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THE ECONOMIC SURVEY OF INDIA (2016-17)

Current Affairs (Indian Economy)

Introduction & Overview

Riku Sayuj

Why Read the Economic Survey The ES reviews the developments in the Indian economy over the previous 12 months, highlights the policy initiatives & performance of the government and the prospects of the economy in the short to medium term. •  Biggest Source of Economy questions •  Almost all dynamic questions and theoretical questions can be

traced to it •  Even questions from Environment & Eco can come from it •  Close to 30-40% of Mains questions (GS-III) are related to the ES! •  Gives you reasons for most things happening in the economy –

useful for almost all economy mains questions •  Gives you explanations for most major Govt initiatives – v useful •  Gives good phrases, etc. that you can use in your answers

•  Example: Good economics is good politics •  Learn to frame answers and use appropriate language!

How to Read the Economic Survey • Vol 1 & Vol 2?

•  Vol 1 conceptual & analytical; Vol 2 is the supporting data •  Both need to be read in parallel •  This time vol 2 is to released in a delayed manner so we have only vol 1

with us. We will cover volume 2 later, once it is released • Boxes? • Phrases and words? •  Figures? • Arguments? • Recommendations? • Note making? •  Theory part?

How to Read the Economic Survey The ES will follow this pattern overall as well in each chapter: • What is the problem? (define) (+list of important problems) • Why Worry? (why important) (+and how they interact) • Why the Problem? (how it happened) • How to Solve? (+will they work) • Analyze Solutions (reforms, schemes, Policy actions, etc.) A good way to answer most Economy Questions – ES is an illustrated guide J

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Importance of The Language of The ES The Beauty of the Economic Survey is the text of the ES

•  Only ideas are not enough – the actual phrases are important too

• Economics is a language – and you have to get used to using the language

•  The language of the ES is to be used throughout – in all answers you practice, when you discuss, when you think •  That will help you a lot

• So in these lectures we will discuss and understand all the ideas, but we will keep original language of ES as much as is required and highlight and underline those. •  – go through these from the notes and keep using them from now on •  And use the language in your answers later…

Structure of the Course •  Lecture I – Previous Economic Survey Gist + First 2 chapters •  Lecture II – Next 5 chapters •  Lecture III – Last 5 chapters •  Lecture IV – Last 4 Chapters •  Lecture V – Budget + Popular recommendations by other

committees etc.

The Links Back • ES 2016-17 starts by talking about 2014-15 ES’s “Soft Spot”

and talked about need for reforms •  Last year survey told Soft spot still there and talked about

urgent need for reforms •  This year survey suggests shifts required and explores effects

of major reforms that have been initiated and the need for those still not initiated fully!

• Every ES assumes you have read the previous one J

Economic Survey (2015-16) 1.  Introduction & Overview 2.  Chakravyuh Challenge (TBS from last to last year) 3.  Spreading JAM (DBT made better) 4.  Agriculture – More form Less (MSP) 5.  Mother & Child (invest in early life health) 6.  Bounties to Well off (For whom the Subsidies Toll) 7.  Fiscal Capacity (taxing (bracket, legitimacy) and spending

capacity (improved delivery)) 8.  PTAs (FTA impact and WTO) 9.  Fertilizer Sector (Urea rationalize) 10.  Labour Markets (Demographic Challenge) 11.  Powering India (UDAY, tariff structure progressivity)

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Economic Survey (2015-16) Chapter 1: Introduction & Overview (Economic Outlook) •  How is India Performing?

•  ES measured India’s economic performance against two distinct benchmarks: •  India versus other countries - good •  India versus its own medium-term potential – still scope for improvement (Potential

GDP concept) •  ES said: For an economy where exports have declined due to weak global demand

and private investment remains weak, India’s economy is performing remarkably well

•  MP & Inflation: •  ES says: The effective stance of monetary policy could be relaxed and in

two ways: •  First, by easing liquidity conditions to make them consistent with the current policy

rate •  Incomplete Pass-through of MP and liquidity tightening – makes TBS worse

•  Second, by further lowering the policy rate consistent with meeting the inflation target while supporting weakening economic activity and corporate balance sheets.

Economic Survey (2015-16) Chapter 1: Introduction (Economic Outlook) •  FP – Consolidation was recommended then •  India’s Global Economic Contribution increasing. • Major Challenges – Monsoon, TBS, increased exposure to

global events •  In other words, a 1 percentage point decrease in the world growth rate is

now associated with a 0.42 percentage point decrease in Indian growth rates.

•  Rapid trade growth needed and WTO essential

Fiscal Policy - Recommendations The fiscal sector registered three striking successes: 1.  Ongoing fiscal consolidation (set to meet target)

•  Targets: 3.5% for 2016-17 (achieved the 3.9% in 2015-16) •  RD – 2.8% to 2.5% •  Fiscal consolidation was recommended! (but changed in this year’s ES)

2.  Improved indirect tax collection efficiency •  Tax Revenue is “buoyant” (GST supposed to further this this year)

3.  Improvement in the quality of spending at all levels of government •  Improvement in quality by shifting expenditures away from current to capital

expenditures. •  Fourteenth Finance Commission recommendations = large devolution toward

the states •  Re-structuring of the centrally sponsored schemes

Box 1.3: Assessing the Quality of General Government Spending in FY2016

•  First, there was a significant increase in aggregate capital expenditure of the general government.

