Report on Currency and Finance 2021-22

REPORT ON CURRENCY AND FINANCE 2021-22 REVIVE AND RECONSTRUCT RESERVE BANK OF INDIA“ The findings, views and conclusions expressed in this Report are entirely those of the contributors from the Department of Economic and Policy Research (DEPR) and do not represent the views of the Reserve Bank of India”. In India - ` 575 (Normal) - ` 625 (Inclusive of Postal Charges) Abroad - US $ 22 (Inclusive of Air Mail Courier Charges) © Reserve Bank of India 2022 All rights reserved. Reproduction is permitted, provided an acknowledgement of the source is made. ISSN 0972-8759 Published by Shashidhar M. Lokare for the Reserve Bank of India, Mumbai-400 001 and printed at ACME Packs & Prints (I) Pvt. Ltd., A Wing, Gala No.73, Virwani Industrial Estate, Goregaon (E), Mumbai - 400 063.FOREWORD Since March 2020, mitigating the impact of the COVID-19 pandemic has been the overarching policy priority of the Reserve Bank of India. The policy responses to this humongous crisis have been unprecedented in scale, reach and speed to minimise the loss of lives and livelihood, protect the vulnerable, safeguard the economy and financial markets, and instil confidence. As two embattled years of living with the virus hopefully draws to a close, growing adaptation and vaccination allow us to imagine a post-pandemic future in which policy attention may be redirected to rejuvenate the Indian economy and place it on a higher growth trajectory. What is the appropriate mix of policy interventions to realise this vision? Clearly, it is not enough to stabilise the economy and pull it out of the depths to which it had plunged during the first wave of infections and the dents made by the succeeding waves. The challenge is to generate a virtuous cycle of greater opportunity for entrepreneurs to innovate and invest; businesses to attract more capital and technology; and fiscal space to manage the distributional effects of the pandemic while expanding public investment in physical infrastructure and human capital. The resilience of certain sectors like agriculture and allied activities, information technology services, exports, digitalisation and renewable energy during the COVID-19 crisis gives us the confidence that the Indian economy can stage a strong comeback. What adds to this confidence is the way certain other sectors used this crisis to rebuild and reconfigure. These sectors would include the organised corporate sector; the financial sector; start-ups; and more recently, the manufacturing sector. Around us too, the world is changing through rearranging of supply chains, geopolitical configurations and policy strategies to new global realities, including even a rethink on globalisation and financial integration. Accordingly, this year’s Report on Currency and Finance has “Revive and Reconstruct” as its theme. Structured in six chapters, the Report draws from facets of actual experience with the pandemic, research and empirical findings to lay out a vision of post-pandemic India and how to get there. I commend the spirit of enquiry which has been the abiding motivation for the team that prepared this Report. As Einstein once said, "To raise new questions, new possibilities, to regard old problems from a new angle, requires creative imagination" 1. Our expectation is that the Report will ask the right questions and provoke readers to imagine, like the team, India’s post-pandemic future. Shaktikanta Das Governor April 29, 2022 1 “The Evolution of Physics”, Albert Einstein and Leopold Infeld, 1938. iiiCONTENTS Sr. No. Page No. Chapter I: Scars of the Pandemic ............................................................... 3-22 1 Introduction ................................................................................................ 3 2 Pre-COVID Slowdown ............................................................................... 4 3 Post-COVID Economic Scenario ............................................................... 6 4 Risks to Recovery ...................................................................................... 20 Chapter II: Rebalancing Monetary and Fiscal Policies Post-Pandemic ... 23-41 1 Introduction ................................................................................................ 23 2 Impact of Policy Stimulus on Growth ......................................................... 24 3 Lessons from India’s Own Experience ...................................................... 27 4 Post-COVID Debt Overhang: Debt Consolidation for Stronger Economic Growth ....................................................................... 35 5 Conclusion ................................................................................................. 39 Chapter III: Structural Issues in Rejuvenating Growth ............................. 42-88 1 Introduction ................................................................................................ 42 2 Structural Transformation in India .............................................................. 42 3 Productivity Trends .................................................................................... 46 4 Structural Impediments in Key Sectors ...................................................... 52 5 Structural Growth Enablers ....................................................................... 65 6 Factor Market Impediments ....................................................................... 71 7 Conclusion ................................................................................................. 75 Chapter IV: Harnessing Open Economy Vistas for Faster Growth .......... 89-116 1 Introduction ................................................................................................ 89 2 Trade Openness, Export Competitiveness and Growth ............................ 90 3 Role of Imports .......................................................................................... 102 4 Capital Flows, Exchange Rate and Growth ............................................... 107 5 Conclusion ................................................................................................. 113 ISr. No. Page No. Chapter V: The Role of Finance in Revitalising Growth 117-136 1 Introduction ................................................................................................ 117 2 COVID Impact on the Indian Financial System ......................................... 118 3 Pre-COVID Financial Intermediation Challenges ...................................... 122 4 Reinvigorating Credit Growth—Policy Options .......................................... 126 5 Leveraging Digital Finance and Start-ups for Reinvigorating Growth ........ 130 6 Green Finance for Sustainable growth ...................................................... 132 7 Conclusion and Way Forward .................................................................... 133 Chapter VI: A Policy Agenda for Post-COVID-19 India .............................. 137-145 IILIST OF BOXES Sr. No. Page No. I.1 Did COVID-19 Expose Pre-existing Weakness in Corporate Balance Sheet? ...................................................................... 15 I.2 COVID-19 Shock - Relative Impact on Demand and Supply ................... 19 II.1 Debt Impact on Risk Premium ................................................................. 32 II.2 Limits to Consolidation of Public Debt in India Post-Pandemic ............... 36 III.1 Structural Determinants of TFP Growth in India ...................................... 50 III.2 Resource Reallocation for Higher Productivity Growth ............................ 51 III.3 Determinants of TFP Growth in Indian Agriculture .................................. 55 III.4 Ease of Doing Business in India and Future Reforms ............................. 68 IV.1 Dynamic Foreign Trade Multiplier of India................................................ 90 IV.2 Country and Product Identification Strategy for Enhancing India’s Export Potential .......................................................... 99 IV.3 India’s Free Trade Agreements – For Trade Creation or Diversion? ........ 106 IV.4 Impact of Foreign Capital on Growth ....................................................... 107 IV.5 Composition of Capital Inflows and Growth ............................................. 110 IV.6 Impact of Exchange Rate Movements on Exporting Firms ..................... 111 V.1 Financial Conditions Index (FCI) and Growth .......................................... 121 V.2 Optimal Credit Growth in India ................................................................ 124 IIILIST OF TABLES Sr. No. Page No. I.1 Episodes of Boom and Bust .................................................................... 4 I.2 Sector-wise Recovery Pattern ................................................................. 14 II.1 Overall Fiscal Multipliers .......................................................................... 24 II.2 Asymmetric Fiscal Multipliers .................................................................. 25 II.3 Relationship Between Debt and Economic Growth ................................. 39 III.1 International Trade in Ores & Minerals from 2015-16 to 2019-20 ............ 60 III.2 A Broad-based Slowdown in Services ..................................................... 64 III.3 Components of Construction - Share in Output (in per cent) .................. 64 III.4 Trend of Key Infrastructure Capacity (2011=100) .................................... 65 III.5 Share of Infrastructure Sector in Real GVA and GFCF ........................... 66 III.6 Investment in Electricity Infrastructure by the Public Sector .................... 66 III.7 State-wise Estimates of Potential for Solar and Wind Energy ................. 66 III.8 Price of Electricity for Businesses (US cents per kWh) .......................... 67 III.9 Vision 2025 for the Healthcare Sector ..................................................... 70 III.10 Sector-wise Labour Productivity .............................................................. 71 IV.1 Country-wise Profile of India’s Export Partners ....................................... 93 IV.2 Change in Revealed Comparative Advantage (2010-20 over 2001-09) ........................................................................... 95 IV.3 Trade Complementarity Index .................................................................. 98 IV.4 Frontier Technologies, Description and Early Adopters ........................... 101 IV.5 Trade and Research and Development Statistics for India ...................... 102 IV.6 Commodities with High Import Dependence on China and Alternative Suppliers ................................................................................ 105 IV.7 Exchange Rate, Competitiveness and Exports Volume – FMOLS Estimates ................................................................... 111 V.1 Impact of COVID-19 on Key Banking Indicators ...................................... 118 IVLIST OF CHARTS Sr. No. Page No. I.1 Movement in Consumption and Investment ............................................ 4 I.2 Employment and Wages .......................................................................... 5 I.3 Gross Capital Formation by Institutional Sectors .................................... 5 I.4 Top 15 Countries Affected by COVID-19 ................................................. 6 I.5 Vaccination Programme in India .............................................................. 7 I.6 Cross-country GDP Growth in 2020-21 ................................................... 7 I.7 Stringency Measure and GDP Growth in 2020-21 .................................. 8 I.8 Factors Contributing to the Deepest Slowdown ....................................... 9 I.9 Economic Activity Index ........................................................................... 9 I.10 Recovery in Demand and Output ............................................................ 10 I.11 Growth in Private Consumption ............................................................... 10 I.12 Current Situation Index (CSI) and Future Expectations Index (FEI) ........ 11 I.13 Labour Market Condition during the Pandemic ....................................... 11 I.14 Activity Status in Urban Areas during the Pandemic ............................... 12 I.15 Investment Demand................................................................................. 12 I.16 Capacity Utilisation in Manufacturing ...................................................... 13 I.17 Business Assessment Index and Business Expectations Index .............. 13 I.18 Corporate Performance During the COVID-19 Pandemic ....................... 16 I.19 Sector-wise Impact of the Pandemic ....................................................... 17 I.20 Sector-wise Growth in Manufacturing GVA ............................................. 17 I.21 Organised and Unorganised Services Sectors ....................................... 18 I.22 Structural Breaks in GDP ........................................................................ 20 I.23 Medium-term Real GDP Path .................................................................. 20 II.1 Impulse Responses to one S.D. Policy Shock ......................................... 26 II.2 Asymmetric Responses of GDP Growth to Policy Shock ........................ 27 II.3 Surplus Liquidity Impact on Inflation – Estimated Threshold Effects .................................................................... 28 VSr. No. Page No. II.4 Surplus Liquidity Impact on Inflation – Estimated Time-Varying Effects ............................................................... 29 II.5 Asymmetric Response of Inflation to One Percentage Point Change in WACR ..................................................................................... 29 II.6 Scope for Monetary Accommodation of Fiscal Stance ............................ 30 II.7 Financing of Fiscal Deficit through Net RBI Credit to the Government ........................................................................ 31 II.8 Weighted Average Cost of Borrowing (Central Government) .................. 31 II.9 Response of Term Premia to One Percentage Point Increase in Net LAF to NDTL Ratio ............................................................................ 33 II.10 Relationship between Inflation and Output Gap in India (1996-97:Q1 to 2019-20:Q4) ................................................................... 34 II.11 General Government Outstanding Liabilities ........................................... 35 II.12 Interest Payments on Government Debt ................................................. 35 II.13 India's Decadal Debt Decomposition ....................................................... 36 III.1 Sectoral Shares in Real GVA .................................................................. 44 III.2 Dependence on Agriculture for Employment ........................................... 44 III.3 Capital Concentration in Industry ............................................................ 44 III.4 Capital Stock Per Worker ......................................................................... 45 III.5 Components of Manufacturing GVA ........................................................ 45 III.6 Sectoral Decompostion of Total Exports .................................................. 46 III.7 An Accelerated Growth in Urban Population ........................................... 46 III.8 Total Factor Productivity Growth - Global Trends ..................................... 47 III.9 Labour Productivity Growth-Global Trends .............................................. 47 III.10 Decomposition of GDP Growth in India ................................................... 48 III.11 Sectoral Drivers of TFP Growth (YoY) in India ......................................... 48 III.12 Indicators for Innovation and Productivity-Global Comparison ................ 49 III.13 Growth in Agricultural Production and GVA ............................................. 53 III.14 India’s Share in World Agriculture and Merchandise Trade ..................... 53 VISr. No. Page No. III.15 GCF and R&D in Agriculture ................................................................... 54 III.16 Cross-Country Comparison of Average TFP Growth and Crop Yields ............................................................................................. 55 III.17 Agricultural Credit in India - Size and Composition ................................. 57 III.18 Ratio of Agriculture Credit to State GVA ................................................. 57 III.19 Cropping Intensity and Irrigation Coverage Appears to have Plateaued . 58 III.20 Skewed Development in the Sources of Irrigation ................................... 58 III.21 Crop-wise Share in Gross Irrigated Area................................................. 58 III.22 Trend of Input Subsidies and Public Gross Capital Formation in Agriculture .......................................................................... 59 III.23 Order of Self Sufficiency .......................................................................... 60 III.24 GDP Size vs. Mining Share ..................................................................... 60 III.25 Index of Coal, Crude Oil and Natural Gas Production ............................. 61 III.26 Growth Rate of GDP and Manufacturing ................................................. 62 III.27 Impact of Manufacturing over Services ................................................... 62 III.28 Electricity Consumption: Industry vs. Others ........................................... 63 III.29 Services Growth ...................................................................................... 64 III.30 Housing Sales, Launches and Pricing ..................................................... 65 III.31 Competitiveness Index and Infrastructure Index ..................................... 65 III.32 Revenue Gap, Transmission Losses, and Power Subsidies .................... 68 III.33 Literacy Trends ........................................................................................ 69 III.34 Gross Enrollment Ratio ........................................................................... 70 III.35 Health Infrastructure - India vs. Peers ..................................................... 70 III.36 Delayed Projects...................................................................................... 72 III.37 Cost Overrun of Delayed Projects ........................................................... 72 III.38 Labour Force Participation Rate 2019-20 ................................................ 73 III.39 High Self-Employment ............................................................................. 74 VIISr. No. Page No. III.40 Job Quality - Status of Written Job Contract ........................................... 74 III.41 Low Level of Job Training ........................................................................ 74 III.42 Education Profile of India ......................................................................... 74 IV.1 Net Exports of Goods and Services ........................................................ 91 IV.2 Profile of India's Major Trading Partners .................................................. 92 IV.3 Growth and Trade Performance – India versus World ............................. 92 IV.4 Trade Performance of Major Economies – Income and Substitution Effect .................................................................................... 94 IV.5 Sectoral Shifts in Revealed Comparative Advantage .............................. 94 IV.6 Revealed Comparative Advantage Index – Merchandise ....................... 95 IV.7 Revealed Comparative Advantage Index – Services .............................. 96 IV.8 India’s Services Exports – Diversification ................................................ 96 IV.9 Services Trade Openness and Export Performance ................................ 97 IV.10 Export Diversification by Market – India vis-a-vis China and the US ....... 98 IV.11 Expected Market Size of Frontier Technologies ....................................... 102 IV.12 Import Content of Exports (ICE) Matters for Export Intensity and GVC Participation ................................................... 103 IV.13 India at the Bottom as Capital Goods Importer Among Major Economies ..................................................................................... 103 IV.14 Tariff Profile of India’s Imports ................................................................. 104 IV.15 Utilisation of Net Capital Inflows .............................................................. 108 IV.16 Regulatory Easing of FDI in India since 1990s ....................................... 109 IV.17 Export Sectors with High Capital Requirement ....................................... 109 V.1 Impact of COVID-19 on Financial Intermediation .................................... 118 V.2 Stress in Large Borrowal Accounts ......................................................... 119 V.3 Stock Indices - Movements ...................................................................... 119 V.4 Resource Mobilisation through Public and Rights Issues of Equities ...... 120 V.5 Corporate Bond Market ........................................................................... 120 VIIISr. No. Page No. V.6 Flow of Resources-to-GDP Gap .............................................................. 122 V.7 Trends in Savings and Deposits .............................................................. 122 V.8 Corporate Leverage in India .................................................................... 123 V.9 Credit Growth and Banking Sector Stress ............................................... 123 V.10 SCBs’ Investment and Credit ................................................................... 125 V.11 Sectoral Credit and Retail NPAs .............................................................. 126 V.12 NPA Recovery Channels ......................................................................... 127 V.13 Capital Infusion by the Government in PSBs .......................................... 128 V.14 Moving Towards Digital India ................................................................... 131 V.15 Google Searches on Green Finance ....................................................... 133 VI.1 Medium-term Growth Scenarios ............................................................. 138 IXLIST OF ABBREVIATIONS A&A Agriculture and Allied Activities CPI Consumer Price Index ACS Average Cost of Supply CRAR Capital to Risk-weighted Assets Ratio AI Artificial Intelligence API Active Pharmaceutical Ingredient CSI Current Situation Index ARCs Asset Reconstruction Companies DFIs Development Financial Institutions ARR Average Revenue Realised DFIS Duty-Free Imports for Exporters Scheme ASEAN Association of Southeast Asian Nations DFM Dynamic Factor Model ASER Annual Status of Education Report DISCOM Distribution Company ASI Annual Survey of Industries DPIIT Department for Promotion of ASTI Advanced Science and Technology Industry and Internal Trade Institute DSGE Dynamic Stochastic General AT&C Aggregate Technical and Equilibrium Commercial D-SIBs Domestic Systemically Important BAI Business Assessment Index Banks BEI Business Expectations Index ECB External Commercial Borrowing BIS Bank for International Settlements EDB Ease of Doing Business BLS Bureau of Labour Statistics EHTP Electronics Hardware Technology BoP Balance of Payments Park BPS Basis Points EMEs Emerging Market Economies BSR Basic Statistical Returns EOU Export Oriented Units BTP Bio-Technology Park EPCG Export Promotion Capital Goods CAD Current Account Deficit ESG Environmental, Social and CCS Consumer Confidence Survey Governance CDS Credit Default Swap EV Electric Vehicle CEPA Comprehensive Economic FCI Financial Conditions Index Partnership Agreement FDI Foreign Direct Investment CET-I Common Equity Tier-I FEI Future Expectation Index CII Confederation of Indian Industry CIS Change in Stock FIs Financial Institutions CMIE Centre for Monitoring Indian FMOLS Fully Modified Ordinary Least Economy Squares XFPOs Follow on Public Offers ISIN International Securities Identification Number FRBM Fiscal Responsibility and Budget Management IT Information Technology FTA Free Trade Agreement ITeS Information Technology Enabled Services GCF Gross Capital Formation KBC Knowledge Based Capital GCI Global Competitiveness Index KLEMS K-capital, L-labour, E-energy, GDP Gross Domestic Product M-materials, and S-purchased GFC Global Financial Crisis services GFCE Government Final Consumption LAA Land Acquisition Act Expenditure LAF Liquidity Adjustment Facility GFCF Gross Fixed Capital Formation LCR Liquidity Coverage Ratio GFD Global Financial Data LFPR Labour Force Participation Rate GOI Government of India LPA Long Period Average GPS Global Positioning System LSE London Stock Exchange GSA Gross Sown Area LTROs Long-Term Repo Operations G-SAP Government Securities Acquisition MEIS Merchandise Exports from India Programme Scheme G-sec Government Securities MGNREGS Mahatma Gandhi National Rural Employment Guarantee Scheme GST Goods and Services Tax MNRE Ministry of New and Renewable GVA Gross Value Added Energy GVC Global Value Chain MoSPI Ministry of Statistics and GW Gigawatt Programme Implementation HTM Held to Maturity MSME Micro, Small and Medium Enterprise HYV High Yielding Variety MSP Minimum Support Price IBC Insolvency and Bankruptcy Code NaBFID National Bank for Financing ILO International Labour Organisation Infrastructure and Development IMF International Monetary Fund NARCL National Asset Reconstruction INR Indian Rupee Company Ltd. IOS Industrial Outlook Survey NAS National Account Statement IPOs Initial Public Offerings NBFC Non-Banking Financial Company IRF Interest Rate Futures NDA Net Domestic Assets IRGD Interest Rate Growth Differential NDC Nationally Determined Contribution XINDTL Net Demand and Time Liabilities PMJDY Pradhan Mantri Jan-Dhan Yojana NFA Net Foreign Assets PP Percentage Point NGFS Network for Greening the Financial PPPs Public Private Partnerships System PSB Public Sector Bank NIP National Infrastructure Pipeline PSL Priority Sector Lending NKPC New Keynesian Phillips Curve PSUs Public Sector Undertakings NMP National Monetisation Pipeline PVBs Private Sector Banks NRA-CU Net Response of Assessment on QPM Quarterly Projection Model Capital Utilisation R&D Research and Development NRE-CU Net Response of Expectation on Capital Utilisation RBI Reserve Bank of India NSA Net Sown Area RCA Revealed Comparative Advantage NSO National Statistical Office RHS Right Hand Scale NSWS National Single Window System RoA Return on Assets OBICUS Order Books, Inventories and RoDTEP Remission of Duties and Taxes on Capacity Utilisation Survey Exported Products OECD Organisation for Economic Co- RoE Return on Equity operation and Development SARFAESI Securitisation and Reconstruction OMOs Open Market Operations of Financial Assets and Enforcement of Securities Interest ONGC Oil and Natural Gas Corporation SDLs State Development Loans OOPE Out Of Pocket Expenditure OSMOS Off-Site Surveillance and SEZ Special Economic Zone Monitoring System SIA Social Impact Assessment OT Operation Twist SLR Statutory Liquidity Ratio P2P Peer-to-Peer SMEs Small and Medium Enterprises PCA Principal Component Analysis SRs Security Receipts PCRs Provision Coverage Ratios STP Software Technology Park PFCE Private Final Consumption STRI Services Trade Restrictiveness Expenditure Index PLFS Periodic Labour Force Survey STVAR Smooth Transition Vector PLI Production Linked Incentive Autoregression PMFBY Prime Minister Fasal Bima Yojna SVAR Structural Vector Autoregression PMGSY Pradhan Mantri Gram Sadak Yojna SWS State Single Window System XIITCI Trade Complementarity Index VAR Vector Autoregression TFP Total Factor Productivity WACR Weighted Average Call Money Rate TOT Terms of Trade TVAR Threshold Vector Autoregression WAP Working Age Population TVP Time-varying Parameter WDI World Development Indicators TVP-SV Time-varying Parameter Stochastic WEO World Economic Outlook Volatility WHO World Health Organisation UAS Unmanned Aircraft System WITS World Integrated Trade Solutions UAV Unmanned Aerial Vehicle WMA Ways and Means Advance UNIDO United Nations Industrial Development Organisation WTO World Trade Organisation This Report can also be accessed on Internet URL : www.rbi.org.in XIIITHE THEME OF THE REPORT Observed patterns of pandemics in history as since H2 of 2016-17 and its structural and cyclical well as insights from epidemiology tell us that drivers. A key pivot has been the unprecedented pandemics are likely to wither in intensity, with public policy support, including progress on sporadic breakouts of limited impact until they vaccination. The thrust of public policy action is now become endemic. The COVID-19 pandemic will go progressively shifting to revitalising growth – even down in history as one of the worst health crises as the fiscal policy stance aims at regenerating the world has ever faced. Its economic impact the capex cycle, monetary policy remains may linger for many more years and confront us accomodative while focusing on the withdrawal challenges of rebuilding livelihoods, safeguarding of accomodation to ensure that inflation remains businesses and reviving the economy. within the target going forward while supporting India suffered among the biggest pandemic- growth. induced losses in the world in terms of output, Lessons from past crises reveal the reality of lives and livelihoods, which may take years to a permanent loss of output, reflected in deep recover. Economic activity has barely recovered wounds to investment and shortfalls in capital and to pre-COVID levels even after two years. India’s total factor productivity (TFP) relative to respective economic rebound also faces difficult challenges pre-crisis trends.a Potential hysteresis effects of from the legacy of deep-rooted structural the pandemic operating through bankruptcies and bottlenecks as well as the scars of the pandemic. capacity destruction are not fully quantified so far The Russia-Ukraine conflict has also dampened and may manifest themselves through balance the momentum of recovery, with its impact sheet impairments and depressed new investment transmitting through record high commodity demand. prices, weaker global growth outlook and tighter global financial conditions. Concerns surrounding Corporate balance sheets have coped with the deglobalisation impacting future trade, capital flows pandemic by deleveraging and increasing liquid and supply chains have amplified uncertainties for assets, but investment appetite that should the business environment. Against this backdrop, motor a renewed capex cycle is still weak. Frail India’s medium-term growth outlook hinges household balance sheets and labour displaced critically on policy measures to address structural from contact-intensive activity have impacted bottlenecks and harness emerging new growth consumption demand and quality of capital. As opportunities. This year’s Report on Currency and a result, the trend growth path of India may have Finance accordingly has “Revive and Reconstruct” shifted downwards, warranting urgency in putting as its theme. in place a comprehensive range of measures The Report begins by taking a deep dive into for reinvigorating growth, while negotiating net- COVID-induced downturn in the economy against zero transition costs, deglobalisation and broken the backdrop of the loss of pace in activity, evident supply chains. a Cerra, M.V. and Saxena, M.S.C. (2017), “Booms, Crises, and Recoveries: A New Paradigm of the Business Cycle and its Policy Implications”, IMF Working Paper, No. 17/250, International Monetary Fund. IMF (2018), “Challenges to Steady Growth”, World Economic Outlook, International Monetary Fund, October. 1REPORT ON CURRENCY AND FINANCE The rest of the Report is structured into six stagnation of the share of manufacturing in gross chapters. Chapter I titled “Scars of the Pandemic” value added (GVA); languishing productivity; draws lessons from the experience with the insufficient expenditure on education, health and pandemic. It covers an assessment of the impact R&D; and high costs of doing business. Those risks of COVID on growth in India, differentiating are accentuated by demographic transition, with sectors that exhibited resilience. It explores risks the fertility rate dropping below the replacement to recovery and presents an assessment of the rate, and a drop in labour force participation. The number of years that India may take to catch up chapter highlights the urgent need to reverse the with a hypothetical no-COVID trend GDP. sustained decline in private investment through a comprehensive range of strategic reforms, Chapter II presents the role of counter-pandemic covering both factor and product markets. monetary and fiscal policies in engineering the economic recovery. It also examines the current Chapter IV highlights the role of exports and monetary and fiscal configuration in India from a foreign capital in pushing up India’s potential output forward-looking perspective, consistent with the through a strategic policy reset that transforms theme of the Report. This chapter also studies the India into a more open economy. It also highlights role of fiscal stimulus in a crisis and the importance greater emphasis on innovations and R&D, easier of fiscal consolidation in normal times for growth. access to critical inputs – both domestic and Given the risks to growth from inflation persisting imported – and more effective trade-creating above a threshold level, an empirical exploration free trade agreements (FTAs) based on trade seeks to identify threshold effects of liquidity on complementarities. It examines opportunities for inflation as well as thresholds for public debt. The adoption of frontier technologies for raising export chapter presents feasible alternative paths for potential and also underscores the need for key parameters of debt sustainability – growth, enhancing the capacity of the economy to absorb inflation, interest rate and primary balance – to foreign capital productively. identify the likely debt consolidation path in India Chapter V addresses the modest penetration of over the next five years, relative to the estimated finance in the Indian economy. This has brought threshold level of debt. to the fore the role of financial sector reforms in Chapter III titled “Structural Issues in Rejuvenating reactivating credit flows to the economy while Growth” explores the role of structural policies in managing the transition to a green economy regaining India’s pre-pandemic trend growth and and a digital world. In essence, the chapter asks lifting it up after the pandemic. It investigates the question: can finance lead growth in a post- structural impediments to growth that are, in a pandemic recovery? In particular, the chapter sense, a pre-pandemic legacy – imbalances in assesses the role and importance of digital and the agriculture sector in the form of low capital green finance in reinvigorating growth. formation, declining R&D expenditure, low crop yields, lack of crop diversity and intensity, and The last chapter presents a roadmap to rejuvenate excessive dependence on subsidies and price growth, with specific recommendations for reforms support schemes; inadequate investments in in different sectors of the economy, drawing on the mining despite abundant natural resources; near essence of findings of the previous five chapters. 2I SCARS OF THE PANDEMIC The perturbations from repeated waves of the COVID-19 pandemic have come in the way of sustained growth recovery in India. The supply constraints pushed up shipping costs and commodity prices, thereby intensifying inflationary pressures and threatening the nascent economic recovery across the world. In India, the private corporate sector showed resilience as firms adopted new modes of operations and aligned their business strategies to the new environment. The capital expenditure push in the Union Budget for 2022-23 can provide the much needed support to achieve sustained high growth by enhancing productive capacity, crowding in private investment and strengthening aggregate demand. Though both private consumption expenditure and investment marginally surpassed their respective pre-pandemic levels in 2021-22, there is a need to strengthen the growth momentum to compensate for the lost output. 1. INTRODUCTION sanctions on Russia pose new risks accentuating supply disruptions in global value chains, and I.1 The ongoing COVID-19 pandemic has commodity price spirals hitting glass ceilings. been the first of its kind the world has witnessed As price pressures become more generalised in the 21st century. The cyclical slowdown that set globally, risk to growth might aggravate. Looking in the Indian economy before the outbreak of the ahead, even as the growth outlook hinges on pandemic, got exacerbated on the back of cliff global headwinds from the Ukraine war and new effects and scarring generated by the pandemic. variants of COVID, the shape of the recovery Despite having witnessed one of the steepest post-pandemic would be guided by realisation contractions in gross domestic product (GDP) in of reform dividend as also the contributions Q1:2020-21 and being hit by three successive from new emerging areas such as healthcare, waves, the Second Advance Estimates of Information Technology Enabled Services (ITeS), National Income released on February 28, and e-commerce, which could drive the future 2022 indicate that the economy has surpassed growth with adaptations to the pandemic that may its pre-COVID level in 2021-22, on the back of become endemic. unprecedented policy support from monetary and I.3 The pandemic has caused a deep dent fiscal authorities. Nonetheless, India’s recovery on livelihoods and has scarred minds, production from the pandemic, despite its innate strength of capacities and confidence with far-reaching macroeconomic fundamentals, remains fragile economic and social costs, and the post-pandemic and is yet to become broad-based. new normal may be very different from the pre- I.2 Supply disruptions, restrained workforce pandemic situation. On the backdrop of the pre- participation, risks from new variants of the virus existing conditions ahead of the pandemic, this and the Russia-Ukraine war have emerged as chapter focuses on a macro-assessment of the the dampeners to global growth outlook. Fresh economic impact of the successive waves of the The chapter has been prepared by Sanjay Hansda, Anupam Prakash, V Dhanya, Shromona Ganguly, Chaitali Bhowmick, Sapna Goel and Sakshi Awasthy. The authors sincerely express their gratitude to Dr Michael Debabrata Patra for illuminating discussions and perceptive comments. The technical support provided by Kunal Priyadarshi is also acknowledged. 