Statement by Rakesh Mohan, Executive Director for India and Janak Raj, Senior Advisor, January 25, 2013

India’s economy has slowed substantially before and after the global financial crisis. The economy is in a weaker position than before the crisis. With investment particularly hard-hit, potential GDP is likely to be lower than estimated. Inflation is constraining the room for monetary policy easing. Banks’ capital ratios have fallen slightly, but asset quality is deteriorating considerably. The current account deficit registered a record high in 2011–12. Delivering on structural reforms, fiscal consolidation, and low inflation are critical for a sustained recovery.


India’s economy has slowed substantially before and after the global financial crisis. The economy is in a weaker position than before the crisis. With investment particularly hard-hit, potential GDP is likely to be lower than estimated. Inflation is constraining the room for monetary policy easing. Banks’ capital ratios have fallen slightly, but asset quality is deteriorating considerably. The current account deficit registered a record high in 2011–12. Delivering on structural reforms, fiscal consolidation, and low inflation are critical for a sustained recovery.

1. We welcome staff’s comprehensive assessment of recent macroeconomic and financial sector developments in India and the evolving outlook. Our authorities had had a constructive and candid engagement with the mission. The current slowdown in domestic growth is a key concern for our authorities. Accordingly, they have taken a number of measures over the past few months to address various domestic bottlenecks to revive investment activity and growth impulses in the short run, and to boost the growth potential over the medium term.

Recent Macroeconomic Developments

2. Staff have attributed the slowdown of the Indian economy mainly to domestic supply side factors. It needs to be noted, however, that strong global headwinds such as ongoing tensions in the euro area and the concomitant persistent slowdown in global growth also had a significant impact on the economy.

3. In pointing out the role of the domestic supply side factors in India’s current growth slowdown, staff are reflecting the concerns of our authorities, who have recognized several constraints that acted as a drag on economic activity recently and had initiated measures to address them. The thrust of the Mid-Year Economic Review presented by the Government to the Parliament in December 2012 was on the domestic constraints that led to a decline in investment activity and slowdown in growth. Some of the major constraints identified are: bottlenecks in project implementation; shortage of coal and underutilization of thermal based power generation; delay in regulatory and environmental clearances; infrastructural bottlenecks; high fiscal deficit; and high inflation. High inflation also mean high interest rates, which have further impacted investment activity.

4. Having recognized these constraints, our authorities have taken measures to address them by following a two-pronged approach. First, measures were initiated to remove short-term constraints, which have already improved business confidence. Second, structural reforms have been pursued to boost the medium-term growth potential of the economy.

Fiscal Policy

5. With tax revenues affected by the slowdown in growth, and expenditures overshooting mainly on account of petroleum subsidies, containing the fiscal deficit in 2012-13 to the budgeted level (5.1 per cent) was proving to be a challenge. Recognizing the need to contain the fiscal deficit, the authorities constituted a high-powered committee in August 2012, based on the recommendations of which a fiscal roadmap was announced in October 2012. Accordingly, our authorities have indicated that the gross fiscal deficit would be contained at 5.3 per cent in 2012-13 and further brought down to 3.0 per cent by 2016-17. In keeping with this, a number of different measures have been introduced. The domestic prices of administered petroleum products have been increased to contain fuel subsidies. The authorities have also raised railway passenger fares to strengthen the Indian Railways. Earlier, the authorities had announced disinvestment in some public sector enterprises. The authorities are thus committed to containing the fiscal deficit at 5.3 per cent for fiscal year 2012-13.

6. The authorities have also announced a plan to gradually roll out direct cash transfers using Unique Identification Numbers (UID) beginning 2013 in select districts in lieu of existing channels, which are largely in kind and subject to leakages. The authorities expect that by 2016-17, cash transfers will be largely in place for the disbursement of key subsidies. This is an innovative step and is expected to prove very effective in avoiding leakages and delays and lead to better targeting of government programs.

7. It needs to be recognized that even as the fiscal deficit is a concern, India’s public debt is on a downward trajectory with the Central Government’s gross debt expected to fall to 45.5 per cent of GDP during 2012-13.


8. To contain inflation and anchor inflation expectations, the Reserve Bank of India (RBI) has pursued an appropriate monetary policy; it raised the policy interest rate during March 2010 – October 2011. The anti-inflationary monetary policy stance has had some dampening effect on domestic demand, but that was to be expected. As the growth slowed down, the RBI reduced the policy rate in April 2012, but has held its policy rate since then as inflation remained above its comfort level.

