Economic Outlook, Prospects, and Policy Challenges: Ntroduction

Economic Outlook, Prospects, and
Policy Challenges
01
CHAPTER
This years Economic Survey comes at a time of unusual volatility in the

international economic environment. Markets have begun to swing on fears
that the global recovery may be faltering, while risks of extreme events are
rising. Amidst this gloomy landscape, India stands out as a haven of stability
and an outpost of opportunity. Its macro-economy is stable, founded on the
governments commitment to fiscal consolidation and low inflation. Its economic
growth is amongst the highest in the world, helped by a reorientation of
government spending toward needed public infrastructure. These achievements
are remarkable not least because they have been accomplished in the face of
global headwinds and a second successive season of poor rainfall.
The task now is to sustain them in an even more difficult global environment. This
will require careful economic management. As regards monetary and liquidity
policy, the benign outlook for inflation, widening output gaps, the uncertainty
about the growth outlook and the over-indebtedness of the corporate sector
all imply that there is room for easing. Fiscal consolidation continues to be
vital, and will need to maintain credibility and reduce debt, in an uncertain
global environment, while sustaining growth. On the governments reform-
to-transform agenda, a series of measures, each incremental but collectively
meaningful have been enacted. There have also been some disappointments
especially the Goods and Services Taxwhich need to be retrieved going forward.
Accelerated structural reforms at the Centre, the dynamism of competitive
federalism, and good economics being good politics could all combine to
maintain the fundamental promise that is India. For now, but not indefinitely,
the sweet spot created by a strong political mandate but, recalibrated to take
account of a weaker external environment, is still beckoningly there.
Introduction Big Bang reforms because of the dispersed

1.1 A year ago, the Economic Survey nature of power in India and the absence of that
spoke about the sweet spot for the Indian impelling drivercrisis. It argued therefore
economy, arising from a combination of a in favour of a persistent, creative and
strong political mandate and a favourable encompassing incrementalism as the guide
external environment. At the same time, it for prospective action and the benchmark for
cautioned against unrealistic expectations of retrospective assessment.
2 Economic Survey 2015-16
1.2 This years Survey comes against the 1.5 Start with the comparisons with other
background of an unusually volatile external countries. At a time when the newest normal
environment with significant risks of weaker for the world economy is one of turbulence and
global activity and non-trivial risks of extreme volatility, India is a refuge of stability and an
events. Fortifying the Indian economy against outpost of opportunity. Its macro-economy is
possible spillovers is consequently one obvious robust, and it is likely to be the fastest growing
necessity. Another necessity is a recalibration major economy in the world in 2016. For an
of expectations. economy where exports have declined due to
1.3 If the world economy lurches into crisis weak global demand and private investment
or slides into further weakness, Indias growth remains weak, Indias economy is performing
will be seriously affected, for the correlation remarkably well.
between global and Indian growth has been 1.6 In part, this performance reflects the
growing dramatically (Figure 1). Assessments
implementation of a number of meaningful
of Indias performance over the coming year
reforms, each incremental, but collectively
will therefore need to be conditional. This
meaningful:
is not an advance apology for likely future
performance but the sobering reality of India Creating the palpable and pervasive
becoming so entwined with the world. sense that corruption at the centre has
been meaningfully addressed, reflected in
1.4 Looking backward, the obvious question
transparent auctions of public assets and
is: how has the economy performed against
non-interference in regulatory decisions;
the standards set in last years Survey? Indias
economic performance can be measured Liberalizing foreign direct investment
against two distinct benchmarks: India versus (FDI) across-the-board, including by
other countries; and India versus its own passing the long-awaited insurance bill.
medium-term potential. On the first, the Indian FDI reforms reflect a decisive change
economy has fared well; on the second, steady in philosophy, from viewing FDI as
progress is being made and there is still scope a tolerable necessity to something to
for translating potential into actuality. welcome;
Source: World Economic Outlook (WEO), January, 2016 update.

Economic Outlook, Prospects, and Policy Challenges 3
Vigorously pursuing efforts to ease the power sector (especially the UDAY
the cost of doing business, which has Scheme); and
allowed India to advance in cross-country Avoiding policy reversals.
competitiveness rankings and become the
1.7 Yet, there was the perception that
crucible for million mutinies reflected in
quantity cannot exculpate quality, that
the unprecedented dynamism of the start-
launching and better implementing schemes
up and e-commerce sectors, and in the
were privileged over policy changes, and that
interest of large employment-generating
policies to unlock Indias full supply potential
companies (Box 1.4 in the Outlook
could have been more vigorously advanced.
section);
This perception owes in part to a failure to
Restoring stability and predictability in aggregate all the individual reforms and hence
tax decisions, reflected in the settlement to appreciate the sum as more than the parts. It
of the Minimum Alternate Tax (MAT) also owes, though, to some disappointments.
imposed on foreign companies, and
1.8 Approval for the game-changing
increasing substantially the limits beyond
GST bills has proved elusive so far; the
which the tax department will file appeals;
disinvestment program fell short of targets,
Implementing a major public investment including that of achieving strategic sales;
program to strengthen the countrys and the next stage of subsidy rationalization
infrastructure and make up for the is a work-in-progress. Critically, corporate and
deficiency of private investment; bank balance sheets remain stressed, affecting
Instituting a major crop insurance program the prospects for reviving private investment,
to cushion farmers against adversity; a key engine of long term growth.
Limiting farm interventions which had 1.9 Perhaps the underlying anxiety is that
a first-order effect in moderating overall the Indian economy is not realizing its full
inflation; potential. It is incontrovertible that India is
Elevating to mission mode the financial still oozing potential. The countrys long run
inclusion agenda via the Jan Dhan Yojana potential growth rate is still around 8-10 per
by creating bank accounts for over 200 cent (Box 1.1 elaborates on this in greater
million people within months. Financial detail). Realizing this potential requires a push
inclusion will also be furthered by the on at least three fronts.
licensing of 11 payments banks and 10 1.10 First, India has moved away from being
small banks; reflexively anti-markets and uncritically
Advancing the game-changing JAM pro-state to being pro-entrepreneurship and
(Jan Dhan Aadhaar Mobile) agenda. skeptical about the state. But being pro-
LPG witnessed the worlds largest direct industry must evolve into being genuinely pro-
benefit transfer program, with about 151 competition, and the legacy of the pervasive
million beneficiaries receiving a total of exemptions Raj and corporate subsidies
R29,000 crore in their bank accounts. highlights why favoring business (and not
The infrastructure is being created for markets) can actually impede competition.
extending the JAM agenda to other Similarly, skepticism about the state must
government programs and subsidies; translate into making it leaner, without
Attempting to change social norms in a delegitimizing its essential roles and indeed
number of areas: open defecation, and by strengthening it in important areas.
voluntarism in giving up subsidies. 1.11 Key to creating a more competitive
Undertaking comprehensive reforms of environment will be to address the exit (the
Chakravyuha) problem which bedevils the per cent of Indian households derive the bulk
Indian economy and endures as an impediment of their income from farming. Smaller farmers
to investment, efficiency, job creation and and landless laborers especially are highly
growth (see Chapter 2). The Indian economy vulnerable to productivity, weather, and market
had moved from socialism with restricted entry shocks changes that affect their incomes. The
to marketism without exit. The government newly introduced crop insurance schemes
is undertaking a number of initiatives should begin to address these problems to a
such as introducing a new bankruptcy law, great extent.
rehabilitating stalled projects, and considering
guidelines for public private partnerships that 1.16 Climate change and emerging scarcities
can help facilitate exit, thereby improving the will necessitate a focus on more for less,
efficiency of the economy. and hence redressing the current system of
incentives and subsidies, which encourages
1.12 Second, major investments in people
using more inputs such as fertilizer, water,
their health and educationwill be necessary
and power, to the detriment of soil quality,
to exploit Indias demographic dividend.
health and the environment. They also
Tomorrows worker is todays child or
foetusborn to and raised by todays mothers. disproportionately benefit rich and large
It would consequently seem important to focus farmers.
on mother and child, involving maternal 1.17 Despite the many challenges, there
health and early life interventions, which is remains considerable room for optimism.
the subject of Chapter 5. Raising the necessary Optimism is engendered by the dynamic of
resources for investments in human capital is competitive federalism. States that perform
discussed in Chapter 7. well are increasingly becoming models and
1.13 More broadly, the delivery of essential magnets. Successful experiments in one state
services is a gargantuan challenge. With are models for others states to emulate by
increased devolution of resources, states will showing what can be done and stripping away
need to expand their capacity and improve excuses for inaction and under-performance.
the efficiency of service delivery. That will They are also magnets because they attract
require them to shift their focus from outlays resources, talent and technology away from
to outcomes, and to learn by monitoring, the lagging states, forcing change via the
innovating, and even erring. channel of exit.
1.14 Improving service delivery in the wake of 1.18 Optimism is reinforced by events of
the Fourteenth Finance Commission requires the last decade that have re-affirmed the
an evolution in the relative roles of the Centre dictum that good economics is good politics,
and the states: the Centre should focus on even as frequent elections complicate the
improving policies, strengthening regulatory task of policy-making. Not always and not
institutions, and facilitating cooperative everywhere but increasingly, Central and State
and competitive federalism while the states governments that have delivered rapid growth
mobilize around implementing programs and and better governance tend to get re-elected
schemes to ensure better service delivery. and vice versa. It is telling, for example, that
the state governments that have been elected
1.15 Third, while dynamic sectors such
three times have been the ones that have
as services and manufacturing tend to grab
delivered rapid agricultural growth.
public attention, India cannot afford to neglect
its agriculture (Chapter 4). After all, nearly 42 1.19 Furthermore, optimism is also fueled
by the Indian decision-making process which numerous silent revolutions taking place all
allowshopefully even creates the pressures around the countrysugar and seeds in Uttar
for disappointments to be retrieved. The GST Pradesh, food and kerosene in Andhra Pradesh,
is within reach; new bankruptcy procedures, Chandigarh and Puducherrythat are helping
as well as the revival of some big stalled projects the spread, and hence realizing the promise, of
such as Dabhol, illustrate that the exit problem the JAM agenda (discussed in Chapter 3).
can be solved; not only is the infrastructure 1.20 In sum, for now but not indefinitely, the
being created for the game-changing JAM sweet spot for India is still beckoningly there.
agenda to be translated into reality, there are
Box 1.1: What is Indias Potential GDP Growth?

