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Macro-Economic
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The External Sector and International Dimensions 2.161 A viable external sector is an important component of a successful development strategy. It is indeed the cornerstone of all efforts at achieving self-reliance, which is one of the objectives of the Ninth Plan. Historically, India’s economic relations with the rest of the world has been characterised by a certain degree of insulation from the international economy. This has, however, not prevented the periodic emergence of balance of payments crises, the latest of which was in 1991-92. The liberalisation of the external sector, following the crisis of 1991-92 indicated a substantial shift in the approach to India’s external economic relations, the lessons from which need to be carefully considered in planning for the future. 2.162 The experience on the balance of payments front during the Eighth Plan brings out four very important lessons. First, the balance of payments outcome is closely influenced by macroeconomic, fiscal and monetary policies. Prudent macro-policies, of which control of the fiscal deficit, particularly the revenue deficit, is a central element, are not only essential for internal balance but also for external balance. Second, excessively high tariffs on imports often impart an anti-export bias to policies through cost escalation of imported inputs essential for exports and through pre-emption of domestic resources for the relatively high cost production of importables in the domestic economy by increasing their profitability relative to exportables. Third, the apprehension that Indian industry will be adversely affected by external competition, when import licensing is relaxed, has largely been proved to be unfounded. Overall industrial growth recovered quickly from the crisis-hit low of 1991-92. In 1994-95 and 1995-96 both industrial output and imports grew unusually rapidly, dispelling apprehensions about Indian industry’s ability to take advantage of external opportunities. Interestingly, during recent years, small scale industry has grown even faster than overall industry. Fourth, the experience during the Eighth Plan demonstrates that Indian industry, particularly the small scale sector, can effectively utilise export opportunities and generate high quality employment opportunities through the export of labour intensive items. 2.163 The approach to the external sector during the Ninth Plan builds on the experience gained during the Eighth Plan and on certain emerging realities which need to be faced squarely. The actual balance of payments outcome will no doubt depend on developments in the world economy - for example, the state of international commodity prices including that of oil, world growth and the state of the international capital market, which have important bearing on India’s exports, imports, invisible earnings (especially remittances), foreign investment flows and non-resident deposit flows. These are exogenous factors which are beyond the control of the country. However, the development strategy, the policy environment and internal macroeconomic balance will also be crucial determinants of the balance of payments outcome. 2.164 The maintenance of an appropriate policy-mix through the Ninth Plan is essential for consolidating and building on the strength of the external sector achieved during the Eighth Plan. Such an appropriate mix requires a close and concerted coordination of fiscal policy, monetary policy, exchange rate policy, export-import (EXIM) policy, industrial policy, foreign investment policy, external borrowing policy and external assistance policy. Furthermore, a restructuring of the policies with reference to the oil sector would be required. 2.165 Large fiscal deficits entail high government borrowing held by the Reserve Bank of India (RBI), leads to an acceleration of growth in money supply, and this, in turn, fuels inflation. Otherwise, they tend to raise the rate of interest, increasing the domestic cost of production. As a result of either effect, Indian exports become less competitive. Therefore, it is important for successful balance of payments management that the consolidated general Government fiscal deficit is steadily brought down to the levels recommended in the Plan. 2.166 The monetary policy stance of the RBI has to strike a fine balance between providing for legitimate credit needs of Government and productive sector versus controlling inflation and maintaining orderly conditions in the foreign exchange market. If money credit conditions are too loose, domestic demand will strengthen inflationary expectations and varying spreads between domestic and international interest rates will cause the Rupee to depreciate in a disorderly fashion along with excessive loss of foreign currency reserves. The more success that is achieved in reducing the fiscal deficit and pressures on the credit market from excessive demand from the public sector, the greater will be the scope for extending credit to productive sectors of the economy without endangering external payments balance. 2.167 The Ninth Plan assumes that the rapid growth of GDP would be associated with an expanding export market which supports high growth of economic activities in which the country has a comparative advantage, particularly those which are labour intensive in nature. The emphasis on exports goes beyond the need for generating foreign exchange earnings for meeting unavoidable imports, and determines to a large extent the entire production structure of the economy. There are three main considerations which need to be taken into account in this regard. 