Business Environment and Policy

Dr. V L Rao Professor Dr. Radha Raghuramapatruni Assistant Professor

Rangarajan (plus current information) Economic Growth (Growth of Real GDP) 1950-1980: 3.7% 1981-82 to 1990-91: 5.6% Q. Q. 1990s ? (Appendix Table 1: RBI AR) ?

2000-01 to 2009-10

Q. Why called Real GDP?

Recent Years % 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11

9.5 9.7 9.0 6.7 8.0 8.5

Q. Why did it fall in 2008-09? Q. Which country has > 10% growth? Q. Indias growth rate expected in 2011-12: _____ %

Current Account Deficit (CAD) (Difference between export and import of goods and invisibles, e.g. tourism, shipping) $ billion As % of GDP* 2008-09 27.9 ? 2009-10 38.4 ? 2010-11 44.3 ? (Source: Appendix Table 1, RBI AR) CAD / GDP of > 3% considered not good. Note: More about this in BoP Section

FX Reserves (Foreign currency assets + gold + SDRs + Reserve Tranche Position in IMF) US $ billion 5.8 (FCA in June 1991: $1.1 bn) 1995 25.2 2000 38.0 2004 113.0 2007 199.2 2008 314.6 (end-May, Peak) 2009 252.0 2010 279.1 2011 (7 Oct.) 311.5 End-March 1991 Q. Why was there a fall in 2009?

Inflation (WPI) (Appendix Table 1 RBI AR) % 1990-91 to 1999-2000 8.1 2000-01 to 2009-10 5.4 2007-08 4.7 2008-09 8.1 2009-10 3.8 2010-11 9.6 PMs Economic Advisory Council (EAC) Food inflation main problem: May-June 2011 8.4% Non-food manufactured inflation: March 2011 8.5% Apr.-June 2011 7 to 7.3% EAC estimate: WPI July-Oct. 2011 9.0% (More of this in MP Section)

Social Indicators HDI Index Educational component: mean years of schooling and expected years of schooling Life expectancy component: life expectancy rate at birth Wealth component: GNI per capita (GNI = GDP + net income from abroad, e.g. remittances and international aid)

HDI 2010 Rankings (out of 169 nations) Norway 1 Australia 2 New Zealand 3 USA 4 Ireland 5 Singapore 27 UAE 32 Sri Lanka 91 Russian Federation 65 Brazil 73 China 89 India 119

1991 Industrial Policy: Pre-1991 controls abolished Barriers to entry and restrictions on growth of firms removed Trade Policy Tariffs brought down Result: improved competition, efficiency and productivity Role of State Redefined: expanding in some areas and reducing in others More market does not mean less government but different government. (Shift from control to facilitation)

Sectoral Shares and Growth Rates Agriculture, Industry, Services Q. Whose share is highest? (Appendix Table 1 RBI AR) Share in GDP (%) 2008-09 2009-10 2010-11 Agriculture 15.7 14.6 14.4 Industry* 20.1 20.2 20.0 Services 64.2 65.2 65.6 (* Mining, manufacturing and electricity. Current share of manufacturing 16%. National Manufacturing Policy target: 25% by 2020). Too high share of Services is a weak point.

Q. Whose growth rate is lowest? % Change 2008-09 2009-10 -0.1 0.4 4.0 8.3 4.2 8.8 9.5 9.7

Agriculture Industry Mfg Services

2010-11 6.6 7.8 8.3 9.2

Worst performer: agriculture. Only in 2010-11, it has improved.

Poverty Ratio (%) 1993-94 2004-05 Planning Commission* Rural 37.3 28.3 Urban 32.4 25.7 Combined 36.0 27.5 Tendulkar Committee** Rural 50.1 41.8 Urban 31.8 25.7 Combined 45.3 37.2 * Calorie-based ** Based on minimum acceptable level of living Q. Why are the estimates higher for the Tendulkar Committee?

