sources: CEIC Data Company Ltd.; and Fund staff estimates and projections.

Data are for April-March fiscal years. Indian authorities’ presentation, including new methodology to estimate direct investment.

Noncustoms imports include defense related items.

Net other capital is sum of net banking capital (RBI format) and net other capital (RBI format) less net NRI deposits.

Sources: CEIC Data Company Ltd.; and Fund staff estimates and projections.

Data are for April-March fiscal years. Indian authorities’ presentation, including new methodology to estimate direct investment.

Noncustoms imports include defense related items.

Net other capital is sum of net banking capital (RBI format) and net other capital (RBI format) less net NRI deposits.

Table 4.India: Reserve Money and Monetary Survey, 2003/04–2007/08 1/
2003/042004/052005/062006/072007/08
Apr.MayJun.Jul.Aug.Sep.Oct.
Reserve money(In billions of rupees, end-period)
Reserve money4,3654,8915,7317,0907,3057,2607,46377,5207,4637,8127,699
Net domestic assets of RBI-479-1,237-999-1,571-1,076-1,046-1,427-1,418-1,891-2,016-2,130
Claims on government (net)449-180815818563-197219-629-744-1,371
Center369-233522118055-197210-643-643-643
States80533036680913-102-728
Claims on commercial sector2114141514141414141414
Claims on banks54535876534413011
Other items (net)-1,003-1,123-1,152-1,721-1,328-1,167-1,256-1,651-1,277-1,287
Net foreign assets of RBI4,8446,1286,7308,6628,3818,3068,6348,9399,3559,8289,828
(Contribution to reserve money growth)
Reserve money18.312.117.223.722.723.322.929.026.429.126.9
Net domestic assets of RBI-15.9-17.44.9-10.02.78.22.76.2-2.4-8.4-11.0
Claims on government (net)-20.5-14.45.3-140.1-0.2-4.84.0-10.5-14.1-24.4
Net foreign assets of RBI34.229.412.333.720.015.220.222.828.937.437.9
Monetary survey(In billions of rupees, end-period)
Broad money (M3)20,05722,51427,29533,10333,21833,27433,86534,53934,75635,74436,082
Currency with public3,1503,5594,1314,8355,0345,0415,0104,9574,8694,8715,065
Deposits16,85618,89123,09628,19328,11428,17928,78429,45829,83630,96830,968
Non-bank deposits at RBI51656975705471123505648
Net domestic assets14,79116,02220,03423,97124,36624,49723,971225,28225,34026,27326,184
Domestic credit17,59120,37024,59629,61529,54229,38329,530,830,41731,04630,851
Net credit to government7,4297,5687,6668,3828,6498,6218,6309,1698,7868,7278,528
Of which: RBI449-180815818563-197219-629-744-1,371
Credit to commercial sector 2/10,16212,80216,93021,23420,89320,76220,91522,31921,63122,31922,323
Of which: commercial bank len8,40811,00415,07119,28918,87818,83719,17519,14519,60119,60119,601
Nonfood8,04810,59314,66418,82418,38018,38918,74718,73519,21619,21619,216
Other items (net)-2,800-4,348-4,562-5,644-5,176-4,885-4,633-5,007-4,667-4,772-4,667
Net foreign assets5,2666,4937,2629,1328,8528,7778,9529,2579,4169,4719,898
(Twelve-month percent change)
Broad money (M3)16.712.321.0221.319.819.721.621.820.721.022.5
Net domestic assets11.78.325.019.721.823.424.520.2220.220.622.5
Domestic credit11.715.820.720.419.318.818.319.318.716.916.3
Net credit to government9.81.91.39.37.48.59.213.69.98.55.1
Credit to commercial sector 2/13.026.03225.424.923.622.521.922.720.521.2
Of which: commercial bank len15.330.937.028.027.126.126.123.024.218.018.5
Nonfood18.431.638.428.426.926.426.723.224.618.018.8
Net foreign assets33.723.311.925.714.610.514.6115.722.122.122.6
(Contribution to broad money growth)
Net domestic assets9.06.117.814.415.716.717.617.414.515.016.4
Net credit to government3.90.70.42.62.622.42.63.92.82.31.4
Of which: RBI-4.4-3.11.2-0.10.10-0.1-1.00.8-2.1-2.9-5.0
Credit to commercial sector 2/6.813.218.315.815.014.313.813.413.912.913.3
Net foreign assets7.76.13.46.94.13.04.04.46.26.06.2
Sources: Reserve Bank of India; and Fund staff estimates.