2.168 First, explicit account has to be taken of the fact that India, as a signatory to the World Trade Organisation (WTO), is committed to becoming a more open economy within a stipulated time-frame. In particular, the deadline for complete removal of all quantitative restrictions, which comes into effect during the Tenth Plan period, requires that the pre-conditions for successfully managing an open trade regime be created within the Ninth Plan period itself. Indeed, as per the existing time-table for the phasing out of quantitative restrictions on imports, a significant number of commodities will have to be taken out of the restricted list within the Ninth Plan itself. The phasing out of quantitative restrictions on imports and replacing license protection by tariff protection, appropriately calibrated to ensure orderly adjustment for domestic producers, has to be combined with providing incentives to domestic and foreign investors to expand their operations in infrastructure, intermediate and capital goods industries efficiently and taking full advantage of international trading opportunities. The possibility of a significantly higher rate of growth of imports during the Ninth Plan period and beyond both because of the commitment to import liberalisation and because of a higher rate of investment, which would still remain highly import intensive for quite some time to come, is accentuated by the fact that the country’s dependence on imported energy will rise rapidly in the coming years. All these will put a strain on the balance of payments unless adequate exports are forthcoming. Thus, exports can no longer be viewed merely as an exogenous variable determined outside the planning system and would have to be planned for in a careful and realistic manner during the Ninth Plan. 2.169 Second, since domestic consumption patterns change only slowly over time, there is a high probability of transient mismatch between the domestic production structure and the domestic demand pattern, especially during periods of rapid capacity creation. In order to prevent the emergence of periodic sectoral capacity underutilisation or excess supply, which has adverse feedback effects on investment demand, exports must have the flexibility to expand rapidly for absorbing the slack. The recent slowdown in the economy demonstrates the importance of sustained export growth for maintaining the tempo of overall growth and investment. Since the Ninth Plan envisages a considerable acceleration in the investment rate, even compared to the recent past, it is not enough to ensure adequate levels of aggregate demand at the macro-level, which has been built into the Plan, but also to create the conditions for adequate demand and supply balance at the meso-level by targetting high growth rate of exports. 2.170 Third - and perhaps the most important - the greater inflow of external investment resources that has been planned for accelerating the growth rate of the economy necessitates collateral planning for the future stream of payments such as interest, dividends and capital gains. Indeed, inflows of foreign capital themselves would depend upon a credible expectation of sustained export expansion to ensure the capacity to service these flows. Although for some time external capital flows may not only meet investment requirements but also maintain the foreign exchange reserves at a desirable level, in the longer run at least the latter requirement should be met from current revenues. This implies that efforts should be made to achieve a situation where a current account deficit (CAD) coexists with a trade surplus within a reasonable period of time. 2.171 For the Ninth Plan, in a significant departure from the past practice, the target for the growth rate of exports has not been derived residually from the estimated growth rate of imports and a target level of CAD. It has been worked out on the basis of the planned structure of growth and the levels of exportable surplus that would have to be made available at a sectoral level in order to attain the targetted growth rate of the economy with sustainable level of external capital inflows. The likely growth rate of imports has, therefore, been endogenously determined, not at the commodity level as was the case earlier, but in the aggregate. This approach reflects at once both the greater uncertainty in predicting the commodity composition of imports consequent upon the present and future import liberalisation and the belief that there is a greater short-run policy influence and control over imports than over exports despite the shift to a more liberal trading regime. 2.172 It needs to be borne in mind that the ex-post value of the current account deficit is determined primarily by the difference between the aggregate investment level and the gross domestic savings in the economy. This variable is amenable to control through fiscal policies, which affect both savings and investment, and through monetary policies, particularly credit policy, which influence investment demand. For an open economy, without much controls on imports and foreign exchange, the level of imports is thus determined mainly by the level of demand, while tariffs, by influencing the relative prices, only determine the composition of imports. Given the exogenously determined level of exports, therefore, the aggregate flow of imports can potentially be regulated in a fairly sensitive manner by normal macro-economic policy instruments. For such policy instruments to be used credibly, however, it is necessary not only to ensure that the fiscal stance described earlier by both the Centre and the States is adhered to rigorously, but also for the Centre in particular to achieve a fiscal position which would allow it to operate flexibly in either direction. It is difficult to achieve a credible degree of fiscal flexibility without the Central Government budget running a revenue surplus. This is one of the reasons why the Ninth Plan lays greater emphasis on the fiscal correction by the Centre as compared to the States. In addition, until the process of fiscal consolidation is complete, exchange rate and import duty policies would need to be used in a deliberate manner in order to ensure that both the level and structure of imports are commensurate with the needs of sustainable growth and development. 2.173 In the more liberal import regime that is being visualised, however, the extent of vigilance over trade matters has to be improved significantly both in degree and quality so that the interests of domestic industry are adequately protected within the limits and procedures set by the WTO. Equally, it is important not to allow any dilution of the rights and privileges to which India is entitled under Article XVIII of GATT in respect of the management of the border regime. Furthermore, the institutional arrangements for anti-dumping measures need to be strengthened quite considerably. With greater openness, the import of differentiated products is likely to increase faster than that of relatively homogeneous commodities. The degree of sophistication required to identify and prove dumping in such differentiated products is qualitatively greater than what exists in the present system. There has to be both an early warning system operating through the Customs authorities, and also an efficient market information system which can rapidly generate the requisite data from the originating countries, both of which being closely integrated with the designated anti-dumping authority to ensure speed and transparency. This would require not only a close coordination between the Ministries of Commerce and External Affairs and the Customs, but perhaps even some redefinition of the functions and responsibilities of the different components of the system. Since such changes tend to take time and involve a certain amount of learning-by-doing, the process for creating the necessary institutional structure needs to begin immediately. 