India: Recent Economic Developments and Selected Issues
Author: International Monetary Fund
Publication Date:
16 Oct 2001
eISBN:
9781451818550
Language:
English
Keywords:
ISCR; CR; India; GDP; exchange rate; deposit; Indian rupee; WPI inflation; capital formation; U.S. dollar; fixed capital; Agricultural commodities; Gross fixed investment; Inflation; Agricultural sector; private sector
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India rebounded strongly from its 1991 balance-of-payments crisis, aided by structural reforms and other policy adjustments. The government has sought to reinvigorate the process of structural and fiscal reform. The paper examines trends in interstate differences in rural poverty; reviews India's postal saving system and possible reform issues; describes and evaluates the current system of pensions and provident funds, and discusses reform options. The paper also briefly reviews the structure of and recent developments in the Indian foreign exchange market.

Abstract

India rebounded strongly from its 1991 balance-of-payments crisis, aided by structural reforms and other policy adjustments. The government has sought to reinvigorate the process of structural and fiscal reform. The paper examines trends in interstate differences in rural poverty; reviews India's postal saving system and possible reform issues; describes and evaluates the current system of pensions and provident funds, and discusses reform options. The paper also briefly reviews the structure of and recent developments in the Indian foreign exchange market.

II. Economic Activity and Prices1

A. Overall Developments

1. The Indian economy slowed in the latter part of the 1990s, with real GDP growth (at factor cost) averaging just under 6 percent between 1997/98 and 1999/00 compared to 7½ percent during the previous three years.2 The slowdown reflected a sharp deceleration in both agricultural and industrial production (Table II.1). Growth in the agricultural sector, which was adversely affected by poor weather conditions (except during 1998/99), slowed to 1¾ percent on average during the last three years. Industrial sector growth decelerated to 4¾ percent per year—less than half the rate of the previous three years—reflecting weaker growth in agricultural incomes, the effects of the Asian crisis, volatile oil prices, and high real interest rates, as well as increasing infrastructure constraints and uncertainty about the impact of the removal of quantitative import restrictions. While measured service sector growth rose, this largely reflected civil service wage hikes associated with the Fifth Pay Commission awards.3

uA02fig01

Contributions to GDP Growth

(in percent)

Citation: IMF Staff Country Reports 2001, 181; 10.5089/9781451818550.002.A002

1/ Government refers to public administration and defense.
Table II.1.

India: GDP at Factor Cost by Sector of Origin, 1994/95-2000/01 1/

article image
Source: Data provided by the Indian authorities.

2000/01 data are official advance estimates, which may differ from IMF staff estimates.

Includes mining and quarrying; manufacturing; electricity, gas and water supply; and construction.

Includes trade, hotels, and restaurants; transport, storage, and communication; financing, insurance, real estate, and business services; and community, social, and personal services.

2. On the expenditure side, the slowdown in the late 1990s reflected both lower consumption and investment growth (Table II.2). Public sector and household capital accumulation accelerated, but this was more than offset by weak private corporate investment, which declined by 2 percent per annum during this period.

Table II.2.

India: GDP at Market Prices by Expenditure Components, 1994/95-1999/2000 1/

article image
Source: Staff estimates based on data provided by the Indian authorities.

Data are provisional.

Excludes statistical discrepancy. Data on exports and imports of goods and services at constant prices are not available.

Indexed to 100 in 1993/94.

3. Official advance estimates indicated that GDP growth remained at 6 percent during 2000/01. The industrial sector was estimated to have rebounded modestly, owing to stronger export growth (see Chapter III). This was offset by weaker service sector growth, reflecting the waning effects of the civil service wage hikes, and the impact of persistent drought conditions in a number of states on agricultural production, which was exacerbated by low water tables in some areas.

4. The advance estimates for 2000/01 may be subject to downside revision. Growth slowed to 5¾ percent (on a four-quarter basis) in the third quarter of the fiscal year and indicators of import growth and industrial production weakened further in the fourth quarter (Charts II.1 and II.2). This slowdown may partly reflect the impact of the devastating earthquake that struck the state of Gujarat in January 2001.

Chart II.1.

India: Industrial Production and Business Confidence, 1995-2001

A02fig01
Sources: Data provided by the Indian authorities, CEIC, and NCAER.1/ Three-month moving average.2/ Based on weighted average of the electricity, coal, steel, crude petroleum, petroleum products, and cement indices.Chart II.2.