3REPORT ON CURRENCY AND FINANCE Table I.1: Episodes of Boom and Bust from 2017-18, culminating in the lowest growth of (Growth in per cent per annum) 3.7 per cent in 2019-20 since the global financial 2003- 2008- 2009- 2011- 2014- 2017- crisis (GFC). Episodes of boom and bust over 08 09 11 14 17 20 the past two decades portray 2003-08 as the Total 6.1 5.5 6.5 6.1 7.4 6.3 sharpest and longest expansionary phase when Consumption PFCE 6.2 4.5 5.9 6.7 7.5 6.2 the economy expanded at an average of 7.9 per GFCE 5.8 11.4 9.7 2.6 7.0 7.4 cent – unprecedented in its recorded history (Table GCF 15.3 -2.6 14.5 2.0 5.4 6.5 I.1). With the onset of GFC, GDP growth had GFCF 12.6 3.2 9.4 6.2 5.9 6.9 CIS 73.5 -51.4 56.2 -27.4 16.7 12.3 plummeted to 3.1 per cent in 2008-09, followed Valuables 27.8 26.9 45 -11.1 2.2 5.4 by a sharp but short revival during 2009-11 on the Exports of goods and 17.8 14.8 7.3 10 0.4 4.4 wings of coordinated fiscal and monetary policy services actions which could not be sustained, giving way Less Imports of goods and 20 22.4 6.9 6.1 -0.2 8.5 to another phase of slowdown between 2011-14. services Following a consumption-led brief boom during GDP 7.9 3.1 8.2 5.7 7.9 5.7 2014-17, the economy eventually entered a phase Source: NSO. of slowdown from 2017-18 onwards, with the GDP COVID-19 pandemic on the Indian economy. In growth moderating for eight successive quarters section 2, the pre-COVID slowdown is described before the onset of the COVID-19 pandemic. with a view to providing a backdrop. This is I.5 The pre-pandemic GDP growth has mainly followed by an impact analysis of the pandemic been consumption-led. However, over the years, in section 3. Section 4 concludes the chapter with the share of consumption, the backbone of India’s an assessment of the risks to recovery. economic growth has been declining, with gross fixed capital formation (GFCF) compensating for 2. PRE-COVID SLOWDOWN the decline (Chart I.1). The ratio of gross capital I.4 Ahead of the COVID-19 pandemic, a formation (GCF) to GDP at current prices or the cyclical downturn had set in the Indian economy investment rate, however, decreased to 30.7 Chart I.1: Movement in Consumption and Investment a. Expenditure Components of GDP b. Trends in Consumption and Investment Source: NSO. 4SCARS OF THE PANDEMIC Chart I.2: Employment and Wages a. Trends in Employment b. Rural Wage Growth Note: Data for 2019-20 are taken from the Periodic Labour Force Survey (PLFS) Report and pertain to July-June 2019-20 and, therefore, capture the impact of the first wave of COVID while for the previous years, data pertain to April-March. Source: RBI KLEMS Database, NSO and Labour Bureau. per cent in 2019-20 from 32.1 per cent during I.8 Liquidity and solvency problems faced 2015-16. Government expenditure provided an by some major non-banking financial companies upward thrust to aggregate demand, excluding (NBFCs)1 and deterioration in asset quality of which the slowdown would have been deeper. the banking sector accentuated the slowdown in I.6 The GDP slowdown coincided with sluggishness in the labour market. The decline Chart I.3: Gross Capital Formation by in employment in general, and the depressed Institutional Sectors employment in the construction sector resulted in low rural wages (Charts I.2a and I.2b). This along with high household leverage in 2017-18 and 2018-19 and domestic shocks pulled down consumption demand. I.7 The moderation in capital formation emanated from both private corporate and household sector investments (Chart I.3). The slowdown in fixed investment by the household sector was more pronounced in ‘dwellings, other buildings, and structures’ which on an average had a share of 53.1 per cent in GFCF during Source: NSO. 2011-12 to 2019-20. 1 Following the debt repayment default by the Infrastructure Leasing and Financial Services (IL&FS) in September 2018, the entire NBFC sector faced headwinds in terms of erosion of confidence, rating downgrades and liquidity stress. Subsequently, recognising the increasing importance of NBFCs in the financial ecosystem, the Reserve Bank has decided to implement scale-based regulation to enhance the regulatory oversight over the sector effective October 2022. 5REPORT ON CURRENCY AND FINANCE private sector investment. The twin balance sheet Chart I.4: Top 15 Countries affected by COVID-19 crisis – banks and corporates – reinforced each (percentage of total cumulative cases) other to contribute to a slowdown in the credit United States of America offtake. Loss of business and consumer confidence India Brazil caused both consumption and investment France to tumble. The corporate sector preferred to Germany continue deleveraging in this environment, thus The United Kingdom Russian Federation exacerbating the slowdown. Republic of Korea Italy I.9 Due to growing integration with the Turkey global economy, the domestic slowdown was Spain accentuated by the subdued global growth Vietnam Argentina attributed to rising trade barriers; elevated Netherlands uncertainty surrounding trade and geopolitics; Japan idiosyncratic factors causing macroeconomic Note: Data as on April 27, 2022. strain in several emerging market economies; Source: WHO. and structural factors, such as low productivity growth and aging demographics in advanced taking its total caseload to the second highest in economies (IMF, 2019). the world (Chart I.4). I.10 Path-breaking structural reforms like I.12 Given the suddenness of the COVID-19 the implementation of the goods and services shock, the Government of India imposed a strict tax (GST), enactment of the Insolvency and lockdown during the first wave delaying its peak Bankruptcy Code (IBC), corporate tax cut, and to September 16, 2020 when 0.97 lakh new cases regulatory measures to streamline the real estate were reported. The peaks for the second and the sector were expected to provide renewed thrust to third waves were attained faster on May 6, 2021 growth momentum when the pandemic struck. with 4.14 lakh new cases, and on January 20, 2022 with 3.47 lakh new cases, respectively. The 3. POST-COVID ECONOMIC SCENARIO first wave, dominated by the alpha variant, was I.11 After being first reported officially in less infectious and virulent compared with the Wuhan city of China at end-December 2019, delta variant which dominated the second wave. COVID-19 was declared a pandemic by the The caseload was far higher in majority of the World Health Organization (WHO) on March states during the second wave compared to the 11, 2020. Dispersed across successive waves first wave. The recovery rate steadily improved and characterised by differentiated intensity of to 97.3 per cent by mid-July 2021 after having infections and mortality, the COVID-19 pandemic declined to 81.8 per cent at the end of April has been expansive in terms of geographical 2021. The third wave, which started in the last spread — touching even the remotest parts of week of December 2021 and began to subside the world. Ever since the first case of COVID-19 after January 20, 2022, was dominated by the was reported in Kerala on January 30, 2020, India Omicron variant which was highly infectious, has experienced three waves of infections so far, though less deadly, raising the hope that the 6SCARS OF THE PANDEMIC pandemic might soon become endemic. Apart Chart I.5: Vaccination Programme in India from deft administrative management based on testing and isolation in micro containment zones, the success of India’s vaccination programme helped in effective containment of the highly infectious Omicron variant during the third wave. I.13 India started vaccination programme from January 16, 2021. The progress of India’s vaccination programme is reflected in the percentage of total population administered with one dose at 73.1 per cent and fully inoculated population at 62.2 per cent as on April 27, 2022 (Chart I.5). India has intensified its vaccination drive by initiating precaution doses and Note: Data as on April 27, 2022. vaccination for 12-14 old age group, in the wake Source: CEIC database; MoHFW, GoI. of the recent surge in new variants-led cases globally. (Chart I.6a). A gradual recovery took hold during I.14 At the height of the first wave of infections, the second half of the year, as a result of which India registered one of the deepest recessions the contraction for the full financial year turned in the world, with GDP declining by as much out to be far less severe at 6.6 per cent – which as 23.8 per cent in the first quarter of 2020-21 also placed India at a relatively better position Chart I.6: Cross-country GDP Growth in 2020-21 a. GDP Growth during April-June 2020 b. GDP Growth in 2020 (in per cent) (in per cent) Source: The Economist Intelligence Unit. 7REPORT ON CURRENCY AND FINANCE Chart I.7: Stringency Measure and GDP Growth in 2020-21 a. Average of Stringency Index b. Stringency Measures and GDP 80 75 Argentina China 70 India Italy 65 Brazil Australia 60 55 UnitedKingdom France Mexico Turkey Germany 50 Russia SouthKorea 45 40 35 Japan 30 -12 -10 -8 -6 -4 -2 0 2 4 Source: Oxford COVID-19 Government Response Tracker and The Economist Intelligence Unit estimates. among the G-20 countries in terms of annual in overall employment among the G-20 economies GDP growth for 2020 (Chart I.6b). (Chart I.8b). The majority of the self-employed workers is engaged in the informal sector with little I.15 A number of factors worked in conjunction job protection and weak social security support, to culminate into the most severe economic impact accentuating the adverse economic impact of the for India, with the stringency of the lockdown as pandemic. Third, countries could adopt alternative the most cited reason. India imposed one of the business continuity plans swiftly due to better most stringent lockdowns in the world in 2020 to access to internet. India, however, with 43 per curb the spread of the virus (Chart I.7a). Countries cent of the population having access to internet ranked higher in terms of stringency Index – India, in 2020, ranked low globally (World Economic Argentina, Italy and the United Kingdom – faced Forum, 2020) [Chart I.8c]. This had hindered deeper contraction in GDP (Chart I.7b). There India’s ability to shield businesses and jobs, which were, however, noteworthy outliers like China and Turkey which, despite stringent measures, were in turn contributed to the deeper contraction in able to expand their GDP in 2020. activity. India used unprecedented fiscal support measures to safeguard livelihood and businesses I.16 Apart from the direct restrictive measures, and reinvigorate the economy. the preponderance of contact-intensive services sector in the existing structure of the I.17 The brunt of the second wave was felt in the domestic economy, exacerbated the economic first quarter of 2021-22. Camouflaged by statistical consequences of the large pandemic shock base effects, the level of GDP fell 8.3 per cent (Chart I.8a). In case of India, as elsewhere, the below the pre-pandemic (or corresponding 2019- services sector which includes majority of the 20) level. Restricted lockdowns and a growing contact-intensive and non-essential activities bore resilience of both firms and individuals in dealing the maximum brunt of the pandemic. Second, with the infections reduced the severity of the self-employment is the pre-dominant nature of economic impact — the economic impact of the employment in India occupying the highest share second wave is estimated to be about one-third of 8 xednI ycnegnirtS GDP Growth in per centSCARS OF THE PANDEMIC Chart I.8: Factors Contributing to the Deepest Slowdown a. Retail, transport and hospitality (per cent to GDP) b. Share of Self-Employment c. Population using Internet Source: CEIC database; Informal Economy Database, World Bank; World Economic Forum. the first wave. The third wave impact is likely to be Chart I.9: Economic Activity Index still smaller as evident from the momentum in high frequency indicators. I.18 An overall monthly composite index of high frequency indicators shows that economic activity rebounded sharply in June 2021 with the ebbing of the second wave, and remained resilient pointing towards steady recovery till October 2021. November 2021 onwards, coal and semi- conductor chip shortages, followed by the third wave in January 2022 led to some weakening in the momentum as the index took a downturn in January and February (Chart I.9). Rural demand, in particular, lost steam after the second wave Sources: CMIE database; CEIC database; and RBI staff estimates. while urban demand recovered. Contagion from 9REPORT ON CURRENCY AND FINANCE Chart I.10: Recovery in Demand and Output a. Aggregate Demand b. Aggregate Supply (2019-20 = 100) (2019-20 = 100) #: Implicit growth. Source: NSO. the Russia-Ukraine conflict dampened activity indicates a sharp fall from 85.6 in March 2020 beginning March, thereby disrupting and delaying to 63.7 in May 2020, dropping further to an all- the recovery. time low of 48.5 in May 2021 with the onset of the second wave (Chart I.12). However, with the I.19 Despite the second wave, the turnaround gradual abatement of the second wave, sentiments in the economy in 2021-22 has been remarkable improved, though the index value remained below with all the components of aggregate demand 100, indicating pessimism about the current surpassing the pre-pandemic levels in H2:2021- economic situation. The future expectations index 22 (Chart I.10a). GDP in 2021-22, however, is estimated to be only 1.8 per cent above pre- pandemic level suggesting lost growth over two Chart I.11: Growth in Private Consumption years. I.20 With discretionary consumption spending still lacking traction, private consumption is just a shade above its pre-pandemic level. On account of the massive hit taken by the contact- intensive activities, consumption of services contracted sharply. Consumption of durable goods – the erstwhile high growing component of total consumption, also suffered a sharp decline, while consumption of non-durable goods which include food items and other essentials held up (Chart I.11). I.21 The current situation index (CSI) from the Source: NSO. consumer confidence survey of the Reserve Bank 10SCARS OF THE PANDEMIC record high and the labour force participation rate Chart I.12: Current Situation Index (CSI) and Future Expectations Index (FEI) plummeting (Chart I.13.a). Reverse migration from urban to rural areas during the first wave period also resulted in a sharp increase in demand for Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS) works in rural areas. The impact of the second wave and third wave was relatively muted and employment conditions have improved (Chart I.13.b). I.23 As per the Periodic Labour Force Survey (PLFS) quarterly reports for the urban areas, casual labourers were the worst affected during the first and second waves of the pandemic, though the extent of the impact was lower during Source: CCS, RBI. the second wave. Out of the total casual labourers working during January-March 2020, only 35.3 (FEI) remained above 100 indicating expectations per cent remained in the same category during the of future recovery during most part of 2020-21 and first lockdown period of April-June 2020; nearly 50 2021-22, except May 2020 and May 2021, when per cent were pushed to unemployment and about the intensity of restrictions during the respective 10 per cent moved out of the labour force during waves of the pandemic was at a high level. this period (Charts I.14a and I.14b). I.22 The Indian labour market witnessed a I.24 Investment demand came to a standstill sharp deterioration during the first wave of the amid lockdown and suffered the deepest pandemic with unemployment rate touching a contraction during Q1:2020-21. The recovery has Chart I.13: Labour Market Condition during the Pandemic a. Labour market: Key rates b. Employment through MGNREGS Source: CMIE database and GoI. 11REPORT ON CURRENCY AND FINANCE Chart I.14: Activity Status in Urban Areas during the Pandemic a. Transition in Activity Status between Q4:2019-20 to b. Transition in Activity Status between Q4:2020-21 and Q1:2020-21 (First Wave) Q1:2021-22 (Second Wave) Source: PLFS Quarterly Reports, MOSPI, GoI. been faster in GFCF primarily aided by a surge and demand for IT and ITeS, investment in in government investment – the only sector that intellectual property products displayed an uptick contributed positively to investment demand in while investment in other dwellings, buildings 2020-21. Consequently, the share of government and structure and machinery and equipment investment increased by 4.0 percentage points declined sharply reflecting a drag in construction in 2020-21 (Chart I.15.a). On the other hand, and manufacturing activities in 2020-21 (Chart I.15.b). subdued demand, inventory overhang and excess capacity held back private investment I.25 Although overall fixed investment turned as reflected in reduced share of both corporate around to rise above the pre-pandemic level and household sector in total investment in in 2021-22, the high frequency indicators of 2020-21. Buoyed by the digitalisation drive investment indicate a government capex-led Chart: I.15: Investment Demand a. Institution-wise Weighted Contribution to GFCF Growth b. Growth in GFCF by Asset Classification Source: NSO. 12SCARS OF THE PANDEMIC recovery with private investment remaining Chart I.17: Business Assessment Index and Business subdued. Expectations Index I.26 Recent estimates from the Order Books, Inventories and Capacity Utilisation Survey (OBICUS) show that capacity utilisation has recovered to 72.4 per cent in Q3:2021-22 from 60.0 per cent in Q1:2021-22 (Chart I.16). Similar trend is reflected in net response of assessment on capacity utilisation (NRA_CU) and net response of expectation on capacity utilisation (NRE_CU) in the Industrial Outlook Survey (IOS), with a positive forward outlook as reflected in the NRE for Q1:2022-23. I.27 The overall business assessment and Source: IOS, RBI. expectation compiled from the survey responses of the quarterly IOS touched its historical low values in Q1:2020-21. A V-shaped recovery is (BEI) remained above 100 since March 2020, observed in subsequent three quarters before it indicating the positive outlook of the industry plummeted again sharply as the second wave hit despite COVID induced disruptions (Chart I.17). the economy. The assessment turned optimistic I.28 Another silver lining is the strong export immediately after the first and the second performance that far-surpassed its pre-pandemic waves and the business expectations index level (detailed in Chapter IV). A strong export performance, if sustained, could lead to additional capacity utilisation and generation and, thereby, Chart I.16: Capacity Utilisation in Manufacturing lead to an upturn in domestic private investment cycle. I.29 From the supply side, agriculture remained resilient throughout the pandemic period. Agriculture and allied activities were exempted from the lockdown measures and resilience also stemmed from a confluence of factors working in conjunction, viz., a bountiful monsoon; adequate soil moisture; replenished reservoir levels; improved labour availability during the pandemic and favourable terms of trade for agricultural products (RBI, 2021). The industrial sector comprising manufacturing, mining and quarrying, Source: IOS, OBICUS, RBI. and electricity, gas and water supply witnessed a 13REPORT ON CURRENCY AND FINANCE sharp decline in Q1:2020-21 with manufacturing I.31 Presently, various sectors of the economy nosediving to a record low (Chart I.10.b). Mining are at different stages of recovery (Table I.2). and quarrying, on the other hand, was lagging While agriculture remained resilient all through for some time and was in contraction even before different waves of the pandemic, manufacturing COVID. Manufacturing which spearheaded the and construction are on the path to recovery. post first wave recovery remained resilient during After ebbing of the Omicron wave, green shoots the second wave. of revival are visible even in contact-intensive services sectors. I.30 Within services, the recovery has been heterogenous with financial, real estate and I.32 Against the backdrop of COVID-19 induced professional services and public administration, business disruptions, the private corporate sector defence and other services gaining traction to has shown robust resilience as firms adopted new surpass their respective pre-pandemic levels by modes of operations and aligned their business 6.6 per cent and 6.4 per cent. On the other hand, strategies to the new environment for doing recovery in trade, hotels, transport, communication business. A disaggregated firm level analysis, and services related to broadcasting remained however, reveals uneven recovery across the sluggish. weak and strong firms (Box I.1). While steady Table I.2: Sector-wise Recovery Pattern Sector Trend Growth Growth Status Pre-Pandemic Pandemic Period 2012- 2017- 2020-21 2021-22 2017 2020 over 2019-20 1. Agriculture, forestry & fishing 3.6 5.2 3.3 6.7 Resilient 2. Mining & quarrying 2.4 2.4 -8.6 2.9 Recovering/Need Repair 3. Manufacturing 6.8 5 -0.6 9.8 4. Electricity, gas, water supply & other utility services 6 7.5 -3.6 3.9 5. Construction 4.2 4.6 -7.3 1.9 6. Trade, hotels, transport, 6.1. Trade, hotel and repair 8.4 8.1 -22.4 communication and 6.2. Transport, communication and -15.3 -10.9 Still Suffering services related to services related to broadcasting broadcasting 7. Financial, real estate & 7.1. Financial services 5.1 professional services 7.2. Real estate, and professional 8.2 5.4 1.2 6.6 Resilient services 8. Public Administration, 8.1. Public Administration, defence 2.3 Resilient 6.5 7.0 6.4 defence and other services 8.2. Other services -11.5 Recovering/Need Repair GVA at basic prices 6.6 5.9 -4.8 3.1 Recovering/Need Repair Source: NSO and RBI Staff Estimates. 14SCARS OF THE PANDEMIC Box I.1 Did COVID-19 Expose Pre-existing Weakness in Corporate Balance Sheet? The private corporate sector has shown resilience through compares the effect of an event (pandemic in this case) on the pandemic. An econometric model using listed firms’ the treatment group (group affected by the event) with the quarterly balance sheet data examines the sensitivity of the control group (group unaffected by the event)2. Following firms to the pandemic, captured by the absolute change in Kulkarni (2020), weak or zombie firms are defined as firms y-o-y profitability ratio, with specific control variables, viz., with ICR<1 and DSCR<1 in a cross-sectional model using age, size, industry as well as debt to assets ratio (DA), debt- quarterly balance sheet data of firms for the time-period service coverage ratio (DSCR) and interest coverage ratio March 2019-March 2021. (ICR). is the time indicator variable which takes value 1 if the observation falls in the post-pandemic period (end- March 2020 onwards) and is the indicator variable for Where indicates profitability ratio and i and j indicate firm treatment group (weak or zombie firms in this case). The and industry, respectively. estimated coefficient captures the differential impact of the In an alternate model (Table 1; column 3), the impact of the event on the treatment group (in this case weaker firms) as pandemic on weak and strong firms has been estimated compared with the control group. To understand the impact by using the difference-in-difference (DID) method that of the pandemic on smaller firms, the DID regression is also Table 1: Empirical Results Dependent Variable (cid:39)(cid:150) (cid:39)(cid:150) (cid:150) (cid:150) (1) (2) (3) (4) DSCR -0.0070263** (0.0017011) ICR -0.0034336** (0.0010129) DL 0.27542 0.2814185 (0.3828997) (0.381821) Size -0.000148** -0.000147** (0.0000496) (0.0000496) Age 0.0130868 0.0093762 (0.0428435) (0.0427686) Q42020 -0.000013** -0.000013** -0.000012** -0.0000118 (0.00) (0.00) (0.000) (0.00) Time((cid:303)) -4.595627** -2.466289 (0.6594099) (1.748093) DID interaction ((cid:306)) 2.765929 0.6538439 (1.792182) (2.675901) Treatment ((cid:537)) -23.46111*** -16.23408*** (1.213463) (1.846779) Industry dummy Yes Yes Yes Yes No of observations 1143 1143 12,447 5455 R2 0.1357 0.1355 0.0918 0.0483 F 360.51 343.39 22.13 21.19 Prob>F 0.000 0.000 0.000 0.000 Note: Standard errors in parentheses. ***: Significant at 1 per cent. **: Significant at 5 per cent. (Contd...) 2 Since pandemic affected all the firms, there is no natural control or treatment groups in the present case. Following the methodology of Vig (2013) and Kulkarni (2020), the pre-treatment cross-sectional variation is explored to construct the treatment and control group in the present case. Here the hypothesis is that firms which had a weaker balance sheet during pre-pandemic period would be more affected by the pandemic and thus these firms constitute the treatment group. 15REPORT ON CURRENCY AND FINANCE estimated separately on a smaller sample of firms which References consists of the bottom 25 per cent of the initial sample set in Vig, V. (2013). Access to collateral and corporate debt terms of asset size (Column 4). structure: Evidence from a natural experiment. The Journal The results suggest that companies with relatively sound of Finance, 68(3), 881-928. financials indicated by higher DSCR and ICR had lower Kulkarni, N. (2020). Resolving Zombie Lending with sensitivity to the pandemic. Further, larger companies Collateral Reform. Working Paper. Centre for Advanced and companies with higher profit in Q4:2019-20 too had Financial Research and Learning (CAFRAL). https://www. lower sensitivity to the pandemic-induced disruptions. cafral.org.in/sfControl/content/Speech/327202152843PMM Weaker firms and weaker small sized firms suffered lower isallocation_Creditor_Rights_II.pdf profitability even in the pre-pandemic era. Weak firms’ financials deteriorated further during the pandemic. improvement was observed for the strong firms, was primarily due to the increased demand during weak firms remained vulnerable with negative lockdown, while online marketplaces, ITES, profitability, indicating a divergent recovery computer software, communication equipment, within the organised corporate sector (Charts drugs and pharmaceuticals, health services and I.18a and I.18b). business services and consultancy are some of the sectors which remained relatively unscathed I.33 It is found that real estate and automobiles from the effect of the pandemic (Chart I.19). which were badly hit by the pandemic, the Impact on the Unorganised Sector slowdown started even before the pandemic. Retail trading, hotel and restaurants, air transport I.34 Household sector’s share in gross value services, transport logistics services, and added (GVA) which represents the unorganised education are some of the contact-intensive sector activity fell to its lowest since 2011-12, sectors in which profitability was dented by the confirming the view that the pandemic took a larger pandemic. The spurt in profitability in consumer toll on the informal economy. In the manufacturing electronics, storage and distribution appliances sector, corporate sector GVA and household Chart I.18: Corporate Performance during the COVID-19 Pandemic a. Solvency Ratios b. Profitability Ratios Note: Profitability ratio is captured by profit after tax (PAT) as percentage of average total income. Figures indicate median values for all the years. Source: RBI staff estimates based on manufacturing firms’ annual balance sheet data for the respective years from Prowess, CMIE. 16SCARS OF THE PANDEMIC Chart I.19: Sector-wise Impact of the Pandemic Note: Pre-COVID and post-COVID profitability ratios are calculated as the average profit after tax as percentage of total income during March- December 2019 and June 2020-March 2021, respectively. Source: CMIE database. sector GVA which had broadly moved together I.35 Within services sector GVA, unorganised in the pre-pandemic period, moved in opposite segment, which has a higher share registered directions in 2020-21. While corporate sector GVA a sharp drop in 2020-21 compared with the registered growth, the household sector GVA organised sector (comprising private corporates, registered heavy contraction (Chart I.20). general government and public sector), indicating larger losses incurred in the unorganised sector (Chart I.21). Chart I.20: Sector-wise Growth in Manufacturing GVA Potential Output and Scarring Caused by the Pandemic I.36 COVID-19 has brought in steep challenges in conceptualising and estimating potential output. Using the standard statistical filtering methods such as Hodrick-Prescott (HP), Baxter- King (BK) and Christiano-Fitzgerald (CF) filters, output gap is seen as closing early in 2022-23. However, the scarring of potential output may be getting overestimated in these methods and the output gap accordingly is likely to close later than is indicated by filter-based techniques. The Source: NSO. multivariate Kalman filter estimates of potential 17REPORT ON CURRENCY AND FINANCE Chart I.21: Organised and Unorganised Services Sectors a. Trends in Services GVA (excl. Construction) Growth b. Sub-Sector wise Growth of Services GVA Source: NSO. output indicate that during the pandemic period, payments (BoP) crisis which was followed by a a negative output gap of about 4-6 per cent per major liberalisation drive that raised India’s trend quarter during Q2:2020-21 through Q1:2021-22 growth; the global financial crisis of 2008; and opened up (Patra et al., 2021). As per an alternative the COVID-19 pandemic which hit India during methodology proposed by Rangarajan-Srivastava early 2020 and still unfolding, and the impact of (2017)3, potential growth for 2020-21 is estimated which on trend growth remains uncertain. Apart to have declined to 5.4 per cent from 7.8 per cent from the immediate moderation in growth caused in 2017-18. by these shocks, they structurally altered the I.37 During the COVID period, multiple dynamics of growth, as observed statistically waves and restrictive measures disrupted the from the structural breaks in GDP growth. The Bai supply chains and interrupted productive activity. and Perron structural break test (Bai and Perron, However, demand conditions were impacted 1998) identifies three break points in the post- far more than the supply situation (Box I.2) as independence period — 1979-80, 2002-03 and both consumer and business confidence fell and 2011-12 (after the GFC) (Chart I.22).4 Risks to remained subpar. post-COVID trend growth can be mitigated through I.38 In last four decades, India has faced targeted structural reforms and policy changes as three major shocks – the 1991 balance of discussed in detail in the subsequent chapters. 3 The Rangarajan-Srivastava (R-S) model (2017) in its assessment of potential output uses a disaggregated approach for deriving relative contribution of different factors, viz., total amount and sectoral allocation of investible resources in the economy, sectoral incremental output-capital ratio. The value of incremental output-capital ratio is taken as the average for the period 2012-13 to 2019-20, and the buoyancy of net indirect taxes to GVA is assumed to be 1 for 2020-21. 4 The outcome of reform measures initiated during the decade of 1990s yielded results with lags and was manifested in a structural break around early 2000s when the growth trajectory shifted to a higher enclave until the GFC. Post GFC, once the macroeconomic stabilisation policies were withdrawn, another structural break occurred during 2011-12, after which trend growth settled at a lower level. The COVID pandemic shock is by far the largest shock in terms of the magnitude of contraction in GDP. 18SCARS OF THE PANDEMIC Box I.2 COVID-19 Shock - Relative Impact on Demand and Supply Against the backdrop of the pandemic, using the Taylor Chart 1: Identification of Demand (+) / (-) and Rule framework, a consensus trend is extracted in the Supply-side Pressures form of a dynamic factor from two series — differences in output gap and differences in inflation gap — which has been used in the identification of demand pressure (Taylor, 1993; Blanchard and Quah, 1989). Phases in the business cycle that are devoid of demand-side disturbances qualify as supply-side disturbances measured as residual effects. Further, a demand-side disturbance can be disentangled into positive and negative demand pressure (+) / (-). Positive demand side pressure is identified when the difference in output gap and the difference in inflation gap are both positive. Similarly, negative demand pressure is recognised whenever the differences in output gap and inflation gap Source: RBI staff estimates. turn negative. The consensus trend from the differences in output gap and References: inflation gap is extracted by using a Two-Step (TS) estimation Blanchard, O.J., Quah, D., 1989. The dynamic effects of procedure in a dynamic factor model (Doz, Giannone, and aggregate demand and supply disturbances. American Reichlin 2011)5. Economic Review 79, 655–673. The pre-COVID growth between the latter half of 2017 and Doz, C., D. Giannone and L. Reichlin (2011) ‘A two-step the first half of 2019 was demand-led, which eventually estimator for large approximate dynamic factor models collapsed during the first wave of the pandemic. Despite the based on Kalman filtering’, Journal of Econometrics, 164(1): presence of supply-side bottlenecks, it is observed that the 188–205. economic contraction during the first wave of COVID-19 was dominated by demand-side factors (Chart 1). The steady Taylor, John B (1993), “Discretion versus Policy Rules in decline in the consensus trend (TS core) in recent months Practice,” Carnegie-Rochester Conference Series on Public implies the presence of supply-side bottlenecks. Policy, 39, pp.195-214. I.39 The pandemic is a watershed moment I.40 The pre-COVID trend growth rate works and the ongoing structural changes catalysed out to 6.6 per cent (CAGR for 2012-13 to by the pandemic can potentially alter the 2019-20) and excluding the slowdown years it growth trajectory in the medium-term. Sustained works out to 7.1 per cent (CAGR for 2012-13 to thrust on capital expenditure by the government, 2016-17). Taking the actual growth rate of (-) 6.6 push to digitalisation and growing opportunities per cent for 2020-21, 8.9 per cent for 2021-22 and for new investment in areas like e-commerce, assuming growth rate of 7.2 per cent for 2022-23, start-ups, renewables and supply chain logistics and 7.5 per cent beyond that, India is expected could in turn, contribute to step up the trend to overcome COVID-19 losses in 2034-35 growth while closing the formal-informal gap in (Chart I.23). The output losses for individual the economy. years have been worked out to `19.1 lakh 5 In this exercise, the monthly index of industrial production (IIP) has been taken as a proxy for output while monthly consumer price index (CPI) excluding food and fuel as a measure for CPI core inflation. 19REPORT ON CURRENCY AND FINANCE Chart I.22: Structural Breaks in GDP Chart I.23: Medium-term Real GDP Path Source: NSO; and RBI staff estimates. Source: RBI staff estimates. crore, `17.1 lakh crore and `16.4 lakh crore for and several parts of Europe. However, various 2020-21, 2021-22 and 2022-23, respectively. economies are reacting divergently ranging from a no-COVID policy in some jurisdictions (e.g., 4. Risks to Recovery China, Hong Kong and Bhutan) on the one hand to those with relatively open borders and removal I.41 The perturbations from repeated waves of internal restrictions (e.g., Denmark and the of COVID-19 pandemic have come in the way of UK). In India, the restriction levels are being sustained recovery and the quarterly trends in dynamically calibrated at local levels in response GDP essentially followed the ebbs and flows of to the evolving situation. the pandemic. Following a very sharp contraction I.43 With the ongoing Russia-Ukraine in Q1:2020-21, the economic momentum conflict, the downward risks to global and progressively picked up till it was hit by the second domestic growth are getting accentuated wave in Q1:2021-22. Similarly, the impact of the through surge in commodity prices and global third wave, concentrated in the month of January supply chain disruptions. The supply constraints 2022 dented partially the recovery process. “We and longer delivery times pushed up shipping are living in a world of Knightian uncertainty (Das costs, commodity prices, thereby intensifying 2022)”, suggesting the lack of any quantifiable inflationary pressures and threatening the knowledge about some possible occurrence as nascent economic recovery across the world. opposed to quantifiable risks. India too felt the pressure from the global I.42 The pandemic is not yet over. A fresh supply chain disruptions with the supplier’s wave of COVID has hit China, South Korea delivery time6 falling to its lowest point of 29.5 6 Suppliers delivery time is an indicator taken from IHS Markit - Purchasing Managers’ Index (PMI). Reading above 50 indicates improvement in delivery times, reading of 50 indicates no change and reading below 50 indicates slower delivery. 20SCARS OF THE PANDEMIC in April 2020. While the delivery time improved I.46 The dividends of reforms initiated to thereafter, it remained below 50 all through counter the pre-COVID slowdown along with 2020-21 and 2021-22. The increased delivery additional measures and initiatives during the times and higher raw material prices squeezed pandemic will help launch the economy on a profits of Indian firms from Q3:2020-21 onwards. sustainable high growth path. The behavioural The Indian automobile sector which benefitted and technological changes brought about by the from consumers’ preference for personal vehicles pandemic may usher in a new normal which would received a jolt from the global semiconductor not necessarily ape the pre-pandemic trends but shortages making them incapacitated to benefit would be built on a more efficient, equitable, clean from increased demand as there was a surge in and green foundations. waiting periods for customers. Growth risk from References: geopolitics-induced supply shocks looks more Bai, Jushan and Perron, Pierre (1998), ‘‘Estimating acute for oil importers like India who are already and Testing Linear Models with Multiple Structural facing a tight fiscal position due to the pandemic Changes’’, Econometrica, The Econometric related relief packages by the Government. Society, Vol. 66, No. 1, pp. 47-78. I.44 The capital expenditure push in the Union Bank of England, (2021), Monetary Policy Report, Budget for 2022-23 can provide the much needed May. support critical to achieve sustained high growth by enhancing productive capacity, crowding in Bhandari, Pranjul, (2019), “Lighten India’s Debt private investment and strengthening aggregate Burden to Give Growth a Chance,” Livemint, demand. India must focus on building world class November 13. infrastructure apropos the needs of a modern Bhoi, Binod K, Behera, Harendra (2017), ‘‘India’s economy. Potential Output Revisited’’. Journal of Quantitative I.45 With unlocking and learnings from the Economics, Springer; The Indian Econometric pandemic that are increasingly getting internalised, Society (TIES), Vol. 15(1), pages 101-120. the time is ripe to start reconstruction. A push Blinder, Alan (2006): “Offshoring: The Next toward universal vaccination and booster doses Industrial Revolution?”, Foreign Affairs, March/ in India, combined with adoption of work-from- April. home mode in workplaces augurs well for the Bodnár, Katalin Le Roux, Julien, Lopez-Garcia, future of the economy. The future work processes Paloma and Szörfi, Bela (2020), ‘‘The Impact of are changing with the help of digitalisation and COVID-19 on Potential Output in the Euro Area’’, India has particularly adapted well to it. In a ECB Economic Bulletin, Issue 7. sequel to the pandemic, India is set to unleash impulses of animal spirits and poised to move to Borio, Claudio, Disyatat, Piti and Juselius, Mikael a higher growth trajectory with digital start-ups (2013), ‘‘Rethinking Potential Output: Embedding and ventures, biomedical, pharmaceuticals and Information about the Financial Cycle’’, BIS healthcare sectors emerging as new winners. Working Papers No 404, February. 21REPORT ON CURRENCY AND FINANCE Bosworth, Barry, Collins, Susan M, Virmani, International Monetary Fund, (2015), World Arvind (2007), ‘‘Sources of Growth in the Indian Economic Outlook, April. Economy’’, NBER working papers, February. International Monetary Fund, (2018), World Chinnoy, Sajjid (2019), “India’s Credit Crunch: Is it Economic Outlook, April. Demand or Supply?” J.P. Morgan Research Note, International Monetary Fund, (2019), World December. Economic Outlook, October. Chinoy, Sajjid, Jain, Toshi (2021), ‘‘COVID-19 and International Monetary Fund, (2020), World India’s Macro Economy: Pre-Existing Conditions, Economic Outlook, April. Performance and Prospects”, India Policy Forum, Nagraj, R (2013), ‘‘India’s Dream Run, 2003-08: NCAER. Understanding the Boom and Its Aftermath’’, Das, Shaktikanta (2022), “Monetary Policy and Economic and Political Weekly, Vol XLVIII, No 20. Central Bank Communication”, Remarks at the Patra, M D (2022), “RBI’s Pandemic Response: National Defence College, Ministry of Defence, Stepping out of Oblivion”, Keynote Address at Government of India, New Delhi. the C D Deshmukh Memorial Lecture, Council for Government of India (2018), ‘‘Chapter III: Social Development, Hyderabad. Investment and Saving Slowdowns and Patra, M D (2022), “Taper 2022: Touchdown in Recoveries: Cross-Country Insights for India’’, Turbulence”, Keynote Address at IMC Chamber of Economic Survey 2017–18, Vol. I, 43–54. Commerce and Industry, Mumbai. Goyal, A and Arora, S (2013), “Inferring India’s Patra, M D, Behera, Harendra and John, Joice Potential Growth and Policy Stance,” Journal (2021), ‘‘Is the Phillips Curve in India Dead, Inert of Quantitative Economics, Vol 11, Nos 1–2, and Stirring to Life or Alive and Well?’’ RBI Bulletin, pp 60–83. November. Goyal, A and Tripathi, S (2015), “Separating Reserve Bank of India (2010), Annual Report, Shocks from Cyclicality in Indian Aggregate 2009-10. Supply,” Journal of Asian Economics, Vol 38, pp Reserve Bank of India (2018), Annual Report, 93–103. 2017-18. Goyal, Ashima (2018), ‘‘Demand-led Growth Reserve Bank of India (2019), Annual Report, Slowdown and Inflation Targeting in India’’, 2018-19. Economic and Political Weekly, Vol. 53, Issue No. Reserve Bank of India (2020), Annual Report, 13, March 31, 2018. 