Economic Survey 2014-15: Economic Outlook and Modi Government’s policy challenges

Newsroom24x7 Desk

economic_surveyNew Delhi: The Union Finance Ministry today released the Economic Survey 2014-15 which presents the economic outlook and the Modi Government’s Policy chhallenges.

The Survey prepared by chief economic adviser Arvind Subramanian and released ahead of the Budget for 2015-16 shows that Macroeconomic fundamentals in 2014-15 have dramatically improved.

The Survey highlights are:
         Inflation has declined by over 6 percentage points since late 2013.
         The current account deficit has declined from a peak of 6.7 percent of GDP (in Q3, 2012-13) to an estimated 1.0 percent in the coming fiscal year.
         Foreign portfolio flows have stabilized the rupee, exerting downward pressure on long-term interest rates, reflected in yields on 10-year government securities, and contributed to the surge in equity prices.
         In response to the favourable terms of trade shock (especially with regard to oil), macroeconomic policy has appropriately balanced government savings (two-thirds) and private consumption (one-third).
         After a nearly 12-quarter phase of deceleration, real GDP has been growing at 7.2 percent on average since 2013-14, based on the new growth estimates of the Central Statistics Office. Notwithstanding the new estimates, the balance of evidence suggests that India is a recovering, but not yet a surging, economy.

         From a cross-country perspective, a Rational Investor Ratings Index (RIRI) which combines indicators of macro-stability with growth, illustrates that India ranks amongst the most attractive investment destinations. It ranks well above the mean for its investment grade category (BBB), and also above the mean for the investment category above it (on the basis of the new growth estimates).

         Several reforms have been undertaken and more are on the anvil.  The introduction of the GST and expanding direct benefit transfers can be game-changers.

         Structural shifts in the inflationary process are underway due to lower oil prices, deceleration in agriculture prices and wages, and dramatically improved household inflation expectations. Going forward inflation is likely to remain in the 5-5.5 percent range, creating space for easing of monetary conditions.

         In the short run, growth will receive a boost from the cumulative impact of reforms, lower oil prices, likely monetary policy easing facilitated by lower inflation and improved inflationary expectations, and forecasts of a normal monsoon in 2015-16. Using the new estimate for 2014-15 as the base, GDP growth at constant market prices is expected to accelerate to between 8.1 and 8.5 percent in 2015-16.

         Medium-term prospects will be conditioned by the “balance sheet syndrome with Indian characteristics” that has the potential to hold back rapid increases in private sector investment. Private investment must be the engine of long-run growth.  However,there is a case for reviving targeted public investment as an engine of growth in the short run to complement and crowd-in private investment.

         India can balance the short-term imperative of boosting public investment to revitalize growth with the need to maintain fiscal discipline. Expenditure control, and expenditure switchingfrom consumption to investment,will be key.

         The outlook is favourable for the current account deficit and its financing. A likely surfeit, rather than scarcity, of foreign capital will complicate exchange rate management. Reconciling the benefits of these flows with their impact on exports and the current account remains an important challenge going forward.

         India faces an export challenge, reflected in the fact that the share of manufacturing and services exports in GDP has stagnated in the last five years. The external trading environment is less benign in two ways: partner country growth and their absorption of Indian exports has slowed, and mega-regional trade agreements being negotiated by the major trading nations in Asia and Europe threaten to exclude India and place its exports at a competitive disadvantage.

         India is increasingly young, middle-class, and aspirational but remains stubbornly male. Several indicators suggest that gender inequality is persistent and high. In the short run, the renewed emphasis on family planning targets,backed by misaligned incentives, is undermining the health and reproductive autonomy of women.
Fiscal Framework
         India must adhere to the medium-term fiscal deficit target of 3 percent of GDP. This will provide the fiscal space to insure against future shocks and also to move closer to the fiscal performance of its emerging market peers.

         India must also reverse the trajectory of recent years and move toward the golden ruleof eliminating revenue deficits and ensuring that, over the cycle, borrowing is only for capital formation.

         Expenditure control combined with recovering growth and the introduction of the GST will ensure that medium term targets are comfortably met.

         In the short run, the need for accelerated fiscal consolidation is lessened by the dramatically changed macro-circumstances and the less-than-optimal nature of pro-cyclical policy. The ability to do so will be conditioned by the recommendations of the Fourteenth Finance Commission (FFC).