India is oozing potential. That is undeniable. But is it measurable?
Typically, economists measure a countrys potential GDP growth in two ways: first, by extrapolating from past
growth; and, second, by projecting the underlying drivers of growth: capital (physical and human), labor, and
productivity. Both have limitations and both rely on a variety of assumptions.
The first methodology has many variants, including the use of Hodrick-Prescott filters. But they are all essentially
mechanical and are really some weighted average of past growth rates. One disadvantage of this method is that
variations in actual growth can induce considerable volatility in estimates of potential growth. But potential
growth should be relatively stable unless there are some fundamental shifts in the underlying policy and
institutional environment.
Estimating potential GDP by projecting the underlying determinants of growth (as done in Rodrik and
Subramanian, Why India Can Grow at 7 Per Cent a Year or More, Economic and Political Weekly (EPW)
[2005]) requires assumptions to be made on total factor productivity growth, which can be arbitrary unless they
too are based on past performance which leads to the problems noted above.
A different way of estimating potential GDP growth is to use a deep determinants-cum-convergence framework.
There is a well-established literature (North, D, Institutions, Journal of Economic Perspectives, [1991],
Acemoglu, D and J.A. Robinson, Why Nations Fail: The Origins of Power, Prosperity and Poverty, Crown
Business [2012]) that suggests that institutions are a key determinant of long run growth. This is summarized in
Figure 1 below.
Contd....
The upward-sloping line in the figure reflects a strong relationship (on average) between political institutions
and economic development that has been found in empirical research, validating the central argument of the
institutions matter hypothesis. However, China and India are outliers (they are far away from the line of best
fit). And the interesting thing is that each of these countries is an exception, or even a challenge, to the relationship
but in opposite ways. India (which is way below the line) is not rich enough given its uncontestably vibrant
political institutions. China (which is well above the line) is too rich given its weak democratic institutions.
The assumption is that India and China will mean-revert, that is they will become more typical, and move
towards the line of best fit, over the medium term. Mean reversion can happen in different ways. For China, the
assumption is that this process of becoming a normal country will happen via a combination of slower growth
and faster democratization as shown in Figure 2. Indeed, the growth slowdown in China should be seen as a
process of normalization after a period of abnormally high growth. For India, normalization should take the form
of an acceleration of growth shown in the figure below.
Indias potential growth rate can thus be estimated as a reversion to a state of things where its economic
development is consistent with its well-developed political institutions. The question is what is the implied
growth rate that is consistent with this mean reversion.
The basic convergence framework provides a framework for estimating, albeit roughly, Indias potential growth
rate during this process of normalization (see Technical Appendix for the simple algebra of this computation).
According to convergence theory, Indias per capita GDP growth rate (in PPP terms) between 2015 and 2030
should be some multiple of the difference in the initial level of per capita GDP between the US and India in 2015.
That difference is about 2.2 log points. The multiple is called the convergence coefficientthe rate at which
India will catch up with the United States. A reasonable parameter from the literature is that this should be about
2 percent per year, at least for countries that are converging. The East Asians converged at a much faster pace but
others at a slower pace.
The significance of the figure shown above is that since India has under-achieved so far, it must converge at a
faster pace than usual, so that it can revert to the normal line. Hence, its convergence coefficient should be
substantially better than 2 percent. These PPP-based growth rates need to be converted into market exchange
rate growth rates. The resulting estimates are shown in the table below for alternative assumptions about this
convergence coefficient.
Contd....
Based on this analysis, Indias medium term growth potential is somewhere between 8 and 10 percent. Of course,
this is an estimate of potential, conveying a sense of opportunity. Hard policy choices and a cooperative external
environment will be required to convert opportunity into reality.
Table: China and Indias Potential Growth Rate,

2015-30 (per cent)
Convergence speed China India
(per cent)
2 3.3 6.2
2.5 4.1 7.6
3 5.0 9.0
3.5 5.9 10.4
Source: Ministry of Finance calculations
The Global Context and proceeding to the prolonged European

crisis, the mini-crises of 2013, and the China-
1.21 Since the Economic Survey and
provoked turbulence in 2015 all hinted that
Budget were presented a year ago, the Indian
the intervals between events are becoming
economy has continued to consolidate the
shorter.
gains achieved in restoring macroeconomic
stability. Inflation, the fiscal deficit, and the 1.24 This hypothesis could be validated
current account deficit have all declined, in the immediate future, since identifiable
rendering India a relative haven of macro- vulnerabilities exist in at least three
stability in these turbulent times. Economic large emerging economiesChina, Brazil,
growth appears to be recovering, albeit at Saudi Arabiaat a time when underlying
varying speeds across sectors. growth and productivity developments in
the advanced economies are soft (see Box
1.22 At the same time, the upcoming
1.2). More flexible exchange rates, however,
Budget and 2016-17 (FY2017) economic
could moderate full-blown eruptions into less
policy more broadly, will have to contend
disruptive but more prolonged volatility.
with an unusually challenging and weak
external environment. Although the major 1.25 One tail risk scenario that India must
international institutions are yet again plan for is a major currency re-adjustment
predicting that global growth will increase in Asia in the wake of a similar adjustment
from its current subdued level, they assess in China, as such an event would spread
that risks remain tilted to the downside. This deflation around the world. Another tail risk
uncertain and fragile outlook will complicate scenario could unfold as a consequence of
the task of economic management for India. policy actionssay, capital controls taken to
1.23 The risks merit serious attention not respond to curb outflows from large emerging
least because major financial crises seem market countries, which would further
to be occurring more frequently. The Latin moderate the growth impulses emanating
American debt crisis of 1982, the Asian from them.
Financial crisis of the late 1990s, and the 1.26 In either case, foreign demand is likely
Eastern European crisis of 2008 suggested to be weak, forcing Indiain the short run
that crises might be occurring once a decade. to find and activate domestic sources of
But then the rapid succession of crises, demand to prevent the growth momentum
starting with Global Financial Crisis of 2008 from weakening. At the very least, a tail risk
event would require Indian monetary and would be that weaker oil and commodity
fiscal policy not to add to the deflationary prices would help keep inflation and the twin
impulses from abroad. The consolation deficits in check.
Box 1.2: Analytical Taxonomy of Financial Crises, Past and Future

Since the 1980s, external financial crises have followed one of three basic forms: the Latin American, the Asian
Financial Crisis (AFC), or the Global Financial Crisis (GFC) model. So one could ask: in the unlikely event that
a major event did take place in a systematically important emerging market, which form would it follow? The
answer is probably none of the above. The implications would be unlike anything seen in the last 80 years. (The
attached table contains a summary).
In the Latin American debt crisis, governments went on a spending binge financed by foreign borrowing (of
recycled petrodollars) while pegging their exchange rates. The spending led to a classic sequence: economic
overheating, large current account deficits that eventually proved difficult to finance, and finally defaults on the
foreign borrowing. The Indian external crisis of 1991 belonged to this category, although the country did not and
has never defaulted.
In the AFC of the late 1990s, the transmission mechanism was similarnamely, overheating and unsustainable
external positions under fixed exchange ratesbut the instigating impulse was private borrowing rather than
government borrowing. The troubles in Eastern Europe in 2008 belonged to this category. The 2013 mini-crises
in a number of emerging markets following the Federal Reserves taper tantrum were also similar to the Asian
crisis, with the difference that affected countries had more flexible exchange rates which obviated the large
disruptive changes that occur when fixed regimes collapse.
The GFC of 2008, with America as its epicentre, was unique in that it involved a systemically important country
and originated in doubts about its financial system. The effects radiated out globally, with the irony that even
though the problems originated in the American financial system, there was a flight of capital toward the United
States, which triggered a sharp appreciation of the dollar and significant currency depreciations in emerging
markets. In this way, the GFC, while inflicting an adverse financial shock on the rest of the world, simultaneously
set in motion an adjustment mechanism that helped emerging markets recover from the crisis.
The Japanese crisis was similar to the GFC in terms of the transmission mechanism (asset price bubbles
encompassing equity markets and real estate). But it was dissimilar in that it was corporate rather than household
borrowing that was the instigating impulse. Also, the crisis did not have a systemic financial impact, since Japan
was not a major international banking centre. Nor did it have a major impact on global exports, even though
Japan was (and is) a major global trader, because, as in the GFC, the epicentres currency appreciated as the crisis
played itself out.
Chinas current situation is similar to the AFC case in that fears about excessive corporate debtsin the context
of slowing growth and changing economic managementare fostering large capital outflows. But the outcome is
less certain, since whereas Asian countries had limited foreign exchange reserves China has more than $3 trillion
in official assets, consequent upon years of running large current account surpluses. This situation gives China
much more space and time to deal with incipient problems, and minimize their consequences, for example, by
allowing a gradual rather than disruptive decline in the exchange rate.
Were a major event in China or another large emerging market to take place nonetheless, it would be very
different from the three categories described above. It would likely involve a large currency depreciation in a
systemically important country which would spread outward as a deflationary/competitiveness shock to the rest
of the world, especially countries competing with it. Consequently, the built-in adjustment mechanism that took
place in the GFCwhere the crisis countrys currency appreciated would be absent.
In this sense, a potential tail event in a systemically important emerging market would resemble more the events
of the early 1930s when the UK and then the US went off the gold standard, triggering a series of devaluations
by other countries, leading to a collapse of global economic activity.
Table: Anatomical Taxonomy of External Financial Crises