2.174 The model results indicate that the rate of growth of imports can be permitted to be 10.8 per cent per annum on an average during the Ninth Plan as compared to 11.7 per cent observed during the Eighth Plan. The Eighth Plan figure, however, is conditioned by the negative growth of imports experienced in 1991-92. Correcting for this aberration, the average annual growth rate of imports was 10.4 per cent yielding an implicit elasticity of imports to GDP of 1.5 during the Eighth Plan, which is assumed to rise to about 1.7 during the Ninth Plan. The increase in elasticity essentially reflects partly the additional import of energy over and above the trend rate observed in recent years, and partly the import of goods which have heretofore not been reflected in the import basket and which may do so consequent upon liberalisation. In the terminal year of the Ninth Plan, the total value of imports is expected to be of the order of Rs. 220,990 crore or US $ 60.7 billion at constant prices. Of this, the standard basket of imports would be about Rs.211,585 crore (US $ 58.1 billion) and the nonstandard about Rs.9405 crore (US $ 2.6 billion). Although the composition of the import basket will be determined by a number of factors, particularly the relative prices of imports, the fact, that a large part of Indian imports are of an essential nature limits the extent to which their requirements will be price sensitive. The detailed commodity-wise structure of imports expected during the Ninth Plan period under the assumption of constant relative prices, is given in Table 2-40. Table 2-40 : Import Projections for Ninth Plan
(Rs. Million)
-----------------------------------------------------------------
1996-97
SECTOR -------------- 2001-02
DGCI and S RBI
-----------------------------------------------------------------
WHEAT 3900 4279 4787
OTHER CEREALS 5 5 8
PULSES 7069 7755 9384
JUTE 780 856 960
RUBBER 950 1042 1715
OTHER CROPS 6937 7610 7125
ANIMAL HUSBANDARY 5649 6198 5440
FORESTRY and LOGGING 7119 7809 6009
FISHING 2 2 4
COAL and LIGNITE 30817 33808 45226
CRUDE PETROLEUM and N.GAS 158802 174214 333908
OTHER METALLIC MINERALS 57038 62573 72084
NON METALLIC and MINOR MINERALS 110678 121419 126663
SUGAR 31 34 38
EDIBLE OIL 28268 31011 25874
OTH. FOOD and BEVERAGE IND. 858 941 1131
COTTON TEXTILES 2838 3114 3481
WOLLEN TEXTILES 2827 3101 3469
SILK TEXTILES 1313 1440 1613
ART.SILK AND SYNTHETIC FIBRES 3818 4188 5629
OTHER TEXTILES 2267 2487 3344
WOOD and WOOD PRODUCTS 9122 10007 10439
PAPER and PAPER PRODUCTS 27994 30711 50791
LEATHER and LEATHER PROD. 4517 4955 5542
RUBBER PRODUCTS 5060 5551 6541
PLASTIC PRODUCTS 3719 4080 3922
PETROLEUM PRODUCTS 190284 208752 154400
FERTILIZERS 27977 30695 26854
PESTICIDES 1546 1696 1899
SYNTH. FIBRE and RESIN 27653 30337 31504
PAINTS, DRUGS, COSMETICS 16038 17594 21644
OTHER CHEMICAL 99223 108854 145617
CEMENT 20 22 0
OTHER NON-METALLIC MINERAL PROD. 4201 4609 5155
IRON and STEEL 50377 55266 35261
NON-FERROUS METALS 37900 41578 56349
TRACTORS and OTH. AGRI. MACHINES 2517 2762 2509
OTHER NON-ELECTRICAL MACHINE 170271 215525 306074
ELECTRICAL MACHINE 30483 47806 73644
COMMUNICATIONS EQUIPMENT 51649 71026 64511
RAIL EQUIPMENT 6613 7255 6589
MOTOR VEHICLES 14089 44186 59886
MOTORCYCLE, SCOOTER and BICYCLES 701 769 861
OTHER TRANSPORT EQUIPMENT 24344 199081 302604
OTHER MANUFACTURING 83676 120523 179371
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TOTAL 1321940 1737530 2209860
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2.175 In so far as exports are concerned, the growth rate of aggregate exports has been targetted to be 11.8 per cent per annum over the Ninth Plan period. This growth rate can be decomposed into two primary factors : (a) the rate of growth of the tradable goods and services sectors; and (b) the propensity to export of these sectors. In view of the fact that Indian exports are primarily in the form of real goods (merchandise) and, with the exception of software and a minor component of consultancy services, is likely to continue to be so in the near future, an adequate approximation of the tradables sector would consist of agriculture, mining and quarrying, and manufacturing. A characteristic feature of the Indian economy has been the steady decline in the share of these sectors in GDP from 68 per cent in the First Five Year Plan to below 50 per cent in the terminal year of the Eighth Plan, as shown in Table 2-41. In other words, the (merchandise) tradables sector in India has grown at a slower pace than the economy as a whole. Table 2-41 : Share of (Merchandise) Tradables in GDP
(per cent)
----------------------------------------------
Plan Period Share of Tradables
----------------------------------------------
1. First 68.0
2. Second 66.8
3. Third 63.8
4. Fourth 61.0
5. Fifth 59.5
6. Sixth 57.3
7. Seventh 54.6
8. Eighth 51.5
1996-97 49.9
----------------------------------------------
NOTE : The
tradable goods sector is defined as the sum of the GDP originating in Agriculture,
Mining and Quarrying, and Manufac-turing. 2.176 If this trend is allowed to continue, the prospect of being able to attain the targetted growth rate of exports will become extremely difficult. It can be shown that the marginal propensity to export, or the share of exports in the incremental output of the tradable goods sectors, necessary to attain a targetted growth rate of exports (gx) is related to the average propensity to export (a), or the share of exports in the base year value of output of the tradables sector; the change in the share of tradable goods in GDP (t); and the growth of GDP (gy). In 1996-97, the value of ‘a’ is estimated to be 5.6 per cent and that of ‘t’ to be 49.9 per cent. The marginal propensity to export necessary for achieving a growth rate of exports of 11.8 per cent with a GDP growth rate of 6.5 per cent at different terminal year shares of the tradables sector is shown in Table 2-42. It may be seen that if the share of tradables is allowed to drop to 46 per cent of GDP, which would be the case if the trend behaviour were to obtain, 13.6 