2019-20. Hansda, S K, Prakash, A, Chattopadhyay, S K Reserve Bank of India (2021), Annual Report, (2021), ‘‘A Foray into Tracking Economic Activities 2020-21. in COVID Time through the Lens of High Frequency Indicators’’, presented at 39th Annual Conference World Economic Forum (2020), Global of IARNIW held on March 6-7, 2021. Competitiveness Report. 22REBALANCING MONETARY AND FISCAL II POLICIES POST-PANDEMIC The recovery in economic activity remains stimulus dependent. For restoring and recreating a policy environment conducive for private sector-led growth post-COVID, timely rebalancing of monetary and fiscal policies may become necessary given the current configurations of debt and liquidity. Government debt exceeding threshold levels exert upward pressures on the term premium and dampen growth. Time varying fiscal multipliers suggest that fiscal consolidation is not growth retarding once the economy recovers to its steady state. The debt path over the next five years, even under the best-case scenario, may further squeeze fiscal space unless strategic policy efforts covering both taxes and expenditure aim at targeted consolidation. What should be the appropriate monetary-fiscal policy mix in the post-pandemic future becomes a searing existential question for which past behavioural regularities, parametric estimates and analytical received wisdom may not provide adequate guidance. 1. Introduction emerging market economies (EMEs) post-COVID could raise the future inflation trajectory. Higher II.1 The monetary and fiscal policy response interest rates to deal with such inflation could to COVID in India was swift, bold and targeted.1 endanger debt sustainability in a weak growth Given the enormous scale and wide-ranging environment (BIS, 2021). nature of the fiscal and monetary stimulus and the overall theme of this report, the post-pandemic II.2 Against this backdrop, the key motivations macroeconomic policy balance in India will warrant of this chapter are to: (i) assess the impact a rethink, in view of the post-COVID debate: of fiscal stimulus on growth under different liquidity trap limits the effectiveness of monetary macroeconomic conditions; and (ii) examine the policy (Krugman, 2020); fiscal multipliers are large importance of timely rebalancing of crisis-time and significantly greater than one during periods policies to minimise risks to medium-term growth of economic slack/high uncertainty (Goemans, and inflation. This assessment is done against 2022); money-financed fiscal stimulus has larger the backdrop of the existing empirical findings multipliers than debt-financed stimulus (Gali, in India which suggest a threshold relationship 2020); excess money injected by central banks is between debt and GDP (at 40 per cent of GDP not always inflationary (Stella, 2021); sustainable for the central government) beyond which further debt levels are much higher than what one increases in debt become detrimental to growth. possibly thought earlier (Blanchard, 2022); and For every 0.3 percentage point of GDP increase secular stagnation – particularly associated with in the central government’s fiscal deficit or market depressed private demand and low interest rate borrowing, long-term G-sec yields could firm up by – justifies fiscal activism (Summers and Rachel, 10 bps (or even higher during periods of sharper 2019). Nevertheless, a large fiscal stimulus in market reactions) (GOI, 2017). The initial gains in This chapter has been prepared by Sitikantha Pattanaik, Harendra Behera, Binod B. Bhoi, Sangita Misra, Saksham Sood, Sujata Kundu and Ranajoy Guha Neogi. The team is grateful to Dr. Michael Debabrata Patra for his helpful comments and suggestions. 1 These measures have been comprehensively documented in RBI (2021a; 2021b) and Patra (2022). 23REPORT ON CURRENCY AND FINANCE output due to delay in monetary policy response of GDP – i.e., the contributions of government tend to get eroded by the higher than warranted final consumption expenditure (GFCE) and public policy reaction later on, eventually resulting in sector capital formation to GDP growth. A more a substantial deterioration in the medium-term comprehensive assessment, however, can be output-inflation trade-offs (RBI, 2021c). In the conducted through time-varying fiscal multipliers, context of these India specific empirical lessons, as the impact materialises over several quarters. this chapter highlights that post-COVID, a return In India, increase in public expenditure is found to the fiscal-monetary steady state balance could to be more effective than tax cuts whereas for be conducive for both higher growth and lower dealing with a situation of economic overheating inflation. The post-COVID period also calls for a tax hikes work better than cutbacks in expenditure revisit of debt sustainability. (Bhat and Sharma, 2021). II.3 Set against these key motivations, this II.5 Against this backdrop, using a three- chapter is organised under five sections. Section variable structural vector autoregression (SVAR) 2 examines the effectiveness of fiscal stimulus model (Blanchard and Perotti, 2002) with annual by estimating the fiscal multipliers associated nominal growth in tax revenue, government with different expenditures and their asymmetric expenditure and GDP for the period 1981- impact over the business cycles. Section 3 82 to 2019-202, general government (centre discusses the lessons learnt from India’s own and states combined) fiscal multipliers for total experience in the past, to draw inferences for post- expenditure and its components are estimated COVID rebalancing. It deals with three specific with relevant controls.3 The estimated impact empirical issues: (i) the impact of surplus liquidity multipliers show that only capital expenditure on inflation; (ii) the threshold level of government leads to proportionately higher increase in GDP debt beyond which term premia and G-sec yields (Table II.1). However, the revenue expenditure and start to harden; and (iii) the relationship between total expenditure multipliers are less than one – in growth and unemployment on one hand and output the range of 0.72 to 0.84 – which corroborates the gap and inflation on the other. Feasible options limited effectiveness of fiscal activism in reviving for public debt consolidation are explored and alternative trajectories for Government debt are Table II.1: Overall Fiscal Multipliers evaluated in Section 4. The key policy inferences Impact Multiplier are summarised in Section 5. Total Expenditure 0.72 Revenue Expenditure 0.79 2. Impact of Policy Stimulus on Growth Revenue Expenditure net of Interest II.4 The impact of fiscal stimulus on growth Payments and Subsidies 0.84 Capital Expenditure 1.32 can be assessed directly from the components 2 The estimation is restricted to pre-COVID period as unprecedented variation in many key macroeconomic variables due to the COVID shock could have disturbed the empirical relationship. 3 Following the literature, control variables used for the estimation are: global growth, changes in exchange rate (Indian rupees per USD), weighted average call money rate (WACR), government debt to GDP ratio and change in Sensex, with appropriate lags. The results are robust under the unit root and the auto-correlation tests. The impact multiplier is derived by taking the ratio of the coefficient to the share of government expenditure in GDP (Blanchard and Perotti, 2002). 24REBALANCING MONETARY AND FISCAL POLICIES POST-PANDEMIC and reconstructing the Indian economy post- Table II.2: Asymmetric Fiscal Multipliers COVID. In order to identify conditions under which Duration of Multiplier/ Impact Cumulative Peak a fiscal stimulus can be expansionary as opposed Types of Multiplier (Current) (Over 4 quarters) to conditions under which fiscal consolidation can be expansionary, time-varying multipliers need to Recession/Slowdown Total Expenditure 0.78 3.98 1.89 be estimated. Capital Expenditure 0.43 6.66 3.41 II.6 A smooth transition vector autoregression Revenue Expenditure 0.43 3.77 2.64 Expansion (STVAR) model4 is employed to assess the Total Expenditure -0.21 -0.22 0.15 impact of government expenditure on GDP in Capital Expenditure -0.13 -0.44 0.55 the Indian context, which captures non-linearity Revenue Expenditure -0.28 -0.74 -0.07 in the relationship and helps estimate the state- Source: RBI staff estimates. dependent multipliers for regimes of economic expansion and contraction (Auerbach and impulses that amplify through multiplier effects. Gorodnichenko, 2012). The STVAR includes Capital expenditure is particularly effective in this nominal GDP and fiscal variables (total state of the economy, signifying the importance of expenditure, capital expenditure and revenue quality of public expenditure even in a period of expenditure; one at a time) as the main variables economic slack. Second, in a period of economic and output gap is taken as the reference variable expansion, multiplier values turn negative, to define expansion and recession. Given that a signifying the detrimental impact of expansionary sufficiently long time series data are needed to fiscal policy on growth. Fiscal consolidation, thus, capture the upcycle and downcycle trends, the becomes a necessity for allowing the private sector analysis has been restricted to the Centre only to sustain the growth momentum and mitigating for which quarterly fiscal data are available for a the potential drag on growth from fiscal activism longer time frame. once the economy fully recovers. The need for a II.7 Two broad policy inferences could be credible medium-term fiscal consolidation plan drawn from the estimated multipliers (Table II.2). after a crisis to safeguard the medium-term growth First, during a period of economic slack, and a trajectory, thus, is corroborated by empirical post-crisis situation of sudden collapse in private assessment of the relationship between fiscal demand, fiscal stimulus helps in generating growth expenditure and growth for India. 4 Logarithmic series for data relating to the period 1998:Q1 through 2020:Q1 are considered for the empirical estimation of the following relationship. …..….(1) where is an index variable considering positive output gap as expansion and negative output gap as contraction, is the vector of variables with fiscal variable placed before GDP, and with Cholesky type identification strategy (Blanchard and Perotti, 2002). 25REPORT ON CURRENCY AND FINANCE II.8 In India, a sizable part of the fiscal stimulus hand, the cumulative response of GDP growth during the pandemic was also aimed at incentivising to one percentage point rise in GFD-GDP ratio is the flow of credit to stressed sectors through found to be 43 bps by the fourth quarter. collateral free guarantee support and interest rate II.9 The VAR model was further augmented subventions. Accommodative monetary policy with interactive dummies to ascertain whether was also pursued alongside, which is likely to fiscal multipliers work symmetrically over the have contributed to enhancing the impact of fiscal business cycle. The findings suggest that an stimulus as it ensured ample and low-cost liquidity expansionary fiscal stance works only under that partly worked through these fiscal incentives. economic contraction; during a period of Accordingly, a four variable VAR model – with expansion, it does not improve the growth outcome year-on-year growth in real GDP, CPI inflation but entails adverse implications for inflation and (excluding food and fuel items), weighted average term premium (as discussed subsequently). In call money rate (WACR) and gross fiscal deficit contrast, monetary policy works symmetrically (GFD) of the central government to GDP ratio for in stabilising output, i.e., it is effective under the period 1998:Q1 to 2020:Q1 – is estimated which suggests a statistically significant response both expansion and contraction (Chart II.2). of growth to both monetary policy and fiscal policy These findings corroborate the need for fiscal shocks (Chart II.1).5 A one percentage point fall in policy to take the lead in a post-crisis period to WACR leads to 26 basis points (bps) rise in GDP support growth, and timely fiscal consolidation growth after one quarter and a cumulative impact to allow monetary policy to effectively stabilise of 92 bps by the fourth quarter.6 On the other the economy around the steady state during Chart II.1: Impulse Responses to one S.D. Policy Shock Response of GDP Growth to increase in WACR Response of GDP Growth to increase in GFD Source: RBI staff estimates. 5 The effectiveness of fiscal policy is further confirmed by extending the VAR estimation to cover the pandemic period (i.e., 2020:Q2 through 2021:Q1); fiscal policy is found to have contributed to growth revival in the presence of an accommodative monetary policy. 6 The estimates are worked out by normalising impulse responses to a one percentage point fall in WACR and a one percentage point rise in GFD-GDP ratio. 26REBALANCING MONETARY AND FISCAL POLICIES POST-PANDEMIC Chart II.2: Asymmetric Responses of GDP Growth to Policy Shock IRF of one percentage point rise in WACR during Expansion IRF of one percentage point fall in WACR during Contraction IRF of one percentage point rise in GFD during Expansion IRF of one percentage point rise in GFD during Contraction IRF: Impulse response function. Source: RBI staff estimates. periods of expansion. Hence, as recovery gains accommodative stance was adopted since June further momentum, fiscal consolidation should 2019. Thus, stabilisation policies had retained ideally precede monetary policy normalisation to their focus on reviving growth even ahead of the minimise trade-off costs. pandemic. II.11 Set against this context, it is important 3. Lessons from India’s Own Experience to identify the threshold-level of surplus liquidity II.10 The monetary-fiscal policy mix in India for India beyond which it could be inflationary. was moving into balance consistent with stated To examine the impact of surplus liquidity on objectives preceding the outbreak of COVID-19. inflation, a structural threshold VAR (TVAR) Nonetheless, a weakening of the growth model – with GDP growth, inflation, net liquidity momentum since 2017-18 prompted deferment adjustment facility (LAF) position [as a per of the fiscal deficit target and use of the escape cent of net demand and time liabilities (NDTL)] clause. As regards monetary policy, with average and WACR as the key variables – has been CPI inflation remaining closer to the target, an estimated using data for the period 2000-01:Q1 27REPORT ON CURRENCY AND FINANCE to 2019-20:Q4.7 The estimated threshold value VAR is estimated with inflation, net LAF (as a per ( ) suggests that net LAF surplus of more than cent of NDTL) and WACR as the key variables 1.52 per cent of NDTL could be inflationary. – using monthly data for the period January The results show that a one percentage point 2012-March 2021.8 The time-varying impulse exogenous increase in surplus liquidity above this responses show that the impact of liquidity is threshold value could push up inflation by 60 bps inflationary, with lingering persistence (Chart II.4). on an average in a year (Chart II.3a). In a situation Moreover, the impact is largely subdued in the when the net LAF surplus is below the threshold initial phases, but the cumulative impact increases level, however, an exogenous increase in LAF over time. The liquidity impact on inflation in fact surplus does not cause any statistically significant appears to have increased over the years. For a impact on inflation (Chart II.3b). one percentage point rise in surplus liquidity (as II.12 The inflationary impact of liquidity is per cent of NDTL) the peak increase in inflation analysed further by using a time-varying parameter ranges between 5 to 11 bps up to December VAR (TVP-VAR) model to find out how the impact 2017. Subsequently, the peak impact is estimated of liquidity on inflation has evolved over time. The to have increased to about 20 bps. The cumulative Chart II.3: Surplus Liquidity Impact on Inflation – Estimated Threshold Effects a. Above Threshold Regime: CPI Inflation b. Below Threshold Regime: CPI Inflation Response to net LAF Surplus Response to net LAF Surplus Source: RBI staff estimates. 7 The following TVAR model is estimated: where is the indicator variable and is the vector of endogenous variables. The indicator function takes the value of one if its regime is realised and zero otherwise. The regression coefficients and the threshold value are estimated jointly by Bayesian method using a metropolis-hastings (MH) algorithm. The structural shocks are identified by using Cholesky approach. 8 The following TVP-VAR with stochastic volatility model is estimated: where, . The coefficients and stochastic volatility are time varying. The standard TVP-SV model of Primiceri (2005) is followed to check for the inflationary effect of the liquidity shock over different phases in India. The model does not use quarterly GDP data as an additional relevant variable because data on net LAF are available since June 2000 when it was introduced, and hence, would not meet the requirement of sufficient number of observations to estimate time-varying parameters. 28REBALANCING MONETARY AND FISCAL POLICIES POST-PANDEMIC accommodation of supply-shock induced inflation Chart II.4: Surplus Liquidity Impact on Inflation – Estimated Time-Varying Effects through persistent excess liquidity can create vicious dynamics in an atmosphere of frequent occurrences of supply side shocks and hardening of inflation expectations. II.13 Estimates using data for the period 1998:Q1 to 2020:Q1 and the same four variables in a VAR as described above suggest that the impact of a policy rate cut (captured through equivalent fall in the WACR) could raise inflation Lags (months) Impact over years by about 25 bps by the fourth quarter (Chart II.5a). Surplus liquidity reinforces the impact of interest rate cuts on inflation, but with asymmetric effects during different phases of a business cycle. The Source: RBI staff estimates. impulse-response path suggests that a reduction in the policy rate is less inflationary during a slowdown in economic activity than expansion impact over about six quarters, however, exceeds (Chart II.5b). 200 bps.9 The persistent impact of liquidity on inflation underscores the importance of timely II.14 Surplus liquidity, and accompanying normalisation of systemic surplus liquidity in the excess money growth, can be viewed both as an post-pandemic period to ward off potential risks to endogenous process of monetary accommodation inflation. Even if surplus liquidity initially may not of the government’s demand for money [through stimulate demand enough to cause inflation, an open market operations (OMOs) and G-sec 9 The inflation impact is found to be statistically significant after six months but persists thereafter for long. 29 stniop egatnecreP Chart II.5: Asymmetric Response of Inflation to One Percentage Point Change in WACR a. Response of Inflation to lower WACR (with and without LAF) b. Asymetric Response of Inflation to a Fall in WACR Source: RBI staff estimates.REPORT ON CURRENCY AND FINANCE Acquisition Programme (G-SAP), indirectly] and had to undertake sterilisation operations [i.e., an exogenous money creation process when the conduct open market sales or reduction in net central bank proactively injects excess liquidity domestic assets (NDA)] to offset the excessive into the system on its own to promote growth expansion in reserve money due to increase in which, in turn, helps in smoother completion of foreign assets (Chart II.6b). government market borrowings at reasonable II.15 Reflecting the above dynamics, indirect interest rates. The space for endogenous indirect accommodation of fiscal deficit through RBI credit accommodation in any normal year in India to the Government (as percentage of gross fiscal is influenced by: (a) the required increase in deficit) has fluctuated over time, with a recent primary money consistent with growth in nominal peak of about 50 per cent in respect of the central GDP, and (b) the extent of automatic increase in government (Chart II.7). primary money that results from net accretion to RBI’s foreign assets. With the share of foreign II.16 Post-COVID, indirect accommodation assets in the RBI’s balance sheet rising with the was ensured through a combination of open progressive liberalisation of the economy and market purchases, higher ways and means surges in capital flows, the scope for indirect advance (WMA) limits in 2020-21, and G-SAPs accommodation has fallen steadily as the share of as an additional instrument in H1:2021-22. domestic assets (acquired through open market Market absorption of fiscal deficit was also purchases) has declined (Chart II.6a). During facilitated through the provision of ample system years when capital inflows are large, the entire level liquidity and higher held to maturity (HTM) increase in reserve money may result through regulatory flexibility for banks. As a result, expansion in net foreign assets (NFA), leaving despite the record high size of the consolidated no space for indirect accommodation of the fiscal fiscal deficit (13.3 per cent of GDP), the cost of requirements in monetary policy operations. In borrowings for the central government fell to a fact, there are several years when the RBI has 17-year low in 2020-21 (Chart II.8). Chart II.6: Scope for Monetary Accommodation of Fiscal Stance a. Shares of Foreign and Domestic Assets in RBI’s Balance Sheet b. Shares of NFA and NDA in Changes of Reserve Money (End-March) *: As on March 25, 2022. Source: RBI staff estimates. 30REBALANCING MONETARY AND FISCAL POLICIES POST-PANDEMIC Chart II.7: Financing of Fiscal Deficit through Net RBI Chart II.8: Weighted Average Cost of Borrowing Credit to the Government (Central Government) *: As on March 25, 2022. Note: State Development Loans (SDLs) have been added as a part of open market operation and thereby form part of RBI’s credit to the Government since October 2020. Source: RBI staff estimates. Source: RBI. II.17 Despite fiscal consolidation in 2021-22, is linked to sovereign risk premium, a high longer term yields witnessed sporadic and larger level of government debt can depress growth than warranted deviations from the policy repo – an expansionary fiscal policy at high levels rate. While concerns relating to inflation and of debt can become effectively contractionary external spillovers largely influenced short-term (Alcidi and Gros, 2019; Mohanty and Panda, movements in yields, it was the overhang of high 2020). In India, an impact assessment suggests fiscal deficit and government debt that exerted that when the central government debt exceeds sustained upward pressures on longer-term a threshold value of 55 per cent of GDP, every yields. It is important in this context to assess one percentage point increase in the debt to the threshold level of debt beyond which the term GDP ratio causes the term premium to harden premium starts moving up significantly. by about 22 bps in the short-run and the impact II.18 In standard forward-looking debt could increase to as high as 56 bps in the long- sustainability analysis, a country/region specific run (Box II.1). risk premium is often added to the interest rate II.19 A dynamic latent factor model, augmented outlook. When debt levels exceed a threshold with macroeconomic variables representing real level of 60 per cent of GDP for the European activity, inflation, policy rate, global uncertainty countries, risk premium rises by about 4 bps (as per the IMF thumb rule) and 3 bps (as per and government market borrowing along with the European Commission thumb rule) for every net LAF, is estimated to study the impact of percentage point increase in debt-to-GDP ratio liquidity on term premium or slope of the yield (Alcidi and Gros, 2018). A 10-percentage point curve, following Diebold et al. (2006). Within increase in debt to GDP ratio can thus increase the modelling framework, term premium term premium by about 30 to 40 bps. Since the has been extracted from the g-sec yields of financing cost for corporates and businesses maturities of 2 to 10 years, and then regressed 31REPORT ON CURRENCY AND FINANCE Box II.1 Debt Impact on Risk Premium In view of the sharp increase in fiscal deficit and debt in Table 1: Estimated Parameters India following the response to the pandemic, an attempt (Sample: 2004Q1 - 2021Q1) is made to assess whether there is any threshold level of Coefficient t-statistics debt beyond which an increase in debt impacts term premia significantly. A standard two regime smooth transition Threshold: 54.85*** 33.57 regression of the following form is estimated (Teräsvirta, Slope: 0.66 1.52 1994): Variable debt < -21.32* -1.98 debt > 21.73* 1.76 where, 0.62*** 10.17 12.68*** 3.44 where is the transition variable which governs the regime -7.52*** -2.82 switching; is an unknown threshold parameter(s); and -13.54*** -2.82 represents the slope parameter . The transition -202.86*** -5.18 function is a continuous function and depends -121.12*** -2.98 on . It is normalised to be bounded between 0 and 1, R2 0.88 and the parameters and represent the linear and non- LM(4) P-val 0.48 linear coefficients of the debt threshold. ARCH(4) P-val 0.81 A quarterly model is used to estimate the impact of ***, **; *: Significant at less than 1 per cent, 5 per cent and debt on term premium by regressing term premia 10 per cent levels, respectively. ( ; defined as the difference between 10-year G-sec yields and 3-month treasury bill yields) on a constant and central government debt to GDP ratio ( ), while the fiscal response to the pandemic, the central government controlling for other determinants of term premia, viz. inflation debt level has gone up, but term premia did not harden as deviation from the target (Inf_gap), net LAF as percentage much as the estimates would suggest, which is because of of NDTL (LAF), output gap (ygap) and two dummy variables the strong downward pull from large surplus liquidity. If the to capture the outlier effects of the taper tantrum (dtaper) debt level continues to remain high for long, any closing of and the global financial crisis (dgfc). The estimated results the output gap or normalisation of liquidity, or both, could show that there exists a nonlinear relationship between term raise term premium by up to 56 bps in the long-run. premia and debt, and debt has differential effects on term Reference: premia beyond the threshold level of 55 per cent of GDP (as against actual debt level of 59.1 per cent of GDP as at end- Teräsvirta, T. (1994). Specification, Estimation, and March 2022). The term premium increases by about 22 bps Evaluation of Smooth Transition Autoregressive Models. for each one percentage point increase in the debt to GDP Journal of the American Statistical Association, 89(425), ratio above the threshold of 55 per cent (Table 1). Following 208-218. on the macroeconomic variables. The Bayesian II.20 It is perhaps prudent to step into a post- impulse response results suggest that a one pandemic world with the sobering lessons from percentage point increase in net LAF (as per cent the recent experience that the salubrious impact of NDTL) results in a reduction in term premium of fiscal actions on growth can potentially be by 16 bps (Chart II.9). The increase in liquidity offset by higher inflation. Both fiscal discipline has a sobering effect across the yield curve, but and effective management of the second order with a relatively higher impact on longer-term effects of supply side pressures on inflation are rates. By reducing risk premium, the injection of essential for achieving macroeconomic stability liquidity flattens the yield curve. which will lay the foundation for monetary 32REBALANCING MONETARY AND FISCAL POLICIES POST-PANDEMIC policy mix in the post-pandemic future becomes Chart II.9: Response of Term Premia to One Percentage Point Increase in Net LAF to NDTL Ratio a searing existential question for which existing behavioural regularities, parametric estimates and analytical received wisdom may not provide adequate guidance. II.21 Empirical estimates in this section indicate that achieving a regime of low inflation and low cost of capital that is conducive to growth and investment is also contingent upon normalisation of liquidity and consolidation of debt over the medium-run. The pragmatic way forward in the post-COVID rebalancing of monetary and fiscal policies is to proceed with the existing state of knowledge on the mix while being prepared for Source: RBI staff estimates. course corrections and innovations as the path evolves. policy’s endeavour to set a post-pandemic path II.22 One regularity of the pre-pandemic of strong, broad-based and sustainable growth. past could be Okun’s Law or the expected In this context, the renewal of the tryst with fiscal inverse relationship between GDP growth and prudence that is the defining feature of the Union unemployment rate (Ball et al., 2017). Estimates Budget 2022-23 is a step in the right direction, of the Okun’s coefficient across geographies especially the strategy of placing less emphasis on range from (-)0.1 to (-)0.8 – a one percentage linear time-invariant GFD reduction and focusing point decline in GDP growth may raise the on the reprioritisation of expenditure in a manner unemployment rate by 0.1-0.8 percentage points. that is growth-friendly and non-inflationary. The For India, the data on unemployment rate and real challenge for the setting of monetary policy is the GDP growth from 1980-81 to 2019-2010 suggest continued pursuit of an accommodative stance that a decline in GDP growth by one percentage even as the fiscal impulse is being withdrawn point increases unemployment rate by around especially in an environment in which persisting 0.13 percentage points.11 This is corroborated pressures from repetitive supply shocks threaten by evidence from the results based on periodic to undermine the credibility of the central bank. labour force survey (PLFS) data (Srija and Singh, What should be the appropriate monetary-fiscal 2021). In a post-pandemic environment, however, 10 Data on unemployment rate are collected from the International Labour Organisation (ILO) and data for a few missing years are intercalated using linear interpolation. 11 The Okun’s equation, estimated using unemployment rate and GDP growth, confirms the presence of an inverse relationship between the two. (cid:507)Unemployment rate = 0.77 -0.13*GDP Growth t t t-stat (3.55) (-3.66) R2 = 0.51 33REPORT ON CURRENCY AND FINANCE stability of the estimated parameter cannot be suggests that closing the output gap by one presumed, and permanent scarring effects on percentage point can raise inflation by about 20 the labour market cannot be ruled out. bps with a lag of seven quarters. There is also evidence of a speed limit effect - rapid changes II.23 The output gap (both in level and changes) in economic activity may cause larger changes in is a commonly used proxy of economy-wide slack/ the inflation rate for a given level of the economic tightness associated with cycles of economic activity (Jose et al., 2021). Inflation expectations activity (Chart II.10). A New Keynesian Phillips (captured by inflation trend or survey-based Curve (NKPC) estimated on seasonally adjusted expectations) also play a role in influencing quarterly data for the period 1996-97:Q1 to 2019- actual inflation outcomes in India.13 Thus, while 20:Q4 of the form: coordinated fiscal-monetary policy stimulus is necessary to revive growth, delayed normalisation can potentially increase inflation alongside or even ....(1)12 ahead of economic recovery. Chart II.10: Relationship between Inflation and Output Gap in India (1996-97:Q1 to 2019-20:Q4) Note: L stands for lag. Sources: NSO, Ministry of Statistics and Programme Implementation, GOI and RBI staff estimates. 12 where, is difference in log CPI (i.e., q-o-q change), is a measure of economic activity represented by output gap [(actual output minus potential output)/potential output*100], is the change in the output gap, and is a vector of supply side factors (minimum support prices, nominal exchange rate, global non-fuel commodity prices and rainfall deviation); is the expected future inflation (which is proxied by lagged inflation trend and 1-year ahead inflation expectations of households) and is the white noise term. Potential output is measured by the Hodrick-Prescott filter method. In equation (1), the coefficients of the inflation term on the right-hand side are assumed to sum up to unity, implying the existence of a vertical long-run Phillips curve. Additionally, a set of quarterly dummy variables has been used as controls in the estimation. 13 NKPC with inflation trend as a proxy for inflation expectations (1996-97:Q1 to 2019-20:Q4) ***, **, *: Statistically significant at 1 per cent, 5 per cent and 10 per cent levels, respectively. Figures in the parentheses are standard errors. These results are corroborated by estimates of NKPC with survey based inflation expectations (2008-09:Q1 to 2019-20:Q4) - with coefficients of and remaining statistically significant and of similar size. 34REBALANCING MONETARY AND FISCAL POLICIES POST-PANDEMIC 4. Post-COVID Debt Overhang: Debt pandemic times will warrant a reordering of strategy. Consolidation for Stronger Economic Growth The desirable condition of debt sustainability needs to be a path of reduction of primary deficits II.24 General government debt in India surged to balance or even a modest surplus that spreads to 89.4 per cent of GDP in 2020-21 (Chart II.11), out consequent output losses so as to minimise the significantly higher than the FRBM target of 60 per cost of consolidation. The sufficient condition could cent, posing risks to medium-term macroeconomic be satisfied by committing upfront to reprioritising stability. Hence, an exploration of paths along which expenditure in favour of those heads that are growth India’s public debt may evolve in the medium-term, enhancing and hence, qualitatively superior so based on alternative feasible scenarios for real that the Domar condition (g>r)14 is always satisfied. GDP growth, inflation, interest rate and the primary Country-specific features need to condition the deficit is desirable in order to derive the threshold level of debt beyond which it may become a drag assessment of tolerable level of government debt on GDP growth. reduction, including the share of interest payments and other committed expenditure in GDP as a II.25 In a post-COVID world, there is likely to be measure of the flexibility for manoeuvre. In India, intellectual support for tolerating higher government interest payment on the stock of central and state debt on the ground of a favourable interest rate government debt is high by international standards - growth differential (Blanchard et al, 2021, GOI, (more than one-fifth of total expenditure) – a drag 2021). It is important to keep in perspective, on debt consolidation (Chart II.12). however, that the behaviour of primary balances also matters from the point of view of generating II.26 Monetary policy can help debt fiscal space to pay down the debt – the sufficient consolidation by keeping nominal interest rates/ condition for debt sustainability. Accordingly, a costs of borrowings low for current/future debt, but credible and viable debt management for post- that is possible only in a low inflation environment. Chart II.11: General Government Outstanding Liabilites Chart II.12: Interest Payments on Government Debt Source: RBI staff estimates. Source: RBI staff estimates. 14 g is the real GDP growth rate and r is the real interest rate. t t 35REPORT ON CURRENCY AND FINANCE II.27 It is against this backdrop that feasible Chart II.13: India’s Decadal Debt Decomposition scenarios for India are evaluated under forward looking debt projections in the equation given below15: If the real interest rate exceeds real GDP growth ( > 0) then the debt to GDP ratio can only increase further, unless it is compensated by a primary surplus.16 In India, ( ) has consistently remained favourable in the last three decades. The debt to GDP ratio, however, actually increased during the 2010s despite negative ( ) (Chart II.13). Starting with a debt level of 89.4 per Source: RBI staff estimates. cent of GDP in 2020-21, the best consolidation efforts in the future (primary deficit of 1.5 per cent debt to GDP ratio above 75 per cent of GDP over of GDP by 2026-27) and most feasible/realisable the next five years, higher than in any year during favourable ( ) outcomes could still keep the the decade preceding the pandemic (Box II.2). Box II.2 Limits to Consolidation of Public Debt in India Post-Pandemic Public debt is regarded as sustainable when the primary still have sustainable debt. In India, except for a few years, balance needed to stabilise the debt, under both baseline the IRGD has been consistently negative, even though its and realistic shock scenarios, is economically and magnitude has decreased significantly over the last two politically feasible and the level of debt is consistent with decades. Historically, several debt crises have occurred an acceptably low rollover risk (IMF, 2021). The debt- globally after years of low and negative IRGD as marginal stabilising level of primary balance (pb*) is given by the interest rates rise sharply and abruptly only a few months t following equation: ahead of a default (Mauro and Zhou, 2020). Besides, debt beyond a certain threshold poses several risks viz., the interest rate on public debt increases with the debt level (Laubach, 2009). High debt countries face significant risk This implies that countries which have a negative interest premia that may create a feedback loop in which high-risk rate-growth differential (IRGD) can run a primary deficit and (Contd...) 15 d is the debt to GDP ratio; r is the real interest rate; g is the real GDP growth rate; pb is the primary balance and dda is deficit-debt t t t t t adjustment or the stock-flow adjustment comprising factors that affect debt but are not included in the budget balance (Alcidi and Gros, 2018). 16 A key aspect of any forward-looking exercise on debt sustainability is the projection of primary balances or fiscal efforts required/feasible to stabilise debt. Unlike the simple static view presented in the above equation, in real life all key variables in the equation may be endogenous, with the relationship likely to be also both asymmetric and time-variant. For example, discretionary fiscal efforts directed at containing primary deficit may impact growth, interest rate and inflation. Fiscal multipliers being sensitive to the state of the business cycle, as mentioned earlier, the endogenous impact on other variables could vary over time. Moreover, any change in debt can also generate positive/negative spillback effects on growth, inflation and interest rate. The emphasis on a forward-looking approach in such analyses may also require taking a view on post-COVID possible trend shifts in the potential growth path and the equilibrium real interest rate. 36REBALANCING MONETARY AND FISCAL POLICIES POST-PANDEMIC Table 1: Debt Dynamics Tool – Key Assumptions and Results Historical Projection (Baseline) 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21 2021-22 2022-23 2023-24 2024-25 2025-26 2026-27 Real GDP Growth 8.0 8.3 6.8 6.5 3.7 -6.6 8.9 7.2 6.6 6.3 6.2 6.1 GDP Deflator Inflation 2.3 3.2 4.0 3.9 2.4 5.6 9.7 6.0 5.0 4.5 4.0 4.0 Gross Primary Balance -2.2 -2.2 -1.1 -1.1 -2.5 -7.8 -4.8 -3.8 -3.3 -2.8 -2.5 -2.2 Nominal Effective Interest 7.8 7.7 7.7 7.5 7.1 7.1 7.1 7.1 7.1 7.1 7.1 7.1 Rate Debt (Per cent of GDP) 68.5 68.8 69.8 70.7 75.7 89.4 85.2 84.3 84.2 83.9 83.8 83.6 Note: 1. Real GDP growth for 2021-22 and 2022-23 are based on NSO advance estimates and RBI projections, respectively. 2023-24 onwards projections are based on World Economic Outlook (October 2021). 