Data are for April-March fiscal years.

Starting in May 2002, figures include ICICI, formerly a large development finance institution, which merged with ICICI Bank Ltd. to form a new commercial bank.

Sources: Reserve Bank of India; and Fund staff estimates.

Data are for April-March fiscal years.

Starting in May 2002, figures include ICICI, formerly a large development finance institution, which merged with ICICI Bank Ltd. to form a new commercial bank.

Table 5.India: Central Government Operations, 2003/04–2007/08
2003/042004/052005/062006/072007/08
BudgetEst.BudgetStaff
proj.
(In billions of rupees)
Total revenue and grants2,8183,2043,6364,1964,4995,4245,622
Net tax revenue1,8862,2642,7213,2873,5314,0574,312
Gross tax revenue2,5433,0503,6624,4224,7345,4815,826
Of which: corporate tax6368271,0131,3301,4331,6841,909
income tax4144936367748659881,148
excise taxes9089911,1121,1901,1771,3021,220
customs duties4865766517718639881,010
other taxes100163250357396520539
Less: States’ share6587869401,1341,2031,4251,514
Nontax revenue 1/9119108848829431,3461,289
Grants22313026252121
Total expenditure and net lending4,2224,5065,1135,6835,9306,9347,181
Current expenditure 2/3,8023,9874,5555,0435,3015,7396,004
Of which: interest payments1,2411,2691,3261,3981,4961,5901,695
wages and salaries322352373398400448448
subsidies 3/443437475462535543609
Capital expenditure and net lending 4/5/4205195576406291,1951,177
Overall balance-1,404-1,302-1,477-1,487-1,431-1,509-1,558
Overall balance (authorities’ definition) 6/-1,234-1,258-1,461-1,487-1,431-1,509-1,558
Overall balance (augmented) 7/-1,576-1,890-1,834-1,913-2,126
Financing1,4041,3021 4771,4871,4311,5091,558
External (net)-1351487583859191
Domestic (net)1,5391,1541,4021,41,3461,4181,467
(In percent of GDP)
Total revenue and grants10.210.210.210.510.911.711.9
Net tax revenue6.87.27.68.28.68.89.1
Gross tax revenue9.29.810.311.5111.511.812.3
Of which: corporate tax2.32.62.83.33.53.64.0
income tax1.51.61.81.92.12.12.4
excise taxes3.33.23.13.02.92.82.6
customs duties1.81.81.81.92.12.12.1
other taxes0.40.50.70.91.01.11.1
Less: States’ share2.42.52.62.82.93.13.2
Nontax revenue 1/3.32.92.52.22.32.92.7
Grants0.10.10.10.10.10.00.0
Total expenditure and net lending15.314.414.314.214.415.015.2
Current expenditure 2/13.712.812.812.612.812.412.7
Of which: interest payments4.54.13.73.53.63.43.6
wages and salaries1.21.211.01.01.01.00.9
subsidies 3/1.61.41.31.21.31.21.3
Capital expenditure and net lending 4/5/1.51.71.61.61.52.62.5
Overall balance-5.1-4.2-4.1-3.7-3.5-3.3-3.3
Overall balance (authorities’ definition) 6/-4.5-4.0-4.1-3.7-3.5-3.3-3.3
Overall balance (augmented) 7/-4.4-4.7-4.4-3.3-4.5
Financing5.14.24.13.73.53.33.3
External (net)-0.50.50.20.20.20.20.2
Domestic (net)5.63.73.93.53.33.13.1
Of which: market borrowing3.21.52.72.83.12.42.3
small savings (net of states’ share)0.20.10.20.20.10.30.3
divestment receipts0.60.10.00.10.00.00.0
Memorandum items:
Military expenditure2.22.42.32.22.12.12.0
Primary balance-0.6-0.1-0.4-0.20.10.20.3
Current balance 6/8/-3.6-2.5-2.6-2.1-2.0-0.7-0.7
Current balance (augmented) 7/8/-2.9-3.1-2.9-0.7-2.0
Central government debt 9/62.863.863.461.961.559.360.4
Food Corporation of India bonds 10/0.40.40.00.1
Oil bonds 10/0.30.60.60.00.8
Fertilizer bonds 10/0.3
Nominal GDP (in Rs. billion)27,65531,26635,67239,95241,25746,31747,193
Sources: Data provided by the Indian authorities; and Fund staff estimates and projections.