per cent of the incremental value of production in the tradables sectors would have to be exported in order to attain the targetted growth rate of exports. This is feasible, but the marginal propensity to export would have to be nearly two and a half times the average, which may be difficult to attain in a short span of time. The Ninth Plan is, therefore, predicated on the share of tradable remaining more or less at the level attained during the terminal year of the Eighth Plan (50 per cent), which would still require a marginal propensity to export of 10.5 per cent – which is somewhat under double the average propensity to export. Even this would require considerable efforts and cannot be assumed to be achievable without active policy intervention. Although targetting an increase in the share of tradables would make the conditions less demanding, there are two arguments against it at the present juncture. First, the Ninth Plan has to take into account the need to make up the backlogs in the infrastructure sectors, which are all nontradables, without which sustained growth of either the economy or of exports will not be feasible. Second, the focus on the social sectors will also require adequate investment in order to meet the objectives of the Plan. Once the immediate urgency of meeting the backlog in the economic and social infrastructure is over, perhaps by the Tenth Plan, efforts at actually raising the share of tradable goods and services in GDP would need to be taken up in order to improve the export base of the economy. Table 2-42 : Parameters for Attaining 11.8 per cent
Growth Rate of Exports
----------------------------------------------------
Share of Tradables Marginal Propensity
in GDP to Export
----------------------------------------------------
54% 8.2%
52% 9.1%
50% 10.2%
48% 11.6%
46% 13.6%
----------------------------------------------------
NOTE : The relevant relationship is :
m = a.gx/[gy + dt/t]
where : m = marginal propensity to export
dt = change in the share of
tradables in GDP.
2.177 The first, and possibly the most important, pre-condition for creating a more open economy, therefore, is to create an expanding production base of tradable goods and services which can not only withstand external competition, but can provide the surplus necessary to provide sufficient export earnings for meeting the import needs of the country. The second pre-condition is to create the conditions under which the export market becomes increasingly more attractive so that there is both a shift from selling in the domestic market to exports and that capacities are developed to specifically target such export opportunities. Both these conditions are inextricably interlinked, and involve the reduction and eventual elimination of the anti-export bias that has characterised the Indian economic system in the past and continues to exist to some degree even at present. There are two dimensions to this. First, the incentive structure has to be re-oriented towards investment in tradable goods and services and away from non-tradables. Second, the relative profitability of exports vis-a-vis domestic sales has to be improved. The principal instrument for achieving both these conditions is the exchange rate, which needs to be discussed in some detail. 2.178 With the steady reduction of controls in trade matters, the exchange rate has emerged as a major instrument of policy. It needs to be used firmly but judiciously to achieve steady and sustainable growth of trade, investment and competitiveness. With the introduction of almost full convertibility on the current account and also partial convertibility on the capital account, the exchange rate has already been made more sensitive to the demand for and supply of foreign exchange in the economy. This, however, may have to be tempered occasionally by strategic intervention by the Government in order to ensure that the imperatives of macro-economic policy are met. Since exports have a central role to play in the attainment of the Ninth Plan targets and in the present and future development strategy, it is suggested that the exchange rate should be viewed primarily as an instrument to affect the behaviour of exports at least until such time as the production base of the economy is sufficiently integrated with the international market and exports are robust enough to withstand periodic fluctuations in the exchange rate and in international prices. 2.179 The exchange rate not only affects the degree of price competitiveness of domestic tradables in comparison to international markets, but also determines the relative profitability of tradables vis-a-vis non-tradables in the domestic economy. In the present context, both the factors are of importance, and the conduct of exchange rate policy would have to take into account the somewhat different considerations that underlie the two objectives. The standard measure of domestic prices relative to the international is the real effective exchange rate, which adjusts the nominal exchange rate by the differential rates of inflation in India and abroad. During the Eighth Plan, the export-weighted real effective exchange rate (REER) of the rupee has shown considerable amplitude combining sharp depreciations with long periods of gradual appreciation, with the effect that at the end of the Eighth Plan (March 1997) the REER was 9.9 per cent above its level in March 1993, which implies that the relative price competitiveness of Indian exports on account of the exchange rate has been eroded to this extent. Matters are even worse if the effect of the exchange rate on relative attractiveness of tradables vis-a-vis non-tradables in the domestic economy is considered. The appropriate measure of this is not the REER, but the nominal exchange rate adjusted only by the domestic inflation rate. This measure has appreciated quite substantially over the same period by 20.6 per cent, as shown in Table 2-43. This behaviour of the exchange rate is not conducive to a steady move towards greater export-orientation of the economy. During the Ninth Plan, the exchange rate will need to be deliberately depreciated in terms of the average level of prices in the country, which would, given the targetted rate of inflation for the Ninth Plan period, imply a nominal depreciation in the range of 5 to 7 per cent per annum under normal circumstances. Such an exchange rate strategy would, to some extent, correct for the bias against tradables by leaving the relative prices of traded and non-traded goods more or less unchanged and thereby facilitate the efforts at containing the secular reduction in the share of tradables in GDP. This should also automatically lead to a depreciation of the REER in the 2 to 3 per cent per annum range, assuming that the international rate of inflation does not accelerate from its historical trend rate of 3 to 4 per cent per annum, and thereby improve the price competitiveness of Indian goods and services in the external market. Table 2-43 : Indices of the Exchange Rate