• Second, in the first 8 months of FY2016, general government expenditure witnessed an uptick in the three major social sectors: 1. Education, 2. Health, and 3. Agriculture and Rural Development •  Real expenditure on education, health, and agriculture and rural

development recorded growth of 4.7 per cent, 9 per cent and 8.1 per cent, respectively.

•  Important - these are good indicators of spending. Quotable J

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Economic Survey (2015-16) Chapter 2: The Chakravyuh Challenge •  The Exit Problem:

•  Origins and Potential Solutions Proposed

•  The Twin Balance Sheet Challenge: •  Potential Solutions •  TBS is actually from last to last year, contd. in last year’s ES

The Twin Balance Sheet Challenge The impaired financial positions of the Public Sector Banks (PSBs) and some large corporate houses • ES says: it is clear that the TBS problem is the major

impediment to private investment, and thereby to a full-fledged economic recovery.

1.  Stressed assets (nonperforming loans plus restructured assets) have been rising ever since 2010, impinging on capital positions.

2.  Corporate profits are low while debts are rising, forcing firms to cut investment to preserve cashflow.

•  This situation is not sustainable; a decisive solution is needed.

4 Rs : Recognition, Recapitalization, Resolution, and Reform

Resolving the TBS challenge comprehensively would require 4 Rs : Recognition, Recapitalization, Resolution, and Reform. 1.  Banks must value their assets as far as possible close to true

value (recognition) as the RBI has been emphasizing 2.  Once they do so, their capital position must be safeguarded via

infusions of equity (recapitalization) as the banks have been demanding

3.  The underlying stressed assets in the corporate sector must be sold or rehabilitated (resolution) as the government has been desiring

4.  And future incentives for the private sector and corporates must be set right (reform) to avoid a repetition of the problem, as everyone has been clamoring.

Possible Solutions to Try Five possible Solutions: 1.  The Bypass Option - Avoid exit through liberal entry

•  Example: Air India – solves

This entry-favoring approach had the virtue of political expediency. • Achieving exit via privatizing public sector companies would have

encountered significant • Allowing private sector companies to enter the market without

touching the public sector incumbents bypassed some of these costs. •  And the strategy broadly worked.

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Possible Solutions to Try 2.  Direct Policy Corrections – Bills and Codes J

•  Example: Bankruptcy Code for Company who took loan; For PPP project?

3.  Technology Solutions – Spreading JAM across India! •  Many of the exit problems—in relation to fertilizer, agriculture, sugar etc—can

be addressed through technology and leveraging the potential of JAM. •  DBT in fertilizer and other input use can achieve targeting which allows the

poor to be protected while allowing the underlying and persistent distortions to be removed.

Possible Solutions to Try 4.  Expose True Cost of No Exit – Transparency

•  Throw light on the true costs of the status quo - of MSP over-production costs, etc. •  Public pressure can be made to be on the side of reforms via such education…

5.  Highlight Benefits of Exit – Exit as Opportunity •  For example, resources earned from privatization could be earmarked for

employee compensation and retraining •  Thus even the vested interest groups can be made pliable

Macroeconomics in ES A Theoretical Survey of the Economy Y = C+I+G+NX • Remember the theory! J •  For the outlook for 2016-17, we need to examine each of the

components of aggregate demand: 1.  Net Exports (NX) (declining + global issues) 2.  Consumption (C) (strengthening) 3.  Private investment (I) (Corporate debt high, NPAs high) 4.  Government Spending (G) (consolidation Recommended) •  The recent growth revival in India is predominantly

consumption-driven

Result? From the angle of aggregate demand, domestic demand has remained reasonably strong, despite reduction in overall investment. •  Private consumption has, of late, been the major driver of growth.

•  The possible shifts on the consumption front in the next year are: •  First, consumption incentives from declining oil prices may partially recede in the

next year •  Second, the pay commission awards could potentially add modestly to consumption

demand •  Third, an improved farm sector performance can add to rural consumption.

•  However, it may be hard to endlessly expect significantly higher growth impetus from Consumption (C) •  Plus Government’s focus on fiscal consolidation limits the option of raising

general government consumption expenditure (G) •  Cant rely on Exports L (NX)

•  With multifaceted measures from the government to foster industry and enterprise, investment-led growth should return. (I)

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Economic Survey (2015-16) Chapter 3: Spreading JAM • DBT and its challenges. JAM as a solution. •  Ingredients of a good JAM? • Where next to spread JAM?

The Three Ingredients of JAM

The Weakest Link • Some important changes have occurred this year to improve

last-mile financial connectivity •  Including the Jan Dhan Yojana’s initiatives to develop the BC space •  And the licensing of several mobile money operators

• But the Bank-Beneficiary connection still appears the weakest link in the JAM chain…

Summing Up JAM 1.  When deciding where next to spread JAM, policymakers should

consider first-mile (beneficiary identification), middle-mile (distributor opposition) and last-mile (beneficiary financial inclusion) challenges.

2.  JAM preparedness index suggests that the main constraint on JAM’s spread is the last-mile challenge of getting money from banks into people’s hands, especially in rural areas.

3.  The government should improve financial inclusion by developing banking correspondent and mobile money networks, while in the interim considering models like BAPU—Biometrically Authenticated Physical Uptake.

4.  At present, the most promising targets for JAM are fertilizer subsidies and within-government fund transfers—areas under significant central government control and with substantial potential for fiscal savings.