In 2007/08, includes a special dividend payment from the RBI amounting to 0.7 percent of GDP. The authorities include this item under “other capital receipts” rather than non-tax revenue.

Includes the surcharge on Union duties transferred to the National Calamity Contingency Fund.

Excludes off-budget subsidy-related bond issuance.

Authorities’ treatment of state debt swap scheme (DSS) in 2002-05 shows the prepayment by States of on-lent funds to the center as net lending. The Center’s prepayment of its debt to the National Small Savings Fund (NSSF) is treated as a capital expenditure.

In 2007/08, includes roughly 0.7 percent of GDP for the government’s purchase of SBI shares from the RBI.

Authorities’ definition treats divestment as a revenue item until 2005/06 (included); excludes off-budget subsidy related bond issuance.

Staff’s definition treats divestment receipts as a below-the-line financing item and includes off-budget subsidy-related bond issuance.

In 2007/08, the authorities’ definition of the current deficit (which classifies the special dividend from the RBI as “other capital receipts”), the budget target for the current deficit is 1.5 percent of GDP. Staff includes this item under non-tax revenue.

External debt measured at historical exchange rates.

Issued by the central government to FCI, fertilizer producers, and the state-owned oil refining/distribution companies as compensation for losses incurred from the subsidized provision of commodities.

Sources: Data provided by the Indian authorities; and Fund staff estimates and projections.

In 2007/08, includes a special dividend payment from the RBI amounting to 0.7 percent of GDP. The authorities include this item under “other capital receipts” rather than non-tax revenue.

Includes the surcharge on Union duties transferred to the National Calamity Contingency Fund.

Excludes off-budget subsidy-related bond issuance.

Authorities’ treatment of state debt swap scheme (DSS) in 2002-05 shows the prepayment by States of on-lent funds to the center as net lending. The Center’s prepayment of its debt to the National Small Savings Fund (NSSF) is treated as a capital expenditure.

In 2007/08, includes roughly 0.7 percent of GDP for the government’s purchase of SBI shares from the RBI.

Authorities’ definition treats divestment as a revenue item until 2005/06 (included); excludes off-budget subsidy related bond issuance.

Staff’s definition treats divestment receipts as a below-the-line financing item and includes off-budget subsidy-related bond issuance.

In 2007/08, the authorities’ definition of the current deficit (which classifies the special dividend from the RBI as “other capital receipts”), the budget target for the current deficit is 1.5 percent of GDP. Staff includes this item under non-tax revenue.

External debt measured at historical exchange rates.

Issued by the central government to FCI, fertilizer producers, and the state-owned oil refining/distribution companies as compensation for losses incurred from the subsidized provision of commodities.

Table 6.India: General Government Operations, 2003/04–2007/08 1/
2003/042004/052005/062006/072007/08
Staff proj.Est. 2/BudgetStaff proj. 3/
(In billions of rupees)
Total revenue and grants5,1716,1277,1898,6488,70210,36510,652
Tax revenue 4/4,1434,9415,9107,2987,3048,5438,888
Nontax revenue 5/6/1,0061,1561,2501,3261,3731,8001,743
Grants22313025252121
Total expenditure and net lending 7/8/7,6838,4109,60011,21411,25112,94213,289
General government balance-2,512-2,283-2,411-2,566-2,549-2,577-2,636
Financing2,5122,2832,4112,5662,5492,5772,636
External (net)-1351487579859191
Domestic (net)2,6472,1362,3362,4872,42,4862,545
Disinvestment receipts1704400000
(In percent of GDP)
Total revenue and grants18.719.620.221.021.122.422.6
Tax revenue 4/15.015.816.617.717.718.418.8
Nontax revenue 5/6/3.63.73.53.23.33.93.7
Grants
Total expenditure and net lending 7/8/27.826.926.927.8227.327.928.2
General government balance-9.1-7.3-6.8-6.2-6.2-5.6-5.6
(including disinvestment receipts)-8.5-7.2-6.8-6.2-6.2-5.6-5.6
(augmented with off-budget bonds)-7.1-7.2-7.2-5.6-6.8
Domestic financing (net)9.66.86.56.06.05.45.4
Memorandum items:
Primary balance-2.7-1.2-10.0-0.6-0.4-0.10.0
Nondefense capital expenditure3.12.92.70.83.14.23.7
Net interest payments6.46.15.85.65.85.55.6
General government balance-9.1-7.3-6.8-6.2-6.2-5.6-5.6
Central government-5.1-4.2-4.1-3.6-3.5-3.3-3.3
State and union territory governments-4.5-3.5-2.5-2.7-2.7-2.4-2.4
Consolidation items 9/0.40.4-0.10.10.00.10.1
Off-budget subsidy-related bond issuance0.31.01.00.01.2
General government debt85.785.782.979.379.076.675.2
Sources: Data provided by the Indian authorities; state level data from the RBI State Finance Bulletin. Fund staff amalgamate and prepare projections.