Crisis Type Originating Origin of Manifestation Trigger Exchange Remarks
Countries problem Rate
Regime
Emerging markets Speculative Greece was
(Latin America 1982; attack and part of euro,
Latin Government Current
India 1991); Small exchange Fixed rate so trigger was
American borrowing account deficit
advanced country rate sharp rise in
(Greece 2010 onwards) collapse interest rates.
Sudden
Emerging markets Fragile Five
stop of
(East Asia 1997-9; Asset price had flexible
Asian capital
Eastern Europe 2008; Corporate bubbles; High exchange
Financial flows and Fixed rate
Fragile Five 2013); borrowing corporate rates. Spain
Crisis exchange
Small advanced leverage was part of
rate
country (Spain 2010) euro.
collapse
Asset price
Floating Yen
Systemically Corporate bubbles; High Asset price
Japan exchange appreciated
Important borrowing corporate collapse
rate after crisis.
leverage
Global Bank and Asset price Correction Flexible
Systemically US dollar
Financial consumer bubble in in asset exchange
Important (US 2008) appreciated.
Crisis borrowing housing prices rate
Sudden Crisis
stop with countrys
Rising debt,
Systemically Corporate potential Managed currency
The NEXT asset price
Important borrowing for sharp float could
bubbles
exchange depreciate
rate decline substantially.
The Indian Context in Indias investment grade (BBB), and a

deterioration of 1.9 percentage points in the
1.27 The Indian economy has continued to
case of Brazil (Figure 2).
consolidate the gains achieved in restoring
macroeconomic stability. A sense of this 1.28 If macro-economic stability is one key
turnaround is illustrated by a cross-country element of assessing a countrys attractiveness
comparison. In last years Survey, we had to investors, its growth rate is another. In last
years Survey we had constructed a simple
constructed an overall index of macro-
Rational Investor Ratings Index (RIRI) which
economic vulnerability, which adds a
combined two elements, growth serving as a
countrys fiscal deficit, current account deficit,
gauge for rewards and the macro-economic
and inflation. This index showed that in 2012 vulnerability index proxying for risks. The
India was the most vulnerable of the major RIRI is depicted in Figure 3; higher levels
emerging market countries. Subsequently, indicate better performance. As can be seen,
India has made the most dramatic strides in India performs well not only in terms of the
reducing its macro-vulnerability. Since 2013, change of the index but also in terms of the
its index has improved by 5.3 percentage level, which compares favourably to its peers
points compared with 0.7 percentage point for in the BBB investment grade and even its
China, 0.4 percentage point for all countries betters in the A grade1. As an investment
1
India is in the BBB investment category according to Fitch rating agency; A is the category just above it.
Source: IMF WEO, October 2015 and January 2016 update.

* BBB is the classification of countries as per Fitch ratings agency in which India falls.
Source: IMF WEO, October 2015 and January 2016 update.
proposition, India stands out internationally. (Figures 4(a) and (b)). Although agriculture
Review of Major Developments is likely to register low growth for the second
year in a row on account of weak monsoons,
1.29 In the Advance Estimates of GDP that it has performed better than last year. Industry
the Central Statistics Office (CSO) released has shown significant improvement primarily
recently, the growth rate of GDP at constant
on account of the surprising acceleration in
market prices is projected to increase to 7.6
manufacturing (9.5 per cent vis--vis 5.5
per cent in 2015-16 from 7.2 per cent in 2014-
per cent in 2014-15). Meanwhile, services
15, mainly because private final consumption
continue to expand rapidly.
expenditure has accelerated. Similarly, the
growth rate of GVA for 2015-16 is estimated 1.30 Even as real growth has been
at 7.3 per cent vis--vis 7.1 per cent in 2014-15 accelerating, nominal growth has been
Source: CSO
*GVA growth of Q4 is the implied GVA number from Advanced estimates of 2015-16 and Quarterly estimates by CSO
falling, to historically low levels, an unusual fluctuated around 51/2 percent, while measures
trend highlighted in the Mid-Year Economic of underlying trendscore inflation, rural
Analysis (MYEA), 2015-16. According to wage growth and minimum support price
the Advance Estimates, nominal GDP (GVA) increaseshave similarly remained muted.
is likely to increase by just 8.6 (6.8) percent Meanwhile, the WPI has been in negative
in 2015-16. In nominal terms, construction is territory since November 2014, the result
expected to stagnate, while even the dynamic of the large falls in international commodity
sectors (see Box 1.4 for one such example) prices, especially oil. As low inflation has
of trade and finance are projected to grow by taken hold and confidence in price stability
has improved, gold imports have largely
only 7 to 73/4 percent.
stabilized, notwithstanding the end of a
1.31 Inflation remains under control (Figure period of import controls (dotted red lines in
5). The CPI-New Series inflation has Figure 6).
Source: CSO. Source: Ministry of Finance.

*Vertical lines in figure 5 indicate the period over which quantitative restrictions on gold imports was in effect (August
2013 to November 2014).
1.32 Similarly, the external position appears actions to normalize monetary policy that
robust. The current account deficit has occurred in December 2015. Although the
declined and is at comfortable levels; foreign rupee has declined against the dollar, it has
exchange reserves have risen to US$351.5 strengthened against the currencies of its
billion in early February 2016, and are well other trading partners.
above standard norms for reserve adequacy; 1.33 The fiscal sector registered three striking
net FDI inflows have grown from US$21.9 successes: ongoing fiscal consolidation,
billion in April-December 2014-15 to improved indirect tax collection efficiency;
US$27.7 billion in the same period of 2015- and an improvement in the quality of
16; and the nominal value of the rupee, spending at all levels of government.
measured against a basket of currencies, 1.34 Despite the decline in nominal GDP
has been steady (Figures 7(a) to (d)). India growth relative to the Budget assumption
was consequently well-positioned to absorb (11.5 per cent in Budget 2015-16 vis--vis
the volatility from the U.S. Federal Reserve 8.6 per cent in the Advance Estimates), the
Source: RBI.
central government will meet its fiscal deficit 1.36 The fiscal stance matters not just
target of 3.9 per cent of GDP, continuing the for macro-economic outcomes but also
commitment to fiscal consolidation. Even for the quality of spending. The budget
on the IMFs definition, the fiscal deficit envisaged an improvement in quality by
is expected to decline from 4.2 per cent of shifting expenditures away from current to
GDP in 2014-15 to 4.0 per cent of GDP in capital expenditures. With the acceptance
2015-16. Moreover, the consolidated revenue of the Fourteenth Finance Commission
deficit has also declined in the first 8 months recommendations, and the large devolution
(for which data are available) by about 0.8 toward the states as well as re-structuring of
percentage points of GDP. the centrally sponsored schemes, the quality
of expenditure must increasingly be assessed
1.35 Government tax revenues are expected
from a general government (i.e. combining
to be higher than budgeted levels. Direct
the center and the states) perspective. This is
taxes grew by 10.7 per cent in the first 9
done in greater detail in Box 1.3.
months (9M) of 2015-16. Indirect taxes were
also buoyant. In part, this reflected excise 1.37 The main findings are that a welcome
taxes on diesel and petrol and an increase in shift in the quality of spending has occurred
the Swachh Bharat cess. The central excise from revenue to investment, and towards
duty collection from petroleum products social sectors. Aggregate public investment
during April to December 2015-16 recorded has increased by about 0.6 per cent of GDP
a growth of 90.5 per cent and stood at Rs. in the first 8 months of this fiscal year, with
1.3 lakh crore as against Rs. 0.7 lakh crore in contributions from both the Centre (54 per
the same period last year. Tax performance cent) and states (46 per cent).
also reflected an improvement in tax Outlook
administration because revenues increased
even after stripping out the additional revenue Real GDP growth
measures (ARMs). Indirect tax revenues 1.38 Real GDP growth for 2015-16 is
grew by 10.7 per cent (without ARMs) and expected to be in the 7 to 73/4 range, reflecting
34.2 per cent (with ARMs). Table 1 shows various and largely offsetting developments
that tax buoyancy of direct and indirect taxes on the demand and supply sides of the Indian
improved in 2015-16 vis--vis the average economy. Before analyzing these factors,
of the last three years, although more so for however, it is important to step back and note
indirect taxes. one important point.
Table 1: Tax buoyancy
Base Growth Revenue Growth Implied Buoyancy
Year DT IDT DT IDT
2012-13 15.1 18.5 25.8 1.2 1.7
2013-14 11.4 13.5 4.1 1.2 0.4
2014-15 12.7 8.2 8.0 0.6 0.6
Avg. 2012-15 13.1 13.4 12.6 1.0 1.0
9M 2015 8.3 9.2 11.7 1.1 1.4
Note:
1. Base is summation of GVA in manufacturing and services at current market price.
2. Annual numbers are average of four quarters in that year
DT= Direct Tax IDT= Excise tax plus service tax 9M= April-December
Source: CSO and Controller General of Accounts.
Box 1.3: Assessing the Quality of General Government Spending in FY2016

