Though timing and phasing of Capital account convertibility (KAC) may involve micro issues, KAC is in essence a macro-economic issue. It relates basically to the gap between domestic Saving and Domestic Investment. Almost by definition a Developing country like India is characterised by an excess of the latter over the former. This has two important implications; a) macro-economic equilibrium in India will be characterised by net inflow of capital, b) any effective constraint on outflows results in a corresponding reduction in gross inflows and higher domestic interest rates. I therefore predict that a complete opening of the capital account (convertibility) in India will result in increased net inflows and a reduction in the real interest rate/cost of capital.
One of the few areas in which the “level playing field” argument has some validity is with respect to restricted access of Indian firms to international capital at international rates. Capital account convertibility will ensure that this source of competitive disadvantage for Indian industry is removed. The cost and availability of risk capital (both equity and long term debt) will improve. This will benefit not only large firms and exporters with direct access to world markets, but also (in due course) Infrastructure developers, Venture capitalists, and individuals with innovative ideas. A completely level playing field requires complete removal of restrictions on borrowing abroad by Indian producers. Foreign inflows may however continue to be restricted into specified short term assets like bank deposits.
As in many other similarly placed countries, KAC is likely to increase the reverse flow of flight capital into India. This forecast is contrary to popular perception that the chief danger from KAC is of potentially large outflows of flight capital. A recent, much quoted paper purporting to show large capital outflows (including over invoicing of aircraft imports) is dangerously misleading. The reduction in NRI deposits and the increased remittances accompanying current account convertibility point in the opposite direction.
The increased capital inflows which are likely to follow KAC will create upward pressure on the rupee and lead to some real appreciation(adversely affecting exports). This problem can only be minimised by removing remaining import restrictions and rapidly freeing export of capital. Fears about exchange rate volatility are highly exaggerated. Cross-country comparison suggests that in a period without KAC( last 3-4 years) the rupee(real exchange rate) volatility was one of the highest. KAC by itself need not lead to higher volatility, though the policy instruments for damping volatility may be more circumscribed. This problem can be handled (during transition) through limits on borrowing by financial companies, banks and large companies for purchase of FE, as individual capital flows will not be significant contributers to volatility. Competitive pressure on banks will intensify and certain policies such as directed credit may have to be overhauled to protect the weakest banks.
In my experience, ex-ante the time is seldom “ripe” for a bold policy reform, ex-post everybody sees it as an obvious next step. If one is convinced about the usefulness and importance of a reform, risk minimising phasing can be devised. This was demonstrated by the 1992 move to partial convertibility.
There are no absolute pre-requisites. Policy reforms should, however, be accelerated to minimise risk (e.g. political) and macro-management difficulties. The Centre & States’ primary deficit must move to zero, the fiscal down trend be maintained, and tax reforms completed. Operational controls on banks must be removed to provide flexibility and access to skilled manpower. The laws must be changed to allow new instruments such as futures & forwards and securitised debt so that economic agents can hedge their risk.
Wednesday, June 4, 1997
Towards Capital Account Convertibility
Though timing and phasing of Capital account convertibility (KAC) may involve micro issues, KAC is in essence a macro-economic issue. It relates basically to the gap between domestic Saving and Domestic Investment. Almost by definition a Developing country like India is characterised by an excess of the latter over the former. This has two important implications; a) macro-economic equilibrium in India will be characterised by net inflow of capital, b) any effective constraint on outflows results in a corresponding reduction in gross inflows and higher domestic interest rates. I therefore predict that a complete opening of the capital account (convertibility) in India will result in increased net inflows and a reduction in the real interest rate/cost of capital.
One of the few areas in which the “level playing field” argument has some validity is with respect to restricted access of Indian firms to international capital at international rates. Capital account convertibility will ensure that this source of competitive disadvantage for Indian industry is removed. The cost and availability of risk capital (both equity and long term debt) will improve. This will benefit not only large firms and exporters with direct access to world markets, but also (in due course) Infrastructure developers, Venture capitalists, and individuals with innovative ideas. A completely level playing field requires complete removal of restrictions on borrowing abroad by Indian producers. Foreign inflows may however continue to be restricted into specified short term assets like bank deposits.
As in many other similarly placed countries, KAC is likely to increase the reverse flow of flight capital into India. This forecast is contrary to popular perception that the chief danger from KAC is of potentially large outflows of flight capital. A recent, much quoted paper purporting to show large capital outflows (including over invoicing of aircraft imports) is dangerously misleading. The reduction in NRI deposits and the increased remittances accompanying current account convertibility point in the opposite direction.
The increased capital inflows which are likely to follow KAC will create upward pressure on the rupee and lead to some real appreciation(adversely affecting exports). This problem can only be minimised by removing remaining import restrictions and rapidly freeing export of capital. Fears about exchange rate volatility are highly exaggerated. Cross-country comparison suggests that in a period without KAC( last 3-4 years) the rupee(real exchange rate) volatility was one of the highest. KAC by itself need not lead to higher volatility, though the policy instruments for damping volatility may be more circumscribed. This problem can be handled (during transition) through limits on borrowing by financial companies, banks and large companies for purchase of FE, as individual capital flows will not be significant contributers to volatility. Competitive pressure on banks will intensify and certain policies such as directed credit may have to be overhauled to protect the weakest banks.
In my experience, ex-ante the time is seldom “ripe” for a bold policy reform, ex-post everybody sees it as an obvious next step. If one is convinced about the usefulness and importance of a reform, risk minimising phasing can be devised. This was demonstrated by the 1992 move to partial convertibility.
There are no absolute pre-requisites. Policy reforms should, however, be accelerated to minimise risk (e.g. political) and macro-management difficulties. The Centre & States’ primary deficit must move to zero, the fiscal down trend be maintained, and tax reforms completed. Operational controls on banks must be removed to provide flexibility and access to skilled manpower. The laws must be changed to allow new instruments such as futures & forwards and securitised debt so that economic agents can hedge their risk.
One of the few areas in which the “level playing field” argument has some validity is with respect to restricted access of Indian firms to international capital at international rates. Capital account convertibility will ensure that this source of competitive disadvantage for Indian industry is removed. The cost and availability of risk capital (both equity and long term debt) will improve. This will benefit not only large firms and exporters with direct access to world markets, but also (in due course) Infrastructure developers, Venture capitalists, and individuals with innovative ideas. A completely level playing field requires complete removal of restrictions on borrowing abroad by Indian producers. Foreign inflows may however continue to be restricted into specified short term assets like bank deposits.
As in many other similarly placed countries, KAC is likely to increase the reverse flow of flight capital into India. This forecast is contrary to popular perception that the chief danger from KAC is of potentially large outflows of flight capital. A recent, much quoted paper purporting to show large capital outflows (including over invoicing of aircraft imports) is dangerously misleading. The reduction in NRI deposits and the increased remittances accompanying current account convertibility point in the opposite direction.
