This Selected Issues paper analyzes the medium-term macroeconomic outlook for India. The paper highlights that in the strong adjustment scenario, the joint effect of strong fiscal consolidation and ambitious structural reforms would bring the Indian economy onto a sustainable high growth path, reaching 7 percent around the turn of the century. Although there could be some initial dip in growth, owing to the contractionary effects of fiscal retrenchment, this should be temporary as a strong surge in investment, together with productivity improvements related to structural reforms, should drive an acceleration in growth performance.

Abstract

This Selected Issues paper analyzes the medium-term macroeconomic outlook for India. The paper highlights that in the strong adjustment scenario, the joint effect of strong fiscal consolidation and ambitious structural reforms would bring the Indian economy onto a sustainable high growth path, reaching 7 percent around the turn of the century. Although there could be some initial dip in growth, owing to the contractionary effects of fiscal retrenchment, this should be temporary as a strong surge in investment, together with productivity improvements related to structural reforms, should drive an acceleration in growth performance.

III. Poverty in India 1

Poverty in India has been substantially reduced over the last 30 years. The incidence of poverty fell strongly during the 1970s and 1980s and, although available evidence points to some temporary rise in poverty rates following the macroeconomic crisis in 1991, indications are that the decline has since resumed (Table III.1) This chapter provides an overview of these developments, and discusses factors behind the long-term decline in poverty. It also reviews recent research that seeks to explain the impact of the 1991 crisis on the poor. Although data on the most recent trends are partial, it appears that economic reforms have played a significant role in alleviating the negative consequences of the crisis. Reform policies that could accelerate the rate of poverty alleviation, in line with the government’s target in the Common Minimum Program of eliminating poverty by the year 2005, are also briefly discussed.

Table III.1.

Poverty Rate Estimates for India 1/

(Percent of population below the poverty line)

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Sources: Economic Survey 1995-96; Datt (1996); Papanek (1996); Tendulkar and Jain (1996); and staff calculations.

Sample periods are not necessarily equivalent to fiscal years.

Estimates by Papanek (1996), using the Planning Commission method.

A. Poverty Trends

Methodology

Poverty incidence in India is measured as the percentage of the population living below a well-defined poverty line.2 It is estimated using data on household consumption expenditure from National Sample Surveys (NSS), which have been conducted for a period of over four decades. Full NSS rounds, covering about 100,000 households, are conducted every four to six years, most recently in 1987/88 and 1993/94. There are also annual “thin sample” surveys, with smaller sample sizes (about one fifth of the full NSS round) and less complete information. However, on the grounds that thin samples are not comparable with the full sample, and that the considerably smaller size of thin samples does not provide a sufficient statistical basis for estimating poverty rates, official estimates are published only for years with full NSS data. Other studies have nevertheless used thin samples to estimate poverty rates, arguing that the sample size is sufficient to provide meaningful estimates at least on a nationwide basis (for example, Tendulkar and Jain [1995], and Ravallion and Datt [1996]). Annual indicators such as real agricultural wages can also be used to shed light on poverty developments.

Although official and other estimates have shown similar long-term trends, there are some differences in methodology (see Appendix III.1). The main difference is that the Planning Commission adjusts for apparent under-reporting of consumption in sample responses by increasing NSS consumption to be consistent with consumption estimates in the national accounts. Although the two consumption estimates were relatively close in the past, the difference has increased in recent years, leading to an increase in the adjustment factor.

Poverty developments

Official estimates put the poverty rate at around 50 percent in 1977/78 and show a decline to 25½ percent by 1987/88 (see Table III.1 and Chart III.1). Based on preliminary results from the 1993/94 round, the poverty rate appears to have fallen further to about 19 percent. Judging from past experience, the final 1993/94 estimate is expected to differ by at most 1-2 percentage points from the preliminary outcome. This long term trend is reflected in substantial improvement in key social indicators (Table III.2).

Chart III.1.

INDIA: POVERTY MEASURES, 1951/52 -1994/95

Citation: IMF Staff Country Reports 1996, 132; 10.5089/9781451818598.002.A003

Source: Economic Survey, 1995-96, Datt (1996); Papanek (1996), and Ravallion and Datt (1995).1/ Based on the methodology of Ravallion and Datt (1993).
Table III.2.

Social Indicators

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Source: World Bank.