The consolidated general government comprises the central government (CG) and state governments.

Based on RBI’s estimate of provisional outturn for state finances.

Based on staff’s projection of state finances.

Tax revenue = Tax revenue of central government (CG), including NCCF and states’ share, plus state tax revenue.

Nontax revenue = Nontax revenue of CG, less interest payments by states on CG loans, plus nontax revenue of states.

In 2007/08, includes a special dividend payment from the RBI amounting to roughly 0.7 percent of GDP. The authorities include this item under “other capital receipts”.

Expenditure and net lending = Total expenditure and net lending of CG (authorities’ definition excluding off-budget bonds), less net loans and grants to states and union territories, plus total expenditure of states (excluding interest payments on CG loans).

In 2007/08, includes 0.7 percent of GDP for the government’s purchase of SBI shares from the RBI.

Above-the-line items in the CGA, which cancel out in the consolidation (e.g., loans to states).

Sources: Data provided by the Indian authorities; state level data from the RBI State Finance Bulletin. Fund staff amalgamate and prepare projections.

The consolidated general government comprises the central government (CG) and state governments.

Based on RBI’s estimate of provisional outturn for state finances.

Based on staff’s projection of state finances.

Tax revenue = Tax revenue of central government (CG), including NCCF and states’ share, plus state tax revenue.

Nontax revenue = Nontax revenue of CG, less interest payments by states on CG loans, plus nontax revenue of states.

In 2007/08, includes a special dividend payment from the RBI amounting to roughly 0.7 percent of GDP. The authorities include this item under “other capital receipts”.

Expenditure and net lending = Total expenditure and net lending of CG (authorities’ definition excluding off-budget bonds), less net loans and grants to states and union territories, plus total expenditure of states (excluding interest payments on CG loans).

In 2007/08, includes 0.7 percent of GDP for the government’s purchase of SBI shares from the RBI.

Above-the-line items in the CGA, which cancel out in the consolidation (e.g., loans to states).

Table 7.India: Macroeconomic Framework, 2003/04–2011/12 1/
Prov.Projections
2003/042004/052005/062006/072007/082008/092009/102011/112010/12
Growth (percent change)
Real GDP (at factor cost)8.57.59.09.48.78.38.28.28.1
Real GDP (at factor cost, on calendar year basis)6.97.99.09.78.98.48.28.28.1
Prices (percent change, period average)
Wholesale prices (1993/94 weights)5.46.54.45.53.63.63.93.93.9
Consumer prices3.93.84.46.75.94.33.93.93.9
GDP deflator3.84.44.45.85.33.94.54.34.2
Interest rate on general government domestic debt (percent)8.98.68.08.38.37.17.67.88.0
Saving and investment (percent of GDP)
Gross saving 2/30.431.232.634.235.636.036.837.037.2
Gross investment3/28.031.533.835.337.038.038.638.939.1
Fiscal position (percent of GDP)
Central government balance - authorities 4/-4.5-4.0-4.1-3.5-3.3-3.0-3.0-3.0-3.0
Central government balance - staff 5/-5.1-4.2-4.5-4.5-4.5-3.9-3.3-3.2-3.2
General government balance - staff 5/-9.1-7.3-7.1-7.2-6.8-6.4-5.8-5.4-5.0
General government debt85.785.782.979.075.272.469.566.864.1
External trade (percent change, BOP basis)
Merchandise exports (in U.S. dollar terms)23.328.523.420.921.515.912.413.114.9
Merchandise imports (in U.S. dollar terms)24.148.632.022.326.018.612.113.013.7
Balance of payments (in billions of U.S. dollars)
Current account balance14.1-2.5-9.2-9.6-17.4-25.1-26.8-29.7-32.8
(in percent of GDP)2.3-0.4-1.1-1.1-1.5-1.9-1.9-1.9-1.9
(in percent of GDP, calendar year basis)1.50.1-1.0-1.1-1.4-1.8-1.9-1.90.0
Foreign direct investment, net2.43.74.78.423.522.124.525.528.2
Portfolio investment, net (equity and debt)11.49.312.57.130.622.718.715.916.7
Overall balance31.426.215.136.693.945.542.940.341.2
External indicators
Gross reserves (US$ bn. end-period)113.0141.5151.6199.2296.1341.6384.5424.8466.0
(in months of imports) 6/9.28.77.67.89.810.09.99.69.0
External debt (percent of GDP, end-period)18.517.817.817.117.918.318.518.718.9
Of which: short-term debt 7/1.83.12.02.12.93.33.63.94.3
Ratio of gross reserves to short-term debt (end-period)10.76.59.510.512.211.210.29.28.3
Debt service (percent of current acct. receipts)16.06.09.75.15.56.16.46.46.3
Memorandum items (in percent of GDP):
Off-budget subsidy related bond issuance 8/0.00.00.31.01.20.90.30.20.2
Sources: Data provided by the Indian authorities; CEIC Data Company Ltd.; and Fund staff estimates and projections.