Structural Reforms

9. FDI has been permitted in some new sectors, including the multi-brand retail sector, while norms have been relaxed in certain existing sectors. To avoid delay in implementation of large projects, a number of measures have been taken, including the setting up of a new Cabinet Committee on Investment (CCI) under the chairmanship of the Prime Minister. The Committee has been mandated to fast track large infrastructure projects. Debt funds have been set up to intermediate long-term resources for infrastructure projects. India has the second largest number of PPP projects in infrastructure in the world, the thrust on which is to be continued in the Twelfth Five Year Plan (2012-17). The authorities have recently accepted all the major recommendations of an Expert Committee on General Anti-Avoidance Rules (GAAR) for bringing about a greater clarity in the matter of taxation. The implementation of GAAR has been deferred till 2016. Efforts are also afoot to implement the Goods and Services Tax (GST) and Direct Tax Code (DTC) as early as possible. These and several other significant measures will help revert the economy on a high growth trajectory.

Global Factors

10. Having recognized the role of domestic constraints, it also needs to be underlined that the uncertain external environment played no less a role. The continued uncertainty in the global financial markets over the euro area sovereign debt concerns and the sluggish US recovery have led to anemic global growth and volatility in capital flows. The Indian economy is now highly integrated with the global economy - in fact, more integrated than some of the major advanced economies are. Therefore, the uncertain global macroeconomic situation directly impacts the Indian economy through various channels. In fact, staff’s own estimates suggest that for every percentage point of lower global growth, India’s growth is shaved off by 0.5 percentage point. As global growth has slowed down significantly, it has obviously impacted India’s growth. At the same time, quantitative easing policies pursued by the major central banks have contributed to continued upward pressure on international commodity prices, which add to domestic inflationary pressures.

11. It also needs to be recognized that the slowdown is not unique to India alone. All the major economies, which experienced a robust rebound from the crisis of 2008-09, have witnessed a growth slowdown, although the extent of India’s slowdown is somewhat higher for reasons outlined above. The growth has also been impacted due to cyclical factors. The Indian economy was quick to recover from the global financial crisis as it registered high growth rates of above 8 per cent in the 2009-10 and 2010-11. However, a cyclical slowdown set in during the second half of 2010-11 (April-March), again which was common across all the major economies of the world.

Short-term Outlook

12. The various measures announced by our authorities since September 2012 are beginning to improve the business sentiment. Various lead indicators suggest that the slowdown has bottomed out and the economy is headed towards higher growth, going forward. Reflecting the change in business sentiment, capital market conditions have improved. As a result, the interest of foreign institutional investors (FIIs) has also revived, resulting in improved capital flows. Headline inflation has moderated over the past two months. A significant decline in core inflation has been particularly comforting. This could possibly facilitate softening of the monetary policy stance, going forward. The RBI’s Business Expectation Index for the October-December 2012 quarter, PMI for November and December and improvement in capital market conditions all suggest that the economy is poised for improved performance. The macroeconomic outlook in the near future is certainly more positive and the authorities expect that growth will be better than the staff‘s projections for 2013-14 and beyond.

Medium-term Outlook

13. Notwithstanding the recent growth slowdown, India’s potential growth still remains intact as the underlying drivers of growth – high domestic savings, high investment, the demographic profile, a diversified and strong financial system, well-functioning financial markets, and, overall, continued macroeconomic and financial stability – remain in place. Accordingly, long-term productive capacity and potential have not been much affected. In this regard, staff’s estimates of potential growth seem to focus on the very near-term growth prospects of the economy and, therefore vary annually and are sensitive to choice of methodology. However, potential growth is a medium to longer-term concept that reflects underlying structural trends rather than cyclical variations and year-to-year shifts and events.

14. Recent structural reforms introduced by the authorities, and as outlined above, will help the economy return to its high growth trajectory. Our authorities recognize that high growth is essential for reducing India’s poverty on a sustained basis. The percentage of the population below the poverty line declined at the rate of 1.5 percentage points every year in the period 2004-05 to 2009-10, twice the rate at which it declined in the previous period 1993-94 to 2004-05. Despite this impressive performance, however, a large proportion of population is still below the poverty line and our authorities are determined to bring that down further. Accordingly, as set out in the Draft 12th Five Year Plan document released recently, the economy is projected to grow at about 8.0 per cent per year during 2012-17 based on successful policy interventions at multiple leverage points which will generate virtuous cycles.

Monetary and Exchange Rate Policies

15. Inflation in India has been a cause of significant concern. Unlike several other emerging market economies, inflation in India has remained high and persistent during the last three years. Inflation has been driven by all the three major groups, viz., food, fuel and core. Food inflation has generally been volatile with large swings in the prices of certain food items such as fruits and vegetables. A major driver of food inflation has been protein-rich items. This reflects the changing consumption pattern due to rising income levels as also rising input costs on account of increase in wages. Recently, there has also been a spurt in cereal prices. As noted above, elevated oil and other international commodity prices on the back of quantitative easing policies in advanced economies added to domestic inflationary pressures. However, latest data suggest that inflation has begun to moderate. More importantly, core inflation has moderated significantly. In view of stabilizing global oil prices, the inflation dynamic, going forward, is expected to be more favorable.