Other studies have confirmed a strongly falling trend in poverty rates, although they show a slower trend decline and a temporary rebound in the early 1990s. According to Datt (1996) and Tendulkar and Jain (1995), the poverty rate fell from 60 percent in the 1950s and 1960s to around 40 percent in 1987/88 (see Table III.1). Using the thin sample data to estimate poverty rates for the last five years, they found a decline in poverty rates to some 35 percent in the 1990/91 sample round, followed by an increase of about 6 percentage points through 1992. Preliminary estimates based on the latest available NSS data indicate that poverty has dropped since 1992, falling back to close to the level prevailing before the crisis by 1993/94 (Tendulkar and Jain [1996]). Papanek (1996), applying the Planning Commission’s methodology to the thin samples, found a similar pattern.

Poverty has fallen in both rural and urban areas. While rural poverty rates have generally been higher than urban rates, the difference between the two has declined in absolute terms. Thin sample estimates indicate that the increase in poverty in 1991/92-a year in which agricultural performance was relatively weak—was more pronounced in rural areas (where three quarters of the Indian population live). In fact, urban poverty increased only very marginally.

A poverty severity (or depth) measure3 used by both Tendulkar and Jain (1995) and Ravallion and Datt (1996) shows that the distribution of consumption among the poor also worsened in the early 1990s as poverty increased in absolute terms (Table III.3). Remarkably, in the years immediately preceding the crisis, poverty was less severe in rural regions than in cities. However, while the severity of urban poverty changed only slightly after 1991, poverty became significantly deeper in rural areas. Gupta (1995, 1996) reached a similar conclusion by applying Lorenz ratios to measure consumption and income inequality.

Table III.3.

A Measure of Poverty Severity 1/

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Source: Tendulkar and Jain (1996).

This index, belonging to the Foster-Greer-Thorebecke class, measures both the incidence and depth of poverty. It has as its components the poverty rate, the squared poverty gap ratio, and the squared coefficient of variation. A higher number indicates higher poverty rates and more unequal distribution of consumption among those below the poverty line.

Consistent with falling poverty rates, unskilled rural wages—another widely used poverty indicator—have shown a strong trend increase since the 1970s, indicating improving rural living conditions (see Chart III.1). Rural real wages also declined in the early 1990s, dropping by more than 6 percent in 1991/92, but recovered quickly in the following years.

B. Long-Run Poverty Determinants

In a series of studies, Ravallion and Datt (1995, 1996a, b) identified a number of determinants for long-term developments of poverty between 1951 and 1991. Applying regression analysis to panel data, pooling information from three decades of consumer surveys with state-specific variables, they reached the following conclusions:

  • Real output growth has had a powerful impact in alleviating poverty, reducing both the overall poverty rate and its severity. Growth in the primary (i.e., agriculture) and tertiary sectors had the largest impact on poverty reduction. Secondary sector growth, i.e., in manufacturing and industry, had little discernible effect. The limited influence of industrial growth on poverty was probably a consequence of a development strategy that encouraged capital-intensive investment, including trade policies that did not take advantage of India’s comparative advantage in the production of labor-intensive goods, and restrictive labor legislation that discouraged employment growth in the organized manufacturing sector.

  • Similarly, rural growth was poverty-reducing, but urban growth was found to have no effect. Higher agricultural yields helped reduce poverty by raising rural wages, as well as through increased employment and higher own-farm productivity.

  • States with better endowment of human capital resources—as expressed in higher literacy rates or lower infant mortality—had on average higher growth and lower poverty rates. Poverty rates also fell more strongly in states with higher productivity growth, lower inflation rates, and higher growth in development expenditure.

  • Unlike other countries, rural-to-urban migration contributed little to overall growth and poverty reduction (the Kuznets effect).

  • There were modest improvements in overall income distribution over the longer term. While this had no significant effect on poverty rates, the impact on poverty severity was strong: redistribution to the very poor accounted for half of the long-term decline in the severity measure.4

C. Impact of the 1991 Crisis

A number of recent studies have concluded that macroeconomic developments in the aftermath of the 1990/91 balance of payments crisis strongly contributed to the higher poverty incidence in the early 1990s (e.g., Tendulkar and Jain [1995], Gupta [1995], Mundle and Tulasidhar [1996]).5 The two main channels for this effect were a sharp rise in food grain prices, to some extent related to a lower agricultural production in the wake of a relatively bad monsoon, and a slowdown in employment growth resulting from a more slowly expanding economy. It should be emphasized, however, that in assessing the impact of the crisis, it is difficult to disentangle cause and effect. The most appropriate exercise would be to compare the actual outturn with what would have happened if the monetary and fiscal policies had not been adjusted promptly to restore macroeconomic stability (i.e., the counterfactual). While a rigorous treatment of this issue is beyond the scope of this paper, most likely the alternative would have been a sustained downturn with an even greater impact on poverty.