2. GDP deflator inflation for 2021-22 is based on NSO’s advance estimates of nominal and real GDP. 3. A declining path of gross primary deficit is assumed in line with the union government’s gradual fiscal consolidation plan of reaching GFD-GDP ratio of 4.5 per cent by 2025-26 and Fifteenth Finance Commission’s indicative deficit path for states. premia result in higher debt, which, in turn, leads to even cent of GDP by 2026-27. An analysis of debt-creating higher risk premia (Alcidi and Gros, 2019). Furthermore, flows shows that in the projection period, debt stabilisation countries with higher public debt experience a larger rests entirely on GDP growth as shocks to both primary increase in interest rate in response to a positive growth deficit and interest rate add to the debt stock (Chart 1a). shock and adverse global volatility shocks (Presbitero and After moderating in 2021-22, debt is likely to remain sticky Wiriadinata, 2020). at around 84 per cent of GDP over the next five years (Chart 1b). Based on the IMF’s recently released Debt Dynamics Tool, India’s general government debt path is projected To assess stress scenarios, a 0.5 standard deviation shock for the period 2021-22 to 2026-27. The historical values (individually) is given to real GDP, primary balance and and baseline assumptions on GDP growth, inflation, interest rate in 2022-23, which lasts until 2023-24. The primary balance and effective interest rate are set out in results show that a real GDP shock has the maximum Table 117. In the baseline scenario the general government adverse impact as debt shoots up to 86.6 per cent of debt is assessed to contract steadily to reach 83.6 per GDP in the terminal year of projection, as against 83.6 per Chart 1: Debt Creating Flows in the Baseline and Fan Chart for General Government Debt a. Contribution to Change in Debt b. Evolution of Debt-to-GDP Ratio Source: RBI Staff estimates. (Contd...) 17 Given that India’s external debt is less than 3 per cent of GDP and around 5 per cent of total debt, we have assumed that entire government debt is held domestically for this exercise. 37REPORT ON CURRENCY AND FINANCE Chart 2: General Government Debt – Stress Tests and Alternate Scenarios a. Stress Tests b. Alternate Scenarios Source: RBI Staff estimates. cent in the baseline scenario. An interest rate shock has References: only a modest impact on the projected debt path Alcidi, C. and Gros, D. (2019), “Public Debt and the Risk (Chart 2a). Premium: A Dangerous Doom Loop”, CEPS Policy Insights, In addition to the baseline scenario, we also explore both No. 2019-06. favourable and unfavourable scenarios incorporating IMF (2021), “Review of the Debt Sustainability Framework for feedback effects which work along with individual shocks. In the favourable scenario, GDP growth is assumed at 8 per Market Access Countries”, IMF Policy Paper, International cent from 2023-24 onwards, associated with slightly higher Monetary Fund, January. inflation (which supports debt consolidation) and primary Laubach, T. (2009), "New Evidence on the Interest Rate balance is assumed to be lower than the baseline scenario Effects of Budget Deficits and Debt", Journal of the (through targeted efforts at consolidation). In this setting, the European Economic Association, 7(4), 858-885. general government debt is assessed to contract to 75.6 per cent of GDP by 2026-27. In the unfavourable scenario, growth Mauro, P. and Zhou, J. (2020), “r-g < 0 : Can We Sleep More is assumed to stagnate at 5 per cent of GDP from 2023-24 Soundly?” IMF Economic Review, 69(1), 197-229. onwards. The primary balance and inflation are assumed to be same as in the baseline scenario. In this case, debt Presbitero, A. and Wiriadinata, U. (2020), “The Risk of High changes its declining trajectory after 2021-22 and expands to Public Debt Despite a Low Interest Rate Environment” 89.1 per cent of GDP by 2026-27 (Chart 2b). VOXEu.org, August 5. II.28 Turning to threshold effects in India, an imports) and the gross fiscal deficit (as per cent empirical estimate of the relationship between of GDP): debt and economic growth for India found the threshold level of general government debt to be 61 per cent (Kaur and Mukherjee, 2012). II.29 The following regression in quadratic where, GDP is the growth in real gross domestic form is estimated for the period from 1981-82 to product at market prices; DEBT is the general 2019-20, controlling for real investment growth, government outstanding liabilities as per cent trade (growth in sum of real non-oil exports and of GDP; INVEST is the growth in real fixed 38REBALANCING MONETARY AND FISCAL POLICIES POST-PANDEMIC investment; TRADE is the growth in sum of real solve the twin problems of management of existing non-oil exports and imports; GFD is the central assets by tapping private sector efficiencies and government’s gross fiscal deficit as a per cent of financing of new infrastructure by unlocking the GDP; and is the error term. value of investment made in public assets which have not yielded appropriate or potential returns II.30 The results find that accumulation of so far (Kant, 2021). Furthermore, the funds general government debt up to a level of 66 received by the government are proposed to be per cent of GDP, leads to an increase in GDP growth beyond which it impacts growth adversely used for creation of new infrastructure which could (Table II.3). In fact, GDP growth may decline by generate substantial multiplier effects, bridge 0.01 percentage points for one percentage point existing infrastructure gaps, and lead to inclusive increase in debt/GDP ratio once the debt level socio-economic development. Beyond innovative exceeds 66 per cent, with the impact magnifying financing options and reorientation of expenditure with higher level of debt. towards capex to benefit from higher multiplier effects, rationalisation of expenditure and raising II.31 This calls for adoption of bold and innovative the country’s tax to GDP ratio may have to be an ways to rebuild fiscal space. The government integral part of the fiscal rebalancing act post- has launched the National Monetisation Pipeline COVID. (NMP) with an aggregate monetisation potential of `6 lakh crore, over a four-year period, 2021-22 to 5. Conclusion 2024-25, making it co-terminus with the balance period of the National Infrastructure Pipeline (2019- II.32 The recovery in economic activity remains 20 to 2024-25). Asset monetisation can potentially stimulus dependent, even as new risks to growth and inflation have emerged from the war in Ukraine Table II.3: Relationship between Debt and and normalisation of monetary policy in the US. Economic Growth18 For restoring and recreating a policy environment Variable Coefficient p-values conducive for private sector-led growth post- DEBT 0.82 0.08 COVID, timely rebalancing of monetary and fiscal DEBT2 -0.01 0.08 policies may become necessary given the current INVEST 0.11 0.02 configurations of debt and liquidity. TRADE 0.09 0.08 II.33 First, large surplus liquidity that helped GFD -0.58 0.01 DUM91 -3.69 0.00 financial conditions to ease significantly during DUM08 -3.46 0.00 COVID needs to be withdrawn in a calibrated Adjusted R-square 0.57 manner. This is because when surplus liquidity DW Statistics 1.74 persists at above 1.5 per cent of NDTL, for every LM(2) P-val 0.60 percentage point increase in surplus liquidity, the ARCH(2) P-val 0.29 average inflation could rise by about 60 basis points Source: RBI staff estimates. in a year. Surplus liquidity within the threshold of 18 DUM08 is a dummy variable to capture the effects of global financial crisis and DUM91 is another dummy variable to capture the effects of balance of payments crisis in India on GDP growth. 39REPORT ON CURRENCY AND FINANCE 1.5 per cent of NDTL, however, is found to pose expenditure aim at targeted consolidation, without no significant risks to inflation. Since inflation relying perpetually on the wobbly comfort from a exceeding a threshold of 4-6 per cent is inimical favourable interest rate minus growth condition of to growth19, adequate supply-side measures to debt sustainability. contain inflation should be the priority rather than II.37 With monetary policy prioritising price passive monetary accommodation through ample stability and pursuing output stabilisation in an surplus liquidity. environment in which debt sustainability is sought II.34 Second, empirical estimates suggest to be achieved by fiscal prudence, the assignment term premium coming under pressure once the rule is satisfied bringing in its train macroeconomic central government debt exceeds a threshold stability to support sustainable growth. level of about 55 per cent of GDP. While surplus References liquidity is found to have a significant sobering Alcidi, C. and Gros, D. (2018), “Debt Sustainability effect on term premium, easy liquidity should not Assessments: The State of the Art”, Economic be a policy instrument to raise the tolerable level Governance Support Unit Directorate-General of debt in the economy. Moreover, when general for Internal Policies of the European Union (PE government debt exceeds another critical 624.430), November. threshold level of about 66 per cent, it is found to dampen growth. Alcidi, C. and Gros, D. (2019), “Public Debt and the Risk Premium: A Dangerous Doom Loop”, CEPS II.35 Third, the scenario analysis suggests Policy Insights, No. 2019-06. that even under best possible macroeconomic outcomes, general government debt may not Auerbach, A. J., and Gorodnichenko, Y. (2012), decline to below 75 per cent of GDP over the next “Measuring the Output Responses to Fiscal five years. If adverse scenarios materialise, in fact, Policy”, American Economic Journal: Economic debt may increase. A medium-term transparent Policy, 4(2), 1-27. strategy of debt consolidation aimed at reducing Ball,L., Leigh, D. and Loungani P. (2017), “Okun’s general government debt to below 66 per cent of Law: Fit at 50?”, Journal of Money, Credit and GDP at the earliest would be important to secure Banking, 49(7), 1413-1441. the medium-term growth prospects of India. Bhat, J. A., and Sharma, N. K. (2021), “Asymmetric II.36 Fourth, fiscal consolidation is unlikely to Fiscal Multipliers in India–Evidence from a Non- be growth retarding, as the time varying fiscal Linear Cointegration”, Macroeconomics and multipliers for India suggest. Once the economy Finance in Emerging Market Economies, 14(2), returns to steady state, fiscal multipliers can 157-179. change from greater than one during a crisis to BIS (2021), Annual Economic Report 2021, Bank less than one or even negative. The debt path for International Settlements. over the next five years, even under the best-case scenario, will further squeeze fiscal space unless Blanchard, O. (2022), Fiscal Policy under Low strategic policy efforts covering both taxes and Interest Rates, MIT Press. 19 See RBI (2021c) for details. 40REBALANCING MONETARY AND FISCAL POLICIES POST-PANDEMIC Blanchard, O., Felman, J. and Subramanian, The Indian Experience”, Reserve Bank of India A. (2021), “Does the New Fiscal Consensus Occasional Papers, 33(1-2), 1-29. in Advanced Economies Travel to Emerging Krugman, P. (2020), “Liquidity Trap Has Spread Markets?”, Policy Brief, Peterson Institute for to Emerging Markets”, Bloomberg May 12, International Economics, 21-7, March. 2020. https://www.bloombergquint.com/politics/ Blanchard, O., and Perotti, R. (2002), “An krugman-says-the-liquidity-trap-has-spread-to- emerging-markets Empirical Characterization of the Dynamic Effects of Changes in Government Spending Mohanty, R. K., and Panda, S. (2020), “How Does and Taxes on Output”, The Quarterly Journal of Public Debt Affect the Indian Macroeconomy? A Economics, 117(4), 1329-1368. Structural VAR Approach”, Margin: The Journal of Applied Economic Research, 14(3), 253-284. GOI (2021), Economic Survey of India 2020-2021, Government of India. Patra, M. D. (2022), “RBI’s Pandemic Response: Stepping out of Oblivion”, Keynote Address ------ (2017), FRBM Review Committee, delivered at the C D Deshmukh Memorial Lecture Government of India. Organised by the Council for Social Development, Diebold, F. X., Rudebusch, G. D., and Aruoba, S. B. Hyderabad on January 28, 2022. (2006), “The Macroeconomy and the Yield Curve: Primiceri, G. E. (2005), “Time Varying Structural A Dynamic Latent Factor Approach”, Journal of Vector Autoregressions and Monetary Policy”, The Econometrics, 131(1-2), 309-338. Review of Economic Studies, 72(3), 821-852. Galí, J. (2020), “The Effects of A Money- RBI (2021a). Annual Report 2020-21, Reserve Financed Fiscal Stimulus”, Journal of Monetary Bank of India, March. Economics, 115, 1-19. ------(2021b). Report on Trend and Progress of Goemans, P. (2022), “Historical Evidence for Larger Banking in India 2020-21, Reserve Bank of India, Government Spending Multipliers in Uncertain December. Times than in Slumps”, Economic Inquiry, https:// ------(2021c). Report on Currency and Finance doi.org/10.1111/ecin.13068 2020-21, Reserve Bank of India, February. Jose, J., Shekhar, H., Kundu, S., Kishore, V., and Srija, A. and Singh, J. (2021), “How Reliable is Bhoi, B. B. (2021). “Alternative Inflation Forecasting Labour Market Data in India? PLFS vs CMIE”, Models for India – what Performs Better in Economic and Political Weekly, 56(52), 21-23. Practice?”, Reserve Bank of India Occasional Stella, P. (2021), “Interpreting Modern Monetary Papers, 42 (1), 71-121. Reality”, Journal of Applied Corporate Kant, A. (2021), “The Asset Monetisation Dividend”, Finance, 33(4), 8-23. The Financial Express. January 05, 2021. https:// Summers, L. H., and Rachel, L. (2019), “On www.financialexpress.com/opinion/the-asset- Falling Neutral Real Rates, Fiscal Policy and the monetisation-dividend-amitabh-kant/2164284/ Risk of Secular Stagnation”, In Brookings Papers Kaur, B., and Mukherjee, A. (2012), “Threshold on Economic Activity BPEA Conference Drafts, Level of Debt and Public Debt Sustainability: March. 41STRUCTURAL ISSUES IN III REJUVENATING GROWTH The Indian economy was baffled with several structural constraints to growth even before the outbreak of COVID. COVID induced disruptions, especially in the supply front, have posed additional challenges before the economy. The sub-optimal share of manufacturing in gross value added (GVA); deployment of the bulk of physical investment in a few capital-intensive sectors leading to low overall productivity; labour market rigidities hindering the creation of formal employment; the subsidy-heavy and low-investment imbalance in agriculture depressing yields; and weak growth dynamism in services reflect several infirmities in major sectors of the economy, which would require bold factor and product market reforms and effective implementation of several momentous reforms already announced to accelerate the growth momentum on a durable basis in the medium-term. 1. Introduction productivity growth, the relative importance of factor productivity over factor endowment in India’s III.1 Even before the outbreak of the pandemic, growth process; and resource reallocation to raise a distinct deceleration in the growth momentum overall productivity growth is the focus of Section had set in from H2: 2016-17 in India, triggering a 3. Section 4 provides an assessment of structural public debate on the state of India’s potential output impediments to growth in agriculture, industry in view of prolonged sluggishness in investment and services, and their sub-sectors. Enabling and productivity (Dieppe, 2021). With trend conditions for growth at the economy level for growth of 7.0 per cent (2003-20) at risk, structural the benefit of all sectors is the focus of Section 5. reforms have been called for in order to regain Section 6 covers issues relating to factor market, and secure it as the trajectory over the medium- in particular land, where litigation free access at term (Economic Survey, 2020). In this context, this affordable cost remains a major impediment to chapter addresses the structural reforms that are growth.1 Section 7 concludes the chapter and needed to invigorate post pandemic growth. Set presents a set of policy priorities that could raise against the backdrop of the transformation that is India’s trend growth path in the medium-term. underway in the economy, the chapter examines key drivers and targeted policy interventions in 2. Structural Transformation in India the form of a range of sector specific reforms to remove bottlenecks and revive growth. The III.2 Transformative structural change requires remaining part of this chapter is organised under moving production to sectors with increasing six sections. Section 2 examines the pattern and returns or higher productivity, where strategic policy nature of structural change in India. Drivers of interventions play a crucial role2. Innovation is the This chapter has been prepared by Mridul Kumar Saggar, Sadhan Kumar Chattopadhyay, Avdhesh Kumar Shukla, Arun Vishnu Kumar, Rakhe Balachandran, Siddhartha Nath, Sreerupa Sengupta, Silu Muduli, D. Suganthi and Ishu Thakur. The authors sincerely acknowledge the guidance and insightful suggestions by Dr. Michael Debabrata Patra. 1 Capital, as the third critical factor, is covered in Chapter IV in the context of contribution of finance to growth. 2 The neoclassical school of thought, however, would suggest that structural changes could be the outcome of market forces. Even on state intervention, the strategy could differ depending on the preference for welfare economics versus neoliberalism. 4422STRUCTURAL ISSUES IN REJUVENATING GROWTH key driver of such structural shifts (Schumpeter, supply chains where specialisation in each part 1939) and diversification (away from traditional of the production process by different players is low productive sectors) along with sophistication more important than one player specialising in of production processes could be an indication of all parts of the value chain. In an open economy such progresses (UNIDO, 2009). setting, comparative advantages open up new opportunities to drive sectoral reallocation of III.3 Accordingly, considerable attention has resources. been devoted to defining and measuring structural change in the presence of productivity gaps III.4 In India, the sub-optimal share of across sectors, and even between firms in the manufacturing sector in gross value added (GVA) same industry. While the two most commonly used is an outcome of persistent structural constraints, indicators of economic progress in the literature resulting in the lowest share of manufacturing in are per capita GDP and some simple measures GVA among a peer group of economies that are of productivity (such as labour productivity), endowed with similar resources (Dieppe, 2021). the three most commonly tracked indicators of Moreover, the bulk of physical investment in India structural transformation are sectoral shares is deployed in a few capital-intensive sectors, in value added, employment and consumption leading to low overall productivity in the economy. expenditure (Herrendorf et al., 2014). It is also Together with labour market rigidities, this has important to track labour productivity (output hindered the creation of formal employment per unit of labour), which could have two broad in the economy. As manufacturing productivity patterns – increase in productivity within a is considerably higher than other sectors, this sector due to capital accumulation or change incentivises the workforce to shift from low in technology, and at the level of the economy productive sectors, particularly agriculture, to due to labour moving from low productive to high manufacturing, as the global experience shows productive sectors (McMillan and Rodrik, 2011). (Lewis, 1955; Kaldor, 1966; Chenery et al., The determinants of structural transformation 1986), giving rise to a virtuous cycle of growth could broadly include: (a) changes in income; and investment. Indian agriculture also suffers (b) changes in relative (sectoral) prices; (c) from structural impediments, resulting in low changes in input–output linkages; and (d) yields and sticky cropping pattern. To correct changes in comparative advantage(s) through imbalances in agriculture, the policy thrust should globalisation and trade. Differences in income not only change from subsidy-led to investment- elasticities across sectors could be a driver of led production but also from managing scarcity to structural change. Changes in sectoral relative managing surpluses (Gulati et al., 2020). In several prices can also induce reallocation of activity services sectors such as telecommunication, to the extent that they reflect differences in transportation and logistics, retail and wholesale technology and total factor productivity (TFP) trade, real estate and tourism, the quality of growth. The input-output matrix, a complex web service and growth dynamism remain less than of the underlying structure of an economy, has desirable. Economic growth, in terms of simple become a major driver of structural change due accounting, is the sum of growth in factor inputs to rising importance of domestic and global and productivity. Contrary to factor inputs, 43REPORT ON CURRENCY AND FINANCE productivity growth provides an opportunity to Chart III.2: Dependence on Agriculture for Employment increase output without increasing inputs and 100 incurring related costs. After the Global Financial 90 Crisis (GFC) 2008-09, however, the world 80 70 economy faces a stagnation in productivity growth 60 (Arnold and Grundke, 2021). A peculiar attribute of 50 factor productivity is its very high correlation with 40 GDP growth. Productivity deceleration/stagnation 30 20 appears to be an emerging risk for India, given 10 the post-GFC global experience, and requires 0 targeted sector-specific policy interventions. III.5 Over the last 70 years, the Indian economy witnessed a remarkable transformation from a predominantly agriculture-based to a services dominated economy (Chart III.1). Industry’s share Source: India KLEMS. was increasing up to 1990s after which it has stagnated. unchanged at around 12 per cent, while the share of services increased from around 19 per to 47 III.6 Employment dependence on agriculture per cent. continues to remain high even after a decline in its share in total employment from around 70 III.7 A dominant share of real gross capital per cent in 1980-81 to 41.3 per cent in 2018-19 formation (GCF) is allocated to the industrial (Chart III.2). During the same period, the sector (Chart III.3). employment share of industry remained Chart III.1: Sectoral Shares in Real GVA Chart III.3: Capital Concentration in Industry Source: National Accounts Statistics (NAS) and India KLEMS. Source: NAS and India KLEMS. 44 tnecreP 18-0891 38-2891 58-4891 78-6891 98-8891 19-0991 39-2991 59-4991 79-6991 99-8991 10-0002 30-2002 50-4002 70-6002 90-8002 11-0102 31-2102 51-4102 71-6102 91-8102 Otherservices PAD Financial and BusinessServices Tradeandtransport Construction Electricity Manufacturing Mining Agriculture 100 90 80 70 60 50 40 30 20 10 0 tnecreP 06-1591 07-1691 08-1791 09-1891 00-1991 01-1002 02-1102 Agriculture Mining Manufacturing Electricity Construction Trade Finance Realestate PAD OtherServicesSTRUCTURAL ISSUES IN REJUVENATING GROWTH Chart III.4: Capital Stock Per Worker Chart III.5: Components of Manufacturing GVA 6000000 18000000 16000000 5000000 14000000 4000000 12000000 10000000 3000000 8000000 2000000 6000000 4000000 1000000 2000000 0 0 Source: India KLEMS. Source: NAS and CMIE Industry Outlook. III.8 An analysis of the composition of aggregate and Chari, 2014). Other factors include low GVA, aggregate employment and GCF shows that wage differentials between the non-agricultural manufacturing has not generated commensurate informal sector and the agricultural sector for the employment and value addition, leading to unskilled work force, linguistic differences, lack adverse outcomes for sectoral productivity and of social protections such as mutual insurance system-wide efficiency (Chart III.4). provided to members of the same sub-caste networks (Munshi and Rosenzweig, 2009), and III.9 The share of capital intensive ‘other lack of cheap urban housing and poor planning manufactured goods’ and ‘machinery and in urban areas (Banerjee, 2006). More recent equipment’ in manufacturing GVA increased studies also show that policy interventions in the to above 60 per cent in 2011-20 (Chart III.5). form of wage setting and providing unemployment However, labour intensive sectors such as benefits by the public sector may only increase textile, readymade garments, leather products, the unemployment rate and increase the size of food products and beverages have lost ground. the informal sector (Ghate and Mazumder, 2019). Stringent labour regulations have contributed to This may also result in lowering the wage rate in a slow growth in employment in the organised the private sector. sector (Panagariya et al., 2008). These regulations III.10 The changing mix of GVA is also visible also result in labour market frictions which cause from the evolution of India’s exports composition. decreases in wages in the modern sector (Ghate The share of services in gross exports increased et al., 2016), employment of inefficient labour from around 20 per cent in 1990-91 to above (Gupta and Kumar, 2012) and constrain the 40 per cent in 2020-21, driven by skill intensive growth of the modern sector by deterring entry information technology (IT) and business services. of firms and skewing firm-size distribution (Alfaro Among goods exports, engineering goods’ share 45 seepuR 18-0891 48-3891 78-6891 09-9891 39-2991 69-5991 99-8991 20-1002 50-4002 80-7002 11-0102 41-3102 71-6102 seepuR Agriculture Mining Manufacturing Construction Tradeandtransport Financial and BusinessServices PAD Otherservices Electricity (RHS)REPORT ON CURRENCY AND FINANCE Chart III.6: Sectoral Decomposition of Total Exports Chart III.7: An Accelerated Growth in Urban Population Note: Items in the chart are in descending order for 2020-21. Sources: CEIC and DBIE, RBI. Source: Census and CEIC. almost doubled from around 10 per cent in 1990- 2.1 Rising Role of Urban Agglomerations 91 to around 18 per cent in 2020-21 (Chart III.6). III.12 Seventeen of the 20 fastest-growing The decline in the share of labour intensive cities in the world between 2019 and 2035 will sectors in exports has adverse repercussions on be from India (Economic Times, 2020). Indian employment generation and absorption of new cities are likely to contribute 70 per cent of workers migrating from agriculture sector. India’s GDP by 20303. A comparison of decadal III.11 In this backdrop, policy actions to alleviate incremental rise in urban and rural population labour market frictions can lift potential output, shows that for the first time, urban areas supported by re-skilling programmes. Higher would add more new persons than rural areas subsidies towards agriculture are hardly a solution (Chart III.7). A rapidly urbanising Indian economy when a shift of resources from subsidies to capital poses several challenges for policymakers, investments in agriculture can yield higher output. ranging from generation of adequate quality A mix of tax and subsidy policies can, therefore, employment to creating a robust and inclusive be used to modernise agriculture to reduce labour infrastructure. dependence on farm activities, besides boosting 3. Productivity Trends capital formation in more productive sectors. In this way, the problems of reverse migration of labour III.13 Globally, productivity growth has amidst the pandemic could be addressed and undergone a prolonged slowdown since 2010, further absorption of labour in firms with higher after a brief recovery in the years immediately productivity and wages can be encouraged. following the GFC (Chart III.8), with the 3 The Economic Times, November 27, 2020. 46STRUCTURAL ISSUES IN REJUVENATING GROWTH Chart III.8: Total Factor Productivity Growth - Chart III.9: Labour Productivity Growth-Global Trends Global Trends Note: Years refer to calender year. Note: Years refer to calender year. Source: Authors’ estimates based on Total Economy Database, The Source: Authors’ estimates based on Total Economy Database, The Conference Board. Conference Board. deceleration in total factor productivity (TFP)4 cent was much higher than the emerging market being relatively sharper in emerging and average of 2.9 per cent (Chart III.9). developing economies. The slowdown in III.15 India suffered a moderate decline in TFP productivity growth has been attributed to a growth compared to the global experience with weakening investment climate, lower growth in average TFP growth rate in India during 2010 to employment in developed economies, reduced 2019 estimated at 2.25 per cent as against the participation in global value chains, and fading emerging market average of -0.3 per cent for the gains from factor reallocation (Dieppe, 2021). same period. TFP growth accounted for about 30 The growing emergence of monopolistic forces per cent of India’s aggregate GDP growth during across sectors and decline in dynamism of 2014 to 2018 (Chart III.10). In fact, the acceleration traditional firms also contributed to the loss of GDP growth during this period can be attributed of productivity (Parente and Edward, 1999; Herrendorf and Teixeira, 2004). to increase in TFP growth, as contributions from both capital and labour declined. Since 2018-19, III.14 Labour productivity, measured by the there has been a notable slowdown in TFP growth. value added per worker, has followed a similar trend. Despite showdown, India’s average labour III.16 TFP growth during 2014 to 2017 was productivity growth for 2010 to 2019 at 6.5 per mainly driven by non-market services such as 4 Total Factor Productivity (TFP) is estimated as a residual growth in an economy’s aggregate output after deducting the contributions from labour, capital and intermediate inputs from growth in gross output. In other words, TFP growth accounts for that part of growth in aggregate output which is not explained by growth in labour, capital, and intermediate inputs. TFP growth essentially measures the impact of technological progress and efficiencies in production processes, collectively called as the productivity growth in an economy. 5 TFP being a residual of growth accounting, it is more appropriate to refer to period averages rather than TFP estimate of any single year. 47REPORT ON CURRENCY AND FINANCE remained higher than aggregate TFP growth in Chart III.10: Decomposition of GDP Growth in India years of high real GDP growth (Chart III.11.b). 3.1 Drivers of TFP Growth III.17 The factors that support sustained TFP growth over the long run can be broadly categorised into: (i) fostering innovation at the national level; (ii) facilitating diffusion of new technologies available at the global level among domestic firms; and (iii) reducing resource misallocation, particularly skill mismatches (OECD, 2015). III.18 In a market economy, the most innovative firms are expected to thrive. Innovation can be Note: Years refer to financial year (FY). FY 2019, for example refer to 2018-19, i.e. the financial year ending as on March 2019. promoted through a pro-competition environment Source: Authors’ estimates based on India KLEMS (available up to 2018-19). incentivising the entry of new innovative firms (OECD, 2015). India ranks significantly below the public administration, defence, education, social major developed and emerging countries in terms works and related services (Chart III.11a). This of innovation activities being carried out nationally raises doubts about the sustainability of aggregate (Chart III.12a)6. India also ranks far below other TFP growth, given that TFP growth from market major economies in terms of aggregate research driven sectors (i.e., when non-market services and development (R&D) expenditures, and also and agriculture are excluded) has generally in the extent of participation by private business Chart III.11: Sectoral Drivers of TFP Growth (Y-o-Y) in India a. Sectoral Drivers of TFP Growth (Y-o-Y) b. TFP Growth: 3Y MA Note: Years refer to financial year (FY). FY 2019, for example refer to 2018-19, i.e. the financial year ending as on March 2019. Source: Authors’ calculations based on India KLEMS. 6 Innovation is measured by the number of patent applications by a country’s residents relative to its total population. 48STRUCTURAL ISSUES IN REJUVENATING GROWTH Chart III.12: Indicators of Innovation and Productivity-Global Comparison a. Resident Patent Applications (2014-19 average) b. R&D Expenditure (2014-18 average) c. R&D by Business (2014-18 average) d. Total Factor Productivity (2014-19 average) Sources: World Intellectual Property Organization (Charts III.12.a-III.12.c) and Penn World Tables (Chart III.12.d). entities in R&D activities (Chart III.12b and as knowledge based capital (KBC) (Griffith et al., Chart III.12c). In fact, the share of businesses in 2004). Lower GVC participation across the globe aggregate R&D expenditures in India is among since 2011 has possibly curtailed the scope for the lowest across major countries, which implies technology diffusion. that innovation activities in India are largely III.20 Investment demand reflected by annual being carried out by the government and public average growth of gross fixed capital formation sector enterprises (Chart III.12c). Consequently, (GFCF) has decelerated since 2008, both in aggregate productivity occupies the lower rung in India and other major emerging economies. This a cross country comparison (Chart III.12d). poses a challenge to sustaining TFP growth in the III.19 On the diffusion of technologies, the future, as stepping up private sector investment in prominent factors are global connections via R&D activities also requires a favourable overall trade and FDI (Alvarez et al., 2013; Melitz and investment outlook. Estimates suggest that capital Trefler, 2012), participation in global value chains deepening through higher investment in machinery (GVCs) (Saia et al., 2015); synergic investments and other fixed assets improve TFP growth in in R&D, skills and organizational know-how, India (Box III.1). This process could, however, particularly managerial capital, commonly known yield a desirable outcome only when supported 49REPORT ON CURRENCY AND FINANCE Box III.1 Structural Determinants of TFP Growth in India Total Factor Productivity (TFP) growth can be explained Table 1: Determinants of TFP Growth through the sensitivity of the economy to four factors: With lag With lag With lag With lag (a) capital deepening, which is represented by growth 1 of en- 2 of en- 3 of en- 4 of en- in the stock of fixed capital; (b) capital composition, dogenous dogenous dogenous dogenous var var var var which is the average rental price of capital across three Dependent Variable: Growth in TFP major types viz. construction, machinery and transport equipments; (c) labour quality, which is an index of the Growth in TFP- 0.05 0.10 0.09 0.18* composition of the labour force under five broad education Lag 1 (0.15) (0.09) (0.09) (0.10) categories7 weighted by their average annual earnings, Growth in TFP- 0.51** 0.41* 0.41* 0.22* Lag 2 (0.24) (0.22) (0.23) (0.13) and (d) input use intensity measured by input growth. Growth in TFP- -0.32*** -0.32*** -0.38*** -0.30*** India KLEMS data for the period 1990-91 to 2017-18 have Lag 3 (0.08) (0.09) (0.09) (0.07) been used for 27 broad industries disaggregated into 6 Growth in Capital 2.89*** 3.15*** 3.03** 2.68*** major sectors, i.e., (1) agriculture; (2) manufacturing; (3) Stock (1.10) (1.13) (1.26) (0.87) infrastructure industries that include mining, construction, Growth in Capital -4.15*** -5.82*** -6.39*** -6.85*** electricity, gas and water supply; (4) financial services; (5) Composition (1.03) (0.99) (1.16) (0.81) market services; and (6) non-market services that include Growth in Labour 58.84*** 69.26*** 75.58*** 75.30*** public administration, defence, health and education Quality (12.55) (17.77) (13.60) (11.47) related services. Panel data estimates8 covering these 6 Input Growth-Lag 2 0.23*** 0.29** 0.29* 0.23 (0.06) (0.15) (0.17) (0.33) sectors suggest that: Value Added -0.57** -0.54* -0.59** -0.37** (cid:115)(cid:0) Capital deepening generally improves TFP growth Growth-Lag 2 (0.28) (0.29) (0.30) (0.15) N 138 132 126 120 (Table 1). Notes: Robust Standard errors in parentheses. (cid:115)(cid:0) Capital composition, representing the average rental *, **, *** represent statistical significance at 10, 5 and 1 per cent, price for capital, has a negative relationship with respectively. TFP growth. An increased cost of capital, such as machineries, without any significant improvement in its effects are positive for agriculture, manufacturing and productive capabilities may restrict firms from expanding non market services. The effects are not significant for its scale of operations and technological upgradation, infrastureture industries and financial services. limiting its TFP growth. References: (cid:115)(cid:0) Improvement in labour quality is observed to have a Levinsohn J., Petrin A., “Estimating Production Functions positive impact on TFP growth. Using Inputs to Control for Unobservables”, The Review of (cid:115)(cid:0) Input growth shows a positive association with TFP Economic Studies, Volume 70, Issue 2, April 2003, Pages growth. A disaggregated analysis suggests that these 317–341. by simultaneous improvement in the productivity suggest that improvement in the education profile of capital through innovations. Estimates also of the labour force improves TFP growth. 7 Education categories are: i) below primary, ii) primary, iii) middle, iv) secondary & higher secondary and v) above higher secondary. 8 A two-step least-square instrumental variable (2SLS IV) approach is used to address the issue of inconsistency in the estimates for the coefficients of capital deepening, capital composition and labour quality due to their correlations with the error terms of the regression. This is also known as the endogeniety problem. This occurs when the explanatory variables are not completely exogenous. We use the contemporaneous growth in intermediate input as instrument for growth in capital stock following Levinsohn and Petrin (2003). For the capital composition and labour quality, we used the fourth lag of capital stock growth, and the second lag of change in labour-capital ratio, respectively, as instruments. 50STRUCTURAL ISSUES IN REJUVENATING GROWTH III.21 As regards reallocation of labour and effects suggest that the contribution of resource capital from low productive to high productive reallocation to aggregate TFP growth declined sectors, reduction in skill mismatches within an from 82 per cent of aggregate TFP during economy is an important channel to improve 2001-2010 to 42 per cent of aggregate TFP aggregate TFP growth (OECD, 2015). Estimates during 2011-2019 (Box III.2). The productivity suggest that a more efficient reallocation of labour increase in India after 2010 was driven mainly and capital across firms can improve TFP growth by within industry TFP rise and less by resource by up to 60 per cent in the Indian manufacturing reallocation effects across industries. From a sector (Hsieh and Klenow, 2009). On the other policy perspective, therefore, the focus should hand, when this reallocation mechanism stalls, be on addressing market distortions, reducing the aggregate TFP growth tends to be lower. The skill mismatches, ensuring greater product and latest estimates for India on factor reallocation labour market flexibilities. Box III.2 Resource Reallocation for Higher Productivity Growth The 27 sector KLEMS data framework is used to determine direct effect of an increase in output of own industry and the role of resource reallocation in driving productivity an indirect effect due to increase in output sold to other growth in India during 2000 to 2019. industries for use as intermediate inputs. Aggregate output is defined in terms of standard production Aggregate annual average TFP growth increased from 1.33 possibility frontiers for estimating industry origin of per cent during 2001-2010 to 2.72 per cent during 2011- aggregate productivity growth and the resource reallocation 2019 (Table 1). During the 2000s, resource reallocation effects (or structural change). Following Jorgensen 20079, was the driver of aggregate productivity whereas post the resource reallocation effect is given as: 2011, within industry TFP increase was a stronger force and contributed more to aggregate productivity growth. On an average, within industry TFP increase accounted for 58 per cent of the aggregate TFP growth during 2011 to 2019 whereas resource reallocation effects accounted for the remaining 42 per cent. In the earlier subperiod of ...(I) 2000, resource reallocation contributed to 84 per cent The first and the second terms in the equation capture of aggregate productivity. During both sub periods, the reallocation of capital and labour across sectors.The third labour reallocation effect were relatively higher than capital term indicates a weighted average of industry TFP growth. reallocation, indicating faster movement of labour to high The weights of the TFP are Domar weights (Domar, 1961) wage sectors and a relatively slower expansion of capital in - improvement of TFP as the result of two effects, i.e., a industries offering higher prices for capital. (Contd...) 9 Resource reallocation effects can be derived from the following growth accounting model: ...(1) ...(2) ...( 3) ...(4) Subtracting (3) from (4) it can obtained ...