(Base 1993 = 100)
------------------------------------------------------------
NEER REER WPI/NEER
As on end -------------- -------------- --------------
of March : Level % Change Level % Change Level % Change
------------------------------------------------------------
1993 100.0 - 100.0 - 100.0 -
1994 99.7 - 0.3 106.9 6.9 109.6 9.6
1995 91.9 - 7.8 106.2 - 0.6 111.2 1.5
1996 88.0 - 4.3 104.1 - 1.9 111.8 0.5
1997 88.8 0.9 109.9 5.6 120.6 7.9
------------------------------------------------------------
SOURCE : Reserve Bank of India, Annual Report 1996-97
NOTES : (1) NEER = Nominal effective exchange rate
= w(i).e(i).e
where : w(i) = x(i)/x
x(i) = exports made in the ith
currency
x = total exports
e(i) = index of the exchange rate of the ith currency against US$
expressed as the number of units of ith currency per US$ 1
e = index of exchange rate of the rupee expressed as the number of
units of US$ to Re. 1
(2) REER = Real Effective exchange rate
= NEER.[ w(i).P/P(i)]
where : P = Price index for India
P(i) = Price index of ith country
(3) WPI = Wholesale price index (domestic)
2.180 There is a point of view which holds that the exchange rate is not only an uncertain instrument of export promotion but it also has the negative effects of generating cost-push inflation and retarding external capital inflows, and that greater reliance should be placed on increases in efficiency and improvements in quality, productivity and technology for attaining greater international competitiveness. While it is no doubt true that in the longer run there is no substitute for efficiency, quality, productivity and technology, these take time to develop and may not be directly affected by public policy during the short to medium run. These attributes are expected to develop steadily over time in the Indian economy as a normal consequence of increased competition and greater integration with the international economy, and the government can play only a facilitative role. The immediate imperative is to encourage a greater degree of outward-orientation through policy initiatives, for which the exchange rate is the principal instrument. 2.181 Note, however, has to be taken of the alleged negative dimensions of exchange rate depreciation. The first argument against a policy of steady depreciation is that it is inherently inflationary and, when exports are either import-dependant or face low price elasticity of demand, may not stimulate exports in any substantial manner. Thus, the trade-off involved in exchange rate depreciation is between the negative effects of an acceleration in domestic inflation and a net export expansion effect. It is true that any effort at altering the relative price structure tends to be inflationary as the various sectors of the economy attempt to protect their relative position. This does not, however, constitute a compelling argument for not making the effort at altering the price relatives when it is desirable as a part of a development strategy. On the other hand, it does underline the need to adopt a stringent anti-inflationary policy stance as a complementary measure, which is in any case an integral component of the Ninth Plan strategy. Furthermore, in the Indian context, there is ample empirical evidence that exchange rate depreciation does have strong export expanding effect. This arises primarily out of the fact that the Indian export basket still has a very low share of differentiated or branded products, which are the category of goods that are less price-sensitive, and the bulk of exports rely principally on price competitiveness. This characteristic of the Indian export basket is likely to continue to obtain in the immediate future, and emphasises the need to follow an active exchange rate policy. 2.182 It is sometimes argued that a stable nominal exchange rate is conducive to attracting greater external capital flows, and an expectation of currency depreciation may deter such inflows by lowering the expected returns denominated in foreign currency terms. But, it should be noted that if the exchange rate gets misaligned due to inflation and macro-economic imbalances there will be expectation of depreciation, and a prolonged non-adjustment of the exchange rate will only strengthen such expectations resulting in reduced capital flows and eventual capital flight. What is called for are appropriate policies to maintain macro-economic balances and not any artificial pegging of the exchange rate. Furthermore, the real benefits of foreign investment can be realised only when these investment come in, on the basis of the intrinsic strengths of and the real factors present in the economy rather than on the basis of the implicit "capital gains" arising out of an expected appreciation of the currency. The advantage of a depreciating currency is that the foreign investment that does come in under such an expectation will not only be less speculative, but also more export-oriented in its own interest as against the greater inward-orientation of investment that relies on nominal exchange rate stability. The possibility of an outflow of existing portfolio investment arising out of an expected depreciation adds to the urgency of clearly signalling the future strategic approach to exchange rate management before the stock of such external portfolio liabilities becomes too large to risk any substantial net outflow. 2.183 There is, however, an issue as to whether the exchange rate should be depreciated gradually or devalued sharply to attain some medium run target value. If the primary emphasis of exchange rate policy is on its effect on external capital flows, then a devaluation is generally to be preferred, since it immediately improves the incentive to export and reduces the probability of generating expectations of further depreciation among foreign investors. However, such a step does not generally create the condition for a sustained shift towards greater export-orientation, particularly as far as new investments are concerned. It may also require much sharper anti-inflationary measures, which may be contractionary in the short run since the fiscal parameters are unlikely to improve sufficiently within the short period. A more gradualist exchange rate stance, on the other hand, not only improves the relative profitability of exports, albeit less than a devaluation, but also affects the pattern of investment in favour of tradables in general, and exportables in particular. It would, however, require strict management in terms of the collateral macro-economic policies, particularly to prevent generation of inflationary expectations that may accompany a process of gradual depreciation. In view of the objectives of the Ninth Plan, it appears preferable to opt for the latter strategy and address the issue of foreign investment through policies aimed at reducing and eventually eliminating the impediments which exist at present. 