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Business Environment and Policy

Dr. V L Rao

Professor

Dr. Radha Raghuramapatruni Assistant Professor

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Rangarajan (plus current information)

Economic Growth (Growth of Real GDP)

1950-1980: 3.7%1981-82 to 1990-91: 5.6%

Q. 1990s ? (Appendix Table 1: RBI AR)

Q. 2000-01 to 2009-10 ?

Q. Why called µReal¶ GDP?

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Recent Years %2005-06 9.5

2006-07 9.72007-08 9.0

2008-09 6.72009-10 8.0

2010-11 8.5

Q. Why did it fall in 2008-09?

Q. Which country has > 10% growth?

Q. India¶s growth rate expected in 2011-12: _____ %

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Current Account Deficit (CAD)

(Difference between export and import of goods andinvisibles, e.g. tourism, shipping)

$ billion As % of GDP*

2008-09 27.9 ?

2009-10 38.4 ?

2010-1144.3 ?

(Source: Appendix Table 1, RBI AR)

CAD / GDP of > 3% considered not good.

Note: More about this in BoP Section

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FX Reserves (Foreign currency assets + gold + SDRs +Reserve Tranche Position in IMF)

End-March US $ billion1991 5.8 (FCA in June 1991: $1.1

bn)1995 25.22000 38.02004 113.0

2007 199.22008 314.6 (end-May, Peak)2009 252.02010 279.12011 (7 Oct.) 311.5

Q. Why was there a fall in 2009?

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Inflation (WPI) (Appendix Table 1 RBI AR)%

1990-91 to 1999-2000 8.1

2000-01 to 2009-10 5.42007-08 4.72008-09 8.1

2009-10 3.8

2010-11 9.6PM¶s Economic Advisory Council (EAC)

Food inflation main problem: May-June 2011 8.4%Non-food manufactured inflation:

March 2011 8.5%

Apr.-June 2011 7 to 7.3%EAC estimate: WPI July-Oct. 2011 9.0%

(More of this in MP Section)

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Social Indicators

HDI Index

±

Educational component:

mean years of schooling andexpected years of schooling

± Life expectancy component: life expectancy rate atbirth

± Wealth component: GNI per capita (GNI = GDP + net

income from abroad, e.g. remittances andinternational aid)

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HDI 2010 Rankings (out of 169 nations)

Norway 1

Australia 2New Zealand 3

USA 4

Ireland 5

Singapore 27

UAE 32

Sri Lanka 91

Russian Federation 65

Brazil 73

China 89

India 119

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1991

Industrial Policy: Pre-1991 controls abolished

± Barriers to entry and restrictions on growth of firmsremoved

Trade Policy

± Tariffs brought down

Result: improved competition, efficiency and productivityRole of State

± Redefined: expanding in some areas and reducing inothers

± µMore market¶ does not mean µless government¶ butµdifferent government¶. (Shift from control tofacilitation)

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Sectoral Shares and Growth Rates

Agriculture, Industry, Services

Q. Whose share is highest? (Appendix Table 1 RBI AR)Share in GDP (%)

2008-09 2009-10 2010-11

Agriculture 15.7 14.6 14.4

Industry* 20.1 20.2 20.0

Services 64.2 65.2 65.6

(* Mining, manufacturing and electricity. Current share of manufacturing 16%. National Manufacturing Policy

target: 25% by 2020).Too high share of Services is a weak point.

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Q. Whose growth rate is lowest?

% Change

2008-09 2009-10 2010-11

Agriculture -0.1 0.4 6.6

Industry 4.0 8.3 7.8

Mfg 4.2 8.8 8.3

Services 9.5 9.7 9.2

Worst performer : agriculture. Only in 2010-11, it hasimproved.

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Poverty Ratio (%)

1993-94 2004-05

Planning Commission*

Rural 37.3 28.3

Urban 32.4 25.7

Combined 36.0 27.5

Tendulkar Committee**

Rural 50.1 41.8

Urban 31.8 25.7

Combined 45.3 37.2

* Calorie-based ** Based on minimum acceptable level of

livingQ. Why are the estimates higher for the Tendulkar

Committee?

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Sustained Growth

9% possible since savings and investment rates are high.

