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India

Author(s):
International Monetary Fund
Published Date:
March 2009
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I. Staff Appraisal and Summary

Like most countries in the world, an increasingly globally integrated India will not be spared significant spillover effects from the present crisis. Its financial markets have sold off considerably and external funding for banks and corporates, which has risen in importance in recent years, has been sharply curtailed, thus jeopardizing investment and growth. The global crisis also coincides with a turning of the growth and credit cycles in India.

India's growth is likely to slow sharply. High frequency indicators already signal a broad-based and marked slowdown in activity. From an average of 8¾ percent in the past five years, growth is projected to fall to 6¼ percent in 2008/09 and 5¼ percent in 2009/10, with investment driving the slowdown. Stimulus measures and a good harvest should support consumption somewhat. Weaker domestic demand should reduce import growth, partly offsetting contracting exports. The current account deficit is projected at about 3 percent of GDP in 2008/09 before narrowing to 1½ percent of GDP the following year aided by lower oil prices. Inflation is anticipated to drop to below 3 percent by March 2009 and to an average of 2 percent in 2009/10 due to the collapse in commodity prices and softer domestic demand.

Reflecting the global economic situation, the uncertainty surrounding the forecasts is unusually large with still significant downside risks. The latter stem mainly from a protracted drought of credit and anemic world growth, as well as uncertainty of the outlook. Negative feedback loops between external shocks and domestic vulnerabilities and between the deteriorating corporate sector and the financial system could be strong. The main source of upside risk would be from a larger impact on growth of the stimulus measures.

Policy Response

The authorities have already taken numerous welcome measures in response to the crisis. The Reserve Bank of India (RBI) was quick in reversing its policy stance and the reductions in interest rates, the cash reserve ratio (CRR), and the statutory liquidity requirement (SLR) together with stepped up open market operations were fully warranted. The authorities should also be commended for continuing to liberalize the capital account and for reiterating their commitment to financial sector reforms.

Given the uncertainty and downside risks, the policy response needs to continue to be flexible, but disciplined. With public debt at 80 percent of GDP, monetary and structural policies will need to carry the weight of the policy response, and the limited fiscal room focused on high priority infrastructure investment and on banking system recapitalization. The priorities are (i) ensuring adequate financing to the real economy while protecting financial stability; and (ii) facilitating corporate restructuring to ensure viable firms can emerge stronger and unviable ones are quickly dealt with. Recognizing that some painful adjustment is inevitable, priorities already identified in the medium-term reform agenda should determine the focus of policies. Such a strategy will give India—whose medium- and long-term advantages remain intact—the best chance to benefit from an eventual return of capital flows. As in all countries, protectionist trade measures should be resisted, as the global economy, including India, will bear the cost of the resulting decline in global trade.

Keeping Credit Flowing While Preserving Financial Stability

With the balance of risks having shifted decisively from inflation to growth, there is more room for interest rate cuts and liquidity provision. Even after the most recent reduction in policy rates, real interest rates based on expected inflation remain higher than a few months ago. Hence, policy rates could be cut further. Although interest rates may have a limited impact as long as the policy transmission mechanism is muted, they would still provide a powerful signal and contribute to easing credit conditions. The RBI's measures have addressed the acute liquidity shortage that occurred in late 2008. If a liquidity crunch were to resurface, further reductions in the CRR and repurchasing market stabilization bonds can be relied upon. If these steps were to prove insufficient, consideration could be given to broadening collateral accepted at the RBI's repo window and providing liquidity over longer horizons as done by several countries.

Exchange rate policy needs to be consistent with ensuring sufficient liquidity in the system. The exchange rate has been managed flexibly in recent months. However, as reserves have fallen substantially, they would be best conserved for limited provision of foreign exchange to relieve concerns about external financing, for example along the lines of what Brazil and Korea have put in place, while letting the exchange rate take the brunt of the adjustment. Banks' and corporates' balance sheets appear more sensitive to interest rate than exchange rate risk.

Based on headline indicators India's financial system compares favorably internationally, but rising credit risk and liquidity pressures are putting it under strain (though information gaps make a definitive assessment difficult). Banks are well capitalized and have low nonperforming assets (NPAs). Nevertheless, the current downturn is likely to lead to a substantial increase in NPAs, and liquidity pressures could re-emerge. Nonbank financial institutions have already shown signs of stress.

International experience suggests that loss recognition and bank recapitalization are the measures most likely to be effective in restoring the flow of credit to the economy. A priority for India in the current circumstances is to identify the capital needs of the banking system by subjecting it to multifactor stress tests that take account of feedback loops between the real and financial sectors—the extent of which have been greatly underestimated in several countries. Key steps include (i) avoiding masking the true extent of the bad asset problem and the underlying capital position of financial institutions; (ii) providing incentives for early loss recognition; (iii) identifying capital needs and recapitalizing banks early; and (iv) enhancing existing frameworks to dispose efficiently of impaired assets and to promote corporate restructuring. Information on unhedged foreign exchange exposures and derivatives should be disclosed to allay market concerns, as done by Mexico recently.

Government-assisted refinance and credit guarantees could be an additional option to spur bank lending. Building on the refinance schemes already existing in India, especially those aimed at funding infrastructure, the government could expand such activities, provided transparency and appropriate assessment and pricing of risks are ensured. Examples of explicit risk sharing mechanisms are offered by the Hong Kong SAR and the U.K. credit guarantee programs.

In addition, the authorities' own financial reform agenda needs to be rapidly advanced to ensure adequate credit to corporates from sources other than the banking system. The domestic banking system should not be expected to fully compensate for the decline in other sources of corporate funding and to finance the needed higher infrastructure investment. Instead, developing the corporate bond market—as recommended by the Parekh, Patil and Rajan committees—and, further capital account liberalization (e.g. lifting all interest rate caps and minimum maturity requirements) could help ease the current funding crunch for corporates and position India well for when capital inflows pick up. Improving banking system efficiency also remains an important objective.

Finally, preparing for a possible deterioration in financial conditions would be advisable. These exercises should aim especially at strengthening cross-institutional coordination and reviewing intervention frameworks. Facilities to supplement international reserves could also be considered.

Corporate Sector Restructuring Is a High Priority

The potential substantial rise in corporate distress would be better addressed through corporate debt and operational restructuring, rather than direct public sector intervention in specific firms or sectors. Although corporate balance sheets seem healthy, the sharp changes in financial and economic conditions are likely to put them under considerable strain. Implementing the Rajan Report recommendations to improve the bankruptcy law and enhance out-of-court restructuring mechanisms, and passing the Companies Bill, would represent major positive steps in dealing with corporate distress.

Limited Role for Fiscal Policy

High government debt and deficits limit the room for maneuver: if further stimulus is deemed necessary, it should be combined with reforms that ensure medium-term debt sustainability. The stimulus implemented this year is already sizable, and with public debt at about 80 percent of GDP, further substantial expansion in the deficit risks backfiring, as concerns about debt sustainability could raise interest rates. The limited room should be conserved for high quality infrastructure investment and bank recapitalization if needed. In addition, lower commodity prices offer an opportunity to reform the fuel subsidy system, which would clearly signal the government's commitment to fiscal discipline.

Beyond the current downturn, fiscal consolidation continues to be a key priority as public finances remain India's Achilles' heel. The medium-term fiscal adjustment should be anchored in a fiscal rules framework centered on a debt target and buttressed by comprehensive expenditure reforms, which could play an important role in promoting fiscal consolidation.

It is proposed that the next Article IV consultation with India take place on the standard 12-month cycle.

II. Context: First International Financial Crisis Since India Went Global

1. India faces the first global economic crisis since emerging as an economic powerhouse. Reaping the benefits of reforms, macroeconomic stability, and a supportive external environment, India achieved growth of 8¾ percent on average during 2003/04-2007/08, with a significant reduction in poverty.1 The surge in investment, the key driver of growth, was financed by rising private and public savings, but increasingly also by foreign capital as links with the rest of the world grew (Figure 1). Now the global crisis is hitting India's financial markets and is sharply curtailing external funding, jeopardizing investment and growth.

Figure 1.India: A Long-Term Perspective

Sources: CEIC Data Company Ltd.; World Development Indicators; and Fund, World Economic Outlook and staff calculations.

1/ Simple average of GDP growth in Hong Kong SAR, Indonesia, Korea, Malaysia, the Philippines, Singapore, Taiwan Province of China and Thailand.

2/ Defined as percentage of people below the poverty line.

3/ Data for the full year available from 2001. Prior to 2000 India's software exports were not significant.

2. The consultation focused on the implications of the global crisis for India and the needed policy response. While the response needs inevitably to be focused on dealing with short-term pressures, these should be set in the context of the longer-term challenges and reforms that India needs to support strong and inclusive growth. In particular, given the country's massive investment needs, it is essential that scarce fiscal resources be focused on jumpstarting infrastructure investment, together with further opening up to foreign inflows and developing the domestic corporate bond market to augment the needed financing. At the same time, reforms to reduce subsidies and other unproductive expenditure will go a long way to provide assurances of the government's commitment to fiscal consolidation.

III. Recent Developments: Global Headwinds Exacerbate Domestic Weaknesses

3. The global financial crisis is exacerbating a cyclical downturn that was already underway. GDP growth softened to 7.8 percent (y/y) in April–September, pulled down mainly by weaker investment and private consumption (Figure 2). Data for the October–December quarter (including trade, industrial production, vehicle sales, and business confidence) suggest that growth has already slowed sharply, and leading indicators signal deeper and broader-based weaknesses ahead.

Figure 2.India: Conjunctural Developments

Sources: Reserve Bank of India; National Council of Applied Economic Research, India; CEIC Data Company Ltd.; Bloomberg L.P.; and Fund staff calculations.

1/ Percent of NCAER survey respondents operating at or close to capacity.

2/ NCAER index.

Growth is moderating

Sources: CEIC Data Company Ltd.; CMIE; and Fund staff calculation.

4. Inflation is decelerating rapidly after rising markedly in mid-2008. Headline inflation (WPI) surged to almost 13 percent (y/y) in August 2008, but dropped to below 6 percent by December. Commodity prices were the drivers of the initial inflation spike, with considerable second-round effects on other goods. However, the inflation momentum—measured by core inflation—is now dissipating rapidly.

5. High commodity prices and the global turmoil have weakened India's external position. With the oil import bill rising by over 50 percent (y/y), the current account deficit widened to 3¾ percent of GDP in April–September compared to 1½ percent of GDP in 2007/08 even though exports of goods and services held up well. October and November saw exports contracting by over 10 percent, partly owing to disruptions in trade credit, but softer import growth kept the trade deficit in check. Capital inflows in H1 2008/09 fell to US$20 billion (3½ percent of GDP), less than half of those in the same period a year earlier. While foreign direct investment (FDI) has been strong possibly owing to projects launched before the onset of the crisis, external commercial borrowing (ECB) disbursements in April–September were less than half of their 2007/08 levels and external funding became significantly more expensive (Figure 3). Portfolio outflows amounted to US$9 billion in April–December, with an outflow of over $4 billion in October alone and a mild recovery since then.

Figure 3.India: Impact of the Global Financial Crisis

Sources: Reserve Bank of India; Bloomberg L.P.; Dealogic; and Fund staff calculations.

1/ Priced from 3-month currency forwards and computed from 20-day moving average.

2/ Difference from 3-month National Stock Exchange Mumbai Interbank Offer Rate (MIBOR).

Inflation has peaked; core measures indicate likely further deceleration

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

Capital flows have fallen sharply

Sources: CEIC Data Company Ltd; and Fund staff calculation.

6. Like in most countries around the world, the global financial crisis has hit Indian assets hard. Amid heightened volatility, the stock market decline was led by foreign investors' sales, which brought price-to-earnings (P/E) ratios broadly in line with the average for emerging markets (Figure 3). Financials and real estate suffered the steepest sell-offs, reflecting earlier sharp increases in leverage and asset prices. Property prices are reported to be falling, especially in the commercial and high-end segments. The 23 percent depreciation of the currency versus the U.S. dollar in 2008 (11 percent since end-August) was one of the largest in Asia, despite RBI intervention.2 From a historical peak of US$315 billion in May 2008, foreign exchange (FX) reserves have declined to US$255 billion (January 2, 2008), with a US$39 billion drop in October alone (half of which was due to valuation losses). Equity prices have recovered marginally since October.

The global crisis has hit India's currency and equity markets

(Change in 2008, in percent)

Sources: Bloomberg L.P.; and CEIC Data Company Ltd.

1/ Exchange rate is defined as national currency per U.S. dollar. Data as of December 30, 2008.

The rupee has depreciated despite heavy central bank intervention

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

7. In response to central bank measures liquidity pressures in the domestic money market have eased since October, but credit conditions remain tight (Box 1). While overnight rates have come down in line with policy rates, TED, overnight index swaps, and commercial paper spreads have eased only slightly. Moreover, credit availability is constrained. Bank credit growth accelerated through October, reflecting in part the shift in corporate demand to domestic banks following the drying up of other sources of financing. However, since then it has decelerated sharply, in particular in momentum terms (with growth negative on a month-on-month, seasonally adjusted basis). Financing from nonbank financial institutions is constrained by redemption pressures and poor asset performance.

The call rate has been volatile, but has remained within the policy rate band since early November

Source: Bloomberg L.P.

8. After several years of rapid expansion, buoyant profits, and improving balance sheets, India's corporate performance is deteriorating appreciably. Indian corporates' balance sheets were healthy as of March 2008.3 However, high commodity prices and interest rates pushed up firms' costs and squeezed margins in 2008. Some importers and firms with large foreign exchange liabilities, incurred partly to finance overseas acquisitions, are also suffering losses from the rupee depreciation. Corporate profit growth fell to 9 percent (y/y) in the April–June quarter from about 25 percent in 2007. Preliminary results for the July–September quarter were weaker, and the 22 percent fall in the December advance corporate tax payments does not bode well for the profit outlook.