The 2015-16 Union budget envisaged an improvement in the quality of expenditure, shifting resources from
current to capital spending and devoting more resources to the agricultural sector at a time of farm distress.
At the same time, the recommendations of the Fourteenth Finance Commission, which were accepted by
the government, implied that a much greater portion of revenues would be spent by the states. As a result,
understanding whether the shift in Union strategy has been successful requires analysing general government
(Centre plus states) expenditures, and not just those of the Centre.
In continuation of the analysis done for the Mid-Year Economic Analysis (MYEA) 2015-16, which covered
the first half (H1) of 2015-16, we now report the results of this analysis for the first 8 months of this fiscal year
(FY2016). These results are also illustrated in the figures below. Two points are noteworthy.
First, there was a significant increase in aggregate capital expenditure of the general government.1 Such spending
increased by 0.6 percentage points of GDP2 (Figure 1). Disaggregating further reveals that the increase in capital
expenditures occurred both in the Centre and states, with the former contributing 54 per cent and the latter 46 per cent.
Thus, the overall budgetary strategy of accelerating public investment seems to be working at an all-India level.
Second, in the first 8 months of FY2016, general government expenditure witnessed an uptick in the three major
social sectorseducation, health, and agriculture and rural developmentboth as a share of GDP and in real
terms3 (Figure 2 & 3). For example, real expenditure on education, health, and agriculture and rural development
recorded growth of 4.7 per cent, 9 per cent and 8.1 per cent, respectively. Available data does not allow for a
further disaggregation of these developments into contributions by the centre and states.
1
Capital expenditure for the Centre includes loans and advances whereas capital expenditure for the states does not due to
non-availability of data.
2
For simplicity, the GDP for the full year has been divided equally across the year.
3
Health expenditure, and Agriculture and Rural Development expenditures have been deflated by the relevant CPI indices.
1.39 Indias long-run potential GDP growth suggests. In other words, in the current global
is substantial, about 8-10 percent (Box 1.1). environment, there needs to be a recalibration
But its actual growth in the short run will of growth expectations and consequently of
also depend upon global growth and demand. the standards of assessment.
After all, Indias exports of manufactured 1.42 Turning to the outlook for 2016-17, we
goods and services now constitute about 18 need to examine each of the components of
percent of GDP, up from about 11 percent a aggregate demand: exports, consumption,
decade ago. private investment and government.
1.40 Reflecting Indias growing globalization, 1.43 To measure the demand for Indias
the correlation between Indias growth rate exports, we calculate a proxy-weighted
and that of the world has risen sharply to average GDP growth rate of Indias export
reasonably high levels. For the period 1991- partners. The weights are the shares of
2002 this correlation was 0.2. Since then, the partner countries in Indias exports of
correlation has doubled to 0.42 (Figure 1). In goods and services. We find that this
other words, a 1 percentage point decrease in proxy for export demand growth declined
the world growth rate is now associated with from 3.0 percent in 2014 to 2.7 per cent in
a 0.42 percentage point decrease in Indian 2015, which helps explain the deceleration
growth rates. in Indias non-oil exports, although the
severity of the slowdownin fact, a decline
1.41 Accordingly, if the world economy in export volumewent beyond adverse
remains weak, Indias growth will face external developments (Figure 8). Current
considerable headwinds. For example, if the projections by the IMF indicate that trading
world continues to grow at close to 3 percent partner growth this demand will improve
over the next few years rather than returning marginally this year to about 2.8 percent.
to the buoyant 4-4 per cent recorded during But the considerable downside risks suggest
2003-2011, Indias medium-term growth that it would be prudent not to count on a big
trajectory could well remain closer to 7-7 contribution to GDP growth from improving
per cent, notwithstanding the governments export performance.
reform initiatives, rather than rise to the 1.44 On the domestic side, two factors could
8-10 per cent that its long-run potential boost consumption. If and to the extent
Source: RBI.
that the Seventh Pay Commission (7th PC) 1.47 Finally, the path for fiscal consolidation
is implemented, increased spending from will determine the demand for domestic
higher wages and allowances of government output from government. The magnitude of
workers will start flowing through the the drag on demand and output will be largely
economy. If, in addition, the monsoon returns
equal to the size of consolidation, assuming a
to normal, agricultural incomes will improve
multiplier of about 1.
(see Box 1.5), with attendant gains for rural
consumption, which over the past two years 1.48 There are three significant downside
of weak rains has remained depressed. risks. Turmoil in the global economy could
1.45 Against this, the disappearance of worsen the outlook for exports and tighter
much of last years oil windfall would work financial conditions significantly. Second, if
to reduce consumption growth. Current contrary to expectations oil prices rise more
prospects suggest that oil prices (Indian crude than anticipated, this would increase the drag
basket) might average US$ 35 per barrel next from consumption, both directly, and owing
fiscal year compared with US$ 45 per barrel to reduced prospects for monetary easing.
in 2015-16. The resulting income gain would
Finally, the most serious risk is a combination
amount roughly equivalent to 1 percentage
of the above two factors. This could arise if
point of GDP an 18 per cent price decline
times a share of net oil imports in GDP of 6 oil markets are dominated by supply-related
percent. But this would be half the size of last factors such as agreements to restrict output
years gain, so consumption growth would by the major producers.
slow on this account next year. 1.49 The one significant upside possibility
1.46 According to analysis done by Credit is a good monsoon. This would increase
Suisse, (non-financial) corporate sector rural consumption and, to the extent that it
profitability has remained weak, falling by 1 dampens price pressures, open up further
percent in the year to December 2015.2 This space for monetary easing (Box 1.6).
decline reflected a sharp deterioration in the
financial health of the metalsprimarily 1.50 Putting these factors together, we
steelcompanies, which have now joined expect real GDP growth to be in the 7 to 73/4
the ranks of companies under severe financial per cent range, with downside risks because
stress. As a result, the proportion of corporate of ongoing developments in the world
debt owed by stressed companies, defined as economy. The wider range in the forecast
those whose earnings are insufficient to cover
this time reflects the range of possibilities
their interest obligations, has increased to 41
for exogenous developments, from a rebound
percent in December 2015, compared to 35
percent in December 2014.3 In response to in agriculture to a full-fledged international
this stress, companies have once again been crisis; it also reflects uncertainty arising from
compelled to curb their capital expenditures the divergence between growth in nominal
substantially. and real aggregates of economic activity.
2
As measured by EBITDA, a common measure of cash flow profits; it refers to earnings before interest, taxes,
depreciation, and amortization.
3
An interest coverage ratio (ICR) less than 1 implies that the corporation is under financial stress, since its
earnings are not sufficient to service its interest obligations. Research indicates that an interest cover of below
2.5x for larger companies and below 4x for smaller companies is considered below investment grade. ICR is
typically measured by calculating the ratio of earnings before interest and taxes (EBIT) to interest obligations.
Box 1.4: Startups and Dynamism
One part of the economy that is witnessing unusual dynamism is the start-up sector, focused on e-commerce and
financial services. As of January 2016, there were 19,400 technology-enabled startups in India, of which 5,000
had been started in 2015 alone.1 No less than 2000 of the startups have been backed by venture capital/angel
investors since 2010, of which 1005 were created in 2015 alone. Indian start-ups raised $3.5 billion in funding
in the first half of 2015, and the number of active investors in India increased from 220 in 2014 to 490 in 2015.2
As of December 2015, eight Indian startups belonged to the Unicorn club (valuations greater than $1 billion).
It is important that start-ups, too, see exit (the theme of Chapter 2), which would take the form of these
companies being listed, allowing the original private investors to cash in on the initial investment, and plough it
back into other similar ventures. Exit valuations in India are still low but are expected to increase as the impact
of new SEBI policies on listings comes into effect, and as equity markets in general revive from current low
valuations caused by a sense of gloom in the global economy.
1
Based on the research done by Your Story and iSPIRT.
2
NASSCOM report titled Startup India-Momentous Rise of the Indian Startup Ecosystem.
Box 1.5: El Nio, La Nia and Forecast for FY 2017 Agriculture

From time to time, agricultural production is affected by El Nio, an abnormal warming of the Pacific waters near
Ecuador and Peru, which disturbs weather patterns around the world. The 2015 El Nio has been the strongest
since 1997, depressing production over the past year. But if it is followed by a strong La Nia, there could be a
much better harvest in 2016-17.
The 1997 episode lasted roughly from April 1997 to June 1998. During these 15 months, the Oceanic Nino Index
(ONI) which compares east-central Pacific Ocean surface temperatures to their long-term average and is used
by the US National Oceanic and Atmospheric Administration (NOAA) for identifying El Nio events was
consistently positive and greater than 0.5 degrees Celsius.
The current El Nio started around February 2015; most climate models predict a return to neutral conditions
not before May 2016. That makes it just as long as the 1997-98 event. Also, in terms of intensity, it is comparable
to that of 1997-98: The most recent Oceanic Nino Index (ONI) value of 2.3 degree Celsius for November
2015-January 2016 tied with the level for the same period of 1997-98.
An extended and strong El Nio explains why India had a deficient south-monsoon and dry weather lasting
through the winter this time. The prolonged moisture stress from it has, in turn, impacted both kharif as well as
the rabi crop. The figure below shows that average agricultural growth in El Nio years since between 1981-82
and 2015-16 has been -2.1 per cent compared with a period average of 3.
There is a silver lining here, though. Since 1950, there have been 22 El Nio events of varying durations and
intensities, according to NOAA data. But out of the 21 prior to this one, 9 have been followed by La Nia,
involving an abnormal cooling of sea surface waters along the tropical west coast of South America with an ONI
less than minus 0.5 degrees Celsius. This phenomenon there have been 14 such events since 1950 has been
associated with normal-to-excess monsoons in India, which may be a by-product of atmospheric convection
activity shifting to the north of Australia.
Now, it is important that some of the strongest El Nio years (1997-98, 1972-73, 2009-10, 1986-87 and 1987-88,
ranked in the order of strength and of which the last four produced droughts in India) were followed by La Nia
episodes, resulting in bumper harvests. The possibility of this being repeated in 2016 after the second strongest El
Nio on record cannot be ruled out. The figure below shows, for example, that average growth in La Nia years
was 8.4 per cent, substantially higher than the period average.
But there is a big catch. El Nio, as of now, continues to be strong and is only gradually weakening. It will
enter neutral zone only with the onset of summer. NOAAs latest forecast assigns only a 22 per cent probability
of La Nia developing in June-July-August, going up to 50 per cent for September-October-November. The
Australian Bureau of Meteorology suggests the neutral state as the most likely for the second half of the
year.
In other words, one shouldnt expect La Nia conditions to develop before the second half of the southwest
monsoon season (June-September). Even if it develops, the translation into actual rainfall in India could take
time. The effects of the 2015 El Nio, after all, were felt only from July, although the east-central Pacific sea
surface temperature anomalies began in February.
In sum, La Nia is unlikely to deliver its full bounty in the coming monsoon, or at least not until late
in the kharif season. That doesnt, however, mean the monsoon is going to be bad, especially when all
models are pointing to a very low probability of a repeat El Nio happening this year. The monsoon
could also be good due to other favourable factors such as a positive Indian Ocean Dipole. The latter
phenomenon where the western tropical Indian Ocean waters near Africa become warmer relative to
those around Indonesia prevented at least two El Nio years (1997 and 2006) from resulting in droughts
in India.
The policy implication of such a cautious prognosis is that the government should be ready with a contingency
plan for a monsoon, especially after two successive drought years. Declaring minimum support prices well
before kharif sowing operations, incentivizing farmers to produce crops most prone to domestic supply pressures
(such as pulses), and timely contracting of imports of sensitive commodities would be essential components of
this strategy.
Box 1.6: Addressing the Twin Balance Sheet Challenge
One of the most critical short-term challenges confronting the Indian economy is the twin balance sheet (TBS)
problemthe impaired financial positions of the Public Sector Banks (PSBs) and some large corporate houses
what we have hitherto characterized as the Balance Sheet Syndrome with Indian characteristics. By now, it is
clear that the TBS problem is the major impediment to private investment, and thereby to a full-fledged economic
recovery.
The problems in the banking system have been growing for some time. Stressed assets (nonperforming loans
plus restructured assets) have been rising ever since 2010, impinging on capital positions, even as the strictures
of Basel III loom ever closer on the horizon. Banks have responded by limiting the flow of credit to the real
economy so as to conserve capital, while investors have responded by pushing down bank valuations, especially
over the past year. The shares of many banks now trade well below their book value.
This balance sheet vulnerability is in some ways a mirror and derivative of similar frailties in the corporate sector,
especially the large business houses that borrowed heavily during the boom years to invest in infrastructure and
commodity-related businesses, such as steel. Corporate profits are low while debts are rising, forcing firms to cut
investment to preserve cashflow.
This situation is not sustainable; a decisive solution is needed. But finding one is difficult. For a start, given the
intertwining set of problems, solutions must strengthen both sets of balance sheets. Some steps have already been
taken. In August last year, the government launched the Indradhanush scheme, which includes a phased program
for bank recapitalization. Meanwhile, the RBI initiated the 5:25 and SDR schemes, which create incentives for
the banks to come together with their borrowers to rehabilitate stressed assets. These are good initial steps which
might require follow-up.
Resolving the TBS challenge comprehensively would require 4 Rs : Recognition, Recapitalization, Resolution,
and Reform. Banks must value their assets as far as posible close to true value (recognition) as the RBI has been
emphasizing; once they do so, their capital position must be safeguarded via infusions of equity (recapitalization)
as the banks have been demanding; the underlying stressed assets in the corporate sector must be sold or
rehabilitated (resolution) as the government has been desiring; and future incentives for the private sector and
corporates must be set right (reform) to avoid a repetition of the problem, as everyone has been clamouring.
But there is a needed sequence to these 4 Rs: Recognition must come first, but it must be accompanied by an
adequate supply of resources; otherwise, banks will be vulnerable. Given the tight fiscal position, where might
the resources to recapitalise PSBs come from?
One possible source is the public sectors own balance sheet. For example, the government could sell off assets
that it no longer wants to hold, such as certain nonfinancial companies, and use the proceeds to make additional
investments in the PSBs. This option is reasonably well understood. What is less appreciated is that RBI could
do the same. That is to say it could redeploy its capital as well.
Like all financial firms, central banks hold capital to provide a buffer against the risks they take. In the case
of central banks, risks arise because the value of the foreign exchange reserves in terms of domestic currency
fluctuates along with the exchange rate, while the value of the government securities they own changes as interest
Source: Bank for International Settlements (BIS).