Savings rate: Gross domestic savings / GDPInvestment rate: Gross domestic investment / GDP

Q. What were the rates prior to 2000? (Appendix Table 1 RBI

AR)Q. What are the saving and investment rates in China?

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Challenges

1. Agriculture

±

Low productivity of land and labour ± Lack of transport infrastructure

Action required:

Better credit delivery

Investment in irrigation and rural infrastructure, etc.2. Infrastructure

± Once only government. Now competition andcooperation between public and private sectors

(More in Infrastructure)

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3. Fiscal Consolidation

Fiscal deficit / GDP %*

2008-09 62009-10 6.7

2010-11 (BE) 5.5

FRBM target 3.0

(More in FP)4. Social Infrastructure

Emphasis on primary education and basic health:

Helps reducing poverty

Quality of expenditure as important as quantum

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5. Good Governance

± Efficient management of economic and social

resources ± Across states in India, outcomes different for same

mix of policies (because of differences in governance)

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Economist, April 23rd, 2011

Q. Good growth rate in 2010-11: How much?

See slide 3Q. Far higher than the low growth (christened µHindu rate¶)

during 1950-1980: how much?

See slide 2

But business confidence low:

± FDI January 2011 y-o-y decline: 48%

± Businessmen and experts in two recent conferences: got together not to praise the country¶s business

environment but to bury it in criticism.

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Q. This statement is similar to which famous statement ?

± World Bank¶s µEase of Doing Business¶ Index -out of 183 countries, ranked:

134 overall, 165th in starting a business, 182nd inenforcing contracts ( More later)

± Legatum Institute¶ ranking on µ Entrepreneurship andOpportunity¶, India ranked 93 out of 110 countries

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Doing Business Report

To build a warehouse:

Mumbai KolkataPermits required 37 27

Days to procure 200 258

Cost as % of

per capita national income 2.718 2.549

(Reflects Rangarajan¶s statement about differences ingovernance across states)

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Legatum Institute Survey

% of entrepreneurs who think the government was doinga very good job:

India 11%

China 30%

The complaints are like the complaints about the weather ±everyone complains about it, but no one does anything

about it.

Q. Whose famous statement is this?

Two major concerns

± Whether the demographic dividend can be realized?

± Corruption

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Demographic Dividend

Increase in working age population (15 ± 64 years) by2020

India 136 m

China 23 m

(Economist , 2 Oct. 2010)

Median age in 2020

India 28

China 37

USA 38

Western Europe 45

Japan 49(Economist , 9 Oct.2010)

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Doubts about realization in India:

± Finding and retaining skilled workers a problem (e.g.garments)

- Unemployable youth (knowledge@wharton ±

handout)

Economist, January 29th, 2011

Indian capitalism looks oligarchic, but is dynamic and

competitive

2009 Paper

In 2005 , there were 8864 firms under 20 years¶ oldaccounting for :

± 56% of total in number

± But only 15% of corporate assets, 17% of sales, and13% of profits

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2011 paper

More evidence of concentration

Share of Sales, %1989 2008

State-owned enterprises 42 37

Business Houses 41 42

Other private firms 3 10

But there is evidence of increased competition

Distribution of Firms, %

1993 2007>20% ROA < 1% 2 ± 3 %

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Case Study of Crompton Greaves

± Maker of electrical appliances and power equipment

±Blue-chip company

± But reported a loss of $33 m in March 2000 due tocompetition

± Threat of Japanese entry brought best technologiesinto India by its European and US rivals

(Joseph Schumpeter : competition can be a threat, evenbefore it is an actuality. ³It disciplines before it attacks.The businessman feels himself to be in a competitivesituation even if he is alone in the field.´)

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Economist, July 23rd 2011

Pre-1991

± Telephones took years to get

± Importing a computer took 3 years and 50 trips toDelhi

July 1991

± High oil prices (Increase -1970: 210%, 1979:135%,1990:40%)

± Fiscal profligacy

Fiscal deficit / GDP (%)

1990-91 8.4

1991-92 6.2

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- FX to last just a fortnight, i.e. enough to financeimports for only 2 weeks (this is called µimport cover¶.More in BoP)

- 47 tonnes of gold airlifted to Bank of England ascollateral for a loan

July 1991 reforms (Manmohan Singh as FM)

± Lasting significance

± Economy became resilient : so not on the brink of another crisis now

± Deserves its spot in the annals of economic history1991 watershed or landmark year

(China in December 1978 and Britain in1846 when itrepealed Corn Laws. More on Corn Laws nexttrimester in µInternational Trade¶ paper.)