Corporate profit growth has weakened as costs have risen

Source: CEIC Data Company Ltd.

Box 1.Measures Adopted in Response to the Crisis since September 2008

Measures to increase rupee liquidity

  • Cut in policy rates. Repo rate by 350 bps to 5½ percent and reverse repo rate by 200 bps to 4 percent.

  • Cut in cash reserve ratio (CRR). By 400 bps to 5 percent.

  • Cut in statutory liquidity requirement (SLR). By 100 bps to 24 percent of net demand and time liabilities (NDTL).

  • Repurchase of market stabilization bonds. About 0.3 percent of GDP re-purchased since end-September.

  • Term repo facility. 14-day repo facility for banks to onlend to mutual funds, NBFCs, and housing financing companies (HFCs). Rs 600 billion (1.1 percent of GDP) available, at the repo rate, through June 2009. SLR reduced by 1½ percentage points for banks using this facility.

  • Refinance facilities. For banks up to 1 percent of NDTL (0.6 percent of GDP), at repo rate, up to 90 days, through June 2009. Additional facilities (0.3 percent of GDP, terms as above, through March 2010) for the Small Industries Development Bank, the National Housing Bank, and the Export and Import Bank. Limit on the RBI's export credit refinance facility (at repo rate) raised from 15 to 50 percent of bank's outstanding export credit.

  • Other measures. Select oil bonds allowed as collateral in RBI repos. Special purpose vehicle to buy up to Rs 250 billion (0.5 percent of GDP) in investment grade paper from NBFCs.

Measures to increase FX liquidity

  • FX swaps. For Indian banks with foreign branches or subsidiaries to access FX swaps, up to three months, through June 2009; for entities with bulk FX requirements through their banks. Reactivation of RBI's special facility for conversion of oil bonds into FX.

Measures to increase credit delivery

  • Trade credit. Period of entitlement for concessional rates on rupee export credits increased.

  • Priority sector lending. Bank loans to HFCs for small housing loans classified as priority. Benefits for SMEs under the Credit Guarantee Scheme enhanced (coverage amount doubled, and guarantee cover increased from to 50-85 percent).

  • Regulatory forbearance. Extension of existing special regulatory regime on asset classification (which allows loan assets in high-priority sectors that have been restructured quickly to remain in the pre-restructuring asset classification category) to commercial real estate and to undersecured working capital term loans. Special regime also extended to second restructuring of all qualifying loans (though not to commercial real estate), and to housing loans with a maturity above 10 years (although additional risk weight of 25 percentage points introduced at time of restructuring).

  • Provisioning requirements. For standard assets reduced to a standard level of 0.4 percent for real estate, personal loans, capital markets, and select NBFCs.

  • Risk weights. Reduced to 100 percent for commercial real estate assets, claims on select NBFCs, and asset financing companies.

  • Other measures. Credit targets for public sector banks increased for January-March 2009. Public sector banks to provide a line of credit to NBFCs for purchase of commercial vehicles.

Measures to encourage capital inflows

  • Trade credit. All-in-cost ceiling raised by 75–125 bps, depending on maturity.

  • Portfolio investment. Removal of curbs on foreign issuance of equity derivatives (so-called P-notes) imposed in October 2007. Limit on FII holdings of corporate bonds raised from $3 billion to $15 billion, and of government bonds from $3 billion to $5 billion. Restriction on allocation of FII investments across equity and debt lifted.

  • External commercial borrowing (ECB). Increase in borrowing limits per company and for the economy as a whole (from $22 billion to $35 billion). All-in cost ceiling removed for ECBs under the approval route (through June 2009) and raised for ECBs under the automatic route. Sectoral restrictions on ECBs relaxed.

  • Nonresident Indian deposits. Cap on interest rates increased by 175 bps.

  • Other measures. Limit on bank borrowing from overseas branches raised from 25 percent to 50 percent of unimpaired Tier I capital or US$10 mn, whichever is higher.

Fiscal measures

  • Tax. Central VAT cut by 4 ppts (excluding petroleum products; cost of 0.2 percent of GDP). Reinstatement of import duties on selected products. Accelerated depreciation of 50 percent for vehicles purchased in January-March 2009.

  • Spending. 0.4 percent of GDP for housing, infrastructure, irrigation, textiles, rural employment, and social assistance schemes. Limit on market borrowing by states to finance capital expenditure raised by 0.5 percent of states' GDP.

  • Promotion of exports. Interest subsidy of 2 percent introduced for export credit for labor intensive exports (until March 2009). Enhancement of duty drawback benefits.

  • Public sector bank recapitalization: over next two years, 0.4 percent of GDP.

  • Off-budgetary measures. India Infrastructure Finance Company Limited authorized to raise (in debt financing) Rs 400 billion (0.8 percent of GDP) over the next 18 months.

9. Mirroring global trends, markets are taking a negative view of India's financial institutions' health. Banks, which dominate the financial system, have seen their share prices fall sharply. Their credit default swap (CDS) spreads and default probabilities have risen dramatically despite a more positive assessment by bank analysts and credit rating agencies. A large private bank suffered a modest deposit run in late September that was quickly contained after official reassurances that the bank was sound. Third quarter results still point to relatively robust profit growth for most banks, but NPAs are rising. Furthermore, mutual funds (MFs) have faced significant redemptions (nearly 15 percent of assets in September) mainly due to corporates' withdrawals, but the situation has stabilized recently. Finally, nonbank finance companies (NBFCs) are reported to have seen a dramatic increase in borrowing costs.

10. The budget performance has deteriorated substantially this year. During April–November 2008, tax revenues grew by 15 percent (y/y), but collections slowed significantly in recent months as economic activity weakened and stimulus measures, notably a 4 percentage point cut in the central VAT, took effect (Figure 4). In the same period, spending also rose rapidly driven by a soaring subsidy bill, an agricultural loan write off, a 21 percent civil servant wage increase, and the strong off-take of a rural employment scheme (NREG). With the two supplementary budgets (announced in October and December) approving additional on-budget spending of 2.7 percent of GDP including to fund the stimulus packages (0.6 percent of GDP), and subsidy-related bonds of 1.6 percent of GDP, the deficit is set to exceed the budget target by a substantial amount. As of March 2008, public debt was 80 percent of GDP, roughly unchanged from end-2007 (see Annex I).4

Figure 4.India: Fiscal Indicators

Sources: Country authorities; and Fund staff calculations.

1/ Includes subsidy-related bond issuance.

IV. Outlook: A Marked Slowdown with High Uncertainty and Downside Risks

11. Growth is set to slow markedly in this fiscal year and next. From 9 percent in 2007/08, growth is projected at 6¼ percent in 2008/09 and 5¼ percent in 2009/10, slightly below market forecasts.5 With nonagricultural growth falling by 4 percentage points, the envisaged slowdown is sharper than that at the time of the 2001 global recession when nonagricultural growth slowed from 7.8 percent in 1999/2000 to 5.9 percent in 2000/01. The current global crisis far exceeds the extent of past recessions and India is significantly more integrated with the rest of the world. As in 2001, investment is likely to weaken substantially via the financing and confidence channels combined with softer demand (Box 2). Moreover, declining corporate profitability and savings will likely reverse the past years' upward trend in domestic savings that enabled investment-led growth to take off. Stimulus measures and a good harvest should support consumption somewhat, but the growth impact of the recently approved fiscal measures could be limited by implementation capacity constraints and only partial pass through of tax reductions to prices. Export growth is projected to fall, but weaker domestic demand should also reduce import growth, keeping net exports' contribution to growth broadly stable.

India: Saving-Investment Balance

(In percent of GDP)

Sources: CEIC Data Company Ltd.

12. Inflation is expected to fall sharply. With commodity prices receding and slackening demand curbing wage growth and pricing power, inflation is anticipated to drop to below 3 percent y/y by March 2009 and to an average 2 percent in 2009/10.

13. The overall balance of payments is projected to be in deficit this year and next. The current account deficit is projected at below 3 percent of GDP in 2008/09, before narrowing to 1½ percent of GDP next fiscal year due to lower oil prices and softer domestic demand, and as the rupee depreciation buffers the effect of slowing external demand on exports. Although it is difficult to predict when investor risk appetite will return, portfolio and debt capital flows are unlikely to recover appreciably at least until late 2009.6 FDI flows, beyond projects already in the pipeline, are also expected to slow and are unlikely to pick up before the recovery in advanced economies materializes.7

14. Reflecting the global economic situation, the margin of uncertainty surrounding the forecasts is unusually large with still significant downside risks. The main risks stem from global spillovers. A protracted drought of credit and anemic world growth would stunt investment, exports, and growth. Consumption could also be hit more, especially if job losses mount and consumer credit dries up. Also, given the high degree of uncertainty, policy trade-offs could become difficult to manage. Finally, the elections, due to take place by May 2009, could add to the policy uncertainty. The main source of upside risk would be from a larger than expected impact of the stimulus measures.

Box 2.India—Spillover Channels of the Global Financial Crisis to India

The global crisis is affecting India mainly through the following channels.

  • Lower investment and growth resulting from reduced availability of financing, higher funding costs, and deteriorating sentiment. By 2007/08, the share of Indian corporates' funding from external sources had risen to 25 percent, while equity issuance accounted for an additional 10 percent. Corporate profitability is expected to deteriorate considerably, thus reducing firms' internal sources of funding. Weaker demand and uncertainty about the outlook are also depressing investment.

  • Some firms and sectors could face dollar funding problems. India's private sector is exposed to a deterioration in investor sentiment mainly in the equity market, where foreigners hold about US$53 billion in shares, a third of the free float. In addition, some large Indian firms are facing significant near-term FX refinancing pressures. The amount of foreign borrowing (bonds and loans) by Indian banks and corporates falling due in 2009 is the third largest among emerging markets. Moreover, the net asset position of Indian banks and corporates vis-à-vis BIS reporting banks has deteriorated rapidly over the last two years, and has become negative. The availability of trade credits was also sharply reduced in the fall of 2008 in line with global developments.

  • Credit quality could deteriorate substantially, which could lead financial institutions to cut credit. India's credit expansion has been fairly strong compared to other emerging markets. Maturation of the domestic credit cycle and an expected deterioration of corporates' financial situation (especially SMEs and real estate firms) are expected to affect banks' performance adversely.

  • A weaker rupee. FX debt is estimated to amount to 20–30 percent of total corporate debt. Continued depreciation would especially affect those firms that have borrowed in FX without hedging, with banks in turn exposed to the deterioration in the financial health of their borrowers. It could also entail higher cost of finance externally and domestically. A depreciation would also increase the current account deficit in the short run.

The contribution from foreign financing has risen significantly
In percent of total funds
Foreign Direct InvestmentForeign BorrowingEquity IssuanceBank CreditRetained Earnings
2003–0411.8−7.913.810.471.8
2004–056.85.97.227.952.3
2005–068.32.45.826.956.6
2006–0714.710.85.021.847.7
2007–0815.410.510.220.643.3
Sources: Securities and Exchange Board of India, Reserve Bank of India and Central Statistical Organization, India.
Sources: Securities and Exchange Board of India, Reserve Bank of India and Central Statistical Organization, India.

India's refinancing needs are high among EMs

Source: J.P. Morgan.

India's international investment position has turned negative 1/
In billions of U.S. dollars
Assets378
Direct48.2
Portfolio0.7
Other16.6
Reserve312
Liabilities427
Direct120
Portfolio108
Equity87
Debt21
Other199
Trade credits47.3
Loans107
Currency & deposit43.6
Other1.85
Memo items
External commercial borrowings62
Multi- and bilateral loans58
Total external debt220
Source: Reserve Bank of India.

As of June 2008.

Source: Reserve Bank of India.

As of June 2008.

Despite these spillovers and vulnerabilities, there are risk-mitigating factors.

  • Low levels of external debt and strong reserve coverage. India's gross external financing requirement and total external debt are low1 and more than covered by reserves (50 and 75 percent of reserves, respectively). Although it has increased recently, the leverage of nonfinancial firms is in line with regional peers.

  • Limited spillovers through trade. A 1 percent slowdown in global growth is estimated to trim only 0.3 percentage point from India's growth. In addition, domestic demand explains almost all of India's recent growth.

  • Declining commodity prices should further lower inflation, narrow the current account deficit, and limit the fiscal burden of oil subsidies. Declines in nonadministered oil prices should contribute to the moderation in inflation, leaving room for monetary easing. A US$10 decline in the oil price reduces the current account deficit by 0.4 percent of GDP and the cost of oil subsidies by 0.6 percent of GDP.

India's credit growth has been strong

Sources: CEIC Data Company Ltd; and Fund, World Economic Outlook, International Financial Statistics and staff calculations.

1/ Data for the Philippines pertain to end-2007. Except for China nominal credit to the private sector is deflated by the quarterly GDP deflator. For China, the consumer price index is used.

India's corporate leverage is in line with regional peers

Source: Fund, Corporate Vulnerability Utility.

India's reserve cover is high

Source: Country authorities; and Fund staff estimates.

1/ As of September 2008

2/ As of December 2008

1 The expected near-term refinancing need of Indian corporations is estimated at US$14 billion in 2009 (JP Morgan, based on international bond and loan issuance data).

