RESTRICTED
WORLD TRADE WT/BOP/R/22
3March 1997
ORGANIZATION(97-0871)
Committee onBalance-of-Payments Restrictions
REPORT ONTHE CONSULTATION WITH INDIA
1. TheWTO Committee onBalance-of-Payments Restrictions resumed itsconsultations withIndia
on20and21January 1997. Theconsultation washeldunder theChairmanship ofMr.P.Witt
(Germany), inaccordance withtheCommittee 'sterms ofreference, pursuant toArticle XVIII:B,
paragraph 12(b) ofGATT 1994 andtheUnderstanding ontheBalance-of-Payments Provisions of
GATT 1994. TheInternational Monetary Fund wasinvited toparticipate intheconsultation in
accordance withArticle XV:2 ofGATT 1994.
2. TheCommittee hadbefore itthefollowing documents:
Basic Document supplied byIndia WT/BOP/16
Background Paper bytheSecretariat WT/BOP/W/11
Addendum totheBackground Paper WT/BOP/W/11/Add.1
Report ontheConsultations withIndia WT/BOP/R/11
Notification byIndia Under Paragraph 9
oftheUnderstanding WT/BOP/N/11 andCorr.1
IMF India -Recent Economic Developments, October 15,1996
India -Selected Issues, October 17,1996
Opening statement bytheRepresentative ofIndia
3. Theopening statement bytherepresentative ofIndia isattached asAnnex I.
Statement made bytheRepresentative oftheInternational Monetary Fund
4. Thestatement made bytherepresentative oftheInternational Monetary Fund isattached as
Annex II.
Discussion intheCommittee
5. Members appreciated theefforts oftheGovernment ofIndiatocontinue toimplement economic
reforms. They shared India'sviewthattheprocess needed tobesustained inorder tobesuccessful
inthelongrun.TheCommittee thanked India forthedetailed notification ofrestrictions maintainedWT/BOP/R/22
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byit,contained indocument WT/BOP/N/11 andCorr.1, inlinewithitsundertaking intheCommittee
meeting ofDecember 1995.
6. Some Members considered thatIndiadidnotfaceabalance-of-payments problem, noting that,
withreference totheconditions specified inArticle XVIII:9, therewasneither athreat ofserious decline
inIndia'sreserves norwere monetary reserves inadequate. While acknowledging thatallcountries
needed tomonitor theirexternal accounts, theyremarked thatreserves were atacomfortable level
(five months ofimports), asmentioned inthedocument provided bytheGovernment ofIndia
(WT/BOP/16, para. 44).These Members pointed outthat,since thereform process begun in1991,
therehadbeenasignificant increase inexports, alowering ofthecurrent account deficit andsustained
improvement inthebalance ofpayments. Inaddition, therehadbeenadramatic reduction ininflation
while foreign direct investment inflows hadrisenfromUS$150 million toUS$2 billion. Theyseconded
theviewoftheIMFthatthebalance ofpayments deficit didnotcompromise India'sexternal viability
andthattheexternalsituationwasmanageableusingmacroeconomicpolicyinstruments.Theyexpressed
theviewthatthebalance-of-payments provisions should bedisinvoked. OneMember pointed outthat
reinvocation would bepossible should circumstances warrant.
7. SomeotherMemberstooktheviewthat,inspiteofimpressiveresultsinthebalance-of-payments
situation, prospects suggested theneedforcaution andprudence inthemanagement ofIndia'sexternal
accounts inlightofthepressure exerted onthebalance ofpayments through thefiscal deficit, which
remained ataround 9percentofGDP. They drew attention tovolatile elements (private transfers,
short-term debtandportfolio investment) inthestructure ofthebalance ofpayments, widefluctuations
incapital flows, acontinued highdebtratio, slowing export growth, asurge inoilimports andthe
consequent possible fragility ofthebalance ofpayments. They suggested thatIndia could continue
tohaverecourse toArticle XVIII:B ofGATT 1994 andtheassociated Understanding.
