India: Staff Report for the 2004 Article IV Consultation

This 2004 Article IV Consultation highlights that India is on track for another year of robust growth in 2004/05. Supported by a strong monsoon, growth rebounded to 8½ percent in 2003/04, the highest level in more than a decade. In 2005, firms appear to have embarked on a new investment cycle, underpinned by strong credit growth. Inflation has been running higher, driven largely by supply-side factors. The balance of payments position remains comfortable notwithstanding the higher oil prices.


This 2004 Article IV Consultation highlights that India is on track for another year of robust growth in 2004/05. Supported by a strong monsoon, growth rebounded to 8½ percent in 2003/04, the highest level in more than a decade. In 2005, firms appear to have embarked on a new investment cycle, underpinned by strong credit growth. Inflation has been running higher, driven largely by supply-side factors. The balance of payments position remains comfortable notwithstanding the higher oil prices.

I. Background

1. Last May’s election returned a Congress-led coalition to power. Reflecting the mandate it received from the poor, the new government has announced an agenda of “reforms with a human face”—described in the Common Minimum Program (CMP)—aimed at accelerating economic growth, reducing poverty, and increasing infrastructure and social spending (Box 1). Infrastructure needs are large, and over a third of the population (more than 300 million persons) continues to live on less than US$1 a day (Table 1). However, the need for fiscal adjustment continues to constrain the fiscal space to address these issues. The challenge is thus to garner political support to advance fiscal consolidation and deepen structural reforms needed to realize the government’s agenda.

Table 1.

India: Millennium Development Goals 1/

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Source: World Development Indicators database, April 2004.

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. Halve, between 1990 and 2015, the proportion of people who suffer from hunger.

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.

Based on financial year data.

2. To advance the reform agenda, the government needs to balance the interests of several coalition partners and supporting parties. The Congress-led government is a coalition of 12 parties, several of which represent regional interests, that account for 40 percent of the Lower House. It depends on support of the communist Left Front and two other small parties to form a majority in Parliament. Efforts to build consensus and promote common interests across party lines will be key to advancing major structural reforms, in particular in the areas of privatization, labor market liberalization, and subsidy reform. Political analysts observe that state elections in the next few years may be a source of frictions as Congress and its allies will come to face each other. For the moment, recent victory in a major state election has strengthened the Congress’s hand at the national level.


India: Lower House of Parliament

Citation: IMF Staff Country Reports 2005, 086; 10.5089/9781451977578.002.A001

3. Since the last Article IV consultation in July 2003, progress has been made in several policy areas. Executive Directors encouraged the authorities to take advantage of the favorable external environment to tackle structural reforms—including in agriculture, labor markets, and industry—to remove impediments to growth and reduce poverty. They also noted the opportunity provided by the new fiscal responsibility framework, then under consideration in Parliament, to restore fiscal sustainability. Since then, the Fiscal Responsibility and Budget Management Act (FRBMA) has been adopted. The central government has embarked on defined-contribution pension reform. Trade tariffs were lowered and the capital account liberalized further. More recently, the foreign direct investment (FDI) cap on aviation was raised. Privatization advanced with the sale of minority stakes in six state-owned companies, and industrial activity has been liberalized with the list of small industries subject to protection and size restrictions continuing to be narrowed. In the financial sector, the authorities took initiatives to improve corporate governance and migrate gradually to regulatory best practices.

The Common Minimum Program (CMP): The Alliance’s Social Pact

The CMP affirms the coalition’s commitment to “economic reforms with a human face to stimulate growth, investment, and employment.” A few days after taking office, the new government delineated in the CMP its priorities for policies and reforms. The CMP reiterates the government’s determination to implement fiscal consolidation and its focus on improving the well-being of farmers and low-income citizens. The government puts the promotion of investment at the center of a strategy to achieve sustained growth of 7–8 percent per year over the next decade.

The CMP underscores a number of measures to be taken over the medium term to reach these objectives. Larger spending on infrastructure and social programs, incentives for FDI, protection of agriculture from imports, increased credit to agriculture and small industry are on the agenda. Also, the government promises:

  • A major increase in infrastructure, in particular, for rural areas. Meeting infrastructure needs are estimated to cost an additional 3-4 percent of GDP per year.

  • Universal access to basic education and health, through a gradual doubling of expenditure to 6 percent of GDP and 2–3 percent of GDP, respectively.

  • A guarantee of 100 days of minimum wage employment for one person in each poor household, at an estimated net cost of 1 percent of GDP (two-thirds of which borne by the central government).

The government expects to fund this higher spending (around 10 percent of GDP) by better targeting of subsidies to the poor and broadening the tax base. Other revenue measures would include increased tax compliance, improved efficiency of tax administration, and an earmarked surcharge on taxes for education. The government also committed to introducing a state-level VAT.