15. Feedback loops between the financial and real sectors and between external shocks and domestic vulnerabilities could be strong. As already unfolding in several countries, corporate difficulties will lead to increased delinquencies on bank loans, undermining financial stability and leading to capital deficiencies and lower credit growth, and in turn causing further difficulties for corporates. Slower growth would further depress foreign investor sentiment and capital flows. Flagging corporate profitability will lower tax revenues and worsen the fiscal position, which could drive up interest rates and India's risk premium, in turn squeezing corporate profits.

16. Once the current downturn is overcome, India's inherent strong long-term fundamentals should prevail once again. As the current risk aversion recedes, investors are expected to become more discriminating, which together with a reduced pool of investable funds entails much greater competition among emerging market countries to attract foreign capital. Against this, India's fundamental strengths—arising from its demographic advantage, well-developed institutions, and large potential domestic demand—remain intact and will likely be seen favorably by investors relative to countries more dependent on external demand.

Authorities' Views

17. The authorities agreed that India is experiencing knock-on effects of the global crisis, but considered the staff's outlook too pessimistic. They noted that like other developing countries, India is being affected mainly via the trade channels. They contrasted India's experience with that of advanced economies where “the contagion spread from the financial to the real sector, while in India, the slowdown in the real sector was affecting the financial sector, which in turn has a second-order impact on the real sector”.8 The authorities contended that the effects were mainly indirect and have been addressed by the measures taken, while noting that they stood ready to act swiftly in response to evolving circumstances, employing both conventional and unconventional measures. They expected 2008/09 growth at 7 percent. They emphasized the overall strength of domestic demand boosted by fiscal stimulus and substantial investment in infrastructure and argued that investment had been financed predominantly via domestic savings. While acknowledging the high uncertainty surrounding next year's outlook, they remained confident that once the situation stabilizes, growth would return to the high trajectory of recent years. Overall, the authorities were cautiously optimistic, while agreeing that the main sources of risks were external.

V. Policy Discussions

18. The policy discussions were conducted recognizing that policymaking the world over is in uncharted territory, and that, policy responses therefore should continue to be flexible, but disciplined. The authorities have already taken numerous measures to address the crisis. Particularly noteworthy are the continued liberalization of the capital account and the renewed commitment to financial sector reforms exemplified by the decision not to ban shortselling of stocks and by the introduction of exchange-traded currency and interest rate futures. As the crisis spreads and deepens, priorities already identified in the medium-term reform agenda should determine the focus of policies, recognizing that some painful adjustment is inevitable. In addition, whenever government involvement is deemed necessary, it would be most effective in partnership with the private sector. If extraordinary measures are needed, an upfront announcement of an exit strategy would help avoid the perception that medium-term sustainability could be at risk. Reforms that would poise the economy for a stronger recovery should be implemented without delay, even if the near-term payoff may not seem large. With competition among emerging markets to attract foreign capital likely to be fierce when global capital markets normalize, strong fundamentals and policies will play a key differentiating role. With little fiscal room for further maneuver, the priorities are: (i) ensuring adequate financing to the real economy while protecting financial stability; and (ii) facilitating corporate restructuring so that viable companies can emerge stronger and unviable companies can be quickly and efficiently resolved.

Authorities' Views

19. The authorities emphasized that in the current circumstances it is not possible to have a precise roadmap for the policy response. There were simply too many “unknown unknowns” and the measures necessarily needed to be partly reactive. They underlined their commitment to respond flexibly and pragmatically to the evolving situation to mitigate the impact of the crisis. While they did not share the staff's view of the centrality of enhancing corporate restructuring mechanisms at this juncture and saw greater room for fiscal stimulus, they agreed that the major challenge was to maintain the flow of credit to the economy while maintaining credit quality.

A. Keeping Credit Flowing While Maintaining Financial Stability: The Role of Monetary and Exchange Rate Policy

Background

20. In the wake of the global financial crisis, the RBI quickly turned its focus to supporting growth and maintaining financial stability. Until early September, monetary policy had been geared towards reducing inflation, with the policy rate and the CRR each raised by 125 bps between May and July. But as financial market conditions tightened, the RBI changed gears, implementing measures to ease liquidity—notably by cutting the CRR by 400 bps, the policy rate by 350 bps beginning in late October, and the SLR (see Box 1). However, because the RBI intervened aggressively, liquidity pressures persisted until early November. Since then, the decline in intervention, combined with additional liquidity measures, have eased these pressures significantly. Nevertheless, as the staff's outlook for the balance of payments suggests further outflows, liquidity strains could reemerge, and in turn could quickly threaten solvency. Markets expect the RBI to ease monetary policy further in the coming months.

Until October, large-scale foreign exchange intervention offset RBI liquidity injections

Sources: Reserve Bank of India; CEIC Data Company Ltd; and Fund staff estimates.

1/ Includes repo and open market operations (including in market stabilization bonds), change in central government deposits at the RBI, and impacts of changes in the cash reserve ratio and the statutory liquidity ratio.

21. Financing conditions remain tight. Overall financing to firms appears to have contracted, despite the substitution of domestic credit for other sources of corporate funding. Banks have become more reluctant to extend credit, especially to sectors to which lending had expanded rapidly in recent years, such as real estate, small- and medium-sized enterprises (SMEs), nonbank financial corporations, and consumers. The decline in credit supply reflects concerns about the outlook for the real economy, an uncertain funding environment, and the increased attractiveness of government securities due to the expectation of capital gains (on the back of further monetary easing). In light of these pressures, commercial lending rates have not fallen in line with the policy rate, and prime lending rates (PLR) are now in the range of 8–10 percent in real terms based on expected inflation.9 Although demand for credit is likely to decline, tight financing conditions are expected to persist into 2009: the slowing economy will further decelerate deposit growth, thus constraining the supply of bank credit, while nonbank financing, foreign financing, and domestic capital market activity are unlikely to revive any time soon. In addition, rising concerns about corporate sector health are likely to keep the cost of credit high.

Nonbank financing for industry has fallen sharply
H1H1ChangeChange
2007/082008/09(year-on-year)(year-on-year)
(In billions of rupees)(In percent)
Bank credit44260416236.8
From low nonbanks to corporates1,198667−531−44.3
Domestic capital issues (bond and equity)200119−81−40.5
Issues of commercial paper1592165735.6
ADR/GDR11247−65−58.3
External commercial borrowing727286−442−60.7
Total1,6401,272−368−22.5
Source: Reserve Bank of India, “Macroeconomic and Monetary Developments: Mid-Term Review 2008-09”.
Source: Reserve Bank of India, “Macroeconomic and Monetary Developments: Mid-Term Review 2008-09”.

Policy Response

22. With the continued very sharp decline in inflation, there is room for further interest rate cuts. Despite having reduced the policy rate by 350 bps since October, the real policy rate (based on projected inflation) has risen. While interest rates may have only a limited impact on credit growth in this uncertain environment, further rate cuts could act as an important signal to the market about the outlook for inflation. They would also reduce the cost of funds for financial institutions and their customers (to the extent that they are passed on) and reduce debt service costs for the government.10 In addition, lowering the reverse repo rate would reduce incentives for banks to deposit funds at the RBI. Moreover, the impact of further rate cuts on capital flows and the exchange rate would likely be limited: the risk that lower interest rates may prompt outflows is small––interest rate differentials have actually widened in favor of India and an improved financing (and growth) outlook could spur inflows. In any case, the exchange rate pass through would likely be quite small given soft demand conditions.11

23. The numerous measures taken by the RBI to boost liquidity and its preparedness to do more in the event of renewed pressure are welcome. The reductions in the policy rates, the CRR, and the SLR were fully warranted. If liquidity were to tighten again, the RBI has a significant stock of “captured” liquidity that could be released: market stabilization bonds could be repurchased; the CRR and SLR could be lowered further; and all subsidy-related bonds issued by the government could be made eligible for repos with the RBI.12 In addition, to ensure the availability of liquidity over the longer horizon, the RBI could (i) introduce a longer-term (say 1 month) repo facility available to all counterparties, and (ii) increase the amounts available under the 90-day special refinance facility and announce its extension until at least end-2009.13 If these steps should still prove insufficient, the RBI could consider extending eligibility of collateral accepted at its repo window to corporate bonds and commercial paper, but with adequate safeguards regarding a minimum credit rating and appropriate discount. The latter measure would also boost the liquidity of corporate bonds, aiding market development and the monetary policy transmission mechanism. Measures along these lines have been taken by numerous countries (Box 3).

24. Exchange rate policy needs to be consistent with ensuring sufficient liquidity in the system. Until November, the large foreign exchange intervention undertaken in the wake of large capital outflows exacerbated pressures on domestic liquidity and resulted in a large loss in reserves. If pressures on the rupee were to re-emerge, letting the exchange rate find a floor would create the conditions 1 under which exchange rate expectations provide incentives for capital inflows. The downside risks of such an approach for banks and corporates would likely be limited, as banks' foreign exchange exposure is subject to strict limits and corporates' exposure to exchange rate risk appears low.14 Collecting data on and disclosing the overall unhedged foreign exchange exposure of the corporate sector would help help reduce uncertainty about its financial health.

Markets expect further depreciation

Source: Bloomberg L.P.

1/ Positive implies expectation of a rupee depreciation.

The real exchange rate has depreciated, reversing last year's appreciation

Source: IMF, Asia and Pacific Department database.

25. The rupee appears broadly in line with its equilibrium level. In 2008, the rupee depreciated over 14 percent in nominal effective terms and 11 percent in real effective terms, and is broadly in line with its long-term average. The latest IMF Consultative Group on Exchange Rate (CGER) exercise also continued to show that the rupee is close to its equilibrium level, although considerable uncertainty surrounds the impact of the crisis on the current account and capital flows. Even though there were large sales of FX during the recent market turmoil, there was sizable two-way intervention during 2008.

Box 3:Select Cross-Country Comparisons of Financial Measures

This box provides a selective list of financial market measures taken by other emerging market countries in the past few months.

Domestic Liquidity Provision

  • Hong Kong SAR: Longer-term liquidity (collateralized lending raised from 1 to 3 months).

  • Korea: Expanded collateral for repos (bank bonds, guaranteed mortgage-backed securities, MBS).

  • Philippines: Expanded collateral for domestic repos (to include FX sovereign debt).

  • Russia: Expanded collateral for repos (stocks, government guaranteed MBS); expansion of counterparties to repo operations (low-rated banks); provision of long-term liquidity (up to 1 year, no collateral).

  • Japan: Expanded collateral for repos (additional government bonds; guaranteed asset-backed commercial paper; lower quality corporate debt).

FX Liquidity Provision

  • Brazil: $20 bn central bank credit line for corporates with FX debt and $10 bn for exporters; auctions of 1-month USD liquidity lines; allow BRZ sovereign debt as collateral for FX repos.

  • Hong Kong SAR: the HKMA to conduct FX swaps with banks on an as-needed basis.

  • Hungary: overnight FX swap facility for domestic banks, facilitated by an agreement between the Central Bank and the ECB.

  • Korea: $5 billion Ex-Im Bank credit line (banks); $55 billion BOK credit line for trade finance.

  • Turkey: daily dollar auctions to inject FX; limit on export rediscount loans raised.

Facilities to Supplement International Reserves

  • Korea, Brazil, Mexico, Singapore: FX swaps with US Fed.

  • Korea: FX swaps with Japan ($20bn) and China ($28 bn).

  • Hungary: FX swap with the ECB (€5 bn).

  • Iceland: FX swaps with Nordic central banks (€1.5 bn).

Credit Guarantees

  • Hong Kong SAR: loan guarantee fund for non-listed companies with risk sharing up provisions.

  • Korea: Expansion of government credit guarantee program for SMEs.

  • Russia: Government to provide corporate loan guarantees to improve liquidity conditions.

  • Japan: Expanded guarantees on new SME lending up to 6 percent of GDP.

  • UK: Government guarantee for half of up to $30 bn of new and existing SME bank loans with risk sharing provisions.

Bank Recapitalization

  • Brazil: Two largest state banks allowed to purchase stakes in private banks.

  • Hong Kong SAR: Contingent Bank Capital Facility (HKMA).

  • Korea: Bank Capital Expansion Fund ($15.5 billion), financed by the Bank of Korea, the Korea Development Bank, and outside investors.

  • Russia: Long-term subordinated debt financing ($30 bn), primarily to state-owned banks, from central bank and government.

26. A limited amount of foreign exchange could be made available in the form of swaps to relieve foreign exchange shortages and allay concerns about external financing. The RBI's recent introduction of foreign exchange swaps for banks with foreign branches or subsidiaries is welcome. If broader foreign exchange shortages should materialize, the RBI could hold regular foreign exchange auctions, open to all RBI counterparties and with the total amount available (over a specified period of time) announced at the outset. Brazil, for example, has introduced such FX swap facilities and direct FX loans to corporates, announcing a sizable amount up front. The amount committed would need to be meaningfully large, within the constraints posed by reserve adequacy. India's reserves remain comfortable compared to imports, short-term external debt, and the external gross financing requirement, and cover more than 70 percent of non-FDI external liabilities. However, they represent only about 30 percent of domestic financial liabilities (M3), which might become the more relevant metric if financial stability conditions were to deteriorate markedly.15

Authorities' Views and Plans

27. The RBI stated that the steps they had already taken to boost liquidity had proven effective, as evidenced by the decline in the interbank rate to within the policy rate corridor. In addition, the introduction of new refinance facilities for certain sectors of the economy (e.g., exporters, housing finance companies, and small and medium-sized enterprises) were helping to alleviate stress on these sectors and obviating the need to expand repoable collateral. The authorities noted that several of the RBI's new and expanded liquidity facilities (including those for foreign exchange) had not been fully utilized, and that banks were depositing excess liquidity in the RBI's overnight facility and still had unused collateral with which to access the RBI's repo facility, especially after the build-up in their government securities' holdings in recent weeks. These factors indicated that liquidity pressures had been addressed successfully.