Food price increases

Tendulkar and Jain (1995) and others have concluded that the most important factor behind the poverty increase was the sharp rise in food grain prices in 1991/92 and 1992/93. This increase was related to three events:

  • First, the rupee devaluation in mid-1991 left domestic food prices about 50 percent below world market levels, leading to withholding of stocks by producers and upward pressure on open market grain prices.

  • Second, in an unfortunate coincidence, food production declined initially after a comparatively bad 1991 monsoon (Table III.4), adding to the upward pressures on prices.6

  • Third, in the context of rising purchases from the public distribution system (PDS) and declining public grain stocks, the government began in late 1991 to raise procurement prices to improve supply incentives for grain producers, and also to partly compensate farmers for a reduction in fertilizer subsidies (Mundle and Tulasidhar [1995]). The ensuing adjustment in issue prices prompted further increases in open market prices (Table III.5), unlike during a drought in 1987/88, when large public food stocks were effectively used to keep price increases in check.

Table III.4.

Indices of Agricultural Production

(Annual growth rates)

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Source: Economic Survey, 1995-96.

Provisional.

Table III.5.

Price Indices

(Percentage change over previous year)

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Source: Economic Survey, 1995-96.

The operations of the PDS appear to have had a strong redistribution effect between rural and urban areas. With most of the public food grain being sold in cities, the PDS in effect shifted grain at subsidized prices from rural to urban areas. Thus, the impact of rising food prices was particularly strong in rural regions (Tendulkar and Jain [1995]).7

Employment effects

The second major effect of the macroeconomic crisis was the impact on employment trends of a temporary slowdown in GDP growth, particularly in the rural and informal urban labor markets. While data on unemployment are of limited value in countries like India with a large and predominant informal sector8, the ILO (1996) have pointed out that underemployment also likely increased after 1991/92. According to ILO estimates based on annual NSS data, while unemployment increased by about 1-2 percentage points, the share of the labor force in regular wage employment declined by 3 percentage points from 16 percent in 1990/91 to about 13 percent in 1992/93 (Table III.6). This suggests that a significant number of workers were driven into casual and self-employment.

Table III.6.

Employment Estimates

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Sources: Economic Survey 1995-96; Ministry of Planning (Government of India), Employment Generation in the Eighth Plan, New Delhi 1995; ILO (1996).

Interpolation.

Owing to labor market regulations restricting layoffs, the labor force in the formal sector of the economy—mainly located in urban areas—was largely protected against the downturn. According to official data, employment in the formal sector in fact increased by about ¾ percent between March 1991 and March 1994. At the same time, however, NSS data indicate that labor demand both in the rural non-farming and urban informal sectors did not keep up with the growth of the labor force (Gupta [1995]), which was partly related to credit rationing and high real interest rates that affected particularly small informal enterprises.

The employment consequences of the 1991 crisis seem to have been exacerbated by cutbacks in spending on public employment programs as part of the overall effort to lower the fiscal deficit from the unsustainable levels reached in the late 1980s.9 For example, central expenditure for Jawahar Rozgar Yojana, the largest rural employment program, was reduced by about 23 percent in real terms in 1991/92, before being restored in 1992/93. Lower spending on these schemes probably had some adverse impact on rural employment, although—given the general weaknesses in program targeting and implementation—the impact on poverty was probably quite small (Tendulkar and Jain [1995]).

D. Role of Reforms

Growth effects of reform

The slowdown in real output growth following the macroeconomic crisis was relatively mild compared to other countries, as the downturn was cushioned by an increasing supply response to sweeping reform measures initiated in 1991, as well as successful efforts to maintain external financing. Growth remained positive in 1991/92, and the expansion gathered pace in the following years.

Particularly striking has been the supply response in the export sector to an increasing external orientation of the economy, mainly focussed in traditionally labor-intensive areas, such as the textile sector and gems and jewelry. The additional labor demand created in the small-scale and informal urban sectors helped to relieve much of the pressure on urban poverty.10

In the rural sector, the reforms have had less impact on production and employment although, with good rainfall, agriculture returned to trend growth in 1992/93. The agriculture sector has benefitted from improved internal terms of trade implied by the increase in agricultural food prices and the reduction in protection of the industrial sector (World Bank [1996]), and this improvement helped rural real wages to recover after the crisis.11 However, other supply restrictions have remained in place, and there is only limited evidence of a more general shift from subsistence farming toward exportable or higher yielding crops (World Bank [1996]).