         Nevertheless, to ensure fiscal credibility and consistency with medium-term goals, the process of expenditure control to reduce the fiscal deficit should be initiated. At the same time, the quality of expenditure needs to be shifted from consumption, by reducing subsidies, towardsinvestment.

         Finally, implementing the FFC recommendations will lead to states accounting for a large share of total tax revenue.  This has the important implication that, going forward, India’s public finances must be viewed at the consolidated level and not just at the level of the central government. If recent trends in state-level fiscal management continue, the fiscal position at the consolidated level will be on a sustainable path.

Subsidies and the JAM Number Trinity Solution
The debate is not about whether but how best to provide support to the poor and vulnerable. The government subsidises a wide variety of goods and services with the aim of making them affordable for the poor, including: rice, wheat, pulses, sugar, railways, kerosene, LPG, naphtha, iron ore, fertiliser, electricity, water.
The direct fiscal cost of these select subsidies is roughly Rs. 378,000 crore or 4.2 percent of 2011-12 GDP.  This is roughly how much it would cost to raise the expenditure of every household to the level of a 35th percentile household (well above the 21.9percentTendulkar Committee poverty line).
Are these subsidies effectively targeted at the poor? Unfortunately, subsidies can sometimes be regressive and suffer from leakages. For example, electricity subsidies by definition only help electrified households. Even in the case of kerosene, 41 percent of PDS kerosene is lost as leakage and only 46 percent of the remaining 59 percent is consumed by households that are poor.
The JAM Number Trinity – Jan Dhan Yojana, Aadhaar, Mobile – can enable the State to transfer financial resources to the poor in a progressive manner without leakages and with minimal distorting effects.
The Investment Challenge
         The stock of stalled projects stands at about 7 percent of GDP, accounted for mostly by the private sector. Manufacturing and infrastructure account for most of the stalled projects.  Changed market conditions and impeded regulatory clearances are the prominent reasons for stalling in private and public sectors, respectively.

         This has weakened the balance sheets of the corporate sector and public sector banks, which in turn is constraining future private investment, completing a vicious circle.

         Despite high rates of stalling, and weak balance sheets, the stock market valuations of companies with stalled projects are quite robust,which is a puzzle.

         Combining the situation of Indian public sector banks and corporate balance sheets suggests that the expectation that the private sector will drive investment needs to be moderated. In this light, public investment may need to step in to ramp up capital formation and recreate an environment to crowd-in the private sector.

The Banking Challenge
         The Indian banking balance sheet is suffering from ‘double financial repression’.  On the liabilities side, high inflation lowered real rates of return on deposits.  On the assets side, statutory liquidity ratio (SLR) and priority sector lending (PSL) requirements have depressed returns to bank assets. As inflation moderates and the banking sector exits liability-side repression, it is a good time to consider addressing the asset-side counterpart.

         In a cross-country comparison, controlling for the level of development, the size of the Indian banking system, measured by credit indicators, does not seem too high either in absolute terms or relative to other sources of financing. However, going forward, capital markets and bond-financing need to be given a boost.

         Private sector banks did not partake in the biggest private-sector-fuelled growth episode in Indian historyduring 2005-2012.  This is reflected in the near-constant share of private sector banks in deposits and advances in those years.

         There is substantial variation in the performance of the public sector banks, so that they should not be perceived as a homogenous block while formulating policy.

Putting Public Investment on Track – the Rail Route to Higher Growth.
         The Indian Railways over the years have beenon a ‘route to nowhere’characterized by underinvestment resulting in lack of capacity addition and network congestion; neglect of commercial objectives; poor service provision; and consequent financial weakness.  These have cumulated to below-potential contribution to economic growth.

         Very modest hikes in passenger tariffs and cross-subsidisation of passenger services from freight operations over the years have meant that Indian (PPP-adjusted) freight rates remain among the highest in the world, with the railways ceding significant share in freight traffic to roads (that is typically more costly and energy inefficient).

         As a result, the competitivenessof Indian industry has been undermined. Calculations reveal that China carries about thrice as much coal freight per hour vis-à-vis India. Coal is transported in India at more than twice the cost vis-à-vis China, and it takes 1.3 times longer to do so.

         Econometric evidence suggests that the railways public investment multiplier (the effect of a Rs. 1 increase in public investment in the railwayson overall output) is around 5.
         However, in the long run, the railways must be commercially viable and public support must be linked to railwayreforms: adoption of commercial practices; tariff rationalization; and technology overhaul.