rates move. Measuring these risks and calculating how much buffer should be provided against them is difficult.
For that reason, central bank capital holdings vary widely.
The figure above depicts the ratio of shareholder equity to assets for various central banks. Shareholder equity
is defined to include capital plus reserves (built through undistributed retained earnings) plus revaluation and
contingency accounts. The chart shows that RBI is an outlier with an equity share of about 32 per cent, second
only to Norway and well above that of the U.S. Federal Reserve Bank and the Bank of England, whose ratios
are less than 2 per cent. The conservative European Central Bank (ECB) and some EM central banks have much
higher ratios, but even they do not approach the level of the RBI.
If the RBI were to move even to the median of the sample (16 per cent), this would free up a substantial amount
of capital to be deployed for recapitalizing the PSBs.
Of course, there are wider considerations that need to be taken into account. Most important, any such move would
need to be initiated jointly and cooperatively between the government and the RBI. It will also be critical to ensure
that any redeployment of capital would preserve the RBIs independence, integrity, and financial soundnessand
be seen to do so. At this stage, what is important is the broader point: that funds for recapitalization can be found,
at least to a certain extent, by reallocating capital that already exists on the public sectors balance sheet.
Once the resources to back recognition are identified, the remaining 2 Rs (Resolution and Reform) can be pursued
with vigour. There are many options here, including creating bad banks to implement the four Rs.
Inflation 1.52 The historical evidence is clear on this

point. Figure 9 illustrates the experience of
1.51 For most of the current fiscal year,
the Sixth Pay Commission (6th PC). It plots
inflation has remained quiescent, hovering
the monthly increase in salaries during the
within the RBIs target range of 4-6 percent.
period of the award, from September 2008
But looming on the horizon is the increase September 2009, against non-food inflation.
in wages and benefits recommended for (At that time, overall inflation was rising due
government workers by the Seventh Pay to a sharp increase in global food prices.)
Commission (7th PC). If the government The figure shows that the 6th PC award barely
accepts this recommendation, would it registered on inflation despite the lumpiness
destabilize prices and inflation expectations? of the award, owing to the grant of arrears.
Most likely, it will not. If the 6th PC award barely registered, the 7th
Source: CSO, 6th Pay Commission report, Budget documents and CGA.
*Reflecting the phased implementation of the 6th PC, the vertical lines indicate the timing of grant of arrears.
PC is unlikely to either, given the relative is muted, since there is considerable slack
magnitudes: even if fully implemented, the in the private sector labour market, as
expected wage bill (including railways) will evident in the softness of rural wages (see
go up by around 52 per cent under the 7th PC Figure 4). And even if private sector wage
vis--vis 70 per cent under the 6th PC. increases nonetheless do quicken somewhat,
1.53 This outcome may seem surprising. the existence of substantial capacity under-
Why would such a large wage increase have utilization (Figure 10) suggests that firms
so little impact on inflation? There are three might find it difficult to pass the cost increase
reasons. Most important is a broad theoretical onto consumer prices.
point. In principle, inflation reflects the 1.55 Finally, there will be some mechanical
degree to which aggregate demand exceeds impact of the increase in the house rent
aggregate supply. And pay awards determine allowance (HRA) on the housing component
only one small part of aggregate demand. In of the CPI. But this effect is likely to be modest
fact, they do not even determine government between 0.15 and 0.3 percentage points.4 And
demand: that depends on the overall fiscal even then it will merely have a one-off effect
deficit, which is the difference between how on the level of the CPI, rather than the rate
much the state is injecting into the economy of inflation going forward, which is the real
through overall spending and how much target of the RBI.
it is taking away through taxes. Since the
1.56 The outlook for inflation will
government remains committed to reducing
consequently depend on other factors. On
the fiscal deficit, the pressure on prices will the domestic side, another year of below-
diminish, notwithstanding the wage increase. potential growth will mean that the output
1.54 That said, theory does suggest that gap (reflected for example in the declining
a sharp increase in public sector wages capacity utilization) will widen further. As
could affect inflation if it spilled over into a result, there will be additional downward
private sector wages and hence private pressure on underlying inflation, which has
sector demand. But currently this channel already fallen below 5 percent, as measured
Source: RBI.
4
The weight of rented government housing in the overall CPI is 0.35 per cent. But this includes central and state
governments and public sector undertakings. Since only central government housing allowances are relevant,
the impact on the CPI would be further moderated.
Source: CSO.
by services inflation excluding the oil-related able to meet its target of 5 percent by March
sub-indices (Figure 11). Meanwhile, if the 2017. Indeed, with the current stance, there
monsoon returns to normal, food prices is a possibility of undershooting. While the
will ease, especially since the government current policy rate seems neutral in that it
remains committed to disciplined increases is only modestly higher than consumer price
in MSPs for cereals, and rural wage growth inflation, liquidity conditions are unusually
remains muted. tight, impeding the passthrough of recent
1.57 Further relief should come from abroad. declines in policy rates to the actual bank
Oil prices have plunged in the first two months rates faced by borrowers (see Box 1.7).5
of 2016, as have some commodity prices, 1.59 Figure 12 depicts the situation. It
suggesting that input prices are likely to be shows a measure of the tightness of monetary
lower next fiscal year. Beyond this factor lie conditions: the gap between bank lending
other deflationary forces. As growth in China (base) rates and nominal GVA growth. If the
continues to slow, excess capacity there could difference is negative, then nominal GVA
continue to increase, which will put further growthand for the average firm, revenue
downward pressure on the prices of tradable growthis increasing faster than interest
goods all around the world. Part of this might is accruing on its debts. In that sense, the
be offset by upward pressure coming from monetary stance poses little problems for
a depreciation of the rupee, especially if the corporate sector. But if interest rates are
the Federal Reserve Bank continues to raise higher than nominal GDP growth, firms
interest rates, prompting capital to reflow to cash flows are being squeezed. If firms then
the U.S, although the prospects of aggressive respond by curbing price increases in order
Fed action are receding. On balance the risk to boost sale volumes sales and cash flow,
to imported pressures, as with domestic this will put downward pressure on inflation.
pressures, remains firmly to the downside. The chart shows that this is indeed what has
1.58 All this suggests that the RBI should be broadly been happening this year.
5
Of course, bank lending rates have also been influenced by weaknesses in firm balance sheets, which increases
the risks of providing credit to them.
1.60 For all these reasons, we project that measured growth of real GDP may not
CPI inflation will ease to between 41/2 - 5 warrant an easing of monetary conditions.
per cent in 2016-17. We therefore think But a risk framework combined with a focus
that the effective stance of monetary policy on the more reliable nominal aggregates is
could be relaxed and in two ways. First, by
useful. If, in fact, real growth is weaker than
easing liquidity conditions to make them
suggested by the headline number, easing is
consistent with the current policy rate (Box
1.7). Second, by further lowering the policy appropriate. On the other hand, if real GDP
rate consistent with meeting the inflation growth is indeed robust, the implied dis-
target while supporting weakening economic inflation is large, mitigating the inflationary
activity and corporate balance sheets. Robust risks of easing.
Source: CSO and RBI.
Box 1.7 What Explains the Incomplete Passthrough of Monetary Policy?