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Manmohan Singh as PM

± Economic policy will not regress, but no guarantee of

progress ± Yearly addition to population: 25 m

± Yearly addition to labour force: 10 m

± No progress on malnutrition, schooling and hiring

± 1990s reforms freed markets for outputs, but marketsfor inputs remain unrepaired

70% of infrastructure projects stalled because of problems in acquiring land

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(Examples of land-related issues: At some places,displaced persons for SEZ land did not getadequate compensation, alternative employment

and place to stay.Some IT companies which got land on lease inVizag wanted it to be on sale basis so that it canbe used for real-estate speculation. When denied,

they backed out.) ± Labour laws reform

± Power shortage

± Central government increased spending on schooling

and passed Right to Education Act, but state andlocal governments need to ensure proper follow-up.

± Introduction of GST delayed (more in FP)

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Overheating

± Current growth rate < 8 %.

± For higher growth, interest rates to be reduced, butproduction (supply) takes time while increaseddemand is immediate.

± So higher inflation will result.

Q. Which is the other country showing signs of

overheating? What are the signs?India¶s Chaotic Model of Development

± Services boomed; stagnant mfg

± Exports world class IT, but imports fridges

± Has 15 times more phone subscribers than taxpayers

± Soon to connect to an electronic biometric systemthan to a sewer

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Summary Table

1990 2010

Population, m 839 1,186GDP, $bn (2010 prices) 433 1,538

One of the trillion-dollar economies

GDP per person, $ (2010 prices) 503 1,265

GDP world ranking (current $) 12 10GDP world ranking (PPP $) 9 4

PPP: purchasing-power parity basis

Exports / GDP % 6.9 21.5

Sign of opening upGross saving / GDP % 21.9 34.7

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Adult literacy rate % 4 8.2 68.3

New official poverty rate, % 45.3 32.2

Q. Estimate of Planning Commission or Tendulkar Committee? Explain your answer.

Number of billionaires

in Forbes rich list 1 49

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Demography

± IMF paper : demography has added 1.7 percentagepoints to the growth rate of GDP per person.

Q. What is the difference between percent and percentagepoint?

± India needs to create 10-13 m jobs a year for whichskills, training and growth of manufacturing required.

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Achieving 10% Growth

Recent growth of 8%: Half to three-quarters of this isexplained by more workers and more capital. Butreaching double-digits requires more efficient utilization

Planning Commission target: 9% for the 12th Plan(2012-17)

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Doing Business Report 2011

Executive Summary

183 economies

9 stages of the life cycle of a business (Ease of DoingBusiness):

Starting a business, getting credit, etc. to closing of business

Ranking

Does not tell the whole story of business environment.The report does not deal, e.g. with:

± Quality of infrastructure services

± Macroeconomic conditions

± Workforce skills

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Regulations

All regulations are not bad: e.g.

Efficient and transparent regulation gives equalopportunities to all, not just only for those withconnections

A recent study of company registries in 100 countriesover 8 years found that efficient business registration

systems have a higher firm entry rate and greater business density.

Case Study of Kenyan Garment Producer

± Spent 18 months to get a trial order for school items

from Tesco, the largest retail chain the UK. ± Everything well planned but goods delayed at Kenyan

port and the back-to-school promotion was over.

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Post-crisis Legal and Institutional Reforms

Rising number of insolvencies and debt disputes

Efficient court and bankruptcy procedures ensure thatviable firms continue to operate.

Earlier, many economies in Eastern Europe and Central Asia insolvent firms were liquidated even if viable.