Data are for April-March fiscal years.

Differ from official data due to revisions in the current account.

Statistical discrepancy adjusted.

Divestment proceeds are treated as revenue until 2005/06 (included); excludes off-budget bond issuance.

Divestment is treated as financing; includes off-budget bond issuance.

Imports of goods and services projected over the following twelve months.

Residual maturity basis, except contracted maturity basis for medium and long-term non-resident Indian accounts.

Issued by the central government to FCI, the state-owned oil refining/distribution companies, and fertilizer companies as compensation for losses incurred from the provision of subsidies.

Sources: Data provided by the Indian authorities; CEIC Data Company Ltd.; and Fund staff estimates and projections.

Data are for April-March fiscal years.

Differ from official data due to revisions in the current account.

Statistical discrepancy adjusted.

Divestment proceeds are treated as revenue until 2005/06 (included); excludes off-budget bond issuance.

Divestment is treated as financing; includes off-budget bond issuance.

Imports of goods and services projected over the following twelve months.

Residual maturity basis, except contracted maturity basis for medium and long-term non-resident Indian accounts.

Issued by the central government to FCI, the state-owned oil refining/distribution companies, and fertilizer companies as compensation for losses incurred from the provision of subsidies.

Table 8.India: Indicators of Financial System Soundness, 2003/04–2007/08
2003/042004/052005/062006/072007/08
Q1 (Prov.
Measures of financial strength and performance 1/
Risk-weighted capital adequacy ratio (CAR)12.912.812.312.312.6
Public sector banks13.212.912.212.412.9
Old Private Sector Banks13.712.511.712.113.0
New Private Sector Banks10.212.112.612.011.6
Foreign banks15.014.013.012.412.3
Number of institutions not meeting 9 percent CAR1231
Public sector banks0000
Old Private Sector Banks0231
New Private Sector Banks1000
Foreign banks0000
Net nonperforming loans (percent of outstanding net loans) 2/3/2.82.01.21.01.2
Public sector banks3.12.11.31.11.2
Old Private Sector Banks3.82.71.71.00.9
New Private Sector Banks1.71.90.81.01.3
Foreign banks1.50.80.80.70.8
Gross nonperforming loans (percent of outstanding loans) 3/7.25.23.32.52.8
Public sector banks7.85.53.62.72.9
Old Private Sector Banks7.66.04.43.13.1
New Private Sector Banks5.03.61.71.92.5
Foreign banks4.62.81.91.82.0
Number of institutions with net NPLs above 10 percent of advances9441
Public sector banks0000
Old Private Sector Banks2000
New Private Sector Banks1000
Foreign banks6441
Net profit (+)/loss (-) of commercial banks 4/0.80.90.90.91.0
Public sector banks1.10.90.60.80.9
Old Private Sector Banks0.20.00.30.51.1
New Private Sector Banks-0.60.80.60.60.8
Foreign banks1.42.01.51.92.2
Balance sheet structure of all scheduled banks
Loan/deposit ratio57.065.572.074.671.5
Investment in government securities/deposit ratio44.943.534.330.531.5
Lending to sensitive sectors (in percent of loans and advances)
Real estate1.812.717.2
Capital market0.41.41.5
Commodities1.10.20.3
Sources: Reserve Bank of India; and Fund staff calculations.