8. Inreply toquestions from oneMember, whodrew attention tothestrengthening ofIndia's
balance ofpayments andreserves position in1996, therepresentative oftheFund stated that,inthe
Staff'sview:
(i) there hadnot,overthepastyear, beenaserious decline inIndia'sforeign exchange
reserves: from endMarch 1996 toendDecember 1996 theyhadincreased by
US$2.7 billion and,inrelation toimports, hadremained relatively constant ataround
fivemonths ofimport coverage;
(ii) US$19.8 billion inreserves appeared acomfortable level inrelation toimports and
tothestock ofshort-term debt(US$5 billion), rather thananinadequate orverylow
level; withcontinued broadly sound macroeconomic policies, India should beable
tomeet allexternal payment requirements without difficulties, andtoweather the
consequences ofpossible external shocks without undue disruption;
(iii) India wasnotfaced withthethreat ofaserious decline initsmonetary reserves; on
thecontrary, barring major unforeseen shocks India'sreserves should continue to
increase in1997andinthemedium term, andthebalance ofpayments could beexpected
tobenefit from asteep decline inamortization oftheexceptional financing obtained
tomeetthe1990-91 crisis. While thecurrent account deficit might widen asaresult
ofimport growth related toinvestment, thisshould becomfortably financed byrising
private capital inflows;
(iv) current quantitative restrictions imposed byIndia were notnecessary toachieve a
reasonable rateofincrease inreserves; indeed, theremoval ofquantitative restrictions,WT/BOP/R/22
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inconjunctionwithothermeasures,couldbeexpectedtostrengthentheexternalposition
overthemedium term, reduce distortions toinvestment andencourage theemergence
ofanefficient consumer goods industry;
(v) thereplacement ofquantitative restrictions bymoderate tariffs would contribute to
stability andeconomic success byproviding revenue fordeficit reduction, since the
government would capture rentsthatnowaccrue tothose abletoobtain import licences
orbring goods intoIndiaillegally. Though thelongrunaimshould beforIndian tariffs
tofalltointernational levels, intheshortrunthereplacement ofquantitative restrictions
bytariffs could beexpected tohelptherevenue position.
9. Members recognized thatthere hadbeenagradual relaxation ofrestrictions asbalance-of-
payments conditions hadimproved. Some Members proposed thatIndia eliminate itsquantitative
restrictions immediately given thatthere wasnojustification onbalance-of-payments grounds. Some
other Members encouraged India tophase outquantitative restrictions asrapidly aspossible andto
move toatariff-based system. Theyreminded theCommittee thatrestrictions forbalance-of-payments
purposes areintended tobetemporary measures and,inIndia'scase, hadbeen inplace foran
inappropriatelylongperiodoftime.StillotherMembers,complimentingIndiaonthetradeliberalization
already inprogress, sympathized withIndia'sconcern thatahasty removal ofrestrictions could
undermine external andeconomic stability.
Replies bytheRepresentative ofIndia
10. Therepresentative ofIndia stated that,although theoverall balance-of-payments position had
improved, itcould notbedescribed assolid, andtherewasstillneedforcaution andcareful monitoring.
Notonlyhadreserves fallen inthecourse offiscal year1995-1996, but,between October 1995 and
February 1996, therupee haddepreciated by23percentraising thecostofimports. Portfolio
investment in1995hadbeenUS$1.2 billion compared toUS$2.2 billion in1994andthestock market
index haddropped by25to30percentinthesecond halfof1996. Theprice ofcrude oil,which
represented one-quarter ofIndia'simports, hadrisensignificantly anddebtanddebtservice toexports
ratios weretoohighforcomfort. Furthermore, thefiscal deficit remained quite stubborn, domestic
savings wereinsufficient tomeetinvestment needs, inflation wasinching backupandgrowth inexports
hadbeenvolatile inrecent months.
11. Hesaidthat,inthissituation, precipitous removal ofquantitative restrictions could undermine
economic stability andthereform process. Hecited thepurpose ofbalance-of-payments invocation
asstated inArticle XVIII:9 :"tosafeguard theexternal financial position andensure alevelofreserves
adequate fortheimplementation of[its]programme ofeconomic development." Hereminded the
Committee thatIndia hadconsulted regularly intheCommittee, acting inaccordance withits
recommendations,andthatuntil1995,thebalance-of-paymentssituationhadnotwarrantedtheCommittee
recommending thephasing outofbalance-of-payments restrictions. India hadprogressively relaxed
restrictions since thereform process began in1991, asconditions hadimproved, andwascommitted
toaphaseoutofquantitativerestrictionsmaintainedforbalance-of-paymentspurposes.Therepresentative
drewaparallel withthecaseofKorea which in1989hadputforward athree-step, seven-year phase-out
programme. Progressive reduction oftariffs wasthepolicy ofhisGovernment andtheability tophase
outquantitative restrictions waslinked tothedegree offlexibility andautonomy thatcould bemaintained
overthetariff structure.