After reforms, average recovery rate in those countrieswas 33 cents on the dollar (cf. average of 69 cents for the OECD high-income countries)

Examples of Positive Impact

Korea: Predictable cargo processing times and rapidturnover by ports provide benefit of some $2 bn annually

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Singapore: Online business registration system for newfirms saves businesses $42 m annually

Ease of Doing Business Rankings

Both 2010 and 2011: top 5 in that order : Singapore, HongKong SAR (China), New Zealand, The UK, the US,Ireland and Australia

Q. What does SAR stand for and what is its significance?

India¶s rank: Marginally improved from 135 in 2010 to 134in 2011

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Regulatory Reform ± 5 years

In 85% of 174 countries, ease of doing business improved

Rw anda Case Study For staring a business:

2005: 9 procedures and official fee amounting to

22.3% of per capita income

2010: 3 days and fee 8.9% of per capita income

No. of entrepreneurs who took advantage: 3,000 in 2008 (earlier, annual average was 700)

2005 2010

Registering Property 371 days 60 days

Transfer fees,% of property value 9.8 0.4

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India: implemented 18 business regulation reforms in 7areas

Mexico: simplified registration formalities resulted in:

± 5% increase in number of registered businesses

± 2.8% increase in employment

E astern E urope and Central Asia Case Study

6 years of business regulation reform:

± Prospect of joining EU

± World financial crisis

Result: a 2009 survey in Georgia showed a new start-up

centre helped businesses save an average of 3.25

% of profits, just from registration services

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Collateral

Laws encouraging all types of assets as collateral:

% of economiesSub-Saharan Africa 35

East Asia and pacific 71

OECD high-income economies 68

Improvements can promote growth of firms and employment

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Infrastructure

11th Plan 12th Plan

(2007-12) (2012-17)

Investment $514 bn $1.025 tr

As share of GDP (%) T 8* 9

Achieved

2008-09 7.18

2011-12 (est.) 8.37

* 10th Plan actual: 5%

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11th Plan 12th Plan

Share of Private Sector (%) 30 (T)* 50

(Projected)

Achieved

2005-06 34.32

2006-07 33.74

11th

Plan 36(anticipated) 36

* 26% earlier

FDI allowed for private sector (domestic and foreign)

Roads, power, ports, and airports 100% Telecom services 74%

Telephone equipment 100%

Aviation 49 100%

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Cost Overruns

(against originally approved costs)

March 1991 61.6%

March 2008 12.06

March 2010* 14.72

October 2010* 20.10

* Reasons for upward trend:

± Projects costing less than Rs. 150 crores excluded from

monitoring system

± Steep rise in prices of steel and cement in 2006-07

Issues in Time and Cost Overruns (Eco. Survey, p.289)

± Tendering of unviable projects

± Bad quality of engineering and planning at theDetailed Project Report (DPR) stage

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± Lack of standardized and sub-optimal contracts

± etc.

M itigation of cost overruns

± Through moving away from item rates to lump sumengineering, procurement and construction (EPC)contracts for large projects

± Creation of greater capacity for project managementand monitoring

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PPP

Appraisal mechanism of PPP projects streamlined:

± To ensure speed

± Eliminate delays

± Adopt international best practices

± Have uniform appraisal mechanism and guidelines

by PPP Appraisal Committee

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V iability Gap Funding

± For PPP projects that are economically essential but

commercially unviable

± Long tenor loans through India Infrastructure Finance

Company (IIFC) Ltd.

± Supports up to 75% of project development expenses in

the form of interest-free loans

± For projects sponsored by state governments andmunicipalities

± Urban sector, health and education, civil aviation, and

roads

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N ational PPP Capacity Building Programme

± Launched Dec. 2010 in collaboration with World Bank

and German KfW

Ashok Chawla¶s Comment

± End products are priced sub-optimally because inputs

and natural resources are provided at µ administered¶prices.

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Monetary Policy

Objectives Maintain adequate liquidity for credit needs and support

investment

Examples of liquidity:

Balancing inflation and growth

Headline inflation, inflationary expectations and asset-price

inflation

Headline inflation: y-o-y inflation48

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Asset price inflation: (e.g. Japan in the 1990s)

Monitor exchange rate and BoP

ER: Earlier problem was appreciation of currency, now

depreciated to Rs.50 per $.

Appreciation hurts exporters and depreciation hurts

importers . Intervention in FX markets by RBI - different from

sterilization. See under MSS below

BoP: will be discussed later under BoP

Maintain stability in financial system (cf. East Asian crisis)

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Major Instruments

LAF (R and RR)

CRR

SLR

MSS

OMO

Interest Rates

Bank rate

Call rate Base rate (formerly BPLR)

50

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LAF: Short-term (usually overnight)

Repo: RBI sells, but repurchases, short-term securities from

commercial banks (as collateral for overnight lending)

Reverse repo: bids invited, but accepted, as decided by RBI

for deposit of surplus funds with RBI. It is not borrowing of RBI

from the commercial banks.