2.184 In recent years, the ability of the Government to determine the behaviour of the exchange rate has eroded quite significantly. Relatively large movements of financial capital and the need for monetary restraint have constrained the extent to which the exchange rate could be used as a policy instrument. In order to re-establish the primacy of the exchange rate as an instrument of macro-economic policy in an open economy, the Government has to create the conditions whereby it can intervene in the foreign exchange markets in a meaningful way. For this, binding ceilings not only on ECBs, as at present, but also some control on net FPI flows, through taxes and other disincentives, appear inescapable, at least until such time as the Indian foreign exchange market achieves sufficient depth and the foreign exchange reserves of the country are sufficiently large to withstand speculative pressures. Such restrictions on the inflow of FDI are, however, unnecessary since they are normally associated with real capital inflows, both physical and in the form of technology and services. 2.185 Exchange rate management, however, is only one of the instruments to effect a greater degree of export-orientation in the economy. Tariff reforms are an important component of the efforts at increasing competition and efficiency in the economy, and making Indian exports more competitive both abroad and also relative to import substitutes in the domestic market. The Ninth Plan will attempt to achieve international levels of tariffs, while carefully phasing out the changes, keeping in view the larger interests of the economy and the progress made on other fronts. This transition can be made without too much disruption in view of the additional protection to domestic industry that is sought to be provided through the process of exchange rate depreciation during the Ninth Plan period. 2.186 The other major contributor to altering the incentive structure in favour of exports and export-orientation is the exemption from, or reimbursement of, all taxes on exports. Although schemes for such exemption or reimbursement have been in existence for quite some time, they have been both incomplete and cumbersome. In particular, these schemes have more or less been limited to Central taxes and there has been no meaningful effort to reimburse State and local taxes, which cumulatively amount to a fairly heavy burden. One of the reasons for lack of movement in this area is that the State Governments by and large do not perceive any direct benefits from participating in the export promotion effort. Moreover, the difficulties in effecting such reimbursement in the existing system of State and local taxes can be formidable. The Central Government will need to take a lead in this matter not only to create a sense of involvement and interest among States in exports, but also to evolve the modalities of achieving an administratively tractable reimbursement mechanism. This may involve a certain amount of restructuring and rationalisation of State and local tax systems, and will have to be considered in the broader framework of tax reforms. 2.187 In addition to the above specific measures, the policies in general must be supportive of sustained high export growth. This includes streamlining of customs and banking facilities and procedures for exporters, removal of the remaining quantitative restrictions on exports (including most agricultural products), implementation of special schemes for exporters to allow them duty-free access to imported inputs, preferential access to exporters for external commercial borrowing approvals, and special efforts to release infrastructure bottlenecks which are hampering the export effort. Other policies necessary to strengthen the export effort include :
2.188 It is expected that with a concerted effort on all the fronts described above for export promotion and creation of conditions for greater export-orientation of the economy, the rate of growth of exports during the Ninth Plan period will attain the targetted level of 11.8 per cent per annum to yield a terminal year (2001-02) value of total exports of Rs. 205,070 crore or US$ 56.3 billion in real terms. The detailed commodity-level break-up of this figure, on the basis of the projections made, is given in Table 2-44. Table 2-44 : Export Projections for Ninth Plan
(Rs. Million)
-----------------------------------------------------------------
1996-97
SECTOR ------------- 2001-02
DGCI and S RBI
-----------------------------------------------------------------
PADDY 31458 32489 19670
WHEAT 6790 7012 17503
OTHER CEREALS 487 503 840
PULSES 1279 1321 0
JUTE 158 165 275
COTTON 16042 16568 25495
TEA and COFFEE 24059 24847 44104
OTHER CROPS 17288 17855 23789
ANIMAL HUSBANDARY 8124 8390 14456
FORESTRY and LOGGING 649 670 1119
FISHING 40221 41539 75350
COAL and LIGNITE 766 791 1320
CRUDE PETROLEUM and N.GAS 1061 1096 1608
IRON ORE 17139 17700 29470
OTHER METALLIC MINERALS 3641 3760 4396
NON METALLIC and MINOR MINERALS 7484 7729 11537
SUGAR 6290 6496 8937
EDIBLE OIL 9226 9528 10826
OTH. FOOD and BEVERAGE IND. 83552 86288 115869
COTTON TEXTILES 110365 113980 212194
WOLLEN TEXTILES 3553 3669 7254
SILK TEXTILES 4296 4436 4403
ART.SILK AND SYNTHETIC FIBRES 25250 26076 59467
JUTE, HEMP., MESTA TEXTILES 4582 4732 6364
READYMADE GARMENTS 132748 137095 249770
OTHER TEXTILES 40056 41367 78756
WOOD and WOOD PRODUCTS 1333 1377 1549
PAPER and PAPER PRODUCTS 5333 5508 9034
LEATHER and LEATHER PROD. 55089 56893 79512
RUBBER PRODUCTS 12086 12482 16708
PLASTIC PRODUCTS 18833 19450 34825
PETROLEUM PRODUCTS 17079 17638 22022
FERTILISERS 0 0 5840
PESTICIDES 1198 1237 2064
SYNTH. FIBRE and RESIN 2946 3042 5076
PAINTS, DRUGS, COSMETICS 53641 55398 99364
OTHER CHEMICAL 48349 49933 88437
CEMENT 0 0 8000
OTHER NON-METALLIC MINERAL PROD. 169360 174901 293782
