RESTRICTED

World Trade WT/BOP/W/11/Add.1

8 January 1997

Organization

(97-0028)

Committee on Balance-of-Payments Restrictions

1997 CONSULTATION WITH INDIA UNDER ARTICLE XVIII:12(b)

OF THE GATT 1994 AND THE RELATED UNDERSTANDING

Background Paper by the Secretariat

Addendum

1. This paper has been prepared as a supplement to WT/BOP/W/11, in accordance with paragraph 12 of the Understanding on the Balance-of-Payments Provisions of the GATT 1994.

I. Trading and Exchange System

(i) Import Policy

2. The establishment of a Tariff Commission, whose terms of reference are being finalized, was announced by the Finance Minister in the 1996-97 budget[1].

(ii) Tariffs

3. The 1996-97 budget introduced a special customs duty of 2 per cent to finance infrastructural investment; duty-free imports and those exempted from duty for export production are not liable to the "infrastructure fee". While this effectively raises the maximum tariff which has declined from over 300 per cent in 1990 to 50 per cent in 1995, India's average import-weighted tariff has fallen from 33 per cent in 1994-95 and 25 per cent in 1995-96, to an estimated 23 per cent in 1996-97.

4. The current budget has cut a wide range of tariffs on raw materials in chemicals, textiles, metal‑related, electronics and other industries. A reduction of customs duty on crude oil from 35 to 25 per cent and an increase in excise duty from 10 to 15 per cent on petroleum products has shifted taxation of the oil sector from the import to the production stage.

(iii) Import Restrictions

5. In December 1995, out of 11,587 tariff lines at the 8-digit level, 6,463 lines were freely importable while 1,487 lines were on the Special Import License list, a tradeable import license allocated to exporters[2]. The Negative Import List (see WT/BOP/W/11) classifies imports into prohibited, restricted and canalized items. Items included in the canalized list are those imported by State-trading entities and under Special Import License. On 25 March 1996 the restricted list was reduced from 5,124 to 4,798 lines. Since then, 105 tariff lines have been made freely importable and 67 tariff lines transferred to the Special Import Licence List.

6. In July 1996, India submitted a notification on the quantitative restrictions maintained on imports (WT/BOP/N/11). Of the 3572 tariff lines, the majority are justified on balance-of-payments grounds

Table 1

India - Tariff structure, 1992-93 - 1996-97

(percentage)

1992-93

1993-94

1994-95

1995-96

1996-97

Maximum Tariff

110

Average tariff (import weighted)

Source: IMF; based on Ministry of Finance and World Bank Staff estimates.

II. Macroeconomic Developments

(i) Output and Expenditure

7. India's real GDP growth increased further from 5.3 per cent in 1994-95 to an estimated 7 per cent in 1995-96. There is some indication that GDP growth is slowing in 1996-97; a rate of 6.6 per cent is now being predicted by the Ministry of Finance. Growth in the last two years has been led mainly by the industrial sector while agriculture remains relatively stagnant. Industrial growth was 8.3 per cent in 1994-95 and 11.7 per cent in 1995-96. Capital goods played a major role in this growth with manufacturing and consumer goods also showing strong recovery. As many as nine sectors recorded growth rates of 20 per cent or more in 1995-96. These included software (50 per cent), machine tools (30 per cent), vehicles (22 per cent) and consumer electronics (20 per cent).[3] During 1996, industry recorded lower growth rates than during the second half of the previous fiscal year, partly because of tighter monetary policy and higher interest rates. As noted below, the RBI eased monetary policy in early 1996-97; an economic upturn is predicted for early next year.

Table 2 - India - Selected Macroeconomic Indicators, 1991-92-1995-96

(Percentage change)

	1991-92	1992-93	1993-94	1994-95	1995-96 est.
Output¹
GDP at factor cost	0.8	5.1	5.0	6.3	7.0
Agriculture	-2.0	5.8	3.3	4.9	2.7
Industry	-1.6	4.4	4.2	8.6	12.0
Services	4.9	5.1	6.8	6.0	7.0
Expenditure²
Consumption	1.4	3.9	4.5	4.2	--
Private	1.8	4.1	4.2	4.3	--
Government	-0.5	3.3	6.1	3.0	--
Gross fixed capital formation	-4.0	6.9	3.4	14.8	--
Construction	2.3	2.7	-0.3	8.8	--
Machinery and equipment	-7.6	9.6	5.6	18.2	--
Prices³
Consumer prices	13.9	6.1	9.9	9.7	8.9
Wholesale prices	13.6	7.0	10.8	10.4	5.0

¹Percent change in constant prices.