28. The authorities saw little evidence of unmet credit demand, but expressed concerns about slowing credit growth which they viewed as primarily demand-driven. RBI officials noted that banks continued to lend vigorously and that credit growth net of the additional demand for credit resulting from reduced external financing remained around 20 percent (y/y) until end-October. While they acknowledged that with deposit growth slowing it would be difficult for banks to reduce deposit rates and hence lending rates markedly, the RBI expected the cost of credit to moderate as the measures to improve the flow of credit took effect. However, they expressed concern about the slow pace of transmission from policy to market interest rates and about what appeared to be a noticeable decline in credit demand since October.

29. The RBI indicated its willingness to consider adopting additional policy measures if needed, and they have since reduced interest rates and the CRR. The RBI intended to continue coordinating its repurchase of market stabilization bonds closely with the issuance of government securities to minimize the net liquidity impact. Additional options if needed included lowering the CRR, lowering the SLR but with due consideration for its prudential importance, and possibly, increasing the amount of refinance available to financial institutions. Since India's banks remain financially robust, the RBI intended to keep relying on them as the primary channels of credit intermediation, including to nonbank financial institutions. Broadening the types of collateral accepted at the RBI's repo window might also be an option, though the RBI noted that in the case of corporate bonds, the absence of a robust secondary market (and hence of reliable pricing information) would make it difficult to accept them. Finally, the authorities highlighted the importance of an exit strategy from the exceptional policy measures adopted in the wake of the crisis, and noted that many of these measures included explicit sunset provisions.

30. The RBI reaffirmed that India pursues a flexible exchange rate policy, intervening only to smooth volatility. In this connection, they pointed to the large depreciation of the rupee against the U.S. dollar in recent months. However, the authorities were skeptical about the staff's recommendation of letting the exchange rate find a floor, since in times of financial volatility, the floor has no significance.

B. Keeping Credit Flowing While Maintaining Financial Stability: The Role of Financial Sector Policy

Context

31. Based on headline indicators India's financial system compares favorably internationally, but rising credit risk and liquidity pressures are putting it under strain (Box 4). Indian banks appear well-capitalized, relatively liquid, and have low NPA ratios and only limited exposure to structured credit products and troubled financial institutions. However, over the last few years, a rapid domestic credit expansion, combined with a sharp increase in foreign liabilities, has increased banks' vulnerability to slowing economic activity and global deleveraging. The downturn in the corporate sector (including in real estate) is of particular concern, as is the fact that risks appear to be concentrated in a few institutions. Information gaps, especially related to derivatives positions and data for detailed stress tests, cloud the staff's assessment. In addition, significant duration mismatches and deteriorating asset quality in NBFCs are worrisome. These problems have in turn affected MFs, which are some of the main investors in the securities issued by NBFCs. While MFs and NBFCs have combined assets equivalent to only 14 percent of banking assets, they are linked to banks through funding relationships and the combined impact of their stress on the cost of working capital as witnessed by the spike in commercial paper rates make them systemically important.

Box 4.India: Financial Stability Risks

Financial stability risks in India have risen in line with global developments. CDS spreads for Indian banks jumped sharply in mid-September and although they have eased since November, the remain elevated and are comparable to those of Indonesian and Korean banks, which are perceived to be vulnerable countries. The Moody's KMV one-year expected default frequencies (EDFs) have also spiked, but are lower than default probabilities implied by CDS spreads. The credit ratings of major Indian banks have also been affirmed with only ICICI's U.K. subsidiary being revised downward to the same level as the parent company and three other small banks downgraded since the global financial crisis began. Some market analysts note that current CDS spreads overstate the risk of default of Indian banks, and reflect instead the severe dislocation and illiquidity of Indian CDS.

Indian banks compare favorably internationally in terms of capitalization and wholesale funding risks. Their average capital adequacy ratio (CAR) is 12½ percent, with tier 1 capital close to 9 percent.1 Their credit-to-deposits (CD) ratio at 74 percent is relatively low, particularly compared to those countries bearing the brunt of the global crisis.1 The CD ratio of Indian banks is affected by a 24 percent SLR held mostly in cash and government securities, which provides a cushion against liquidity shocks.

CAR and liquidity appear adequate

Source: UBS.

India's banking system, however, remains vulnerable, especially to credit and liquidity risks.

Credit risk. Staff's stress tests indicate that the capitalization of systemically important banks does not drop below the regulatory CAR minimum (9 percent) if impaired loans rise to twice the current gross NPA ratio of 2½ percent. This provides some comfort. However, spillovers from the global financial crisis coinciding with the turning of the domestic credit cycle could result in a substantial increase in NPAs. For example, some countries during the Asian crisis saw NPAs increase as much as 200-300 percent. In such an extreme scenario, the capital position of a number of Indian systemically important banks would fall below the minimum CAR. In addition, while banks' interest rate risk is relatively low as most loans (including mortgages) are at floating rates, indirect credit risks related to an interest rate spike could be significant. In terms of sectoral exposure, industry accounts for about 40 percent of total bank credit (of which roughly a quarter is to small firms). The property sector, which has come under considerable stress with real estate prices already down sharply and likely to fall further, accounts for about 19 percent of bank credit (with the majority accounted for by housing loans), although this does not include the indirect exposure via nonbank financing institutions and collateral.

Banks' capital should be able to withstand a doubling of NPAs

Sources: Bankscope; and Fund staff estimates.

1/ Based on staff's stress test estimates of top thirty banks by asset size as of March 2008.

  • Liquidity risk. Even before the onset of the recent crisis, Indian banks had seen much more rapid credit than deposit growth. This had been accompanied by a sharp rise in external liabilities to BIS reporting banks (with liabilities at US$51billion at end-June 2008 or about 5 percent of total assets, double their end-2006 level) financing a growing share of foreign currency loans to residents (from 16.2 percent of total foreign assets in March 2001 to 47.8 percent in December 2007), suggesting a potential maturity mismatch in their FX book. The largest share of external liabilities is accounted for by nonresident deposits (27 percent), a relatively stable source of finance, although in the past they have declined at times of stress. Starting in September, the withdrawal of foreign credit lines to banks in India and Indian bank branches abroad increased dollar funding risks. While banks responded by borrowing in the domestic interbank market, the spike in interest rates demonstrated the link between domestic and global liquidity.

  • Exposure to structured credit products, troubled financial institutions, and derivatives. According to the RBI, India has virtually no exposure to U.S. subprime mortgage assets or to other structured credit products. The total exposure to five troubled global institutions is reported at US$1 billion (0.1 percent of system's assets). While these exposures are small compared to earnings and capital, they are fairly concentrated. As in Korea, Indian banks also face an earnings shock from FX derivatives losses (the authorities estimate mark-to-market losses at $5.5 billion).

  • Foreign exchange risk. Stringent daily limits on net foreign exchange open position limits and restrictions on foreign borrowing by banks are deemed to have limited their exposure to FX risks. Nevertheless, it is not clear to what extent banks may be affected indirectly by corporations' unhedged FX exposures and/or FX derivative losses. Also, within their FX book, banks may have maturity mismatches, which have not been publicly disclosed.

  • Equity risk: banks' overall exposure to equity is limited to less than 40 percent of net worth and if loans are secured against shares, the margin has to be 50 percent: nevertheless, the latter may be insufficient in some cases when equity volatility is as high as in recent months.

  • There are also several information gaps (e.g. off-balance sheet derivative positions, and foreign borrowing mismatches and covenants) that make a conclusive assessment of financial stability risks difficult. These gaps call for further data dissemination, analysis of asset quality, and stress testing of banks allowing for extreme events, multiple factors and feedback loops from the corporate sector.

Credit growth has outpaced deposit mobilization

Sources: CEIC Data Company Ltd; and Fund staff calculations.

1 These data refer to September 2008.

Indian banks had recently increased funding from foreign sources

Source: Bank for International Settlements, Consolidated Banking Statistics, October 2008.

32. In light of the deterioration in economic conditions, the RBI has eased prudential guidelines for loans. Provisioning norms for lending to sectors that had previously been subject to higher standards (such as real estate, personal loans, and exposures to capital markets) have been reduced to the rate prevailing for most other loans. Similarly, risk weights on exposures previously subject to a higher risk weight have also been reduced. Commercial real estate loans have been made eligible for special treatment under the RBI's prudential regulations for restructured loans, such that even after restructuring loans can continue to be classified as “standard”. In addition, standard accounts (except exposures to commercial real estate, capital markets, and personal loans) that have to undergo a second restructuring no longer need to have their loan classification downgraded.

Policy Response

33. These circumstances call for careful identification and disclosure of systemic risks in the financial system. Detailed analysis of bank asset quality and off-balance sheet structures is essential, with mark-to-market accounting important to ensure that asset quality problems are not masked.16 Multifactor stress tests for extreme events, particularly credit and liquidity shocks and allowing for feedback loops between the financial and nonfinancial sectors, which have tended to be greatly underestimated in a number of countries, would be advisable.17 Stepped-up efforts of this type have been adopted by the Hong Kong Monetary Authority, which has intensified stress testing of banks and brokers and issued additional guidance to them. Data on critical variables such as open foreign exchange exposures and derivative positions of financial institutions and corporates should be disseminated and monitoring mechanisms for foreign and other wholesale borrowing could be strengthened. (For example, Mexico recently required corporations to report the losses that would result from their derivative exposures for given changes in market variables.) The information gathered could then be disseminated through a regular financial stability report.

34. International experience suggests that early loss recognition and bank recapitalization (where necessary) are the measures most likely to be effective in restoring the flow of credit. Key steps in this process would include the following:

  • Avoiding masking the underlying capital position of financial institutions. Recent reductions in provisioning requirements are consistent with countercyclical prudential regulation and cuts in risk weights can also be viewed in this light, particularly since they still meet the minimum Basel standards. However, measures that permit regulatory forbearance on asset classification—for example, allowing restructured assets not to be classified as NPAs—obscure banks' true asset quality and undermine confidence in the accuracy of their accounts in the absence of disclosure. These measures could defer the recognition of bad assets, encourage adverse selection of borrowers, and undermine risk management practices.

  • Providing incentives for early loss recognition. Banks could be given the right to absorb the losses arising from the difference between the book and new net present value of restructured assets in a special account limited in size (say up to 1 percent of risk-weighted assets), not immediately set off against regulatory capital. The accounting losses in this account could be amortized over time or through capital raised when markets become vibrant again. Also, consideration could be given to making public money available to banks for recapitalization conditional on certain restructuring targets.

  • Identifying capital needs and recapitalizing banks. The RBI should move quickly to estimate the likely increase in NPAs, and hence the possible need for additional capital. The authorities have announced their intention to raise the capital of some public banks to 12 percent of risk weighted assets, and have pledged spending of 0.4 percent of GDP for this purpose. This proposed increase in capital should be adequate to face an increase in NPAs of up to 200 percent, which is in line with India's past experience in the 2002–03 downturn, but may not be sufficient to withstand a more severe deterioration in asset quality. 18 If additional recapitalization were needed, private money should be the first option, given the limited fiscal space. With public banks accounting for about 70 percent of system assets, removing the 10 percent cap on single investors' voting rights and reducing the 51 percent minimum state ownership in public banks would be instrumental. If public recapitalization becomes necessary, high standards of transparency should be upheld, and a clear exit strategy announced. Given constraints on funding for recapitalization, it may be necessary to exercise regulatory forbearance on the minimum capital asset ratio (CAR) during the transition period of recapitalization.

  • Facilitating the disposal of impaired assets. To bolster the market for NPAs, restrictions on foreign investment in asset reconstruction companies (ARCs) should be eased. Also to expand the participants in the NPA market, nonbank financial secured creditors should be given the same rights as bank secured creditors under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act.

35. Cyclical and structural limitations on the banking system underscore the importance of advancing the authorities' financial reform agenda. Besides cyclical factors, such as moderating deposit growth and high credit to deposit ratios, expansion of bank credit is also constrained by structural factors, including the high government borrowing requirement and priority sector lending. This highlights the importance of implementing recommendations to develop nonbank financing in line with the Rajan Report and accelerate capital account liberalization, as in the Tarapore II Report. Advances in these areas are essential to ensure that sufficient financing is available to support India's ambitious growth trajectory.19 The priorities are as follows:

  • Developing the corporate bond market. To build the institutional investor base, insurance companies and pension funds should be allowed to invest a greater share of their assets in corporate bonds. The enactment of the insurance and pension reform bills now in parliament would also be important. Foreign participation remains instrumental to promote market liquidity, which will require raising the limits on FII investment in corporate bonds considerably.20

  • Further capital account liberalization. The authorities have already taken numerous measures, some since the conclusion of the mission (see Box 1).21 To sustain access of Indian borrowers to foreign capital and ensure smooth refinancing of external debt, all interest rate caps and minimum maturity requirements on foreign borrowing, including trade credits, should be lifted. To position India well for when the tide of capital flows turns, the authorities should (i) liberalize FDI, especially in the financial sector; (ii) ease restrictions on foreign borrowing and foreign participation in local debt securities markets;22 and (iii) expand the range of contracts and participants in the derivatives markets. Consideration could be given to tapping multilateral development banks' trade credits. Rediscount facilities for trade credits could be expanded and foreign exchange auctions for this specific purpose (as part of the foreign exchange swaps proposed above or separately as outright sales) could be carried out.