12. Following thediscussion oftheconclusions, oneMember sought clarification from India on
theprospective time-table foradoption ofthenewpolicy, andurged India toconsult withitstrading
partners toensure thatdueconsideration waspaidtotheinterests ofWTO Members inabalancedWT/BOP/R/22
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manner. Healsoasked thatdetails ofthephase-out planbemade available toMembers wellinadvance
ofthemeeting, scheduled forthefirstweek ofJune1997, toconclude theconsultations.
13. Therepresentative ofIndiaresponded thatdelegations werewelcome tocontact hisGovernment
toconsult onelements ofthephase-out plan. Herecalled thattheExport-Import Policy would normally
bepublished bytheendofMarch andconfirmed thatthephase-out planwould becirculated tothe
Committee, inaccordance withestablished rules ofprocedure, three weeks inadvance oftheJune
meeting.
Conclusions
14. Initsresumed consultation withIndia, theCommittee tooknoteofthepositive developments
inIndia'seconomic situation since 1995. TheCommittee welcomed theIndian authorities 'continued
commitment toeconomic reform andliberalization andnoted India'sprogressive removal ofquantitative
restrictions notified under Article XVIII:B.
15. TheCommittee tooknoteoftheIMF'sstatement thatIndia'scurrent monetary reserves were
notinadequate andthatthere wasnothreat ofaserious decline inIndia'smonetary reserves. The
IndiandelegationcautionedthatIndia'sbalanceofpaymentsneededclosemonitoringandthatprecipitous
removal ofthequantitative restrictions notified under Article XVIII:B could have theeffect of
undermining thestability oftheIndian economy andthereform process.
16. Inthelightofongoing discussions, theCommittee agreed toresume theconsultation inthe
week beginning 2June1997. Thepurpose ofthecontinued consultation would betoconsider aplan,
which theCommittee invited Indiatopresent, toeliminate themeasures notified under Article XVIII:B,
andtoconclude theconsultations consistently withallrelevant WTO balance-of-payments provisions.
Indrawing upitsplan,Indiawillgivedueconsideration totheinterests ofWTO Members inabalanced
manner.WT/BOP/R/22
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ANNEX I
Statement bytheRepresentative ofIndia
Mr.Chairman, distinguished Members oftheCommittee, distinguished representative ofIMF
andfriends from theSecretariat.
Iamhappy tobehereforthisimportant meeting oftheBalance ofPayments Committee for
making these opening remarks onbehalf oftheGovernment ofIndia.
Alltherelevant documents, thatis,theBasic Document supplied byIndia totheCommittee,
theBackground Paper oftheSecretariat, asalsotheReport oftheIMFarebefore you.These documents
cover thefactual position relating toIndia’stradeandeconomic scenario. TheIMFandtheSecretariat
have, asusual, produced excellent reports andourthanks areduetothem.
Asyouareaware, since thelastmeeting oftheCommittee, theeleventh General Elections
havetaken place inourcountry, andamulti-party Government tookcharge attheCentre afewmonths
ago.However, thebroad thrust ofthepolicy ofeconomic reforms andliberalisation hascontinued.
Thecontinuity ofthereform process isinlarge measure duetotheconsensus thathasdeveloped in
favour oftheliberalisation process. Thedocuments before theCommittee detail thevarious measures
thathavebeentaken sofar.
Significant structural reforms havetaken place since1991. Domestic deregulation andexternal
liberalisation, including intheareaofforeign investment havebeenthetwomajor aspects ofthese
measures. Theregulatory framework foradomestic capital market including theprudential aspects
have been streamlined andstrengthened. Central depositories forscripless trading have started
functioning, andareexpected tohaveasalutary impact onportfolio investment byforeign institutional
investors inthemedium term. Progressive relaxation ofnorms ofequity participation anddividend
repatriation hasbeenannounced andimplemented since 1991. Therecent restructuring oftheForeign
Investment Promotion Board forfastapproval, andthesetting upoftheForeign Investment Promotion
Council, areaimed ataccelerating theinflow offoreign direct investment intoIndia. These measures
havebrought about significant results interms ofinvestment generation, more employment andadded
GDPgrowth. Reform iscontinuing, andtheGovernment isactively pursuing policies which willtake
thecountry toagrowth pathof7percentperyear.