Q. ____ (Repo / Reverse repo) injects liquidity

Q. ____ absorbs liquidity

Wikipedia: Continued with old definition (reverse of the presentone). Anyone can edit the articles. So not reliable. References

at the end of articles, however, can be used because theycant be altered.

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Q. Which rate would be higher? Why?

Cash Reserve Ratio (CRR)

Cash holdings with RBI / total deposits

Q. Hike___ (absorbs / injects) liquidity

17 Jan. 2009 5.00

13 Feb. 2010 5.50

27 Feb. 2010 5.75

24 April 2010 till now 6.00

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SLR (Statutory Liquidity Ratio)

Holding of specified securities / net demand and timeliabilities (NDTL) by scheduled commercial banks (SCBs)

Q. Liabilities refer to the banks _______ (deposits / advances)

Q. Lowering of SLR _______ (injects / absorbs) liquidity.

2004 7 Nov. 2008 25%

w.e.f. 7 November 2008 24%

w.e.f. 7 November 2009 25%

Q. Why was it reduced?

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Q. Why was it raised in 2009? (Answer: see below)

Market Stabilization Scheme (MSS)

Capital inflow release of rupees sterilized by MSS

Issue of Treasury Bills (TBs), and dated securities (< two years)

: 91-, 182-, and 364-day promissory notes issued by

the Government, at a discount

Operated by RBI for the Government . Funds kept with RBI

Only sale; no repurchase by Government. Only redemption at

maturity.

Q. What is the difference between sterilization and intervention?

Q. What is the difference between LAF and MSS?

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Open Market Operations

Sale and purchase of MSS securities

Operated by RBIInterest Rates

Bank rate

Rate charged by RBI on medium-term lending tocommercial banks

6% (unchanged for a long time)

Call rate

Rate at which banks borrow overnight from each other

wide fluctuation 1% to 30%Recent years 3% to 7%

55

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Q: 3% rate reflects _____ (easy / tight) liquidity

Call Rate, Repo Rate and Bank RateCall rate Repo rate

Determined by: S&D RBI

Rate Fluctuates Fixed

Quantity traded No limits Discretion of RBI

Q. What is the difference between repo rate and bank rate?

Q. Which of the following are instruments of MP? Why?

* Call rate * Bank rate *Base Rate

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BPLR and Base Rate (Box III.I)

BPL

RRate charged by commercial banks on loans to borrowers withhighest credit rating.

Drawback: banks were charging sub-BPLR (even other than forexport credit and small loans)

SCBs Sub-BPLR lending (excl. export credit and smallloans) / Total loans

Sept.2008 77%

June 2010 70%57

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Base Rate (since July 2010)

± No lending below Base rate (some exceptions allowed)

±

All lending to be Base rate + borrower-specific charges ± Thus ensured transparency

± Transmission of MP improved

Table 2 Box III.1

Initially increase in repo rate is higher than the av. increasein Base Rate and no. of days to raise Base Rate was alsohigh.

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Increase in Base rate picked up later and the time taken tofollow suit by SCBs came down

Summary of monetary instruments:

Repo

Reverse Repo

CRR

SLR

MSS

OMO

Q. Which of the above is not a direct instrument of RBI?59

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Q. Which one is an instrument of RBI, but was left out?

A. Bank rate

MP in Practice

RBI takes into account: growth and inflation. Announces

indicative projections for growth in: M3, Total Deposits, and

Non-food Credit

Money Supply (M3)

Currency with the public + Demand deposits + Time deposits

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April August 2008

Growth projection for 2008-09: 8.5%

Inflation (y-o-y)June 2007 4.28%

March 2008 7.75%

June 2008 11.05%

August 2008 12.91%

Q . On balance which is more problematic? _______ (Inflation /Growth)

CRR and RR were used.