The reform agenda

What more could be done to bring poverty down faster? As emphasized in the Government’s Common Minimum Program (CMP), high labor-intensive growth is the most effective economic means to reduce poverty. Accordingly, the Government aims to raise growth rates to 7 percent over the medium term, with the objective of eliminating poverty by 2005. Within the framework of a sound macroeconomic growth policy, most studies agree that an aggressive reform program could help to maximize the positive impact of growth on poverty (e.g. Mundle and Tulasidhar [1995]). In light of the earlier analysis of long-term poverty determinants, the following reforms would seem particularly relevant:

Perhaps most important, more fundamental agricultural reforms would encourage growth in rural areas where the bulk of the population lives. In the CMP, the Government has announced an initiative to strengthen agricultural investment, review the system of controls and regulations in the sector. Similarly, the World Bank (1996) offers a broad strategy for agricultural development that combines higher public investment with improved price incentives and further trade liberalization, while also strengthening safety nets to cushion the effects of higher food prices on the poor.

Labor market reform would help to promote a shift from capital intensive to labor intensive investment in the organized sector, and thus enhance the employment generated by strong industrial growth. Present labor laws designed to protect the interests of existing workers reduce incentives for new hires, as well as preventing the closure of inefficient enterprises, particularly those owned by the public sector.12 New legislation suggested by Goswami (1996) and others would greatly increase the flexibility of hiring and retrenchment decisions. Such reform would need to be supported by actions to ensure adequate compensation for retrenched workers, including by broadening the scope and strengthening the operations of the National Renewal Fund (NRF).13 Utilization of the NRF has so far been low, owing to insufficient funding, inefficient program implementation and, most importantly, a lack of alternative employment opportunities (ILO [1996]).

A third key area is to strengthen human capital development. For its income level India in fact spends quite a large share of GDP on education and health care; however, programs are known to benefit to a large extent the middle classes (Fischer [1995], Gupta [1995]). More effective delivery and better targeting of education and health care, with greater emphasis on meeting primary needs, especially in rural areas, would help to boost the stock of human capital of those below the poverty line. Indeed, states with higher spending on human capital development have generally done better in reducing poverty (Ravallion and Datt [1996a]).

Reform of the Indian social safety net would help to cope with the consequences of poverty. Priorities would include better targeting of the PDS, and more efficient schemes for public employment. The CMP has emphasized that a reform of the PDS could improve its effectiveness as a poverty alleviation mechanism (see discussion in Chapter IV of this report), and the new Government has announced plans to issue PDS grain to the very poor at half the normal issue prices, while at the same time improving targeting efforts. However, earlier targeting strategies have not proven very successful14, implying a risk that costs of the PDS could be substantially raised. Greater use of self-targeting schemes, such as distributing exclusively inferior cereals consumed only by the poor, and efforts to reduce the costs of the Food Corporation of India could help to forestall such an increase.

Public employment schemes probably serve as an anti-poverty device, albeit quite a costly one (ILO [1995]). The effectiveness of public employment programs as an anti-poverty device could be improved by strengthening the capacity of village councils (panchayats) to distribute projects efficiently. In the past, the distribution of program funds by government bureaucracies often resulted in administration costs amounting to 50 percent of total project cost. Village councils have recently received greater autonomy under the Indian constitution; nevertheless, problems resulting from the domination of fund distribution by local elites would have to be overcome before the programs could become effective in providing sufficient employment to the poor (World Bank [1996]).

APPENDIX III.1: Poverty Measures

Official estimates

  • The poverty measure used by the Planning Commission is anchored to a nutritional norm of 2100 calories per person per day in urban areas, and 2400 calories for rural areas. For the base year 1973/74, the poverty line was defined by the consumption expenditure at which these nutritional intakes were typically met.

  • For each round of the National Sample Survey (NSS), the poverty line is updated by the implicit private consumption deflator from the national account statistics (NAS). Before 1984, the wholesale price index was used, but it was determined that the consumption deflator more accurately reflected the consumption patterns of the poor (Gupta [1995]).

  • Aggregate household consumption expenditure estimated from NSS data is different from private consumption expenditure contained in the NAS. To correct for this difference, the NSS consumption data is adjusted uniformly across all households by the ratio of NAS consumption to NSS consumption. This was begun in 1979, when the difference between the two estimates was about 5 percent, implying a slightly lower poverty rate. Since then, however, the difference between the two consumption estimates has risen to 22 percent in 1987/88 and 43 percent in 1992 (Gupta [1995]).

Alternative Method

Other studies (Tendulkar and Jain [1996], Ravallion and Datt [1995]) have used variations on the official method, based on the same nutritional norm and base year. They differ, however, in two significant aspects:

  • NSS consumption estimates are not adjusted to NAS levels.

  • The price indices used for updating the poverty line are: the price index for agricultural workers for rural areas; and a combination of the price index for industrial workers and for non-manual employees for urban areas. Ravallion and Datt have compiled a slightly modified consumption price index that also allows the analysis of poverty rates back into the 1950s.