TheresponseoftheIndianeconomytothepackageofreformsandstabilizationmeasuresinitiated
in1991-92 hasbeenverypositive. Growth, which was0.8percentin1991-92, afterrecovering to
about 5percentinthetwosubsequent years, accelerated further to6.3percentand6.6percentin
1994-95 and1995-96, respectively. Inflation --onanendofperiod basis --came down from 13.6
percentin1991-92 to5percentin1995-96. Steady progress hasbeenachieved inemployment
generation andpoverty reduction.
Trade liberalisation, Mr.Chairman, hasbeenanessential component oftheGovernment ’s
reform programme. TheExport-Import Policy of1992-97 hasremoved most ofthequantitative
restrictionsonrawmaterials,intermediategoodsandcapitalgoods.Theprocessofremovingquantitative
restrictions onconsumer goods hasalsocommenced. Furthermore, inOctober 1995, theExport-Import
Policy wasaligned withtheIndian Trade Classification, which isbased ontheHarmonised System
ofclassifying commodities under theinternationally recognised coding system. Inaccordance with
thedecision oftheCommittee onBalance ofPayments atitsconsultations withIndia inDecember
1995, Indiahasnotified totheWTO allremaining restrictions maintained onimports forBOPreasons,WT/BOP/R/22
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incorporating amendments upto25March 1996. Forthesakeofcomprehensiveness, thisnotification
alsoincludes quantitative restrictions onimports maintained forother GATT-consistent reasons.
Aspartofexchange liberalisation, India unified itsexchange ratein1993, andintroduced
current account convertibility inAugust 1994. Theturn-around inthebalance ofpayments andthe
recovery inreserves were achieved notbyimport compression andexchange restrictions, but
simultaneously withsignificant trade andexchange market liberalisation. Letmereiterate thatIndia
iscommitted tofurther tradeliberalisation. AsIhavesaidearlier, Government haveoverthepastfew
years, progressively withdrawn quantitative restrictions onmany items. Thequantitative restrictions
nowapply onlyonaround 30percentoftheHS-line items. Most importantly themaximum tariff
hasbeenreduced fromapeakofover100percenttoaround 52percenttoday andtheimport-weighted
tariff ratehasbeenprogressively brought down overasixyearperiod from 87percentto22.7per
cent. IamsurethatalltheMembers would agree thatthisisanimpressive achievement andexcellent
progress.
Thereflection ofallthetrade liberalisation measures, aswellasthepickupintheeconomic
activity canbeseenfromthefactthatimports havesurged by85percentbetween 1991-92 and1995-96.
Asagainst this,theexport ofgoods andservices hasgoneupbyabout 78percentbetween 1991-92
and1995-96. Thehigher baseofimports relative toexports together withtherelatively higher growth
ofimports, resulted inawidening ofthetrade deficit from US$1.5billion in1991-92 toUS$4.5
billion in1995-96. Thehealthy recovery ofreserves hasbeenpossible onlybecause ofimproved
invisible receipts andcapital inflows. Invisible receipts, inUSdollar terms, recorded anaverage annual
growth rateof16.6percentduring thelastfiveyears ending 1995-96. Foreign direct investment and
portfolio investment have emerged asthedominant components ofthecapital account, andsuch
investments intheaggregate increased from lessthanUS$100 million in1990-91 toalmost US$5
billion in1994-95. In1995-96, however, suchinvestments declined toUS$4.2 billion.
Theslowpaceoffiscal consolidation andfinancial market reforms aretwoadditional factors
complicating themanagement ofthebalance ofpayments. While wearefullyengaged inspeeding
uptheprocess offiscal correction aswellasfinancial market reforms, theprogress todatehasfallen
short ofourexpectations. Asomewhat highfiscal deficit continues tokeepdomestic ratesofinterest
atrelatively highlevels, andexacerbate theproblems ofvolatile short-term capital flows. Thefinancial
system isnotyetsound andflexible enough torapidly adapt tochanging situations. Webelieve that
reform oftheexternal sector canbeexpedited ifthefiscal deficit isquickly brought down, theprudential
supervisionoffinancialinstitutionsisstrengthened,andappropriateinstitutionalarrangementsforspeedy
foreign exchange andpayments clearing systems areputinplace.