Some loan classification and provisioning standards do not meet international standards.

Gross nonperforming loans less provisions.

Starting in 2001/02, figure includes ICICI, formerly a large development finance institution, which merged with ICICI Bank Ltd. in 2002.

In percent of total assets.

Sources: Reserve Bank of India; and Fund staff calculations.

Some loan classification and provisioning standards do not meet international standards.

Gross nonperforming loans less provisions.

Starting in 2001/02, figure includes ICICI, formerly a large development finance institution, which merged with ICICI Bank Ltd. in 2002.

In percent of total assets.

Table 9.India: Indicators of External Vulnerability, 2003/04–2007/08 1/
2003/042004/052005/062006/072007/082/
Financial indicators
General govenment debt (percent of GDP)85.785.782.975.275.2(Projection)
Broad money (percent change, 12-month basis)16.712.321.820.822.8As on 11/23/07
Private sector credit (percent change, 12-month basis)13.026.032.425.721.7As on 11/23/07
91 day T-bill yield (percent; end period)4.25.36.18.07.4As on 12/18/2007
91 day T-bill yield (real, percent; end period) 3/-1.1-1.11.62.43.6As on 12/18/2007
External indicators
Exports (percent change, 12-month basis in US$) 4/5/23.328.523.920.935.6(October 2007)
Export volume (percent change, 12-month basis) 5/10.711.515.516.315.3(Projection)
Imports (percent change, 12-month basis in US$) 4/5/24.648.632.322.324.3(October 2007)
Import volume (percent change, 12-month basis) 5/8.828.020.013.213.2(Projection)
Terms of trade (percent change, 12 month basis) 5/-2.6-2.9-4.2-1.3-1.3(Projection)
Current account balance (percent of GDP)2.3-0.4-1.1-1.5-1.5(Projection)
Capital and financial account balance (percent of GDP)2.84.02.94.99.4(Projection)
Of which: net portfolio investment (debt and equity)1.91.31.60.82.6(Projection)
Other investment (loans, trade credits, etc.)2.11.23.55.22.8(Projection)
Net foreign direct investment0.50.50.90.92.0(Projection)
Foreign currency reserves (billions of US$)131.5141.5151.6199.2273.5(November 2007)
RBI forward liabilities (billions of US$)1.40.00.00.00.0(October 2007)
Official reserves in months of imports (of goods and services)9.28.77.67.89.8(Projection)
Ratio of foreign currency reserves to broad money (percent)24.627.526.826.328.8(October 2007)
Total short-term external debt to reserves (percent)9.315.510.69.58.2(Projection)
Total external debt (percent of GDP)18.517.715.717.917.9(Projection)
Of which: public sector debt8.37.56.76.14.9(Projection)
Total external debt to exports of goods and services (percent)119.995.975.975.081.5(Projection)
External interest payments to exports of goods and services (percent)4.73.13.13.13.1(Projection)
External amortization payments to exports of goods and services (percent)15.74.88.32.93.4(Projection)
Exchange rate (per US$, period average)45.944.945.245.540.5As on 12/18/2007
REER (y/y change in percent; end period) 6/1.51.50.20.26.3(November 2007)
Financial market indicators
Stock market index (end period)5,5916,49311,28013,07219,080As on 12/18/2007
Foreign currency debt rating
Moody’s Investor ServicesBaa3Baa3Baa3Baa3Baa2(November 2007)
Standard and Poor’sBBBB+BB+BBB-BBB-(November 2007)
Fitch RatingsBBBB+BB+BBB-BBB-(November 2007)
Sources: Data provided by the Indian authorities; Bloomberg LP; IMF, Information Notice System; and Fund staff estimates and projections.

April-March fiscal year.

Latest date available or staff estimate, as noted.

Nominal yield is less than actual WPI inflation, when negative.

Data on BOP basis.

Merchandise trade only; volumes are derived from partner country trade price deflators from the WEO database.