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Economic Survey (2015-16) Chapter 4: Agriculture – More form Less (MSP) • Modifying MSP? • Exit problem in agriculture (Green Rev) • Changing problem – First Food Security, Now Climate Change

& scarcity + changing demand patterns •  Rapid industrialization and climate change are raising the scarcity value

of land and water, respectively •  Evolving dietary patterns are favoring greater protein consumption

Need to Adapt to these changes

A New Paradigm for Agriculture Changes = Scarcity value of land and water + Dietary demand for protein To adapt to these changes, agriculture requires a new paradigm with the following components: 1.  Increasing productivity by getting “more from less” especially

in relation to water via micro irrigation 2.  Prioritizing the cultivation of less water-intensive crops,

especially pulses and oil-seeds 3.  A Supportive Minimum Support Price (MSP) regime that

incorporates the full social benefits of producing such crops + backed by a strengthened procurement system

4.  Re-invigorating agricultural research and extension

More From Less Less Land; Less water = More From Less needed •  The Land Challenge: sharp decline in cultivable land per

person in India – Population + Industrialization •  Large tracts of land is locked in low value agriculture, despite growing

demands for high value products such as fruits, vegetables, livestock products

•  The Water Challenge: India has much lower levels of water per capita in comparison – Population + Climate change

Productivity: The Biggest Problem? The central challenge of Indian agriculture is low productivity, especially in pulses. •  First, consider the main food grains – wheat and rice.

•  These are grown on the most fertile and irrigated areas in the country. •  They use a large part of the resources that the government channels to

agriculture •  - water, fertilizer, power, credit or procurement under the MSP program

•  Still, average yields in India are much below that of China’s – 46% below for rice and 39% in the case of wheat. •  In wheat, India’s average yield in 2013 of 3075 kg/ha is lower than the world

average of 3257 kg/ha. •  ES emphasizes one important message: India could make rapid gains

in productivity through convergence within India. •  If all states were to attain even Bihar’s level of productivity, pulses production

would increase by an estimated 41% on aggregate. •  Can be done by providing irrigation and other resources more uniformly

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Subsidies & Wastage • A key factor undermining the efficient use of water is subsidies

on power for agriculture that incentivizes wasteful use of water and hasten the decline of water tables. •  India’s water tables are declining at a rate of 0.3 meters per year.

• Plus, India, a water-scarce country, has been “exporting water” as a result of distorted incentives. •  Water “embedded” in crops is the water content of each crop and once

the crop is exported, it cannot be recovered. •  In 2010, India exported about 25 cu km of water embedded in its

agricultural exports. •  This is equivalent to the demand of nearly 13 million people.

Exporting Water? •  India has now become a net exporter of water – about 1 per

cent of total available water every year. •  The ratio of export to import of such virtual water is about 4 for

India and 0.1 for China. •  Thus China remains a net importer of water.

•  China imports water-intensive soybeans, cotton, meat and cereal grains6, while exporting vegetables, fruits and processed food.

•  India, on the other hand, exports water-intensive rice, cotton, sugar and soybean.

Micro Irrigation = More for Less Micro irrigation methods can help to increase productivity while conserving water

•  = more for less

•  In drip irrigation perforated pipes are placed either near ground and drip water on the roots and stems of plants, directing water more precisely to crops that need it. •  An efficient drip irrigation system reduces consumption of fertilizer

(through fertigation – fertilizer delivered directly to roots) and water lost to evaporation or dissipated away.

•  = higher yields than traditional flood irrigation.

MSP Crops Crops covered •  25 commodities are currently covered. They are as follows.

•  Cereals (7) - paddy, wheat, barley, jowar, bajra, maize and ragi •  Pulses (5) - gram, arhar/tur, moong, urad and lentil •  Oilseeds (8) - groundnut, rapeseed/mustard, toria, soyabean, sunflower

seed, sesamum, safflower seed and nigerseed •  Copra •  Raw cotton & Raw jute •  Sugarcane (Fair and remunerative price) •  Virginia flu cured (VFC) tobacco

http://pib.nic.in/newsite/PrintRelease.aspx?relid=145856

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Economic Survey (2015-16) Chapter 5: Mother & Child (invest in early life health) Imagine the government were an investor trying to maximize India's long-run economic growth (Potential GDP) • Given fiscal and capacity constraints, where would it invest? •  This chapter shows that relatively low-cost maternal and early-

life health and nutrition programs offer very high returns on investment because: 1)  The most rapid period of physical and cognitive development occurs in

the womb •  so in utero and early-life health conditions significantly affect outcomes in adulthood

2)  The success of subsequent interventions—schooling and training—are influenced by early-life development

Investing In Tomorrow’s India Today India generally under-performs on maternal and child health indicators:

•  pre-pregnancy weights and weight-gain during pregnancy are both low

•  Taking full advantage of our demographic dividend (window) requires a healthy and educated population.

• Making these investments in maternal nutrition and sanitation + enhancing their effectiveness by working to change social norms, can help India exploit this window

Tomorrow’s Productivity Human capital— physical health, education, skills and broader capabilities—is a key determinant of a country’s growth potential. •  The government’s investment in skills training

•  Through schemes like the Deen Dayal Uphadyay Grameen Kaushalya Yojana—tertiary education, and schooling

•  And even Skill India, etc.

• Are all investments in the productivity of tomorrow’s worker.

Economic Survey (2015-16) Chapter 6: Bounties to Well off (For whom the Subsidies Toll) • Whom do the subsidies benefit? • How to control this? •  JAM and targeting.

