RESTRICTED

World Trade WT/BOP/R/22

3 March 1997

Organization

(97-0871)

Committee on Balance-of-Payments Restrictions

REPORT ON THE CONSULTATION WITH INDIA

1. The WTO Committee on Balance-of-Payments Restrictions resumed its consultations with India on 20 and 21 January 1997. The consultation was held under the Chairmanship of Mr. P. Witt (Germany), in accordance with the Committee's terms of reference, pursuant to Article XVIII:B, paragraph 12(b) of GATT 1994 and the Understanding on the Balance-of-Payments Provisions of GATT 1994. The International Monetary Fund was invited to participate in the consultation in accordance with Article XV:2 of GATT 1994.

2. The Committee had before it the following documents:

Basic Document supplied by India WT/BOP/16

Background Paper by the Secretariat WT/BOP/W/11

Addendum to the Background Paper WT/BOP/W/11/Add.1

Report on the Consultations with India WT/BOP/R/11

Notification by India Under Paragraph 9

of the Understanding WT/BOP/N/11 and Corr.1

IMFIndia - Recent Economic Developments, October 15, 1996

India - Selected Issues, October 17, 1996

Opening statement by the Representative of India

3. The opening statement by the representative of India is attached as Annex I.

Statement made by the Representative of the International Monetary Fund

4. The statement made by the representative of the International Monetary Fund is attached as Annex II.

Discussion in the Committee

5. Members appreciated the efforts of the Government of India to continue to implement economic reforms. They shared India's view that the process needed to be sustained in order to be successful in the long run. The Committee thanked India for the detailed notification of restrictions maintained by it, contained in document WT/BOP/N/11 and Corr.1, in line with its undertaking in the Committee meeting of December 1995.

6. Some Members considered that India did not face a balance-of-payments problem, noting that, with reference to the conditions specified in Article XVIII:9, there was neither a threat of serious decline in India's reserves nor were monetary reserves inadequate. While acknowledging that all countries needed to monitor their external accounts, they remarked that reserves were at a comfortable level (five months of imports), as mentioned in the document provided by the Government of India (WT/BOP/16, para. 44). These Members pointed out that, since the reform process begun in 1991, there had been a significant increase in exports, a lowering of the current account deficit and sustained improvement in the balance of payments. In addition, there had been a dramatic reduction in inflation while foreign direct investment inflows had risen from US$150 million to US$2 billion. They seconded the view of the IMF that the balance of payments deficit did not compromise India's external viability and that the external situation was manageable using macroeconomic policy instruments. They expressed the view that the balance-of-payments provisions should be disinvoked. One Member pointed out that reinvocation would be possible should circumstances warrant.

7. Some other Members took the view that, in spite of impressive results in the balance-of-payments situation, prospects suggested the need for caution and prudence in the management of India's external accounts in light of the pressure exerted on the balance of payments through the fiscal deficit, which remained at around 9 per cent of GDP. They drew attention to volatile elements (private transfers, short-term debt and portfolio investment) in the structure of the balance of payments, wide fluctuations in capital flows, a continued high debt ratio, slowing export growth, a surge in oil imports and the consequent possible fragility of the balance of payments. They suggested that India could continue to have recourse to Article XVIII:B of GATT 1994 and the associated Understanding.

8. In reply to questions from one Member, who drew attention to the strengthening of India's balance of payments and reserves position in 1996, the representative of the Fund stated that, in the Staff's view:

(i)there had not, over the past year, been a serious decline in India's foreign exchange reserves: from end March 1996 to end December 1996 they had increased by US$2.7 billion and, in relation to imports, had remained relatively constant at around five months of import coverage;

(ii)US$19.8 billion in reserves appeared a comfortable level in relation to imports and to the stock of short-term debt (US$5 billion), rather than an inadequate or very low level; with continued broadly sound macroeconomic policies, India should be able to meet all external payment requirements without difficulties, and to weather the consequences of possible external shocks without undue disruption;

(iii)India was not faced with the threat of a serious decline in its monetary reserves; on the contrary, barring major unforeseen shocks India's reserves should continue to increase in 1997 and in the medium term, and the balance of payments could be expected to benefit from a steep decline in amortization of the exceptional financing obtained to meet the 1990-91 crisis. While the current account deficit might widen as a result of import growth related to investment, this should be comfortably financed by rising private capital inflows;