India: Components of Industrial Production, 1995-2001

A02fig02
Source: Data provided by the Indian authorities; and CEIC, and NCAER.1/ Three-month moving average.

5. The Gujarat earthquake caused a massive loss of life and damage to physical assets as well as a widespread disruption of economic activities. Some estimates put the loss of life at over 20,000, with 165,000 injured, and asset losses and reconstruction costs around $4.4 billion (about 1 percent of India’s GDP). Output losses were estimated to be $650 million over three years, with most of the loss concentrated in 2000/01, related to the absence of workers, power and telecommunications shortages, transportation problems, and the suspension of regular operations at Kandla—India’s busiest port. Nonetheless, the impact on production was expected to be moderated by the fact that the areas most affected by the earthquake were not major contributors to state GDP. Large-scale industrial plants mostly survived owing to quakeproof construction, and damage was concentrated on medium- and small-scale industries, especially in areas of textiles and jewelry.

6. Employment in the organized sector, which accounts for only 28 million of the working-age population of almost 600 million, fell by ½ percent in the two years to 1998/99, the last year for which data are available (Table II.3). The decrease was largely explained by a 2% percent decline in employment in public sector enterprises. Employment remained largely unchanged elsewhere in the public sector and in the private sector. However, the composition of employment in the private sector shifted as service sector jobs (particularly in financing, insurance, and real estate) increased, while agricultural and industrial sector jobs decreased modestly.

Table II.3.

India: Employment and Labor Statistics, 1993/94-1998/99

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Source: CEIC.

All establishments in the public sector and nonagricultural private establishments with ten or more employees.

B. Sectoral Developments

Agriculture

7. Agricultural sector growth weakened in 1999/00 to ¾ percent, following a jump to 7 percent the previous year. Output of groundnuts declined sharply, particularly in Gujarat because of adverse weather conditions, while production of other oilseeds, cotton, and tea also decreased (Table II.4). Growth in foodgrain production decelerated to 2% percent and, despite inadequate rainfall in a number of districts, still reached a record high of 209 million tons, reflecting gains in rice and wheat production. Growth of coffee and natural rubber output slowed, partly in response to weak domestic and international prices.

Table II.4.

India: Agricultural Production and Yields, 1994/95-2000/01

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Sources: Government of India, Economic Survey; and data provided by the Indian authorities.

Nine major oilseeds.

In million bales of 170 kg. each.

In million bales of 180 kg. each.

Data are for calendar years. For example, data under the heading 1993/94 are for 1993.

In metric tons per hectare.

8. The advance estimates indicated that agricultural sector growth remained under 1 percent in 2000/01. Foodgrain production was estimated to have declined by almost 5 percent. Although the monsoon was considered to be normal (within 10 percent of the long-term average), a large number of districts received deficient rainfall for the second year in succession, contributing to low water reservoir levels—through March 2001, water levels in the 70 major reservoirs had fallen to 63 percent of the average over the last decade. Critically-affected states included Gujarat, Madhya Pradesh, Orissa, Himachal Pradesh, and Rajasthan—which together usually account for over 20 percent of foodgrain production. In addition, production of oilseeds and tea was also estimated to have decreased, while fishing and production of other commercial crops and coffee increased, but at a slower pace.

Industry

9. Industrial sector growth recovered in 1999/00 to 6½ percent, but remained below the 9½ percent growth rates achieved in the mid-1990s. The pickup reflected strength in public sector construction, in response to fiscal stimulus, and manufacturing, which was boosted by stronger external demand as partner countries recovered from the Asian crisis and increased domestic demand for intermediate goods and consumer durables (Table II.5). Nonetheless, growth in industrial activity remained substantially below average growth rates achieved in the mid-1990s, owing to weaker private consumption and corporate investment—the latter reflecting the effects of a buildup of excess capacity in the mid-1990s and poor infrastructure, particularly in the transportation and power sectors.

Table II.5.

India: Index of Industrial Production, 1995/96-2000/01

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Source: CEIC.

Weights for 1993/94 base-year data. Weights for index classified by use were revised slightly for data from 1998/99 onwards.