A number of CMP measures are already implemented or under way. On the revenue side, the budget introduced a 2 percent education surcharge, as well as a tax on securities transactions, and broadened the base of the service tax. FDI caps on civil aviation were increased. The states are expected to introduce the VAT by April 2005.

II. Recent Developments and Outlook

4. Economic performance in 2003/04 was impressive. Supported by favorable monsoons, growth rebounded to more than 8 percent, the highest in a decade and among the highest in the world (Table 2). The recovery was broad-based, stemming from a vigorous recovery in agriculture from the previous year’s drought, and spillover effects on industry and services.1

Table 2.

India: Summary Indicators 1/

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Sources: Data provided by the Indian authorities; CEIC; CMIE; and staff estimates and projections.

Data are for April-March fiscal years.

Current staff projections.

Incomplete month, latest available figures for the month reported.

In official data, national accounts are not reconciled with balance of payments data.

Privatization investment proceeds treated as below-the-line financing.

Monthly data are on a customs basis; annual data are on a BOP basis.

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

Residual maturity basis, except contracted maturity basis for medium and long-term non-resident Indian accounts.

In percent of current account receipts excluding grants.

5. Despite a below-normal monsoon, economic activity remains buoyant this year.2 GDP grew 7½ percent in the first quarter, driven by services and industry.3 Manufacturers appear to be embarking on a new investment cycle as capacity constraints begin to bite (Figure 1). Rapid credit growth underpins the revival of investment as well as consumer spending, particularly in housing. However, below-average rainfall has depressed agricultural activity. Staff expects growth of 6.4 percent in 2004/05, within the range of the Reserve Bank of India (RBI)’s 6–6½ percent forecast, thanks to continued dynamism in services and industry.

Figure 1.
Figure 1.

India: Growth

Citation: IMF Staff Country Reports 2005, 086; 10.5089/9781451977578.002.A001

Sources: Data provided by the Indian authorities; CEIC Data Company Ltd; NCAER; and IMF staff projections.

Contributions to Growth

(In percent, year-on-year)

Citation: IMF Staff Country Reports 2005, 086; 10.5089/9781451977578.002.A001


Direction of Exports

(In percent of total exports)

Citation: IMF Staff Country Reports 2005, 086; 10.5089/9781451977578.002.A001

6. India’s trade deficit is widening, but the current account is expected to end 2004/05 in surplus. Rising imports, reflecting higher oil prices and strong investment demand, have more than offset strong growth in goods and services exports (Figure 2, Table 3). As India’s oil bill has ballooned, the trade deficit has widened to 2.6 percent of GDP in the fiscal year to September. However, services income, tourism receipts, and remittances remain strong and the current account is projected to end 2004/05 in a small surplus. Gains in export market shares and the apparent lack of wage pressures indicate adequate competitiveness. Moreover, the fact that gains in trade shares in the last several years have come partly in Asia suggest that that they are not primarily exchange rate driven.

Figure 2.
Figure 2.

India: External Sector

Citation: IMF Staff Country Reports 2005, 086; 10.5089/9781451977578.002.A001

Sources: Data provided by the Indian authorities; and CEIC Data Company Ltd.1/ Customs data; based on U.S. dollar values.
Table 3.

India: Balance of Payments 1/

(In billions of U.S. dollars)

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Sources: Data provided by CEIC; and staff estimates and projections.

Fiscal year runs from April 1-March 31. Indian authorities’ presentation, including new methodology to estimate direct investment.

Net foreign direct investment in India less net foreign investment abroad.

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

7. Financial market confidence in India remains strong. During 2003/04, large portfolio inflows and remittances helped push reserves to US$113 billion. Election-related uncertainty and interest rate tightening in the United States triggered a pause in capital inflows in May. Since then, capital flows have returned vigorously: the Bombay stock exchange index soared 25 percent in June-November, reaching an all-time high, and FDI is responding to the gradual opening of the economy.4 External bond issuances by Indian corporates and banks have gained momentum and loans raised abroad in April-June were double their level in the same period last year.


Rupee-U.S. Dollar Exchange Rate

Citation: IMF Staff Country Reports 2005, 086; 10.5089/9781451977578.002.A001

8. Faced with a resurgence of capital inflows, the RBI has allowed increased two-way flexibility in the exchange rate. The rupee has recovered the ground lost since the elections, appreciating about 3 percent since May. However, reflecting the overall weakness of the U.S. dollar, the rupee has depreciated slightly in real effective terms, in line with other regional currencies. International reserves increased further during 2004/05, reaching US$131 billion at the start of December, partly a reflection of the weaker dollar.