The increased capital inflows which are likely to follow KAC will create upward pressure on the rupee and lead to some real appreciation(adversely affecting exports). This problem can only be minimised by removing remaining import restrictions and rapidly freeing export of capital. Fears about exchange rate volatility are highly exaggerated. Cross-country comparison suggests that in a period without KAC( last 3-4 years) the rupee(real exchange rate) volatility was one of the highest. KAC by itself need not lead to higher volatility, though the policy instruments for damping volatility may be more circumscribed. This problem can be handled (during transition) through limits on borrowing by financial companies, banks and large companies for purchase of FE, as individual capital flows will not be significant contributers to volatility. Competitive pressure on banks will intensify and certain policies such as directed credit may have to be overhauled to protect the weakest banks.
In my experience, ex-ante the time is seldom “ripe” for a bold policy reform, ex-post everybody sees it as an obvious next step. If one is convinced about the usefulness and importance of a reform, risk minimising phasing can be devised. This was demonstrated by the 1992 move to partial convertibility.
There are no absolute pre-requisites. Policy reforms should, however, be accelerated to minimise risk (e.g. political) and macro-management difficulties. The Centre & States’ primary deficit must move to zero, the fiscal down trend be maintained, and tax reforms completed. Operational controls on banks must be removed to provide flexibility and access to skilled manpower. The laws must be changed to allow new instruments such as futures & forwards and securitised debt so that economic agents can hedge their risk.
Tuesday, June 3, 1997
Macroeconomic Transition: Supply To Demand Cycles
The Puzzle
A prominent feature of the Indian economy in 1996-97 was the contradiction between good performance, as measured by official statistics, and reports of “recession” in newspapers based on corporate sources. Besides large corporations, sub-sectors dependent on them such as capital market intermediaries and advertising apparently shared this feeling. In 1996, CSO had forecast economic growth to be 6.8% in 1996-97, only marginally lower than in 1995-96.[1] CSO also forecast a 10.6% growth of manufacturing, which was somewhat lower than last year, and a 3.7% growth of Agriculture (& allied sectors) which would constitute a sharp improvement. Facts available till January (when the economic survey is normally finalised) supported this forecast: Industrial production (IIP), grew by 9.8% in the first half of 1996-97, compared to an average growth of 7.5% in the eighties and 8.5% during the seventh plan. Manufacturing grew by 12.4% during April-September 1996 compared to 12.5% growth in the first half of 1995-96(IIPM). There were however some indicators signalling a significant slowing down of corporate growth during 1996-97. Among these were, (a) poor demand for credit by large corporations, (b) declining sanctions by financial institutions, (c) a fall in non-oil imports, and, (d) company first half-year sales results [qualitative results as reported in the media]. This “Duality/Dualism” in the economy between industry in general and the large corporate sector have been a puzzle during the second half of 1996-97.
Cyclical Fluctuation
Earlier economic downturns in the Indian economy have been associated primarily with cycles in rainfall and agricultural production. Over the last decade or so the connection between these agricultural cycles and Industrial production has considerable weakened. Low or negative growth of GDP from agriculture in 1995-96 had little impact on industrial production during that year. Thus such supply side [Classical/Neo-classical] cycles have not been an important feature of the economy for some time. The conventional wisdom about developing countries such as India also holds that such economies are not subject to Keynesian demand driven cycles of the kind common in developed countries. Such “Keynesian” cycles are driven by the interaction of demand fluctuations with downward price rigidity and cost-push factors (in contrast to neo-classical sectors where price flexibility ensures demand-supply equilibrium). It is my hypothesis that in the transition from a closed to an open economy such a “Keynesian” sub-sector is emerging, consisting primarily of large capital intensive corporations. A cyclical “Keynesian” slowdown or growth recession in this large corporate sector provides an explanation of the puzzle outlined above.
The last few years have seen the transition of the economy to a higher growth path following from the various policy reforms undertaken since 1991-92. These reforms also have their effect on the macro-economic interrelations in the economy. The removal of controls has to a significant extent reduced the protection provided to large corporate industry, putting competitive pressure and providing increased opportunities. This has forced corporations to rapidly achieve economies of scale by building capacity in anticipation of future growth, and to upgrade products and plants to meet potential competition. The “animal spirits” unleashed by the early spate of reforms, perhaps also resulted in over-optimistic forecasts of demand growth for new and/or upgraded products. A hump is demand for durable goods and slow adjustment in real interest rates accentuated the mismatch between capacity addition and demand growth. The deterioration in non-tradable infrastructure has raised its effective cost. This in turn has put upward pressure on costs of production. The supply problem arising from import controls on agricultural goods, which artificially creates non-tradable goods, has added to this cost pressure. Though the relative price of manufactures has fallen sharply during 1996-97, the fall was probably less in the large capital intensive sectors. This combination of falling demand and rising (infrastructure) input costs resulted in a Keynesian excess supply situation for these sub-sectors, which can plausibly be labelled a “growth recession”
Corporate Demand
Among the identifiable sources of fall in demand for the corporate sector the most important one related to the pent-up demand for higher quality consumer durable goods [e.g. cars, white goods]. The de-licensing of investment in durable goods and the de-control of imports of parts for the same, led to a boom in investment and production of consumer durable goods, culminating in the phenomenal 37% growth in 1995-96. The decline in growth of consumer durable goods to 9.8% in the first half of 1996-97(compared to 31.9% in the first half of 1995-96) and further to 6.5% in the first nine months of 1996-97 suggests that the pent-up demand for higher quality durable goods have been met. Further growth will depend on increased cost competitiveness or introduction of new (innovative/adapted) products. The former requires fuller exploitation of the comparative advantage that India has in production of (skilled & unskilled) labour intensive parts.
Other sources of decline in demand during 1996-97 included a sharp fall in the growth of World imports, a real appreciation of the Rupee and a decline in new orders for capital goods. The relatively tight money policy in 1995-6 led to an expectation that high real interest rates would persist into the future (wrongly in my view, as high interest rates were due primarily to high investment demand). This affected new demand for both consumer durable goods and capital goods in 1996. The decline in agricultural production during 1995-6 may also have contributed to the demand slow-down for the corporate sector. As a result the growth rate for April-December 1996 was 10.1% for manufacturing and 8.3% for Industry.
Import Liberalisation and Substitution
Another aspect of macroeconomic transition was the import hump commonly resulting from the opening of international trade and investment. Accelerated modernisation and development of the relatively backward consumer durable sector, likely required higher initial imports of capital goods, parts and components. This led to a higher than normal growth in imports during the last few years. This hump in imports seems therefore to have passed, accentuating the import slowdown; non-oil imports (revised DGCI&S) consequently grew by only a 2% during the first 11 months of 1996-97.