Sustained Growth 9% possible since savings and investment rates are high. Savings rate: Gross domestic savings / GDP Investment rate: Gross domestic investment / GDP Q. What were the rates prior to 2000? (Appendix Table 1 RBI AR) Q. What are the saving and investment rates in China?

Challenges 1. Agriculture Low productivity of land and labour Lack of transport infrastructure Action required: Better credit delivery Investment in irrigation and rural infrastructure, etc. 2. Infrastructure Once only government. Now competition and cooperation between public and private sectors (More in Infrastructure)

3. Fiscal Consolidation Fiscal deficit / GDP %* 2008-09 6 2009-10 6.7 2010-11 (BE) 5.5 FRBM target 3.0 (More in FP) 4. Social Infrastructure Emphasis on primary education and basic health: Helps reducing poverty Quality of expenditure as important as quantum

5. Good Governance Efficient management of economic and social resources Across states in India, outcomes different for same mix of policies (because of differences in governance)

Economist, April 23rd, 2011 Q. Good growth rate in 2010-11: How much? See slide 3 Q. Far higher than the low growth (christened Hindu rate) during 1950-1980: how much? See slide 2 But business confidence low: FDI January 2011 y-o-y decline: 48% Businessmen and experts in two recent conferences: got together not to praise the countrys business environment but to bury it in criticism.

Q. This statement is similar to which famous statement ? World Banks Ease of Doing Business Index out of 183 countries, ranked: 134 overall, 165th in starting a business, 182nd in enforcing contracts ( More later) Legatum Institute ranking on Entrepreneurship and Opportunity, India ranked 93 out of 110 countries

Doing Business Report To build a warehouse: Permits required Days to procure Cost as % of per capita national income 2.718 Mumbai 37 200 Kolkata 27 258 2.549

(Reflects Rangarajans statement about differences in governance across states)

Legatum Institute Survey % of entrepreneurs who think the government was doing a very good job: India 11% China 30% The complaints are like the complaints about the weather everyone complains about it, but no one does anything about it. Q. Whose famous statement is this? Two major concerns Whether the demographic dividend can be realized? Corruption

Demographic Dividend Increase in working age population (15 64 years) by 2020 India 136 m China 23 m (Economist, 2 Oct. 2010) Median age in 2020 India 28 China 37 USA 38 Western Europe 45 Japan 49 (Economist, 9 Oct.2010)

Doubts about realization in India: Finding and retaining skilled workers a problem (e.g. garments) - Unemployable youth (knowledge@wharton handout) Economist, January 29th, 2011 Indian capitalism looks oligarchic, but is dynamic and competitive 2009 Paper In 2005 , there were 8864 firms under 20 years old accounting for: 56% of total in number But only 15% of corporate assets, 17% of sales, and 13% of profits

2011 paper More evidence of concentration Share of Sales, % 1989 2008 42 37 41 42 3 10

State-owned enterprises Business Houses Other private firms

But there is evidence of increased competition Distribution of Firms, % 1993 2007 >20% ROA < 1% 23%

 Case Study of Crompton Greaves Maker of electrical appliances and power equipment Blue-chip company But reported a loss of $33 m in March 2000 due to competition Threat of Japanese entry brought best technologies into India by its European and US rivals (Joseph Schumpeter: competition can be a threat, even before it is an actuality. It disciplines before it attacks. The businessman feels himself to be in a competitive situation even if he is alone in the field.)

Economist, July 23rd 2011 Pre-1991 Telephones took years to get Importing a computer took 3 years and 50 trips to Delhi July 1991 High oil prices (Increase -1970: 210%, 1979:135%, 1990:40%) Fiscal profligacy Fiscal deficit / GDP (%) 1990-91 8.4 1991-92 6.2

- FX to last just a fortnight, i.e. enough to finance imports for only 2 weeks (this is called import cover. More in BoP) - 47 tonnes of gold airlifted to Bank of England as collateral for a loan July 1991 reforms (Manmohan Singh as FM) Lasting significance Economy became resilient : so not on the brink of another crisis now Deserves its spot in the annals of economic history 1991 watershed or landmark year (China in December 1978 and Britain in1846 when it repealed Corn Laws. More on Corn Laws next trimester in International Trade paper.)