This method follows closely suggestions put forward by an expert group on poverty measures in 1993 (Gupta [1995]). In particular, the report found no evidence that consumption expenditure was significantly underreported, and that an adjustment of NSS consumption to NAS levels was therefore not required.

References

  • Datt, G. (1996), Poverty in India 1951-92: Trends and Decompositions, World Bank, mimeo Datt, G., and M. Ravallion (1996), Why Did Poverty Increase Sharply After India’s Macroeconomic Stabilization?, World Bank, mimeo.

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  • Dev, S.M. (1995), “Economic Reforms and the Rural Poor”, Economic and Political Weekly, 30, 20852088.

  • Fischer, S.M., (1995), “Reform Can Reduce Poverty and Boost Growth in India”, IMF Purvey, May 22, 1995.

  • Goswami, O. (1996), Wither Corporate Sector Reform in India?, Indian Statistical Institute, mimeo.

  • Gupta, S.P. (1996), Social Cost of Economic Reform, Indian Council for Research on International Economic Relations, mimeo.

  • Gupta, S.P. (1995), “Economic Reform and Its Impact on the Poor”, Economic and Political Weekly, 30, 12951313.

  • ILO (1993), India: Employment, Poverty and Economic Policies: New Delhi.

  • ILO (1996), India: Economic Reforms and Labour Policies: New Delhi.

  • Mundle, S., and V.B. Tulasidhar (1996), Adjustment and Distribution: The Indian Experience, Asian Development Bank, mimeo.

  • Papanek, G.F. (1996), Indian Economic Reforms and the Poor, Boston Institute for Developing Economies, mimeo.

  • Ravallion, M., and G. Datt (1996a), Poverty and Growth: Lessons from Forty Years of Data on India’s Poor, World Bank, mimeo.

  • Ravallion, M., and G. Datt (1996b), “How Important to India’s Poor Is the Sectoral Composition of Economic Growth?”, The World Bank Economic Review, 10, 125.

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  • Ravallion, M., and G. Datt (1995), Growth, Wages and Poverty: Time Series Evidence for Rural India, World Bank, mimeo.

  • Tendulkar, S.D., and L.R. Jain (1996), Indian Economic Reforms and Poverty, Paper presented at the 14th European Conference on Modern South Asian Studies, Copenhagen.

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  • Tendulkar, S.D., and L.R. Jain (1995), “Economic Reforms and Poverty”, Economic and Political Weekly, 30, 13731377.

  • World Bank (1996), Five Years of Stabilization and Reform: The Challenges Ahead, India: Country Economic Memorandum: Washington, DC.

1

Prepared by Martin Mühleisen.

2

The Planning Commission defines poverty relative to a consumption level equivalent to a daily food intake of 2, 100-2,400 calories.

3

Simple poverty rates do not reflect for the severity of poverty, i.e., how far people fall below the poverty line. By contrast, severity measures account for both the number of people below, and their relative distance from, the poverty line.

4

Most of this was achieved before 1970.

5

Datt and Ravallion (1996) attempted to relate the poverty increase between 1991/92 and 1993/94 to changes in these fundamental determinants. However, only about 36 percent of the change in the poverty rate could be explained through an econometric model that included variables for inflation, wages, agricultural yields, and development expenditure.

6

The strong impact of adverse weather conditions is underlined by the fact that poverty increased most in the grain producing states (Tendulkar and Jain [1995]).

7

Cumulative inflation measured by the consumer price index for agricultural laborers (33 percent during 1991/92-1992/93) was significantly higher than in the price index for urban industrial workers (25 percent).

8

Employment statistics cover mainly the formal sector of the economy that employs 8 percent of the labor force.

9

Increased spending on these schemes is believed to have contributed to the increase in rural non-farm employment during the 1980s, as well as boosting unskilled wages in rural areas over this period (ILO [1993], Gupta [1995]).

10

According to ILO (1996) estimates, urban employment increased by an average 3 percent between 1990/91 and 1992/93. Since the increase in organized employment was only 0.8 percent between March 1991 and March 1993, most of the additional labor demand fell on the informal sector.

11

According to the World Bank (1996), the agricultural terms of trade improved by 6 percent between 1990/91 and 1994/95.

12

According to ILO (1996), even conservative estimates suggest that more than 16 percent of employees in the organized sector are redundant.

13

At present, the NRF is confined to centrally owned public enterprises, and mainly finances voluntary retirement schemes.

14

According to recent surveys, a substantial share of PDS ration cards held by households living above the poverty line.