  • Improving banking system efficiency and reach. When credit is less readily available, the premium on its efficient allocation becomes greater. Efficiency could be improved by (i) lowering the minimum government ownership in public banks and increasing managerial autonomy; (ii) liberalizing interest rates on priority-sector loans and introducing priority-sector loan certificates; (iii) allowing greater foreign investment in banks; and (iv) allowing more consolidation in the banking sector, including by domestically incorporated subsidiaries of foreign banks.

36. Government-assisted refinance and credit guarantees could also be an option to encourage banks to extend credit, but transparency and appropriate assessment and pricing of risks should be ensured. In case unconventional measures entailing greater government intervention become necessary, government refinance and credit guarantees can be a timely and largely market-based means of alleviating a credit crunch. The advantage of these programs is that they involve sharing of risk and reward, while loans would be administered by the banks, thus exploiting their technical expertise. There are a number of these programs in India, for example, via the EXIM Bank, the National Housing Bank, and the Small Industries Development Bank of India, where the RBI provides refinancing, and more recently via the India Infrastructure Finance Company Limited (IIFCL), which will issue government-guaranteed bonds to provide refinancing for infrastructure. The government could allow the IIFCL to ratchet-up its refinancing activities and expand the scope of its support for public-private partnerships (PPPs) by permitting further debt issuance. However, due regard would need to be paid to transparency by disclosing the contingent liabilities and managing the resulting fiscal risks. Recently, Hong Kong SAR and the U.K. introduced credit guarantees for nonlisted companies and SMEs, respectively, with explicit risk sharing mechanisms. Consideration would also need to be given to lifting interest rate ceilings on on-lending to reflect the true credit risks of borrowers or to providing explicit partial guarantees for excess risk held by financial institutions.

37. Crisis preparedness exercises would enhance the authorities' ability to intervene quickly if financial conditions were to deteriorate significantly. These exercises should aim especially at strengthening cross-institutional coordination, speeding up decision making processes, and reviewing intervention frameworks. An interagency task force may be helpful in this regard. For example, Hong Kong SAR has established a Task Force on Economic Challenges and Korea has set up a high level committee to prepare contingency plans. Also, should concerns about financial stability intensify, possibly as a result of financial contagion, the authorities could consider arranging foreign exchange swaps with other central banks and availing themselves of the IMF's Short-Term Liquidity Facility (SLF) to allay concerns about the availability of external financing.23 If the funding situation of banks deteriorated substantially, a guarantee on banks' new debt could be considered such as in Korea, given that capital controls limit the scope for residents' outflows. An explicit blanket guarantee to all banks' creditors should be reserved for more extreme events.

Authorities' Views

38. The RBI reiterated that the financial system is well capitalized and that the policy stance has consistently balanced growth, inflation, and financial stability concerns. They noted that the RBI's Financial Self Assessment, which will be published in early 2009, confirmed this assessment. With the average regulatory CAR at about 13 percent, well above the 9 percent minimum (which in turn is 1 percentage point above the minimum under Basel II), the authorities did not expect that a major bank recapitalization program would be needed although a few smaller public banks may require additional capital. In the medium term, banks generally were deemed to have sufficient headroom to maintain a 12 percent CAR, despite the increase in bank assets and the new requirements under Basel II.24 Derivatives exposures were largely concentrated in foreign banks operating in India, while daily net foreign exchange open positions limits were strictly enforced. Detailed analysis of institutions' assets and off-balance sheet items was already underway through periodic off-site and on-site inspections.25 With regards to the sharp deterioration of banks' market performance (e.g., equity prices and CDS spreads), the RBI noted that these were poor indicators of credit risk perception of financial institutions, and that in any case such market information was only available for a few banks.

39. The authorities did not yet see any evidence of a turn in the credit cycle and maintained that banks were well-positioned to weather a deterioration in market conditions. Instead of banks' reluctance to lend, the problem was more that high economic growth witnessed in the last few years had resulted in a sharp rise in demand for bank credit and the onset of the global financial turmoil had further raised this demand due to the drying up of external funding sources. Moreover, India's banks have sufficient margins (loan to value ratio) and capital to absorb loan losses should they materialize, although at present there was no reason to expect a substantial increase in NPAs. Indeed, RBI officials stated that the stress tests carried out in the RBI's self assessment—which is yet to be published—had not revealed significant risks in this respect.

40. The RBI emphasized that appropriate regulatory and supervisory measures had already been undertaken to maintain financial stability and keep credit flowing. RBI officials noted that systematic stress testing was being done and that reporting of banks' exposure to sensitive sectors (such as real estate, unsecured consumer lending, SMEs, and equities) and their liquidity positions had recently been enhanced: a new liquidity monitoring framework had just been established for rupee funds and a similar one was being developed for FX liquidity. Recent reductions in provisioning requirements and risk weights to particular sectors were counter-cyclical prudential measures. Moreover, allowing restructured assets not to be classified as NPAs was seen as a temporary measure to encourage banks to restructure their assets during the current slowdown as it is always better to go for restructuring rather than allow the impaired assets to turn into NPAs. They noted that coordination among agencies was already effective and that the Prime Minister himself headed a committee tasked with sustaining growth and safeguarding financial stability. Finally, the deposit insurance coverage was judged to be adequate covering 93 percent of the total number of accounts as against international benchmarks of 80 percent.

41. The authorities were satisfied with the functioning of India's insolvency framework. The corporate debt restructuring framework (for out-of-court workouts) and the SARFAESI Act (which strengthens the hand of secured creditors) have worked well, facilitating debt restructuring and improving recovery rates by creditors. In addition, during 2008, the RBI has granted certificates of registration to five new ARCs, bringing the total to eleven.

42. The authorities noted that financial sector reforms were proceeding as planned. Banking system efficiency had improved since the beginning of the financial sector reforms in the 1990s and the government would review the role of public and foreign ownership of banks as planned in mid-2009. Listing procedures for corporate bonds had been streamlined, and a state-of-the-art trading platform and settlement system would be implemented soon, guaranteeing delivery versus payment. However, the RBI was of the view that corporates have little interest in issuing bonds, preferring instead private placements. They acknowledged the importance of a healthy domestic institutional investor base, but noted that in the current environment, investors preferred the safety of government securities. Easing prudential restrictions on the corporate bond holdings of pension funds and insurance companies was therefore unlikely to be effective.

43. The authorities argued that capital account liberalization has been in line with the country's long-term strategy as outlined in the Tarapore II Report. As for accelerating liberalization, the RBI noted that with prospects for capital inflows quite low, liberalization at this time would not have any notable impact on raising external financing. Moreover, the RBI maintained that easing restrictions on foreign investment in corporate bonds would expose India to risks associated with volatile capital flows while offering excess returns to foreign investors. Finally, the authorities considered that interest rate caps on foreign borrowing were advisable from a prudential point of view to prevent exposing domestic borrowers to extremely high rates of interest which could result in systemic stress.26

C. India's Corporate Sector: A Challenging Outlook

Background

44. While corporate balance sheets appeared healthy through early 2008, the recent sharp deterioration in financial and economic conditions is likely to have heightened vulnerabilities. Staff's analysis suggested that such a deterioration is likely to have more than doubled the share of companies facing difficulties in servicing their debt (defined as firms with earnings below interest expenses).27 Moreover, the exceptional equity volatility and the steep fall in equity prices have increased the probability of distress.

Policy Response

45. Problems in the corporate sector may give rise to demands for support, but direct government intervention in specific companies or sectors is fraught with risks. From an efficiency standpoint, the financial sector, with much greater ability to assess firms' earnings potential, is in a significantly better position to allocate scarce financial resources. Direct government support for specific sectors and companies is also likely to pose governance challenges. Similarly, while pressures for increased trade protection will intensify, trade restrictions would be highly counterproductive.28 Hence, public financial support would be best concentrated on providing financial institutions with the resources they need to keep credit flowing.

46. Ensuring that the insolvency framework is ready to handle a potentially large rise in corporate distress is a high priority. As companies run down their liquidity cushions, India may face a significant rise in corporate distress. In this regard, staff noted that implementation of Rajan Report recommendations to improve the bankruptcy law and enhance out-of-court restructuring mechanisms, as well as passage of the Companies Bill, would represent major steps forward. They also encouraged the authorities to consider strengthening incentives for operational restructuring (and reducing incentives for pure rescheduling of debt) under India's Corporate Debt Restructuring framework. As mentioned above, better functioning of ARCs and enhanced incentives to renegotiate debts for financial institutions would also facilitate a speedier resolution and higher recovery rates.

Authorities' Views

47. The authorities expressed a more sanguine outlook for the corporate sector. While India's firms may experience rising difficulties, they expected them to be contained at the level of a normal business cycle, as their performance had been very strong in recent years and hence firms were well-positioned to weather the downturn. With regards to restructuring mechanisms, they emphasized that India's existing framework for resolving corporate distress was already working well. Finally, the authorities reiterated that they did not plan to introduce trade restrictions.

D. Fiscal Policy: Limited Room for Further Stimulus

Background

48. After five years of fiscal consolidation, India's public finances deteriorated markedly in 2008/09. Between 2003, when the Financial Responsibility and Budget Management Act (FRBMA) was passed, and 2007/08, strong revenue performance driven by rapid growth and enhanced tax administration lowered the deficit and public debt (see Figure 4). The 2008/09 Budget envisaged continued consolidation targeting a 2.5 percent of GDP central government deficit compared to 2.8 percent in 2007/08. But with elections approaching, and the sharp rise in international oil prices in an unreformed subsidy regime, the government's ability to maintain fiscal discipline was severely tested. A soaring subsidy bill and a number of schemes that were not fully provisioned in the budget (e.g. the agricultural debt write-off, the NREG, and the wage hike) led to a substantial widening of the deficit. The 2008/09 central government budget deficit is now projected to reach 7 percent of GDP, including subsidy-related bonds. The states' deficit is projected to widen to about 2¾ percent of GDP, resulting in a general government deficit of almost 10 percent of GDP. Weaker corporate profits, lower imports, and a deeper downturn in economic activity, which have started to weigh on both direct and indirect tax collections, are the main downside risks. On the upside, lower commodity prices could lighten the subsidy bill.

Near-Term Policy Response

49. High government debt and deficits limit room for further fiscal stimulus. Staff's estimate of the discretionary fiscal measures provided in the budget and the two supplementary budgets is sizable, amounting to about 3 percent of GDP.29 In addition, the IIFCL was allowed to issue bonds fully backed by a sovereign guarantee and the ceiling for states' market borrowing was raised. With a high deficit and debt close to 80 percent of GDP, among the highest in emerging markets, expanding the deficit further could turn out to be contractionary, through its impact on India's risk premium, interest rates, and credit rating.30 In this context, the limited fiscal space would best be reserved for measures to jumpstart high quality infrastructure investment and strengthen the financial system.

Major Discretionaly Fiscal Measures in 2008/09 will contribute to a substantial widening of the deficit
(In percent of GDP)
Budget (and Supplementary Budgets) 2008/09
Tax measures 1/1.1
Spending 2/1.8
Fiscal Stimulus Packages (Dec 2008, Jan 2009) 3/
Tax measures0.2
Spending0.4
Total3.5
Other (off-budgetary) measures 3/1.7
Within 2008/090.7
Beyond 2008/090.9

Includes post-budget, inflation-related cuts in customs duties.

Reflects full amount of agricultural debt relief (Rs 600bn). The related net cash outgo in 2008/09 is Rs 150bn.

For details, see Box 1.

Includes post-budget, inflation-related cuts in customs duties.

Reflects full amount of agricultural debt relief (Rs 600bn). The related net cash outgo in 2008/09 is Rs 150bn.

For details, see Box 1.

50. If the authorities deem further fiscal stimulus necessary to support demand, it should be accompanied by reforms that ensure medium-term fiscal sustainability. Setting out a medium-term debt target and announcing credible accompanying reforms will boost confidence in the government's commitment to fiscal discipline when market conditions stabilize. If implemented, the fiscal stimulus should be timely and take into account implementation constraints to avoid governance lapses. Additional spending could focus on accelerating already planned infrastructure projects or increasing the public component of PPPs. Expanding well-targeted social programs that would raise the purchasing power of the poor, who have a high propensity to consume, could also be a valid alternative. Tax cuts, however, would likely be ineffective. The personal income tax base is very narrow, while for corporates, the impact would be small given the anticipated decline in profits; moreover, tax changes may be difficult to reverse.

51. Although getting back to the FRBMA targets is not feasible, next year's budget should strive to achieve a reduction in the central government deficit. Lower oil prices are estimated to reduce the 2009/10 subsidy bill by 2 percentage points of GDP, but revenue growth could decline as automatic stabilizers are triggered by slower economic activity. Thus, it would be inadvisable to offset fully the savings on the subsidy bill with additional discretionary spending measures. Moreover, the fiscal position of the states will likely deteriorate as growth in own revenues and resources transferred from the center decelerates, while spending pressures from the implementation of the Sixth Pay Commission public sector pay award persist. Next year's budget should also bring all spending on-budget to improve transparency and outline a concrete strategy for returning to a sustainable fiscal position in the Medium-Term Fiscal Policy Statement.

52. Lower commodity prices offer an opportunity to reform the subsidy system, which would provide a powerful signal of the government's commitment to expenditure reform, and thus fiscal discipline. The 2008/09 subsidy bill at 3⅔ percent of GDP (roughly equal to general government education and health outlays) highlights the centrality of subsidies in rationalizing spending. As suggested by the recent Chaturvedi Committee Report, a subsidy reform should eliminate regressive subsidies, namely on petroleum and diesel, phase out the LPG subsidy, and introduce a market-based pricing mechanism that aligns domestic prices to international levels. Carrying out this reform at a time of weak commodity prices would minimize the impact on domestic demand and inflation. Improved targeting for subsidies on kerosene, food and fertilizers and strengthening the delivery mechanism would enhance subsidies' efficiency and lower costs with minimal disruptions to the poor. In this regard, this year's pilot introduction of smart cards, as well as the plans to allot unique identification numbers to India's residents, are welcome steps.