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Why Help the Well-Off? The government spends nearly 4.2% of GDP subsidizing various commodities and services. Many of these policies provide benefits (mostly) to the well-off! • ES focuses on seven areas: small savings schemes + tax/

subsidy policies on: kerosene, railways, electricity, LPG, gold, and aviation turbine fuel (ATF). •  Finds that together these schemes and policies provide a bounty to the

well-off of about Rs. 1 lakh crore!

•  The policies that are based on providing tax incentives will, in India, benefit not the middle class but those at the very top end of the income distribution

Cost-Benefit Analysis for Subsidies For determining the efficacy of government interventions on taxes and subsidies: •  The benefit could be thought of as the share of the subsidy

going to the target (poor) group •  The cost is the proportion that “leaks” to the non-target group

•  More precisely, the benefit/cost ratio is defined as a share of expenditure of that commodity in the household budgets of the poor

•  Divided by the share of consumption of that particular commodity by the non-target group.

Economic Survey (2015-16) Chapter 7: Fiscal Capacity (taxing (bracket, legitimacy) and spending capacity (improved delivery))

• Get More + Spend Less = G Neutral

India Vs. World: Who Taxes Best 1.  A simple comparison of aggregates with other countries

indicates that India under-taxes and under-spends. 2.  Controlling for the level of economic development, India

neither under-taxes nor under-spends. 3.  India does tax and spend less than other politically

developed nations •  but given that most other democracies took a long time to strengthen tax

capacity, perhaps it is not an outlier on this dimension, either.

4.  Where India does stand out is in the number of individual income taxpayers. •  The ratio of taxpayers to voters is only about 4 percent, whereas it should be

closer to 23 percent.

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First Deliver Vital Services then Redistribute! J

The history of Europe and the US suggests that typically, states first provide essential services (physical security, health, education, infrastructure, etc.) before they take on their redistribution role. •  That sequencing is not accidental:

•  Unless the middle class in society perceives that it derives some benefits from the state, it may be largely unwilling to finance redistribution

•  In other words, the legitimacy to redistribute is earned through a demonstrated record of effectiveness in delivering essential services

“Exiting the State” A corollary is that if the state's role is predominantly redistribution, the middle class will seek to exit from the state.

•  They will avoid or minimize paying taxes •  they will cocoon themselves in gated communities •  they will use diesel generators to obtain power •  they will go to private hospitals •  send their children to private education institutions.

• By reducing the pressure on the state, middle class exit will shrink it, eroding its legitimacy further, leading to more exit and so on. •  A state that prioritizes or over-emphasizes redistribution without providing

basic public goods, risks unleashing this vicious spiral.

Beyond “Inaction” J Beyond that, ES mentions FOUR POINTS for building fiscal capacity: 1.  First, the government’s spending priorities must include essential

services that all citizens consume: public infrastructure, law and order, less pollution and congestion, etc.

2.  Second, reducing corruption must be a high priority not just because of its economic costs but also because it undermines legitimacy. •  The more citizens believe that public resources are not wasted, the greater their

willingness to pay taxes.

3.  Third, subsidies to the well-off need to be scaled back. •  Similarly, the tax exemptions Raj which often amount to redistribution towards the

richer private sector will also need to be reviewed and phased out. •  And, reasonable taxation of the better-off, regardless of where they get their income

from—industry, services, real estate, or agriculture--will also help build legitimacy.

4.  Fourth, property taxation needs to be developed.

Economic Survey (2015-16) Chapter 8: PTAs (FTA impact and WTO) • Effect of PTAs • Mega Regionalism – fear being left out? • Big but Poor Dilemma – SSM, Food Security/Public

Stockholding Issue • WTO stance – Proactive engagement

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Issues to Introspect ES says: Introspection is overdue on five issues: 1.  Providing support to farmers in light of WTO rules 2.  Mitigating the impact of erratic trade policy on farmer

incentives 3.  Reconciling the “big but poor” dilemma that confronts India in

trade negotiations 4.  Dealing with ongoing stresses brought on by the external

environment 5.  Engaging more broadly with the world on trade

Economic Survey (2015-16) Chapter 9: Fertilizer Sector (Urea) • Second largest subsidy, too many leakages, black market • NPK – Urea under-pricing = Overuse issues

Summary Overview Fertilizer accounts for large subsidies - the second-highest after food

•  About 0.73 lakh crore = 0.5 percent of GDP •  Food>Fertilizer>Fuel

• Of this only 17,500 crores or 35% of total fertilizer subsides reaches small farmers…

•  The urea sector is highly regulated which: •  Creates a black market that burdens small farmers disproportionately •  Incentivizes production inefficiency •  And leads to over-use, depleting soil quality and damaging human health.

• Reforms to increase domestic availability via less restrictive imports (“decanalization”) and to provide benefits directly to farmers using JAM will address many of these problems…

Box 9.1: The ABC of Fertiliser Some basic facts about the fertilizer sector. •  There are 3 basic types of fertilizer used:

•  Urea, Diammonium Phosphate (DAP), and Muriate of Potash (MOP) •  Fertilizer provides 3 major nutrients which increase agriculture

yields: •  The optimal N:P:K ratio varies across soil types but is generally

around 4:2:1

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UREA: Basic Facts In many ways, urea dominates the fertilizer sector:

•  Of all the fertilizers, it is the most produced (86 per cent) •  The most consumed (74 per cent share) •  And the most imported (52 per cent) •  It also faces the most government intervention:

•  Urea is the most physically controlled fertilizer •  With 50 per cent under the Fertilizer Ministry’s movement control order compared with 20

per cent for DAP and MOP.