(I) 51REPORT ON CURRENCY AND FINANCE Disaggregated domar weighted productivity trends Table 1: Aggregate Reallocation Effects suggest that the pattern of TFP growth is not broad-based, Time Period 2001 to 2010 2011 to 2019 and there are substantial productivity gaps across sectors Aggregate TFP Growth 1.33 2.72 (Chart 1). Within industries, the top performing sector in terms of contribution to productivity includes labour Domar Weighted Productivity intensive industries like textiles and leather; rubber and Agriculture -0.09 0.52 rubber products; parts and component producing sectors Industry -0.05 0.76 like machinery and transport equipment; and import Market Services 0.40 -0.24 intensive sectors like coke refined products and petroleum Financial and Business Services -0.19 0.17 products. In services, financial and business services, Non Market Services 0.14 0.36 which has the largest interlinkages with other sectors, Reallocation of Capital 0.47 0.46 productivity has been high. Market services like trade, Reallocation of Labour 0.66 0.68 telecom, transport and storage contributed negatively to productivity growth. Source: Authors’ estimates based on India KLEMS. Chart 1: Sectoral Drivers of Aggregate TFP Growth Industry Contribution to Aggregate TFP Growth: 2011 to 2019 Service Contribution to Aggregate TFP Growth 2011 to 2019 Percentage points Percentage points Source: Authors’ estimates based on India KLEMS. References: Jorgenson, D. W., Ho, M. S., Samuels, J. D., & Stiroh, K. J. (2007). Industry origins of the American productivity resurgence. Economic Systems Research, 19(3),229–252. Domar, D. E. (1961). On the Measurement of Technological Change, The Economic Journal, Volume 71, Issue 284, Pages 709-72 4. Structural Impediments in Key Sectors nutrition security, the supply of raw materials to the industrial sector and the generator of demand for 4.1 Agriculture and Allied Activities industrial and services output. The sector is also III.22 The agriculture and allied (A&A) the largest provider of livelihood and employment. sector comprises crops (both agricultural and horticultural), livestock, fishing and aquaculture, III.23 From an initial condition of subsistence and forestry and logging. The importance of the farming, food shortages and dependence on sector arises from the point of view of food and imports at the time of independence, India has 52STRUCTURAL ISSUES IN REJUVENATING GROWTH Chart III.13: Growth in Agricultural Production and GVA a. Production Growth b. Sub-sectoral Share in Agricultural GVA (Number of times) Source: MoA&FW, MOSPI. transformed into a food surplus economy and an Low Capital Formation exporter of agricultural commodities. The country III.27 Over the last decade, there has been a has emerged as a leading producer of cereals, trend deceleration in the growth of gross capital pulses, vegetables, fruits, sugarcane, milk, fish, formation (GCF) (Chart III.15a). poultry and cotton in the world. III.28 Public sector GCF in agriculture has III.24 Horticulture crop production has increased stagnated during the 2010s. Growth in private 11.2 times since 1950-51 while production in the GCF has also moderated, reflecting the behaviour livestock sector has increased in similar large multiples (Charts III.13a and Charts III.13b) driven by rising per capita incomes and the consequent Chart III.14: India’s Share in World Agriculture and change in consumption patterns. Merchandise Trade III.25 India’s share in world agricultural exports has risen steadily from a little less than one per cent in the mid-1990s to 2.2 per cent in 2020 and in world agricultural imports from less than 0.5 per cent to 1.4 per cent (Chart III.14). The export shares of rice, marine products, meat products, groundnut, spices, fruits, vegetables, milk products, processed vegetables and fruit juices have increased. III.26 The agriculture export policy of 2018 aimed at doubling India’s agricultural exports from US$30 billion to US$60 billion by 2022; by 2020- Source: FAOSTAT, MoA&FW. 21 these exports reached US$41.7 billion. 53REPORT ON CURRENCY AND FINANCE Chart III.15: GCF and R&D in Agriculture a. GCF and R&D b. Institutional Share in GCF Notes: GCF: Gross Capital Formation, R&D: Research and Development Expenditure. Source: MOSPI, MoA&FW. of the household sector which accounts for the of growth in agriculture (Akber and Paltasingh, majority share (Chart III.15b). 2019; Bathla, 2014). III.29 As early as 2000, the Pradhan Mantri Research and Development Expenditure Gram Sadak Yojana (PMGSY) (Prime Minister’s Village Road Scheme) was launched as a III.30 Agriculture R&D expenditure has been centrally sponsored scheme. The connectivity it less than 1 per cent of agriculture GVA, which is provided to villages that had no access to the rest substantially lower than some of the peer groups such as that of 1.82 per cent for Brazil in 2013 of the economy, except by way of foot, brought (latest available data, (ASTI, 2016)) and exhibits a about sweeping changes in the lifestyles of many declining trend. At the regional level, the excessive villagers in hilly terrains and boosted income input use practices driven by Minimum Support levels, altered production and consumption Price (MSP), procurement and buffer stock policy cycles and integrated these villages with the have led to soil degradation, overexploitation broader Indian economy. This nationwide plan of groundwater resources and declining yields. is crying out for replication across the country. Technology adoption in terms of climate-smart Investments in rural roads have strong multiplier agriculture techniques has also been low and effects, working through improved access to skewed. better agricultural inputs, extension services and alternative rural occupations. Public investment III.31 Total factor productivity (TFP)10 growth in in roads, agricultural research and development agriculture plays a central role in sustaining higher (R&D) and rural infrastructure can crowd in private agriculture growth (Evenson et al., 1999; Chand investment and generate sustained impulses et al., 2012). The key propellers of TFP growth 10 Total factor productivity (TFP) is the quantum of change in output not accounted for by changes in the conventional inputs such as land, labour and capital. 54STRUCTURAL ISSUES IN REJUVENATING GROWTH Chart III.16: Cross-Country Comparison of Average TFP Growth and Crop Yields a. TFP Growth (2000-19) b. Crop Yield (2019) Source: USDA. Source: FAOSTAT. Notes: TFP index is at 2005 base year. Oilseed yield data pertains to 2018-19. are technological innovations driven by R&D two decades (Chart III.16a). India’s crop yields and physical and human capital accumulation also lag behind levels achieved by other countries (Fan et al., 2007). (Chart III.16b). An empirical assessment of the determinants of TFP growth in Indian agriculture for III.32 In India, growth in agriculture GVA is primarily driven by TFP growth, reflecting the the period from 1981-82 to 2018-19 (latest available lower contribution of factor inputs (Gulati et al., data), shows that area under irrigation, rural 2020). Average TFP growth in Indian agriculture roads, growth in GCF and cumulative expenditure has, however, been lower than in several on R&D are the most significant influences other emerging and Asian economies over the last (Box III.3). Box III.3 Determinants of TFP Growth in Indian Agriculture TFP growth in Indian agriculture has been volatile The distribution of certified quality seeds12 (direct outcome) is (Chart 1). used as a proxy for R&D expenditure. The results from various alternative formulations (Table 1) show that growth in GCF, We examined the drivers of the TFP growth in Indian distribution of certified quality seeds, research stock, rural agriculture, such as growth in GCF (at 2011-12 constant road length and irrigated area are positively associated with prices), R&D stock (cumulative expenditure in real terms)11, TFP growth. The results are consistent with the findings of agriculture credit (in reals terms), rural road length, irrigation past research (Evenson et al., 1999; Fan et al., 1999; Chand facility (irrigated area in thousand hectares), rainfall deviation from long period average (LPA) and labour quality. (Contd...) 11 The real values were obtained by using GDP deflators. 12 To elevate crop yields by enhancing seed replacement rate, mostly the certified/quality seeds are made available to the farmers. The contribution of private sector to the commercial seed requirement of the country stood at 58.8 per cent in 2016 (Chauhan et al., 2016). Since private sector R&D expenditure data is unavailable, it has been proxied by the distribution of certified quality seeds. 55REPORT ON CURRENCY AND FINANCE Chart 1: Trends in TFP and Foodgrain Yield Growth Note: Decadal average given in the boxes. Source: KLEMS database, MoA&FW. Table 1: Determinants of TFP growth in Indian Agriculture et al., 2012) and recent cross-country studies that focus on the role of capital and technological innovations (Anik et al., Model 1 Model 2 Model 3 Model 4 2017; Liu et al., 2020). Growth Growth Growth in Growth in in TFP in TFP foodgrain foodgrain yield yield References Growth in Agri-TFP- -0.233 -0.269* Lag 1 (0.15) (0.15) Anik, A. R., S. Rahman, and J.R. Sarker (2017), “Agricultural Growth in Agri-TFP- 0.099 0.115 Lag 2 (0.12) (0.13) Productivity Growth and the Role of Capital in South Asia Growth in foodgrain -0.274* -0.272* (1980-2013)”, Sustainability, Vol.9, No. 3, pp. 1-24. yield growth-Lag 1 (0.15) (0.15) Growth in foodgrain -0.085 -0.035 Chand, R., P. Kumar, and S. Kumar (2012), “Total Factor yield growth-Lag 2 (0.15) (0.14) Productivity and Returns to Public Investment on Agricultural Growth in Agri-GCF- 0.048* 0.030 0.084** 0.059 Lag 2 (0.03) (0.03) (0.04) (0.04) Research in India”, Agricultural Economics Research Review, Growth in cumulative 0.113* 0.153** Vol. 25, No. 2, pp. 181-194. R&D expenditure (0.06) (0.07) Growth in distribution 0.067 0.039 Chauhan, J.S, S.R. Prasad, S. Pal, P.R. Choudary and U.K. of certified quality (0.08) (0.13) seeds-Lag 1 Baskar (2016), “Seed Production of Field Crops in India: Growth in GDP per 0.463 0.392 0.185 0.043 Quality Assurance, Status, Impact and Way Forward”, Indian capita-Lag 1 (0.35) (0.36) (0.38) (0.36) Journal of Agricultural Sciences, Vol. 86, No. 5, pp. 563-579. Growth in Rural roads- 0.174 0.169* 0.069 0.069 Lag 1 (0.10) (0.09) (0.14) (0.13) Evenson, R., E. Pray, E. Carl and M.W. Rosegrant (1999), Rainfall deviation from 0.325 0.379 0.714 0.592 LPA (Dummy) (1.14) (1.11) (1.38) (1.30) “Agricultural Research and Productivity Growth in India”, Growth in irrigated area 0.991*** 0.998*** 1.032*** 1.092*** Research Report 109, International Food Policy Research (0.21) (0.19) (0.24) (0.22) Institute, Washington, DC, USA. Growth in direct agri- -0.052 -0.066 -0.039 -0.052 credit-Lag 1 (0.06) (0.06) (0.08) (0.07) Growth in labour quality 2.013 2.199 20.39 17.949 Fan, S., P. Hazell and S. Thorat (1999), “Linkages between (11.88) (11.28) (18.69) (15.02) Government Spending, Growth and Poverty in Rural India”, National Agriculture -0.603 0.194 -2.23 -1.104 Research Report 110, International Food Policy Research Policy (Dummy) (1.42) (1.64) (2.53) (2.34) Constant -4.356 -4.388 -6.29* -5.883* Institute, Washington, DC, USA. Rosegrant, M. W. (2.63) (2.55) (3.53) (3.36) N 35 35 35 35 Liu, J., M. Wang, L. Yang, S. Rahman, and S. Sriboonchitta R square 0.73 0.74 0.72 0.74 (2020), “Agricultural Productivity Growth and Its Determinants Notes: Robust Standard errors in parentheses. in South and Southeast Asian Countries”, Sustainability, *, **, *** represent statistical significance at 10, 5 and 1 per cent, respectively. Vol. 12, No. 12. 56STRUCTURAL ISSUES IN REJUVENATING GROWTH Chart III.17: Agricultural Credit in India - Size and Composition a. Credit as Per cent of GVA b. Composition of Loans 60 50 40 30 20 10 0 Source: MoA&FW, RBI Credit to Agriculture data). On the other hand, GSA increased during III.33 Credit flows to the A&A sector has the period primarily due to higher irrigation stagnated in recent years (Chart III.17). In addition, facilities and short-duration crops, consequently, the inter-state imbalance in usage of agriculture the cropping intensity13 has shown a gradual credit is also stark (Chart III.18). increase. Cropping Intensity III.34 There are two broad options to raise production: (1) increasing the Net Sown Area (NSA) under crops, which may be difficult due to the rising demand for land from the non-agriculture sector, and (2) increasing the Gross Sown Area (GSA) by increasing the cropping intensity, which is possible if farmers adopt short-duration crops and investment in irrigation infrastructure is raised by the public and private investors. Another option is to enhance investment in R&D in agriculture to develop newer high-yielding varieties (HYV) in both agriculture and horticulture crops. III.35 As regards NSA, it has declined to 139 million hectares in 2017-18 (latest available 13 Cropping Intensity = GSA/NSA * 100 57 15-0591 27-1791 47-3791 67-5791 87-7791 08-9791 28-1891 48-3891 68-5891 88-7891 09-9891 29-1991 49-3991 69-5991 89-7991 00-9991 20-1002 40-3002 60-5002 80-7002 01-9002 21-1102 41-3102 61-5102 81-7102 90 80 70 nt 60 ce 50 Per 40 30 20 10 0 Agri-CreditDisbursementas a per cent of Agri-GVA Agri-CreditOutstandingasa per centof Agri-GVA 28-1891 48-3891 68-5891 88-7891 09-9891 29-1991 49-3991 69-5991 89-7991 00-9991 20-1002 40-3002 60-5002 80-7002 01-9002 21-1102 41-3102 61-5102 nt ce Per Share of Short-term Loan Share of Long-term Loan Chart III.18: Ratio of Agriculture Credit to State GVA (average for 2015-16 to 2019-20) Source: MoA&FW, RBIREPORT ON CURRENCY AND FINANCE Chart III.19: Cropping Intensity and Irrigation Coverage Chart III.20: Skewed Development in the Appears to have Plateaued Sources of Irrigation 100 90 80 70 60 50 40 30 20 10 0 Note: For 2018-19 and 2019-20, the gross sown area has be computed summing the area under foodgrains, oilseeds, horticulture, fibre and cash crops. Source: MoA&FW. Source: MoA&FW III.36 Irrigation coverage14 has increased from Farm Input Subsidies 17 per cent in 1950-51 to nearly 49 per cent III.39 The policy approach to support the farm in 2017-18 (latest available data). However, sector in India has been to subsidise farm inputs despite this positive development, nearly half such as fertiliser, power, credit, irrigation and of the GSA continues to depend on rainfall (Chart III.19). III.37 There has also been a skewed development in the sources of irrigation. In the recent period, the share of tubewells has been increasing significantly, which has posed the challenge of groundwater depletion - a risk to sustainability of growth in the sector (Chart III.20). III.38 Paddy and wheat continue to garner the highest share in the gross irrigated area in the country. The various input subsidies and price incentives through MSP, backed by procurement, allow paddy and wheat this dominating position. (Chart III.21). 58 15-0591 45-3591 75-6591 06-9591 36-2691 66-5691 96-8691 27-1791 57-4791 87-7791 18-0891 48-3891 78-6891 09-9891 39-2991 69-5991 99-8991 20-1002 50-4002 80-7002 11-0102 41-3102 71-6102 Government Canals Private Canals Tanks Tubewells Other wells Other sources tnecreP Chart III.21: Crop-wise Share in Gross Irrigated Area Source: MoA&FW 14 Irrigation Coverage = Net Irrigated Area / Net Cropped Area *100STRUCTURAL ISSUES IN REJUVENATING GROWTH this scheme provided financial insurance to Chart III.22: Trend of Input Subsidies and Public Gross Capital Formation in Agriculture farmers suffering crop loss due to uncertain events. The program assumed significance in a 120000 16 14 country where rainfed agriculture is predominant 100000 12 80000 and where farmer’s income fluctuated due to other 10 60000 8 natural calamities such as cyclones and floods. 6 40000 The program functions on a self-selection basis 4 20000 2 and is voluntary for participation15. The scheme, 0 0 apart from smoothening farmer’s income over the years has indirectly helped financial institutions by ensuring loan repayment capacity of farmers by insulating them from production risks. The percentage of beneficiaries in the total insurers stands at 31 per cent from 2016-17 to 2019-20 so Source: MOSPI, Fertiliser Association of India, Compiled from WTO far, with the highest number of beneficiary farmers (www.wto.org). being from Maharashtra. insurance in order to increase farm production 4.2 Industry rapidly by promoting technology adoption (Ellis, III.42 As discussed in Section 2, the contribution 1992; Gulati and Sharma, 1995; Fan et al., 2007; of the industrial sector to India’s growth has not Chand and Kumar, 2004; Gulati and Narayanan, been adequate relative to its potential. Almost all 2003). constituent sectors under industry face challenges III.40 The significant share of input subsidies to that limit their contribution to growth. agriculture has squeezed space for public GCF in agriculture. Though input subsidy as a per Mining cent of agriculture GVA declined from a peak of III.43 India possesses one of the largest reserves 15 per cent in 2008-09, public GCF as a per cent of metallic, non-metallic, fuel and minor minerals. of agriculture GVA continues to hover between It produces as many as 95 minerals, including 2 per cent to 3 per cent in the last two decades four fuels, ten metallic, 23 non-metallic, three (Chart III.22). atomic, and 55 minor minerals (including building III.41 Protecting the farmer through crop and other materials) (GoI, 2021). Accounting for insurance led to the implementation of the Pradhan around 2.4 per cent of the real gross value added Mantri Fasal Bima Yojana (PMFBY) in 2016. (GVA)16, mining and quarrying contributes more Operational across all States and Union Territories, than 10 per cent of total industry output. 15 PMFBY 1.0 was not voluntary; the farmers availaing loan were covered by default under the crop insurance scheme; however, the awareness among the farmers was poor. Currently, PMFBY 2.0 has been made voluntary. 16 Mining and Quarrying accounted for 2.4 per cent share in real GVA during 2021-22 as per the second advance estimates of National Accounts released on February 28, 2022. 59 serorc` 69-5991 89-7991 00-9991 20-1002 40-3002 60-5002 80-7002 01-9002 21-1102 41-3102 61-5102 81-7102 02-9102 tnecreP InputSubsidyas aper cent of Agri-GVA(RHS) PublicGCF as aper centof Agri-GVA(RHS) IrrigationandPower Subsidy FertilizerSubsidy InsuranceSubsidy CreditSubsidyREPORT ON CURRENCY AND FINANCE Table III.1: International Trade in Ores and Minerals from 2015-16 to 2019-20 (Rupees crore) Year Exports Imports Export - Import Of which Petroleum Natural gas Imports excluding crude petroleum oil and natural gas 2015-16 170947 738788 -567841 429400 43782 265606 2016-17 200131 809445 -609314 474219 40249 294977 2017-18 199469 1028529 -829060 563098 52366 413064 2018-19 219168 1299186 -1080018 798158 73888 427140 2019-20 189683 1151530 -961847 728112 68467 354951 Source: Annual Report 2020-21, Ministry of Mines, Government of India. III.44 India has the largest coal reserves in the imports for blending with locally available mineral world and is the third largest producer of coal in raw materials and/or for manufacturing special the world. Indian coal is, however, of low calorific quality mineral-based products (Chart III.23). value with high ash content. India is the fourth III.46 Starting from 2004-05, however, the share largest producer of iron ore. The reserve stock of mining and quarrying in total GVA has reduced of iron (Magnetite) has more than doubled since almost by half, which appears to be a puzzle in 2010. Chromite reserves increased by almost 70 view of natural endowments and high dependence per cent and the reserves of Laterite increased by on annual imports (Table III.1) including in a cross- 50.1 per cent. country perspective (Chart III.24). III.45 India is self-reliant in bauxite, chromite and limestone. For magnesite, manganese ore, rock III.47 The output of three fuel minerals, viz. phosphate and lead, India still largely depends on coal, crude oil and natural gas in the eight core Chart III.23: Order of Self Sufficiency Chart III.24: GDP Size vs. Mining Share *: Apparent demand (production+ import-export). #: Including Apatite. Source: Indian Bureau of Mines. Source: CEIC; MOSPI; Staff estimates. 60STRUCTURAL ISSUES IN REJUVENATING GROWTH or more remunerative returns through better Chart III.25: Index of Coal, Crude Oil and Natural Gas Production price realisations need to be examined afresh to create an enabling environment for investments to flow in. Major Challenges and Policy Options III.48 A large number of small mines (including quarries for extracting minor minerals) and rampant illegal mining complex challenges for sustainable development. The government has taken various steps in recent years, especially in 2021-22, to address these challenges (Annex Table 2). Nevertheless, a comprehensive energy planning strategy is needed so that the country’s Source: CEIC and Office of the Economic Adviser, GoI. commitments to move towards net zero emission and related targets and the changing energy mix are dovetailed into energy security. India has set industries index is of particular relevance from a target of achieving 40 per cent of electric power the viewpoint of the country’s energy security (Chart installed capacity from non-fossil fuel sources by III.25). Crude oil production is almost stagnant at 2030 in its Nationally Determined Contribution the levels achieved in the early 1990s and, in fact, (NDC) under the Paris Agreement. At the ‘Climate has declined over the last 10-years. Natural gas Change Conference’ in Glasgow, India committed has been witnessing a secular contraction. Crude itself to one of the fastest transitions towards oil and natural gas production performance renewable sources that any country has ever largely reflects the ageing of existing fields, sand undertaken. It will require to raise the country’s ingress, and technological limitations of domestic non-fossil energy capacity to 500GW by 2030. producers. Import dependence in these three While complete coal phase out is impractical in critical minerals (for meeting domestic demand) the context of India’s energy security, it is clear pose significant spillover risks to India from that incrementally new private investments will volatility in international prices as well as from flow into renewables to tap more solar energy global supply chain constraints, as experienced and to develop grid-level storage for EV batteries during 2021-22. As new fields become operational network. by the end of 2022, some ramp up in gas production can be expected. ONGC or major private Indian Manufacturing players can partner with international majors for offshore and ultra-deep sea exploration for III.49 Nations seek to raise economic growth oil and gas fields. India has already launched through manufacturing because of at least four a Deep Ocean Mission 2021-24 with a plan to reasons. First, shifting labour from traditional, extract minerals from oceans. Price deregulation low-productivity sectors to higher-productivity 61REPORT ON CURRENCY AND FINANCE manufacturing sector can lift labour productivity Chart III.26: Growth Rate of GDP and Manufacturing (Lewis, 1955; Kaldor, 1966; Chenery et al.,1986). As productivity is higher in manufacturing than in agriculture, transferring resources from agriculture generates a ‘structural bonus.’ Second, manufacturing has the potential for productivity catch-up with the rest of the world that is often unmatched by most services. Arithmetically, this effect could be more significant when employment- intensive manufacturing expands. Third, to the extent that manufactured goods have high income elasticities of demand (higher than those of agricultural products), and are also more likely to be produced under increasing returns to scale, industrialisation sets in motion a virtuous growth Source: NAS and RBI staff estimates. cycle (Rosenstein-Rodan, 1943, Murphy et al., 1989). Fourth, as income per capita increases, lower backward and forward inter-sectoral linkages so does per capita demand for manufactured of services with manufacturing. Therefore, targeted products. If a developing country does not have policy attention to manufacturing is necessary. a strong manufacturing sector, it may face the III.51 A decomposition of manufacturing growth risk of perpetual trade deficits (Thirlwall 1979). between corporate and household sectors To cover this deficit, the economy may have to borrow or secure an equally large surplus through Chart III.27: Impact of Manufacturing over Services trade in non-manufactured goods (e.g., services, minerals, food, etc.). Either of these is challenging for a typical developing country (Felipe, 2018). III.50 In India, GDP and manufacturing display a high degree of co-movement, during the 40-year period from 1980-81 to 2020-21 (Chart III.26). The correlation coefficient between them for this period was found to be high at 0.8. Rolling regressions of manufacturing growth on services growth and vice versa (for a time window of 20- year period) suggest that manufacturing has a positive spillover effect on services growth17 (Chart III.27). In contrast, services coefficients are Source: RBI staff estimates. found to be statistically insignificant, indicating 17 The coefficient is greater than zero and statistically significant. 62STRUCTURAL ISSUES IN REJUVENATING GROWTH reveals that the slowdown is more pronounced global demand for computers, electronic and in the household sector’s output as also visible optical products, their share in industrial fixed in electricity consumption (Chart III.28). An investment remains low. In fact, in the last two analysis of investment in fixed assets and decades, the fixed investment share of this crucial employment trends from the annual survey of sector in overall industrial investment has shrunk industries (ASI) reveals that the share of the drastically. top four sectors, viz., basic metals, coal and III.53 India’s manufacturing investment base refined petroleum, chemical and chemical is also narrow. A handful of capital intensive products and other manufacturing in overall fixed industries, metal and petrochemicals, have investment is 56 per cent. Many other industries garnered the lion’s share of physical investment. which are either important from an employment Since metals and petroleum are highly procyclical generation perspective or for meeting domestic and linked to global demand conditions, India and global demand of industrial goods account is often affected by adverse price movements for a small share in fixed capital. This highlights worldwide. The narrow investment base of the importance of correcting the imbalance with manufacturing also reflect the low employment a focus on employment-intensive and export- elasticity of the sector and lower labour intensive manufacturing. productivity, leading to loss of competitiveness. III.52 Food products, textiles and wearing apparel III.54 The price of electricity charged to the provide around one-third of total employment in Indian industry is considerably higher vis-à-vis the manufacturing sector. Yet, their share in fixed other countries, which is the result of a policy of investment has exhibited a sustained decline. cross-subsidization (of agriculture and household Despite a manifold increase in domestic and consumption), leading to higher input costs in the economy. Electricity tariffs paid by the industry and commercial establishments are almost twice the Chart III.28: Electricity Consumption: Industry vs. Others rate at which it is sold by the electricity generating companies to the distribution companies. These factors act adversely on the overall competitiveness of the industry sector. III.55 Thus, in a nutshell, the industrial sector has witnessed a secular trend of stunted capital formation in not only traditional employment intensive sectors but even in the fast growing sectors, viz., computers and electronics. Importantly, all these sectors faced high demand in both domestic and global markets. Thus, it may be appropriate to conclude that the industrial slowdown in India has not occurred due to Source: CEIC. downturn in the business cycle, and hence, 63REPORT ON CURRENCY AND FINANCE Table III.2: A Broad-based Slowdown Chart III.29: Services Growth in Services Sectors 1996-2017 2017-2022 Services 7.9 4.0 Construction 7.5 3.1 Trade, hotels, transport, communication and services related to broadcasting 8.4 3.0 Financial , real estate & professional services 7.8 4.4 Public Administration, defence and other services 7.6 5.8 GVA at basic prices 6.6 3.9 Source: NAS. construction, financial services, and transport and communication services (Table III.2). The Source: NAS. slowdown is stark in transport and communication countercyclical policies alone may not be enough sub-sectors (Annex Table 3). to address the slowdown. Rather it shows a more 4.4 Construction generalised structural problem, requiring targeted III.58 Construction contributes around eight policy interventions. per cent of real GVA. It is critical to the economy for employment generation and creation of a 4.3 Services lasting asset base. Around 5.7 crore workers are III.56 Services represent a complex universe of estimated to be employed directly in construction heterogeneous activities. Since 2015-16 services activity, which has high inter-sectoral backward sector growth has been showing a distinct and forward linkages. Importantly, expenditure on deceleration (Chart III.29). construction related activities contributes almost III.57 A sector-wise breakdown reveals that half of total real gross fixed capital formation growth slowdown in services is primarily led by (GFCF)18. Table III.3: Components of Construction - Share in Output (in per cent) Year Dwellings Non-Residential Roads and Other Structures and Plantation Mineral Exploration Buildings Bridges Land Improvements 2011-12 34.3 33.5 5.4 25.4 0.1 1.3 2020-21 20.8 34.3 8.4 35.5 0.1 1.0 Source: RBI Staff estimates based on the NSO data. 18 Its share declined from 58 per cent in 2011-12 to around 48 per cent in 2019-20. 64STRUCTURAL ISSUES IN REJUVENATING GROWTH Chart III.30: Housing Sales, Launches and Pricing Chart III.31: Competitiveness Index and Infrastructure Index 160 20 18 140 16 120 14 100 12 80 10 8 60 6 40 4 20 2 0 0 Q2 Q3 Q4Q1 Q2 Q3 Q4Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2013 2014 2015 2016 2017 2018 2019 2020 2021 Source: RBI; and Prop Tiger Datalabs. Source: IMD’s World Competitiveness Index. III.59 A bifurcation of construction output (Chart III.31). India witnessed impressive growth reveals that the share of residential construction in several infrastructure sectors such as national declined to 20.1 per cent in 2019-20 from 34.3 highways, seaport capacity, and installed electricity per cent in 2011-12 (Table III.3). The count of generation capacity. However, expansion of new launches and sales of the residential units railway tracks has remained relatively subdued (apartments and villas) as surveyed in 10 major (Table III.4). cities by Prop Tiger for the past few years has slackened (Chart III.30). Table III.4: Trend of Key Infrastructure Capacity (2011=100) III.60 At the same time, the share of non- residential buildings, roads and bridges Year National Railway Cargo Electricity Highways tracks* handling installed expanded from 38.9 per cent to 49 per cent. This (Kilometers) capacity capacity decomposition reveals that growth retardation of ports (MW) (MTPA) in construction primarily emanates from the 2011 100 100 100 slowdown in residential construction. The policy- 2012 108 103 115 induced push to construction of roads and bridges 2013 112 102 127 has not been adequate to compensate for the 2014 129 103 100 140 2015 138 104 109 154 drag in the residential sector. 2016 142 106 123 170 2017 161 108 156 182 5. Structural Growth Enablers 2018 178 108 163 192 2019 187 110 170 207 5.1 Infrastructure 2020 114 180 215 III.61 Availability of high-class infrastructure *: Running Track Kilometres. Source: CEIC and Government of India. enhances the comptetiveness of an economy 65 sdnasuohT )tnecrep(htworgY-o-Y Launches Sales RBI-HousingPriceIndex (RHS)REPORT ON CURRENCY AND FINANCE Table III.5: Share of Infrastructure Sector in Table III.6: Investment in Electricity Real GVA and GFCF Infrastructure by the Public Sector (in per cent) (` crore) Share in GVA Share in GFCF Year Generation Transmission Distribution 2011-12 8.8 17.7 2015-16 78032 39389 49970 2012-13 8.9 16.9 2016-17 57794 41932 5477 2013-14 9.0 18.3 2017-18 44370 42922 16382 2014-15 9.1 14.6 2018-19 43205 39735 - 2015-16 9.1 18.7 2019-20 (Prov) 26658 - - 2016-17 8.9 17.6 Source: Annual Reports, Central Electricity Authority. 2017-18 8.9 19.5 2018-19 8.8 20.9 2019-20 8.8 18.9 III.64 A peculiarity of renewable energy is 2020-21 8.1 17.5 dependence on location and geographical Source: NAS. suitability. Hence, renewable energy sources are concentrated in a few states, with adequate sun- III. 62 By their nature, infrastructure industries lit waste, fallow land and windy areas together are capital intensive (Table III.5). Their share in accounting for 81 per cent of potential renewable aggregate capital formation increased from 17.7 energy capacity (Table III.7). per cent in 2011-12 to above 20 per cent in 2019- III.65 With rising electricity demand, keeping the 20. During the same period, their contribution to cost of power reasonable becomes paramount for the aggregate GVA remained stagnant at around long-term growth. Electricity tariffs for businesses 9 per cent. This asymmetry indicates that many are higher in India than in export competitors of these sectors may struggle to generate an such as Bangladesh, ASEAN economies, and operating surplus in a cyclical slowdown. China (Table III.8). In this context, renewable 5.2 Energy Table III.7: State-wise Estimates of Potential III.63 India has a high degree of reliance for Solar and Wind Energy on imported energy. With renewable energy States Solar Wind [Wind Power Potential emerging as an economical alternative to at 120 mtr agl (GW)] conventional energy resources and the evolution Andhra Pradesh 38.44 74.90 Gujarat 35.77 142.56 of newer technologies in the transport sector, Karnataka - 124.15 India’s imported energy dependence could shift Madhya Pradesh 61.66 15.40 to domestic sources in the long run. This could Maharashtra 64.32 98.21 Rajasthan 142.31 127.75 be promoted by rationalising investment in the Tamil Nadu 17.67 68.75 energy infrastructure. Historically, the emphasis Jammu and Kashmir 111.05 - has been more towards generation capacity vis- Uttar Pradesh 22.83 - a-vis transmission and distribution (Table III.6). Himachal Pradesh 33.84 - Odisha 25.78 - The focus however needs to gradually shift Sub-total 553.67 651.72 towards transmission and distribution, with higher Total 748.98 695.50 participation by the private entities. Source: Annual Report 2019-20, MNRE. 66STRUCTURAL ISSUES IN REJUVENATING GROWTH Table III.8: Price of Electricity for of advanced economies, viz. the UK and the US, Businesses19 (US cents per kWh) where AT&C losses are about 6-7 per cent. Economy 2015 2016 2017 2018 2019 2020 III.67 The electricity sector has a complex Bangladesh 9 9 9 9 9 10 cross-subsidisation scheme under which high Indonesia 14 14 11 11 11 11 energy-consuming customers from industry and Taiwan, China 14 14 12 11 12 12 commercial sectors subsidise consumption in Malaysia 17 15 14 13 12 12 agriculture and domestic sectors. Based on the New Zealand 14 14 13 12 12 12 experience gained so far from rationalization of Canada 13 13 16 14 13 12 petroleum product subsidies, electricity pricing France 14 14 15 14 13 14 China 14 15 14 15 16 15 may also be completely deregulated. Levy of Hong Kong, China 15 16 15 15 15 16 additional taxes/cess after deregulation must be South Africa 10 9 15 15 15 16 eschewed as it could dilute the intended benefits Mexico 17 14 7 7 12 17 of reforms. Brazil 12 16 18 15 16 18 United Kingdom 15 16 16 16 17 18 5.3 Telecommunication United States 15 15 16 17 17 18 III.68 Decrease in number of private telecom India 23 22 21 18 17 18 players, beside the one operating in the public Australia 22 21 19 17 23 20 Japan 29 26 23 22 19 21 sector, has led to an oligopolistic market structutre. Pakistan 21 19 19 19 19 22 Further, the industry suffers the burden of high Germany 29 29 27 34 32 26 debt. The declining average revenue per user in Spain 23 25 16 19 25 26 this segment is noteworthy in this context. 5G Source: Doing Business Reports, Various Rounds, World Bank. and IoT are sources of future economic growth for which a viable and strong telecom industry energy can play a vital role and depress overall is a necessity. Limited spectrum availability and tariffs. low broadband penetration in the country are two other concerns. III.66 For lowering the cost of power it is also essential to reform the electricity distribution III.69 There is a need to make India attractive for companies - closing the gap between the start-ups like Singapore or UAE by simplifying rules average cost of supply (ACS) and average and regulations. According to the Department for revenue realised (ARR) by DISCOMs (Chart Promotion of Industry and Internal Trade (DPIIT), III.32). The aggregate technical and commercial start-ups in India are also employment-intensive. (AT&C) loss or the deadweight loss - the The potential of the start-ups could be harnessed percentage of power procured by a distribution by ensuring sufficient access to funds to the sector, company for which it did not receive any payment both at the early stage of risk taking and when remains high. This contrasts with the experience they scale up, and reducing red-tapes. Delayed 19 The price of electricity is measured in U.S. cents per kWh. A monthly electricity consumption is assumed, for which a bill is then computed for a warehouse based in the largest business city of the economy for the month of March. The bill is then expressed back as a unit of kWh. The index is computed based on the methodology in the Doing Business 16-20 Studies. 67REPORT ON CURRENCY AND FINANCE Chart III.32: Revenue Gap, Transmission Losses, and Power Subsidies a. Per Unit Cost and Per Unit Revenue of Electricity b. Aggregate Technical and Commercial Losses c. Ratio of Power Subsidy to Petroleum Subsidy (per cent) 450 400 350 300 250 200 150 100 50 0 Source: Power Finance Corporation and staff estimates. enforcement of formal contracts or business in contract enforcement relative to other emerging agreements impede new investment and may countries, affecting ease of doing business also dampen foreign direct investment. India lags (Box III.4). Box III.4 Ease of Doing Business in India and Future Reforms In 2020, India improved its rank to 63rd position from 77th minority investors, paying taxes, trading across borders, position in 2019 in terms of ease of doing business (EDB) resolving insolvency, enforcing contracts, starting a among 190 countries. The broad dimensions of EDB business, and registration of property. Based on cross- are transaction costs to start and operate a business, country annual data of 93 countries from 2006 to 2019, a regulatory environment, cost of litigation, and tax structure. dynamic panel regression shows that improving the EDB Based on these dimensions, the ten parameters that are rank by one position can increase FDI inflows to GDP by used for assigning the score are dealing with construction 0.07 percentage points and real GDP growth by 0.006 permits, getting electricity, getting credit, protecting percentage points (Table 1). (Contd...) 68 01-9002 11-0102 21-1102 31-2102 41-3102 51-4102 61-5102 61-6102 81-7102 91-8102STRUCTURAL ISSUES IN REJUVENATING GROWTH Table 1: Impact of Ease of Doing Business on FDI India has taken several steps to improve the ease of doing Inflow and Economic Growth business. Dependent Variables FDI (% of GDP) Real GDP growth (cid:115)(cid:0) The “Enforcing Contracts Portal” launched on June it it 29, 2021 aims to promote ease of doing business and FDI (% of GDP) 0.184*** i,t-1 (0.0213) improve the contract enforcement regime’ in the country. Ease of Doing Business -0.0696** This will provide easy access to latest commercial cases Rank (0.0290) in the Dedicated Commercial Courts of Delhi, Mumbai, it Deposit interest rate 1.559*** Bengaluru and Kolkata. it (0.201) Real GDP growth 0.596*** (cid:115)(cid:0) The universal portal, Maadhyam, a National Single it (0.156) Window System (NSWS) to identify and apply for various Real GDP growth i,t-1 0.251*** approvals required to commence a business in India, will (0.00292) further help investors use central government licenses/ Ease of Doing Business -0.00632*** Rank (0.000541) approvals by filling a common registration form. The i,t-1 Maadhyam portal is also integrated with the State Single Lending interest rate -0.0612*** i,t-1 (0.00259) Window System (SWS) of all the participating states. Constant -1.694 4.050*** References (2.352) (0.0653) No. of Observations 1092 1092 Adepoju, U. (2017). Ease of doing business and economic AR(1) test p-value 0.0237 5.98e-08 growth. AR(2) test p-value 0.280 0.0416 Hansen test p-value 0.868 0.858 Vogiatzoglou, K. (2016). Ease of doing business and FDI inflows in ASEAN. Journal of Southeast Asian Economies, Standard errors are in parentheses. * p < 0.1, ** p < 0.05, *** p < 0.01 343–363. 