Manmohan Singh as PM Economic policy will not regress, but no guarantee of progress Yearly addition to population: 25 m Yearly addition to labour force: 10 m No progress on malnutrition, schooling and hiring 1990s reforms freed markets for outputs, but markets for inputs remain unrepaired 70% of infrastructure projects stalled because of problems in acquiring land

(Examples of land-related issues: At some places, displaced persons for SEZ land did not get adequate compensation, alternative employment and place to stay. Some IT companies which got land on lease in Vizag wanted it to be on sale basis so that it can be used for real-estate speculation. When denied, they backed out.) Labour laws reform Power shortage Central government increased spending on schooling and passed Right to Education Act, but state and local governments need to ensure proper follow-up. Introduction of GST delayed (more in FP)

Overheating Current growth rate < 8 %. For higher growth, interest rates to be reduced, but production (supply) takes time while increased demand is immediate. So higher inflation will result. Q. Which is the other country showing signs of overheating? What are the signs? Indias Chaotic Model of Development Services boomed; stagnant mfg Exports world class IT, but imports fridges Has 15 times more phone subscribers than tax payers Soon to connect to an electronic biometric system than to a sewer

Summary Table 2010 1990 Population, m 839 1,186 GDP, $bn (2010 prices) 433 1,538 One of the trillion-dollar economies GDP per person, $ (2010 prices) 503 1,265 GDP world ranking (current $) 12 10 GDP world ranking (PPP $) 9 4 PPP: purchasing-power parity basis Exports / GDP % 6.9 21.5 Sign of opening up Gross saving / GDP % 21.9 34.7

Adult literacy rate % 48.2 68.3 New official poverty rate, % 45.3 32.2 Q. Estimate of Planning Commission or Tendulkar Committee? Explain your answer. Number of billionaires in Forbes rich list 1 49

Demography IMF paper: demography has added 1.7 percentage points to the growth rate of GDP per person. Q. What is the difference between percent and percentage point? India needs to create 10-13 m jobs a year for which skills, training and growth of manufacturing required.

Achieving 10% Growth Recent growth of 8%: Half to three-quarters of this is explained by more workers and more capital. But reaching double-digits requires more efficient utilization Planning Commission target: 9% for the 12th Plan (2012-17)

Doing Business Report 2011 Executive Summary 183 economies 9 stages of the life cycle of a business (Ease of Doing Business): Starting a business, getting credit, etc. to closing of business Ranking Does not tell the whole story of business environment. The report does not deal, e.g. with: Quality of infrastructure services Macroeconomic conditions Workforce skills

Regulations All regulations are not bad: e.g. Efficient and transparent regulation gives equal opportunities to all, not just only for those with connections A recent study of company registries in 100 countries over 8 years found that efficient business registration systems have a higher firm entry rate and greater business density. Case Study of Kenyan Garment Producer Spent 18 months to get a trial order for school items from Tesco, the largest retail chain the UK. Everything well planned but goods delayed at Kenyan port and the back-to-school promotion was over.

Post-crisis Legal and Institutional Reforms Rising number of insolvencies and debt disputes Efficient court and bankruptcy procedures ensure that viable firms continue to operate. Earlier, many economies in Eastern Europe and Central Asia insolvent firms were liquidated even if viable. After reforms, average recovery rate in those countries was 33 cents on the dollar (cf. average of 69 cents for the OECD high-income countries) Examples of Positive Impact Korea: Predictable cargo processing times and rapid turnover by ports provide benefit of some $2 bn annually