Capital Markets
The credit and capital markets are also undergoing major changes during this transition period. Growth in bank credit to the non-food sector and Sanctions by development finance institutions (DFIs) declined dramatically during 1996-97. This implies a fall in demand from large, triple, corporations. Disbursements by DFIs, however, grew at a respectable pace; implying continuing high levels of investment coupled with a sharp fall in new starts. Household saving invested in shares and debentures declined from 1.3% of GDP in 1994-5, to 0.6% of GDP in 1995-96. This decline probably continued in 1996-97, and made it difficult to raise equity funds. Besides the direct negative effect on corporate investment, this also raises debt-equity ratios, making it difficult for banks to lend for investment. These changes, along with the rise in foreign direct investment and GDR issues, suggest that the fortunes of the large corporate sector are getting linked to continuing globalisation and acceleration in foreign direct investment and inflow of equity & debt capital.
Infrastructure Cost Push
The slowing of industrial growth in the first half of 1996-97 was clearly attributable to a dramatic slowdown in the growth of the electricity and mining sectors. The 10% decline in crude oil production was a major contributing factor in the latter. During the first nine months of 1996-97 electricity production (as measured by the index) has grown by only 3.7% that is 2/3 rd of the 8.9% growth in the first nine months of 1995-96. Given the high correlation of 0.67 between manufacturing and electricity (over the past 25 years), it was somewhat surprising that manufacturing production was apparently unaffected by the slow growth in electricity production. To an extent, highly electricity intensive industries are the first to face power rationing and this would dampen the effect of less public supply on manufacturing output. It is likely that own account electricity generation has substituted for the lack of generation by electricity boards. The high growth of diesel imports coupled with normal refinery throughput is a pointer. This substitution, however, provides no relief from the rising effective cost of electricity, and the cost-push that it generates.
Investment & Capital Goods
Another aspect of the macro puzzle was acceleration in the rate of growth of capital good's production to 18.2% in the first half of 1996-97 from 14% in the first half of 1995-96. This on top of the new peak in total and Private gross fixed capital formation to 24.1% and 16.3% of GDP respectively, in 1995-96. In complete contrast, import of capital goods declined by 4% in the first half of 1996-97. This showed the strength of the domestic capital good's industry, which was initially subject to the fastest tariff reduction so as to ensure quick recovery of private fixed investment. The move to more uniform tariffs on manufactured goods has contributed to the removal of anomalies and to the growth of capital goods production.
There has, however, been a slowing down in the growth of capital goods production in the third quarter of 1996-97. As a result, the rate of growth has declined to 11.8% in the first nine month of 1996-97, significantly lower than the 17.9% growth in the corresponding period of 1995-96(Import growth till February is nil.). This happened despite an easing of monetary growth during 1996-97 and a decline in market interest (call money and T-bill rates), partly because interest rates for private borrowers lagged these developments. The growth pattern for capital goods supports the hypothesis that previously started investment plans were being completed during 1996-97, while new starts were declining. Nevertheless, fixed capital formation seems to have remained strong in 1996-97.
Macro Policy, Reforms and Growth
The above analysis leads directly to a number of Policy conclusions-- both “Dos and Don’ts”. Given the very circumscribed and limited sub-sector of the economy subject to the growth slowdown, a conventional aggregate growth stimulus would have been (and is) the worst policy response. Thus for instance a higher fiscal deficit, providing such a stimulus would have aggravated the infrastructure problem and the cost push elements and raised the inflation rate considerably. In contrast the effect on aggregate output would be limited to the effect on the large corporate sector. Thus any inflation output trade-off from such a policy would be very limited, and possibly illusory.
The appropriate policy response had (and has) several elements. The infrastructure constraint was addressed by a number of policy reforms and initiatives designed to ease the entry of the private sector in the provision of these services. The second important problem was the lag in response of interest rates to the easing monetary policy and reduced demand for credit. A number of procedural and other actions were taken culminating with more fundamental reforms in the financial sector as per the Credit policy of April 1997. The 1997-8 budget, one of the most outstanding since 1992-93, cleared the air of pessimistic expectations, which hung over the corporate sector in the third quarter of the year. The reductions in personal and corporate income tax rates will not only provide an environment for efficient growth but also will also partly address the demand growth slowdown in the corporate sector.
Sustained growth of 7% to 9% will however require quicker and bolder action with respect to the electricity sector. The most urgent is the setting up of central/regional/state regulatory authorities, which are strong and independent and have the power to discipline the SEBs and to regulate both tariffs and conditions of supply. The second critical need is for reforming the State electricity boards themselves. The faster and deeper the policy reforms in the infrastructure sector, the quicker will be our approach to a high growth (employment, output), low inflation, internationally competitive economy. Flexible and speedy policy response and a pragmatic approach to reforms are also needed to generate new leading sectors and maintain high growth.
[1] Many commentators have confused forecasts given before the year has ended with estimates produced after the year has ended. These are quite different animals, as even the best forecasters in the world frequently revise their forecasts.
A prominent feature of the Indian economy in 1996-97 was the contradiction between good performance, as measured by official statistics, and reports of “recession” in newspapers based on corporate sources. Besides large corporations, sub-sectors dependent on them such as capital market intermediaries and advertising apparently shared this feeling. In 1996, CSO had forecast economic growth to be 6.8% in 1996-97, only marginally lower than in 1995-96.[1] CSO also forecast a 10.6% growth of manufacturing, which was somewhat lower than last year, and a 3.7% growth of Agriculture (& allied sectors) which would constitute a sharp improvement. Facts available till January (when the economic survey is normally finalised) supported this forecast: Industrial production (IIP), grew by 9.8% in the first half of 1996-97, compared to an average growth of 7.5% in the eighties and 8.5% during the seventh plan. Manufacturing grew by 12.4% during April-September 1996 compared to 12.5% growth in the first half of 1995-96(IIPM). There were however some indicators signalling a significant slowing down of corporate growth during 1996-97. Among these were, (a) poor demand for credit by large corporations, (b) declining sanctions by financial institutions, (c) a fall in non-oil imports, and, (d) company first half-year sales results [qualitative results as reported in the media]. This “Duality/Dualism” in the economy between industry in general and the large corporate sector have been a puzzle during the second half of 1996-97.
Cyclical Fluctuation
Earlier economic downturns in the Indian economy have been associated primarily with cycles in rainfall and agricultural production. Over the last decade or so the connection between these agricultural cycles and Industrial production has considerable weakened. Low or negative growth of GDP from agriculture in 1995-96 had little impact on industrial production during that year. Thus such supply side [Classical/Neo-classical] cycles have not been an important feature of the economy for some time. The conventional wisdom about developing countries such as India also holds that such economies are not subject to Keynesian demand driven cycles of the kind common in developed countries. Such “Keynesian” cycles are driven by the interaction of demand fluctuations with downward price rigidity and cost-push factors (in contrast to neo-classical sectors where price flexibility ensures demand-supply equilibrium). It is my hypothesis that in the transition from a closed to an open economy such a “Keynesian” sub-sector is emerging, consisting primarily of large capital intensive corporations. A cyclical “Keynesian” slowdown or growth recession in this large corporate sector provides an explanation of the puzzle outlined above.