Skill India to Complement Make in India
What should we ‘Make in India’?  Sectors that are capable of facilitating structural transformation in an emerging economy must:
Have a high level of productivity.
Show convergence to the technological frontier over time.
Draw in resources from the rest of the economy to spread the fruits of growth.
Bealigned with the economy’s comparative advantage; and Betradeable.

Registered manufacturing, construction and several service sectors — particularly business services — perform well on these various characteristics.  A key concern with these sectors however is that they are rather skill-intensive and do not match the skill profile of the Indian labour force.
India could bolster the Make in India’’initiative, which requires improving infrastructure and reforming labor and land laws by complementing it with the‘’Skilling India initiative.  This would enable a larger section of the population to benefit from the structural transformation that such sectors will facilitate.

A National Market for Agricultural Commodities
•      Markets in agricultural products are regulated under the Agricultural Produce Market Committee (APMC) Act enacted by State Governments. India has not one, not 29, but thousands of agricultural markets.
•      APMCs levy multiple fees of substantial magnitude, that are non-transparent, and hence a source of political power.
•      The Model APMC Act, 2003 could benefit from drawing upon the ‘Karnataka Model’ that has successfully introduced an integrated single licensing system. The key here is to remove the barriers that militate against the creation of choice for farmers and against the creation of marketing infrastructure by the private sector.

Climate Change
         India has cut subsidies and increased taxes on fossil fuels (petrol and diesel along with a coal cess) turning a carbon subsidy regime into one of carbon taxation. The implicit carbon tax is US$ 140 for petrol and US$64 for diesel.

         In light of the recent falling global coal prices and the large health costs associated with coal, there may be room for further rationalization of coal pricing. The impact of any such changes on affordable energy for the poor must be taken into account.

         On the whole, the move to substantial carbon taxation combined with India’s ambitious solar power program suggests that India can make substantial contributions to the forthcoming Paris negotiations on climate change.

Rashtriya Swasthya Bima Yojana; Provides Health Insurance to Unorganized Workers Belonging to BPL Category and their Families
The Government has not received any reports that suggest single women, widows and senior citizens do not have aceess to private health insurance and are excluded from State funded schemes in rural areas. Rashtriya Swasthya Bima Yojana (RSBY) is a Government run scheme which provides health insurance to unorganized workers belonging to BPL category and their families. During the course of implementation, apart from BPL families, RSBY coverage has been extended to other categories of unorganized workers viz building and other construction workers, licensed railway porters, street vendors, MGNREGA workers (who have worked for more than 15 days during preceding financial year), beedi workers, domestic workers, sanitation workers, mine workers, rickshaw pullers, rag pickers and auto/taxi drivers. Under the scheme, the eligible families in the unorganized sector are provided smart card based cashless health insurance cover of Rs. 30,000/- per annum. Single women, widows and senior citizens falling in the above categories of beneficiaries are covered under RSBY notwithstanding whether they hold or have access to private health insurance policy or not. This was stated by Shri Jayant Sinha, Minister of State in Ministry of Finance in written reply to a question in the Lok Sabha today.

Cut in Repo Rate
The Reserve Bank of India (RBI) has cut the Repo Rate recently. It has reduced the Repo Rate under the liquidity adjustment facility (LAF) by 25 basis points (bps) from 8.0 per cent to 7.75 per cent on January 15, 2015. With the introduction of Base Rate System since July 1, 2010, all rupee lending rates (including advances upto Rs. 2 lakh) have been deregulated. Accordingly, the interest rates on rupee advances are determined by banks with the approval of their respective Boards. In a deregulated environment, banks have complete freedom in deciding their spread, risk premia, term premia and other customer specific charges as considered appropriate on the loans and advanes based on their commercial judgment. Following the reduction in the policy rate by 25bps to 7.75 per cent on January 15, 2015, the median base (lending) rate of banks declined by 5 bps to 10.20 per cent so far (upto February 23, 2015). Eight banks (2 Public Sector Banks, 1 private sector bank and 5 foreign banks) have reduced their base rates in the range of 25-50 bps so far. br> This was stated by Shri Jayant Sinha, Minister of State in Ministry of Finance in written reply to a question in the Lok Sabha today.