(iv)current quantitative restrictions imposed by India were not necessary to achieve a reasonable rate of increase in reserves; indeed, the removal of quantitative restrictions, in conjunction with other measures, could be expected to strengthen the external position over the medium term, reduce distortions to investment and encourage the emergence of an efficient consumer goods industry;

(v)the replacement of quantitative restrictions by moderate tariffs would contribute to stability and economic success by providing revenue for deficit reduction, since the government would capture rents that now accrue to those able to obtain import licences or bring goods into India illegally. Though the long run aim should be for Indian tariffs to fall to international levels, in the short run the replacement of quantitative restrictions by tariffs could be expected to help the revenue position.

9. Members recognized that there had been a gradual relaxation of restrictions as balance-of-payments conditions had improved. Some Members proposed that India eliminate its quantitative restrictions immediately given that there was no justification on balance-of-payments grounds. Some other Members encouraged India to phase out quantitative restrictions as rapidly as possible and to move to a tariff-based system. They reminded the Committee that restrictions for balance-of-payments purposes are intended to be temporary measures and, in India's case, had been in place for an inappropriately long period of time. Still other Members, complimenting India on the trade liberalization already in progress, sympathized with India's concern that a hasty removal of restrictions could undermine external and economic stability.

Replies by the Representative of India

10. The representative of India stated that, although the overall balance-of-payments position had improved, it could not be described as solid, and there was still need for caution and careful monitoring. Not only had reserves fallen in the course of fiscal year 1995-1996, but, between October 1995 and February 1996, the rupee had depreciated by 23 per cent raising the cost of imports. Portfolio investment in 1995 had been US$1.2 billion compared to US$2.2 billion in 1994 and the stock market index had dropped by 25 to 30 per cent in the second half of 1996. The price of crude oil, which represented one-quarter of India's imports, had risen significantly and debt and debt service to exports ratios were too high for comfort. Furthermore, the fiscal deficit remained quite stubborn, domestic savings were insufficient to meet investment needs, inflation was inching back up and growth in exports had been volatile in recent months.

11. He said that, in this situation, precipitous removal of quantitative restrictions could undermine economic stability and the reform process. He cited the purpose of balance-of-payments invocation as stated in Article XVIII:9 : "to safeguard the external financial position and ensure a level of reserves adequate for the implementation of [its] programme of economic development." He reminded the Committee that India had consulted regularly in the Committee, acting in accordance with its recommendations, and that until 1995, the balance-of-payments situation had not warranted the Committee recommending the phasing out of balance-of-payments restrictions. India had progressively relaxed restrictions since the reform process began in 1991, as conditions had improved, and was committed to a phase out of quantitative restrictions maintained for balance-of-payments purposes. The representative drew a parallel with the case of Korea which in 1989 had put forward a three-step, seven-year phase-out programme. Progressive reduction of tariffs was the policy of his Government and the ability to phase out quantitative restrictions was linked to the degree of flexibility and autonomy that could be maintained over the tariff structure.

12. Following the discussion of the conclusions, one Member sought clarification from India on the prospective time-table for adoption of the new policy, and urged India to consult with its trading partners to ensure that due consideration was paid to the interests of WTO Members in a balanced manner. He also asked that details of the phase-out plan be made available to Members well in advance of the meeting, scheduled for the first week of June 1997, to conclude the consultations.

13. The representative of India responded that delegations were welcome to contact his Government to consult on elements of the phase-out plan. He recalled that the Export-Import Policy would normally be published by the end of March and confirmed that the phase-out plan would be circulated to the Committee, in accordance with established rules of procedure, three weeks in advance of the June meeting.

Conclusions

14. In its resumed consultation with India, the Committee took note of the positive developments in India's economic situation since 1995. The Committee welcomed the Indian authorities' continued commitment to economic reform and liberalization and noted India's progressive removal of quantitative restrictions notified under Article XVIII:B.