The last few years have seen the transition of the economy to a higher growth path following from the various policy reforms undertaken since 1991-92. These reforms also have their effect on the macro-economic interrelations in the economy. The removal of controls has to a significant extent reduced the protection provided to large corporate industry, putting competitive pressure and providing increased opportunities. This has forced corporations to rapidly achieve economies of scale by building capacity in anticipation of future growth, and to upgrade products and plants to meet potential competition. The “animal spirits” unleashed by the early spate of reforms, perhaps also resulted in over-optimistic forecasts of demand growth for new and/or upgraded products. A hump is demand for durable goods and slow adjustment in real interest rates accentuated the mismatch between capacity addition and demand growth. The deterioration in non-tradable infrastructure has raised its effective cost. This in turn has put upward pressure on costs of production. The supply problem arising from import controls on agricultural goods, which artificially creates non-tradable goods, has added to this cost pressure. Though the relative price of manufactures has fallen sharply during 1996-97, the fall was probably less in the large capital intensive sectors. This combination of falling demand and rising (infrastructure) input costs resulted in a Keynesian excess supply situation for these sub-sectors, which can plausibly be labelled a “growth recession”
Corporate Demand
Among the identifiable sources of fall in demand for the corporate sector the most important one related to the pent-up demand for higher quality consumer durable goods [e.g. cars, white goods]. The de-licensing of investment in durable goods and the de-control of imports of parts for the same, led to a boom in investment and production of consumer durable goods, culminating in the phenomenal 37% growth in 1995-96. The decline in growth of consumer durable goods to 9.8% in the first half of 1996-97(compared to 31.9% in the first half of 1995-96) and further to 6.5% in the first nine months of 1996-97 suggests that the pent-up demand for higher quality durable goods have been met. Further growth will depend on increased cost competitiveness or introduction of new (innovative/adapted) products. The former requires fuller exploitation of the comparative advantage that India has in production of (skilled & unskilled) labour intensive parts.
Other sources of decline in demand during 1996-97 included a sharp fall in the growth of World imports, a real appreciation of the Rupee and a decline in new orders for capital goods. The relatively tight money policy in 1995-6 led to an expectation that high real interest rates would persist into the future (wrongly in my view, as high interest rates were due primarily to high investment demand). This affected new demand for both consumer durable goods and capital goods in 1996. The decline in agricultural production during 1995-6 may also have contributed to the demand slow-down for the corporate sector. As a result the growth rate for April-December 1996 was 10.1% for manufacturing and 8.3% for Industry.
Import Liberalisation and Substitution
Another aspect of macroeconomic transition was the import hump commonly resulting from the opening of international trade and investment. Accelerated modernisation and development of the relatively backward consumer durable sector, likely required higher initial imports of capital goods, parts and components. This led to a higher than normal growth in imports during the last few years. This hump in imports seems therefore to have passed, accentuating the import slowdown; non-oil imports (revised DGCI&S) consequently grew by only a 2% during the first 11 months of 1996-97.
Capital Markets
The credit and capital markets are also undergoing major changes during this transition period. Growth in bank credit to the non-food sector and Sanctions by development finance institutions (DFIs) declined dramatically during 1996-97. This implies a fall in demand from large, triple, corporations. Disbursements by DFIs, however, grew at a respectable pace; implying continuing high levels of investment coupled with a sharp fall in new starts. Household saving invested in shares and debentures declined from 1.3% of GDP in 1994-5, to 0.6% of GDP in 1995-96. This decline probably continued in 1996-97, and made it difficult to raise equity funds. Besides the direct negative effect on corporate investment, this also raises debt-equity ratios, making it difficult for banks to lend for investment. These changes, along with the rise in foreign direct investment and GDR issues, suggest that the fortunes of the large corporate sector are getting linked to continuing globalisation and acceleration in foreign direct investment and inflow of equity & debt capital.
Infrastructure Cost Push
The slowing of industrial growth in the first half of 1996-97 was clearly attributable to a dramatic slowdown in the growth of the electricity and mining sectors. The 10% decline in crude oil production was a major contributing factor in the latter. During the first nine months of 1996-97 electricity production (as measured by the index) has grown by only 3.7% that is 2/3 rd of the 8.9% growth in the first nine months of 1995-96. Given the high correlation of 0.67 between manufacturing and electricity (over the past 25 years), it was somewhat surprising that manufacturing production was apparently unaffected by the slow growth in electricity production. To an extent, highly electricity intensive industries are the first to face power rationing and this would dampen the effect of less public supply on manufacturing output. It is likely that own account electricity generation has substituted for the lack of generation by electricity boards. The high growth of diesel imports coupled with normal refinery throughput is a pointer. This substitution, however, provides no relief from the rising effective cost of electricity, and the cost-push that it generates.
Investment & Capital Goods
Another aspect of the macro puzzle was acceleration in the rate of growth of capital good's production to 18.2% in the first half of 1996-97 from 14% in the first half of 1995-96. This on top of the new peak in total and Private gross fixed capital formation to 24.1% and 16.3% of GDP respectively, in 1995-96. In complete contrast, import of capital goods declined by 4% in the first half of 1996-97. This showed the strength of the domestic capital good's industry, which was initially subject to the fastest tariff reduction so as to ensure quick recovery of private fixed investment. The move to more uniform tariffs on manufactured goods has contributed to the removal of anomalies and to the growth of capital goods production.
There has, however, been a slowing down in the growth of capital goods production in the third quarter of 1996-97. As a result, the rate of growth has declined to 11.8% in the first nine month of 1996-97, significantly lower than the 17.9% growth in the corresponding period of 1995-96(Import growth till February is nil.). This happened despite an easing of monetary growth during 1996-97 and a decline in market interest (call money and T-bill rates), partly because interest rates for private borrowers lagged these developments. The growth pattern for capital goods supports the hypothesis that previously started investment plans were being completed during 1996-97, while new starts were declining. Nevertheless, fixed capital formation seems to have remained strong in 1996-97.
Macro Policy, Reforms and Growth
The above analysis leads directly to a number of Policy conclusions-- both “Dos and Don’ts”. Given the very circumscribed and limited sub-sector of the economy subject to the growth slowdown, a conventional aggregate growth stimulus would have been (and is) the worst policy response. Thus for instance a higher fiscal deficit, providing such a stimulus would have aggravated the infrastructure problem and the cost push elements and raised the inflation rate considerably. In contrast the effect on aggregate output would be limited to the effect on the large corporate sector. Thus any inflation output trade-off from such a policy would be very limited, and possibly illusory.