5.5 Education Chart III.33: Literacy Trends III.70 Globally, efforts towards educating children suffered a major setback during the pandemic by making more than 100 million additional children fall below minimum reading proficiency levels in 202020. In India, concerted efforts are required to make further progress, with a focus on skill augmentation/upgradation (Chart III.33). III.71 It is important to recognise that rising literacy rates alone may not ensure the desired learning outcomes. Survey based results (ASER 2018) show deficiencies in quality of learning in elementary schools. The gap is also visible from Note: Gender gap is defined as difference between male and female the level of India’s gross enrollment ratio in higher literacy rate. Source: Office of the Registrar General and Census Commissioner. education relative to the developed and developing nations (Chart III.34). 20 As per United Nations progress report on SDG Goal 4, it is estimated that 101 million additional children and young people (from grades 1 to 8) fell below the minimum reading proficiency level in 2020 owing to the consequences of the pandemic, which wiped out the education gains achieved over the past 20 years. 69REPORT ON CURRENCY AND FINANCE Chart III.34: Gross Enrollment Ratio Chart III.35: Health Infrastructure - India vs. Peers 100 80 60 40 20 0 Source: Our World in Data (OWID). Source: World Health Organisation and World Bank. 5.6 Health set out in the national infrastructure pipeline (NIP) policy for the healthcare sector (Table III.9). III.72 The pandemic has brought to the fore the defiencies in the Indian healthcare system, Table III.9: Vision 2025 for the particularly the poor state of the healthcare Healthcare Sector infrastructure, falling short on most of the WHO Current Status Vision 2025 standards (Chart III.35). This has been the result Health care (cid:115)(cid:0) 1.28 per cent of GDP 2.5 per cent of GDP of meagre public expenditure (1.26 per cent of Spending (cid:115)(cid:0) Per capita spending GDP) incurred on health in India over successive - $63 decades. Immunisation Only 62 per cent children Mission Indradhanush between ages 12 and Objectives to be III.73 Close to 75 per cent of outpatient care 23 months are fully achieved immunised (cid:115)(cid:0) 90 per cent and 65 per cent of in-hospital care in India is immunisation provided in the private sector. India also has one Healthcare Expensive due to import Need to scale up India’s of the highest levels of out of pocket expenditure and dependence on medical medical devices and diagnostic devices and diagnostic diagnostic equipment (OOPE) incurred by patients among countries equipment manufacturing under “Make in India” initiative – highlighting the limited support from public expenditure and insurance. The private sector may Health care Shortage of well (cid:115)(cid:0) New Medical professionals qualified doctors and Colleges in PPP have little incentives to invest in rural/semi urban and Human support healthcare staff basis resources owing to insufficient (cid:115)(cid:0) Overall an estimated areas where the gaps in healthcare infrastructure medical colleges in the capital expenditure is more alarming. country of `1,51,019 crore (cid:115)(cid:0) Pupil teacher ratio – would be made by III.74 Recognising glaring gaps in India’s 24 both central and (cid:115)(cid:0) College per lakh states governments healthcare infrastructure, the government put in population - 28 over fiscals 2020- (cid:115)(cid:0) Medical colleges - 476 2025. place a policy framework with targeted measures Source: NIP and Niti Aayog. for implementation over the medium-term. This is 70 tnecreP 0002 1002 2002 3002 4002 5002 6002 7002 8002 9002 0102 1102 2102 3102 4102 5102 Argentina Australia Brazil China India Indonesia Netherlands Philippines Russia Thailand United Kingdom United States VietnamSTRUCTURAL ISSUES IN REJUVENATING GROWTH 6. Factor Market Impediments and Resettlement Act, 2013. The usefulness of the present Act, however, has been questioned 6.1 Land by several stakeholders, stating that it may stall III.75 Agriculture has a disproportionately high land acquisition by making the cost of land share in land available for use in economic activity, prohibitive for industry and the procedures more despite being the least productive (Table III.10). cumbersome (Yoshino et.al., 2018). An effort to Access to land is intimately tied to protecting change this law in 2015 was not successful, and property rights, and by extension, expropriation the state governments were advised to frame their procedures (OECD, 2015). Domestic legal own land acquisition laws. Gujarat, Rajasthan, frameworks must provide clarity on compensation Maharashtra, Jharkhand, and Telangana have to land owners in the event of expropriation and enacted new laws. Gujarat and Telangana have also set out the public benefit purposes for which exempted a long list of projects from social an expropriation can lawfully occur for attracting impact assessment (SIA) and mandatory long-term investment, including in infrastructure consent of landowners. They include projects of and industrial zones. national security, defence, rural infrastructure, III.76 Since independence, India has enacted affordable housing, industrial corridors, and more than a hundred land acquisition laws other infrastructural projects, including projects (Yoshino et al., 2018), including central and state under public-private partnerships (PPPs). In laws which contain provisions for land acquisition, Maharashtra, PPP projects have been fully viz., the Forest Act 1927, the Railways Act 1989, exempted from the SIA and consent clauses. Electricity Act 2003, and the Special Economic Telangana, Uttar Pradesh and Andhra Pradesh Zones Act, 2005 etc. Post-1991, land acquisition have reduced the notice period for public by the government for industrial use by the private hearings under SIA from three weeks to one sector increased significantly, leading to episodes of discontent among the public. Therefore, week. In Jharkhand, for instance, the quorum for the Land Acquisition Act (LAA) 1894 was seeking consent from the gram sabha has been replaced by the Right to Fair Compensation and reduced from half to one-third. For parity and Transparency in Land Acquisition, Rehabilitation distributional justice, however, India needs to explore laws for land pooling (Yoshino, Paul, Sarma, and Lakhia, 2018). Table III.10: Sector-wise Labour Productivity Sector Number of Real GVA GVA per Labour III.77 According to the Ministry of Statistics and employees (` crore) worker productivity Programme Implementation data, the number (in (in relative to thousands) Rupees) the national of stalled projects has increased sharply since average (%) 2018 for projects above `150 crore of investment Agriculture 196306 18,87,145 96133 36 (Chart III.36). Industry 57120 29,51,076 516645 193 Manufacturing 53124 23,26,067 437852 163 III.78 Since 2018, the share of stalled projects in Services 222448 79,05,981 355408 133 the railway sector has increased significantly (from Total 475874 127,44,203 267806 100 11 per cent in 2018 to around 25 per cent in 2019). Source: India KLEMS 2018-19. The average cost overrun per project shows an 71REPORT ON CURRENCY AND FINANCE Chart III.36: Delayed Projects a: Number of Delayed Projects b. Share of Different Sectors in Delayed Projects Source: MOSPI. increasing trend, touching a high of 31 per cent of Commission on Rural Labour (1991), National the original cost in 2020 (Chart III.37). Commission on Labour (2002) and National Commission for Enterprises in the Unorganised 6.2 Labour sector (2009) have shaped existing labour laws. III.79 Favourable demographies and the large As a concurrent list subject, both the Central pool of excess labour absorbed into agriculture and State Governments have powers to make require industry friendly labour reforms to labour legislations. In 2019, the Ministry of harness their potential as growth drivers of the Labour introduced four labour bills to consolidate future. Over the years, recommendations of the existing 29 labour laws. These bills relate various Committees on labour such as the First to (1) industrial relations; (2) minimum wages; National Commission on Labour (1969), National (3) social security; and (4) occupational safety, Chart: III.37: Cost Overrun of Delayed Projects a. Cost Overrun of Delayed Projects b. Percentage Increase in Cost Overrun to the Original Estimate Source: MOSPI. 72STRUCTURAL ISSUES IN REJUVENATING GROWTH health and working conditions. All labour codes Chart III.38: Labour Force Participation Rate 2019-20 have been passed by the Parliament and will be implemented from the fiscal year 2022-23. III.80 The code on minimum wages ensure that the employers pay minimum wages to their employees. The industrial relations code provides that if a firm employed more than 100 employees at any point of time in the past 12 months, it must constitute a works committee comprising members from both the employer and employees with the responsibility of nurturing amicable relationship between the employer and employees. Firms employing more than 20 workers need to have more than one grievance redressal committees to resolve issues of Source: PLFS 2019-20. individual employees. simplify the process of labor administration (filling III.81 The labour code on social security of one return, one license and one registration). envisages strengthening social security for labour Collectively these reforms, when implemented, through employees’ provident fund, state insurance will improve flexibility in India’s labor markets. corporations, medical benefit committee, and the national social security board that will recommend 6.2.1 Labour Participation schemes to unorganised workers. The code on occupational safety, health and working conditions III.83 As per the Periodic Labour Force Survey requires every employer to ensure that the (PLFS), around 42 per cent of the population occupational place is free of hazards. forms the labour force. India has one of the lowest Labour Force Participation Rate (LFPR) among III.82 Apart from benefiting the workers, these the major economies, partly due to very low female labor codes may also be beneficial for industry. LFPR (22 per cent) (WDI,World Bank), especially The inclusion of fixed term employment will among poorer states (Chart III.38). provide flexibility to firms to hire workers according to the changing economic environment. At the III.84 The prevalence of high informal same time, these codes may streamline the employment is a major challenge with 71 per process of settlement of labor disputes; envisage cent of the total employed labour force being a time bound and hassle free resolution of labor ‘self-employed’ (Chart III.39). Seventy seven per disputes; create enabling conditions for collective cent of the self employed enterprises are small bargaining between the firm and workers; and enterprises with less than six workers. 73REPORT ON CURRENCY AND FINANCE Chart III.39: High Self-Employment Chart III.41: Low Level of Job Training Proprietary(Self-employed) Government/Local Body PSU Automonous Bodies Public/PrivateLtd.Company Coperative Society Non-Profit Organisation EmployerHousehold Others Source: PLFS 2019-20. Source: PLFS 2019-20. III.85 Seventy nine per cent of the working III.87 Twenty eight per cent of the population population do not have a written job contract in is illiterate and another 26 per cent have their usual principal activity (Chart III.40). received only primary school education (PLFS, 2019-20). Only nine per cent of the population III.86 Seventy eight per cent of the working possesses a graduate/post graduate degree in population in India have not received any type of India (Chart III.42). job training (PLFS, 2019-20) (Chart III.41). Chart III.40: Job Quality - Status of Written Job Contract Chart III.42: Education Profile of India Source: PLFS 2019-20. Source: PLFS 2019-20. 74STRUCTURAL ISSUES IN REJUVENATING GROWTH 7. Conclusion III.91 These reforms need to be augmented by other measures to reverse the sustained decline III.88 The Indian economy was riddled with in private investment and low productivity in the several structural impediments to growth even economy. What is needed include access to before the outbreak of COVID-19 which had litigation free low cost land; raising the quality of dampened the investment outlook. COVID induced labour through large scale expansion of public supply disruptions and potential hyteresis effects expenditure on education and health and the skill have imposed testing challenges. Addressing India mission; reducing the cost of capital for industry these structural constraints has become central and improve resource allocation in the economy to reviving and reconstructing the Indian economy by promoting competition; encouraging industries from the ravages of the pandemic. and corporates to scale up R&D activities with an III.89 The agriculture sector suffers from emphasis on innovation and technology; creating low capital formation, declining R&D, low crop an enabling environment for startups and unicorns; yields, inadequate crop diversity and intensity, encouraging corporate investment in agriculture; with excessive dependence on subsidies and addressing the challenges faced by the debt-ridden price support schemes. India’s dependence on telecom industry and DISCOMs; rationalisation of imports of minerals, depleted natural endowment subsidies that promote inefficiencies; encouraging is another drag. In manufacturing, a few capital- urban agglomerations by improving the housing intensive industries have garnered the lion’s share and physical infrastructure. of physical investment, whereas the investment III.92 While aiming to boost India’s participation share of employment generating industries and in global value chains (GVCs) and raise export high-demand electronics and computer industries competitiveness, greater adoption of technology has either stagnated or contracted over the years. assumes critical importance. The reform package In the service sector, growth slowdown was of the future hinges around (i) an ecosystem that primarily led by construction, financial services, increases the adaptability of domestic firms to and transport and communication services, due state-of-the-art technology; (ii) ensuring policy to prevalence of many sector-specific problems as certainty on royalty payments for technology discussed in this chapter. transfer by foreign companies; (iii) improving domestic R&D infrastructure for innovations. The III.90 Recognising the need for urgent and bold industrial revolution 4.0 and committed transition to structural reforms, the Government has announced net zero emission target will create new investment privatisation and asset monetisation; tax reforms opportunities requiring greater policy emphasis on (GST and corporate tax rationalisation); targeted technology and green financing. The next wave sector-specific incentives to raise production and of global structural transformation is likely to be exports under the production linked incentive (PLI) powered by both technology and environmentally scheme; insolvency and bankruptcy code (IBC) to sustainable production processes. improve the credit culture and resource allocation mechanism; labour reforms (four codes); and a III.93 A comprehensive plan is necessary to fiscal policy focus on capex and infrastructure. revive the rural economy of the country alongside 75REPORT ON CURRENCY AND FINANCE the existing several other policy measures disputes). Unless the structural impediments (Annex - I). Organising farmers’ clubs or agricultural are addressed, these reforms may become cooperatives is a possible solution to correct the unsustainable. Building on “Start-up India, Stand- pricing imbalances by reducing gaps between up India”, the policy ecosystem for the startups farm gate prices and retail prices. In this regard, needs a dynamic framework with provision for the development of a modern supply chain adequate access to risk capital and globally infrastructure needs priority attention. competitive environment for doing business. The textile industry has a special place in the Indian III.94 Farmers are still dependent on money industrial landscape owing to its labour intensive lenders. There is a need to adopt a viable ‘whole nature, particularly employment of women in the of business’ approach covering all aspects of sector. For enhancing female labour participation farming. Developing numerous small-scale and the associated scope to raise output, greater irrigation projects as well as using wind energy support to the textile sector is necessary. to lift water from bore wells as implemented in many western African countries can be replicated III.96 The National Infrastructure Pipeline (NIP) in India’s drought prone areas. India is one of the through public-private partnerships would require most vulnerable countries to extreme weather a strategy for meeting the financing requirement, events in the world21. According to the India given limited domestic financial savings and Meteorological Department, the occurrence of sustainable levels of capital flows. extreme weather events like floods, cyclones, III.97 Labour reform with flexibility to hire and fire heat waves and droughts has increased in both workers can allow firms to adjust their workforce frequency and intensity. Furthermore, the average according to economic cycles, thereby enabling temperature has increased by 1.8 degrees Celsius them to use their resources more efficiently. This, between 1997 and 2019 as against an increase however, could come only at the cost of lower of 0.5 degrees Celsius between 1901 and 2000. welfare/social security of the workers. One option Similarly, the fall in groundwater level in Punjab, here could be to build an unemployment insurance Haryana and Madhya Pradesh has exceeded the fund during periods of economic boom at the firm annual recharging levels. level, which can be utilized to financially support III.95 Apart from measures already taken workers up to a limited period after retrenchment. (Annex Table 3), the production linked incentives Further, many of the social security measures (PLI) scheme recognises growth opportunities apply to firms having a certain minimum number in 14 key manufacturing sectors of the economy. of workers, which creates incentives for firms The incentives, however, effectively compensate to not scale up. To address this issue, a policy industries for domestic structural impediments option could be universal access to social security (ranging from access to litigation free land, irrespective of firm size, with each firm required to high cost of electricity tariff, inefficient domestic earmark a certain percentage of their profit for the supply chain, high cost of logistics and settlement social security schemes for the workers. 21 Climate Risk Index for 1998-2017, German Watch. 76STRUCTURAL ISSUES IN REJUVENATING GROWTH References Chenery, H.B., S. Robinson, M. Syrquin and S. Feder (1986), Industrialization and growth, New Akber, N. and K. R. Paltasingh (2019), York: Oxford University Press, pp. 175. “Investment, Subsidy and Productivity in Indian Agriculture: An Empirical Analysis”, Agricultural Dieppe, A (2021), “Global Productivity: Trends, Economics Research Review, Vol. 32, No. 3, pp. Drivers, and Policies’, Washington, DC: World 13-25. Bank. Alfaro, L. and A. 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Framework for Asia”, ADBI Working Paper No. 854, Asian Development Bank Institute, United Nations Industrial Development Japan. Organization, (2017), Annual Report. 79REPORT ON CURRENCY AND FINANCE Annex – I: List of Measures for Agriculture (cid:115)(cid:0) (cid:52)(cid:72)(cid:69)(cid:0) (cid:45)(cid:73)(cid:78)(cid:73)(cid:83)(cid:84)(cid:82)(cid:89)(cid:0) (cid:79)(cid:70)(cid:0) (cid:33)(cid:71)(cid:82)(cid:73)(cid:67)(cid:85)(cid:76)(cid:84)(cid:85)(cid:82)(cid:69)(cid:0) (cid:65)(cid:78)(cid:68)(cid:0) (cid:38)(cid:65)(cid:82)(cid:77)(cid:69)(cid:82)(cid:83)(cid:0) Spectrophotometer, Thermal imaging system, Welfare, Government of India and the Psychrometric chambers etc. have been Indian Council of Agricultural Research established at various ICAR institutes to (ICAR), launched a network project 'National facilitate the climate change research. The Innovations in Climate Resilient Agriculture' construction and operation of psychometric (NICRA) in 2011. The project aims at strategic chambers have been undertaken for studying research on adaptation and mitigation; the effect of different environmental conditions demonstration of technologies on farmers' viz., temperature, humidity, and air movement fields; and creating awareness among on livestock, with special reference to farmers and other stakeholders to minimise cattle and buffaloes, environmental growth the climatic change impacts on agriculture. chambers with CO and temperature controls 2 The main thrust areas covered for strategic and a special calorimetric system to study research are (i) identifying the most vulnerable livestock response to heat stress. Custom districts/regions; (ii) evolving crop varieties hiring centres (CHCs) have been established and management practices for adaptation and in 121 NICRA villages to ensure the availability mitigation; and (iii) assessing climate change of farm implements for timely operations. impact on livestock, fisheries and poultry and (cid:115)(cid:0) (cid:52)(cid:72)(cid:69)(cid:0)(cid:46)(cid:65)(cid:84)(cid:73)(cid:79)(cid:78)(cid:65)(cid:76)(cid:0)(cid:33)(cid:71)(cid:82)(cid:73)(cid:67)(cid:85)(cid:76)(cid:84)(cid:85)(cid:82)(cid:65)(cid:76)(cid:0)(cid:50)(cid:69)(cid:83)(cid:69)(cid:65)(cid:82)(cid:67)(cid:72)(cid:0)(cid:51)(cid:89)(cid:83)(cid:84)(cid:69)(cid:77)(cid:0) identifying adaptation strategies. (NARS) under the aegis of Indian Council of So far, seven climate resilient varieties and Agricultural Research (ICAR) comprising of 650 district agricultural contingency plans ICAR Institutes and State/Central Agricultural have been developed besides assessing the Universities are involved in the development risk and vulnerability of Indian agriculture to of new high yielding and biotic/abiotic stress climate change. Location specific technologies tolerant crop varieties of field and horticultural have been demonstrated in 151 climatically crops. During the last 3 years (2018-2020) and vulnerable districts. in the current year, 1,017 new varieties of 69 field crops and 206 varieties of 58 horticultural State-of-the-art infrastructure facilities have crops have been developed. been established by ICAR in the National Agricultural Research and Education System (cid:115)(cid:0) (cid:52)(cid:72)(cid:69)(cid:0)(cid:39)(cid:79)(cid:86)(cid:69)(cid:82)(cid:78)(cid:77)(cid:69)(cid:78)(cid:84)(cid:0)(cid:79)(cid:70)(cid:0)(cid:41)(cid:78)(cid:68)(cid:73)(cid:65)(cid:0)(cid:72)(cid:65)(cid:83)(cid:0)(cid:66)(cid:69)(cid:69)(cid:78)(cid:0)(cid:80)(cid:82)(cid:79)(cid:77)(cid:79)(cid:84)(cid:73)(cid:78)(cid:71)(cid:0) (NARES) across the country to facilitate organic farming through dedicated schemes of climate change research. Unique infrastructure Paramparagat Krishi Vikas Yojana (PKVY) and facilities viz. High Throughput Plant Mission Organic Value Chain Development Phenomics, Free Air Temperature Enrichment in the North East Region (MOVCDNER). Facility (FATE), Free Air CO2 Enrichment Farmers are provided financial assistance Facility (FACE), CO2 Temperature Gradient (`31000/ ha / 3 years in PKVY and `32500/ ha/ Chambers (CTGC), Gas Chromatography, 3years under MOVCDNER) for organic inputs Atomic Absorption Spectrophotometers, including seeds, bio-fertilisers, bio-pesticides, Environmental Growth Chamber, UV-VIS organic manure, compost/vermicompost and 80STRUCTURAL ISSUES IN REJUVENATING GROWTH botanical extracts. In addition, support is Pusa Decomposer. In addition, ICAR – IARI also provided for group/ Farmers Producers has produced about 20000 packets of Pusa Organization (FPO) formation, training, decomposer at its facility for use by the certification, value addition and marketing farmers. of their organic produce. Organic cultivation (cid:115)(cid:0) (cid:52)(cid:72)(cid:69)(cid:0)(cid:39)(cid:79)(cid:86)(cid:69)(cid:82)(cid:78)(cid:77)(cid:69)(cid:78)(cid:84)(cid:0)(cid:79)(cid:70)(cid:0)(cid:41)(cid:78)(cid:68)(cid:73)(cid:65)(cid:0)(cid:72)(cid:65)(cid:83)(cid:0)(cid:77)(cid:65)(cid:68)(cid:69)(cid:0)(cid:65)(cid:0)(cid:80)(cid:82)(cid:79)(cid:86)(cid:73)(cid:83)(cid:73)(cid:79)(cid:78)(cid:0) on either side of the River Ganga, natural for the opening of one Krishi Vigyan Kendra farming, large area certification and support for (KVK) in each of the rural districts across individual farmers have also been introduced the country. A total of 725 KVKs have been under PKVY to increase organic production. established across the country to date. The (cid:115)(cid:0) (cid:34)(cid:85)(cid:82)(cid:78)(cid:73)(cid:78)(cid:71)(cid:0) (cid:79)(cid:70)(cid:0) (cid:35)(cid:82)(cid:79)(cid:80)(cid:0) (cid:82)(cid:69)(cid:83)(cid:73)(cid:68)(cid:85)(cid:69)(cid:0) (cid:76)(cid:69)(cid:65)(cid:68)(cid:73)(cid:78)(cid:71)(cid:0) (cid:84)(cid:79)(cid:0) (cid:72)(cid:73)(cid:71)(cid:72)(cid:69)(cid:82)(cid:0) KVKs are mandated for frontline extension air pollution and health hazards has been a which act as a bridge between research contentious issue within/between the States. organisations and the main extension The 'Pusa Decomposer Technology' is a system operated by different development new low-cost capsule technology developed departments of the State Governments. by the ICAR - Indian Agriculture Research Considering the role and resources of a KVK, Institute (IARI), New Delhi for crop residue it caters to the requirement of the selected management. In coordination with the State farmers of the district and provides capacity Governments, the Government of India has development support to State Development made multiple efforts to demonstrate this Departments. technology for crop residue management (cid:115)(cid:0) (cid:52)(cid:72)(cid:69)(cid:0) (cid:39)(cid:79)(cid:86)(cid:69)(cid:82)(cid:78)(cid:77)(cid:69)(cid:78)(cid:84)(cid:0) (cid:79)(cid:70)(cid:0) (cid:41)(cid:78)(cid:68)(cid:73)(cid:65)(cid:0) (cid:72)(cid:65)(cid:83)(cid:0) (cid:76)(cid:65)(cid:85)(cid:78)(cid:67)(cid:72)(cid:69)(cid:68)(cid:0) across the country. the Agriculture Infrastructure Fund (AIF) During 2020-21, the Pusa Decomposer was scheme to mobilise a medium - long term provided for 5730 ha area comprising of Uttar debt financing facility for investment in viable Pradesh (3700 ha), Punjab (200 ha), Delhi projects for post-harvest management (PHM) (800 ha), West Bengal (510 ha), Telangana Infrastructure and community farming assets (100 ha); Confederation of Indian Industry (CFAs) through incentives and financial (100 ha) and NGO and Farmers (320 ha). support to improve agriculture infrastructure In-situ application of Pusa decomposer in the country. This financing facility will also on paddy residue was demonstrated at help APMCs to upgrade their Infrastructure, farmers' fields in several villages of Punjab which will ultimately benefit the farmers. and Haryana. A slogan of "jalana nahi, galana The scheme provides financial assistance hai" was publicised among the farmers. In in interest subvention and credit guarantee addition, regular interactive sessions with for setting PHM projects, which will help farmers through online meetings, Webinars, better post-harvest management and reduce and messaging Apps have been conducted wastage. Further, the following CFA projects to make them aware of this technology and are eligible under the scheme: (1) Organic to wean them away from burning. The IARI inputs production, (2) Biostimulant production has licensed this technology to 12 companies units, (3) Infrastructure for smart and for mass multiplication and marketing of the precision agriculture, (4) Projects identified 81REPORT ON CURRENCY AND FINANCE for providing supply chain infrastructure for Greenhouse gas emissions and the associated clusters of crops including export clusters, climate change risks pose new concerns for (5) Projects promoted by Central/State/Local the sector which include lower yields, weed Governments or their agencies under Public- and pest proliferation and large crop losses, Private Partnerships (PPP) for building CFAs the frequency of which could even endanger or PHM projects. national food security. 82STRUCTURAL ISSUES IN REJUVENATING GROWTH Annex Table 1: Major Policy Reforms in the Agriculture and Allied Sectors Policy Objective Expected Outcome Agriculture Infrastructure Fund For financing infrastructure at Better management and realization the farm gate as well as at other of remunerative prices for agricultural aggregation points of agricultural produce. Reduction of post-harvest produce. loss and middlemen network. Scheme for Formalisation of Micro Improving quality standards and Increased marketing opportunities Food Enterprises (MFEs) production practices of MFEs. for the MFE units leading to higher growth. Pradhan Mantri Fasal Bima Yojana To provide protection to farmers Smoothen farmers’ income over the (PMFBY) through crop insurance. years. Indirectly helps the financial institutions by ensuring the loan repayment capacity of farmers. The Digital India Land Records To build an all-encompassing Help farmers and small business men Modernisation Programme and transparent land record access finance from formal financial management system. institutions using proper land titles. Multiplier effect on growth. Kisan Rail Services (KRS) To reduce time taken to transport Increases the marketing opportunities the perishable agricultural produce available to farmers though quality from the production centres to and less expensive transportation of consumption centres and to keep agricultural produce. them fresh for a longer time through cold storage transport. Animal Husbandry Infrastructure Incentivize the investment in Will provide integrated market for Development Fund (AHIDF) dairy production and processing the unorganised producers of meat industries, and meat production and milk and ensure quality products and processing industries in rural for the consumers. Stabilize the areas of the country. prices of these products through the integrated production, processing and marketing. Blue revolution To increase fish production, Better employment and income productivity and creation of prospects in the fisheries sector. adequate infrastructure. Fisheries and Aquaculture Development of infrastructure in Better employment and income Infrastructure Development Fund the fisheries sector. prospects in the fisheries sector. (FIDF) Pradhan Mantri Matsya Sampada To enhance the fisheries sector Higher production and productivity in Yojana (PMMSY) production. the fisheries sector. 83REPORT ON CURRENCY AND FINANCE Policy Objective Expected Outcome Agriculture Export Policy (AEP) Promotion of export-oriented Farmers get benefit of export production with focus on exportable opportunities in overseas markets. crops. Mission for Integrated Development Capacity building of farmers and Holistic growth of the horticulture of Horticulture (MIDH) technicians. sector. Horticulture Cluster Development Address the concerns of the Geographical specialisation of Programme (HCDP) horticulture value chain. Reduce horticulture clusters making them harvest and post-harvest globally competitive. losses. introduction of innovative technologies and practices. Build the capacity of stakeholders. 84STRUCTURAL ISSUES IN REJUVENATING GROWTH Annex Table 2: Major Policy Reforms in the Industrial Sectors Policy Objective Expected Outcome National Steel Policy To attain self-sufficiency in steel Higher economic growth by production and to make India a net exploiting the competitive advantage exporter of steel by 2025-26. in steel production. National Mineral Policy To increase transparency, better Sustainable mining sector regulation and enforcement, development. Addresses the balanced social and economic concerns of persons affected by growth and promotion of sustainable mining. mining practices. Mineral (Auction) Second End captive mining. More participation in the mining Amendment Rules, 2021 and the industry and a healthy and Minerals (Evidence of Mineral competitive bidding process in the Contents) Amendment Rules, 2021 mining industry. Amendments in the Mines and Improve transparency and efficiency Bridge the gap between domestic Minerals (Development and in the management of coals through demand and supply of coal. Boost Regulation) (MMDR) Act commercial auctions. production in other sectors such as steel, aluminium, fertilizer and cement. Oil Sector - Hydrocarbon Exploration To bring more transparency in the Higher production and contribution and Licensing Policy (HELP) oil sector licensing procedures. to economic growth in the long run. Oil Sector - Open Acreage Licensing Incentivises companies to take Increase in the acreage under policy (OALP) up oil exploration. Freedom for oil exploration leading to higher companies to carve out own areas production. for exploration and declare it to the GoI at any time of the year. Petroleum and natural gas industry Move towards uniform pipeline Would stop the pricing discrimination - Gas Pricing Reforms pricing. based on the distance from the production locations. Integrated Power Development Strengthen the transmission and Increase the customer satisfaction Scheme (IPDS) distribution networks, IT-enabling and improve the reliability of power of the distribution network for supply. all statutory towns, additional incentives for performing UDAY states, solar panels on government buildings, and schemes for enterprise resource planning (ERP), among others. 85REPORT ON CURRENCY AND FINANCE Policy Objective Expected Outcome National Renewable Energy Policy Produce more electricity through Higher electricity production. Higher (NREP) renewable energy sources. economic growth in the long run. MSME reforms - Emergency credit Support the growth momentum in Higher growth in the long run. line, subordinated debt for stressed the sector. MSMEs, MSME funds of funds for equity infusion. Revised the definition of MSME’s To address the concern of many Suports MSME growth. investment limit. successful MSMEs to grow more regarding the loss of special status and incentives. MSME Sector - Disallowed global To provide a boost to the MSME Higher marketing opportunities for tenders up to `200 crores sector. the sector E-market linkage for MSMEs Higher marketing opportunities. Higher income The enhancement of minimum Beneficial to most of the MSMEs as Higher and sustainable growth in threshold for initiation of insolvency they would fall below this threshold. the MSME sector. proceedings under the Insolvency and Bankruptcy Codes (IBC) from `1 lakh to `1 crore. The integrated textile parks Set up infrastructure of international Attract foreign investment. standard in the sector. SAMARTH (Scheme for Capacity Skill development in the sector Higher growth in the long run. Building in Textile sector). “Start-up India, Stand-up India” To encourage start-ups in India Higher growth in the long run. Start-ups Intellectual Property Help start-ups to take help from Facilitate the growth of start-ups. Protection (SIPP) scheme. empanelled facilitators to file and prosecute their application without any charge, fund of funds for start- ups to increase investment, income tax exemptions on a case to case basis, and the start-ups have also been provided with rebate on patent filing fees and trade mark filing fees. Production Linked Incentives To enhance manufacturing, promote Higher economic growth Scheme manufacturing exports and generate employment opportunities. 86STRUCTURAL ISSUES IN REJUVENATING GROWTH Annex Table 3: Movement of key services indicators (Growth rate in per cent) Construction Transport Trade Financial services Telecommunication Steel Registered IT firms Year Cement Registered com- Rail Rail Aviation Aviation Port Sales revenue Bank Bank Telephone Internet Consump- produc- motor ve- mercial passenger freight passenger cargo cargo tax growth deposit credit subscribers subscribers tion tion hicle vehicles 1998-99 6 8 1 6 -2 1 -1 -1 9 52 20 14 22 1999-00 14 9 6 7 6 6 14 16 18 40 17 20 26 2000-01 -1 13 9 6 0 8 6 10 22 46 17 19 27 2001-02 7 7 1 7 3 -5 1 4 5 12 14 23 24 2002-03 9 14 17 5 2 9 15 9 12 17 13 14 21 2003-04 6 9 7 5 -2 11 9 11 13 27 16 17 40 2004-05 7 12 9 6 5 22 20 12 20 53 17 33 29 2005-06 12 10 10 7 3 24 10 11 10 31 18 32 43 2006-07 9 8 19 13 5 31 10 12 19 38 25 31 47 2007-08 11 8 9 9 11 7 21 11 11 13 23 23 25 45 2008-09 0 7 9 7 9 5 -7 -1 3 14 22 22 21 43 2009-10 13 11 11 6 8 5 14 15 14 11 1 17 17 45 2010-11 12 5 11 9 8 3 16 20 4 26 15 18 23 36 2011-12 7 7 12 8 7 6 13 -3 3 24 24 15 18 12 2012-13 3 7 10 8 5 3 -2 -4 2 17 16 15 16 -6 2013-14 1 4 8 5 6 4 6 4 4 12 23 15 15 4 2014-15 4 6 10 7 -1 -4 13 11 8 9 10 11 10 7 20 2015-16 6 5 10 8 0 -2 18 7 2 7 19 7 7 6 13 2016-17 3 -1 10 6 1 -1 18 10 6 11 11 10 3 13 23 2017-18 8 6 10 7 2 1 17 13 7 -32 7 6 8 1 17 2018-19 9 13 9 7 -2 5 12 6 6 -28 13 9 11 -2 29 2019-20 1 -1 8 -9 -4 -1 -7 1 8 10 8 6 0 17 2020-21 -5 -11 9 0 -66 -26 -5 10 4 12 5 2 11 Source: CMIE Economic Outlook and CEIC. 87REPORT ON CURRENCY AND FINANCE Annex Table 4: Major policy Reforms in the Services Sectors Policy Objective Expected Outcome The National Intellectual Put in place an appropriate legal system Promotion of entrepreneurship and Property Rights (IPR) for handling the IPRs, creating awareness start-ups for economic growth. policy. about IPRs, encouraging IPRs, commercialization of IPRs, preventing IPR infringements, among others. The Real Estate Regulation To bring in more transparency and equity Protects the interests of the home and Development Act in the real estate transactions. buyers. Ease stress and increase (RERA). investment in the real estate sector. IT-BPM industry - Reduction in the compliance burden of Opens opportunities for the global Relaxation of OSP Terms & business process outsourcing companies. companies to invest in India. Bring Conditions, and Consumer in more women and physically Protection (E-commerce) handicapped persons into the labor Rules, 2020. force. Sagarmaala Programme Reduce the cost of transportation for Opportunities for economic growth and foreign and domestic trade. development. The National Waterways Identified more than hundred waterways Facilitation of domestic trade. Act, 2016. to improve the inland water transport. The National Civil Aviation To connect the underserved airports with Fast connectivity to global cities from Policy 2016. major airports in India at a relatively lower various places in India and domestic cost by subsidising the airlines. outreach to far off places. Affordable air travel for the common masses and balanced regional development. ‘National Rail Plan (NRP)’ Set of forward looking measures aimed at Aims at preparing the railways ahead Vision 2024. creating capacity with a view to increasing of the realisation of actual demand. the share of freight traffic to 45%. The National Digital Universal coverage of the population Accelerate economic growth and Communications Policy through the digital modes. prepare the economy for next (NDCP) 2018. generation developments and reforms. ‘Bharatnet’ initiative Connect 600,000 villages through Accelerate economic growth and broadband. prepare the economy for next generation developments and reforms. Tourism - Liberalized Visa Increase the number of countries’ citizens To boost the tourist arrivals to India. Regime who can enter India with a valid e-visa. National Infrastructure Structural reforms across 34 sub-sectors Boost the infrastructure development Pipeline (NIP) and more than 9000 infrastructure across several sectors of the economy. projects. 