Source: IMF, Information Notice System.

Sources: Data provided by the Indian authorities; Bloomberg LP; IMF, Information Notice System; and Fund staff estimates and projections.

April-March fiscal year.

Latest date available or staff estimate, as noted.

Nominal yield is less than actual WPI inflation, when negative.

Data on BOP basis.

Merchandise trade only; volumes are derived from partner country trade price deflators from the WEO database.

Source: IMF, Information Notice System.

Table 10.Comparative Size of Capital Markets (2006)

(In billions of U.S. dollars and percent of GDP) 1/

Stock Market

Capitalization
Debt SecuritiesBank

Assets 2/
Bonds, Equities,

and Bank Assets 3/
PublicPrivateTotal
Australia929123.110714.175199.5858113.61,381182.93,167419.6
Canada1,472116.070255.363349.91,336105.32,033160.24,841381.4
Japan4,865111.46,751154.61,96945.18,719199.66,617151.520,201462.5
New Zealand4240.22221.055.12726.1154149.3223215.6
United States17,436131.66,23447.120,502154.826,736201.910,28577.754,457411.2
China1,14443.579130.142216.01,21346.14,126156.96,483246.5
Hong Kong, PRC1,715905.02010.69550.311560.9847446.92,6781,412.8
India81692.130534.4414.634639.075785.41,919216.4
Indonesia13737.78523.4205.610629.014941.0392107.7
Korea81591.846852.664372.41,111125.11,058119.12,984336.0
Malaysia235155.86341.711676.6179118.3297196.7711470.8
Philippines6858.16556.0129.97765.96858.5213182.5
Singapore364275.35642.66851.412494.0337254.7825624.0
Taiwan, POC650182.610429.311933.422362.8729204.91,602450.3
Thailand13866.87636.84622.312259.1228110.8488236.6
Chile169116.11812.63221.85034.411276.9330227.4
Mexico36943.921325.418922.440247.823928.41,010120.2
Peru4851.41213.155.91819.02627.99298.4
Russia1,030105.2636.4616.312412.734835.51,502153.4
Sources: World Federation of Exchanges, Bank for International Settlements, Bankscope, Bloomberg LP.

Percent of GDP are in italics.

Commercial bank assets, end-2006.

Sum of the stock market capitalization, debt securities, and bank assets.

Sources: World Federation of Exchanges, Bank for International Settlements, Bankscope, Bloomberg LP.

Percent of GDP are in italics.

Commercial bank assets, end-2006.

Sum of the stock market capitalization, debt securities, and bank assets.

Table 11.India: External Debt Sustainability Framework, 2003/04–2012/13(In percent of GDP, unless otherwise indicated)
ActualProjections
2003/042004/052005/062006/072007/082008/092009/102010/112010/1122012/13
Debt-stabilizing

non-interest

current account 6/
Baseline: external debt18.517.815.817.117.918.318.518.718.919.0-3.2
Change in external debt-2.1-0.7-2.01.30.70.40.20.20.20.1
Identified external debt-creating flows (4+8+9)-7.7-3.9-3.4-2.6-4.3-2.9-2.5-2.1-2.1-1.9
Current account deficit, excluding interest payments-3.1-0.30.50.30.81.11.00.90.90.8
Deficit in balance of goods and services0.62.63.53.54.04.23.93.73.63.4
Exports15.518.520.722.921.923.624.525.526.628.0
Imports16.121.124.126.425.927.928.429.330.231.4
Net nondebt creating capital inflows (negative)-2.3-1.9-2.1-1.7-4.6-3.5-3.0-2.6-2.5-2.4
Automatic debt dynamics 1/-2.3-1.7-1.8-1.2-0.5-0.5-0.5-0.4-0.4-0.3
Contribution from nominal interest rate0.70.70.60.70.70.80.91.01.01.0
Contribution from real GDP growth-1.5-1.3-1.4-1.3-1.1-1.3-1.3-1.4-1.4-1.4
Contribution from price and exchange rate changes 2/-1.6-1.1-1.0-0.6
Residual, including change in gross foreign assets (2-3) 3/5.63.21.43.95.03.32.72.32.22.0
External debt-to-exports ratio (in percent)119.996.776.675.081.577.375.373.471.067.8
Gross external financing need (in billions of U.S. dollars) 4/5.213.030.624.338.060.769.979.790.3102.0
In percent of GDP0.91.93.82.73.24.74.95.05.15.2
Scenario with key variables at their historical averages 5/23.424.725.425.725.825.7-2.6
Key macroeconomic assumptions underlying baseline
Real GDP growth at market prices (in percent)8.48.39.29.48.68.38.28.28.18.0
GDP deflator in US dollars (change in percent)9.46.76.03.518.72.02.52.32.22.1
Nominal external interest rate (in percent)4.24.24.15.15.14.95.35.86.06.0
Growth of exports goods and services (U.S. dollar terms, in percent)25.037.929.725.123.619.115.315.115.216.1
Growth of imports goods and services (U.S. dollar terms, in percent)18.651.732.623.726.818.713.114.014.014.8
Current account balance, excluding interest payments3.10.3-0.5-0.3-0.8-1.1-1.0-0.9-0.9-0.8
Net non-debt creating capital inflows2.31.92.11.74.63.53.02.62.52.4
Source: Fund staff projections.