The appropriate policy response had (and has) several elements. The infrastructure constraint was addressed by a number of policy reforms and initiatives designed to ease the entry of the private sector in the provision of these services. The second important problem was the lag in response of interest rates to the easing monetary policy and reduced demand for credit. A number of procedural and other actions were taken culminating with more fundamental reforms in the financial sector as per the Credit policy of April 1997. The 1997-8 budget, one of the most outstanding since 1992-93, cleared the air of pessimistic expectations, which hung over the corporate sector in the third quarter of the year. The reductions in personal and corporate income tax rates will not only provide an environment for efficient growth but also will also partly address the demand growth slowdown in the corporate sector.
Sustained growth of 7% to 9% will however require quicker and bolder action with respect to the electricity sector. The most urgent is the setting up of central/regional/state regulatory authorities, which are strong and independent and have the power to discipline the SEBs and to regulate both tariffs and conditions of supply. The second critical need is for reforming the State electricity boards themselves. The faster and deeper the policy reforms in the infrastructure sector, the quicker will be our approach to a high growth (employment, output), low inflation, internationally competitive economy. Flexible and speedy policy response and a pragmatic approach to reforms are also needed to generate new leading sectors and maintain high growth.
[1] Many commentators have confused forecasts given before the year has ended with estimates produced after the year has ended. These are quite different animals, as even the best forecasters in the world frequently revise their forecasts.
Saturday, June 1, 1996
POLICY FRAMEWORK FOR POWER
POLICY FRAMEWORK
Competitive Generation
The Indian Electricity Act (and related acts and rules) should be changed to allow for a competitive electricity generation system, in which entry into power generation is free i.e. investment is de-licensed. Nuclear power should be de-reserved and opened to foreign investors, and safeguards limited to these plants. Even after the enabling legislation is enacted, the actual move to competitive generation would be gradual.
The move from the MOU to a competitive bidding system should continue. Unlike in communist or capitalist dictatorships, MOU type deals are unlikely to work in India because of vigilant opposition parties, free press, active public interest groups and independent judiciary. Periodic democratic changes of government magnify the risks involved in MOU type systems, and thus raise costs.
India has, however, the potential for creating one of the more competitive generating industries in the World. This could be achieved within the next 5 years if all State Electricity Boards hive of their generation operations into companies, and sell 26% to 75% equity to entrepreneurs and the public. Large states could create two or more companies, while smaller ones could amalgamate into a single entity. Once created, these companies will have to be freed to compete against each other and to operate in any state.
Regulated Monopoly Transmission
The backbone transmission network is technologically still a natural monopoly and will consequently have to remain a regulated monopoly for the time being. This does not mean a single transmission company for the whole country, but a monopoly provider for each segment. This sector would also include short distance transmission lines; From a generating station to a user (e.g. an aluminium plant) or distributor in a nearby city, and to and from the back-bone transmission network. The regulator must ensure inter-connectivity (between different transmission companies) and access to transmission services (wheeling) at reasonable rates to all generators and distributors of electricity. The regulator must also ensure that conditions of access are fair and non-discriminatory.
Benchmark Competition in Distribution
In the area of distribution, we need, in the words of Mao Tse Tung, to "let a hundred flowers bloom." The policy framework must allow and encourage different forms of ownership and organisation such as co-operatives, private companies, public companies and joint ventures. The frame work would make it possible for a city to have a single organisation to distribute to the whole city or have several networks run by different organisations. One organisation could also operate in only one or in several cities and regions.
All these organisations, including the existing State Electricity Boards, should be required by law, to provide and publish performance indicators that can be used to benchmark performance. These would include the unit cost of distribution (cost of electricity received minus cost of electricity supplied) and quality indicators [such as period of outage, average voltage and its variance]. This will require metering of supply at different points such as the distribution station and sub-stations. This is particularly so for State Electricity Boards which currently combine transmission and distribution. The availability of such information will make it possible for the users and regulators to apply countervailing pressure against the vested interests encouraging power theft and inefficiency.
INDEPENDENT REGULATORS
For a non-tradable service such as power, characterised by substantial elements of natural monopoly, fair and forceful regulation is not a luxury or fad but a necessity. This is particularly so in our country, where `public utilities’ have deteriorated to such an extent that some of them have become `rogue organisations’ (without much exaggeration). The low prices charged to certain categories of consumers is critically affecting the health of State electricity boards today. The underlying problem is the predominance of the personal interests of those who control, direct or run these organisations over consumer interest. Current & potential users (consumers) are consequently treated with contempt. An independent Tariff authority may be sufficient to get the private investment rolling. An independent Regulatory authority is essential to discipline the `public utilities’ and put the consumer (user) at the centre of the system where he belongs.
The root of the deterioration of systems and procedures for electricity supply in India is the bundling of three distinct functions into a single system. These functions are:
Policy
It is the prerogative of the government to make policy. This it can do through the concerned department, associated organisations like the Planning Commission or subsidiary organisations such as the Central Electricity Authority. This includes the issue of licensing of generation plants (MOU or competitive bidding). Licensing and associated planning, where they exist, should remain the responsibility of the government and its associated and subsidiary organisations.
Regulation
Broadly speaking the central function of the regulator is to regulate the "Conditions of Supply." This has three elements; Tariff or price, quality of supply (power cuts, voltage & its fluctuation) and Access (to the natural monopoly network). For the healthy development of the Power sector in India it is essential to have a Regulatory Body (or bodies) with the power, independence and authority to enforce fair and rational "conditions of supply." Tariff setting has to protect the interest of both current and potential consumers. The regulatory body must therefore encourage investment. For this reason, all actions and disputes following the issue of an investment license (within a well-specified licensing policy), come within the purview of the regulatory authority. Government should make clear that it will not interfere at this stage, if the policy framework is to have sufficient credibility with potential investors.
Production and Supply
The functions of production and supply need to be separated from the policy making and regulatory functions. This is essential no matter what the relative role of public and private sectors in the future. The producer or supplier must function within a system of rules and regulations designed to promote the long-term interests of all users (consumers). Within this framework they must have freedom to function as commercial organisations.
STATE ELECTRICITY BOARDS
There is an urgent need to reform the State Electricity Boards. This reform has many dimensions, and it is useful to define the range of possibilities. The diversity of economic and political conditions under which State Electricity Boards operate, makes it unlikely that any single solution will be adopted by all.
Bifurcation or Trifurcation
Given the existing monopoly of the State Electricity Boards in both Production and Supply, there is a strong case for separating Production from Supply by making them the responsibility of different organisations. This will make it easier to introduce effective competition into generation. It may also be desirable to go one step farther by separating transmission from distribution, as this will help in attracting independent distribution companies into the system.
Corporatisation
Our experience with Public Sector Companies and Nationalised Banks shows that Corporatisation can help in changing the orientation and performance of publicly owned units. A professional board, consisting of a mix of internal and external directors, is also helpful in orienting these units towards efficient and profitable operation. The attitude and objectives of the minister and the secretary of the concerned department are also critical in the transition period.