Mr.Chairman, while thebalance ofpayments situation might appear tobecomfortable, itneeds
close monitoring andcallsforexercise ofcaution intaking measures intheinterrelated fieldoftrade,
particularly given ourfiscal situation. Ishallillustrate theneedforcaution byciting fewdevelopments
during theyear1995-96 andinthefirstthree quarters ofthecurrent financial year.
First, reserves declined byalmost US$3 billion in1995-96. Infact,thereserve lossona
monetary basis, thatisinclusive ofvaluation change, wasalmost US$4 billion lastyear! Awidening
ofthecurrent account deficit to1.7percentofGDP in1995-96 from 0.9percentofGDP inthe
previous year, andadecline ofUS$1.8 billion intheinflows fromtheissue ofEuro-equities explain
thebulkofthereserve decline in1995-96.
Second, thesecond halfof1995-96 witnessed periodic speculative pressures ontheexchange
rateoftherupee, andtheexchange rateoftherupee vis-a-vis theUSdollar depreciated fromamonthly
average ofRs.31.6inAugust 1995 toRs.36.6toadollar inFebruary 1996. While some easingWT/BOP/R/22
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oftheexchange rateoftherupee inthesecond halfof1995-96 wasconsistent witheconomic
fundamentals, speculative pressure inarelatively thinmarket hadledtoanovershooting. While the
appropriate andrapidpolicy responses bytheReserve BankofIndiarestored orderly market conditions,
andtherupee recovered toRs.34.2inApril 1996, theexchange market developments inthesecond
halfof1995-96 underscores theneedforcaution inbalance ofpayments management.
Third, exports fortheperiod April-November, 1996, estimated atUS$21.4 billion, showed
agrowth ofonly7.8percentcompared tothegrowth of24.5percentinthecorresponding period
oftheprevious year. Forthemonth ofNovember 1996, exports actually declined by5.9percent,
when compared tothecorresponding month oftheprevious year. Thesharp decline inexport
performance hastobeseeninthecontext ofafallintheimport demand byindustrialised countries,
ourownconstraints intheinfrastructure sector, andasteep decline inournon-petroleum imports.
Wearedeeply concerned about thedeceleration inexports andaredetermined toreverse itthrough
appropriate policies, particularly because ouroil-import billhasbeenrising rapidly. Partly dueto
thestiffening oftheinternational price ofoil,theimport billforcrude andpetroleum products went
upbyover41percentinApril-November, 1996 indollar terms relative tothesame period ayear
ago.
Theinvestment needs oftheeconomy, particularly those ininfrastructure, areenormous. The
savings rateissluggish, mainly because ofthepoor performance ofpublic savings. Thesaving-
investment gapisexpected toincrease, andgetreflected inawidening ofthecurrent account deficit
withresurgence ofgrowth intheeconomy. Weconsider itimperative toattract largeinflows offoreign
investmenttobridgethecurrentaccountdeficit.TheGovernmenthastakenvariousmeasurestofacilitate
theinflow offoreign investment, andanambitious target ofattracting US$10 billion peryearhasbeen
announced. Thesoundness ofourbalance ofpayments willcrucially depend onoursuccess inattracting
foreign investment. Mr.Chairman, weareoptimistic, butuncertainty remains.
Inrecent times, there havebeensigns ofsome resurgence ofinflationary pressures inthe
economy. Thistogether withtherelatively slowpaceoffiscal consolidation complicates thetaskof
controlling inflation, maintaining international competitiveness, andmanaging thebalance ofpayments.
Thus, Mr.Chairman, thebalance ofpayments prospects needtobeunder close scrutiny.
Thecurrent levelofforeign currency reserves provide cover forabout 4months ofimport ofgoods
andservices. However, inrecent times, some ofthevolatility ofthedomestic stock market isgetting
reflected inthebehaviour ofportfolio investment byforeign institutional investors. Furthermore, the
deceleration inexport growth, rapid growth inpetroleum imports, andpotential outflow associated
withtheredemption ofUS$2.2 billion worth ofIndia Development Bonds aresome important factors
thatneedtobetaken intoaccount intheevaluation oftheadequacy ofourforeign exchange reserves.
Ourdebt-service payments havealsoincreased from US$8.2 billion in1991-92 toUS$12.3 billion
in1995-96.
Thetrade policy components ofthereform process aremotivated byafullrecognition ofthe
important rolethattrade canplayinpromoting growth. Theutilisation oftheexpanded scope for
specializing inareas ofcomparative advantage ismanifest inthegrowth performance oftheeconomy.