15. The Committee took note of the IMF's statement that India's current monetary reserves were not inadequate and that there was no threat of a serious decline in India's monetary reserves. The Indian delegation cautioned that India's balance of payments needed close monitoring and that precipitous removal of the quantitative restrictions notified under Article XVIII:B could have the effect of undermining the stability of the Indian economy and the reform process.

16. In the light of ongoing discussions, the Committee agreed to resume the consultation in the week beginning 2 June 1997. The purpose of the continued consultation would be to consider a plan, which the Committee invited India to present, to eliminate the measures notified under Article XVIII:B, and to conclude the consultations consistently with all relevant WTO balance-of-payments provisions. In drawing up its plan, India will give due consideration to the interests of WTO Members in a balanced manner.

ANNEX I

Statement by the Representative of India

Mr. Chairman, distinguished Members of the Committee, distinguished representative of IMF and friends from the Secretariat.

I am happy to be here for this important meeting of the Balance of Payments Committee for making these opening remarks on behalf of the Government of India.

All the relevant documents, that is, the Basic Document supplied by India to the Committee, the Background Paper of the Secretariat, as also the Report of the IMF are before you. These documents cover the factual position relating to India’s trade and economic scenario. The IMF and the Secretariat have, as usual, produced excellent reports and our thanks are due to them.

As you are aware, since the last meeting of the Committee, the eleventh General Elections have taken place in our country, and a multi-party Government took charge at the Centre a few months ago. However, the broad thrust of the policy of economic reforms and liberalisation has continued. The continuity of the reform process is in large measure due to the consensus that has developed in favour of the liberalisation process. The documents before the Committee detail the various measures that have been taken so far.

Significant structural reforms have taken place since 1991. Domestic deregulation and external liberalisation, including in the area of foreign investment have been the two major aspects of these measures. The regulatory framework for a domestic capital market including the prudential aspects have been streamlined and strengthened. Central depositories for scripless trading have started functioning, and are expected to have a salutary impact on portfolio investment by foreign institutional investors in the medium term. Progressive relaxation of norms of equity participation and dividend repatriation has been announced and implemented since 1991. The recent restructuring of the Foreign Investment Promotion Board for fast approval, and the setting up of the Foreign Investment Promotion Council, are aimed at accelerating the inflow of foreign direct investment into India. These measures have brought about significant results in terms of investment generation, more employment and added GDP growth. Reform is continuing, and the Government is actively pursuing policies which will take the country to a growth path of 7 per cent per year.

The response of the Indian economy to the package of reforms and stabilization measures initiated in 1991-92 has been very positive. Growth, which was 0.8 per cent in 1991-92, after recovering to about 5 per cent in the two subsequent years, accelerated further to 6.3 per cent and 6.6 per cent in 1994-95 and 1995-96, respectively. Inflation -- on an end of period basis -- came down from 13.6 per cent in 1991-92 to 5 per cent in 1995-96. Steady progress has been achieved in employment generation and poverty reduction.

Trade liberalisation, Mr. Chairman, has been an essential component of the Government’s reform programme. The Export-Import Policy of 1992-97 has removed most of the quantitative restrictions on raw materials, intermediate goods and capital goods. The process of removing quantitative restrictions on consumer goods has also commenced. Furthermore, in October 1995, the Export-Import Policy was aligned with the Indian Trade Classification, which is based on the Harmonised System of classifying commodities under the internationally recognised coding system. In accordance with the decision of the Committee on Balance of Payments at its consultations with India in December 1995, India has notified to the WTO all remaining restrictions maintained on imports for BOP reasons, incorporating amendments up to 25 March 1996. For the sake of comprehensiveness, this notification also includes quantitative restrictions on imports maintained for other GATT-consistent reasons.

As part of exchange liberalisation, India unified its exchange rate in 1993, and introduced current account convertibility in August 1994. The turn-around in the balance of payments and the recovery in reserves were achieved not by import compression and exchange restrictions, but simultaneously with significant trade and exchange market liberalisation. Let me reiterate that India is committed to further trade liberalisation. As I have said earlier, Government have over the past few years, progressively withdrawn quantitative restrictions on many items. The quantitative restrictions now apply only on around 30 per cent of the HS-line items. Most importantly the maximum tariff has been reduced from a peak of over 100 per cent to around 52 per cent today and the import-weighted tariff rate has been progressively brought down over a six year period from 87 per cent to 22.7 per cent. I am sure that all the Members would agree that this is an impressive achievement and excellent progress.