Medium-Term Reform Agenda

53. Beyond the current downturn, fiscal consolidation continues to be a key priority as public finances remain India's Achilles heel. As emerging market investors are expected to be far more discriminating in the coming period, addressing this key vulnerability will be important to attract inflows, boost confidence, and buttress the credibility of measures that might be needed to strengthen the financial system. Also, fiscal consolidation remains necessary to gain room for countercyclical measures and expenditures related to the financial sector if needed. As credit markets thaw, consolidation will also be necessary to reduce the risks of crowding out.

54. The medium-term fiscal adjustment should be anchored in a fiscal rules framework centered on a debt target. With the current fiscal responsibility law setting targets through 2009/10, a new fiscal rule that addresses the weaknesses in the current FRBMA framework and is buttressed by comprehensive expenditure reforms, could play an important role in promoting fiscal consolidation.31 An eventual successor to the FRBMA could entail a significant expansion of the coverage of the fiscal operations of the public sector and include an explicit medium-term debt target, combined with consistent annual nominal expenditure growth rules. These rules would squarely put the focus of fiscal policy on debt sustainability, tackle the deficit bias at its very core (expenditure overruns), and allow for a more countercyclical fiscal policy by letting the automatic stabilizers operate. Subsidy reform should be complemented by ongoing efforts to improve spending efficiency, such as output-based budgeting and improved service delivery. The introduction of a goods and service tax will be an important milestone for strengthening the revenue collection efforts and streamlining indirect taxes.

Authorities' Views and Plans

55. The authorities reiterated their commitment to the process of fiscal consolidation as a prerequisite for sustained growth: however, they underscored that this is not the time for fiscal rectitude. They acknowledged that the overall central government fiscal and current deficit for 2008/09 will exceed the budget estimates due to the rise in commodity prices in the first half of the year as well as the fiscal measures taken in December and January to support growth. However, the authorities disagreed with staff's projected 2008/09 fiscal outturn for the states, arguing that states' revenue has remained buoyant and that the usual lag in the introduction of the pay increases at the state level would limit expenditure pressures. For the remainder of the year, the government will focus on pruning unproductive expenditure and monitoring the FRBMA targets closely. The authorities do not envisage the need for further measures in the current fiscal year.

56. They argued that the fiscal consolidation of the last five years, and the concomitant reduction in public debt, have created room for the current fiscal expansion. Also, the increase in government borrowing was being largely offset by the repurchase of market stabilization bonds, such that the impact of government spending on overall liquidity and credit available to the private sector has been minimized. The authorities were in agreement with staff's suggestions on the form that any further fiscal stimulus should take, namely an acceleration of spending on infrastructure projects that have already been launched, higher spending on easily scalable targeted social programs (such as NREG, housing for the poor, social assistance programs) and a limited role for tax measures. They also agreed that implementation capacity constraints had to be taken into account.

57. The authorities concurred that a return to the FRBMA targets was unrealistic for next year's budget. The slowdown in economic growth will likely necessitate continued fiscal stimulus. In addition, a significant ramp up in priority spending is in the works. The plan spending for next year will also include funds for the recapitalization of public sector banks. However, details on the broad outline of the 2009/10 Budget and the expected fiscal stance were not available as a full budget, which would reflect the policy agenda of the newly elected government, will be prepared only after the government is formed, likely as late as July.

58. The authorities agreed that reforms are necessary to secure lasting consolidation and signal the government's commitment to fiscal discipline. The government remains committed to reducing the subsidy bill and is exploring reform options, as evidenced by the introduction of a pilot smart card scheme. While there are signs that the fuel subsidy reform might be gaining support, the timing of such a politically difficult reform is unclear. Regarding plan spending, the authorities emphasized their increased focus on judicious spending of funds and expenditure management, as well as the limited scope for further rationalization of centrally sponsored schemes. On the revenue front, they argued that there are still substantial gains to be achieved on both direct and indirect taxes through ongoing compliance improvements and base-broadening.

59. The authorities viewed the FRBMA as having been very useful in instilling fiscal discipline. They pointed to its role in sensitizing ministries and departments and acting as a catalyst for fiscal consolidation at the state level. However, as the Thirteenth Finance Commission, tasked with assessing the need for a successor to the FRBMA, has not yet issued its recommendations, the authorities were noncommittal on the staff's proposal for a potential successor rule which includes an explicit debt target and nominal expenditure growth rules.

Table 1.India: Millennium Development Goals, 1990–2006 1/
199019951998200120042006
Eradicate extreme poverty and hunger 2/
Income share held by lowest 20%8.1
Malnutrition prevalence, weight for age (% of children under 5)44.443.5
Poverty headcount ratio at national poverty line (% of population)36.028.627.5
Prevalence of undernourishment (% of population)25.021.020.0
Achieve universal primary education 3/
Literacy rate, youth total (% of people ages 15-24)61.976.4
Persistence to grade 5, total (% of cohort)59.761.473.0
Primary completion rate, total (% of relevant age group)63.877.169.772.483.885.7
School enrollment, primary (% net)78.589.488.7
Promote gender equality 4/
Proportion of seats held by women in national parliament (%)5.07.09.09.08.3
Ratio of girls to boys in primary and secondary education (%)70.382.179.890.391.4
Ratio of young literate females to males (% ages 15-24)67.180.5
Share of women employed in the nonagricultural sector (% of total nonagricultural employment)12.714.416.016.817.9
Reduce child mortality 5/
Immunization, measles (% of children ages 12-23 months)56.072.051.053.058.059.0
Mortality rate, infant (per 1,000 live births)80.074.072.066.061.658.7
Mortality rate, under-5 (per 1,000)114.9101.589.378.4
Improved maternal health 6/
Births attended by skilled health staff (% of total)34.242.342.546.6
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 (% of women ages 15-49)43.046.956.3
Incidence of tuberculosis (per 100,000 people)167.8
Prevalence of HIV, female (% ages 15-24)
Prevalence of HIV, total (% of population ages 15-49)0.3
Tuberculosis cases detected under DOTS (%)0.31.623.155.363.8
Ensure environmental sustainability 8/
CO2 emissions (metric tons per capita)0.81.01.11.11.2
Forest area (% of land area)21.522.722.8
GDP per unit of energy use (constant 2000 PPP $ per kg of oil equivalent)3.23.43.73.94.34.5
Improved sanitation facilities (% of population with access)14.023.028.0
Improved water source (% of population with access)71.077.082.089.0
Nationally protected areas (% of total land area)
Develop a global partnership for development 9/
Aid per capita (current US$)1.61.91.61.60.61.2
Debt service (PPG and IMF only, % of exports of G&S, excl. workers' remittances)
Fixed line and mobile phone subscribers (per 1,000 people)0.61.33.624.3
Internet users (per 1,000 people)0.517.8
Total debt service (% of exports of goods, services and income)31.929.721.214.713.87.7
Unemployment, youth female (% of female labor force ages 15-24)8.010.210.8
Unemployment, youth male (% of male labor force ages 15-24)8.410.110.4
Unemployment, youth total (% of total labor force ages 15-24)8.310.110.5
General indicators
Fertility rate, total (births per woman)3.83.43.33.12.72.5
GNI per capita, Atlas method (current US$)390.0380.0420.0460.0630.0820.0
GNI, Atlas method (current US$) (billions)330.9350.2415.1478.6680.6914.7
Gross capital formation (% of GDP)24.226.622.624.231.636.0
Life expectancy at birth, total (years)59.161.462.262.963.464.5
Literacy rate, adult total (% of people ages 15 and above)48.261.0
Population, total (millions)849.5932.2982.21,032.51,079.71,109.8
Trade (% of GDP)15.723.124.026.437.947.2
Source: World Development Indicators database, September 2008.

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 database, September 2008.

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 Social and Economic Indicators, 2004/05–2009/10 1/
I. Social Indicators
GDP (2007/08)Poverty (Percent of population)
Nominal GDP (billions of U.S. dollars):1,173Headcount ratio (2003/04):27.5
GDP per capita (U.S. dollars):999Undernourished (2000):21.0
Population characteristics (2007)Income distribution (2004, WDI)
Total (in billions):1.2Richest 10 percent of households:31.1
Urban population (percent of total):29.3Poorest 20 percent of households:8.1
Life expectancy at birth (years):64.5Gini index:36.8
II. Economic Indicators
2004/052005/062006/072007/082008/09 2/2009/10 2/
Proj.Proj.
Growth (y/y percent change)
Real GDP (at factor cost)7.59.49.69.06.35.3
Non-agricultural sector9.510.311.010.07.15.9
Industrial production8.48.211.58.5
Prices (y/y percent change, period average for annual data)
Wholesale prices (1993/94 weights)6.54.45.44.78.81.9
Consumer prices - industrial workers (2001 weights)3.84.46.76.27.83.4
Saving and investment (percent of GDP)
Gross saving 3/31.834.334.836.034.634.9
Gross investment 3/32.235.535.937.537.636.4
Fiscal position (percent of GDP) 4/5/
Central government deficit−4.1−4.7−4.4−3.4−7.1−5.7
General government deficit−7.3−7.3−6.3−5.8−9.9−8.8
General government debt86.584.280.680.180.782.9
Money and credit (y/y percent change, end-period)
Broad money12.321.221.520.8
Credit to commercial sector26.032.225.820.6
Financial indicators (percent, end-period)
91-day treasury bill yield5.36.18.07.2
10-year government bond yield6.77.58.07.9
Stock market (y/y percent change, end-period)16.173.715.919.7
External trade 6/
Merchandise exports (US$ billions)85.2105.2128.9166.2186.4169.0
y/y percent change28.523.422.628.912.2−9.4
Merchandise imports (US$ billions)118.9157.1190.7257.8298.0265.5
y/y percent change48.632.121.435.215.6−10.9
Net oil imports (US$ billions)22.932.338.352.260.038.6
Balance of payments (US$ billions)
Current account balance−2.5−9.9−9.6−17.0−35.1−18.6
(in percent of GDP)−0.4−1.2−1.0−1.5−3.0−1.5
Foreign direct investment, net3.73.07.715.419.914.0
Portfolio investment, net (equity and debt)9.312.57.129.6−11.7−2.5
Overall balance26.215.136.692.2−27.9−3.3
External indicators
Gross reserves (in billions of U.S. dollars, end-period)141.5151.6199.2309.7246.8243.5
(In months of imports) 7/8.97.77.710.59.18.0
External debt (in billions of U.S. dollars, end-period) 8/133.0138.1171.4224.8229.0238.0
External debt (percent of GDP, end-period) 8/19.017.118.719.219.518.7
Of which: short-term debt 9/4.63.33.87.37.67.9
Ratio of gross reserves to short-term debt (end-period) 9/4.45.65.73.62.82.4
Gross reserves to broad money (percent; end-period)27.524.826.131.028.9
Debt service ratio 10/6.010.14.95.35.55.7
Real effective exchange rate 11/
(y/y percent change, period average for annual data)2.24.4−2.28.2
Exchange rate (rupee/US$, end-period)43.744.643.540.1
Memorandum items (in percent of GDP):
Subsidy-related bond issuance 12/0.00.51.00.61.30.3
Sources: Data provided by the Indian authorities; CEIC Data Company Ltd; Bloomberg L.P.; World Development Indicators; and Fund staff estimates and projections.

Data are for April-March fiscal years.

Current staff projections.

Differs from official data, calculated with gross investment and current account. Gross investment includes errors and omissions.

Divestment proceeds treated as below-the-line financing.

Subsidy-related bond issuance included in total expenditure.

Annual data are on balance of payments basis.

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

For projection, data are reported relative to staff's estimated annual GDP.

Including short-term debt on contracted maturity basis, NRI deposits due within one year, and medium and long-term debt on residual maturity basis.

In percent of current account receipts excluding grants.

IMF INS calculation.

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; Bloomberg L.P.; World Development Indicators; and Fund staff estimates and projections.

Data are for April-March fiscal years.

Current staff projections.

Differs from official data, calculated with gross investment and current account. Gross investment includes errors and omissions.

Divestment proceeds treated as below-the-line financing.

Subsidy-related bond issuance included in total expenditure.

Annual data are on balance of payments basis.

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

For projection, data are reported relative to staff's estimated annual GDP.

Including short-term debt on contracted maturity basis, NRI deposits due within one year, and medium and long-term debt on residual maturity basis.

In percent of current account receipts excluding grants.

IMF INS calculation.