16. While the wholesale price inflation is the headline indicator of inflation, the Reserve Bank makes use of an array of indicators to assess the underlying inflationary pressures, including movements in various consumer price indices, GDP deflator and inflation expectations surveys. However, in the Indian context, there are significant limitations of relying solely on consumer price indices for the conduct and formulation of monetary policy in view of the large weight of food items in the consumer price indices, over which monetary policy has limited direct effect. Moreover, in view of limited data points, it is not possible to use the new series as a measure of headline inflation. The authorities, will, therefore, continue to use the new series along with other indicators, as hitherto. Staff have made a suggestion that the RBI could make rolling one-year projections of inflation. Uncertainty about the patterns and magnitude of seasonal effects such as monsoon complicates the generation of rolling projections. Such projections, if therefore made, could undermine the credibility of the RBI. In this context, it is relevant to note that, as the Reserve Bank has consistently articulated in its policy statements, the conduct of monetary policy continues to be conditioned by the need to contain perception of inflation in the range of 4.0-4.5 per cent, in line with the medium-term objective of 3.0 per cent inflation consistent with India’s broader integration into the global economy.

17. Staff have made a suggestion that the debt limits for FIIs be raised, particularly in view of recent relaxation in external commercial borrowing (ECB) limits and also on the ground that FIIs will bear the forex risk. The authorities keep revising these limits periodically based on several considerations. However, given the wide interest rate differential between India and the major advanced economies, the authorities exercise caution while effecting revisions in these limits.

Financial Policies

18. The financial sector remains well-capitalized and has been contributing to growth in India. Prudent macroeconomic and financial policies have helped maintain financial stability in the Indian economy over the past two decades on a consistent basis, including in the period since 2007 when major advanced economies have seen a high degree of financial instability. Although NPAs have risen in consonance with the cyclical slowdown, they are still at a low level. Banks remain adequately capitalized, with overall capital adequacy at 13.6 per cent. Insofar as the restructured standard advances becoming NPAs is concerned, it needs to be noted that restructuring is allowed only in those cases where the account is expected to become viable after restructuring. Restructured standard advances are only 5.9 per cent of gross advances and historical experience suggests that only a small fraction of such restructured standard assets become NPAs. Even in a scenario when 30 per cent of restructured standard assets become NPAs, the average Tier I ratio at 8.1 per cent remains far above the prescribed level of 6 per cent. Nevertheless, the authorities have increased provisions for restructured standard accounts.

19. India is among the first G20 countries to have developed Basel III compliant regulations. The authorities are committed to keep all the public sector banks (PSBs) financially sound and healthy so as to ensure that the growing credit needs of our economy are adequately met. Full implementation of Basel III by 2018 could necessitate government cumulative capital injections in the PSBs of about 1 per cent of GDP. Although the amount looks large, it will be spread over the next six years. In this context, it may be noted that early this month the authorities decided to infuse capital of the order of Rs. 125 billion in public sector banks during the year 2012-13 to maintain their Tier-l CRAR at comfortable level so that they remain compliant with the stricter capital adequacy norms under Basel III.

20. Staff favor a lower statutory liquidity ratio (SLR), currently at 23 per cent, on the ground that it is crowding out private sector investment. At present, however, banks’ actual holding of SLR securities is above the statutory requirement, which would suggest that the SLR is not crowding out private investment. In this context, it is relevant to note that, first, the SLR holding of banks has been brought down over time from 38.5 per cent of net demand and time liabilities of banks in the early 1990s to 23 per cent at present. Second, the SLR securities are issued by the government at market-determined interest rates. Third, the holding of high-quality, highly liquid government bonds has strengthened banks’ balance sheets and helped banks to better cope with financial stress situations by providing them with greater access to liquidity through a special window in the RBI. The financial stability enhancing role played by the SLR is thus important. It is, therefore, intriguing that the staff recommend the reduction in the SLR when it is now widely recognized that there is a need to boost the liquidity buffers of banks.


21. India’s growth has slowed down and the Indian economy is facing some challenges. Having said that, however, recent developments are comforting. Inflation is beginning to moderate. A significant decline in core inflation is particularly encouraging. The authorities have initiated measures to reverse the negative sentiment and address supply side concerns. The authorities are also committed to contain the fiscal deficit. They have not hesitated to take several politically sensitive measures, including adjustments in fuel prices. The various lead indicators suggest that the slowdown has bottomed out and growth prospects from hereon should only be improving. The improvement in domestic growth will also be contingent on the global economic outlook, which still remains uncertain and subject to a number of downside risks as indicated in the January 2013 WEO Update. Notwithstanding the recent slowdown, India’s medium to long-term growth prospects continue to be strong. Several measures taken by our authorities will help overcome various supply constraints, encourage fresh investment and revert the economy to a high growth trajectory.