•  It also receives the largest subsidies: •  In outlay terms: accounting for nearly 70 per cent of total fertilizers subsidy •  And as proportion of actual cost of production:

•  75 per cent per kg, compared with about 35 per cent for DAP and MOP

Economic Survey (2015-16) Chapter 10: Labour Markets (Demographic Challenge) • Good Jobs needed • Sectoral Focus • Competitive Federalism to the rescue!

Chapter Overview To exploit its demographic dividend, India must create millions of “good”— safe, productive, well-paying—jobs – in the formal sector! •  ES studies constraints on formalization and ongoing developments

which are responding to these challenges. •  First, the increasing use of contract labour supplied by specialized staffing

companies, which allows large firms to grow, raising aggregate productivity. •  Second, the dynamic of competitive federalism is at work, with states competing

to attract employment-intensive, high-quality companies… •  The third trend involves labour-intensive manufacturing—like apparel—firms

relocating to smaller cities •  The centre could complement these developments and boost formal

sector job growth by expanding employees’ choice regarding their employment benefits

Economic Survey (2015-16) Chapter 11: Powering India (UDAY, tariff structure progressivity)

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Chapter Focus ES looks at issues like: 1.  Reducing the complexity of tariff schedules that may prevent

consumers from fully responding to price signals 2.  The impact of quality-adjusted tariffs on the competitiveness of

Indian industry •  ES provides estimates of the optimal structure of consumer tariffs

3.  And the impediments to creating one market for power. The results suggest the possibility of achieving reasonably greater progressivity in tariff structures

•  With lower tariffs for the poor, while also ensuring cost recovery = cross-subsidization

Key Points Overall some focus areas you should know clearly from last years Economic Survey: 1.  Banking Sector = TBS & Impact on I in GDP 2.  The Chakravyuh Challenge 3.  Cooeprative Federalism 4.  Spreading JAM and DBT (Subsidy Rationalization) 5.  International Trade – TPP etc and Role of India and WTO – what stance

should we take? 6.  Employment, Health, Education, Skilling and Demographic Dividend •  These were seen as key problems and key solutions to be discussed and

were discussed in good detail

Focal Points This year’s survey has two main focal points: •  GST & Demonetization + Some important reforms that lead out from

last year’s recommendations has been implemented •  Let us map them: Bankruptcy, UPI, Aadhar’s legal basis, State

capacity (federalism goal still a challenge) & UBI as a step towards redistribution, TBS still an issue and hence I still weak in (CIGNX)

•  And Major pending reforms – state over reach and exit (chakravyuh), state capacity (competitive federalism enough?), redistribution mess, banking system

THE ECONOMIC SURVEY: CHAPTER 1

Economic Outlook and Policy Challenges

Riku Sayuj riku@byjus.com

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First Chapter = Important •  The first chapter acts as a brief summary of the entire document. •  It introduces the overall ES + touches on the issues that will be

covered in more detail later •  It will help you understand:

•  The main focus of the ES & the Budget •  The Important observations and themes that will come back again and again

•  We will cover the introduction, focus areas and broad outline of the summary here.

•  Some of the areas we will cover in respective chapters. •  We will read the first chapter in line with first chapter of volume 2

which is more factual and rigorous, but covers the same ground.

List of Chapters SECTION I: THE PERSPECTIVE 1. Economic Outlook and Policy Challenges 2. The Economic Vision for Precocious, Cleavaged India SECTION II: THE PROXIMATE 3. Demonetization: To Deify or Demonize? 4. The Festering Twin Balance Sheet Problem 5. Fiscal Framework: The World is Changing, Should India Change Too? 6. Fiscal Rules: Lessons from the States 7. Clothes and Shoes: Can India Reclaim Low Skill Manufacturing? 8. Review of Economic Developments 9. Universal Basic Income: A Conversation With and Within the Mahatma SECTION III: THE PERSISTENT 10. Income, Health and Fertility: Convergence Puzzles 11. One Economic India: For Goods and in the Eyes of the Constitution 12. India on the Move and Churning: New Evidence 13. The 'Other Indias': Two Analytical Narratives (Redistributive and Natural Resources)on States' Development 14. From Competitive Federalism to Competitive Sub-Federalism: Cities as Dynamos

Structure Structurally, the Survey is divided into three sections: I.  The Perspective

•  In Section I, the introductory chapter provides a broad overview of recent developments and a near-term outlook.

•  The following chapter takes a long-term perspective to analyze where India stands on the underlying economic vision

II.  The Proximate •  Section II deals with four pressing near-term issues:

1.  Demonetisation 2.  The festering twin balance sheet challenge and ways to address it 3.  Fiscal policy of the center and states 4.  Labour-intensive employment creation

III.  The Persistent. •  Section III deals with more medium term issues.

•  There are perhaps two broad themes to this section: the states (and cities) and Big Data.

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Introduction ES says the year was marked by two major domestic policy developments: 1.  The passage of the Constitutional amendment, paving the way for

implementing the transformational GST •  The GST will create a common Indian market, improve tax compliance and governance,

and boost investment and growth •  It is also a bold new experiment in the governance of India’s cooperative federalism.

2.  And the action to demonetise the two highest denomination notes. •  Demonetisation has had short-term costs but holds the potential for long- term benefits. •  Follow-up actions to minimize the costs and maximise the benefits include:

•  fast, demand-driven, remonetisation; •  further tax reforms, •  including bringing land and real estate into the GST, •  reducing tax rates and stamp duties; •  and acting to allay anxieties about over-zealous tax administration.

•  These actions would allow growth to return to trend in 2017-18, following a temporary decline in 2016-17.