Indiaiscommitted totheprogressive removal ofquantitative restrictions onimports subject tobalance
ofpayments continuing tomaintain sustained improvement. Thephasing isimportant forthreereasons.
First, thebalance ofpayments situation needs tobemonitored, andthephasing should bedoneina
careful manner toavoid abalance ofpayments crisis. Theshock ofthebalance ofpayments crisis
atthebeginning ofthedecade, aswellasthelossofUS$4 billion reserves in1995-96, arestillfresh
inpublic memory toriskacrisis. Second, thefiscal stance ofpolicies isstillsomewhat loose, and
creates pressure onmonetary policy aswellasexchange markets. Trade liberalisation hastobedoneWT/BOP/R/22
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instepwithourfiscal consolidation. Third, there ispopular democratic consensus behind reforms
inIndia, andagradual phase outwithout anyriskofadverse falloutisthebestguarantee forcontinuity
ofthepopular support baseforreforms.
TheIndian commitment toaphased liberalisation ofitsquantitative restrictions ismotivated
byitsbelief inthebenefits ofaprice-based, market-oriented import regime aswellasananticipated
sustained improvement intheexternal trading environment. Quantitative restrictions areinefficient,
butguarantee, intheIndian context, alevelofcertainty which price-based measures cannot. Thus,
while suchrestrictions havetoberemoved, itisbestto"feelourwaythrough" byagradual process.
Anyprecipitous action onremoval ofquantitative restrictions which mayundermine thestability of
theIndian economy orthereform process itself, cannotonlydogreat harm toIndia, butaswellto
foreign investors andthemajor trading partners whohaveastake inthesustainable development of
theIndiaeconomy. Thegrowth momentum oftheIndian economy appears tobeaccelerating inresponse
totheboldreform measures oftheGovernment. Theprocess needs stimulation through further
restructuring andliberalisation, butthepaceneeds tobecalibrated inacareful manner toavoid
unnecessary riskandadjustment costs. Thebestwayofpreserving thepopular consensus onthereforms
process thathasemerged inIndia, istopursue apolicy ofhastening slowly, andthatisthepolicy we
arepursuing.
Mr.Chairman, Mycolleagues andIstand ready torespond toquestions andcomments from
you andfrom theMembers oftheCommittee. TheIndian delegation counts onthecontinued
understanding oftheMembers oftheCommittee.WT/BOP/R/22
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ANNEX II
Statement bytheIMFRepresentative
1. Thereforms ofthepastfiveyears havealready yielded substantial gains. Output hasgrown
vigorously, propelled bythesignificant transformation oftheIndian economy thatisnowunderway.
Atthesame time, acautious monetary policy hascontributed toareduction ininflation, while the
external situation hasremained manageable, notwithstanding arising current account deficit. However,
continued economic success willdepend onthenewGovernment taking firmstepstoaddress difficult
challenges, particularly tolower thestillhighfiscal deficit andtogiverenewed impetus tothereform
program.
2. Thenewgovernment inherited astrongly growing economy. RealGDP roseby6½percent
in1995/96 (theIndian fiscal yearrunsApril 1-March 31),fuelled bybuoyant investment andexport
growth. Thus farin1996/97, industrial production hasslowed somewhat, reflecting mainly supply
constraints incertain sectors (e.g., power generation andoilproduction) related toinadequate investment
overanumber ofyears. Nevertheless, agricultural production should benefit from aparticularly
favourable monsoon. RealGDP growth in1996/97 isexpected toremain over6percent.
3. Inflation hasbeensubdued overthepastyear. Tight monetary policy combined withadelay
ofadministered priceadjustments untilaftertheelection brought wholesale priceinflation -theprinciple
price indicator usedbytheauthorities -down to4½percentduring 1995/96. Inrecent months,
wholesale priceinflation hasrisentoaround 6½percent,reflecting thepass-through ofa20percent
increase inpetroleum product prices inJuly1996 andrising foodprices.