The reflection of all the trade liberalisation measures, as well as the pick up in the economic activity can be seen from the fact that imports have surged by 85 per cent between 1991-92 and 1995-96. As against this, the export of goods and services has gone up by about 78 per cent between 1991-92 and 1995-96. The higher base of imports relative to exports together with the relatively higher growth of imports, resulted in a widening of the trade deficit from US$ 1.5 billion in 1991-92 to US$ 4.5 billion in 1995-96. The healthy recovery of reserves has been possible only because of improved invisible receipts and capital inflows. Invisible receipts, in US dollar terms, recorded an average annual growth rate of 16.6 per cent during the last five years ending 1995-96. Foreign direct investment and portfolio investment have emerged as the dominant components of the capital account, and such investments in the aggregate increased from less than US$100 million in 1990-91 to almost US$5 billion in 1994-95. In 1995-96, however, such investments declined to US$4.2 billion.

The slow pace of fiscal consolidation and financial market reforms are two additional factors complicating the management of the balance of payments. While we are fully engaged in speeding up the process of fiscal correction as well as financial market reforms, the progress to date has fallen short of our expectations. A somewhat high fiscal deficit continues to keep domestic rates of interest at relatively high levels, and exacerbate the problems of volatile short-term capital flows. The financial system is not yet sound and flexible enough to rapidly adapt to changing situations. We believe that reform of the external sector can be expedited if the fiscal deficit is quickly brought down, the prudential supervision of financial institutions is strengthened, and appropriate institutional arrangements for speedy foreign exchange and payments clearing systems are put in place.

Mr. Chairman, while the balance of payments situation might appear to be comfortable, it needs close monitoring and calls for exercise of caution in taking measures in the interrelated field of trade, particularly given our fiscal situation. I shall illustrate the need for caution by citing few developments during the year 1995-96 and in the first three quarters of the current financial year.

First, reserves declined by almost US$3 billion in 1995-96. In fact, the reserve loss on a monetary basis, that is inclusive of valuation change, was almost US$4 billion last year! A widening of the current account deficit to 1.7 per cent of GDP in 1995-96 from 0.9 per cent of GDP in the previous year, and a decline of US$1.8 billion in the inflows from the issue of Euro-equities explain the bulk of the reserve decline in 1995-96.

Second, the second half of 1995-96 witnessed periodic speculative pressures on the exchange rate of the rupee, and the exchange rate of the rupee vis-a-vis the US dollar depreciated from a monthly average of Rs. 31.6 in August 1995 to Rs. 36.6 to a dollar in February 1996. While some easing of the exchange rate of the rupee in the second half of 1995-96 was consistent with economic fundamentals, speculative pressure in a relatively thin market had led to an overshooting. While the appropriate and rapid policy responses by the Reserve Bank of India restored orderly market conditions, and the rupee recovered to Rs. 34.2 in April 1996, the exchange market developments in the second half of 1995-96 underscores the need for caution in balance of payments management.

Third, exports for the period April-November, 1996, estimated at US$21.4 billion, showed a growth of only 7.8 per cent compared to the growth of 24.5 per cent in the corresponding period of the previous year. For the month of November 1996, exports actually declined by 5.9 per cent, when compared to the corresponding month of the previous year. The sharp decline in export performance has to be seen in the context of a fall in the import demand by industrialised countries, our own constraints in the infrastructure sector, and a steep decline in our non-petroleum imports. We are deeply concerned about the deceleration in exports and are determined to reverse it through appropriate policies, particularly because our oil-import bill has been rising rapidly. Partly due to the stiffening of the international price of oil, the import bill for crude and petroleum products went up by over 41 per cent in April-November, 1996 in dollar terms relative to the same period a year ago.