Singapore: Online business registration system for new firms saves businesses $42 m annually Ease of Doing Business Rankings Both 2010 and 2011: top 5 in that order: Singapore, Hong Kong SAR (China), New Zealand, The UK, the US, Ireland and Australia Q. What does SAR stand for and what is its significance? Indias rank: Marginally improved from 135 in 2010 to 134 in 2011

Regulatory Reform 5 years In 85% of 174 countries, ease of doing business improved Rwanda Case Study For staring a business: 2005: 9 procedures and official fee amounting to 22.3% of per capita income 2010: 3 days and fee 8.9% of per capita income No. of entrepreneurs who took advantage: 3,000 in 2008 (earlier, annual average was 700) 2010 2005 Registering Property 371 days 60 days Transfer fees, % of property value 9.8 0.4

India: implemented 18 business regulation reforms in 7 areas Mexico: simplified registration formalities resulted in: 5% increase in number of registered businesses 2.8% increase in employment Eastern Europe and Central Asia Case Study 6 years of business regulation reform: Prospect of joining EU World financial crisis Result: a 2009 survey in Georgia showed a new start-up centre helped businesses save an average of 3.25% of profits, just from registration services

Collateral Laws encouraging all types of assets as collateral: % of economies Sub-Saharan Africa 35 East Asia and pacific 71 OECD high-income economies 68 Improvements can promote growth of firms and employment

Infrastructure 11th Plan (2007-12) Investment As share of GDP (%) T Achieved 2008-09 2011-12 (est.) * 10th Plan actual: 5% $514 bn 8* 7.18 8.37 12th Plan (2012-17) $1.025 tr 9

Share of Private Sector (%)

11th Plan 30 (T)*

12th Plan 50 (Projected)

Achieved 2005-06 34.32 2006-07 33.74 11th Plan 36 (anticipated) 36 * 26% earlier FDI allowed for private sector (domestic and foreign) Roads, power, ports, and airports 100% Telecom services 74% Telephone equipment 100% Aviation 49 100%

Cost Overruns (against originally approved costs) March 1991 61.6% March 2008 12.06 March 2010* 14.72 October 2010* 20.10 * Reasons for upward trend: Projects costing less than Rs. 150 crores excluded from monitoring system Steep rise in prices of steel and cement in 2006-07 Issues in Time and Cost Overruns (Eco. Survey, p.289) Tendering of unviable projects Bad quality of engineering and planning at the Detailed Project Report (DPR) stage

 Lack of standardized and sub-optimal contracts etc. Mitigation of cost overruns Through moving away from item rates to lump sum engineering, procurement and construction (EPC) contracts for large projects Creation of greater capacity for project management and monitoring

PPP Appraisal mechanism of PPP projects streamlined: To ensure speed Eliminate delays Adopt international best practices Have uniform appraisal mechanism and guidelines by PPP Appraisal Committee

Viability Gap Funding For PPP projects that are economically essential but commercially unviable Long tenor loans through India Infrastructure Finance Company (IIFC) Ltd. Supports up to 75% of project development expenses in the form of interest-free loans For projects sponsored by state governments and municipalities Urban sector, health and education, civil aviation, and roads

National PPP Capacity Building Programme Launched Dec. 2010 in collaboration with World Bank and German KfW Ashok Chawlas Comment End products are priced sub-optimally because inputs and natural resources are provided at administered prices.

Monetary Policy Objectives Maintain adequate liquidity for credit needs and support investment Examples of liquidity: Balancing inflation and growth Headline inflation, inflationary expectations and asset-price inflation Headline inflation: y-o-y inflation 48

Asset price inflation: (e.g. Japan in the 1990s) Monitor exchange rate and BoP ER: Earlier problem was appreciation of currency, now depreciated to Rs.50 per $. Appreciation hurts exporters and depreciation hurts importers . Intervention in FX markets by RBI - different from sterilization . See under MSS below BoP: will be discussed later under BoP Maintain stability in financial system (cf. East Asian crisis) 49

Major Instruments LAF (R and RR) CRR SLR MSS OMO Interest Rates Bank rate Call rate Base rate (formerly BPLR) 50