Further Challenges •  Looking further ahead, we need to overcome three long-

standing meta-challenges: 1.  Inefficient redistribution, 2.  Ambivalence about the private sector and property rights, 3.  And improving but still-challenged state capacity.

Demonetisation! A radical governance-cum-social engineering measure was enacted on November 8, 2016. •  The two largest denomination notes, Rs 500 and Rs 1000—

together comprising 86 percent of all the cash in circulation—were “demonetised” with immediate effect, ceasing to be legal tender except for a few specified purposes. •  In other words, restrictions were placed on the convertibility of domestic

money and bank deposits

Aim of Demonetisation The aim of the action was fourfold: 1.  to curb corruption, 2.  counterfeiting, 3.  the use of high denomination notes for terrorist activities, 4.  and especially the accumulation of “black money”, generated

by income that has not been declared to the tax authorities. •  The action followed a series of earlier efforts to curb such illicit

activities, including: •  the creation of the Special Investigation Team (SIT) in the 2014 budget, •  the Black Money Act, 2015; •  the Benami Transactions Act of 2016; •  the information exchange agreement with Switzerland, •  changes in the tax treaties with Mauritius and Cyprus, •  and the Income Disclosure Scheme.

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Questions about Demonetisation The public debate on demonetisation has raised three questions. 1.  About design and implementation of the initiative. 2.  Second, its economic impact in the short and long run. 3.  And, third, its implications for the broader vision underlying

the future conduct of economic policy. • Chapter 3 addresses in detail the second question.

•  The broad conclusion is that demonetisation will create short-term costs and provide the basis for long run benefits.

Short Term Vs Long Term •  Short-term costs have taken the form of inconvenience and hardship

•  Especially those in the informal and cash-intensive sectors of the economy who have lost income and employment.

•  These costs are transitory, and may be minimised in recorded GDP •  Because the national income accounts estimate informal activity on the basis

of formal sector indicators, which have not suffered to the same extent. •  But the costs have nonetheless been real and significant.

•  At the same time, demonetisation has the potential to generate long-term benefits •  in terms of reduced corruption, greater digitalization of the economy,

increased flows of financial savings, and greater formalization of the economy, all of which could eventually lead to higher GDP growth, better tax compliance and greater tax revenues.

•  The magnitudes of short-term costs remain uncertain, as do the timing and extent of long-term benefits.

Needed Actions Needed actions include: • Remonetizing the economy expeditiously by supplying as

much cash as necessary, especially in lower denomination notes;

• And complementing demonetisation with more incentive-compatible actions such as bringing land and real estate into the GST, reducing taxes and stamp duties,

• And ensuring that the follow-up to demonetisation does not lead to over-zealous tax administration.

Reforms and Vision The highlight was, of course, the transformational GST bill •  In addition, the government:

•  Overhauled the bankruptcy laws so that the “exit” problem that pervades the Indian economy--with deleterious consequences highlighted in last year’s Survey--can be addressed effectively and expeditiously;

•  Codified the institutional arrangements on monetary policy with the Reserve Bank of India (RBI), to consolidate the gains from macroeconomic stability by ensuring that inflation control will be less susceptible to the whims of individuals and the caprice of governments

•  Solidified the legal basis for Aadhaar, to realise the long-term gains from the JAM trifecta (Jan Dhan-Aadhaar-Mobile), as quantified in last year’s Survey

•  Also, The government enacted a package of measures to assist the clothing sector that by virtue of being export-oriented and labor- intensive could provide a boost to employment, especially female employment

•  The National Payments Corporation of India (NPCI) successfully finalized the Unified Payments Interface (UPI) platform. To facilitate M in JAM.

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India Vs Rating Agencies • Page 20, Box 1

Structural Challenges Pending But much more needs to be done to address three major challenges: •  Reducing “inefficient redistribution,” strengthening state capacity in

delivering essential services and regulating markets, and dispelling the ambivalence about protecting property rights and embracing the private sector.

•  These structural challenges have their proximate policy counterparts. •  Chapter 9 discusses India’s extensive efforts at redistribution.

•  The central government alone runs about 950 central sector and centrally sponsored schemes and sub-schemes which cost about 5 percent of GDP.

•  Clearly, there are rationales for many of them. But there may be intrinsic limitations in terms of the effectiveness of targeting.

•  The government has made great progress in improving redistributive efficiency over the last few years, most notably by passing the Aadhaar law, a vital component toward realizing its vision of JAM

Private Sector Ambivalence •  India has been wary about Pvt sector and Foregn Sector

historically • ES says, the wariness does not just extend to the foreign

private sector. •  The twin balance sheet problem—in the corporate and banking

sectors (as detailed in Chapter 4) --remains a millstone around the economy’s neck, casting a pall over private investment and hence aggregate growth.

• One important reason this problem has not been resolved in the many years since it emerged in 2010 is the political difficulty in being seen as favoring the private sector •  A problem which will necessarily arise in cases where some private

sector debts have to be forgiven.

State Capacity • On state capacity, delivery of essential services such as health

and education, which are predominantly the preserve of state governments, remains impaired.

•  The deepest puzzle here is the following: •  While competitive federalism has been a powerful agent of change in

relation to attracting investment and talent •  It has been less in evidence in relation to essential service delivery.