88HARNESSING OPEN ECONOMY IV VISTAS FOR FASTER GROWTH Exports and foreign capital are the twin engines of growth in an open economy. Post-COVID, a strategic policy reset in India can help harness these growth opportunities. Based on empirical assessment of constraints to export growth, this Chapter finds that India has revealed comparative advantage (RCA) in certain export categories; past free trade agreements (FTAs) have not been trade creating; without higher import and technology-intensity of exports, raising India’s participation in global value chain may be difficult; and exchange rate stability helps promote exports. While the Production Linked Incentive (PLI) Scheme can incentivise effective diversification of the export basket, it needs to emphasise global quality benchmarks, including carbon emission standards, to be able to harness green export opportunities and to achieve ambitious exports target of US$1 trillion by 2030. Ongoing and future FTAs may need to prioritise transfer of technology and easier access to critical intermediate inputs to widen the basket of items where India can build its RCA. Greater openness to imports at lower tariff and non-tariff restrictions and FDI can not only boost exports but also enhance the capacity to absorb foreign capital. 1. Introduction post-pandemic years, exploiting opportunities opening up via greater participation in GVCs, a IV.1 For an open economy, trade and financial focus on services exports and strategic trade integration, including through global value integration through free trade agreements (Das, chains (GVCs), can generate strong impulses 2020). The Chapter also explores the role of of economic growth, supported by a congenial strategic policies in addressing challenges and domestic policy environment. The COVID-19 harnessing opportunities. pandemic disrupted global supply chains, IV.3 The absorptive capacity of the economy shipping and logistics, which persist even today. in respect of capital flows can also influence the Global trade volume (of goods and services) growth outlook of an emerging market economy contracted by 7.9 per cent in 2020. In 2021, and hence their size and composition matters. as world trade (goods and services) staged a Accordingly, the chapter attempts to evaluate robust recovery from the deep contraction in the growth enhancing effects of foreign capital, 2020, India’s merchandise exports also regained especially FDI, and policies for attracting growth momentum from pandemic lows, registering a capital. Section 2 focuses on India’s export growth of 43.8 per cent in 2021-22 and by 33.9 competitiveness, drilling down to sectors with per cent over pre-pandemic level. Imports too cutting edge and identifies areas for adoption of revived and surged as domestic demand picked- frontier technologies that can potentially enhance up steam. India’s participation in GVCs and raise exports. IV.2 The theme of this chapter is the Section 3 evaluates Aatmanirbhar Bharat, sustainability of this rebound in exports as the particularly the role of imports in boosting exports. Indian economy revives and reconstructs in the Section 4 examines the role of capital flows in This chapter has been prepared by Rajeev Jain, Dhirendra Gajbhiye, Rakesh Arya, Soumya Suvra Bhadury, Bhanu Pratap, Satadru Das and Abhishek Ranjan. Authors express their gratitude to Dr. Michael Debabrata Patra for his comments. 89REPORT ON CURRENCY AND FINANCE financing domestic growth and exchange rate demand, allowing all other components of effects. Section 5 summarises the findings and aggregate demand, viz., consumption, investment, presents policy options. and government expenditure to expand and break through the limits to growth that a foreign 2. Trade Openness, Export Competitiveness exchange constrained developing economy and Growth typically encounters in the early and intermediate IV.4 A virtuous model of economic growth stages of development. This model essentially tracks the interrelationship between exports and operationalises Harrod’s super trade multiplier in growth by boosting productivity through increasing an open economy context. In the case of India, it is returns to scale, which makes the growth process estimated that a sharp fall in the income elasticity ‘circular’ and ‘cumulative’ (Verdoorn, 1949; Kaldor, of imports improved the contribution of net exports 1966). Exports ease an important impediment to to GDP growth during 2013-14 to 2020-21 despite import purchasing power and thereby domestic a moderation in export growth (Box IV.1). Box IV.1 Dynamic Foreign Trade Multiplier of India The model of balance of payments constrained growth Table 1: Income Elasticity of Imports (Thirlwall, 1979; 2013) views demand as the central force Period Income Elasticity of Imports behind growth, productivity, factor accumulation and other structural changes. Thirlwall’s law posits that a high income Period 1: 2000Q1 to 2007Q4 2.25** elasticity of import is a binding constraint on an export-led Period 2: 2009Q1 to 2019Q4 0.60** Full Sample: 2000Q1 to 2019Q4 1.0 ** growth strategy. Unlike the static foreign trade multiplier (FTM), which measures the response of GDP to change Note: Statistically significant at 5 per cent. in exports through the marginal propensity to import, the dynamic analogue of the Harrod trade multiplier takes rising trade protectionism (both in India and world), weaker into account changes in import and export intensity of an demand conditions for India’s exports, and policies for economy in identifying the maximum growth rate consistent securing domestic supply chains may have contributed with balance of payments equilibrium, which can be to the decline in import elasticity. Despite average export growth moderating sharply during 2013-14 to 2020-21, expressed as: India’s FTM has improved on the back of a sharp decline in the income elasticity of imports (Chart 1). The deceleration where g is the GDP growth rate, x is export volume growth and is the income elasticity of imports. Export growth, in turn, depends on the income elasticity of exports ( ) and Chart 1: Export Growth and Income Elasticity of Imports world income (w). From a macroeconomic perspective, if 25 21.1 the income elasticity of demand for imports exceeds unity, 20 exports must grow faster than overall output to support 16.1 16.8 growth on a sustainable basis. 15 A cointegration and vector error correction model is used 10 9.2 on quarterly data from 2000Q1 to 2019Q4 (the pre-COVID period) for estimating the peace-time FTM for India, the 5 3.5 3.1 choice of the period being governed by availability of data. 1.8 1.6 1.6 0.5 Estimates are also generated separately for the pre-GFC 0 2000-01to 2005-06to 2009-10to 2013-14to 2021-22 and post-GFC periods to ascertain any structural shift in the 2004-05 2008-09 2012-13 2020-21 imports-GDP relationship following a major shock. Note: Income elasticity based on annual changes in imports and GDP has The estimated results show that the income elasticity been used. Source: Authors’ calculations. of imports has come down in the last decade, especially after the GFC (Table 1). A combination of factors such as (Contd...) 90 tnecreP ExportsofGoods andServices IncomeElasticity of ImportsHARNESSING OPEN ECONOMY VISTAS FOR FASTER GROWTH trade multiplier. In 2021-22, however, the post-pandemic Chart 2: Dynamic Foreign Trade Multiplier and Actual Growth pick-up in imports has weakened the FTM despite stronger 10 8.9 export growth (Chart 2). 68 6.0 5.7 6.7 6.8 5.1 In the post-pandemic recovery, further improvement in FTM 4 2 1.9 1.8 1.4 can result from higher export growth via expanding to new 0 product lines and new markets. Substitution of imports with -- 42 -1.0 -2.9 -3.3 -2.3 domestically available alternatives can also help reduce the -4.2 income elasticity of imports. -6 -5.7 -8 2000-01to 2005-06to 2009-10to 2013-14to 2021-22 References: 2004-05 2008-09 2012-13 2020-21 Thirlwall, A. P. (March 1979), “The balance of payments constraint as an explanation of international growth rate differences”, Banca Nazionale del Lavoro Quarterly Review, Note: Income elasticity based on annual changes in imports and GDP has been used. vol. 32(128), pages 45-53. Source: Authors’ calculations. Thirlwall, A. P. (2013) Economic Growth in an Open Developing Economy: The Role of Structure and Demand, in average GDP growth during 2013-14 to 2020-21 would Cheltenham: Edward Elgar.Downing College, Cambridge, have been sharper without this improvement in the foreign CB2 1DQ, UK. IV.5 In the years leading up to the pandemic, of world import demand are projected by the IMF a fall was observed in India’s trade openness, to grow faster than the world average in 2022-26. particularly from 2013-14. The moderation in These 15 economies account for 31 per cent of imports was more perceptible than exports (Chart India’s total exports (Chart IV.2). IV.1a). The sharp increase in imports during IV.7 Going forward, low growth economies 2021-22 has lowered the direct contribution of net may limit country’s export prospects. The focus exports to GDP growth even further (Chart IV.1b). should be to not only expand the export basket IV.6 Among India’s 40 major trading partners, to high growth economies but also to improve only 15 economies, accounting for 20.1 per cent the intensive margin of exports in low growth Chart IV.1: Net Exports of Goods and Services a. Exports and Imports of Goods and Services b. Contribution of Net Exports to GDP Growth *Including discrepancies. Source: MOSPI. 91 tnecreP/oitaR DynamicForeign Trade Multiplier NetExportsofGoodsandServices asper centof GDP ActualGDPGrowth 30 20 10 20.9 23.0 21.5 18.8 20.9 13.3 0 -10 -1. -0 14.3 -23.8-2.9 -28.7 -5.7 -23.7-2.2 -21.1-2.3 -25.- 24.2 -20 -30 -40 2000-01 2005-06 2009-10 2013-14 2020-21 2021-22 to to to to 2004-05 2008-09 2012-13 2019-20 PDGfotnecreP 12 12 9 9 6 6 3 3 0 0 -3 -3 -6 -6 -9 -9 -12 2000-01 2005-06 2009-10 2013-14 2020-21 2021-22 -12 to to to to 2004-05 2008-09 2012-13 2019-20 Importsof GoodsandServices ExportsofGoods andServices NetExports tniop eganecreP tnecreP Consumption + Investment* Importsof GoodsandServices ExportsofGoods andServices NetExports Growth (RHS)REPORT ON CURRENCY AND FINANCE years (Raj, 2017; Kaur, 2019). The correlation Chart IV.2: Profile of India’s Major Trading Partners between the cyclical component of India’s GDP and OECD+ economies2 has increased from 0.48 during 2000:Q1 - 2009:Q4 to 0.89 during 2010:Q1 - 2020:Q4 (Charts IV.3a and b). IV.9 In terms of static comparative advantage, a country’s competitive export strengths are based on specialisation and its ability to produce certain products at lower cost than other countries. Competitiveness, on the other hand, is a function of trade policies and development strategies, viz., tariffs; non-tariff measures; real exchange rates; export infrastructure; R&D and innovations. *: Based on latest available data. IV.10 In the post-GFC period, India’s merchandise Source: ITC; IMF and Authors’ calculation. exports have gained from the substitution effect (by gaining market share in export markets) as economies,1 which account for more than two- well as the income effect (by co-moving with thirds of world imports (Table IV.1). global income) (Chart IV.4). India’s merchandise IV.8 India’s business cycle is more exports need to grow at a compound rate of 12 synchronised with that of trading partners and per cent to attain the target of US$ 1 trillion by the co-movement has intensified further in recent 2030. Unless supported by rapid improvement in Chart IV.3: Growth and Trade Performance – India versus World a. Cyclical Component of India’s GDP and OECD+ b. World Imports and India’s Exports of Goods and Services: Volume Growth 0.10 0.05 0 -0.05 -0.10 -0.15 -0.20 -0.25 -0.30 Source: Authors’ own calculation based on IMF and OECD data. 1 Intensive margin refers to the growth of exports in such goods that are already being exported. 2 OECD+ group includes GDP of OECD plus five major EMEs, viz., China, Brazil, Russia, South Africa and Indonesia, aggregated in an index form, weighted by their respective shares in India’s exports. 92 )golnI(tnenopmoClacilcyC 1Q0002 1Q1002 1Q2002 1Q3002 1Q4002 1Q5002 1Q6002 1Q7002 1Q8002 1Q9002 1Q0102 1Q1102 1Q2102 1Q3102 1Q4102 1Q5102 1Q6102 1Q7102 1Q8102 1Q9102 1Q0202 Correlation:0.48 Correlation:0.89 OECD+_CY IND_CYHARNESSING OPEN ECONOMY VISTAS FOR FASTER GROWTH Table IV.1: Country-wise Profile of India’s Export Partners Countries Share in India's 2022-2026 Export Growth India's share Partner's Trade weighted exports (%) (GDP Growth 2016-2020 in partner's share in world average (2019) Differential imports (%) imports (%) with World Average)* United States of America 17.9 -1.3 5.0 2.2 13.8 2.4 China 6.9 1.4 20.0 1 11.8 3.4 United Arab Emirates 6.5 0.5 -10.0 10.8 1.0 3.4 Hong Kong, China 3.5 -0.7 -9.0 1.3 3.3 0.0 Singapore 3.0 -0.6 2.0 1.6 1.9 0.0 Bangladesh 2.9 3.5 8.0 16.3 0.3 14.0 United Kingdom 2.8 -1.4 -2.0 1.2 3.6 5.1 Germany 2.8 -1.7 2.0 0.9 6.7 5.1 Netherlands 2.3 -1.5 10.0 0.8 2.8 5.1 Malaysia 2.2 1.5 9.0 3.1 1.1 3.9 Saudi Arabia 2.2 0.4 5.0 4.8 0.8 5.1 Nepal 2.1 1.8 8.0 72.9 0.1 12.2 Belgium 1.7 -2.0 -3.0 0.9 1.7 5.1 Vietnam 1.6 3.4 -9.0 1.7 1.5 5.6 Indonesia 1.6 2.1 9.0 2.7 0.8 5.7 Korea 1.6 -0.9 6.0 1 2.7 8.5 France 1.6 -1.7 -1.0 1 3.3 5.1 Italy 1.6 -2.0 -1.0 1.1 2.4 5.1 Japan 1.5 -2.1 2.0 0.7 3.6 2.3 Thailand 1.4 0.2 7.0 2.1 1.2 6.7 Brazil 1.3 -1.8 14.0 2.6 0.9 10.0 Turkey 1.3 -0.2 -5.0 2.2 1.3 4.7 South Africa 1.3 -1.9 1.0 5.2 0.4 6.4 Australia 1.3 -0.7 1.0 1.8 1.2 2.5 Sri Lanka 1.2 -0.7 -5.0 19.3 0.1 9.3 Spain 1.1 -0.5 0.0 1.1 1.9 5.1 Mexico 1.1 -1.4 -2.0 1.1 2.2 4.2 Nigeria 1.1 -0.4 18.0 7.9 0.3 8.2 Canada 1.0 -1.1 10.0 0.9 2.3 3.4 Israel 0.9 0.3 -1.0 2.4 0.4 3.1 Russia 0.9 -4.9 10.0 1.5 1.3 5.5 Egypt 0.8 2.2 2.0 3.8 0.3 12.4 Oman 0.8 -0.1 -5.0 13 0.1 5.8 Iran 0.8 -1.2 3.0 10.1 0.1 12.9 Kenya 0.7 2.0 -4.0 11.5 0.1 12.0 Taipei, Chinese 0.6 -0.9 -6.0 0.8 1.6 2.0 Mozambique 0.5 3.7 19.0 9.6 0.0 7.2 Philippines 0.5 3.0 0.0 1.8 0.5 5.6 Poland 0.5 -0.2 6.0 0.8 1.5 5.1 Iraq 0.5 1.2 14.0 4.4 0.2 N.A. N.A.: Not Available. Note: * Red/Green implies lower/higher than world average growth. Source: Authors’ calculations based on IMF and ITC data. net terms of trade (implying higher export prices), the world import volume growth is projected by this export growth may seem ambitious, given that the IMF to average 4.2 per cent over the next five 93REPORT ON CURRENCY AND FINANCE Chart IV.4: Trade Performance of Major Economies - Income and Substitution Effect BR: Brazil, EG: Egypt, CHN; China, GER: Germany, IN: India, JP: Japan, UK: United Kingdom and US: United States. Note: * Measured by correlation between country’s export volume growth and world GDP growth during 2010-20. Source: Authors’ own calculations. years (2022-26). Hence, substantial gains through 47 sectors but deteriorated for 44 sectors during both the income effect and the substitution effect 2010-20. Out of the remaining 167 sectors with would be necessary. RCA of less than one, 58 per cent gained market share by moving closer to the RCA value of 1 IV.11 In this context, the production linked (Table IV.2). incentive (PLI) scheme targeted at creating domestic capacity and boosting export potential Chart IV.5: Sectoral Shifts in Revealed Comparative could be a game changer in making Indian Advantage manufacturing globally competitive, creating economies of scale and integrating India into the global value chain. In fact, a strong manufacturing base has greater potential to absorb a low-skilled labour force as compared to services. IV.12 While the revealed comparative advantage3 (RCA) of sectors has shifted over the last two decades, the number of sectors with RCA greater than one remained broadly the same in 2010-20 vis-à-vis 2001-09 (Chart IV.5). An inter-temporal comparison shows that out of 91 sectors which currently enjoy comparative advantage (i.e., RCA Source: Authors’ Calculations; and UNCTAD. index greater than one), the index improved for 3 RCA is based on Ricardian trade theory, which posits that patterns of trade among countries are governed by their relative differences in productivity. RCA index is used as a first approximation of competitive strengths of exports. 94HARNESSING OPEN ECONOMY VISTAS FOR FASTER GROWTH Table IV.2: Change in Revealed Comparative transportation, machinery and electrical, wood, Advantage (2010-20 over 2001-09) plastic and metals during 2011-19, whereas it RCA>1 RCA<1 Total declined for food products, footwear, textile and Increase 47 97 144 clothing, stones and glass and minerals. Overall, Decrease 44 72 116 commodity groups accounting for 58 per cent Total 91 167 258 weight in the export basket gained RCA during Note: RCA index as defined by Balassa (1965) is as follows: 2011-19 (Charts IV.6a and b). IV.14 While services exports accounted for 22 Where represents country i’s exports of commodity j and w per cent of total exports globally during 2010-21, represents world exports. If RCA is greater than 1, it is interpreted the share of India’s services exports was much that the country has a comparative advantage in exports. higher at 36 per cent. Further, world trade in IV.13 An inter-temporal comparison of product services has been more resilient than merchandise group-wise comparative advantage suggests that trade in the post-GFC period, which provides the RCA index of exports of consumer goods an upside potential for growth in low labour cost improved during 2011-19. Capital goods exports economies like India. While the pandemic and gained market share but remained well below the resultant supply chain disruptions severely the threshold level of RCA. By contrast, the RCA impacted world trade in commercial services for intermediate goods and raw materials was in 2020, India’s net exports of services were eroded reflecting a lower scale of participation relatively resilient, primarily on the back of robust in GVCs. An item-wise comparison shows that software exports earnings. India needs to tap the RCA improved for exports of fuels, chemicals, post-pandemic global opportunities arising from Chart IV.6: Revealed Comparative Advantage Index – Merchandise a. India b. China Source: World Integrated Trade Solutions (WITS). 95REPORT ON CURRENCY AND FINANCE accelerated digital investment with a growing Chart IV.7: Revealed Comparative Advantage Index – focus on contactless commerce, live commerce, Services and B2B consumerisation. IV.15 Despite being the seventh largest exporter of services with a global share of 3.3 per cent during 2010-21, India enjoys comparative advantage only in computer services (including software) covered under the category of telecommunication, computer and information services. In this segment too, the RCA index has moderated during 2011-20 due to growing competition from other countries in the last few years (Chart IV.7). IV.16 Lower RCAs across services exports reflect India’s highly skewed services export basket Source: Authors’ calculations based on UNCTAD data. (Chart IV.8a). In telecommunication, computer and information services and other business services, deliver computer and IT enabled services not only (together contributing two-thirds of India’s services through Mode 1 (cross-border supply), but also exports), India caters to just over 6 per cent of the through Mode 4 (movement of natural persons) global demand, implying a vast export potential and Mode 3 (commercial presence). in untapped markets (Chart IV.8b). In order to achieve the indicative target of services exports of IV.17 India’s RCA in computer services needs to US$ 1 trillion by 20304, the services export basket be enhanced further by tapping new opportunities needs to be diversified. Today, IT companies in this sector. Export potential in other segments, Chart IV.8: India’s Services Exports - Diversification a. Diversification of Services Export Basket b. Computer and other Business Services: Market Size by Country (Lower Value Means Higher Diversification) Source: Calculations based on UNCTAD database. 4 https://pib.gov.in/PressReleaseIframePage.aspx?PRID=1770270 (Ministry of Commerce & Industry, November 7, 2021). 96HARNESSING OPEN ECONOMY VISTAS FOR FASTER GROWTH Chart IV.9: Services Trade Openness and Export Performance a. Services Trade Restrictiveness Index and Share in b. Sectoral STRI (2020): India vis-a-vis OECD Global Exports (2010-20) (High value means Lower Openess) Note: US-United States, UK: United Kingdom, GER: Germany, FR: France, NL-Netherlands, JP-Japan, IT-Italy, CHN-China, IND-India, IR-Ireland, LUX-Luxemburg, TU-Turkey, SW-Switzerland, KO-Korea, PL-Poland, BEL-Belgium. Sources: UNCTAD; and OECD. viz., professional and management consulting lower than other major advanced economies in services, charges for intellectual property rights, most of the segments, as estimated by OECD’s financial services, entertainment services services trade restrictiveness index (STRI) including audio-visual and gaming, auditing [Charts IV.9a and b]. Given India’s Act East Policy services, education and healthcare, may be and strategic partnership with East Asia and the explored, especially through new or renegotiated Asia-Pacific region, there is immense potential to FTAs. For instance, India’s Comprehensive increase services trade with countries like Japan Economic Partnership Agreement (CEPA) with and Australia. the United Arab Emirates (UAE) in February 2022 IV.18 Export market diversification can help focuses on 11 service sectors and over 100 sub- to overcome export instability and the negative sectors including inter alia business services, impact of net terms of trade shocks originating telecommunications, construction, education, from concentration in a few commodities. On tourism, nursing and finance, besides goods. Some this metric, India fared better than other large segments involving digital modes for delivery of economies during 2010-20 as its top-20 export services are fraught with regulatory issues relating destinations accounted for two-thirds of total to data privacy, storage and localisation which may goods exports. India’s overall export market weaken the case for a push to services exports diversification measured by the Herfindahl- through bilateral/multilateral trade agreements. Hirschman market concentration index also shows Incidentally, India’s openness in services trade is lower concentration of exports (Chart IV.10)5. 5 Herfindahl–Hirschman Index (HHI), a commonly accepted measure of market concentration, is calculated by squaring the share of each trading partner in a country’s total exports and then summing up the resulting numbers. HHI can range from 0 to 1.0. 97REPORT ON CURRENCY AND FINANCE IV.19 An analysis based on the trade Chart IV.10: Export Diversification by Market – India vis-a-vis China and the US complementarity index (TCI)6 shows that India’s 85 0 .100 export basket has high complementarity with import 0. 074 0 .090 baskets of Italy, Belgium, the Netherlands, the UK 80 0 .080 and Brazil, but they account for a lower share in 0. 066 0 .070 India’s total exports than other countries, viz., the 75 0. 047 0 .060 USA, China, the UAE and Hong Kong which exhibit 79.4 0 .050 70 0 .040 modest levels of trade complementarity. Similarly, 75.0 0 .030 India’s import basket complements exports from 65 67.3 0 .020 the USA, Singapore, the UK, Netherlands and 0 .010 Malaysia. As a high degree of complementarity 60 0 .000 India China US indicates more favourable prospects for successful trade arrangements, India’s exports have scope to expand in countries with high TCI (Table IV.3). Note: Higher value of HHI indicates low diversification and vice versa. Source: Calculations based on DOTS (IMF). IV.20 In order to expand market overseas for domestic products, it is imperative to not only Table IV.3: Trade Complementarity Index India’s TCI ranking with Top Exporting Countries Major Partner Countries TCI Ranking to India Country Share in total exports (%) TCI (2019) Country Share in total imports (%) TCI (2019) USA 17.7 59.1 USA 7.34 67.6 China 7.3 55.4 China 14.07 54.7 UAE 5.7 61.2 UAE 6.76 48.8 Hong Kong 3.5 39.5 Hong Kong 3.85 57.6 Bangladesh 3.1 56.1 Bangladesh 0.26 5.7 Singapore 3.0 51.1 Singapore 3.38 67.8 UK 2.8 67.7 UK 1.42 63.6 Germany 2.8 64.5 Germany 3.32 56.1 Nepal 2.3 63.3 Nepal 0.14 23.2 Netherlands 2.2 65.9 Netherlands 0.73 67.0 Malaysia 2.1 59.6 Malaysia 2.13 61.6 Saudi Arabia 2.0 60.2 Saudi Arabia 5.59 31.5 Belgium 1.8 69.9 Belgium 1.76 59.9 Indonesia 1.7 65.7 Indonesia 3.17 55.3 Vietnam 1.7 50.7 Vietnam 1.56 40.4 France 1.6 65.0 France 1.32 55.4 Italy 1.6 72.8 Italy 0.97 54.6 Korea 1.6 61.5 Korea 3.25 61.5 Japan 1.5 64.6 Japan 2.78 56.6 Brazil 1.5 66.3 Brazil 0.63 43.5 Source: WITS. 6 TC indicator between countries k and j is defined as: Where is the share of good i in total exports of country j and is the share of good i in total imports of country k. The index is zero when no goods are exported by one country or imported by the other and 100 when the export and import shares exactly match. 98 02poTfoerahS tnecreP IHH Top 20ExportDestinations Overall MarketDiversification Index(RHS)HARNESSING OPEN ECONOMY VISTAS FOR FASTER GROWTH ease supply-side bottlenecks but also undertake goods” to “rich-country goods” by enhancing reforms that facilitate a process of structural the efficiency and competitiveness of domestic transformation from producing “poor-country industry (Box IV.2). Box IV.2 Country and Product Identification Strategy for Enhancing India’s Export Potential As India revamps its trade policy strategy to re-engage perspective, it is imperative that India captures a greater with the rest of the world post-COVID, an effective export market share, based on differentiated products, especially promotion strategy identifies markets with high growth during a time when global supply chains are going through potential and augments comparative advantage of a larger a major transformation. Accordingly, product classification set of products in the export basket. An empirical analysis in terms of organised exchange, referenced price, and to identify India’s all-weather-partners using a measure differentiated products (Rauch, 1999) is examined, and of trade frequency, i.e., the number of times a country mapped to sectoral RCAs7 and the medium-term growth has registered as India’s top-10 trade partners in the last potential of India’s trading partners. decade may be useful. While countries such as the US, the The desirable country and product mix may meet the UK, the UAE, Singapore, Hong Kong, Germany and China following criteria: (i) the product classified as differentiated; have consistently remained in the list of India’s top-10 trade partners, trading partners such as Sri Lanka, South Korea, (ii) India’s RCA in that product category vis-a-vis trading Indonesia, France and Brazil have made sporadic entries partners; and (iii) trade in that product with a country that and exits. has a high growth potential. This aspect is examined by applying K-means clustering8 to identify centroids based The medium-term growth potential of India’s top trading on (a) a scatter of sectoral RCAs and country’s medium- partners is identified on the basis of IMF’s latest growth term growth potential; and (b) a scatter of sectoral RCAs projections in the post Covid-19 period, i.e., 2023 to 2026. and product classification (Charts 1a and b). The blue The choice of the period ensures that a mechanical rebound cluster represents a centroid associated with relatively on account of base effects does not overestimate the actual high RCA value and low GDP growth. On the other hand, growth potential of a country. Next, revealed comparative the green cluster represents a centroid associated with advantage (RCA) is explored to gauge India’s export potential. relatively high GDP growth values and relatively low RCA Product differentiation is a short-run phenomenon between value. The red cluster represents relatively low RCA and new trading partners and its importance dissipates over low GDP growth values. A medium-term repositioning time (Herman and Lee, 2019). From the medium-term of India’s trade strategies must focus on the centroids Chart 1: Identification of a Right Mix of Trading Partners and Products based on K-means Clustering a. RCA and GDP Growth b. RCA and Product Groups Note: Centroid clusters are based on a scatter of RCA values and product classifications across 16 key sectors. It would be desirable to reposition India’s external sector away from the red and green clusters and closer to the blue cluster. (Contd...) 7 According to WITS, products are classified under 16 major sectors: 8 K-means clustering method determines the centroid position from a cluster of data points by minimising the within-cluster variation. The algorithm starts with a set of randomly chosen centroids that serve as the starting points for each cluster, and then iterative (repetitive) calculations are used to optimise the centroids’ positions. 99REPORT ON CURRENCY AND FINANCE that can help reap the untapped potential in high growth Paper 2019-11-A, Available at SSRN: https://ssrn. economies. com/abstract=2690336 or http://dx.doi.org/10.2139/ ssrn.2690336. References: Rauch, James E. (1999), “Networks versus markets in Herman, Peter and Lee, Ryan (2019), “The Short-Run international trade”, Journal of International Economics, Effects of Product Differentiation on Trade (November 7, 2019)”, USITC Office of Economics Working Vol.48, Issue 1, pp.7-35. IV.21 There is a need to re-examine the domestic levies on the exported products should be either incentive structure for exporters in consonance exempted or remitted to exporters and therefore with the WTO guidelines in order to boost is a step towards zero-rating of exports.10 The exports.9 In recent years, India’s export incentive PLI schemes mandate investment thresholds schemes have been challenged at the WTO and targets for incremental sales for availing dispute settlement mechanism. These schemes the scheme incentives. Improvement in export include i) Export Oriented Units (EOU) Scheme; competitiveness in the long-run would, however, (ii) Sector-Specific schemes, viz., Electronics require infrastructure and logistics support to Hardware Technology Park (EHTP) Scheme, provide exporters a level playing field in the global Software Technology Park (STP) Scheme and Bio- market. Technology Park (BTP) scheme; (iii) Merchandise IV.23 On India’s export potential, the Bloomberg Exports from India Scheme (MEIS); (iv) Export Economics ranked India at the first position among Promotion Capital Goods (EPCG) Scheme; (v) 10 Asian economies. The Confederation of Indian Special Economic Zones (SEZ) Scheme; and (vi) Industry (CII) shortlisted 31 export items which Duty-Free Imports for Exporters Scheme (DFIS). could improve India’s export potential.11 IV.22 Taking cognisance of the non-compliance IV.24 The large-scale digitalisation of the with WTO guidelines, the Government has economy that is currently underway, along introduced the Remission of Duties and Taxes with the advances in frontier technologies on Exported Products (RoDTEP) (that replaces such as artificial intelligence (AI), robotics, the MEIS) and PLI scheme for 13 sectors which biotechnology and nanotechnology, are likely are WTO-compliant. The RoDTEP scheme aims to drive economic development going forward. to reimburse taxes/duties/levies at the central, While telecommunications, information services, state and local level incurred in the process of hardware manufacturing, software and IT manufacture and distribution of exported products. consulting form the core of this digital economy, RoDTEP is based on the principle that taxes and these frontier technologies have opened up 9 WTO subsidies rules are covered under Subsidies and Countervailing Measures (“SCM Agreement”). SCM agreement classifies the subsidies into two categories prohibited and actionable. 10 Zero rating refers to zero taxes on inputs of final products. 11 This list included items such as cyclic hydrocarbons, motor cars, motor vehicles, and electrical apparatus which require the use of high, if not complex, technologies along with a moderately high investment on research and development (R&D). 100HARNESSING OPEN ECONOMY VISTAS FOR FASTER GROWTH avenues in digital services, cloud platforms, Firms in the financial and manufacturing sectors e-commerce, e-business, industry, precision have been some of the early adopters of frontier agriculture and algorithm-driven business technologies including AI, IoT, big data and processes. blockchain (Table IV.4). IV.25 Adoption of digital technologies can IV.26 Financial firms, especially new age improve India’s trade competitiveness through FinTech firms, have leveraged these technologies economies of scale, scope and speed of trade. for credit decisions, risk management, fraud It affects all stages of a value chain, including prevention, trading, personalised banking and pre-production, production and post-production, process automation (UNCTAD, 2021). On the improves access of domestic firms to new export other hand, the manufacturing sector has used markets and also exposes domestic consumers these technologies for predictive maintenance, to new products and producers (Banga, 2019). quality control and human-robot combined Table IV.4: Frontier Technologies, Description and Early Adopters Technology Description Early Adopters Artificial intelligence (AI) AI is normally defined as the capability of a machine to engage in cognitive Retail, banking, discrete manufacturing activities typically performed by the human brain. Internet of Things IoT refers to Internet-enabled physical devices that are collecting and Consumer, insurance, healthcare (IoT) sharing data and has potential applications in areas such as wearable providers devices, smart homes, healthcare, smart cities and industrial automation. Big data Big data refers to datasets whose size or type is beyond the ability of Banking, manufacturing, professional traditional database structures to capture, manage and process. services Blockchain A blockchain refers to an immutable time-stamped series of data records Finance, manufacturing, retail supervised by a cluster of computers not owned by any single entity and is used as a base technology for cryptocurrencies and also enables peer- to-peer transactions. 5G 5G networks are the next generation of mobile internet connectivity, Energy utilities, manufacturing, offering download speeds of around 1-10 giga bytes per second as well public safety as more reliable connections. 3D printing 3D printing (i.e., additive manufacturing) produces three-dimensional Discrete manufacturing, healthcare, objects based on a digital file using less material than traditional education manufacturing. Robotics Robots are programmable machines that can carry out actions and interact Discrete manufacturing, process with the environment via sensors and actuators either autonomously or manufacturing, Resource industry semi-autonomously. Drones A drone, also known as unmanned aerial vehicle (UAV) or unmanned Utilities, construction, discrete aircraft systems (UAS), is a flying robot that can be remotely controlled manufacturing or fly autonomously using software with sensors and global positioning system (GPS). Gene editing Gene editing, also known as genome editing, is a genetic engineering Pharma-biotech, academic/ research tool to insert, delete or modify the genome in organisms. centre, agri-genomic/ contract research organisations Nano-technology Nano-technology deals with the manufacturing of objects in scales Medicine, manufacturing, energy smaller than 1 micrometre. Solar photovoltaic Solar photovoltaic (Solar PV) technology transforms sunlight into direct Residential, Commercial, Utilities (Solar PV) current electricity using semiconductors within PV cells. Sources: UNESCAP (2018) and UNCTAD (2021). 101REPORT ON CURRENCY AND FINANCE Chart IV.11: Expected Market Size of Frontier Technologies a. 2018 (US$350 billion) b. 2025 (US$3226 billion) Source: UNCTAD (2021). working activities. Frontier technologies currently industrialisation. Countries are likely to induce represent a global market of US$ 350 billion, shifts in consumer preference for lower-emission which is expected to grow to over US$ 3.2 trillion goods and services and facilitate adoption of by 2025 (Charts IV.11a and b). climate-friendly technology. Trade baskets could, therefore, undergo compositional shifts to the IV.27 India could create a digital economy of extent that CO emission control norms are US$ 800 billion - US$ 1 trillion (equivalent to 18 2 embedded into export and import baskets. India to 23 per cent of India’s nominal GDP) by 2025 is likely to face sharper contraction in volumes (MEITY, 2019). As per available data, India’s high- of exports than imports over the long-run technology exports were roughly 10.3 per cent (OECD, 2017; UNCTAD, 2019). Mobilising green of total manufactured exports, while ICT goods investments, adopting cleaner technologies, and exports were about 2 per cent (Table IV.5). promoting green collaborations to reduce carbon IV.28 There is also a need for domestic firms footprints in domestic production early could to reap the opportunity thrown by “green” rebalance the export basket towards climate friendly goods for environment sensitive markets. Table IV.5: Trade and Research and Development Statistics for India India has so far not been able to tap this export potential due to institutional and infrastructure Parameters Value bottlenecks (Nguyen and Kalirajan, 2013). Researchers (per million, 2010-18) 253 Technicians (per million, 2010-18) 73 Scientific and Technical Journal Articles 1,35,788 3. Role of Imports R&D Expenditure (% GDP, 2010-18) 0.65 High-technology Exports (% manufacturing exports, as 10.3 IV.29 Experience with the export-led growth of 2019) strategies highlights the critical role of imports in ICT Goods Exports (% total goods exports, as of 2019) 2.0 raising exports and productivity (Kim, 2007 and Patent Applications Filed (as of 2019) 53,627 Trademark Applications Filed (as of 2019) 45,467 Chen, 2020). Economies can raise participation in Industrial Design Applications Filed (as of 2019) 13,723 GVCs by importing foreign inputs to produce goods Source: World Bank Database. and services meant for exports (backward GVC 102HARNESSING OPEN ECONOMY VISTAS FOR FASTER GROWTH Chart IV.12: Import Content of Exports (ICE) Matters for Export Intensity and GVC Participation* a. ICE and Export Intensity b. ICE and GVC Participation Index *Based on data on backward and forward GVC participation of 62 advanced and emerging market economies. Sources: OECD, WTO and World Bank. participation) and also by exporting domestically IV.30 The composition of imports also matters, produced inputs to trading partners for value including for productive absorption of capital from addition at different stages of production (forward abroad. India’s import basket has undergone a GVC participation). Import substitution policies shift away from raw materials to intermediate and work against opportunities for becoming more capital goods over the last two decades (Chart productive and cost competitive (Charts IV.12a IV.13a). Nevertheless, the share of capital goods in and b). In the case of India, it has been empirically India’s total imports at 22.8 per cent is significantly established that higher GDP and export growth lower than economies with higher export intensity can be induced by imports (Shirazi and Manap, (Chart IV.13b). Going forward, India’s foreign trade 2005; Maitra, 2020). policy must not be oblivious to the experience of Chart IV.13: India at the Bottom as Capital Goods Importer among Major Economies a. Composition of India’s Imports by Stage of Processing b. Share of Capital Goods in Import Basket (% Share) Source: Based on WITS data. 103REPORT ON CURRENCY AND FINANCE Chart IV.14: Tariff Profile of India’s Imports a. Trade Weighted Average Import Tariffs b. India’s Tariff Rate (Simple Average) – Stages of Processing (2019) Source: WTO. firms in most competitive economies which source policy regime to promote agricultural exports foreign inputs of superior quality and improve (Charts IV.14a and b). competitiveness. IV.32 Diversification of India’s import basket IV.31 The focus on building domestic capacities away from a few source countries to a larger set of under ‘Aatmanirbhar Bharat’ aims at putting countries may also help domestic firms to become in place an eco-system that strengthens the more resilient to global supply chain disruptions. At supply chains within the country for products present, China accounts for 43.5 per cent of India’s with export opportunities. The focus is to provide imports of electrical machinery and equipment, incentives and create an enabling environment 37.8 per cent of imports of other machineries, for the private sector for creating capacities mechanical appliances, nuclear reactors, boilers while fostering competitiveness. The correction and parts thereof, and 45.6 per cent of organic in the inverted duty structure is one such chemicals. An analysis based on HS 6-digit data example in recent years, i.e., lower tariffs on shows that there is a scope for diversification imports of raw materials/inputs than final goods. of India’s imports to other alternative suppliers Downward adjustments in India’s average import (Table IV.6). tariff levels, which remain higher than other EMEs, can help in further enhancing export IV.33 India’s experience with various trade competitiveness and higher participation in GVCs agreements so far may not have been encouraging (Panagariya, 2021). India regulates its trade in (as import growth often exceeded export growth), agricultural commodities more intensively than but there is a need to secure favourable trade manufactured products and natural resources. terms with partners for the right kind of imports There is scope for a more stable and open that augment domestic production capacity and 104HARNESSING OPEN ECONOMY VISTAS FOR FASTER GROWTH Table IV.6: Commodities with High Import Dependence on China and Alternative Suppliers Sr. No. Commodities at HS-6 digit Alternative Suppliers I. Electrical machinery, equipment and parts High import 1. Parts of telephone sets Hong Kong, Vietnam, Korea, Singapore value 2. Processors and controllers Hong Kong, Malaysia, USA, Singapore 3. Photosensitive semiconductor devices* Malaysia, Japan, Korea, Vietnam 4. Telephones for wireless network/mobile phones* Vietnam, Hong Kong, UAE, USA 5. Parts of machines such as transmission/radar/reception apparatus, Korea, Hong Kong, Taiwan, Vietnam cameras, etc. 6. Lithium-ion accumulators (such as batteries mostly used in laptops, Korea, Hong Kong, Japan, Poland PCs and mobile phones) 7. Static converters (such as electric inverter, rectifier, stabilizers, etc.) Germany, Hong Kong, USA, Japan Low import 1. Parts of Electronic ICs and micro assemble Malaysia, Hong Kong, Japan, Singapore, USA value but 2. Electronic ICs Hong Kong, Singapore, Malaysia, USA crucial II. Machinery/mechanical appliances/nuclear reactors/boilers & parts High import 1. Data processing machines such as PCs** USA, Germany, Hong Kong, Czech value 2. Parts such as microprocessors, motherboards Hong Kong, USA, Korea, Taiwan 3. Parts of road rollers, ships, cranes USA, Germany, Japan, Korea 4. Other pumps, compressors etc. Germany, USA, Romania, Italy 5. Air conditioners** Thailand, Malaysia, UAE, Korea 6. Ball bearings Japan, Germany, Italy, France Low import 1. Agricultural/horticultural mechanical appliances USA, Israel, Italy, Turkey value but 2. Numerically controlled shearing machines Germany, Italy, Netherlands, Turkey crucial 3. Condensers for steam/other vapour power units* Korea, Indonesia, USA III. Organic chemicals primarily bulk drugs and active pharmaceutical ingredient (API) High import 1. Heterocyclic compounds with nitrogen hetero-atom[s] only Switzerland, Ireland, Germany value 2. Penicillin and its derivatives* Spain, Italy, Singapore 3. Other ‘Rifampicin and its salts’ Switzerland, Italy, USA 4. Other heterocyclic compounds Ireland, Japan, Switzerland, Germany *: China’s share is more than 40 per cent in world exports; **: China dominates with more than 55 per cent share in world exports. Source: Authors’ calculations based on ITC data. make the conditions for export competitiveness In this regard, the Aatmanirbhar Bharat initiative more conducive (Box IV.3). may play an important role by incentivising use of lower-carbon fuels for power generation, IV.34 Given the growing focus on meeting climate conservation of energy, and production of greener change goals, India’s dependence on imported vehicles. Lower dependence on import of crude fossil fuels for meeting domestic energy demand oil and coal by switching to domestically available needs to be reduced. India has set visionary substitutes can also reduce the income elasticity targets to achieve 50 per cent of installed electric of imports. In this direction, various measures power capacity from non-fossil fuel sources and have been undertaken, including the target of 20 reduce the carbon emission intensity of its GDP by per cent ethanol blending by 2023-24 and 100 per 33-35 per cent compared to 2005 levels by 2030. cent ethanol-run vehicles over time, the focus on 105REPORT ON CURRENCY AND FINANCE Box IV.3 India’s Free Trade Agreements – For Trade Creation or Diversion? Trade Agreements12 as a strategy to expand trade, Table 1: Impact of Trade Agreements on investment and economic cooperation is required to manage Exports and Imports post-COVID challenges. FTA countries, however, accounted LBEXP LBIMP for just 21 per cent and 18 per cent of India’s exports and imports, respectively, during 2017-21. In order to examine LGDP 0.628** TP the impact of free trade and other preferential agreements (0.0434) LGDP 0.829** 1.244** on India’s trade, a fixed effects model is attempted, using IND (0.048)** (0.078) bilateral panel data of the following form: Dummy_TA -0.015 0.170* (0.047) (0.088) LBEXP (c, t) = (cid:68)0 + (cid:68)1 (TA)t + (cid:74)’ X (c, t) + D (c, t) + (cid:72) (c, t) ...