LAF: Short-term (usually overnight) Repo: RBI sells, but repurchases, short-term securities from commercial banks (as collateral for overnight lending) Reverse repo: bids invited, but accepted, as decided by RBI for deposit of surplus funds with RBI. It is not borrowing of RBI from the commercial banks. Q. ____ (Repo / Reverse repo) injects liquidity Q. ____ absorbs liquidity Wikipedia: Continued with old definition (reverse of the present one). Anyone can edit the articles. So not reliable. References at the end of articles, however, can be used because they can t be altered. 51

Q. Which rate would be higher? Why? Cash Reserve Ratio (CRR) Cash holdings with RBI / total deposits Q. Hike___ (absorbs / injects) liquidity 17 Jan. 2009 5.00 13 Feb. 2010 5.50 27 Feb. 2010 5.75 24 April 2010 till now 6.00

52

SLR (Statutory Liquidity Ratio) Holding of specified securities / net demand and time liabilities (NDTL) by scheduled commercial banks (SCBs) Q. Liabilities refer to the bank s _______ (deposits / advances) Q. Lowering of SLR _______ (injects / absorbs) liquidity. 2004 7 Nov. 2008 w.e.f. 7 November 2008 w.e.f. 7 November 2009 Q. Why was it reduced? 25% 24% 25%

53

Q. Why was it raised in 2009? (Answer: see below) Market Stabilization Scheme (MSS) Capital inflow release of rupees sterilized by MSS Issue of Treasury Bills (TBs), and dated securities (< two years) : 91-, 182-, and 364-day promissory notes issued by the Government, at a discount Operated by RBI for the Government . Funds kept with RBI Only sale; no repurchase by Government. Only redemption at maturity. Q. What is the difference between sterilization and intervention? Q. What is the difference between LAF and MSS? 54

Open Market Operations Sale and purchase of MSS securities Operated by RBI Interest Rates Bank rate Rate charged by RBI on medium-term lending to commercial banks 6% (unchanged for a long time) Call rate Rate at which banks borrow overnight from each other wide fluctuation 1% to 30% Recent years 3% to 7% 55

Q: 3% rate reflects _____ (easy / tight) liquidity Call Rate, Repo Rate and Bank Rate Call rate Determined by: S&D Rate Fluctuates Quantity traded No limits

Repo rate RBI Fixed Discretion of RBI

Q. What is the difference between repo rate and bank rate? Q. Which of the following are instruments of MP? Why? * Call rate * Bank rate *Base Rate 56

BPLR and Base Rate (Box III.I) BPLR Rate charged by commercial banks on loans to borrowers with highest credit rating. Drawback: banks were charging sub-BPLR (even other than for export credit and small loans) SCBs Sub-BPLR lending (excl. export credit and small loans) / Total loans Sept.2008 77% June 2010 70% 57

Base Rate (since July 2010) No lending below Base rate (some exceptions allowed) All lending to be Base rate + borrower-specific charges Thus ensured transparency Transmission of MP improved Table 2 Box III.1 Initially increase in repo rate is higher than the av. increase in Base Rate and no. of days to raise Base Rate was also high. 58

Increase in Base rate picked up later and the time taken to follow suit by SCBs came down Summary of monetary instruments: Repo Reverse Repo CRR SLR MSS OMO Q. Which of the above is not a direct instrument of RBI? 59

Q. Which one is an instrument of RBI, but was left out? A. Bank rate MP in Practice RBI takes into account: growth and inflation. Announces indicative projections for growth in: M3, Total Deposits, and Non-food Credit Money Supply (M3) Currency with the public + Demand deposits + Time deposits

60

April August 2008 Growth projection for 2008-09: 8.5% Inflation (y-o-y) June 2007 4.28% March 2008 7.75% June 2008 11.05% August 2008 12.91% Q. On balance which is more problematic? _______ (Inflation / Growth) CRR and RR were used. 61