4. Withthefiscaldeficithigh,monetarypolicyhascarriedthemainburdenofstabilization.During
1995/96, themonetary policy stance waskepttight, andmoney growth slowed. Liquidity wasfurther
constrained bytheweakness inthestock market andtheslowdown incapital inflows, andinterest rates
rosesharply. Inearly 1996/97, inresponse toconcerns thattightfinancial conditions werebeginning
todampen themomentum ofgrowth, themonetary policy stance waseased moderately, bringing interest
ratesdown, particularly attheshort end.Nevertheless, broad money growth hasremained essentially
ontrack withtheauthorities 'target of15½-16 percentfor1996/97 asawhole, which should be
consistent withexpected realGDPgrowth andtheobjective ofholding inflation within the6-7percent
range. Itwillbeimportant fortheauthorities tostickwiththistarget, andrespond promptly totighten
policy ifinflation continues toriseoriftheexternal position wakens.
5. Thefiscal deficit hasbeenreduced inrecent years, butremains toolarge. Thedeficit ofthe
combined public sector (including thecentral government, thecental public enterprises, theoilpool
account, andthestategovernments) wasstillabout 9percentofGDP in1995/96, compared to
12percentin1990/91. Thecentral government 'sdeficit wasreduced moderately in1995/96 to
5.7percentofGDP (slightly exceeding thebudget target of5.5percent), asstrong growth intax
revenues generated bythebuoyant economy balanced ashortfall indivestment proceeds. Spending
over-runs onsubsidies andsocial progams werelargely offset bycutstocapital expenditures. State
governments havecontributed lesstothefiscal consolidation process, andtheirfiscal situation has
deteriorated inrecent years inthatarising share oftheirrevenues hasbeenabsorbed byinterest costs
andother current expenses.
6. ThenewGovernment hasindicated itsintention tocontinue theprocess offiscal adjustment,
albeit atagradual pace, withtheobjective oflowering thecentral government 'sdeficit tounder
4percentofGDP within afewyears. Asafirststep,the1996/97 budget aimstoreduce thecentralWT/BOP/R/22
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government 'sdeficit to5percentofGDP. Thebudget introduced aminimum taxoncorporate book
profits -asignificant base-broadening measure. Italsocutimport duties substantially onarange of
rawmaterials andintermediate products. Expenditure allocations forsocial sectors, infrastructure,
andthefertilizer subsidy were increased significantly, while asubstantial contingency wasincluded
tocover thepossible impact ofthesalary increase likely tofollow from thePayCommission 's
recommendations duelaterthisyear. Thebudget envisaged asubstantial increase indivestment receipts,
which nowlooks unlikely tomaterialize. Thisshortfall, together withhigher-than-budgeted outlays
insome areas (inparticular foodandfertilizer subsidies anddefense), imply thatthedeficit in1996/97
islikely tobearound 5½percentofGDP.
7. IntheFund'sview, abolder strategy toward fiscal consolidation isrequired inorder torelieve
pressures oninterest rates, reduce thevulnerability oftheeconomy toshifts intheexternal environment,
andstrengthen thefoundation forachieving thesustained higher rateofgrowth rightly desired bythe
authorities. Accordingly, thebudget for1997/98 should takeadvantage ofthefavorable cyclical position
ofthedomestic economy andglobal economic environment tolaunch astrong front-loaded fiscal
adjustment.Themainthrustofdeficitreductionwouldneedtobethroughimprovedrevenuemobilization
(e.g., cutting taxexemptions, broadening thetaxbase, andmoving toward theVAT atthestatelevel).
Serious efforts tocurbexpenditures inareas suchassubsidies andthewage billwould helptofree
resources forpriorities suchasinfrastructure andsocial programs. States should alsomake agreater
contribution todeficit reduction, while atthesame timebeing encouraged toreform theirownfiscal
management.
8. After several years ofsurplus, India'sbalance ofpayments moved intodeficit in1995/96.
Thecurrent account deficit widened to1½percentofGDP, asrapid import growth related torising
domesticdemandmorethanoffsetacontinuedstrongexportperformance.Whileportfolioequityinflows
slowed, direct investment continued torise.Theauthorities responded toseveral episodes ofdownward
pressure ontheexchange ratethrough intervention supported bystepstotighten liquidity, while taking
administrative measures todiscourage speculative activities. Since February 1996, exchange market
pressures haveeased asimport growth hasslowed andprivate capital inflows havestrengthened. Against
thisbackground, theReserve Bank ofIndiahasbeenabletoreplenish international reserves inadvance
oflarge amortization payments thatfalldueinearly 1997. Thevalue oftherupee hasfluctuated in
arelatively narrow bandinrecent months.