Derived as [r - g - ρ(1+g) + ea(1+r)]/(1+g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; ρ = change in domestic GDP deflator in U.S. dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1 +g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Source: Fund staff projections.

Derived as [r - g - ρ(1+g) + ea(1+r)]/(1+g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; ρ = change in domestic GDP deflator in U.S. dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1 +g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

1

See the Selected Issues paper.

2

The central government issued bonds amounting to 1 percent of GDP to oil companies and the Food Corporation of India to offset subsidy-related losses. Staff treats these quasi-fiscal outlays as budgetary expenditure.

3

Fuel prices are administered. Full oil-price pass-through would add 3⅓ percentage points to WPI inflation.

4

NPLs would have to roughly double to push the capital adequacy ratio of the weakest banks below the statutory level of 9 percent (Box 3).

5

See Oura, Wild or Tamed? India’s Potential Growth, IMF Working Paper 07/224.

6

Staff estimates annualized sterilization costs and the tax on the banking system from higher reserve requirements at about $3 billion (0.2 percent of GDP).

7

Evidence consistent with this notion is presented in Patnaik and Shah, “Does the Currency Regime Shape Unhedged Currency Exposure” (NIPFP Working Paper, 2007).

8

See the Selected Issues paper.

9

See the Selected Issues paper.

10

See the Selected Issues paper.

11

Lowering the SLR would require offsetting monetary operations to avoid a sharp rise in liquidity.

12

Pension funds are allowed to invest up to ten percent of annual accruals in corporate bonds, while total FII investment is capped at $1.5 billion.

13

See the Selected Issues paper.

14

Banks face regulatory limits on their own foreign exchange exposure.

15

McKinsey Global Institute, 2006, “Accelerating India’s Growth Through Financial System Reform.”

16

“Developing Debt Markets in India,” speech by RBI Governor Y.V. Reddy, October 18 2007.

17

Bond issuance (in compensation for losses related to commodity subsidies) is expected to reach 1.2 percent of GDP this year, primarily to oil producers (0.8 percent of GDP) and fertilizer producers (0.3 percent of GDP).

18

Staff projects this year’s revenue deficit at 0.8 percent of GDP. However, this includes a one-off special dividend payment from the RBI amounting to 0.7 percent of GDP.

19

See WP/07/268.

20

Pay Commissions make recommendations on government pay scales every ten years. The SPC’s recommendation is expected by April 2008.

21

Government studies find that 58 percent of subsidized food goes to non-poor families and that subsidized liquefied petroleum gas is widely used by middle-class households.

22

See the Selected Issues paper.

23

The FRBM Rules (2004) set out annual reductions in the revenue and overall deficits. While the aim of the FRBMA is to achieve revenue balance (and an overall deficit of 3 percent of GDP) by March 2009, the annual deficit reduction targets are set in perpetuity.

24

The fiscal condition of some states remains worrisome, however.

25

In this connection, they acknowledged that the official deficit was understated, though they noted that subsidy-related bonds are considered extra-budgetary because India’s fiscal accounts are on a cash basis.

26

They also noted that because some central government transfers to states are classified as revenue expenditure when they actually finance capital expenditure (in education and health), the revenue deficit was overstated.

27

Among 26–30 year olds, unemployment rates rise from 0.5 percent for the illiterate to 15.4 percent for those with postgraduate education and above.

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