²Percent change in constant prices. Figures for 1993-94 are provisional and estimated for 1994-95.

³End of period.

Source: IMF.

(ii) Investment-Savings Balance

8. The savings rate, both public and private, rose in 1994-95, reversing several years of stagnation. Public savings remain a small fraction of GDP. The increase in private investment, mostly in machinery and equipment, and imports of capital goods, stemming from strong growth in industrial output as mentioned above, continued in 1995-96. Infrastructure presents a bottleneck where investment by both public and private sectors remains inadequate, the latter partly due to delays in establishing a transparent framework with respect to bidding procedures and cost recovery, for private sector participation.

Table 3 - India - Savings and Investment, 1991-92-1994-95

(In percent of GDP at market prices)

	1991-92	1992-93	Prov. 1993-94	Est. 1994-95
Gross domestic savings	22.8	21.2	21.4	24.4
Private sector	20.9	19.6	20.8	22.7
Public sector	1.9	1.5	0.5	1.7

Gross capital formation	23.4	23.1	21.6	25.2
Private sector¹	13.5	15.1	12.8	14.3
Public sector	9.2	8.9	8.6	8.8

Savings-investment gap	-0.5	-2.0	-0.3	-0.8
Private sector	7.3	4.5	8.1	8.4
Public sector	-7.2	-7.4	-8.0	-7.1

¹Includes errors and omissions.

Source:IMF.

(iii) Fiscal Developments

9. The previous government aimed to reduce the Central Government budget deficit to 5 per cent of GDP; however, in 1994-95, the deficit fell short of this goal (Table 4). The new government has reaffirmed this commitment and the current budget aims to lower the deficit to 5 per cent of GDP in 1996-97. Recent figures from the Ministry of Finance show that the revenue deficit for April-August 1996 was 26.9 per cent compared to an average of 44.3 per cent for the preceding five years, a promising indication.

Table 4 - India

Consolidated Public Sector Operations, 1991-92-1995-96¹

	1991-92	1992-93	1993-94	Rev Est. 1994-95	Budget 1995-96
	(In billions of rupees)
Total revenue and grants²	1,422.3	1,613.3	1,713.9	2,172.9	2,390.6
Tax revenue	1,031.2	1,145.1	1,223.2	1,475.9	1,654.1
Non-tax revenue²	381.7	458.9	498.7	686.6	725.0
Grants	9.5	9.2	9.9	10.4	11.5
Total expenditure and net lending³	1,996.3	2,274.7	2,612.7	3,031.3	3,425.2
Overall deficit (-)	-574.0	-661.5	-880.9	-858.4	-1,034.5
	(In percent of GDP)
Total revenue and grants²	23.1	23.0	21.6	23.0	22.8
Total expenditure and net lending³	32.4	32.4	32.6	32.1	32.7
Overall deficit	-9.3	-9.4	-11.0	-9.1	-9.9
Memorandum items:
Central Government (CG)	-5.9	-5.7	-7.5	-6.1	-5.5
States	-3.1	-3.0	-2.6	-2.9	-3.2
Central public enterprises	-2.8	-2.9	-3.1	-2.6	-2.7
Net loans to states by Central Government	1.5	1.2	1.3	1.5	1.1
Budgetary support of public sector enterprises	1.1	0.9	0.9	0.9	0.7
Central Government's non-plan loans to public sector enterprises	0.1	0.1	0.1	0.1	--

¹The consolidation covers budgetary transactions at the levels of the Central and State Governments, the departmental undertakings of both levels of Government, the balance of the Oil Coordination Committee and the central public enterprises.

²Including internal resources of public enterprises indicated in footnote 1.

³Including investment expenditure by public enterprises indicated in footnote 1.

Source: IMF.

10. Successive tax reforms in previous years have been a major factor in the modest decline in the fiscal deficit. A simplified and more broad based customs and excise tax structure has been aided by a more effective tax administration. The 1996-97 budget proposed that the central excise structure be further simplified within the next two years so as to make its application more transparent. The budget also brought the textiles sector under the modified VAT (MODVAT) system, a system of rebates of taxes on inputs under the excise tax system, completing the coverage of manufactured goods. A number of consumer goods were also made exempt from excise duty.

11. Despite these reforms, concerns remain regarding India's fiscal deficit. The Government's privatization programme, expected to raise Rs 50 billion (US$ 1.4 billion), has received a temporary setback with its postponement to early 1997. The budget deficit of the States is estimated to have increased from 2.9 per cent of GDP in 1994-95 to around 3.1 per cent in 1995-96, as a result of a drop in grants from the Central Government; the combined States' deficit is projected at 2.8 per cent of GDP in 1996-97 on top of a Central Government deficit of 5 per cent. Including the expected decline in operating surpluses of public enterprises, the overall public sector deficit is forecast at 8.3 per cent of GDP, down from 9.1 per cent, as estimated for 1995-96.