The investment needs of the economy, particularly those in infrastructure, are enormous. The savings rate is sluggish, mainly because of the poor performance of public savings. The saving-investment gap is expected to increase, and get reflected in a widening of the current account deficit with resurgence of growth in the economy. We consider it imperative to attract large inflows of foreign investment to bridge the current account deficit. The Government has taken various measures to facilitate the inflow of foreign investment, and an ambitious target of attracting US$10 billion per year has been announced. The soundness of our balance of payments will crucially depend on our success in attracting foreign investment. Mr. Chairman, we are optimistic, but uncertainty remains.

In recent times, there have been signs of some resurgence of inflationary pressures in the economy. This together with the relatively slow pace of fiscal consolidation complicates the task of controlling inflation, maintaining international competitiveness, and managing the balance of payments.

Thus, Mr. Chairman, the balance of payments prospects need to be under close scrutiny. The current level of foreign currency reserves provide cover for about 4 months of import of goods and services. However, in recent times, some of the volatility of the domestic stock market is getting reflected in the behaviour of portfolio investment by foreign institutional investors. Furthermore, the deceleration in export growth, rapid growth in petroleum imports, and potential outflow associated with the redemption of US$2.2 billion worth of India Development Bonds are some important factors that need to be taken into account in the evaluation of the adequacy of our foreign exchange reserves. Our debt-service payments have also increased from US$8.2 billion in 1991-92 to US$12.3 billion in 1995-96.

The trade policy components of the reform process are motivated by a full recognition of the important role that trade can play in promoting growth. The utilisation of the expanded scope for specializing in areas of comparative advantage is manifest in the growth performance of the economy. India is committed to the progressive removal of quantitative restrictions on imports subject to balance of payments continuing to maintain sustained improvement. The phasing is important for three reasons. First, the balance of payments situation needs to be monitored, and the phasing should be done in a careful manner to avoid a balance of payments crisis. The shock of the balance of payments crisis at the beginning of the decade, as well as the loss of US$4 billion reserves in 1995-96, are still fresh in public memory to risk a crisis. Second, the fiscal stance of policies is still somewhat loose, and creates pressure on monetary policy as well as exchange markets. Trade liberalisation has to be done in step with our fiscal consolidation. Third, there is popular democratic consensus behind reforms in India, and a gradual phase out without any risk of adverse fall out is the best guarantee for continuity of the popular support base for reforms.

The Indian commitment to a phased liberalisation of its quantitative restrictions is motivated by its belief in the benefits of a price-based, market-oriented import regime as well as an anticipated sustained improvement in the external trading environment. Quantitative restrictions are inefficient, but guarantee, in the Indian context, a level of certainty which price-based measures cannot. Thus, while such restrictions have to be removed, it is best to "feel our way through" by a gradual process. Any precipitous action on removal of quantitative restrictions which may undermine the stability of the Indian economy or the reform process itself, can not only do great harm to India, but as well to foreign investors and the major trading partners who have a stake in the sustainable development of the India economy. The growth momentum of the Indian economy appears to be accelerating in response to the bold reform measures of the Government. The process needs stimulation through further restructuring and liberalisation, but the pace needs to be calibrated in a careful manner to avoid unnecessary risk and adjustment costs. The best way of preserving the popular consensus on the reforms process that has emerged in India, is to pursue a policy of hastening slowly, and that is the policy we are pursuing.

Mr. Chairman, My colleagues and I stand ready to respond to questions and comments from you and from the Members of the Committee. The Indian delegation counts on the continued understanding of the Members of the Committee.

ANNEX II

Statement by the IMF Representative

1. The reforms of the past five years have already yielded substantial gains. Output has grown vigorously, propelled by the significant transformation of the Indian economy that is now underway. At the same time, a cautious monetary policy has contributed to a reduction in inflation, while the external situation has remained manageable, notwithstanding a rising current account deficit. However, continued economic success will depend on the new Government taking firm steps to address difficult challenges, particularly to lower the still high fiscal deficit and to give renewed impetus to the reform program.

2. The new government inherited a strongly growing economy. Real GDP rose by 6½ per cent in 1995/96 (the Indian fiscal year runs April 1-March 31), fuelled by buoyant investment and export growth. Thus far in 1996/97, industrial production has slowed somewhat, reflecting mainly supply constraints in certain sectors (e.g., power generation and oil production) related to inadequate investment over a number of years. Nevertheless, agricultural production should benefit from a particularly favourable monsoon. Real GDP growth in 1996/97 is expected to remain over 6 per cent.