IRON and STEEL 27556 28459 42882
NON-FERROUS METALS 22613 23354 25051
TRACTORS and OTH. AGRI. MACHINES 192 198 187
OTH. NON-ELECTRICAL MACHINE 39588 40885 71627
ELECTRICAL MACHINE 479 495 601
COMMUNICATIONS EQUIPMENT 30403 31399 99024
RAIL EQUIPMENT 328 339 405
MOTOR VEHICLES 24504 25306 35952
MOTORCYCLE, SCOOTER and BICYCLES 7875 8133 8178
OTH. TRANSPORT EQUIPMENT 339 351 585
OTH. MANUFACTURING 37822 39061 75263
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TOTAL 1173510 1211940 2050740
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2.189 These export projections are based primarily on the supply-side possibilities under the assumption that for the most part Indian exports are unlikely to be constrained by lack of international demand provided that the price and quality factors are adequately taken care of. However, cognisance has to be taken of the possibility of various potential barriers to exports emerging in the future. In recent years, a number of non-tariff barriers to Indian exports have emerged with varying degrees of effect. In certain cases, such as on issues involving child labour and environment, there is little that can be done at the level of economic policies and institutions, and reliance will have to be placed on diplomatic initiatives for explaining the wider ramifications of the problem while taking appropriate steps at home to prevent any abuse. In other cases, however, such as quality or hygiene-based and anti-dumping restrictions, there is need to evolve mechanisms through which such measures can be anticipated and the appropriate steps taken to enable Indian industry to adapt or respond to them. Such indirect restrictions are likely to become more pronounced as the existing controls on trade in agricultural products and the Multi-Fibre Arrangement (MFA) are phased out under the WTO. The principal instrument for addressing such problems would again be a pro-active and responsive system of economic intelligence monitoring and dissemination which needs to be created expeditiously. 2.190 With the intellectual property rights issues getting linked to trade matters under the WTO, there is a need to take appropriate initiatives at the national as well as international levels to prevent this from emerging as an area of concern. The domestic IPR mechanism also needs to be strengthened in order to ensure that common intellectual property and local traditional knowledge are granted adequate protection, on the one hand, and to withstand unilateral restrictions being placed on transfer of technology on the ground of ‘dual use’, on the other. There is also a need to recognise that the grant of product patents in accordance with the WTO provisions in effect confers quasi monopoly powers. The standard and widely accepted device to ensure that such monopoly powers are not used to the detriment of the consumers is to establish independent regulatory mechanisms. It is, therefore, necessary to identify areas where such problems may occur and to establish regulatory authorities as and when required. 2.191 Furthermore, a strategy will need to be evolved for meeting the challenges of inter-regional blocs. It needs to be remembered that under the WTO, preferential tariff areas or customs unions are expected to have a common set of tariffs such that the tariff rate on any product must be equal to or less than the lowest rate prevailing in any member country prior to the formation of the bloc. In view of this, all the trade-offs will have to be fully evaluated before joining the existing trade blocs until such time as the Indian tariff rates are brought close to those of the potential partner countries. 2.192 While the Ninth Plan does seek to reduce the level of protection substantially in the country and thereby create the conditions conducive to joining the existing trade blocs, it will be desirable to place special emphasis on the development of regional initiatives in trade and investment under the broad aegis of SAARC. Efforts at realising the objectives of SAPTA, and eventually SAFTA, are critical for building upon the potential synergies that are available in the South Asian region. Studies have shown that the possible gains from considerable liberalisation of trade within the SAARC region are substantial with very little risk. These gains go beyond trade and investment. Regional cooperation can yield even greater potential dividends in a number of non-traded products such as power, transport and water resources, which need to be explored with greater vigour. 2.193 External capital flows have always played, and are expected to continue to play, an important supplemental role in overall resource availability for investment in the country. Considerable attention has been paid to this issue in the context of a number of aspects of Plan formulation. It has been repeatedly emphasised that foreign direct investment has a special role to play in the development strategy that is envisaged for the Ninth Plan in comparison to the other forms of external capital. Although foreign direct investment flows into India have been increasing steadily, attracting higher levels of direct foreign investment in high priority infrastructural sectors such as power, telecommunication, roads, ports, etc. the removal of all policy barriers is necessary for improving the facilities in these sectors and achieving an acceleration in the GDP growth during the Ninth Plan. An inadequate policy and regulatory framework continues to inhibit direct foreign investment in infrastructure and this problem will have to be redressed. This aspect of FDI is by now well accepted in India. However, there is a need to go beyond this. In a situation where the extent of import competition is expected to rise through gradual reduction in tariff and non-tariff barriers, there is no logical or compelling reason to deny access to foreign investors in industries where imports are freely allowed. The growth and employment effects of such investments are certainly more beneficial than the mere availability of the products that occur through the import route. 