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Q. CRR and RR ________ (raised / lowered)(Economic Survey 2009-10, T.4.20)

April 2008 August 2008CRR 7.75% 9% (in six tranches)RR 7.75% 9% (in three tranches)

Sept. 2008 Jan. 2009

Global recession deepened FII outflows - Tight liquidity inIndiaQ. Call rate: high or low? ( >10% or <5%)A. > 10%

16 September 2008 13%10 October 2008 19.8%

62

V l d i d

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Volume under repo windowRs crore

Sept. 20081st half 12,5002nd half 68,000

Early October 2008 90,000

Real GDP projection: 7.5% to 8% (down from earlier 8.5%)for 2008-09

Inflation (end-March 2009) projection:7% (down from two-digit inflation)

On balance, growth considered more important

Q. Rates ________ (lowered / raised).

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August 2008 Jan. 2009

CRR 9% 5% (in four tranches)

Released Rs. 1,60,000 crore of liquidity to the banking systemRR 9% 5.5% (in four tranches)

R-RR 6% 4% (in three tranches)

SLR : reduced from 25% to 24% on

8 November 2008

MSS: Starting Sept. 2008, issue of Treasury Bills wassuspended.

Q. Why?

OMO

Q. Nov. 2008 RBI _____ (bought /sold) MSS securities worthRs.37,964 crore

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October 2009

Growth projection: 6% (with an upward bias)- same as before

Inflation expectations:

± weak monsoon

± global upswing in commodity prices

± Domestic D-S imbalance

So inflation projection: 6.5% (with upward bias) - up from 5%Cautious implementation of exit.

Q. Exit from what?

A. Exit from easy MP

Q . SLR back to pre-crisis level of ____ %

65

S A il 2008 F b 2010

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Summary April 2008 Feb. 2010

(Eco. Survey 2009-10,Table 4.20)

April 2008 to Oct. 2008 ± Inflation main problem

± RR raised from 7.75 to 9 (RRR: no change)

± CRR raised till August, but brought down later to easeliquidity

October 2008 onwards

± Recession main problem

± All three rates lowered

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April 2010 onwards

± Inflation again a problem (Economic Survey 2010-11, Table4.3), esp. food inflation

± Well above RBIs comfort level (5.5%)

Shift of policy from management of recovery to managementof inflation

April 2010

All three rates raised by 25 bps

(Economic Survey 2010-11, Table 4.17)

Q. From what level to what level? 67

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Still the real policy rates were negative

Real interest rate is nominal rate less inflation rate.

Q. Why should it be positive?

July 2011 to July 2011

( RBI AR 2010-11, T.III.1)

RR and RRR raised by 25bps or 50 bps tranches

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Fiscal Policy

Receipts and expenditure: Interest payments, direct and indirect

taxes, roads and bridges, PSU disinvestment, subsidies,salaries and pensions, defence, borrowings (excl. MSS), spaceresearch

Q . Why exclude MSS from borrowings?

Receipts: revenue receipts and capital receipts

Expenditure: revenue expenditure and capital expenditure

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Rough distinction: revenue - regular; capital not regular; but

need-based

Revenue Receipts Revenue Expenditure

Capital Receipts Capital Expenditure

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Revenue deficit = revenue expenditure revenue receipts

Fiscal deficit = total expenditure total revenue (revenue

receipts + capital receipts), except borrowings

Q . Why borrowings excluded?

FRBMA targets

By March 2009 Revenue deficit / GDP 0%

Fiscal deficit / GDP 3%

Q. Why an Act?

71

Sources of Tax Revenue

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Sources of Tax Revenue

(Economic Survey, Table 3.3)

Tax revenue = tax rate x income or turnover

Direct tax: cant be passed on

Indirect tax: can be passed on

Share in Tax Revenue,%

2006-07 2010-11

Direct taxes 46.4 58.6

Indirect taxes 51.0 42.2

Q. In 2005-06, which tax contributed the most?

72

Q 2006 07 onwards which tax contributed the highest?

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Q. 2006-07 onwards, which tax contributed the highest?

Q. Excise revenue / GDP ratio: Lowest in which year?

Q. Why?

Q. 2008-09 onwards which tax has lowest share (other than

service tax)?

73

Q Why?

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Q. Why?