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Good Examples •  There have been important exceptions, such as: 1.  The improvement of the public distribution system (PDS) in

Chhattisgarh, 2.  The incentivization of agriculture in Madhya Pradesh, 3.  Reforms in the power sector in Gujarat which improved delivery

and cost recovery, 4.  The efficiency of social programs in Tamil Nadu, 5.  The recent use of technology to help make Haryana kerosene-

free. •  But on health and education there are insufficient instances of good

models that can travel widely within India and that are seen as attractive political opportunities.

•  Competitive populism needs a counterpart in competitive service delivery.

Other Pending Issues •  Equally, signs of a political dynamic that would banish the ambivalence toward the private

sector and property rights have not been strongly evident for decades. This ambivalence is manifested in: •  the difficulties in advancing strategic disinvestment; •  the persistence of the twin balance sheet problem—over-indebtedness in the corporate

and banking sectors—which requires difficult decisions about burden-sharing and perhaps even forgiving some burden on the private sector;

•  the legacy issues of retroactive taxation, which remain mired in litigation even though the government has made clear its intentions for the future;

•  agriculture, where the protection of intellectual property rights, for example in seeds, remains a challenge;

•  reform in the civil aviation sector, which has been animated as much by an interventionist as liberalizing spirit;

•  in the fertilizer sector, where it is proving easier to rehabilitate unviable plants in the public sector rather than facilitate the exit of egregiously inefficient ones;

•  frequent recourse to stock limits and controls on trade in agriculture, which draws upon the antiquated Essential Commodities Act, and creates uncertainty for farmers.

•  In each of these examples, there may be valid reasons for the status quo but overall they indicate that the embrace of markets remains a work-in- progress.

India & The World: Global Context Even as the domestic agenda remains far from complete, the international order is changing, posing new challenges. •  The impact of Brexit and the US elections, though still

uncertain, risk unleashing paradigmatic shifts in the direction of isolationism and nativism. •  The post war consensus in favour of globalisation of goods, services and

labor in particular, and market-based economic organization more broadly, is under threat across the advanced economies.

•  For India these events have immense consequences. Given that India’s growth ambitions of 8-10 percent require export growth of about 15-20 percent, any serious retreat from openness on the part of India’s trading partners would jeopardize those ambitions

Main External Developements For India, three external developments are of significant consequence. •  In the short-run, the change in the outlook for global interest

rates as a result of the US elections •  and the implied change in expectations of US fiscal and monetary policy

will impact on India’s capital flows and exchange rates.

• Second, the medium-term political outlook for globalisation •  and in particular for the world’s “political carrying capacity for

globalisation” may have changed in the wake of recent developments.

• Page 23, Box 2

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China •  Third, developments in the US, especially the rise of the dollar,

will have implications for China’s currency and currency policy. •  If China is able to successfully re-balance its economy, the spillover

effects on India and the rest of the world will be positive. •  On the other hand, further declines in the yuan, could interact with

underlying vulnerabilities to create disruptions in China that could have negative spillovers for India

• China with its underlying vulnerabilities remains the country to watch for its potential to unsettle the global economy.

What do the Indicators Signal? 1.  Growth – Subdued (7.2% as against ES projected to increase from 7.0%

to 7.75%, down from 7.6% last year) 2.  Inflation – Declined (CPI ~ 3.4 – don due to good kharif and pulses, WPI

positive again 3.4 with recovering oil prices, CPI-WPI wedge down, gold stable, core inflation 5%). CPI Expected to be at 5% for the year

3.  Food Inflation – Lowered 4.  Growth in agriculture – modest pickup with better monsoon 5.  Fiscal deficit – Stable; State fiscals under stress (rising from 2.5% to

3.6%, due to UDAY scheme) 6.  CAD – Declined (to 0.3% GDP, Exports and Imports recovering) 7.  Exchange Rate – Unremarkable 8.  Foreign reserves – Stable & Highest ever levels (360+) 9.  Net FDI inflows - have grown 10.  Trade Balance – deficit has shrunk 11.  IIP – Moderation

Outlook & Impact of Demonetisation • Outlook let us see in PDF, page 29

C, G, I, NX – Standings? •  C – drag due to rising oil prices, but boost due to post-

demonetization catch-up and lower borrowing cost •  I – TBS - Since no clear progress is yet visible in tackling the twin

balance sheet problem, private investment is unlikely to recover significantly from the levels of FY2017. •  Some of this weakness could be offset through higher public investment, but

that would depend on the stance of fiscal policy next year •  which has to balance the short-term requirements of an economy recovering from

demonetisation against the medium-term necessity of adhering to fiscal discipline. •  G – Consolidation, NX – global issues •  Putting factors together, we expect real GDP growth to be in the 63⁄4

to 71⁄2 percent range in FY2018. Even under this forecast, India would remain the fastest growing major economy in the world.

•  Some risks – see PDF, Page 36

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Downside Risks Three main downside risks to the forecast: •  First, the extent to which the effects of demonetisation could

linger into next year •  especially if uncertainty remains on the policy response.

• Second, geopolitics could take oil prices up further than forecast.

•  Third, there are risks from the possible eruption of trade tensions amongst the major countries, triggered by geo-politics or currency movements. •  This could reduce global growth and trigger capital flight from emerging

markets.

What to Do about I? •  Since the decline in oil prices from their peak in June 2014 there has

been a lift to incomes •  which combined with government actions imparted dynamism by increasing

private consumption and facilitating public investment •  shoring up an economy buffeted by the headwinds of weak external demand

and poor agricultural production. •  => C and I Boost

•  This year that important source of short-term dynamism may be taken away as international oil prices are now on the rise.

•  Moreover, private investment remains weak because of the twin balance sheet problem that has been the economy’s festering wound for several years now (Chapter 4).