According to the February 2016 policy statement, the RBI has shifted to an accommodative policy stance.
Without doubt, policy rates have been reduced substantially: in 2015, there were no less than four rate cuts
cumulating to 125 basis points, including a 50 basis point cut at the October meeting. But there has been much
less accommodation in bank lending rates, which have only fallen by around 50 basis points. What explains
the failure of passthrough from policy rates to bank rates?
Figure 1 illustrates the transmission problem. It shows that the gaps between policy rates and bank rates have
increased significantly over the past year. For example, deposit rates before the first rate cut were about 50 basis
points higher than the policy rate, whereas now they are around 75 basis points higher. The lending rate spread,
meanwhile, has increased by even more, from 200 basis points to 275 basis points.
Many commentators have emphasized that transmission is limited by high administered and small savings
rates. The argument is that banks worry that if they cut their deposit rates, customers will flee to small savings
instruments. Recognizing this, the government has reduced rates on some small savings schemes to make them
more responsive to market conditions. But it is also clear from the chart that the small saving schemes dont
always constrain passthrough. For example, the June rate cut was followed by a large reduction in deposit rates
whereas the much larger October cut was barely passed on at all. And the small saving schemes cannot explain
why the reductions that have taken place in deposit rates have not led to commensurate reductions in lending
rates.
6
The base rate for Q4 is taken to be the base rate for January 2016.
Source: RBI.
* Vertical Lines in all these boxes refer to dates when repo rate changes were announced.
It consequently seems that additional factors are at work. One possible factor could be changes in liquidity
conditions as these can reinforce or negate the changes in policy rates. The reason is straightforward: if liquidity
conditions are tight, commercial banks will be extra cautious about passing on policy rate cuts into lower deposit
rates, for fear of losing customers and hence more liquidity.
Figure 2 measures the tightness of monetary conditions in terms of quantities, plotting the RBIs provision of
funds in the form of overnight and term repos (the LAF or Liquidity Adjustment Facility) in response to banks
demand for liquidity (The LAF is, by definition, a measure of the demand for liquidity). After the June rate cut,
bank borrowing under the LAF fell to zero on average, in line with the RBIs strategy of easing its monetary
stance. But around the time of the October cut, something changed: suddenly, banks began to borrow again,
demanding an average of R1 lakh crore per day, rising to R1.75 lakh crore per day by February 2016.
Figures 3 and 4 show how the liquidity tightness has shown up in prices, that is to say short-term market interest
rates most influenced by RBI policy. In the periods following the first three rate cuts, the spread between the
91 day t-bill rate and the repo rate declined. But it increased sharply starting in August and continuing after the
October rate cut (Figure 3). Similarly, in the period following the first three rate cuts, the call money rate was
below the repo rate, signalling easy liquidity conditions. After the October cut, that wedge has disappeared,
signalling a tightening of liquidity (Figure 4).
Source: RBI.
Contd....
Source: RBI.
What the quantity and price data suggest is that starting in late 2015 liquidity has been tightening even as policy
rates have been cut. The consequence is that market interest rates and exchange rates are higher than otherwise,
with implications for domestic growth, exports, and the health of the over-indebted corporate sector.
Source: RBI.
Medium-Term Fiscal Framework repay the debts it is incurring today. And it

needs to be seen to possess this strength.
1.61 The 2016-17 fiscal stance needs to be
assessed in two contexts. Most obviously, it 1.62 Governments adopt various targets to
needs to be evaluated against the likely short- achieve and signal fiscal sustainability. These
term outlook for growth and inflation. At include the overall deficit, the primary deficit,
the same time, it also needs to be framed in the revenue deficit, and the debt-to-GDP
a medium-term context. Thats because the ratio. In principle, sustainable ratios are very
most fundamental task of budget policy is to much time, country, and history-contingent
preserve fiscal sustainability. The government (Reinhart, Rogoff, and Savastano, 2003).
needs to be in a strong position tomorrow to But pinning down a relationship between
7
Reinhart, C., K. Rogoff, and M. A. Savastano, 2003, Debt Intolerance, NBER Working paper No. 9908.
these contingencies and targets is difficult why such a commitment would be abandoned
to do scientifically. Accordingly, countries when the economy is growing at more than
often adopt targets established by others. For 7 per cent. Such rapid growth would seem
example, countries in other regions adopted to provide ample revenues for the Budget,
targets of 3 percent of GDP for the fiscal while enabling the economy to withstand
deficit and 60 percent for the debt-to-GDP the reduction in government demand. So,
ratio as these had been adopted by Eurozone credibility and optimality seem to argue for
economies under the Stability and Growth adhering to the 3.5 percent of GDP target.
Pact (SGP).
1.66 However, there are also arguments on
1.63 The clearest sign that a government is the other side. With respect to feasibility, two
on a sustainable path is the direction of its factors complicate the fiscal task in 2016-17
debt-to-GDP ratio. If this ratio is declining, and beyond:
then the governments fundamental fiscal
strength is improving. For much of the The Seventh Pay Commission has
period since the 2008-09 the government recommended that government wages and
has run large annual deficits in order to allowances be increased significantly. Full
reflate the economy. Initially, the impediment implementation of this pay award--which
was the large annual deficits that the the government will decide on--would add
government incurred as it sought to reflate about percent of GDP to the Centres
the economy. These deficits were eventually wage bill.
curtailed, but macro imbalances nonetheless Public investment may need to be
continued to grow, leading by 2013-14 to the increased further to address a pressing
second impediment: a sharp exchange rate backlog of infrastructure needs. Such an
depreciation that inflated the rupee value of increase would merely return spending
foreign debts. to its 2010-11 level of around 2 percent
1.64 As a result, overall government debt of GDP, well below the level in other
continued to grow as fast as GDP, keeping emerging markets.
the debt ratio of the consolidated government 1.67 Taking these factors into account, the
(Centre plus states) near 67 per cent of GDP. Centres deficit could swell substantially. As
This ratio is high compared to some countries a result, achieving the original could prove
in Emerging Asia, Indias credit rating peers. difficult unless there are tax increases or
Accordingly, the government is determined cuts in expenditures. There is some scope
to break the post-GFC trend, and finally put to increase receipts from disinvestment and
the debt ratio on a downward path toward spectrum auctions to realize which will
more comfortable levels. require effort.
1.65 For this reason, there are strong 1.68 Second, even the desirability of a strategy
arguments to stick to a path of aggressive fiscal of aggressive fiscal consolidation could
consolidation as envisaged at the time of the be questioned. This is because the current
last budget. Such a low deficit would not only environment is fraught with risks, which
curtail the debt accumulation, but would also threaten all the engines of Indias growth, as
offer some wider advantages. To begin with, explained earlier. It would consequently seem
it would mean that the government would important for the government to purchase
be delivering on a commitment, thereby insurance against these downside risks --
reinforcing its credibility, which is one of the rather than reduce fiscal demand significantly
most precious assets that any authority can and take the chance of precipitating their
command. Conversely, it is far from clear realization. Data uncertainty reinforces the
need for purchasing insurance. holdings. At the same time, foreign portfolio
1.69 But if the deficit target were to be investors might also increase their purchases,
relaxed, two questions would need to be since the RBI has been relaxing the limits
answered. First, what would happen to interest on their G-sec investments. Conversely, if
rates? The lower the fiscal deficit, the lower foreign inflows prove small, the RBI itself
the borrowing requirement, and possibly may need to buy G-secs to assure an adequate
the lower the interest rate on government increase in money supply. Finally, if demand
securities, which would be very helpful to proves weak the government can always scale
companies facing debt servicing difficulties. back its bond issues and instead run down its
International empirical research, however, ample cash balances.
suggests that the impact of deficits on long- 1.72 What about short-term interest rates?
term rates is typically small and uncertain. Isnt there a risk that large pay awards could
The reason for this is straightforward: push up inflation, forcing the RBI to increase
long-term rates are basically determined their policy rate? As discussed above, the risk
by expectations of the future path of short- seems small, as theres little evidence that
term rates. And this expected path typically public sector pay increases are transmitted to
depends largely on the long-term outlook for prices, or even to wages in the private sector.
growth and inflation-and, not necessarily on In fact, the more significant risks to inflation
the current years fiscal deficit. would seem to be to the downside: from
1.70 In Indias case, the impact of fiscal lower oil prices, a slowing Chinese economy,
deficits on long-term rates might be somewhat and the impact of fiscal deficit reduction of
larger than elsewhere. Thats because most any size on aggregate demand.
government securities (G-secs) are held by 1.73 Summing up the cyclical considerations,
banks, and banks have limited capacity to small differences in the degree of fiscal
absorb bond supplies. This risk might seem adjustment may not have much impact on
particularly pertinent because over the past interest rates. Which means that any positive
few years banks have accumulated large effects from a large adjustment (austerity)
holdings of G-secs, exceeding by a large coming from lower interest rates could
margin the statutory liquidity ratio (SLR) be offset by the direct negative impact on
minima that they are required to hold. aggregate demand.
Moreover, they will be acquiring sizeable 1.74 That still leaves the second issue: the
amounts of state bonds over the next few need to put debt on a downward path. To
years as bank loans to electricity distribution see whether this would be possible with a
companies are securitized under the UDAY more moderate pace of adjustment, a careful
scheme. So, banks appetite for additional examination of the medium-term fiscal
bond issues might seem to be limited. outlook is in order. The basic drivers of
1.71 In fact, the risk of oversupply seems government debt can be specified precisely.
fairly small. For a start, a reduction in the Aside from exchange rate movements, which
fiscal deficit even to one somewhat higher are unpredictable, the evolution of the debt-
than 3.5 percent of GDP implies a lower net to-GDP ratio depends on two factors. These
bond issue, relative to GDP. And banks might are: (i) the level of the primary deficit, that
actually be eager to purchase additional is, the fiscal deficit once interest costs are
G-secs, since falling oil prices could lead set aside; and (ii) the difference between
to lower inflation, which could then lead to the interest rate on government debt and the
lower interest rates and capital gains on their growth of nominal GDP (multiplied by the
previous years debt ratio). In symbols: differential may not normalize anytime soon.
d(t)- d(t-1) = pd(t) + [i-g]/[1+g]*d(t-1)8 1.78 Consequently, a much more prudent
1.76 Put simply, primary deficits push up approach would be to assume a more gradual
the debt ratio. But nominal growth can bring recovery of nominal GDP, say one where
it down, as long as the growth rate exceeds nominal growth averages 11 percent over
the interest rate on government debt. The the next 5 years. In that case, the interest-
primary deficit has been curbed to less than growth differential would not be sufficient
1 percent of GDP in 2015-16, far below the to bring down the debtthe primary deficit
nearly 3 percent of GDP recorded in 2011- would need to be reduced. But if such a
12. But nominal growth has collapsed, as strategy were to be pursued, even modest
the GDP deflator has plunged to minimal and gradual adjustment could eventually
levels, virtually eliminating the gap between make a significant difference. For example,
growth and interest rates. And therein lies the if the fiscal deficit were reduced annually by
problem. around 0.2-0.3 percentage points of GDP,
by the end of the period the overall deficit
1.76 The fiscal outlook consequently hinges would be around 3 percent and the primary
on what will happen to the interest-growth deficit would be essentially eliminated.
differential. If it normalizes, the debt-GDP Most significantly, the debt ratio would
ratio could come down on its own, even eventually though not immediatelyfall.
without adjustment measures. For example, Debt would decline by 2 percentage points of
if nominal growth quickly recovers and GDP in overall, and 41/2 percentage points in
averages 12 percent over the next five years underlying terms, slightly further than in the
(say, around 8 percent real and 4 percent
more favourable growth scenario (in Figure
inflation) while the effective interest rate
14, this scenario would be very close to that
on government debt stays near current
shown as Debt_H). And of course if the
levels, then consolidated debt could fall by
economy responded to the fiscal prudence,
11/2 percentage points of GDP over the next
as well as other structural reforms being
five years even as states assume debts of
pursued, and growth rebounded toward
around 21/2 percent of GDP under the UDAY
earlier levels, then the debt reduction would
electricity reform scheme. Since the states
be even larger.
would merely be recognizing an existing
contingent liability, and bringing it onto their 1.79 In sum, fiscal policy needs to navigate
own balance sheet, a better measure of the between Scylla and Charybdis. There are very
underlying fiscal progress would perhaps good arguments for a strategy of aggressive
be the reduction in debt, excluding UDAY fiscal consolidation, as earlier envisaged,
bonds. This would be 4 percent of GDP and equally good arguments for a strategy
(Figures 13 and 14). of moderate consolidation that can place the
debt on a sustainable path while avoiding
1.77 It would be imprudent, however, to
imparting a major negative demand shock
count on this scenario materializing. For
to a still-fragile recovery. The Union Budget
one thing, adverse shocks have a way of
will carefully assess these options.
throwing debt dynamics off course. The
global recovery could falter. Inflation could 1.80 In any event, the time is ripe for a
turn out to be lower than expected. For these review of the medium term fiscal framework.
or many other reasons, the interest- growth A medium-term perspective to expenditure
8
d refers to public liabilities of the general government; pd refers to primary deficit; i is the interest rate and g is
the growth rate.
Source: CSO, RBI & projections.
P=Projected
GDP Growth_S= Slower GDP growth forecast
GDP Growth_H= Higher GDP growth forecast
Interest rate_S= Projected interest rates under Slower GDP growth forecast
Interest rate_H= Projected interest rates under Higher GDP growth forecast
Source: CSO, RBI, DMO, budget document and Projections.
E= Estimated P=Projected E= Estimated P=Projected