3. Inflation has been subdued over the past year. Tight monetary policy combined with a delay of administered price adjustments until after the election brought wholesale price inflation - the principle price indicator used by the authorities - down to 4½ per cent during 1995/96. In recent months, wholesale price inflation has risen to around 6½ per cent, reflecting the pass-through of a 20 per cent increase in petroleum product prices in July 1996 and rising food prices.

4. With the fiscal deficit high, monetary policy has carried the main burden of stabilization. During 1995/96, the monetary policy stance was kept tight, and money growth slowed. Liquidity was further constrained by the weakness in the stock market and the slowdown in capital inflows, and interest rates rose sharply. In early 1996/97, in response to concerns that tight financial conditions were beginning to dampen the momentum of growth, the monetary policy stance was eased moderately, bringing interest rates down, particularly at the short end. Nevertheless, broad money growth has remained essentially on track with the authorities' target of 15½-16 per cent for 1996/97 as a whole, which should be consistent with expected real GDP growth and the objective of holding inflation within the 6-7 per cent range. It will be important for the authorities to stick with this target, and respond promptly to tighten policy if inflation continues to rise or if the external position wakens.

5. The fiscal deficit has been reduced in recent years, but remains too large. The deficit of the combined public sector (including the central government, the cental public enterprises, the oil pool account, and the state governments) was still about 9 per cent of GDP in 1995/96, compared to 12 per cent in 1990/91. The central government's deficit was reduced moderately in 1995/96 to 5.7 per cent of GDP (slightly exceeding the budget target of 5.5 per cent), as strong growth in tax revenues generated by the buoyant economy balanced a shortfall in divestment proceeds. Spending over-runs on subsidies and social progams were largely offset by cuts to capital expenditures. State governments have contributed less to the fiscal consolidation process, and their fiscal situation has deteriorated in recent years in that a rising share of their revenues has been absorbed by interest costs and other current expenses.

6. The new Government has indicated its intention to continue the process of fiscal adjustment, albeit at a gradual pace, with the objective of lowering the central government's deficit to under 4 per cent of GDP within a few years. As a first step, the 1996/97 budget aims to reduce the central government's deficit to 5 per cent of GDP. The budget introduced a minimum tax on corporate book profits - a significant base-broadening measure. It also cut import duties substantially on a range of raw materials and intermediate products. Expenditure allocations for social sectors, infrastructure, and the fertilizer subsidy were increased significantly, while a substantial contingency was included to cover the possible impact of the salary increase likely to follow from the Pay Commission's recommendations due later this year. The budget envisaged a substantial increase in divestment receipts, which now looks unlikely to materialize. This shortfall, together with higher-than-budgeted outlays in some areas (in particular food and fertilizer subsidies and defense), imply that the deficit in 1996/97 is likely to be around 5½ per cent of GDP.

7. In the Fund's view, a bolder strategy toward fiscal consolidation is required in order to relieve pressures on interest rates, reduce the vulnerability of the economy to shifts in the external environment, and strengthen the foundation for achieving the sustained higher rate of growth rightly desired by the authorities. Accordingly, the budget for 1997/98 should take advantage of the favorable cyclical position of the domestic economy and global economic environment to launch a strong front-loaded fiscal adjustment. The main thrust of deficit reduction would need to be through improved revenue mobilization (e.g., cutting tax exemptions, broadening the tax base, and moving toward the VAT at the state level). Serious efforts to curb expenditures in areas such as subsidies and the wage bill would help to free resources for priorities such as infrastructure and social programs. States should also make a greater contribution to deficit reduction, while at the same time being encouraged to reform their own fiscal management.

8. After several years of surplus, India's balance of payments moved into deficit in 1995/96. The current account deficit widened to 1½ per cent of GDP, as rapid import growth related to rising domestic demand more than offset a continued strong export performance. While portfolio equity inflows slowed, direct investment continued to rise. The authorities responded to several episodes of downward pressure on the exchange rate through intervention supported by steps to tighten liquidity, while taking administrative measures to discourage speculative activities. Since February 1996, exchange market pressures have eased as import growth has slowed and private capital inflows have strengthened. Against this background, the Reserve Bank of India has been able to replenish international reserves in advance of large amortization payments that fall due in early 1997. The value of the rupee has fluctuated in a relatively narrow band in recent months.