Q. From what level to what level?

Q. Why?

74

i l li S S

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Fiscal Policy Strategy Statement

___________________________

Share of GDP, %

Revenue Deficit Fiscal Deficit_2007-08 1.1 2.5

2008-09 4.8 7.8

2009-10 5.3 6.5

2010-11 (RE) 3.4* 5.1*

2011-12 (BE) 3.4 4.6**

2012-13 (T) 2.7 4.1

* BE: 5.5%. But higher revenue from 3G and BWA auction; so <5.7% of 13th Finance Commission

** Committed not to exceed 5.5% 75

Fi l C lid i

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Fiscal Consolidation _________________________________________

Share of GDP, %Gross Tax Revenue___Expenditure_

2003-04 9.2 (Pre-FRBM)2007-08 11.9 (all time high) 15.12008-09 10.8 17.62009-10 9.6 15.72010-11 10.0 (RE) 14.1(BE)

15.4 (RE)*

2011-12 14.0 (BE)___

2008-09 and 2009-10: two years of fiscal expansion

Q. What in the above two tables indicate this?

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* Lower than expected correction additional revenue from 3G

and BWA auctions; so expenditure cut not required to be

steep

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Subsidies

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Subsidies

Fertilizer Subsidy

Nutrient-based Subsidy (NBS) regime introduced except for

urea expected to promote balanced use of fertilizers andincrease ag. productivity

Increase in MRP of urea

Proposal to cover urea also in NBS

Encourage use of bio and organic fertilizers

Q. How does the last point help reduce fiscal deficit?

A. Since it does not require subsidies

P etroleum Subsidy

Decontrol of price

Oil companies provided cash instead of securities from 2009-

10 78

Tax Policy

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Tax Policy

Direct Taxes

Moderate levels and few rates

Widening tax base Use of IT (e.g. e-filing of returns)

Less intrusive system to encourage voluntary compliance

DTC Bill (expected to become Act by April 2012) - Includes,inter alia:

± Integrates and consolidates all direct tax laws

± Minimizes exemptions and deductions

± Replaces profit-linked deductions with investment-linkeddeductions for priority areas

± Increasing Minimum Alternative Tax (MAT) from 18% to18.5%

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± Corporate tax rate for foreign owned companies will be reducedfrom 40% to 30%, same as for domestic companies

Indirect Taxes

Excise duty Reduced from 16% to 12% in December 2008

Reduced further to 10% in February 2009

Continues at 10%, but number of exempt items reduced

Sales Tax, VAT, GSTSales tax: double taxation or cascading taxVAT avoids this introduced by all StatesDrawbacks of VAT: ± States can levy VAT on goods but not on services

80

± Large number of central and state taxes leading to disputes

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Large number of central and state taxes leading to disputes ± Too many exemptions

Goods and Services Tax (GST) Widening tax base and lowering tax rates

New Zealand: tax base 94% of total consumption and rate is15%Singapore: rate is 7%India: rates under discussion

Removal of inter-state trade barriers Central GST, State GST taxation on inputs can be credited

against taxation of outputs (i.e. the VAT system) Interstate GST on interstate trade credited against both

CGST and SGST81

Balance of Payments

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Balance of Payments

Receipts and Payments in $ and past year (cf. Receipts andExpenditure in FP in Rs. and coming year)

Receipts Payments NetCurrent Account

Merchandise(Exports and Imports of

Goods)Invisibles (e.g. tourism)

Capital Account(e.g. FII)

Overall BalanceReserves

82

Q Did we have a surplus in trade balance?

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Q. Did we have a surplus in trade balance?See Table 6.1

InvisiblesNon-factor Services* (e.g. tourism)Income (e.g. interest on NRI deposits)Transfers (e.g. workers remittances)

Q . *Why called non-factor?

Current a/c: recipient country keeps the FX

Capital a/c: owner can take back

83

Q T hi h / h f th f ll i b l ?

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Q. To which a/c each of the following belong?

FDI

Exports of Garments

Shipping

NRI deposits

ECB

FII Software

Tourism

Workers remittances

External assistance Import of oil

Interest on ECB

84

Q . What is the difference between FDI and FII and which one is

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Q

better for India?

Goods and Services Balance:

Merchandise + Non-factor Services

Current Account Balance:

Merchandise + Invisibles

85

Q To which a/c the following belong and why?

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Q. To which a/c the following belong and why?