In some States, it may be easiest to hive off the generation part into a separate corporation, while leaving the State Electricity Board in charge of distribution. In other States it may be easier to convert the entire Electricity Board into a single company, while leaving open the issue of Bifurcation or trifurcation to a later date. The bolder ones may like to follow in the footsteps of Orissa by forming three separate companies for generation, transmission and distribution.
Co-operatives \
Another possibility that needs to be seriously considered is, to hive off parts of the distribution system into consumer co-operatives. Thus we should encourage the formation of professionally managed farmer's electricity distribution co-operatives in rural areas. An alternative would be, to hive off all three functions of the State Electricity Board, over defined rural areas, into Power co-operatives. The generating capacity transferred would be equal to the current supply of electricity to the concerned region. Further growth and development of power in the region would primarily be the responsibility of the co-operative. Similarly co-operative could be formed for distribution of electricity to slum areas, with metered supply by the State Electricity Board to the co-operative.
Leasing
There are several generating plants, whose performance is abysmal. We must encourage the State Electricity Boards to lease out such plants to the private sector for a defined period. The period should be long enough to encourage investment in renovation and maintenance. One arrangement for such leasing could be as follows:
The current supply of electricity by each such generating station and its cost would be estimated. The lessee would be required to supply this amount of power at the calculated cost (along with the existing formula for adjustment in fuel charges). The lessee would be free to sell any additional power he generates to anyone, at rates to be negotiated directly by him.
Similar experimentation is needed on the distribution side with selected distribution areas to be leased out, benchmarked on current supply to and revenues from, the area. The additional revenues generated by the lessee will be shared between it and the State Electricity Board, in a proportion to be determined through an auction.
Sale
Generating stations could also be transferred to co-operatives and private operators on a Buy Operate Transfer basis. As in the case of the lease, a certain amount of power would have to be given to the State Electricity Board at the current cost. The hiving of a rural region from the State Electricity Board, as a co-operative, could also require sale of the assets to the co-operative.
Accounts & Audit
State Electricity Boards should be required by law to maintain accounts and have them audited by independent auditors (whether they are converted into companies or not). Public interest would be even better served if annual cost and social audit are also made compulsory. This will bring pressure to check theft, collusion, corruption and inefficiency even before regulatory authorities are set up. These audits would be an invaluable source of information for tariff setting and preservation of consumer interests, once regulatory authorities are set up.
FUEL DE-CONTROL
There are reasons to believe that the control on fuel supply to power projects has resulted in rent seeking and delay in entry of private power producers. To solve this problem for good, all fuels of potential use by the power sector should be de-controlled. This means that import of Naphtha must be on OGL with an appropriate tariff to protect domestic producers. Any remaining controls on import of gas (LNG, CNG, etc) should also be removed. At the very least, a start must be made by putting imports of all these on SIL. Tariff setting must keep in view the necessity of dismantling of the Administered Price Mechanism, and the objective of bringing tariffs to Asian levels by the turn of the century.
Remaining impediments to competition within and private entry into the coal sector must also be dealt with urgently. This requires a review and reform of policies, procedures and rules for exploration, leasing and exploitation of coal reserves, with the active participation of potential investors.
ELECTRICITY CONSERVATION
Energy Labelling
Power consumption labelling must be made compulsory. Purchasers can then judge the efficiency and running costs of electrical machinery, equipment and consumer goods that they purchase. This will also create awareness among the producers of power equipment about the energy efficiency of their products. Such energy labelling would also be required on all imported electrical equipment before it is sold in India. Labelling will ultimately create competitive pressure for improvement in energy efficiency of equipment and appliances.
POSTSCRIPT (September 2000)
Over four years have passed since the above paper was written and the pace of reforms is not adequate to give us any confidence that the power problem will be licked within the next 5 years. The time may therefore have come to consider even more radical reforms. That is a complete de-control and de-licensing of power generation and distribution. That is any individual, co-operative or company could generate and/or distribute power without getting any investment licence or prior clearance. It would therefore be free to compete with the State Electricity Board, just as the latter would be free to compete (operate) in any other State. As with any other producer the power producer or distributor would be subject to the environment, health and safety laws of the country.
The regulatory authority would set upper limits on the electricity rates that can be charged at the retail level and leave (at least for the next 5 years till there is a visible improvement in supply) everything else to competition. Regulatory permits could, however, still be required for distribution and transmission systems above a certain size. These limits could initially be set quite high to encourage a Small-Scale Power sector and gradually reduced over the next 5 years or so.
Essential to the success of this policy would be a complete de-control and de-licensing of all potential fuels (e.g. coal, LNG) for the power industry. Even though this is already in process and is to be completed in the next few years, it would be helpful if the process is speeded up.
Given the horrendous state of T&D losses in India, with the figure reaching 50% in the capital city of India, it is no exaggeration to call these “Theft & Dacoity” losses. The Mafia like operation of those within these electricity distribution outfits who are responsible for such losses has to be experienced to be believed. Each State must set up a Special Task Force (STF) a la Veerapan to root out this “Dacoity.” This root and branch operation can start with the metropolitan cities and move on to the large towns.
Competitive Generation
The Indian Electricity Act (and related acts and rules) should be changed to allow for a competitive electricity generation system, in which entry into power generation is free i.e. investment is de-licensed. Nuclear power should be de-reserved and opened to foreign investors, and safeguards limited to these plants. Even after the enabling legislation is enacted, the actual move to competitive generation would be gradual.
The move from the MOU to a competitive bidding system should continue. Unlike in communist or capitalist dictatorships, MOU type deals are unlikely to work in India because of vigilant opposition parties, free press, active public interest groups and independent judiciary. Periodic democratic changes of government magnify the risks involved in MOU type systems, and thus raise costs.
India has, however, the potential for creating one of the more competitive generating industries in the World. This could be achieved within the next 5 years if all State Electricity Boards hive of their generation operations into companies, and sell 26% to 75% equity to entrepreneurs and the public. Large states could create two or more companies, while smaller ones could amalgamate into a single entity. Once created, these companies will have to be freed to compete against each other and to operate in any state.
Regulated Monopoly Transmission
The backbone transmission network is technologically still a natural monopoly and will consequently have to remain a regulated monopoly for the time being. This does not mean a single transmission company for the whole country, but a monopoly provider for each segment. This sector would also include short distance transmission lines; From a generating station to a user (e.g. an aluminium plant) or distributor in a nearby city, and to and from the back-bone transmission network. The regulator must ensure inter-connectivity (between different transmission companies) and access to transmission services (wheeling) at reasonable rates to all generators and distributors of electricity. The regulator must also ensure that conditions of access are fair and non-discriminatory.
Benchmark Competition in Distribution
In the area of distribution, we need, in the words of Mao Tse Tung, to "let a hundred flowers bloom." The policy framework must allow and encourage different forms of ownership and organisation such as co-operatives, private companies, public companies and joint ventures. The frame work would make it possible for a city to have a single organisation to distribute to the whole city or have several networks run by different organisations. One organisation could also operate in only one or in several cities and regions.