Q. CRR and RR ________ (raised / lowered) (Economic Survey 2009-10, T.4.20) CRR RR April 2008 7.75% 7.75% August 2008 9% (in six tranches) 9% (in three tranches)

Sept. 2008 Jan. 2009 Global recession deepened FII outflows - Tight liquidity in India Q. Call rate: high or low? ( >10% or <5%) A. > 10% 16 September 2008 13% 10 October 2008 19.8% 62

Volume under repo window Rs crore Sept. 2008 1st half 2nd half Early October 2008 12,500 68,000 90,000

Real GDP projection: 7.5% to 8% (down from earlier 8.5%) for 2008-09 Inflation (end-March 2009) projection: 7% (down from two-digit inflation) On balance, growth considered more important Q. Rates ________ (lowered / raised). 63

August 2008 Jan. 2009 CRR 9% 5% (in four tranches) Released Rs. 1,60,000 crore of liquidity to the banking system RR 9% 5.5% (in four tranches) R-RR 6% 4% (in three tranches) SLR : reduced from 25% to 24% on 8 November 2008 MSS: Starting Sept. 2008, issue of Treasury Bills was suspended. Q. Why? OMO Q. Nov. 2008 RBI _____ (bought /sold) MSS securities worth Rs.37,964 crore

64

October 2009 Growth projection: 6% (with an upward bias)- same as before Inflation expectations: weak monsoon global upswing in commodity prices Domestic D-S imbalance So inflation projection: 6.5% (with upward bias) - up from 5% Cautious implementation of exit. Q. Exit from what? A. Exit from easy MP Q. SLR back to pre-crisis level of ____ % 65

Summary April 2008 Feb. 2010 (Eco. Survey 2009-10,Table 4.20) April 2008 to Oct. 2008 Inflation main problem RR raised from 7.75 to 9 (RRR: no change) CRR raised till August, but brought down later to ease liquidity October 2008 onwards Recession main problem All three rates lowered 66

April 2010 onwards Inflation again a problem (Economic Survey 2010-11, Table 4.3), esp. food inflation Well above RBI s comfort level (5.5%) Shift of policy from management of recovery to management of inflation April 2010 All three rates raised by 25 bps (Economic Survey 2010-11, Table 4.17) Q. From what level to what level? 67

Still the real policy rates were negative Real interest rate is nominal rate less inflation rate. Q. Why should it be positive? July 2011 to July 2011 ( RBI AR 2010-11, T.III.1) RR and RRR raised by 25bps or 50 bps tranches

68

Fiscal Policy Receipts and expenditure: Interest payments, direct and indirect taxes, roads and bridges, PSU disinvestment, subsidies, salaries and pensions, defence, borrowings (excl. MSS), space research Q. Why exclude MSS from borrowings? Receipts: revenue receipts and capital receipts Expenditure: revenue expenditure and capital expenditure 69

Rough distinction: revenue - regular; capital not regular; but need-based Revenue Receipts Revenue Expenditure

Capital Receipts

Capital Expenditure

70

Revenue deficit = revenue expenditure revenue receipts Fiscal deficit = total expenditure total revenue (revenue receipts + capital receipts), except borrowings Q. Why borrowings excluded? FRBMA targets By March 2009 Q. Why an Act?

Revenue deficit / GDP Fiscal deficit / GDP

0% 3%

71

Sources of Tax Revenue (Economic Survey, Table 3.3) Tax revenue = tax rate x income or turnover Direct tax: can t be passed on Indirect tax: can be passed on Share in Tax Revenue,% 2006-07 2010-11 Direct taxes 46.4 58.6 Indirect taxes 51.0 42.2 Q. In 2005-06, which tax contributed the most? 72

Q. 2006-07 onwards, which tax contributed the highest? Q. Excise revenue / GDP ratio: Lowest in which year? Q. Why? Q. 2008-09 onwards which tax has lowest share (other than service tax)? 73