Real Effective Exchange Rates

(November 2002=100)

Citation: IMF Staff Country Reports 2005, 086; 10.5089/9781451977578.002.A001

9. Inflation has picked up, driven by rising international commodities prices and supported by buoyant demand and comfortable liquidity. With high international oil and steel prices, and rising food prices on account of a weak monsoon, WPI inflation accelerated to close to 9 percent in August year-on-year, before declining to around 7½ percent more recently on lower food prices (Figure 3, Table 4). Data limitations, in particular the absence of indices for consumer and nontradables prices, make it difficult to ascertain the extent of pass-through to domestic retail prices to date.5 CPI inflation for industrial workers and staff’s estimate of core inflation have, however, accelerated. This, together with the recent surge in credit, may point to the emergence of demand pressures. Also, the partial sterilization of large capital inflows in the past year has increased banking system liquidity. The RBI took several measures in response to emerging inflationary pressures (See Section E). Inflation is expected to remain around 7 percent at end-2004/05 as domestic demand remains strong and a larger share of the rise in international oil prices passes through.

Figure 3.
Figure 3.

India: Money and Inflation

Citation: IMF Staff Country Reports 2005, 086; 10.5089/9781451977578.002.A001

Sources: Data provided by the Indian authorities; CEIC Data Company Ltd; and IMF staff projections.1/ Prime lending rate deflated by the WPI.
Table 4.

India: Reserve Money and Monetary Survey 1/

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Sources: Reserve Bank of India; and staff estimates.

Annual data on fiscal year basis ending March 31.

Starting in May 2002, figures include ICICI, formerly a large development finance institution, which merged with ICICI Bank Ltd. to form a new commercial bank.

10. For the first time since the mid-1990s, the central government deficit came in below target in 2003/04. The overall deficit fell to 5.1 percent of GDP, almost 1 percent of GDP lower than the previous year, owing to strong economic growth (Figure 4, Table 5). The current deficit declined to 3.5 percent of GDP from 4.4 percent of GDP. Tax revenues exceeded expectations, as buoyant corporate tax revenues more than offset a shortfall in excise and customs duties, and spending fell short of budget.

Figure 4.
Figure 4.

India: Fiscal Trends

Citation: IMF Staff Country Reports 2005, 086; 10.5089/9781451977578.002.A001

Sources: Data provided by the Indian authorities; and staff projections.1/ Excluding privatization receipts.
Table 5.

India: Central Government Operations

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Sources: Union Budget documents and Economic Survey, Government of India; and staff estimates and projections.

Ratios utilize the CSO’s latest estimates of nominal GDP.

For 2003/04, unaudited provisional outturn. Ratios utilize the staff’s estimate of nominal GDP.

Ratios utilize the authorities’ projections of nominal GDP.

Includes surcharge on Union duties transferred to the National Calamity Contingency Fund (NCCF).

Includes the receipts from commercial departments.

Excludes onlending to the states from small savings collections in all years.

Shows 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 outlay in 2002/03 and 2003/04. The budgeted loan recoveries under the debt swap scheme (DSS) in 2004/05 are used to pay for military capital spending. Staff projections for 2004/05 include an additional Rs. 430 billion projected loan recoveries under the DSS, used to prepay NSSF debt (under capital outlay).

Includes divestment receipts as financing.

Authorities’ definition includes divestment in revenue and excludes small savings from on-lending.

Total receipts (excluding divestment proceeds) less non-capital expenditure.

External debt measured at historical exchange rates. For 2003/04, pertains to revised estimates.

Prepayment by states of central loans under the DSS.

11. States continued to face financial difficulties. In 2003/04, states’ overall deficit deteriorated to an estimated 5.1 percent of GDP, nearly 1 percent of GDP worse than the previous year (Table 6). Part of this deterioration reflects the recognition of past arrears.6 However, states face continued pressure from interest and pension payments, which absorb about 70 percent of states’ tax revenue, and subsidies, in particular to the power sector, have increased. States’ debt has risen to 30 percent of GDP. The deterioration at the state level offset the improvement in central government accounts, and staff estimates that the general government deficit remained broadly stable at 9.7 percent last year.

Table 6.

India: General Government Operations 1/

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Sources: Data provided by the Indian authorities; state level data from the RBI State Finance Bulletin and RBI Handbook of Statistics on the Indian Economy. Staff amalagmate and prepare projections.

The consolidated general government comprises the central government (including Oil Coordination Committee (OCC) up to 2000/01) and state governments.

The ratios in the budget column employ the authorities’ budget projection for nominal GDP, while the ratios in the staff estimate and projection columns use the staff’s projection of nominal GDP.

For 2002/03, based on actual central government outturn and provisional outturn for the states; for 2003/04, based on provisional unaudited central government outturn and staff’s’ projection of state finances. For 2004/05, based on staff’s projections.

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

Nontax revenue = Nontax revenue of CG (including OCC), less interest payments by states on CG loans, plus nontax revenue of states.

Expenditure and net lending = Total expenditure and net lending of CG, less net loans and grants to states and union territories, plus total expenditure of states (excluding interest payments on CG loans).

From the RBI Handbook of Statistics, 2003-04; the authorities treat disinvestment proceeds above-the-line as capital receipts.

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