9. For1996/97 asawhole, thebalance ofpayments isexpected toregister asmall surplus. The
current account deficit would risemodestly toaround 1¾percentofGDP, withbothexport andimport
growth slowing. Theslowdown inimport growth islikely tobeparticularly sharp, despite astrong
riseinoilimports, reflecting inpartthemoderation inindustrial growth. Atthesametime, thesurplus
onthecapital account isexpected torisesignificantly, asahump inamortization requirements related
tofinancing the1990/91 external crisis would bemore thanbalanced byrising private capital inflows,
particularly portfolio investment andexternal commercial borrowing. Gross international reserves
areexpected toincrease byabout $1½billion toaround $18½ billion atyear-end, acomfortable
5months ofimports andalevel thatisalsosizable incomparison tothestock ofshort-term debt
($5billion) andthecumulative stock ofportfolio equity inflows ($14billion). Thepresent levelof
theexchange ratewould seem tobebroadly appropriate forcurrent circumstances, butflexibility in
exchange ratemanagement, inclosecoordination withothermacroeconomic policy instruments, should
bemaintained.
10. Looking tothemedium term, thecurrent account deficit islikely tocontinue towiden, reflecting
theimpact ofrising infrastructure investment andcontinued tradeliberalization, notwithstanding good
prospectsforexportsastheeconomybecomesmoreopen.Privatecapitalinflowsshouldremainbuoyant,
withrising foreign direct investment complementing portfolio flows andexternal borrowing. FurtherWT/BOP/R/22
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capital account liberalization would contribute tofostering suchinflows, withpriority being given to
direct andportfolio investment. Provided thatmacroeconomic policy areprudent -notably thatgood
progress ismade onfiscal consolidation -thisoutlook should befullyconsistent withcontinued external
viability. Indeed, agradual riseinthecurrent account deficit upto3-4percentofGDP, would still
becompatible withbringing thedebtservice ratiodown from 26percentthisyeartowellunder
20percentoverthenextfewyears. However, caution would beneeded toavoid progressing toofar
along thepathofincreased reliance onforeign savings untilfiscal consolidation iswelladvanced.
11. Theprocess ofstructural reform wasgradual inthepre-election period, withmostheadway
being achieved inthefinancial sector where interest rateswereliberalized andcapital market reforms
(such assteps todevelop thegovernment securities market) proceeded. Thenewgovernment plans
topushreforms forward across arange offronts, asdescribed initsCommon Minimum Program,
andhasintroduced anumber ofinitiatives, including taxreform andfurther liberalization ofthe
investment regime. While these steps were welcome, theremaining reform agenda isalongand
challenging one. Itwillbeimportant totakeadvantage ofcurrent favorable economic circumstances
torevive themomentum ofreform through early elaboration ofacomprehensive reform framework.
Main areas forattention include: establishing aviable institutional framework forprivate participation
ininfrastructure tohelprelieve keysupply bottlenecks; sustaining themomentum offinancial reform
tostrengthen further thepublic sector banks, foster wellfunctioning capital markets, andensure effective
supervision ofarapidly evolving financing system; privatization andrestructuring ofpublic enterprises
topromote afundamental improvement incorporate governance; andamore effective exitpolicy
tofacilitate theredeployment ofresources locked intounproductive units.
12. Trade reform should alsobeaparticular priority. Substantial progress hasbeenmade over
thepastfiveyears, reflected inalowering oftheaverage import-weighted tariff from 87percentin
1990/91 tounder 23percentin1996/97. Nevertheless, tariffs remain highbyEastAsian standards,
and-notwithstanding some recent progress -quantitative restrictions (QRs) stillcover most ofthe
consumer goods sector. While thelowering oftariffs onrawmaterials andintermediate products in
the1996/97 budget waswelcome, oneimplication isthatthealready higheffective ratesofprotection
fortheconsumer goods sector haveincreased. Early action andaclear timetable forremoving the
continuing QRsonconsumer goods imports -together withliberalization ofthesystem ofreservation
forsmall-scale units ofmany manufactured products -would helpreduce distortions toinvestment
incentives andencourage theemergence ofanefficient, export-oriented consumer goods industry.
Moreover, intheFund'sjudgement, theexternal situation canbewellmanaged using macroeconomic
policy instruments without recourse toQRs. TheFund'sview, therefore, isthatQRsshould beremoved
overarelatively shortperiod; thetarifflevels applied topreviously restricted consumer goodimports
could initially bekeptclose tothetopendoftheexisting tariff structure, buttariffs should bescaled
backgradually overapre-set timetable.