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 3.India: Balance of Payments, 2004/05–2009/10 1/(In billions of U.S. dollars)
2004/052005/062006/072007/082008/092009/10
Proj.Proj.
Current account balance−2.5−9.9−9.6−17.0−35.1−18.6
Merchandise trade balance−33.7−51.9−61.8−91.6−111.6−96.5
Merchandise exports85.2105.2128.9166.2186.4169.0
Merchandise imports118.9157.1190.7257.8298.0265.5
Oil29.944.056.977.090.759.9
Non-oil89.0113.1133.7180.8207.3205.6
Non-factor services balance15.423.229.537.640.341.5
Receipts43.257.773.890.196.8100.6
Of which: software services17.223.631.340.3
Payments27.834.544.352.556.559.1
Income, net−5.0−5.9−7.3−4.9−10.1−13.3
Transfers, net20.824.730.141.946.349.6
Capital account balance28.025.545.2108.06.915.3
Direct investment, net3.73.07.715.419.914.0
Of which: direct investment in India6.08.922.734.225.819.1
Portfolio investment, net9.312.57.129.6−11.7−2.5
Government borrowing, net1.91.71.82.12.42.0
Commercial borrowing, net5.22.516.122.60.8−3.2
Short-term credit, net3.83.76.617.2−3.01.3
NRI deposits, net−1.02.84.30.23.53.8
Rupee debt−0.4−0.6−0.2−0.1−0.1−0.1
Other capital, net 2/5.5−0.21.821.0−5.00.0
Errors and omissions0.6−0.51.01.20.30.0
Overall balance26.215.136.692.2−27.9−3.3
Valuation changes 3/2.4−4.911.018.4−35.026.7
Increase in gross reserve stock (-, including valuation changes)−28.6−10.1−47.6−110.562.9−23.4
Memorandum items:
Foreign exchange reserves141.5151.6199.2309.7246.8295.1
In months of next year's imports (goods and services)8.97.77.710.59.18.0
Current account balance (percent of GDP)−0.4−1.2−1.0−1.5−3.0−2.1
Merchandise trade balance (percent of GDP)−4.8−6.4−6.7−7.8−9.5−8.6
Overall balance (percent of GDP)3.71.94.07.9−2.4−0.3
Sources: CEIC Data Company Ltd; and Fund staff estimates and projections.

Data are for April-March fiscal years. Indian authorities' presentation.

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

Calculated as difference between the stock of reserves and the overall balance of BOP.

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

Data are for April-March fiscal years. Indian authorities' presentation.

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

Calculated as difference between the stock of reserves and the overall balance of BOP.

Table 4.India: Reserve Vloney and Monetary Survey, 2004/05–2008/09 1/
2004/052005/062006/072007/082008/09
Jun.Sep.Dec.
Reserve money(In billions of rupees, end-period)
Reserve money4,8915,7317,0909,2849,3169,5698,863
Net domestic assets of RBI−1,237−999−1,572−3,077−4,084−3,935−3,078
Claims on government (net)−1806624−1,132−1,132−619−316
Center−2335221−1,146−1,132−618−319
States5314314003
Claims on commercial sector14141518141914
Claims on banks535876461661116
Other items (net)−1,123−1,152−1,721−2,009−2,982−3,397−2,892
Net foreign assets of RBI6,1286,7308,66212,36113,40113,50411,941
(Contribution to reserve money growth)
Reserve money12.117.223.730.929.322.59.7
Net domestic assets of RBI−17.44.9−10.0−21.2−36.9−24.6−4.7
Claims on government (net)−14.45.0−0.7−16.8−13.01.613.4
Net foreign assets of RBI29.412.333.752.266.147.014.4
Monetary survey(In billions of rupees, end-period)
Broad money (M3)22,51427,29533,16140,06740,94442,71144,302
Currency with public3,5594,1314,8295,6756,0385,8706,266
Deposits18,89123,09628,25734,30234,85736,78737,911
Non-bank deposits at RBI656975914954126
Net domestic assets16,02220,03424,02929,86430,38328,98831,351
Domestic credit20,37024,59629,67634,77035,49737,34839,684
Net credit to government7,5687,6668,3769,0719,4299,68610,996
Of which: RBI−1808158−1,132−1,132−619−316
Credit to commercial sector12,80216,93021,30125,69926,06927,66228,687
Of which: commercial bank lending11,00415,07119,31223,61924,14025,51026,445
Nonfood10,59314,66418,84723,17523,63425,05925,924
Other items (net)−4,348−4,562−5,647−4,906−5,114−8,360−8,332
Net foreign assets6,4937,2629,13210,20310,56113,72312,951
(Twelve-month percent change)
Broad money (M3)12.321.221.520.820.819.019.8
Net domestic assets8.325.019.912.89.512.524.2
Domestic credit15.820.720.717.219.819.625.2
Net credit to government1.91.39.38.39.310.330.5
Credit to commercial sector26.032.225.820.624.223.223.2
Of which: commercial bank lending30.937.028.122.325.925.223.0
Nonfood31.638.428.523.026.125.323.0
Net foreign assets23.311.925.741.852.135.49.5
(Contribution to broad money growth)
Net domestic assets6.117.814.69.37.09.016.9
Net credit to government0.70.42.62.12.42.57.0
Of which: RBI−3.11.2−0.1−3.6−2.80.42.9
Credit to commercial sector13.218.316.013.315.014.514.6
Net foreign assets6.13.46.911.513.810.02.8
Sources: Reserve Bank of India; CEIC Data Company Ltd.; and Fund staff calculations.

Data are for April - March fiscal years.

Sources: Reserve Bank of India; CEIC Data Company Ltd.; and Fund staff calculations.

Data are for April - March fiscal years.

Table 5.India: Central Government Operations, 2004/05–2008/09 1/
2004/052005/062006/072007/082008/09
BudgetProv.BudgetStaff
proj.
(In billions of rupees)
Total revenue and grants3,2043,6224,5005,4245,9126,2145,961
Net tax revenue2,2642,7183,5324,0574,3935,0904,859
Gross tax revenue3,0503,6624,7355,4815,9116,8776,566
Of which: corporate tax8271,0131,4431,6841,8952,2642,265
income tax4935607519881,0571,3831,276
excise taxes9911,1121,1761,3021,2331,3791,190
customs duties5766518639881,0291,1891,105
other taxes163326502520697662730
Less: States' share7869441,2031,4251,5181,7881,707
Nontax revenue 2/9158749431,3461,4921,1061,085
Grants26302521271818
Total expenditure and net lending4,5065,1025,9266,9347,2107,6379,122
Current expenditure 3/3,9874,5455,3025,7396,1226,7668,114
Of which: interest payments1,2691,3261,5031,5901,7151,9081,912
wages and salaries352373398448441518778
subsidies 4/4604755715437117141,279
Capital expenditure and net lending 5/6/5195576241,1951,0898711,008
Overall balance−1,302−1,480−1,426−1,509−1,298−1,423−3,160
Overall balance (authorities' definition) 7/−1,258−1,464−1,426−1,509−1,298−1,333−3,070
Overall balance (augmented) 8/−1,653−1,829−1,586−3,880
Financing1,3021,4801,4261,5091,2981,4233,160
External (net)14875859193110110
Domestic (net)1,1551,4051,3411,4181,2051,3133,051
(In percent of GDP)
Total revenue and grants10.210.110.911.712.511.711.0
Net tax revenue7.27.68.58.89.39.68.9
Gross tax revenue9.710.211.411.812.513.012.1
Of which: corporate tax2.62.83.53.64.04.34.2
income tax1.61.61.82.12.22.62.3
excise taxes3.13.12.82.82.62.62.2
customs duties1.81.82.12.12.22.22.0
other taxes0.50.91.21.11.51.21.3
Less: States' share2.52.62.93.13.23.43.1
Nontax revenue 2/2.92.42.32.93.22.12.0
Grants0.10.10.10.00.10.00.0
Total expenditure and net lending14.314.314.315.015.314.416.8
Current expenditure 3/12.712.712.812.413.012.814.9
Of which: interest payments4.03.73.63.43.63.63.5
wages and salaries1.11.01.01.00.91.01.4
subsidies 4/1.51.31.41.21.51.32.4
Capital expenditure and net lending 5/6/1.61.61.52.62.31.61.9
Overall balance−4.1−4.1−3.4−3.3−2.8−2.7−5.8
Overall balance (authorities' definition) 7/−4.0−4.1−3.4−3.3−2.8−2.5−5.7
Overall balance (augmented) 8/−4.1−4.6−4.4−3.4−7.1
Financing4.14.13.43.32.82.75.8
External (net)0.50.20.20.20.20.20.2
Domestic (net)3.73.93.23.12.62.55.6
Of which: market borrowing1.52.72.72.42.71.91.9
small savings (net of states' share)0.10.20.10.3−0.10.30.3
divestment receipts0.10.00.00.00.10.20.2
Memorandum items:
Primary balance−0.1−0.40.20.20.90.9−2.3
Current balance 7/9/−2.5−2.6−1.9−0.7−0.4−1.0−4.0
Current balance (augmented) 8/−3.1−2.9−1.1−5.3
Central government debt 10/63.363.161.259.259.757.759.5
Subsidy-related bonds 11/0.00.51.00.00.60.01.3
Of which: Food Corporation of India bonds0.00.00.40.00.0
Oil bonds0.00.50.60.51.0
Fertilizer bonds0.00.00.00.20.4
Nominal GDP (in Rs. billion)31,49435,80341,45846,33747,13153,03854,304
Sources: Data provided by the Indian authorities; and Fund staff estimates and projections.

Data for April - March fiscal year.

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 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). In 2008/09, authorities treat proceeds from selling shares vested with SUTI (estimated at 0.2 percent of GDP) as revenue.

Staff's definition treats divestment receipts as a below-the-line financing item. Includes subsidy-related bond issuance as current expenditure.

In 2007/08, under 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 the Food Corporation of India, 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.

Data for April - March fiscal year.

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 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). In 2008/09, authorities treat proceeds from selling shares vested with SUTI (estimated at 0.2 percent of GDP) as revenue.

Staff's definition treats divestment receipts as a below-the-line financing item. Includes subsidy-related bond issuance as current expenditure.

In 2007/08, under 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 the Food Corporation of India, 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, 2004/05–2008/09 1/
2004/052005/062006/072007/082008/09
Prov 2/BudgetProv. 3/BudgetStaff proj.
(In billions of rupees)
Total revenue and grants6,1277,0408,73510,26510,87811,92011,552
Tax revenue 4/4,9415,7857,2618,4228,84510,2459,899
Nontax revenue 5/6/1,1601,2261,4491,8222,0051,6571,635
Grants26302521271818
Total expenditure and net lending 7/8/8,4109,45710,93512,92813,30614,60416,189
General government balance−2,283−2,417−2,200−2,663−2,428−2,684−4,637
Financing2,2832,4172,2002,6632,4282,6844,637
External (net)14875859193110110
Domestic (net)2,1362,3422,1162,5722,3352,5744,528
Disinvestment receipts441624118126252252
(In percent of GDP)
Total revenue and grants19.519.721.122.223.122.521.3
Tax revenue 4/15.716.217.518.218.819.318.2
Nontax revenue 5/6/3.73.43.53.94.33.13.0
Grants
Total expenditure and net lending 7/8/26.726.426.427.928.227.529.8
General government balance−7.3−6.7−5.3−5.7−5.2−5.1−8.5
(including divestment receipts)−7.1−6.7−5.2−5.5−4.9−4.6−8.1
(augmented with subsidy-related bonds)−7.2−6.3−5.8−9.9
Domestic financing (net)6.86.55.15.65.04.98.3
Memorandum items:
Primary balance−1.2−1.10.3−0.40.40.4−3.2
Nondefense capital expenditure2.93.03.24.54.53.73.8
Net interest payments6.15.75.65.45.65.45.3
Central government balance−4.1−4.1−3.4−3.3−2.8−2.7−5.8
State and union territory governments' balance 9/−3.5−2.5−1.9−2.6−2.5−2.4−2.7
Consolidation items 10/0.4−0.10.00.10.10.00.0
Subsidy-related bond issuance0.51.00.61.3
General government debt86.584.280.678.680.175.980.7
Sources: Data provided by the Indian authorities; state level data from the RBI Study on State Finances; and Fund staff amalgamate and prepare projections.

The consolidated general government comprises the central government (CG) and state governments. Data for April - March fiscal year.

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

Based on RBI's revised estimates of state finances.

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

Nontax revenue equals 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 equals total expenditure and net lending of CG (authorities' definition excluding subsidy-related 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.

The authorities treat states' divestment proceeds, including land sales, above-the-line as miscellaneous capital receipts. Staff's definition treats divestment receipts as a below-the-line financing item. Asset sales amount to 0.2 percent of GDP in 2007/08 and are budgeted at 0.3 percent of GDP in 2008/09.

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 Study on State Finances; and Fund staff amalgamate and prepare projections.

The consolidated general government comprises the central government (CG) and state governments. Data for April - March fiscal year.

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

Based on RBI's revised estimates of state finances.

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

Nontax revenue equals 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 equals total expenditure and net lending of CG (authorities' definition excluding subsidy-related 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.

The authorities treat states' divestment proceeds, including land sales, above-the-line as miscellaneous capital receipts. Staff's definition treats divestment receipts as a below-the-line financing item. Asset sales amount to 0.2 percent of GDP in 2007/08 and are budgeted at 0.3 percent of GDP in 2008/09.

