I. Introduction¹

1. India’s economic performance in recent years has been remarkable. After slowing in 1997/98, in response to a weak harvest and the effects of the Asia crisis, GDP growth averaged 6¼ percent in the subsequent two years, among the highest in the world. The balance of payments also remained comfortable, despite the regional slowdown, turmoil in international capital markets, international sanctions, and sharply higher oil prices. During the past two years, the current account deficit is estimated to have remained close to 1–1¼ percent of GDP, capital inflows surged, contributing to a sharp increase in domestic stock prices, and India’s foreign exchange reserves rose by $8.6 billion to $38 billion. Inflation, which had increased sharply in late 1998, also fell with an improvement in agricultural supply conditions and reached an 18-year low of 2 percent in mid-1999.

2. The capable handling of monetary and exchange rate policies contributed significantly to the favorable economic performance. In response to pressures stemming from the regional crisis, the Reserve Bank of India (RBI) tightened monetary conditions between mid-1997 and August 1998, while accommodating an orderly depreciation of the rupee. However, as exchange market pressures moderated, monetary policy shifted in early 1999 to supporting the industrial recovery—the Bank Rate was cut by 1 percentage point in February 1999 and bank cash reserve requirement also were lowered during the year. The government followed in late 1999 and early 2000 by lowering interest rates on’provident fund and postal saving deposits, and the RBI reduced the Bank Rate and repo rate by a further 1 percentage point on April 1, 2000, and also cut the cash reserve ratio.

3. Nonetheless, significant challenges still face the Indian economy. The durability of the recovery remains a question, given signs that much of the growth in recent years has been fueled by fiscal stimulus and private consumption. Private investment appears to have been constrained by high interest rates, lack of infrastructure, and crowding out by the public sector. Inflation also has rebounded strongly in early 2000, particularly with the adjustment of administered energy and fuel prices, and the scope for monetary policy to sustain noninflationary growth is complicated by the large fiscal deficit. Moreover, recent data suggest that, despite rapid growth in recent decades, the poverty rate remains high, with more than a third of the population estimated to be living below the official poverty line.

4. The fiscal situation has deteriorated markedly in recent years, erasing much of the consolidation that was achieved during the mid-1990s. The overall public sector deficit has increased steadily from 8¼ percent of GDP in 1995/96 to an estimated 11 percent of GDP in 1999/00, reflecting roughly equivalent erosions in the fiscal positions of the central and state governments. Slippages from the central government’s 1999/00 budget were severe, with the deficit reaching 7 percent of GDP, and the states’ fiscal position also weakened considerably. Although the central government’s 2000/01 budget contained important reforms to the tax system, it suggests that little or no deficit reduction will be achieved in the coming year.

5. Political uncertainties also appear to have delayed progress in the area of structural reform. This was particularly noticeable during 1999, ahead of the elections that were concluded in October. Nonetheless, a number of key reforms have been implemented in recent years, including in the areas of urban land reform, the insurance sector, foreign exchange management, telecommunications, and trade and capital account liberalization. The authorities also have continued to strengthen the regulation and supervision of banks and other deposit-taking institutions. Nonetheless, regulatory and other structural impediments in the industrial and agricultural sectors remain significant.

6. Many of these issues are addressed in the following chapters. Chapter II reviews recent economic developments, and Chapter III describes fiscal developments at the central and state levels. Monetary policy and financial market developments are discussed in Chapters IV and V, and the balance of payments and trade policy are reviewed in Chapters VI and VII. Chapter VIII describes structural policy developments.