Q. Why? Q. From what level to what level? Q. Why? 74

Fiscal Policy Strategy Statement ___________________________ Share of GDP, % Revenue Deficit Fiscal Deficit_ 2007-08 1.1 2.5 2008-09 4.8 7.8 2009-10 5.3 6.5 2010-11 (RE) 3.4* 5.1* 2011-12 (BE) 3.4 4.6** 2012-13 (T) 2.7 4.1 * BE: 5.5%. But higher revenue from 3G and BWA auction; so < 5.7% of 13th Finance Commission ** Committed not to exceed 5.5% 75

Fiscal Consolidation _________________________________________ Share of GDP, % Gross Tax Revenue___Expenditure_ 2003-04 9.2 (Pre-FRBM) 2007-08 11.9 (all time high) 15.1 2008-09 10.8 17.6 2009-10 9.6 15.7 2010-11 10.0 (RE) 14.1(BE) 15.4 (RE)* 2011-12 14.0 (BE)___ 2008-09 and 2009-10: two years of fiscal expansion Q. What in the above two tables indicate this? 76

* Lower than expected correction additional revenue from 3G and BWA auctions; so expenditure cut not required to be steep 77

Subsidies Fertilizer Subsidy Nutrient-based Subsidy (NBS) regime introduced except for urea expected to promote balanced use of fertilizers and increase ag. productivity Increase in MRP of urea Proposal to cover urea also in NBS Encourage use of bio and organic fertilizers Q. How does the last point help reduce fiscal deficit? A. Since it does not require subsidies Petroleum Subsidy Decontrol of price Oil companies provided cash instead of securities from 200910 78

Tax Policy Direct Taxes Moderate levels and few rates Widening tax base Use of IT (e.g. e-filing of returns) Less intrusive system to encourage voluntary compliance DTC Bill (expected to become Act by April 2012) - Includes, inter alia: Integrates and consolidates all direct tax laws Minimizes exemptions and deductions Replaces profit-linked deductions with investment-linked deductions for priority areas Increasing Minimum Alternative Tax (MAT) from 18% to 18.5% 79

 Corporate tax rate for foreign owned companies will be reduced from 40% to 30%, same as for domestic companies Indirect Taxes Excise duty Reduced from 16% to 12% in December 2008 Reduced further to 10% in February 2009 Continues at 10%, but number of exempt items reduced Sales Tax, VAT, GST Sales tax: double taxation or cascading tax VAT avoids this introduced by all States Drawbacks of VAT: States can levy VAT on goods but not on services 80

 Large number of central and state taxes leading to disputes Too many exemptions Goods and Services Tax (GST) Widening tax base and lowering tax rates New Zealand: tax base 94% of total consumption and rate is 15% Singapore: rate is 7% India: rates under discussion Removal of inter-state trade barriers Central GST, State GST taxation on inputs can be credited against taxation of outputs (i.e. the VAT system) Interstate GST on interstate trade credited against both CGST and SGST 81

Balance of Payments Receipts and Payments in $ and past year (cf. Receipts and Expenditure in FP in Rs. and coming year) Receipts Current Account Merchandise (Exports and Imports of Goods) Invisibles (e.g. tourism) Capital Account (e.g. FII) Overall Balance Reserves 82 Payments Net

Q. Did we have a surplus in trade balance? See Table 6.1 Invisibles Non-factor Services* (e.g. tourism) Income (e.g. interest on NRI deposits) Transfers (e.g. workers remittances) Q. *Why called non-factor ? Current a/c: recipient country keeps the FX Capital a/c: owner can take back

83

Q. To which a/c each of the following belong? FDI Exports of Garments Shipping NRI deposits ECB FII Software Tourism Workers remittances External assistance Import of oil Interest on ECB 84

Q. What is the difference between FDI and FII and which one is better for India? Goods and Services Balance: Merchandise + Non-factor Services Current Account Balance: Merchandise + Invisibles

85

Q. Q.

To which a/c the following belong and why? NRI deposits Interest on NRI deposits Workers remittances Which one is more desirable current a/c surplus or capital a/c surplus? Why?