9. For 1996/97 as a whole, the balance of payments is expected to register a small surplus. The current account deficit would rise modestly to around 1¾ per cent of GDP, with both export and import growth slowing. The slowdown in import growth is likely to be particularly sharp, despite a strong rise in oil imports, reflecting in part the moderation in industrial growth. At the same time, the surplus on the capital account is expected to rise significantly, as a hump in amortization requirements related to financing the 1990/91 external crisis would be more than balanced by rising private capital inflows, particularly portfolio investment and external commercial borrowing. Gross international reserves are expected to increase by about $1½ billion to around $18½ billion at year-end, a comfortable 5 months of imports and a level that is also sizable in comparison to the stock of short-term debt ($5 billion) and the cumulative stock of portfolio equity inflows ($14 billion). The present level of the exchange rate would seem to be broadly appropriate for current circumstances, but flexibility in exchange rate management, in close coordination with other macroeconomic policy instruments, should be maintained.

10. Looking to the medium term, the current account deficit is likely to continue to widen, reflecting the impact of rising infrastructure investment and continued trade liberalization, notwithstanding good prospects for exports as the economy becomes more open. Private capital inflows should remain buoyant, with rising foreign direct investment complementing portfolio flows and external borrowing. Further capital account liberalization would contribute to fostering such inflows, with priority being given to direct and portfolio investment. Provided that macroeconomic policy are prudent - notably that good progress is made on fiscal consolidation - this outlook should be fully consistent with continued external viability. Indeed, a gradual rise in the current account deficit up to 3-4 per cent of GDP, would still be compatible with bringing the debt service ratio down from 26 per cent this year to well under 20 per cent over the next few years. However, caution would be needed to avoid progressing too far along the path of increased reliance on foreign savings until fiscal consolidation is well advanced.

11. The process of structural reform was gradual in the pre-election period, with most headway being achieved in the financial sector where interest rates were liberalized and capital market reforms (such as steps to develop the government securities market) proceeded. The new government plans to push reforms forward across a range of fronts, as described in its Common Minimum Program, and has introduced a number of initiatives, including tax reform and further liberalization of the investment regime. While these steps were welcome, the remaining reform agenda is a long and challenging one. It will be important to take advantage of current favorable economic circumstances to revive the momentum of reform through early elaboration of a comprehensive reform framework. Main areas for attention include: establishing a viable institutional framework for private participation in infrastructure to help relieve key supply bottlenecks; sustaining the momentum of financial reform to strengthen further the public sector banks, foster well functioning capital markets, and ensure effective supervision of a rapidly evolving financing system; privatization and restructuring of public enterprises to promote a fundamental improvement in corporate governance; and a more effective exit policy to facilitate the redeployment of resources locked into unproductive units.

12. Trade reform should also be a particular priority. Substantial progress has been made over the past five years, reflected in a lowering of the average import-weighted tariff from 87 per cent in 1990/91 to under 23 per cent in 1996/97. Nevertheless, tariffs remain high by East Asian standards, and - notwithstanding some recent progress - quantitative restrictions (QRs) still cover most of the consumer goods sector. While the lowering of tariffs on raw materials and intermediate products in the 1996/97 budget was welcome, one implication is that the already high effective rates of protection for the consumer goods sector have increased. Early action and a clear timetable for removing the continuing QRs on consumer goods imports - together with liberalization of the system of reservation for small-scale units of many manufactured products - would help reduce distortions to investment incentives and encourage the emergence of an efficient, export-oriented consumer goods industry. Moreover, in the Fund's judgement, the external situation can be well managed using macroeconomic policy instruments without recourse to QRs. The Fund's view, therefore, is that QRs should be removed over a relatively short period; the tariff levels applied to previously restricted consumer good imports could initially be kept close to the top end of the existing tariff structure, but tariffs should be scaled back gradually over a pre-set timetable.