Debt_S= Debt under Slower GDP growth forecast Debt_S= Debt under Slower GDP growth forecast
Debt_S_UDAY= Debt under Slower GDP growth forecast and Debt_H= Debt under Higher GDP growth forecast
without UDAY
Debt_H= Debt under Higher GDP growth forecast
Debt_H_UDAY= Debt under Higher GDP growth forecast and
without UDAY
planning is necessary. The fundamental was due to falling commodity prices but
growth and fiscal outlooks have changed the decline in non-oil dollar exports and
considerably since the Fourteenth Finance export volume was still sizable. Exports of
Commission provided medium term revenue commercial services remained stagnant in
projections. And, above all, there are new the first 3 quarters compared with an average
developments in, and approaches to, medium growth of about 17 per cent during 2006-2011
term fiscal frameworks around the world (Figure 8). As a result, growth this year was
from which India could usefully learn. held backby about 1-1.2 percentage points
relative to last year. A questioncritical
External Outlook for assessing prospects going forward
1.81 Last years Survey had identified is whether this recent export performance
a weak external environment as a major is explained mainly by a decline in global
medium- term risk. It turned out to be a short demand or a decline in competitiveness,
run risk as well, and the prospects are that it related to the exchange rate or other factors.
might continue to be one in the period ahead.
1.84 It has been well documented that at the
1.82 One of the puzzles this year has been global level, trade has sputtered and more
how remittances have held up despite a so than the world GDP. So, the question is
dramatic decline in oil prices and hence in the whether India has fared worse than other
health of countries that host overseas Indian exporters.
workers. (Figure 15). The Indian economy 1.85 One can answer this question by
and foreign exchange earnings were buoyed examining how Indias exports relative to
by this non-decline in remittance flows. Still, world GDP have fared compared with world
prudence warrants monitoring this source of exports. Figure 16 plots four relationships:
earnings because it is plausible that with oil between Indias exports of goods and world
prices remaining low in the near future, oil GDP (top left panel); between Indias export
exporting countries will eventually be forced of services and world demand (top right
to curtail their use of foreign labour. panel); and the two equivalents for the world
1.83 Overall exports declined by about 18 (bottom panels). It is noteworthy that in
per cent in the first 3 quarters; much of this the 2000s, Indias exports of manufactured
Source: RBI & DGCA.

goods and services were above the line of 1.87 What makes this development puzzling
best fit but note that services outperformed is that in recent years the composition of
manufacturing (services data points are Indian exports of services is more favorable
more above the line than manufacturing than that of Indian exports of manufactured
data points). For the world, there is a similar goods. More of the former goes to the United
but less pronounced pattern, especially for States, and more of the latter to Asia. Since
services. In the last two years, however, Asia has slowed down more rapidly, Indias
Indian services exports have been more exports of manufactures should have been
affected than Indian manufacturing exports more affected. Furthermore, in the last year,
and also world service exports. the rupee has depreciated strongly against
1.86 Put differently, all the focus on the dollar which should have helped Indias
manufacturing exports has distracted exports of services.
attention from what might be a no less 1.88 These developments have longer-term
noteworthy development. It is Indias exports implications. Realizing Indias medium
of services that has changed in the most term growth potential of 8-10 per cent will
significant, and perhaps alarming, way. One require rapid growth of exports. How rapid
can see the problem looking at market shares. this should be is suggested by comparing
Indias share of world exports of services, Indias export performance in services with
after surging in the mid-2000s, has flattened Chinas performance in manufacturing at
out. a comparable stage of the growth surge.
Figure 17 plots Chinas global market share on the national near-consensus.