86

FDI and FII (Table 6.1: Portfolio investment is mainly FII) Negative in 2008-09 Q. Why? 2009-10 FII much higher than FDI Invisibles Resilient items: Software and Workers Remittances ($ billion) Software Workers Remittances 2008-09 43.7 44.6 2009-10 48.2 52.1 87

CAD / GDP (%) 2005-06 1.2 2006-07 1.0 2007-08 1.3 2008-09 2.3 2009-10 2.8 Apr.- Sep.2009 2.2 Apr. Sep.2010 3.7 Q. Table 6.2 gives negative sign. The above table doesn t. Why? Another Achilles Heel [the first one being high fiscal deficit / GDP ratio] 88

Import Cover More than 10 months except in 2008-09 Openness of Economy One measure: (Exports* +Imports*) / GDP, % 2005-06 ? 2009-10 ? A. Table 6.2 (Goods only) FX Reserves Objectives: safety and liquidity Return optimization - secondary 89

Safety: major investment in low-yield US Treasuries Self- insurance mechanism: i.e. maintaining high level of FX reserves Helped India insulate from world economic crises But costly (opportunity cost is high investment elsewhere gives good returns) Suggestion: multilateral option of pre-arranged line of credit Not feasible for India, since: Foreign investors look at size of reserves Reserves are a consequence of FII, not current a/c surplus 90

ER Management Reducing excess volatility Preventing speculative activities Maintaining adequate levels of reserves Developing an orderly FX market Rs. / US $ 31 March 2009 50.95 End March 2010 45.15 31 Dec. 2010 44.81 July 2011 43.85 November 2011 52 + 91

Reasons for reverse trend after July 2011 As Euro zone crisis deepened, demand for $ increased for investing in Treasuries India s fundamentals are perceived to be weakening: Fiscal deficit < GDP ratio above 4% CAD / GDP ratio > 3% Inflation stubborn at 9% Export target for 2011-12 of $3oo bn may not be reached because of sluggish US and EU economies BoT deficit likely to be $150 bn (i.e. demand for $ > supply) 92

 When the rate was $1 = Rs. 47, further depreciation was anticipated. So exporters were unwilling to part with $ Importers were anxious to buy $ So Re depreciated NEER, REER (paragraphs 6.57 and 6.58 of BoP handout) REER is a less effective indicator of rupee competitiveness as far as weights are concerned. But inflation differentials will have a role in competitiveness External Debt (Table 6.13) Short-term debt / FX reserves, % India: 1990-91 146.5 2009-10 18.8 93 93

Impossible Trinity or Trilemma (ADBI handout) Thailand 1997 Example of East Asian Economic Miracle Liberalized capital flows (followed full capital a/c convertibility), maintained fixed ER and so could not have an independent MP External debt 1990 $29 bn (34% of GDP) 1997 $108.7 bn (59% of GDP) Short-term debt end-1996: $47.7 bn > FX reserves $38.7 bn (more than 100%) Crony capitalism and asset price bubbles 94

 When bubble burst and capital was leaving Depreciation of currency was not an option since its ER was fixed Thailand tried by increasing interest rates to attract capital back, but did not succeed, because investors lost confidence Q. Page 2, para 2: what is the wrong paradigm that is mentioned, between current a/c and capital a/c? Clue: it is similar to India s case (see Slide 90) 95

Carry Trade (Para 6.69 of BoP handout) NRIs were borrowing at low interest rates and depositing at higher rates in India 9called carry trade . To discourage this, rates in India were lowered Dutch Disease Discovery of North Sea oil Huge FX inflow Currency appreciated Traditional Dutch export industries suffered Similarities in India Till recently Re appreciated due to FII inflow and reliance on Software. Industries like garments and leather goods suffered 96

99