All these organisations, including the existing State Electricity Boards, should be required by law, to provide and publish performance indicators that can be used to benchmark performance. These would include the unit cost of distribution (cost of electricity received minus cost of electricity supplied) and quality indicators [such as period of outage, average voltage and its variance]. This will require metering of supply at different points such as the distribution station and sub-stations. This is particularly so for State Electricity Boards which currently combine transmission and distribution. The availability of such information will make it possible for the users and regulators to apply countervailing pressure against the vested interests encouraging power theft and inefficiency.
INDEPENDENT REGULATORS
For a non-tradable service such as power, characterised by substantial elements of natural monopoly, fair and forceful regulation is not a luxury or fad but a necessity. This is particularly so in our country, where `public utilities’ have deteriorated to such an extent that some of them have become `rogue organisations’ (without much exaggeration). The low prices charged to certain categories of consumers is critically affecting the health of State electricity boards today. The underlying problem is the predominance of the personal interests of those who control, direct or run these organisations over consumer interest. Current & potential users (consumers) are consequently treated with contempt. An independent Tariff authority may be sufficient to get the private investment rolling. An independent Regulatory authority is essential to discipline the `public utilities’ and put the consumer (user) at the centre of the system where he belongs.
The root of the deterioration of systems and procedures for electricity supply in India is the bundling of three distinct functions into a single system. These functions are:
Policy
It is the prerogative of the government to make policy. This it can do through the concerned department, associated organisations like the Planning Commission or subsidiary organisations such as the Central Electricity Authority. This includes the issue of licensing of generation plants (MOU or competitive bidding). Licensing and associated planning, where they exist, should remain the responsibility of the government and its associated and subsidiary organisations.
Regulation
Broadly speaking the central function of the regulator is to regulate the "Conditions of Supply." This has three elements; Tariff or price, quality of supply (power cuts, voltage & its fluctuation) and Access (to the natural monopoly network). For the healthy development of the Power sector in India it is essential to have a Regulatory Body (or bodies) with the power, independence and authority to enforce fair and rational "conditions of supply." Tariff setting has to protect the interest of both current and potential consumers. The regulatory body must therefore encourage investment. For this reason, all actions and disputes following the issue of an investment license (within a well-specified licensing policy), come within the purview of the regulatory authority. Government should make clear that it will not interfere at this stage, if the policy framework is to have sufficient credibility with potential investors.
Production and Supply
The functions of production and supply need to be separated from the policy making and regulatory functions. This is essential no matter what the relative role of public and private sectors in the future. The producer or supplier must function within a system of rules and regulations designed to promote the long-term interests of all users (consumers). Within this framework they must have freedom to function as commercial organisations.
STATE ELECTRICITY BOARDS
There is an urgent need to reform the State Electricity Boards. This reform has many dimensions, and it is useful to define the range of possibilities. The diversity of economic and political conditions under which State Electricity Boards operate, makes it unlikely that any single solution will be adopted by all.
Bifurcation or Trifurcation
Given the existing monopoly of the State Electricity Boards in both Production and Supply, there is a strong case for separating Production from Supply by making them the responsibility of different organisations. This will make it easier to introduce effective competition into generation. It may also be desirable to go one step farther by separating transmission from distribution, as this will help in attracting independent distribution companies into the system.
Corporatisation
Our experience with Public Sector Companies and Nationalised Banks shows that Corporatisation can help in changing the orientation and performance of publicly owned units. A professional board, consisting of a mix of internal and external directors, is also helpful in orienting these units towards efficient and profitable operation. The attitude and objectives of the minister and the secretary of the concerned department are also critical in the transition period.
In some States, it may be easiest to hive off the generation part into a separate corporation, while leaving the State Electricity Board in charge of distribution. In other States it may be easier to convert the entire Electricity Board into a single company, while leaving open the issue of Bifurcation or trifurcation to a later date. The bolder ones may like to follow in the footsteps of Orissa by forming three separate companies for generation, transmission and distribution.
Co-operatives \
Another possibility that needs to be seriously considered is, to hive off parts of the distribution system into consumer co-operatives. Thus we should encourage the formation of professionally managed farmer's electricity distribution co-operatives in rural areas. An alternative would be, to hive off all three functions of the State Electricity Board, over defined rural areas, into Power co-operatives. The generating capacity transferred would be equal to the current supply of electricity to the concerned region. Further growth and development of power in the region would primarily be the responsibility of the co-operative. Similarly co-operative could be formed for distribution of electricity to slum areas, with metered supply by the State Electricity Board to the co-operative.
Leasing
There are several generating plants, whose performance is abysmal. We must encourage the State Electricity Boards to lease out such plants to the private sector for a defined period. The period should be long enough to encourage investment in renovation and maintenance. One arrangement for such leasing could be as follows:
The current supply of electricity by each such generating station and its cost would be estimated. The lessee would be required to supply this amount of power at the calculated cost (along with the existing formula for adjustment in fuel charges). The lessee would be free to sell any additional power he generates to anyone, at rates to be negotiated directly by him.
Similar experimentation is needed on the distribution side with selected distribution areas to be leased out, benchmarked on current supply to and revenues from, the area. The additional revenues generated by the lessee will be shared between it and the State Electricity Board, in a proportion to be determined through an auction.
Sale
Generating stations could also be transferred to co-operatives and private operators on a Buy Operate Transfer basis. As in the case of the lease, a certain amount of power would have to be given to the State Electricity Board at the current cost. The hiving of a rural region from the State Electricity Board, as a co-operative, could also require sale of the assets to the co-operative.
Accounts & Audit
State Electricity Boards should be required by law to maintain accounts and have them audited by independent auditors (whether they are converted into companies or not). Public interest would be even better served if annual cost and social audit are also made compulsory. This will bring pressure to check theft, collusion, corruption and inefficiency even before regulatory authorities are set up. These audits would be an invaluable source of information for tariff setting and preservation of consumer interests, once regulatory authorities are set up.
FUEL DE-CONTROL
There are reasons to believe that the control on fuel supply to power projects has resulted in rent seeking and delay in entry of private power producers. To solve this problem for good, all fuels of potential use by the power sector should be de-controlled. This means that import of Naphtha must be on OGL with an appropriate tariff to protect domestic producers. Any remaining controls on import of gas (LNG, CNG, etc) should also be removed. At the very least, a start must be made by putting imports of all these on SIL. Tariff setting must keep in view the necessity of dismantling of the Administered Price Mechanism, and the objective of bringing tariffs to Asian levels by the turn of the century.
Remaining impediments to competition within and private entry into the coal sector must also be dealt with urgently. This requires a review and reform of policies, procedures and rules for exploration, leasing and exploitation of coal reserves, with the active participation of potential investors.