2.194 It is sometimes argued, however, that in recent years a significant proportion of FDI has been utilised in the acquisition of Indian companies and not in the creation of new productive assets and as a result FDI has involved only a change of ownership of existing assets rather than an increase in the productive capacity of the economy. Further, it is claimed that this trend may be accentuated in the future, with greater incidence of hostile take-overs of Indian companies, if FDI inflow is further liberalised. Arising from this, a case is made for protection of Indian companies from take-overs through restrictions on the investment behaviour of foreign corporations. It is difficult to assess the validity of this argument without a full assessment of the deployment of the new investible resources that become available to domestic entrepreneurs through this process. However, there is no doubt that the real benefits of FDI occur either when new capacities are created in the economy or when the existing capacities are made more efficient and competitive, particularly for addressing export markets. Consideration, therefore, needs to be given to evolving methods of ensuring that FDI flows add substantively to the productive capacity of the nation and to suitably amend the Monopolies and Restrictive Trade Practices (MRTP) Act for preventing abridgement of competition through take-overs and mergers. 2.195 The balance of payments position of the economy and its mode of financing projected for the Ninth Plan period is given in Table 2-45. As may be seen, the inflow from net invisibles, including factor payments, is projected to decline, which primarily reflects the effect of higher servicing needs on account of external capital flows. As a result, the current account deficit is expected to grow faster than the deficit on the trade account. On the other hand, it should also be noted that the financing of the CAD envisages a higher level of FDI flow and lower levels of FPI and external debt. Table 2-45 : Balance of Payments and Its Financing in the
Ninth Five Year Plan
(Rs.'000 crores in 1996-97 prices)
------------------------------------------------------------
1996-97 2001-02 Ninth Plan
------------------------------------------------------------
Exports 117.3 205.1 800.9 (10.4)
Imports 132.2 221.0 936.1 (12.2)
Trade Balance -14.9 - 15.9 - 135.2 (-1.8)
Net Invisibles 0.5 - 2.0 - 24.6 (-0.3)
Current A/C Balance -14.4 - 17.9 - 159.8 (-2.1)
Financed by :
Net External Assistance 0.5 1.0 7.7 ( 0.1)
Net External Debt 15.5 5.9 53.9 ( 0.7)
FDI 8.7 10.7 92.3 ( 1.2)
Net FPI 9.3 4.8 23.1 ( 0.3)
Total Capital Inflow 34.0 22.4 177.0 ( 2.3)
Change in Reserves 20.8 4.5 17.2 ( 0.2)
------------------------------------------------------------
NOTES :
(1) Repayment of IMF loan has been adjusted against external assistance
in 1996-97.(2) Net external debt includes NRI deposits and short-term credit. (3) Figures in brackets are percentages to GDP. 2.196 The Ninth Plan will ensure that the process of attaining the prerequisites for capital account convertibility is begun. The Committee on Capital Account Convertibility (CCAC) set up by the Reserve Bank of India (RBI) has outlined the minimum conditions under which capital account convertibility can be reasonably considered. These include first a set of macro-economic targets, which are: (a) the fiscal position is brought under control so that the gross fiscal deficit of the Central Government is below 3.5 per cent of GDP and a significant reduction in the borrowing needs of States and PSEs is achieved; (b) inflation is brought under control to the range of 3 to 5 per cent; (c) external debt service ratio is reduced to 20 per cent of current external receipts; (d) the level of minimum foreign exchange reserves is determined so as to satisfy four distinct parameters, and not merely on the existing norm of three months of imports. It is felt that in addition to the recommendations of the CCAC, two less quantifiable conditions would also need to be met. These are : (a) the availability and costs/ prices of nontraded goods and services which are critical inputs into production and distribution, and which therefore determine competitiveness of the tradable goods sectors, are not significantly out of line with those prevailing internationally; and (b) Indian exports are sufficiently robust so as to withstand periodic fluctuations in the exchange rate and in international prices. 2.197 The Ninth Plan is based on the attainment of a 4.1 per cent gross fiscal deficit to GDP target for the Centre by the terminal year. However, it appears unlikely that the borrowing needs of the States and PSEs can be curtailed sufficiently during this period without jeopardising the attainment of the Plan objectives. Secondly, the Ninth Plan is targetting an inflation rate in the 5 to 7 per cent range in order to provide sufficient elbow room to effect the necessary corrections in the relative prices of agricultural products and infrastructural facilities, on the one hand, and to ease the process of fiscal consolidation, on the other. It may not be either feasible or even desirable to compress inflation further to the levels recommended by the CCAC at this stage. Third, while the external debt service ratio is likely to attain the level stipulated by the CCAC by the end of the Ninth Plan, meeting the desired foreign exchange reserve position may not be easy. It may be noted from the analysis of BOP sustainability described earlier that increases in the rate of growth of reserves reduces the sustainable level of CAD as a percentage of GDP. This will have adverse implications on the growth performance of the economy, unless the additional reserve accretion is based on higher FDI flows. Finally, the process of benchmarking the infrastructural sectors to international standards of cost and quality is only just beginning. Moreover, correction of the anti-export bias in policies leading to a requisite degree of export-orientation also has some distance to go before the desired robustness of exports can be attained. Therefore, although the Ninth Plan will begin the process of moving towards capital account convertibility, it is unlikely that all the pre-requisites will be met by the end of the Plan period. 2.198 In addition to the macro-economic pre-requisites, the CCAC has also recommended certain minimum conditions pertaining to the financial sector. These include : (a) an uniform regulatory framework for all financial institutions; (b) the nonperforming assets of the banking sector to be brought below 5 per cent of total credit outstanding; (c) cash reserve ratio (CRR) of banks to be reduced to 3 per cent of net demand and time liabilities (NDTL); and (d) tighter prudential norms to be established than required by international practice. While these conditions may be desirable in themselves, they have to be seen in the context of the role and functioning of the financial sector in the development strategy and will be taken up in the following section. |
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