10. The advance estimates for 2000/01 suggested that industrial sector growth remained about 6½ percent, but more recent indicators point to slower growth. In the advance estimates, growth in industry excluding construction was estimated to have remained at 6 percent. More recent data from the Index of Industrial Production (IIP)—which covers industry excluding construction—indicated a sharp slowdown in these sectors towards the end of the fiscal year with growth slowing from 6 percent in the fiscal year to November 2000 to 5 percent in the fiscal year to March 2001.4 Other indicators also point to weakness, including the sluggishness of capital goods imports and production of vehicles, textiles, and cement.

Services

11. Services sector growth accelerated further in 1999/00 from 8¼ percent to over 9½ percent, near its historical peak reached in 1995/96. As in recent years, growth was led by the communications sector—including telecommunications—and the financing, insurance, and real estate sector, aided by government reforms that deregulated these segments of the economy. In addition, information technology services continued to grow rapidly with software services increasing by over 40 percent in U.S. dollar terms (Box II. 1). Transportation sector growth also accelerated to 7½ percent after two relatively weak years, as port and freight traffics and railway passenger growth rebounded.

India: The Information Technology Sector

India’s information technology (IT) sector has grown rapidly in recent years. According to the National Association of Software and Services Companies (NASSCOM), IT industry revenue reached $8.7 billion (2 percent of GDP) in 1999/00, after growing almost 34 percent annually (in dollar terms) in the previous five years. The main contributor to growth in the IT sector was software services exports which grew 52½ percent annually during the period and accounted for 46 percent of IT industry revenues by 1999/00. Other areas of strength included software services for the domestic market and networking, which grew at annual rates of 37 percent and 54 percent, respectively. Employment in the sector also grew rapidly (over 20 percent per year) and was estimated to be over 400,000 (about 1½ percent of employment in organized sectors) by end-2000. By contrast, hardware exports contracted in the late 1990s in both rupee and dollar terms.

uA02fig02

IT Industry Revenue

(US$ billions)

Citation: IMF Staff Country Reports 2001, 181; 10.5089/9781451818550.002.A002

Source: NASSCOM.
uA02fig03

IT Industry Exports

(US$ billions)

Citation: IMF Staff Country Reports 2001, 181; 10.5089/9781451818550.002.A002

Source: NASSCOM.

Booming IT exports have helped sustain India’s external current account in the late 1990s, moderating the effects of several external shocks—including the Asian crisis and a surge in oil prices. Growth in IT exports during the late 1990s accounted for about one-sixth of the overall growth in goods and services exports, and during 1999/00, IT exports were roughly equal to the increase in the oil import bill. Moreover, the surge in inward remittances from Indian workers abroad (a component of private transfers) and the shift in the source of these remittances from the Middle East to the United States may reflect the repatriation of savings by overseas Indian IT professionals.

India’s success in the IT services field is attributable to a combination of factors, including its large pool of English-speaking university graduates in sciences, relatively low wages, a well-placed international diaspora, favorable government policies, and low start up costs for software firms. India graduates over 60,000 engineers a year, and salaries are about one-tenth to one-half of those found in the United States.1 It is estimated that there are over 250,000 Indian IT professionals in the United States alone, including many in management positions, some of whom play important roles in outsourcing work to India. Government policies have benefited the IT industry by minimizing interference in the sector (particularly, compared to other industrial and services sectors), providing favorable tax treatment, and emphasizing investments in higher education. Indian IT firms have also benefited from the establishment of a number of software technology parks that provide infrastructure—particularly, reliable communication and power—that are not readily available elsewhere.

The structure of India’s IT sector appears to make it less vulnerable to the global cyclical downturn. Unlike other Asian economies, hardware (including peripherals) accounts for a negligible share (less than 3 percent in 1999/00) of IT exports. Moreover, a large share of India’s software services exports are back-office and data services or customization of non-mission critical software—areas where low wages bring significant competitive advantages. Indeed, analysts have argued that as global firms cut costs during an economic slowdown, more work could be outsourced to Indian companies.

Over the medium term, India’s IT sector is expected to remain vibrant, although benefits to the rest of the Indian economy may be limited. The IT sector employs a small share of the Indian population and is largely confined to the southern states of Andhra Pradesh, Karnataka, and Tamil Nadu, the western state of Maharashtra, and a few enclaves around Delhi. Even under the most optimistic scenarios that assume that India will be able to shift to higher value-added exports as IT sector wages and competition from other developing countries increase, the sector will employ only just over 2 million people by 2008 (out of a current working population of 600 million). Moreover, some analysts suggest that if productivity does not improve in other sectors of the economy, these may be adversely affected if the real exchange rate appreciates because of strong IT export earnings.