•  Re-establishing private investment and exports as the predominant and durable sources of growth is the proximate macro-economic challenge.

The Macroeconomic Policy Stance for 2017-18

ES says, An economy recovering from demonetisation will need policy support. • On the assumption that the equilibrium cash-GDP ratio will be

lower than before November 8, the banking system will benefit from a higher level of deposits. •  Thus, market interest rates—deposits, lending, and yields on g-secs—

should be lower in 2017-18 than 2016-17.

•  This will provide a boost to the economy (provided, of course, liquidity is no longer a binding constraint). •  ES even says policy rates can be lower to support this.

Fiscal Policy Support Fiscal policy is another potential source of policy support. •  This year the arguments may be slightly different from those of

year in two respects. • Unlike last year, there is more cyclical weakness on account of

demonetisation. • Moreover, the government has acquired more credibility

because of posting steady and consistent improvements in the fiscal situation for three consecutive years, •  the central government fiscal deficit declining from 4.5 percent of GDP in

2013- 14 to 4.1 percent, 3.9 percent, and 3.5 percent in the following three years.

• But fiscal policy needs to balance the cyclical imperatives with medium term issues relating to prudence and credibility.

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PMKGY Money One key question will be the use of the fiscal windfall (comprising the unreturned cash and additional receipts under the Pradhan Mantra Garib Kalyan Yojana (PMGKY)) which is still uncertain. •  Since the windfall to the public sector is both one-off and a wealth

gain not an income gain, it should be deployed to strengthening the government’s balance sheet rather than being used for government consumption.

•  In this light, the best use of the windfall would be: 1.  To create a public sector asset reconstruction company

(discussed in Chapter 4) so that the twin balance sheet problem can be addressed, facilitating credit and investment revival;

2.  or toward the compensation fund for the GST that would allow the rates to be lowered and simplified;

3.  or toward debt reduction. The windfall should not influence decisions about the conduct of fiscal policy going forward.

Pradhan Mantra Garib Kalyan Yojana •  Pradhan Mantri Garib Kalyan Yojana, 2016 (PMGKY) is an amnesty scheme launched by

the Narendra Modi led Government of India in December 2016 •  on the lines of the Income declaration scheme, 2016 (IDS) launched earlier in the year.

•  A part of the Taxation Laws (Second Amendment) Act, 2016, the scheme provides an opportunity to declare unaccounted wealth and black money in a confidential manner

•  and avoid prosecution after paying a fine of 50% on the undisclosed income. •  An additional 25% of the undisclosed income is invested in the scheme which can be

refunded after four years, without any interest. •  Scheme can only be availed to declare income in the form of cash or bank deposits in

Indian bank accounts and not in the form of jewellery, stock, immovable property, or deposits in overseas accounts

•  Not declaring undisclosed income under the PMGKY will attract a fine of 77.25% if the income is shown in tax returns.

•  In case the income is not shown in tax returns, it will attract a further 10% penalty followed by prosecution.

Other Reforms • See pdf page 38

• UBI, New Forex Rate, Trade Policy Outline, Climate Change, Women & Sanitation

India’s soon-to-recede DemographIc Dividend

•  India seems to be in a demographic sweet spot with its working-age population projected to grow by a third soon.

•  Theory suggests that the specific variable driving the demographic dividend is the ratio of the working age to non-working age (NWA) population

• Page 46

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Peninsular Divide •  There is a clear divide between peninsular India (West Bengal,

Kerala, Karnataka, Tamil Nadu and Andhra Pradesh) and the hinterland states (Madhya Pradesh, Rajasthan, Uttar Pradesh, and Bihar).

•  The peninsular states exhibit a pattern that is closer to China and Korea, with sharp rises and declines in the working age population. •  The difference, of course, is that the working age ratio of most of the

peninsular states will peak at levels lower than seen in East Asia (West Bengal comes closest to Korea’s peak because of its very low TFR).

•  In contrast, the hinterland states will remain relatively young and dynamic, characterized by a rising working age population for some time, plateauing out towards the middle of the century.

Growth Consequences This demographic pattern will have two important growth consequences. 1.  First, it seems that the peak of the demographic dividend is approaching fast for India. 2.  ES shows that this peak will be reached in the early 2020s for India as a whole; 3.  Also shows that peninsular India will peak around 2020 while hinterland India will peak

later (around 2040). •  The estimated demographic dividend for India (the additional growth due to demographic

factors alone) peak in 2011-20 at 2.6 percentage points and start declining thereafter. •  The incremental growth boost in the 2020s, for example, is estimated to be about 1.8

percentage points. •  In other words, India will approach, within four years, the peak of its demographic

dividend. •  (Note: this does not mean that the demographic dividend will turn negative; rather, the

positive impact will slow down.)

Convergence & Divergence •  The encouraging overall pattern masks some interesting outliers. •  Bihar, Jammu and Kashmir, Haryana, and Maharashtra are positive outliers

•  in that they can expect a greater demographic dividend over the coming years than would be suggested by their current level of income.

•  This extra dividend will help Bihar converge •  While already rich Haryana and Maharashtra will pull further away from the

average level of income per capita in India. •  On the other hand, Kerala, Madhya Pradesh, Chhatisgarh, and West Bengal are

negative outliers: •  their future dividend is relatively low for their level of income.

•  This will make the poorer states fall back, unless offset by robust reforms and growth, while the relatively rich Kerala will probably converge to the average as its growth momentum declines rapidly.

• End of Lecture 1