(iv) Monetary Developments

12. As a result of the opening of the economy, monetary policy has become increasingly linked with exchange rate developments. The Reserve Bank of India (RBI) continues to target broad money as its basic monetary policy indicator but has started paying greater attention to interest rate and exchange rate developments. The tight monetary policy stance of 1994-95 continued in 1995-96 with some relaxation in early 1996. Strong demand for credit from both the Government and the private sector exerted upward pressure on both nominal and real interest rates which rose sharply during 1995-96, helping to slow wholesale price inflation (Table 2). Prime lending rates increased to 16.5-20 per cent by February 1996 and effective lending rates were still higher. The net result was a reduction in broad money growth to about 15 per cent in 1995-96, in line with the RBI's target of 15.5 per cent.

13. In early 1996-97 monetary policy was eased somewhat in response to concerns that the economy was slowing down and that tight liquidity was dampening economic activity. The Credit Reserve Ratio was reduced from 14 per cent to 13 per cent in May 1996 and further to 12 per cent in July of the same year. RBI credit to the Government increased sharply through to July 1996 although by September 1996 there was a reversal. As a result of the looser monetary restrictions, broad money growth rose to 16.5 per cent in September 1996 and short term interest rates declined sharply. The Central Bank has targeted broad money growth for 1996-97 at 15.5 to 16 per cent which is expected to reduce wholesale price inflation to 6-7 per cent without curtailing growth of real GDP.

Table 5 - India - Monetary Developments, 1992-93 to 1995-96

	1992-93	1993-94	1994-95	1995-96
	(Percentage change)
Reserve money	11.3	25.2	22.1	14.8
Net foreign assets	3.8	26.0	16.8	-0.4
Net domestic assets	7.5	-0.8	5.3	15.2
Broad money (M3)	15.7	18.4	22.3¹	13.2¹
Currency	11.7	20.6	22.3	17.4
Deposits	16.5	17.6	22.2	12.4
Memorandum items:
Flow of credit to Govt (Rs bn)²	180	277	185	350
Money multiplier	3.31	3.13	3.14	3.10

¹The end-March data for March 1994-95 and 1995-96 contain a surge in deposits associated with the reporting date. The percent changes for broad money in 1994-95 and 1995-96 using mid-March data are 17.7 percent and 14.9 percent, respectively.

²Cumulative flow from start of fiscal year.

Source: IMF

(v) External Developments

14. India's current account deficit has, over time, varied considerably between 3.4 per cent of GDP in 1990-91 and 0.5 per cent in 1993-94. Preliminary estimates for 1994-1995 and 1995-96 show the deficit growing to 1.7 per cent in the latter year (Table 6). Estimates for 1995-96 show export growth of almost 21 per cent and import growth of 27 per cent, resulting in an increase of 79 per cent in the merchandise trade deficit. Foreign trade in the first seven months of the current fiscal year appears to have slowed considerably: exports grew by an estimated 9.9 per cent, imports by 6.4 per cent, placing the forecast current account deficit for 1996-97 at 1.5 per cent of GDP.[4] Significantly, non-oil imports declined by 1.8 per cent during this period reflecting a weakness in investment demand.

15. Net capital inflows rose in 1993-94 and 1994-95 largely due to increased foreign direct and portfolio investment. FDI has grown from an annual flow of around US$100 million a year in 1990-91 to more than US$2 billion per year in 1995-96. Net capital inflows in 1995-96 are estimated to have fallen, resulting in a net balance of payments deficit of US$2.9 billion. However, inflows from Foreign Institutional Investors (FIIs), which had begun to grow in in 1996, remain strong, predicting an overall increase in portfolio investment in the current year.

16. Foreign exchange reserves fell from US$20.8 billion to US$17 billion in the last year, although this still covers 4.9 months of imports. In the course of 1996, India's balance of payments has strengthened considerably; foreign exchange reserves increased to around US$19.5 billion by end November 1996.[5] External debt has gradually declined; at the end of March 1996, the share of external debt to GDP stood at 28.6 per cent.