1Ashish Arora, “Software Development in Non-Member Economies; The Indian Case,” OECD Information Outlook 2000.

12. The advance estimates indicated that service sector growth remained robust, but decreased to 8¼ percent in 2000/01. However, this decline may be exaggerated as measured government services growth was adversely affected by the completion of arrears payments and wage hikes associated with the Fifth Pay Commission awards. Communications sector output surged almost 25 percent, while other services sectors remained buoyant.

C. Saving and Investment

13. The gross domestic saving rate, which reached its historical peak of over 25 percent of GDP in 1995/96, has shown a declining trend in recent years, falling to 22¼ percent of GDP in 1999/00 (Table II.6). The decline is attributable to a drop in public sector saving, which fell from 2 percent of GDP to -1¼ percent of GDP, reflecting the widening deficit of the central and state governments. The private sector saving rate increased modestly, as the household saving rate, continuing its long-run secular trend, increased to a historical peak of 19¾ percent of GDP in 1999/00. This more than offset a 1¼ percentage point decline in private corporate saving rate, attributable to the effects of the industrial slowdown and increased energy prices on profits.

uA02fig04

Gross Saving and Fixed Investment

(in percent of GDP at market prices)

Citation: IMF Staff Country Reports 2001, 181; 10.5089/9781451818550.002.A002

Table II.6.

India: Saving and Investment, 1994/95-1999/2000 1/

article image
Sources: Staff estimates based on data provided by the Indian authorities.

Data are provisional.

Not adjusted for statistical discrepancy.

Percent change.

14. Gross fixed capital formation, in nominal terms, also declined from its historical peak of 24½ percent of GDP to 21¼ percent of GDP during 1995/96 to 1999/00. This reflected a drop in the public sector investment rate of ¼ percentage points, as capital expenditures were constrained by the widening public sector deficit, and a fall in the private corporate investment rate of 2¼ percentage points—largely in machinery and equipment—in response to the excess capacity built up in the mid-1990s. The household sector investment rate increased by ½ percentage point as higher investment in construction more than offset lower investment in machinery and equipment. In real terms, the decrease in the rate of gross fixed capital formation was more moderate—declining by only 1 percentage point—as the investment deflator, particularly of private sector machinery and equipment, grew at a much slower rate (4 percent per year) than the overall GDP deflator (6¾ percent).

D. Inflation

15. Inflation measured using the wholesale price index (WPI) fell to under 3 percent (on a 12-month basis) in late 1999, but rebounded to 8½ percent in early 2001 (Chart II.3 and Table II.7). The higher inflation rate largely reflected fuel and energy prices that increased by almost 40 percent between September 1999 and October 2000 as administered fuel prices were raised in three steps (October 1999, and March and September 2000). The pass-through to other domestic prices was generally contained, helped by weak prices of primary and manufactured food products, in part reflecting abundant food stocks. Nonfood manufacturing inflation, nonetheless, increased to 6¾ percent in early 2001 from 2¼ percent in January 2000.

Chart II.3.

India: Inflation Indicators, 1995-2001

A02fig03
Source: Data provided by the Indian authorities.1/ For industrial workers.
Table II.7.

India: Price Developments, 1995/96-2000/01

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Source: CEIC.

16. However, WPI inflation declined to 5½ percent in March 2001, reflecting the waning base effect of hikes in administered fuel prices along with still quiescent food prices and weakening domestic demand. Indicative of falling inflation pressures, nonfood manufacturing inflation also decreased to 5½ percent.

17. In contrast to historical trends, inflation measured using the consumer price index (CPI) has remained below WPI inflation since September 1999. CPI inflation decreased to 3½ percent in 1999/00 (period-average basis), reflecting weak food prices. After increasing modestly during most of 2000/01, CPI inflation declined to 3 percent in February 2001 (on a 12-month basis), as the impact of higher energy prices on consumer prices has been more muted than on wholesale prices because of the relatively higher weight of food in the CPI (nearly 60 percent of the total index).5

E. Macroeconomic Dynamics in India

18. The Indian economy has been subject to a number of external and domestic shocks in recent years. On the external side, global oil prices fell to under $12 per barrel in early 1999 and then increased by over 150 percent in the next 18 months, while global GDP growth also fluctuated, declining to 2¾ percent in the aftermath of the Asian crisis before rising to almost 5 percent in 2000. During the last few years, the Indian rupee also faced intermittent bouts of downward pressure. On the domestic side, agricultural production suffered from patchy monsoons in the late 1990s, contributing to weak growth in rural incomes and private consumption. Monetary policy was also adjusted on several occasions, even though the bank rate generally declined from 12 percent in early 1997 to 7 percent in early 2001.