ELECTRICITY CONSERVATION
Energy Labelling
Power consumption labelling must be made compulsory. Purchasers can then judge the efficiency and running costs of electrical machinery, equipment and consumer goods that they purchase. This will also create awareness among the producers of power equipment about the energy efficiency of their products. Such energy labelling would also be required on all imported electrical equipment before it is sold in India. Labelling will ultimately create competitive pressure for improvement in energy efficiency of equipment and appliances.
POSTSCRIPT (September 2000)
Over four years have passed since the above paper was written and the pace of reforms is not adequate to give us any confidence that the power problem will be licked within the next 5 years. The time may therefore have come to consider even more radical reforms. That is a complete de-control and de-licensing of power generation and distribution. That is any individual, co-operative or company could generate and/or distribute power without getting any investment licence or prior clearance. It would therefore be free to compete with the State Electricity Board, just as the latter would be free to compete (operate) in any other State. As with any other producer the power producer or distributor would be subject to the environment, health and safety laws of the country.
The regulatory authority would set upper limits on the electricity rates that can be charged at the retail level and leave (at least for the next 5 years till there is a visible improvement in supply) everything else to competition. Regulatory permits could, however, still be required for distribution and transmission systems above a certain size. These limits could initially be set quite high to encourage a Small-Scale Power sector and gradually reduced over the next 5 years or so.
Essential to the success of this policy would be a complete de-control and de-licensing of all potential fuels (e.g. coal, LNG) for the power industry. Even though this is already in process and is to be completed in the next few years, it would be helpful if the process is speeded up.
Given the horrendous state of T&D losses in India, with the figure reaching 50% in the capital city of India, it is no exaggeration to call these “Theft & Dacoity” losses. The Mafia like operation of those within these electricity distribution outfits who are responsible for such losses has to be experienced to be believed. Each State must set up a Special Task Force (STF) a la Veerapan to root out this “Dacoity.” This root and branch operation can start with the metropolitan cities and move on to the large towns.
Wednesday, June 28, 1995
Inflation and Import Liberalisation
The inflation rate has been falling fairly steadily since the beginning of 1995, and is expected to continue on this path. This has happened despite the increase in aggregate demand arising from the sharp increase in industrial production and the step up in GDP growth. The demand factors which have restrained inflation during 1995 are a lower fiscal deficit( as % of GDP) and tighter monetary policy. On the supply side the continuing growth in agricultural output has played a positive role, and this is expected to continue given the normal monsoon forecast. The freed imports of several commodities such as edible oils, sugar, cotton and rubber also has a restraining effect, though rising world prices have nullified this potential benefit in some cases. As world demand growth is slowing, the impact of these measures will be enhanced. The build-up of food stocks, though it suppresses inflationary expectations, also reduces current supply. It has therefore to be carefully managed over the rest of 1995-96 to ensure a restraining effect on inflation.
Further declines in inflation in the medium term, will depend critically on the fiscal deficit, trade policy and policy for, and investment in, non-tradeable goods. Since the seventies, poor public saving performance and low expenditure productivity, to which the fiscal deficit is related, have acted as a drag on the economy. A sustained reduction in the fiscal deficit of the Centre and States, through a reduction in unproductive revenue and capital expenditures, is essential for simultaneously attaining both higher growth and lower inflation.
Trade policy affects those goods, which are available in international markets and can be readily transported. Most goods fall in this category. The transfer of all these goods to OGL by the end of the eighth plan as envisaged in the plan document, would make it possible to reduce inflation. As the last few years surge in world GDP growth has now plateaued and may even decline in the next few years, this will reduce the pressure on critical agricultural and intermediate goods prices.
There are a few agricultural goods such as pulses and gram in which the world market is very limited or non-existent. Such goods are effectively "non-tradeable", and productivity enhancing investments in R&D and extension, will be needed if supply is to keep pace with demand.
The most critical area of non-tradeable for the future is infrastructure services. The speed at which policies, rules and procedures are changed to attract private investment will determine how far inflation can be reduced. Transparent procedures which generate public support can speed up private investment to fill supply gaps. Power distribution and rail transport, the two sectors in which private entry is still restricted, are most likely to hinder a further reduction in inflation. Privatisation of urban power distribution and entry of private providers for freight and passenger services, coupled with establishment of Independent regulatory agencies are possible solutions.
The average rate of inflation since 1970-71 has been a little over 9% per annum. It was, however, significantly lower than this in the 1950s and 1960s. The average inflation rate depends on the degree of openness of the economy and the rate of increase in productivity.
The eighties were characterised by an average inflation rate lower than, and a growth rate higher than, in the seventies. The policy reforms initiated in 1980 played an important role in this development. Once excess capacity is used up, faster growth can however, generate inflationary pressures. These pressures are most likely to emerge from the non-tradeable infrastructure sectors. The experience of East Asia shows that the correlate on can be reduced by faster policy reforms, better governance, reduced fiscal deficits and increased private including (direct) foreign investment.
Further declines in inflation in the medium term, will depend critically on the fiscal deficit, trade policy and policy for, and investment in, non-tradeable goods. Since the seventies, poor public saving performance and low expenditure productivity, to which the fiscal deficit is related, have acted as a drag on the economy. A sustained reduction in the fiscal deficit of the Centre and States, through a reduction in unproductive revenue and capital expenditures, is essential for simultaneously attaining both higher growth and lower inflation.
Trade policy affects those goods, which are available in international markets and can be readily transported. Most goods fall in this category. The transfer of all these goods to OGL by the end of the eighth plan as envisaged in the plan document, would make it possible to reduce inflation. As the last few years surge in world GDP growth has now plateaued and may even decline in the next few years, this will reduce the pressure on critical agricultural and intermediate goods prices.
There are a few agricultural goods such as pulses and gram in which the world market is very limited or non-existent. Such goods are effectively "non-tradeable", and productivity enhancing investments in R&D and extension, will be needed if supply is to keep pace with demand.
The most critical area of non-tradeable for the future is infrastructure services. The speed at which policies, rules and procedures are changed to attract private investment will determine how far inflation can be reduced. Transparent procedures which generate public support can speed up private investment to fill supply gaps. Power distribution and rail transport, the two sectors in which private entry is still restricted, are most likely to hinder a further reduction in inflation. Privatisation of urban power distribution and entry of private providers for freight and passenger services, coupled with establishment of Independent regulatory agencies are possible solutions.
The average rate of inflation since 1970-71 has been a little over 9% per annum. It was, however, significantly lower than this in the 1950s and 1960s. The average inflation rate depends on the degree of openness of the economy and the rate of increase in productivity.
The eighties were characterised by an average inflation rate lower than, and a growth rate higher than, in the seventies. The policy reforms initiated in 1980 played an important role in this development. Once excess capacity is used up, faster growth can however, generate inflationary pressures. These pressures are most likely to emerge from the non-tradeable infrastructure sectors. The experience of East Asia shows that the correlate on can be reduced by faster policy reforms, better governance, reduced fiscal deficits and increased private including (direct) foreign investment.
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