in manufacturing exports beginning in 1991, 1.90 Introspection is overdue on five issues:
and juxtaposed on it is Indias global market
Providing support to farmers in light of
share beginning in 2003 when the shares
WTO rules;
were roughly similar. The magnitude of the
challenge becomes evident when examining Mitigating the impact of erratic trade
Chinas trajectory over the last fifteen years. policy on farmer incentives;
To achieve a similar trajectory, Indias Reconciling the big but poor dilemma
competitiveness will have to improve so that that confronts India in trade negotiations;
its services exports, currently about 3 per Dealing with ongoing stresses brought on
cent of world exports, capture nearly 15 per by the external environment; and
cent of world market share. That is a sizeable Engaging more broadly with the world on
challengeand recent trends suggest that a trade.
major effort at improving competitiveness
will be necessary to meet it. Agriculture and the WTO
Trade Policy 1.91 Start first with the two key issues in
the Doha Development Agenda (DDA): the
1.89 For decades, Indias fundamental special safeguard mechanism (SSM) and
position on trade has been common across food security/public stockholding both of
the political spectrum, shared by a wide which affect farmer interests.
range of intellectual opinion. But during
this period the economy has changed almost 1.92 The SSM embodies the right to impose
beyond recognition. The non-success of the trade barriers if there is a surge in agricultural
Nairobi WTO negotiations, the seismic shifts imports into India. But there is one critical
in the international trade architecture because but overlooked question: to what extent
of the emergence of mega-regional trade does India really need SSM? In the Uruguay
agreements, and a slowing world economy Round, many countries including India were
which creates pressures on domestic industry allowed to set ceiling (jargon for very high)
combine to present India with a great tariff bindings: that is, they were allowed to
opportunity to collectively self-interrogate set, as their WTO obligation, high levels of
tariffs which range from 40 per cent to 100 its appropriate level and form. The particular
per cent (India's modal rate in agriculture) policies which are being defended are those
to 150 per cent. In a preponderance of tariff that India intends to move out of in any case
lines, there is a considerable gap between because of their well-documented impacts:
applied tariffs and the level of tariff bindings. decline in water tables, over-use of electricity
1.93 Once India had this freedom, it was not and fertilizers (causing health harm), and
necessary to have safeguard actions because, rising environmental pollution, owing to
in response to import surges, but even post-harvest burning of husks. Moreover,
otherwise, India could raise tariffs up to the the government is steadfastly committed to
high level of bindings. Why then, for a long providing direct income support to farmers
time, has India been asking for the right to and crop insurance which will not be
impose SSMs, which is in effect asking for restricted by WTO rules.
even more freedom to determine agricultural 1.97 The way forward on agriculture and
policies? the WTO can be thought of in the following
1.94 The answer is not very clear. As Table conceptual terms. At the time of the Uruguay
2 illustrates, Indias applied rate is less than 5 Round, India was a net importer of food and
percent of the bound rate for about 4 percent decided that it needed a lot of room to maintain
of tariff lines, and less than 20 percent for border protection (tariffs in particular) and
about 16 percent of its tariff lines. So, Indias was less concerned about providing support
only real need for SSM arises in relation to agriculture via domestic support (producer
to a small fraction of its tariff linessome subsidies, minimum support prices etc). That
milk and dairy products, some fruits, and was Indias choice.
raw hideswhere its tariff bindings are in 1.98 Twenty years on, Indias position in
the range of about 10-40 percent which can agriculture has changed: it has become more
be uncomfortably close to Indias current competitive in agriculture and it now relies
tariffs, limiting Indias options in the event relatively more on domestic support (and
of import surges. But if that is the case, India less on tariff protection) for agriculture both
should call for a discussion of SSMs not as a to sustain domestic production and address
generic issue of principle but as a pragmatic low incomes for farmers. Indias WTO
negotiating objective covering a small obligations could predominantly be based
part of agricultural tariffs. Perhaps, in this on this domestic shift away from border
instance, lofty theologizing about freedom protection to domestic support. India could
and sovereignty needs to cede to mundane consider offering reduction in its very high
haggling over hides and hibiscuses. tariff bindings and instead seek more freedom
1.95 Take next the food security/ to provide higher levels of domestic support:
stockholding issue. India had obtained a this would be especially true for pulses going
virtual cast-iron legal guarantee in 2014, forward where higher minimum support
which made the Bali Decision permanent prices may be necessary to incentivize pulses
and put it on a sound legal basis. This was re- production. This would be good for India,
iterated in Nairobi. It remains open whether and Indias trading partners should be more
pressing for permanent solution is vitally reasonable about accepting this shift.
necessary. Volatile Trade Policy
1.96 Especially at a time of farm stress, 1.99 Agricultural policy, especially trade
India must have the freedom to provide policy, is characterized by unusual volatility.
support to its farmers. The open question is The ups and downs are striking. Take the case
of cotton shown in Table 1A in the technical should in relation to its partners markets.
appendix of this volume. In 2010, there were 1.103 The latter means that partners expect
ten changes in policy, mostly relating to India to play the reciprocity game: you
exports, and often reversing previous actions. open your markets and/or you reduce your
Look at the August 4, 2011 action compared freedom to protect in return for us doing the
with the action on March 31, 2011. There same. If the WTO is not to be consigned to
were then 5 changes in 2011, 5 in 2012 and irrelevancein the wake of the big trading
2 in 2014. countries turning decisively away from it
1.100 The view is that in agriculture, the towards regional agreementsthere is only
interests of the producer and consumer have one way forward: in return for similar actions
to be balanced. When world prices go up or by its trading partners, India, China and other
there is domestic scarcity, export restrictions similar countries must be willing to offer to
or bans are imposed; when the reverse open up their markets and undertake greater
happens, import tariffs are imposed. But this commitments in the context of future WTO
policy volatility actually ends up hurting negotiations.
farmers (of course) but eventually also
1.104 In the 1970s and 1980s, Indias
consumers. This is because farmers produce
engagement in the WTO was broadly non-
less because of the policy volatility which
reciprocal. This was possible because was small
results in reduced domestic availability and
enough for trading partners to overlook this
hence higher prices. Farmers are affected not
non-reciprocity. Today they do care because
only by the fact that on average they get less
of Indias market size, and India must respond,
for their produce but even more so by the
balancing the big-but-poor dilemma.
policy uncertainty that dampens, even chills,
the incentive to produce. The notion that there 1.105 Partner countries must show a serious
is a trade-off between farmers and consumers interest in reviving multilateralism. Equally
is false except in the very short run. India and other emerging market economies
1.101 Farm policyminimum support must make it attractive for trading partners
prices and import and export policyshould to engage in the WTO. An important part
be announced well in advance of the crop of this will require India playing more of
growing season and should not be altered the reciprocity game and using its growing
during the course of the season unless there markets as leverage to attain its own market
are exceptional developments. interests abroad, including the mobility of
labor.
Broader issues: The Big-but-Poor
Dilemma 1.106 The costs of reluctant engagement
need careful review. The US and others are
1.102 India also needs to address two broader
issues. The first is what might be called the negotiating agreements (the Trans-Pacific
big-but-poor dilemma. On the one hand, Partnership (TPP)) that have excluded India
Indias self-perception as a poor country and hence shaped in a way that do not take
translates into a reluctance to recognize and into account Indias important interests (the
practice reciprocity (give-and-take) in trade rules on intellectual property are a good
negotiations. On the other hand, India's illustration). If and when India joins these
policies have a significant impact on global agreements, it will be not on Indias terms
markets and it has become a large economy but on terms already cast in stone, terms that
in which partner countries have a legitimate India could not influence because of being
stake in seeking market accessjust as India perceived as not engaging fully.
Dealing with ongoing stresses 1.110 Third, India should eliminate all the
1.107 Trade policy is under stress also for policies that currently provide negative
reasons related to the ongoing turmoil in the protection for Indian manufacturing and
international environment. Global demand is favor foreign manufacturing. This could
weak, and one of the powerhouses of trade be achieved by quick implementation of
in recent timesChinais slowing down. the GST as recommended by the recent
Chinese slowdown has important implications report of the GST Committee. If delays are
for India. As the Chinese currency weakens, envisaged, a similar result could be achieved
setting in train reactions from other countries, by eliminating the countervailing duty
Indias external competitiveness across-the- exemptions.
board will come under pressure. But there Broader issues: Prerequisites for Trade
will also be sectoral impacts. Chinese excess opening
capacity in commodity-related sectors such 1.111 Underlying all these proximate
as steel and aluminum will lead to a surge in issues is a much deeper problem: can trade
imports into India. liberalization be a source of efficiency,
1.108 How should India respond? India dynamism and growth not just for services
should resist calls to seek recourse in but also agriculture and manufacturing going
protectionist measures, especially in forward?
relation to items that could undermine the 1.112 To put it in the terms that Rodrik and
competitiveness of downstream firms and Subramanian (2004) used to describe Indias
industries. India could respond in three reforms of the 1980s and 1990s: is India really
ways. First, the most effective instrument to pro-competition or is it just pro-business?9
respond to threats to overall competitiveness
is the exchange rate. The rupees value 1.113 Every country, and every constituency
must be fair, avoiding strengthening. This in every country, wants more exports. But
can be achieved through some combination there is much more ambivalence about
imports. The efficiency effects of trade,
of monetary relaxation, allowing gradual
however, work through imports: by exposing
declines in the rupee if capital flows are weak,
domestic industry to greater competition and
intervention in foreign exchange markets if
by creating incentives domestically to move
inflows are robust, and being cautious about
resources toward export sectors.
any further opening to inflows that could
unduly strengthen the rupee. 1.114 Now, it is intrinsic to creating greater
competition that there will be churn, stress,
1.109 Second, India should strengthen and dislocation, necessitating some exit of
procedures that allow WTO-consistent and uncompetitive firms and industries. Accepting
hence legitimate actions against dumping the transitory costs of trade liberalization
(anti-dumping), subsidization (countervailing and providing a cushion against themin
duties), and surges in imports (safeguard the form of targeted assistancewill be
measures) to be taken expeditiously and necessary for India to be able to negotiate
effectively. Ineffective domestic procedures credibly in the WTO today and, if India so
risk becoming the excuse for broad-based decides, the Trans-Pacific Partnership (TPP)
protectionist actions. tomorrow. That is why, the governments
9
Dani Rodrik and Arvind Subramanian, From "Hindu Growth"to Productivity Surge: The Mystery of the Indian
Growth Transition," NBER Working Paper No. 10376.
Skill India and Make in India initiatives are greater foreign competition, stemming in
so important. Greater trade opening will turn from the domestic politics of disruption
increase the size of the pie but it must be and exit, is at the heart of Indias difficulties
combined with assistance in the transition with the WTO, trade agreements, and trade
phase to make everyone better off. policy more broadly (as discussed in Chapter
1.115 In some ways, that ambivalence about 2). There is no getting away from it.
Table 2: Indias Actual and Bound Rates in Agriculture (Per cent)
Bound minus applied No. of tariff Lines Cumulative tariff Lines Percentage Cumulative
0 21 21 1.6 1.6
1-5 20 41 1.5 3.1
6-10 136 177 10.4 13.5
11-20 39 216 3.0 16.4
21-30 109 325 8.3 24.7
31-40 354 679 26.9 51.7
41-60 111 790 8.4 60.1
61-80 235 1025 17.9 78.0
81-100 101 1126 7.7 85.7
Above 100 188 1314 14.3 100.0
Total 1314
Source: WTO.

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Economic Outlook, Prospects, and

This years Economic Survey comes at a time of unusual volatility in the

Introduction Big Bang reforms because of the dispersed

Source: World Economic Outlook (WEO), January, 2016 update.

Box 1.1: What is Indias Potential GDP Growth?

Table: China and Indias Potential Growth Rate,

The Global Context and proceeding to the prolonged European

Box 1.2: Analytical Taxonomy of Financial Crises, Past and Future

Table: Anatomical Taxonomy of External Financial Crises

The Indian Context in Indias investment grade (BBB), and a

Source: IMF WEO, October 2015 and January 2016 update.

Source: IMF WEO, October 2015 and January 2016 update.

Source: CSO. Source: Ministry of Finance.

Box 1.3: Assessing the Quality of General Government Spending in FY2016

Box 1.5: El Nio, La Nia and Forecast for FY 2017 Agriculture

Source: Bank for International Settlements (BIS).

Inflation 1.52 The historical evidence is clear on this

Source: CSO and RBI.

Box 1.7 What Explains the Incomplete Passthrough of Monetary Policy?

Medium-Term Fiscal Framework repay the debts it is incurring today. And it

Source: CSO, RBI & projections.

Source: CSO, RBI, DMO, budget document and Projections.

E= Estimated P=Projected E= Estimated P=Projected

Source: RBI & DGCA.

Figure 17 plots Chinas global market share on the national near-consensus.

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