19. To quantify the impact on the Indian economy of these and similar shocks over time, vector autoregressions (VARs) were estimated. The VARs were based on annual data between 1969/70 and 1999/00.6 The VARs generally included the log of real GDP, the log of the wholesale price index (WPI), and the current account balance-to-GDP ratio, in that order.7 The log of world real GDP, the log of world oil prices, and the log of the U.S. dollar/rupee exchange rate (on a period-average basis) were included individually and jointly in the VARs to obtain the impact of external shocks.8 The effect of domestic shocks was assessed by adding the short-term interest rate and/or the log of agricultural sector GDP.9

20. The main findings were:

  • Real output was most responsive to (one standard error positive) shocks to either world oil prices or short-term interest rates, followed to a lesser extent by (negative) shocks to world real GDP (Chart II.4). The impact of each of these shocks reached a peak between one to three years and was permanent. The effect on output of exchange rate shocks was smaller.10 Shocks to agricultural production had an insignificant impact, which were also of the wrong sign, on aggregate activity.

  • Shocks to short-term interest rates had a negative and relatively large impact on the price level, which began to reverse within 2 years. Higher oil prices tended to increase the price level—but only temporarily—while lower world GDP and exchange rate appreciation led to lower price levels.

  • The impact on the current account balance of any of the shocks was relatively small, generally less than ¼ percent of GDP. Higher interest rates had the largest effect, leading to an increase in the current account balance, in turn reflecting the slowdown in real activity. Counterintuitively, higher world oil prices also led to a small improvement in the current account balance, likely owing to the slowdown in real GDP or demand.

Chart II.4.

India: Dynamic Responses to Shocks 1/

(Percent change)

A02fig04
1/ Impulse-response functions for VAR with ordering log(GDP at factor cost), log(WPI), current account balance-to-GDP ratio, log(dollar-rupee exchange rate), call money interest rate, log(world oil price), and log(world GDP). One standard deviation positive innovations are 2.6 percent for exchange rate, 2.8 percentage points for interest rate, 27.5 percent for oil prices, and 0.5 percent for world GDP.
1

Prepared by Ranil Salgado.

2

Data that are presented in this chapter reflect official data releases (some provisional) through mid-May 2001. In a few instances, official estimates may differ from IMF staff estimates.

3

Government services (or public administration and defense) are estimated by the Central Statistical Organization (CSO) using the government’s wage bill (with arrears counted in the year that they are paid) deflated by the wholesale price index.

4

The CSO uses data from the IIP to prepare estimates of growth in the registered industrial sector.

5

The WPI is heavily weighted towards manufactured items, which comprise almost 64 percent of the index, with primary articles accounting for 22 percent of the index and fuel and energy for the remaining 14 percent. Food products in the WPI are components of both primary articles and manufactured items and sum to 27 percent of the index.

6

Annual data was used reflecting the limited availability of some time series at a higher frequency. For example, quarterly GDP data in India is available only since 1996/97.

7

Two lags of each variable and a constant term were included in each equation of the VAR. Although GDP and prices are nonstationary, the VARs were estimated in levels, instead of first differences, so as not to impose the restriction that the shocks have permanent effects.

8

World real GDP and world oil prices are from the World Economic Outlook database.

9

The call money market rate was used for the short-term interest rate. In the VARs with the log of agricultural sector GDP, the log of industrial sector GDP and the log of services sector GDP replaced the log of real GDP.

10

The VARs were also estimated with the real interest rate and the real effective exchange rate with similar albeit generally weaker effects.

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Cover IMF Staff Country Reports
India: Recent Economic Developments and Selected Issues
Author: International Monetary Fund
Volume/Issue:
Volume 2001: Issue 181
Publisher:
International Monetary Fund
ISBN:
9781451818550
ISSN:
1934-7685
Pages:
164
DOI:
https://doi.org/10.5089/9781451818550.002

Contributions to GDP Growth

(in percent)

IT Industry Revenue

(US$ billions)

IT Industry Exports

(US$ billions)

Gross Saving and Fixed Investment

(in percent of GDP at market prices)