NRI deposits

Interest on NRI deposits

Workers remittances

Q. Which one is more desirable current a/c surplus or capital

a/c surplus? Why?

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FDI and FII

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(Table 6.1: Portfolio investment is mainly FII)

Negative in 2008-09

Q. Why?

2009-10 FII much higher than FDI

Invisibles

Resilient items: Software and Workers Remittances

($ billion)Software Workers Remittances

2008-09 43.7 44.6

2009-10 48.2 52.1

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CAD / GDP (%)

2005-06 1.2

2006-07 1.02007-08 1.3

2008-09 2.3

2009-10 2.8

Apr.- Sep.2009 2.2

Apr. Sep.2010 3.7

Q. Table 6.2 gives negative sign. The above table doesnt. Why?

Another Achilles Heel

[the first one being high fiscal deficit / GDP ratio]

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Import Cover

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Import Cover

More than 10 months except in 2008-09

Openness of Economy

One measure: (Exports* +Imports*) / GDP, %

2005-06 ?

2009-10 ?

A. Table 6.2 (Goods only)

FX Reserves

Objectives: safety and liquidity

Return optimization - secondary

89

Safety: major investment in low-yield US Treasuries

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Self- insurance mechanism: i.e. maintaining high level of FX

reserves

± Helped India insulate from world economic crises ± But costly (opportunity cost is high investment elsewhere

gives good returns)

Suggestion: multilateral option of pre-arranged line of credit

Not feasible for India, since: ± Foreign investors look at size of reserves

± Reserves are a consequence of FII, not current a/c surplus

90

ER M t

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ER Management

Reducing excess volatility

Preventing speculative activities Maintaining adequate levels of reserves

Developing an orderly FX market

Rs. / US $

31 March 2009 50.95End March 2010 45.15

31 Dec. 2010 44.81

July 2011 43.85

November 2011 52 +91

Reasons for reverse trend after July 2011

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Reasons for reverse trend after July 2011

As Euro zone crisis deepened, demand for $ increased for

investing in Treasuries

Indias fundamentals are perceived to be weakening:

± Fiscal deficit < GDP ratio above 4%

± CAD / GDP ratio > 3%

± Inflation stubborn at 9%

Export target for 2011-12 of $3oo bn may not be reached

because of sluggish US and EU economies

BoT deficit likely to be $150 bn (i.e. demand for $ > supply)

92

When the rate was $1 = Rs. 47, further depreciation was

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When the rate was $1 Rs. 47, further depreciation wasanticipated. So

± exporters were unwilling to part with $

± Importers were anxious to buy $ ± So Re depreciated

NEER, REER (paragraphs 6.57 and 6.58 of BoP handout)

REER is a less effective indicator of rupee competitiveness as far asweights are concerned.

But inflation differentials will have a role in competitivenessExternal Debt (Table 6.13)

Short-term debt / FX reserves, %

India: 1990-91 146.5

2009-10 18.8

93

93

Impossible Trinity or Trilemma (ADBI handout)

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Impossible Trinity or Trilemma (ADBI handout)

Thailand 1997

Example of East Asian Economic Miracle Liberalized capital flows (followed full capital a/c

convertibility), maintained fixed ER and so could not have an

independent MP

External debt

1990 $29 bn (34% of GDP)

1997 $108.7 bn (59% of GDP)

± Short-term debt end-1996: $47.7 bn > FX reserves $38.7

bn (more than 100%)

Crony capitalism and asset price bubbles

94

When bubble burst and capital was leaving

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When bubble burst and capital was leaving

± Depreciation of currency was not an option since its ER

was fixed

± Thailand tried by increasing interest rates to attract capital

back, but did not succeed, because investors lost

confidence

Q. Page 2, para 2: what is the wrong paradigm that is

mentioned, between current a/c and capital a/c?

Clue: it is similar to Indias case (see Slide 90)

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Carry Trade

(Para 6.69 of BoP handout)

NRIs were borrowing at low interest rates and depositing athigher rates in India 9called carry trade. To discourage this,

rates in India were lowered

Dutch Disease

Discovery of North Sea oil Huge FX inflow

Currency appreciated

Traditional Dutch export industries suffered

Similarities in India Till recently Re appreciated due to FII inflow and reliance on

Software. Industries like garments and leather goods suffered

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