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

Table 7.India: Macroeconomic Framework, 2004/05–2012/13 1/
Projections
2004/052005/062006/072007/082008/092009/102010/112011/122012/13
Growth (percent change)
Real GDP (at factor cost)7.59.49.69.06.35.37.07.67.9
Non-agricultural sector9.510.311.010.07.15.97.88.68.8
Real GDP (at factor cost, on calendar year basis)7.29.19.89.37.35.16.57.57.8
Prices (percent change, period average)
Wholesale prices (1993/94 weights)6.54.45.44.78.81.94.03.93.9
Consumer prices3.84.46.76.27.83.44.03.93.9
Interest rate on general government domestic debt (percent)8.47.87.97.17.56.38.08.08.0
Saving and investment (percent of GDP)
Gross saving 2/31.834.334.836.034.634.934.534.735.2
Gross investment 3/32.235.535.937.537.636.436.737.037.6
Fiscal position (percent of GDP)
Central government balance - authorities 4/−4.0−4.1−3.4−2.8−5.8−5.4−4.1−3.3−3.0
Central government balance - augmented 5/−4.1−4.7−4.4−3.4−7.1−5.7−4.3−3.5−3.2
General government balance - augmented 5/−7.3−7.3−6.3−5.8−9.9−8.8−7.3−6.1−5.6
General government debt86.584.280.680.180.782.982.580.277.3
External trade (percent change, BOP basis)
Merchandise exports (in U.S. dollar terms)28.523.422.628.912.2−9.410.212.512.7
Merchandise imports (in U.S. dollar terms)48.632.121.435.215.6−10.913.312.612.3
Balance of payments (in billions of U.S. dollars)
Current account balance−2.5−9.9−9.6−17.0−35.1−18.6−29.6−35.3−40.1
(in percent of GDP)−0.4−1.2−1.1−1.5−3.0−1.5−2.1−2.3−2.4
(in percent of GDP, calendar year basis)0.1−1.3−1.1−1.0−2.5−1.8−2.0−2.3−2.4
Foreign direct investment, net3.73.08.415.419.914.020.719.619.9
Portfolio investment, net (equity and debt)9.312.57.129.6−11.7−2.515.119.621.6
Overall balance26.215.136.692.2−27.9−3.323.924.324.0
External indicators
Gross reserves (in billions of U.S. dollars, end-period)141.5151.6199.2309.7246.8243.5267.4291.6315.7
(in months of imports) 6/8.97.77.710.59.18.07.87.37.0
External debt (in billions of U.S. dollars, end-period)133.0138.1171.4224.8229.0238.0268.8303.8342.8
External debt (percent of GDP, end-period)19.017.118.719.219.518.719.520.120.7
Of which: short-term debt 7/4.63.33.87.37.67.98.89.39.7
Ratio of gross reserves to short-term debt (end-period) 7/4.45.65.73.62.82.42.22.12.0
Debt service (percent of current account receipts)6.010.14.95.35.55.77.08.58.4
Memorandum items (in percent of GDP):
Subsidy-related bond issuance 8/0.00.51.00.61.30.30.30.20.2
Sources: Data provided by the Indian authorities; CEIC Data Company Ltd; and Fund staff estimates and projections.

Data are for April-March fiscal years unless otherwise mentioned. Calendar year data in 2008/09 column indicate data for 2008, for instance.

Differs from official data, calculated with gross investment and current account.

Statistical discrepancy adjusted.

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

Divestment is treated as financing; includes subsidy-related bond issuance.

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

Including short-term debt on contracted maturity basis, NRI deposits due within one year, and medium and long-term debt on residual maturity basis.

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 unless otherwise mentioned. Calendar year data in 2008/09 column indicate data for 2008, for instance.

Differs from official data, calculated with gross investment and current account.

Statistical discrepancy adjusted.

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

Divestment is treated as financing; includes subsidy-related bond issuance.

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

Including short-term debt on contracted maturity basis, NRI deposits due within one year, and medium and long-term debt on residual maturity basis.

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 External Vulnerability, 2004/05–2008/09 1/
2004/052005/062006/072007/082008/092/
Financial indicators
General government debt (percent of GDP)86.584.280.680.180.7(Projection)
Broad money (percent change, 12-month basis)12.321.221.520.819.8(December 2008)
Private sector credit (percent change, 12-month basis)26.032.225.820.623.2(December 2008)
91 day T-bill yield (percent; end-period)5.36.18.07.24.8(December 2008)
91 day T-bill yield (real, percent; end-period) 3/−1.11.62.42.5−1.0(December 2008)
External indicators
Exports (percent change, 12-month basis in US$) 4/5/28.523.422.628.9(9.9)(November 2008)
Export volume (percent change, 12-month basis) 5/11.715.516.515.314.9(Projection)
Imports (percent change, 12-month basis in US$) 4/5/48.632.121.435.26.1(November 2008)
Import volume (percent change, 12-month basis) 5/28.020.013.513.212.8(Projection)
Terms of trade (percent change, 12 month basis) 5/−3.5−4.8−2.3−3.1−0.1(Projection)
Current account balance (percent of GDP)−0.4−1.2−1.0−1.5−3.0(Projection)
Capital and financial account balance (percent of GDP)4.03.14.99.20.6(Projection)
Of which: Net portfolio investment (debt and equity)1.31.50.82.5−1.0(Projection)
Other investment (loans, trade credits, etc.)1.41.33.13.60.3(Projection)
Net foreign direct investment0.50.40.81.31.7(Projection)
Foreign currency reserves (billions of US$)141.5151.6199.2309.7254.6(December 2008)
RBI forward liabilities (billions of US$)0.00.00.0−14.7−0.1(October 2008)
Official reserves (in months of imports of goods and services)8.97.77.710.59.1(Projection)
Ratio of foreign currency reserves to broad money (percent)27.524.826.131.028.0(December 2008)
Total short-term external debt to reserves (percent) 6/22.717.717.627.636.2(Projection)
Total external debt (percent of GDP)19.017.118.719.219.5(Projection)
Of which: public sector debt8.97.36.76.16.3(Projection)
Total external debt to exports of goods and services (percent)103.584.884.587.780.9(Projection)
External interest payments to exports of goods and services (percent)2.43.22.73.23.2(Projection)
External amortization payments to exports of goods and services (percent)4.88.83.13.33.4(Projection)
Exchange rate (per US$, period average)44.944.345.240.348.7(December 2008)
REER (y/y change in percent; end-period)1.44.20.15.2−11.6(December 2008)
Financial market indicators
Stock market index (end-period)6,49311,28013,07215,6449,647(December 2008)
Foreign currency debt rating
Moody's Investor ServicesBaa3Baa3Baa3Baa2Baa2(December 2008)
Standard and Poor'sBB+BB+BBB-BBB-BBB-(December 2008)
Fitch RatingsBB+BB+BBB-BBB-BBB-(December 2008)
Sources: Data provided by the Indian authorities; CEIC Data Company Ltd.; Bloomberg L.P.; and Fund, Information Notice System and staff estimates and projections.

Data for April-March fiscal year.

Latest date available or staff estimate, as noted.

Equals nominal yield minus actual WPI inflation.

Data for 2008/09 are on a customs basis, whereas data for previous years are on a BOP basis.

Terms of trade including goods and services. Goods volumes are derived from partner country trade price deflators, and services volumes are derived using U.S. CPI from the WEO database.

Including short-term debt on contracted maturity basis, NRI deposits due within one year, and medium and long-term debt on residual maturity basis.

Sources: Data provided by the Indian authorities; CEIC Data Company Ltd.; Bloomberg L.P.; and Fund, Information Notice System and staff estimates and projections.

Data for April-March fiscal year.

Latest date available or staff estimate, as noted.

Equals nominal yield minus actual WPI inflation.

Data for 2008/09 are on a customs basis, whereas data for previous years are on a BOP basis.

Terms of trade including goods and services. Goods volumes are derived from partner country trade price deflators, and services volumes are derived using U.S. CPI from the WEO database.

Including short-term debt on contracted maturity basis, NRI deposits due within one year, and medium and long-term debt on residual maturity basis.

Table 9.India: Indicators of Financial System Soundness, 2004/05–2008/09
2004/052005/062006/072007/082008/09 Q1
Measures of financial strength and performance 1/
Risk-weighted capital adequacy ratio (CAR)12.812.312.313.012.7
Public sector banks12.912.212.412.512.3
Old Private Sector Banks12.511.712.114.113.9
New Private Sector Banks12.112.612.014.414.1
Foreign banks14.013.012.413.112.2
Number of institutions not meeting 9 percent CAR0100
Public sector banks0000
Old Private Sector Banks0100
New Private Sector Banks0000
Foreign banks0000
Net nonperforming loans (percent of outstanding net loans) 2/3/2.01.21.01.01.1
Public sector banks2.11.31.11.01.0
Old Private Sector Banks2.71.71.00.70.8
New Private Sector Banks1.90.81.01.21.5
Foreign banks0.90.81.01.20.7
Gross nonperforming loans (percent of outstanding loans) 3/5.23.32.52.32.4
Public sector banks5.53.62.72.22.2
Old Private Sector Banks6.04.43.02.32.4
New Private Sector Banks3.61.71.92.53.2
Foreign banks2.92.01.81.81.9
Number of institutions with net NPLs above 10 percent of advances4310
Public sector banks0000
Old Private Sector Banks0000
New Private Sector Banks0000
Foreign banks4310
Net profit (+)/loss (-) of commercial banks 4/0.90.90.91.00.9
Public sector banks0.90.80.80.90.6
Old Private Sector Banks0.30.60.71.00.8
New Private Sector Banks1.11.00.91.00.6
Foreign banks1.31.51.71.82.7
Balance sheet structure of all scheduled banks
Loan/deposit ratio65.572.074.571.573.9
Investment in government securities/deposit ratio43.534.330.532.730.3
Lending to sensitive sectors (in percent of loans and advances)
Real estate12.717.218.818.0
Capital market1.41.51.82.5
Commodities0.20.30.00.1
Source: Reserve Bank of India: Report on Trend and Progress of Banking in India, 2007-08.

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.

Source: Reserve Bank of India: Report on Trend and Progress of Banking in India, 2007-08.

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.

The fiscal year starts in April.

The nominal effective exchange rate depreciated by over 14 percent in 2008.

See Chapter I of the accompanying Selected Issues Paper for an analysis of corporate vulnerabilities.

These subsidy-related bonds are not included in the authorities's definition of the central government budget deficit, while they are included in the staff's definition.

While the Mumbai attacks, which took place in November 2008, might reduce tourism, it is difficult to disentangle their impact from the broader slowdown.

See Chapter II of the accompanying Selected Issues Paper, which discusses the determinants of capital flows to emerging markets and India in particular.

The recently disclosed accounting scandal involving Satyam, one of India's largest IT companies, adds to the uncertainty of the outlook for foreign direct investment and for the IT and outsourcing sector.

Governor Subbarao's speech at the Bankers' Club, Kolkata on December 10, 2008.

The PLR reported by the RBI averaged 12–14 percent in November, but some private banks have reported PLRs of 14–17 percent.

Banks have to compete for funds with small savings schemes, whose administered interest rates are not linked to market rates and act as a floor for commercial bank deposit rates. Linking these rates to market rates, as proposed by the Reddy and Mohan committees in the early 2000s, would facilitate monetary policy transmission.

As discussed in Chapter III of the accompanying Selected Issues Paper, the exchange rate pass through is likely to be relatively weak in an economic downturn and in an environment of volatile exchange rates.

In this connection, staff noted that the government should fund its entire borrowing requirement through regular government securities, rather than issuing special-purpose bonds.

By increasing the availability of term money, these steps would be of more general benefit to the development of India's financial markets.

As discussed in Chapter I of the Selected Issues Paper, foreign exchange debt is estimated at 20–30 percent of corporate debt and stress tests indicate that corporate balance sheets are more sensitive to interest rate risk than exchange rate risk.

Obstfeld, Shambaugh, and Taylor (“Financial Stability, the Trilemma, and International Reserves,” NBER Working Paper No. 14217, 2008) notes that concerns about domestic financial stability were a key motive for emerging markets' massive reserve accumulation in recent years.

The insurance regulator's decision to direct life insurers to furnish data on the performance of their funds is a step in the right direction.

The BIS notes that the current crisis was possibly compounded by weaknesses in stress testing practices. See Bank for International Settlements, “Principles for sound stress testing practices and supervision” (January 2009), http://www.bis.org/publ/bcbs147.htm.

International evidence suggests that bank recapitalizations during times of financial distress have cost on average 6 percent of GDP (Laeven and Valencia, 2008, “Systemic Banking Crises: A New Database” IMF Working Paper No. 08/224). The capital of the whole Indian banking system stood at about 7 percent of GDP as of March 2008. However, it should be noted that the latter is not the upper limit of potential recapitalization costs, which depend on the amount of impaired assets.

Without this, financing India's ambitious target of $500 billion in infrastructure investment by 2012 would require more than doubling bank credit to infrastructure over the next four years.

The limit on FII investment in corporate bonds was raised to $15 billion from $6 billion on January 2, 2009.

Portfolio equity investment is highly liberalized and restrictions on ECBs have been gradually eased. Nevertheless, ECBs are still subject to a number of restrictions, and FDI to sector-specific limits and exclusions.

For example, market participants indicated that there is good appetite for mezzanine financing—a hybrid product of equity and debt financing, which is considered external commercial borrowing—and investing in distressed assets, but current restrictions are binding.

India would have access of up to SDR20.8 billion under the SLF.

Apart from equity, banks have been provided with a variety of capital raising options for Tier I and II capital, such as innovative perpetual debt instruments, upper Tier -II debt, preference shares, and subordinated debt.

In India, off-balance sheet vehicles in the form of SPVs for securitization exist, but extensive guidelines, in line with the international best practices, have been issued and liquidity facilities to SPVs are subject to a capital charge.

Nevertheless, on January 2, 2009, the authorities abolished the interest rate cap on ECBs on a temporary basis.

See Chapter I of the Selected Issues Paper for details.

Since the onset of the crisis, India has increased import duties on selected steel products and reduced exemptions from countervailing duties on cement and from custom duties on zinc and alloys, reversing measures that had been taken earlier in 2008. Export taxes have also been cut.

This excludes the impact of tax cuts implemented earlier in the year to contain inflation.

See Giavazzi and others (2000) “Searching for Nonlinear Effects of Fiscal Policy: Evidence from Industrial and Developing Countries,” European Economic Review 44, pp. 1259–1289 and Scott and others (2008) “Fiscal Policy as a Countercyclical Tool” in IMF, World Economic Outlook, October 2008.

Chapter IV of the accompanying Selected Issues Paper discusses India's experience with fiscal rules and proposes possible changes.

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