Improvement in Female Literacy and Educational Challenges 

There has been a marked improvement in female literacy as per Census 2011. Though the male literacy is still higher at 80.9 percent than female literacy at 64.6 percent, the increase has been 10.9 percent compared to 5.6 percent of the males. The new Scheme Beti Bachao Beti Padhao, for promoting survival protection and education of girl child aims to address the issue of declining figures through a mass campaign targeted at changing social mindset and creating awareness. The right of Children to free and compulsory Education (RCE) act 2009 implemented under Sarv Shiksha Abhiyan aimed to increase the quality as well as accessibility of elementary Education in India. Economic Survey points out that the overall Standard of Education in India is below global Standards. The Programme for International Students Assessment (PISA) which measures the knowledge and skills of 15 year-olds has rated Tamil Nadu and Himachal Pradesh only higher to other States in the Country. There is a considerable scope for Post-Secondary Education and Training System, as well as for places, to improve the Proficiency of young People. The inadequacy of human capital at the base of the pyramid leading to a huge backlog in basic skills put become a big impediment in India’s growth as a result of the changing demography and declining child population. The Padhe Bharat Badhe Bharat initiative to create a base for reading, writing, and math fluency can be effective if the local administration is fully involved and sensitized in it. India has about 100 million young people in the age group of 15-18 years, majority of which could land up in unorganized sector as there are educational and age requirement for entry into most vocational skills Programmes. There is a need for research into the type of knowledge or skills required to address this issue. In order to build capacity in secondary schools on par with expanded primary enrolments, several schemes like the Mid-Day Meal scheme, Rashtriya Madhyamik Shiksha Abhiyan, Model School Scheme and Saakshar Bharat/Adult Education have also been implemented in the country. To strengthen the cadre of teacher educators by providing early career choice to prospective teachers and to fill the vacancies in teacher education institutions, a new four-year integrated programme, i.e. BA./Bed, and BSc./Bed. has been introduced. The Indian higher education system is one of the largest in the world with 713 universities, 36,739 colleges, and 11,343 diploma-level institutions. To make Higher Education to be futuristic envision areas that will generate future employment opportunities, there is a need to match the supply with demand and dovetail education policy to employment opportunities.

Wiping Every Tear from Every Eye: The Jan Dhan Yojana, Aadhaar and Mobile Numbers Provide the Solution
Both the Central and State Government subsidize the price of wide range of products with the expressed intention of making them affordable for the poor. Rice, wheat, pulses, sugar kerosene, LPG, naptha, water, electricity, diesel, fertilizer, iron ore, railways- these are just a few of the commodities and services that the Government subsidises.

There is always a question over how much of these benefits actually reach the poor.

  Price subsidies  are often regressive: It means that a rich household benefits more from the subsidy than a poor household.

         Price subsidies in electricity can only benefit the (relatively wealthy) 67.2 percent of household that are electrified.
         The poorest 50 percent of household consume only 25 percent of LPG.
         Majority (51 percent) of subsidized kerosene is consumed by the non-poor and almost 15 percent of subsidized kerosene is actually consumed by relatively well-off (the richest 40 percent).
         A large fraction of price subsidies allocated to water utilities- upto 85 percent- are spent on subsidizing private taps when 60 percent of poor household get their water from public taps.
         Controlled rail prices actually provide more benefits for wealthy household than poor households.

  Price subsidies can distort markets in ways that ultimately hurt the poor.

         This contributes to food price inflation that disproportionately hurts poor household who tend to have uncertain income streams and lack the assets to weather economic shocks.
         High MSPs and price subsidies for water together lead to water-intensive cultivation that causes water tables to drop, which hurts farmers, especially those without irrigation.
         In order to cross subsidise low passenger fares, fright tariffs in railways are among the highest in the world. This reduces the competitiveness of Indian manufacturing and raises the cost of manufactured goods that all households, including the poor, consume.
         Benefits from fertilizer price subsidies probably accrue to the fertilizer manufacturer and richer farmer, not the intended beneficiary, the farmer


Recent experimental evidence documents that unconditional cash transfers- if targeted well- can boost household consumption and asset ownership, reduce food security problems for the ultra-poor and opportunities for leakage.

The JAM Number Trinity- Jan Dhan Yojana, Aadhaar and Mobile numbers- allows the state to offer this support to poor households in a targeted and less distortive way.
         As of December 2013 over 720 million citizens had been allocated an Aadhaar card. By December 2015 the total number of Aadhaar enrolments in the country is expected to exceed 1 billion. Linking the Aadhaar Number to an active bank account is key to implementing income transfers.
         With the introduction of Jan Dhan Yojana, the number of bank accounts is expected to increase further and offering greater opportunities to target and transfer financial resources to the poor.
Two alternative financial delivery mechanisms below:
  Mobile Money

          With over 900 million cell phone users and close to 600 million unique users, mobile money offers a complementary mechanism of delivering direct benefits to a large proportion of the population. And this number is increasing at a rate of 2.82 million per month.
         Aadhaar registrations include the mobile numbers of a customer, the operational bottlenecks required to connect mobile numbers with unique identification codes is also small.