17. India's nominal exchange rate vis-à-vis the dollar, which had remained fairly stable during 1993-94 and 1994-95, began coming under pressure in early 1995-96 as a result of the worsening current account deficit and reduced inflows of portfolio investments. Speculation about further depreciations exacerbated the situation in mid-1995 and the RBI intervened by selling foreign exchange on the open market; policies to tighten domestic liquidity, including a 15 per cent interest surcharge on import finance, were introduced, stabilizing the currency until another depreciation in February 1996. In addition to other measures to raise liquidity, the surcharge on import financing was raised to 25 per cent and since then the currency has traded within a fairly narrow band. The import financing surcharge was rescinded in July 1996. Despite these sudden fluctuations, the nominal effective rate depreciated only by about 3 per cent because of the considerable appreciation of the US dollar against other major currencies. The real effective exchange rate, however, had appreciated by about 8 per cent by end-November 1996, relative to its level in March 1993, when India unified its exchange rate system.

Table 6 - India - Balance of Payments, 1991-92-1995-96

(In US$ million)

	1991-92	1992-93	1993-94	Prel. Est. 1994-95	Prel. Est. 1995-96
Trade balance	-2,798	-4,368	-2,386	-4,983	-8,938
Exports, f.o.b.	18,266	18,869	22,683	26,857	32,467
Imports, c.i.f.¹	-21,064	-23,237	-25,069	-31,840	-41,405
Non-factor services	1,207	1,128	535	-407	-34
Net investment income	-3,830	-3,422	-3,270	-3,983	-4,479
Private transfers	3,783	2,773	3,595	6,200	7,480
Current account balance	-1,178	-3,526	-1,158	-2,701	-5,487
Capital account	3,968	2,966	9,835	8,806	4,278
Direct investment	139	341	586	1,314	2,008
Portfolio investment	--	214	3,649	3,581	2,214
FIIs	--	1	1,665	1,503	2,008
External Assistance	3,037	1,859	1,901	1,434	780
Commercial borrowing²	1,456	-358	607	1,029	527
Disbursements	3,133	1,167	2,913	3,841	3,876
Amortization	1,677	1,525	2,306	2,812	3,349
Short term credit, net	-515	-1,079	-769	330	160
Non-resident deposits, net	290	2,001	1,205	847	1,365
Rupee Debt	-1,240	-878	-1,053	-1,050	-963
Other capital	801	866	3,708	1,321	1,813
Overall balance	2,790	-560	8,677	6,105	-1,209
Increase in gross reserves (- = increase)	-3,576	-728	-8,864	-4,959	2,919
Memorandum items: Current account /GDP (in percent)	-0.5	-1.8	-0.5	-1.0	-1.7
External debt/GDP (in percent)	33.9	33.7	36.3	32.9	27.9
Debt service ratio (in percent)	30.2	28.6	26.5	26.4	26.2
Foreign exchange reserves (in US$ billions)	5.6	6.4	15.1	20.8	17.04
(in months of imports)	3.2	3.3	7.2	7.8	4.9

¹Includes interest on trade finance. Excludes personal imports of gold and silver.

²Includes Foreign Currency Convertible Bonds (FCCBs) and other Euro bond issues.

Source:IMF.

(vi) Sectoral Policies

18. India's external trade policy has been liberalised considerably as has its policy on foreign direct investment. The approval process for FDI has been streamlined and the Foreign Investment Promotion Council (FIPC) has been established to promote investment. The number of industries which are eligible for automatic approval of foreign investment up to 51 per cent of equity is presently 35 and is expected to be expanded shortly. Foreign institutional investors are now allowed to invest up to 10 per cent of a company's shares and they have also been allowed to invest in non-listed countries. Financial sector reform is another area where considerable progress has been made of late.

19. Since the early 1990s when India embarked on a new policy of liberalisation, Government policies have concentrated on structural changes to open the Indian economy. Along with reform of the country's external trading system, the Government has attempted to increase private sector participation in the economy and recent policy statements have emphasized reforms in infrastructure where the country experiences major bottlenecks.

20. Infrastructure remains a problem in India and reform here has been relatively slower. Private sector investment has been encouraged in a number of sectors including power generation, airports, ports and roads. Restructuring of the state power sectors has been initiated which is expected to improve the financial condition of State Electricity Boards. Private sector participation in power generation is being encouraged and an effort has been made to streamline the approval process for new projects up to Rs 10 billion. In the case of roads, the National Highways Act was amended in 1995 to allow private sector participation. In telecommunications, licenses have been allocated for private sector provision of telephone services in eight major delivery areas and a bill to set up the Telecom Regulatory Authority of India was introduced in Parliament in July 1996.

[1] India's fiscal year begins on April 1.

[2] Specified commodities on the negative list are first allowed to be imported through Special Import Licenses (SILs) before shifting these commodities to the Open General License (OGL) list.