 Post Offices

         India has the largest Postal Network in the world with over 1,55,015 Post Offices of which (89.76 percent) are in the rural areas.
         Similar to the mobile money framework, the Post Office can seamlessly fit into the Aadhaar linked benefits-transfer architecture by applying for an IFSC code which will allow post offices to start seeding Aadhaar linked accounts.
Converting all subsidies into direct benefit transfers is therefore a laudable goal of government policy. Even as it focuses on second generation and third generation reforms in factor markets, India will then be able to complete the basic first generation of economic reforms.

Major Reform Initiatives Undertaken by Government in Banking, Insurance and Financial Sector
Economic Survey 2014- 15 states that liquidity conditions (money supply) have remained broadly balanced during 2014-2015 except for some temporary tight conditions due to delayed government expenditure. Steps taken by the Reserve Bank of India (RBI) played a positive role in managing the liquidity conditions.
         Till January 2015, RBI had kept the policy rates unchanged. As inflationary conditions eased, RBI softened the monetary policy by cutting the Repo rates by 25 basis points in January 2015 (from 8% to 7.75%).
         The Reserve Bank of India (RBI) also adopted new Consumer Price Index (combined) as the measure for nominal anchor (Headline CPI) for policy communication.

Economic Survey 2014- 15 also mentions about the many reform initiatives undertaken in the banking sector during 2014- 2015. These include

1.       Banks being allowed to raise capital from the market to meet capital adequacy norms by diluting the government’s stake up to 52 per cent.

2.      Pradhan Mantri Jan Dhan Yojana launched to provide universal access to banking facilities with at least one basic banking account for every household.

3.      In April 2014, two applicants have been granted ‘in principle’ approval to set-up new banks in the private sector within 18 months.

4.      RBI released guidelines and invited applications for setting up payments banks and local area banks.

According to Economic Survey, FY 2014- 2015 saw some stress on the asset quality of the Scheduled Commercial Banks as there was an increase in gross NPA (Non Performing Advances) to the total gross advances. NPA increased from 4.1 %( March 2014) to 4.5 %( September 2014). As on June 2014 , five subsectors, viz. Infrastructure, Textiles, Iron & Steel, Mining and aviation hold 54% of total stressed advances of Public Sector Banks.
Actions taken by RBI to deal with NPAs
1.      Issued guidelines, prompting banks to act as soon as a sign of stress is noticed in borrower’s actions and not to wait for it to become a NPA.
2.      Tightened norms to Asset Reconstruction Companies, increasing the minimum investment in security receipts to 15% from 5%.
3.      Issued guidelines to bring flexibility in project loans to infrastructure and core industry projects.

2014- 2015 also saw a decline in the growth of bank credit due to high accretion of NRI deposits and also due to low deposit mobilization

Economic Survey points out that insurance penetration in India has grown from 2.3% in 2000 t0 3.9% in 2013. This insurance penetration level compares well with the emerging market economies. The sector registered a growth of 9.4% during 2013- 14 with Life Insurance Corporation of India registering 13.5 % growth.

 Reform initiatives in Insurance sector during 2014- 2015

1.      Promulgation of Insurances Laws (Amendment) Ordinance 2014  :
         to remove archaic and redundant provisions in insurance laws
         empowering Insurance Regulatory and Development Authority to enable more effective regulation
         to increase the foreign equity cap in Indian Insurance Companies from 26% to 49%

Equity Markets continue to do well for the financial year 2014- 2015 as per the Economic Survey 2014- 15. The benchmark indices, BSE Sensex and Nifty showed a general upward trend in the current year with growth rates of 29.9 % and 31.4 % year on year.
Reform initiatives in financial sector during 2014- 2015
1.      Improvement in Corporate Governance norms
2.      Establishment of a foreign portfolio investor for better functioning of both primary and secondary markets

Overall Economic Survey 2014-15 talks about increased financial inclusion, improved insurance penetration and fast growing equity markets in India. It also dwells into the problems faced by the banking sector and the major policy initiatives by the government to enable the growth of banking, insurance and financial sectors.