(1) Obs. 780 780 LBIMP (c, t) = (cid:68)0 + (cid:68)1 (TA)t + (cid:74)’ X (c, t) + D (c, t) + (cid:72) (c, t) …(2) R-squared 0.55 0.40 Year FE Yes Yes where c represents bilateral country-wise exports/imports Country FE Yes Yes of India in year t. The dependent variables that capture trade relationships are measured by bilateral exports * statistically significant at 10% level. (LBEXP) and bilateral imports (LBIMP). X is a vector of ** statistically significant at 1% level. other variables such as domestic GDP (LGDP ) and GDP Note: Figures in parentheses are standard errors. IND of trade partners (LGDP ). The coefficient of interest is (cid:68)1 TP such as unequal decline in tariffs vis-à-vis trade partners, to assess the impact of trade agreements (Dummy TA) on high cost of compliance of FTAs, and non-tariff measures India’s exports and imports. continuing even after entering into FTAs. In fact, India’s net The sample covers 1995-2020 period and comprises imports in certain segments increased manifold. In the case India’s 30 major trading partners that include 10 countries13 of steel, 74 per cent of India’s imports are from Japan and having either FTA or any other bilateral or multilateral Korea at much lower tariffs under the FTAs, affecting the trade agreement with India. The results suggest that trade domestic sector (EXIM Bank, 2020). agreements do not have any positive and statistically Ongoing trade negotiations with the UK, Canada, the US, significant impact on India’s exports. In the case of imports, and the European region provide new opportunities, but however, it is found that the trade agreements have a they need to be structured strategically in terms of market positive and statistically significant impact (Table 1). access for exports and assurance on high technology Any trade agreement is more likely to benefit countries imports. FTAs are more likely to benefit India through trade having complementary export and import baskets. Evidently, in services without losing the focus on merchandise trade. India has recorded higher trade deficits with some of the Reference: ASEAN countries in the post-FTA period, underscoring the limited benefits of FTAs due to a combination of factors Relooking India’s Tariff Policy Framework, EXIM Bank. 2020. efficient battery technologies, and setting up of period. A gradual switch to indigenous sources 5,000 compressed bio-gas plants to turn municipal of renewable and non-renewable energy and and agricultural wastes into energy. thrust on improving energy efficiency will help achieve a reduction in dependency on imported IV.35 Despite these policy efforts, India’s energy transition, however, may face renewed energy, going forward. Securing energy security uncertainties owing to ongoing global supply by diversifying from imports to indigenous sources chain disruptions during the post-pandemic would bode well for domestic growth as well. 12 FTA is signed between two or more group of countries for encouraging bilateral trade by reducing or eliminating tariff and non-tariff barriers on goods and services. Moreover, many countries have established a broad agreement known as comprehensive economic cooperation agreement which consists of an integrated package of goods, services and investment, including Intellectual property rights (IPR). 13 The sample countries include Bangladesh, Indonesia, Japan, Korea, Malaysia, Singapore, Sri Lanka, Thailand, the UAE and Vietnam. 106HARNESSING OPEN ECONOMY VISTAS FOR FASTER GROWTH 4. Capital Flows, Exchange Rate and Growth flowing from the rich to poor countries (Lucas, 1990) is often due to a variety of bottlenecks, IV.36 Neo-classical models of growth assume viz., low absorptive capacity - given inadequate that capital flows from countries with high capital- infrastructure - low skilled labour force and poor to-labor ratios to those with relatively low capital- governance, besides higher risk of default on labour ratios. Foreign capital enables capital foreign debt. In a demand constrained model, deficient countries with unexploited investment the growth impact of foreign capital depends on opportunities to grow faster as it may bring in how it affects domestic investment, savings and new technologies and ease the domestic saving import propensities (Bhanumurthy et al. 2014). constraint on growth. In general, the received wisdom is that foreign IV.37 Empirical evidence on capital moving from capital does not always boost long-term growth in non-industrial developing countries (Prasad et al. surplus to deficient countries, however, remains 2007). limited. Instead, there has been substantive evidence on high correlation between domestic IV.38 In the case of India, both domestic and savings rates and domestic investment rates, foreign savings seem to play an important role in which is a puzzle in the context of perceived boosting growth, but the latter in excess of 2.5 per benefits of financial openness (Feldstein and cent of GDP (i.e., the sustainable level of CAD) Horioka, 1980). Further, the modest level of capital appears to be growth retarding (Box IV.4). Box IV.4 Impact of Foreign Capital on Growth An analysis is undertaken to examine the relative roles of that growth tends to be negative at very high levels of CAD domestic and foreign capital in India’s growth performance (Table 1). From equation 3, the threshold CAD works out following the specifications suggested by Soto (2000). Data Table 1: Impact of Domestic and over the period 1980-2020 are used, covering various Foreign Savings on Growth phases of domestic growth. Besides key variables, viz., the investment rate (IR), the saving rate (SR) and the current Variable Regression Coefficients account deficit (CAD), other control variables used are trade Equation 1 2 3 openness (XMGDP), net terms of trade (TOT), government C -4.55** -6.72* -2.11 IR 0.42* consumption (GCON). While XMGDP and TOT augment SR 0.28*** 0.53*** GDP growth, GCON is expected to have a negative CAD 1.04** 2.31* impact on growth as it represents distortions introduced by CAD2 -0.51** government interventions (Barro and Sala-i-Martin, 1995). XMGDP 0.30** 0.41* 0.09** LTOT 1.13* 1.63* 0.55** When the investment rate is split into the national savings LGDP(-1) -0.02 0.01 -0.001 rate and the CAD in order to distinguish between the effects LGCON(-1) -0.05 -0.08 -0.04 of domestic savings and foreign savings, it is found that both Adj. R2 0.32 0.36 0.32 sources of savings boost growth. However, the coefficient of D.W 1.69 1.86 1.71 F-Stat 4.11 4.14 3.32 the CAD turns out to be larger than SR, implying a greater N 40 40 40 per unit contribution of foreign savings to growth (equation 2). Coefficients of other control variables, viz., XMGDP, net *, **, ***: Represent significance at 1per cent, 5 per cent and 10 per cent, respectively. TOT and GCON have expected signs (equation 1) as seen Note: IR: Inestiment Rate, SR: Saving Rate, CAD: Current Account in the cross-country experience. Deficit (+)/Surplus(-) as ratio to GDP, XMGDP: Export and imports as Equation 3 which tests the presence of a non-linear ratio of GDP, LGDP; Log of real GDP, LGCON: Log of Government Consumption (constant prices), LTOT: Log of Net Terms of Trade Index relationship between CAD and growth finds that the and DUMS=Dummy 1 for current account surplus period 2001-03. coefficient of the squared term of CAD is negative, implying (Contd...) 107REPORT ON CURRENCY AND FINANCE to be 2.3 per cent of GDP beyond which growth begins to Chart 1: Current Account Balance and GDP Growth decelerate. A scatter plot of India’s current account balance and growth also confirms a non-linear relationship between these two variables, with the slope turning negative around a CAD level of 2.5 per cent of GDP (Chart 1). The sustainable level of CAD can be raised by undertaking reforms that enhance the country’s export potential, quality of imports and higher external funding in the form of FDI. References: Barro, R. and X. Sala-I-Martin (1995), Economic Growth, McGraw-Hill, New York. Soto, Marcelo (2000), “Capital Flows and Growth in Developing Countries: Recent Empirical Evidence”, Note: The period 2001-03, for which a dummy variable was used in the regression equation, has been dropped. OECD Development Centre Working Papers 160, OECD Source: Authors’ own calculations. Publishing. IV.39 Net capital flows to India have generally containing exchange rate volatility and mitigating exceeded the funding requirements of the economy, external vulnerability concerns. as reflected in overall balance of payments IV.40 Besides the size of foreign capital, its surpluses (i.e., build-up of foreign exchange composition can also influence the growth reserves) over the last two decades (Chart IV.15). outcome. The impact of FDI is widely perceived In an open economy, foreign exchange reserves to be the largest in open economies with a skilled contribute to growth and investment indirectly by workforce and developed financial markets. Equity insulating the economy from global spillovers, flows in the form of FDI are generally procyclical and inter alia driven by domestic growth Chart IV.15: Utilisation of Net Capital Inflows prospects, implying that the latter can generate a virtuous cycle of stronger growth and higher FDI flows. While FDI benefits by diversifying the capital structure of local companies and providing positive externalities such as technology and knowledge diffusion (Mansfield and Romeo, 1980; Markusen and Venables, 1999; Blomström et al. 1994; Blomström and Kokko, 2002), its impact on growth also depends on whether it is for greenfield or brownfield projects. IV.41 India has followed a gradualist approach to capital account liberalisation in order to mitigate the destabilising impact of surges and sudden Source: RBI. stops in capital flows. Recognising the critical 108HARNESSING OPEN ECONOMY VISTAS FOR FASTER GROWTH Chart IV.16: Regulatory Easing of FDI in India since 1990s a. FDI Regulatory Restrictiveness Index for India b. FDI Stock in India Note: Lower Index means easing of FDI policy and vice versa. Sources: OECD; and UNCTAD. role of FDI, the Government has put in place a IV.43 One of the reasons that FDI has been transparent and predictable policy framework less than potential in India is the lack of quality wherein 100 per cent ownership is permitted infrastructure which reduces the comparative under the automatic route in most sectors/ advantage of firms/industries. While raising the FDI activities, except for a few prohibited sectors. Its investment limits in certain sectors, particularly at impact is reflected in the sharp improvement in the higher end of the engineering and economic OECD’s FDI Regulatory Restrictiveness Index, value chain (e.g., defence), foreign firms expect which measures statutory restrictions on foreign full flexibility to own proprietary technology and direct investment in 22 economic sectors (Chart decide on manufacturing processes. In the post- IV.16a). In fact, the improvement in India’s FDI Regulatory Restrictiveness Index from 0.23 in Chart IV.17: Export Sectors with High Capital Requirement 1997 to 0.04 in 2020 has been remarkable in the manufacturing sector (covered under secondary sector) and is closer to the OECD’s average of 0.02. Nevertheless, India’s inward FDI stock at 13.4 per cent of GDP during 2010-20 is modest when compared with other EMEs, viz., Brazil, Chile, Thailand, Mexico, Malaysia, Indonesia and Vietnam (Chart IV.16b). IV.42 Despite 100 per cent FDI in majority of sectors, FDI flows have remained skewed towards a handful of sectors. The PLI scheme by attracting foreign companies for domestic production can potentially generate additional exports in targeted Source: Deloitte Report (September 2021). sectors by 2026-27 (Chart IV.17). 109REPORT ON CURRENCY AND FINANCE pandemic period, building supply chain resilience in resources such as capital and advanced has been a top priority for domestic firms. In this technology through FDI (PIB, 2021). In order to regard, FDI in R&D needs to be integrated with harness growth and employment benefits of FDI, domestic innovation systems by putting in place therefore, India needs to offer itself as a feasible suitable enabling provisions in the intellectual alternative to concentrated GVCs by providing a property laws. globally competitive manufacturing environment and strengthening its commitment towards free IV.44 India’s ongoing FTAs with advanced trade. countries/regions may need to include special clauses relating to collaboration and investment IV.45 As regards other capital flows, investment promotion in the R&D sector. FDI in renewable limits for FPIs’ participation in the debt segment energy sector, which has picked up in recent years, of domestic capital market have been significantly needs a further boost. The PLI scheme for High eased in recent years. FPIs have also been Efficiency Solar PV Modules to build domestic provided flexibility to undertake exposures in capacity could play a crucial role in bringing the domestic debt market through alternative Box IV.5 Composition of Capital Inflows and Growth Cross-country evidence suggests that FDI impacts growth Table 2: VEC Granger Causality/Block Exogeneity positively, but the evidence is mixed on debt related flows Wald Tests (Aizenman et al., 2011; Soto, 2000). In order to estimate Sample: 2000:Q2 - 2021:Q1 the sensitivity of growth in India to various components of Included observations: 76 Dependent variable: DLOG(GDPVOL) capital flows, data on real GDP (LGDPVOL), net foreign direct investment (LNFDI), net foreign portfolio investment Excluded Chi-sq df Prob. (LNFPI), external commercial borrowings (LECB) and trade DLNFDI 12.35 5 0.03 credit (LSTC) are used for the period 2000:Q2 to 2021:Q1. DLNFPI 19.00 5 0.00 As these variables are found to be cointegrated of order DLNECB 10.41 5 0.06 one, confirming the existence of a long-run relationship DLSTC 2.14 5 0.83 among them, a vector error correction model is specified All 132.28 20 0.0 to estimate the long-term elasticity of GDP with respect to various components of capital flows. While the long-term coefficients of FDI and FPI are found to be positive and statistically significant at 1 per cent, the coefficient of STC Table 1: Vector Error Correction Model is weakly significant at 10 per cent level (Table 1). The VEC Granger Causality (Block Exogeneity Wald Test) confirms Cointegrating Equation the causal influence of FDI and FPI on GDP growth but not Variables Coeff. T-Value for trade credit (Table 2). Empirical results do not support LGDPVOL 1.00 any growth enhancing role of ECB. LNFDI -0.37 [-3.96] References: LNFPI -0.86 [-2.95] Aizenman, Joshua; Yothin Jinjarak; Donghyun Park (2012), LNECB 0.77 [6.39] “Capital Flows and Economic Growth in the Era of Financial LSTC -0.14 [-1.65] Integration and Crisis, 1990-2010”, NBER Working Paper ECT -0.01 [-2.81] 17502. Adj. R2 0.89 F-Stat 20.65 Soto, Marcelo (2000), “Capital Flows and Growth in Developing Countries: Recent Empirical Evidence”, Note: In VECM, a lag of five quarters was used. Signs need to OECD Development Centre Working Papers 160, OECD be inversed while interpreting the coefficients in the cointegrating equation. Publishing. 110HARNESSING OPEN ECONOMY VISTAS FOR FASTER GROWTH routes, viz., the voluntary retention route and the Table IV.7: Exchange Rate, Competitiveness special access route. The policy framework for and Exports Volume – FMOLS Estimates external commercial borrowings (ECBs) has been Dependent Variable: LEXPVOL liberalised since 2015, particularly in terms of end- Total panel (balanced) observations: 531 Long-run covariance estimates use restrictions with regard to working capital, (Bartlett kernel, Newey-West fixed bandwidth) general corporate purposes and repayment of Variable Coefficient t-Statistic Prob. Rupee loans availed domestically for capital LREER -0.22 -2.41 0.02 expenditure subject to certain conditions. The LWGDP 0.59 7.03 0.00 ERVOL -1.62 -1.82 0.07 liberalised policy framework allows greater access LFDI 0.10 2.72 0.01 to funds for corporates and non-banking finance D(GCI) 0.14 1.64 0.10 companies. Policies need to sustain the emphasis Adjusted R-squared 0.97 on composition of capital flows, while prioritising Note: A majority of panel unit tests confirmed the presence of common unit root process. Panel Cointegraton tests, viz., Pedroni equity over debt flows (Box IV.5). and Kao Cointegration Test confirmed the cointegrating relationship. IV.46 Exchange rate is another key factor a fully modified ordinary least squares (FMOLS) that can affect the viability of external sector by approach for the period 2010-20, which suggests influencing not only the trade performance of firms, that sustained real appreciation of the exchange but also their ability to undertake investments, rate and increase in volatility have contractionary especially those with foreign currency liabilities impact on export volumes (Table IV.7). Other on their balance sheets. A panel cointegration control variables, viz., LWGDP, LFDI and D(GCI) relationship between export volume (LEXPVOL) have export boosting effects. of 59 countries and their respective real exchange rates (LREER) and nominal exchange rate IV.47 Empirical research has shifted focus to volatility (ERVOL), world demand (LWGDP) and firm level analysis where endogeneity between other competitiveness variables [viz., foreign exchange rate and export decisions of firms is direct investment (LFDI) and progress in global less of a concern (Forbes, 2002; Fitzgerald and competitiveness index (GCI)] is estimated by using Haller, 2010 and Campa, 2004) (Box IV.6). Box IV.6 Impact of Exchange Rate Movements on Exporting Firms Using data up to March 2020, an unbalanced panel is set or average exchange rate volatility at time t; is a vector up consisting of 11,075 exporting firms, of which 3,187 firms of other macro variables which may affect the outcome exported services and the rest were exporters of goods. The variables such as global GDP growth, inflation rate, etc.; sample accounts for about 44 per cent of India’s total goods is a time varying firm level variable which may affect and services exports.The following fixed effects (FE) model the outcome variables such as gross sales (it is taken at one is estimated : period lag to ensure there is no reverse causality); is time trend and are idiosyncratic errors. ...(1) Estimation results indicate that while exchange rate volatility where, is a firm level outcome such as export earnings, has an adverse effect on export earnings of firms, the operating profit, interest payment on foreign currency loans, level of the exchange rate does not affect export earnings and addition to gross fixed capital; is the independent variable of interest which is log of average exchange rate (Contd...) 111REPORT ON CURRENCY AND FINANCE Table 1: Effect of Exchange Rate Volatility and In terms of size of firms, the effect of volatility is observed Depreciation on Exporting Firms for export earnings of larger firms while no statistically significant effect is observed for small firms. Earnings Earnings from Export from Export Analysis of firms’ profits reveals that both the level of the Average INR Volatility (In Log) -4.2292*** NA exchange rate and exchange rate volatility affect profits (1.3562) of exporters, with the effect of volatility being smaller Average INR-USD (In Log) NA -7.3396 than the exchange rate level (a 10 per cent increase in (5.9854) volatility decreases profits by 3 per cent, while a 10 per Average Inflation Rate 0.1937 -0.3336 cent depreciation of INR against the US dollar decreases (0.3111) (0.2356) profit by 21 per cent). This may be explained by the fact Global GDP Growth 0.2058** 0.2905*** (0.0984) (0.1070) that exchange rates movements may affect the cost of Firm Size (Lag of Annual Sales) 0.4718*** 0.4717*** borrowings for firms which have foreign debt. Estimation (0.1344) (0.1345) results indicate that depreciation of exchange rate N 50423 50423 increases the interest payments on foreign loans although Notes: The regressions are run on a nineteen-year panel of firms volatility has no significant effect (Table 2). The impact of (unbalanced) with firm level fixed effects. Errors are clustered at the exchange rate volatility on investment decisions of firms firm level. *p < 0.1, **p < 0.05, ***p < 0.01. is also investigated but it is not found to be statistically significant. (Table 1). A 10 per cent increase in average exchange rate The estimation results, thus, indicate that export performance volatility decreases export earnings by 1.6 per cent. Among of firms is affected more by exchange rate volatility than the other macro-economic variables, the effect of global by exchange rate levels. This is in line with the findings of GDP growth is positive and significant. Cheung and Sengupta (2013) which used firm level data Analysing sectorally. the effect of volatility is found to be and found that both exchange rate and its volatility have an similar in magnitude for goods and services exporting firms. impact on firms’ output and exports. Table 2: Effect on Firms’ Profit and Cost of Debt Operating Profit Operating Profit Interest Payments on Interest Payments on (INR) (INR) Foreign Loans Foreign Loans Average INR Volatility (In Log) -219.3699* 0.0505 (127.8230) (0.6233) Average INR-USD (In Log) -1422.3789*** -1.9530** (366.8112) (0.8820) Average Inflation Rate 45.8780*** 1.7925 0.0465 0.0190 (13.7187) (14.0050) (0.0487) (0.0296) India GDP Growth 9.2388 15.0752 -0.0866 -0.1010** (15.4392) (12.7094) (0.0983) (0.0501) Global GDP Growth 6.9624 7.2449 -0.0009 -0.0041 (4.6268) (5.2356) (0.0135) (0.0156) Firm Size 0.0507*** 0.0507*** 0.0021*** 0.0021*** (Lag of Annual Sales) (0.0004) (0.0186) (0.0005) (0.0000) N 65832 65832 15274 15274 Notes: The regressions are run on a nineteen year panel of firms (unbalanced) with firm level fixed effects. Errors are clustered at the firm level. *p < 0.1, **p < 0.05, ***p < 0.01. Reference: Cheung, Yin-Wong and Rajeswari Sengupta (2013), “Impact of exchange rate movements on exports: An analysis of Indian non-financial sector firms”, Journal of International Money and Finance, Vol. 39, Issue C, pp. 231-245. 112HARNESSING OPEN ECONOMY VISTAS FOR FASTER GROWTH 5. Conclusion India’s recent focus on having bilateral FTAs with the USA, the UK, the European Union and IV.48 Enhancing the contribution of exports and Australia is a step in the right direction, though capital flows to economic growth in the medium- rebalancing in trade strategies is required keeping term would require a strategic policy reset based in view the changes taking place in the global on India’s own experience so far as also the economic environment. The focus of bilateral evolving global macro-economic conditions and trade agreements with these advanced countries changing trade policy practices. Growing incidents should be bilateral technology-sharing and forging of geo-political conflicts can have economic partnership/alliance in sectors where indigenous repercussions by strengthening the case for a capabilities may be weak. As the global trade reconfiguration of global supply chains. India’s environment is becoming increasingly complex foreign trade policy, therefore, needs to recognise and prone to more disputes, rules and provisions the opportunities that may come along with the with regard to digitally enabled trade, data security evolving world economic order. issues and intellectual property rights should get IV.49 In order to benefit from the global recovery adequate coverage in trade agreements. in demand post-pandemic, certain preconditions IV.52 While incentivising domestic production such as improving the quality of exports through through various initiatives under Atmanirbhar greater emphasis on innovations and R&D, Bharat to enhance export potential, it is important easier access to critical inputs - both domestic and imported - exchange rate stability and more that global quality benchmarks are put in place for effective FTAs based on trade complementarities new capacities to be created in identified sectors would be essential. under the PLI scheme. IV.50 The growing focus on digitalisation offers IV.53 Globally, it is well recognised that lower immense opportunities. The early adopters of tariffs and easing of non-tariff measures can help frontier technologies will have the first mover a quicker global trade recovery. India has a strong advantage by becoming more cost efficient. services sector that contributes significantly to Small- and medium-sized businesses would need India’s total exports but faces Non-tariff Barriers to gain access to global markets by using digital (NTBs) in other countries. In order to expand platforms and improving operational and supply exports, India needs to rationalise its tariff and chain efficiencies. Therefore, the foreign trade non-tariff rate structure on a reciprocal basis, and policy needs to foster the adoption of technologies this should be accorded priority under the ongoing that enhance the scope for complementarities FTAs. between goods and services. IV.54 Greater absorption of foreign capital in IV.51 India’s ongoing and future FTA negotiations the economy for productive investment within the must focus not only on securing greater market current sustainable level of CAD and raising the access for domestic goods and services but also sustainable threshold for CAD in the medium-run on better trade terms for high quality imports from through higher FDI flows and export conducive partner countries and transfer of technology. The imports can raise the benefits of financial openness capital goods content in imports of major export- for India. When foreign exchange reserves exceed led economies is much higher than that of India. a certain precautionary level, further easing of 113REPORT ON CURRENCY AND FINANCE outward FDI norms and incentivisation of capital Barro, R. and X. Sala-I-Martin (1995), Economic goods imports can contain the fiscal (sterilisation) Growth, McGraw-Hill, New York. cost and/or appreciation pressure on the INR. It Bhanumurthy, N. R., Sukanya Bose and can also help strengthen India’s linkage in GVCs Swayamsiddha Panda (2014), “Modeling India’s through a combination of trade and strategic External Sector: Review and Some Empirics”, partnerships abroad. NIPFP Working Paper No. 2014-138. IV.55 The growth inducing impact of FDI is higher Blomström, M., A. Kokko and M. Zejan (1994), than foreign debt flows. Despite significant easing “Host Country Competition and Technology of norms (limits and routes), FDI inflows in the Transfer by Multinationals”, Weltwirtschaftliches manufacturing sector remain modest compared Archiv, Band 130, pp. 521-533. with the services sector. Relative to the size of the economy, FDI inflows in India are also much lower Blomström, Magnus, and Ari Kokko (2002), “The than export-led economies. 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The established mechanisms of IBC, NARCL and NaBFID need to be harnessed more efficiently while lenders need to accept haircuts to kick-start the economic recovery process. Deeper and more vibrant corporate debt and stock markets will go a long way in channelising resources for growth. The long strides taken in the digital finance arena need to be leveraged to promote growth, bolster financial inclusion, and combat inequalities. In the cascade of policy priorities, greater focus needs to be given to green finance to achieve the goal of ‘Net Zero’ by 2070. 1. Introduction and productivity enhancement become more pronounced when stock markets are active V.1 The Indian financial sector came under and developed (Botev et al., 2019). In the severe stress during the pandemic. With recent period, innovations in the realm of digital illiquidity and risk aversion becoming pervasive payments and FinTech — such as alternative and heightened uncertainty clouding the near- lending, platform-based insurance, online trading, term outlook for income and employment, the electronic remittances, crowd funding, robo- Reserve Bank faced the twin challenge of advisory services, etc. — have made banks and preserving financial stability and mitigating the other financial institutions more efficient. A new ravages of COVID-19. Through conventional and breed of peer-to-peer lenders (P2P) has emerged, unconventional measures, financial conditions meeting the credit requirements of marginalised were quickly eased to avert liquidity concerns borrowers. FinTech is also becoming instrumental while supporting business continuity and recovery. in providing a range of non-financial services, Regulatory measures were carefully calibrated enabling a seamless customer experience to to shore up the health of the financial system. users via integration with application software As the Indian economy recovered from the deep (Bank of Japan, 2018). recession in H1:2020-21, an advocacy started V.3 The major motivation of this Chapter is to to gain ground for pursuing a finance-led growth assess the sustainability of a finance-led growth strategy, accompanied by necessary reforms strategy and suggest reforms that could enhance (Panagariya, 2020; Kant, 2019). the contribution of finance to growth post-COVID. V.2 Banking and market finance often The chapter begins by assessing the impact of complement each other and the positive effects COVID on the financial system in Section 2. India of bank credit on growth, capital accumulation, specific financial intermediation challenges faced This chapter has been prepared by a team comprising Saurabh Ghosh, Snehal S. Herwadkar, Radheshyam Verma, Pawan Gopalakrishnan, Abhinandan Borad, Rajas Saroy and Vidya Kamate. The authors are grateful to Dr. Michael Debabrata Patra for his encouragement and constructive comments. Data support provided by Mayuri Chaturvedi is gratefully acknowledged. 117REPORT ON CURRENCY AND FINANCE in the pre-COVID period, which may continue to Chart V.1: Impact of COVID on Financial Intermediation constrain the contribution of finance to growth post-COVID, are set out in Section 3. Section 4 elaborates various policy options available at this juncture to manage challenges faced by the financial sector. Recognising that the pandemic coincided with the beginning of a new digital finance era, Section 5 evaluates its potential contribution to financial inclusion and growth. As India grapples with climate change risks and strives towards ‘Net Zero’ by 2070, green finance will require greater policy attention, which is addressed in Section 6. Finally, Section 7 concludes the chapter with a discussion on the way forward. Source: Quarterly Statistics on Deposit and Credit of SCBs. 2. COVID Impact on the Indian Financial System temporary relief to borrowers as well as lenders, V.4 As a first reaction to the pandemic-related although some banks faced depleted profitability. lockdowns, supply chains froze, demand declined, Banking stocks were affected particularly adversely and precautionary/ forced savings increased due as compared to other sectors, as markets priced in future asset quality deterioration, affecting to lack of opportunities to spend, particularly on shareholder wealth and confidence (RBI, 2021a). contact-intensive services. The confluence of these factors resulted in a sharp decline in credit V.5 Dispelling market concerns about potential growth even as deposits increased, affecting financial stability risks, banks’ gross as well as net banks’ net interest margins (Chart V.1). A fall in non-performing assets (NPAs) have moderated yields in the bond market provided a silver lining, while provision coverage ratios (PCRs), capital as banks booked profits on their trading accounts. buffers as well as profitability indicators have Measures such as loan moratorium, asset quality improved in 2021-22, relative to pre-pandemic standstill and restructuring of loans provided levels (Table V.1). Table V.1: Impact of COVID-19 on Key Banking Indicators (Per cent) Indicators Public Sector Banks Private Sector Banks Scheduled Commercial Banks Mar-20 Mar-21 Dec-21 Mar-20 Mar-21 Dec-21 Mar-20 Mar-21 Dec-21 Capital to Risk Weighted Assets Ratio (CRAR) 12.9 14.0 14.3 16.6 18.4 18.2 14.8 16.3 16.3 GNPA Ratio 10.8 9.4 8.2 5.1 4.7 4.2 8.3 7.3 6.5 NNPA Ratio 4.0 3.2 2.7 1.4 1.4 1.2 2.9 2.4 2.0 Provision Coverage Ratio (Without write-off adjusted) 64.2 66.4 67.8 72.6 70.9 73.1 66.2 67.4 69.1 Return on Assets (RoA) -0.29 0.29 0.54 0.51 1.22 1.32 0.11 0.70 0.86 Return on Equity (RoE) -4.23 4.62 8.30 4.47 10.50 11.08 1.21 7.88 9.36 Source: Supervisory Returns. 118THE ROLE OF FINANCE IN REVITALISING GROWTH Chart V.2: Stress in Large Borrowal Accounts Chart V.3: Stock Indices-Movements Note: RSA: Restructured standard advances; SMA-1: where principal or interest payment was overdue for 31-60 days; SMA-2: where principal or interest payment was overdue for 61-90 days. Source: Supervisory Returns. Source: Bloomberg. V.6 A closer look at granular data, however, the healing impact of these measures on financial reveals a more nuanced picture. Despite market conditions and borrowing costs of agents the recovery in economic activity since in the economy. Event study analysis around the H2:2020-21, credit growth remains muted, announcement dates for Operation Twist (OT) and indicative of pandemic scarring as also risk Long-Term Repo Operations (LTROs) indicates aversion of banks. Although non-banking financial that these operations led to a significant reduction companies (NBFCs) stepped up their lending in G-sec yields (Das et al., 2020). Moreover, operations during the pandemic period, concerns the OT announcements helped reduce the term have emerged about their asset quality. Under spread between 10-year and 1-Year G-secs, the Reserve Bank’s resolution framework 1.0 and thereby, flattening the yield curve (Talwar et al., 2.0, the restructured standard advances of large 2021). borrowal accounts have increased as compared V.8 The Indian equity market witnessed a to the pre-pandemic level (Chart V.2). As support V-shaped recovery with the BSE Sensex and measures start unwinding, their asset quality will Nifty 50 doubling by February 2021 from their become clearer and some of them may require March 2020 lows (Chart V.3). The buoyant additional provisioning. secondary market conditions reduced risk V.7 The COVID outbreak stifled risk appetite, perceptions and enabled companies to tap resulting in a hardening of money market rates, resources from the primary market, particularly widening of risk spreads, and a drop in equity from June 2020. Resource mobilisation market indices. The Reserve Bank responded through Initial Public Offerings (IPOs), Follow- proactively with a flurry of policies aimed at easing on Public Offerings (FPOs) and Rights financial conditions while maintaining macro- Issues increased to record levels (Chart V.4). financial stability. Empirical research highlights Stock market valuations measured by P/E ratio, 119REPORT ON CURRENCY AND FINANCE Chart V.5: Corporate Bond Market a. Corporate Bond Issuances b. Corporate Bond Issuances by Lower Rated Borrowers 60000 1000 900 50000 800 40000 700 600 30000 500 400 20000 300 10000 200 100 0 0 Source: SEBI, RBI, CSO, Prime Database, Crisil and RBI Staff Calculations. 120 erorC(cid:2) 11-0102 21-1102 31-2102 41-3102 51-4102 61-5102 71-6102 81-7102 91-8102 02-9102 12-0202 22-1202 BB/B/C:Amount Raised A/BBB:Amount Raised A/ BBB:No.of Issues(RHS) BB/B/C:No. of Issues (RHS) srebmuN V.9 In the post-pandemic period, the yields on Chart V.4: Resource Mobilisation through Public and Rights Issues of Equities corporate bonds fell to their lowest levels since 2004. The risk premium or spread on AAA-rated 3-year bonds (over 3-year G-sec) decreased from 122 bps to 23 bps for public sector undertakings, financial institutions and banks; from 203 bps to 37 bps for NBFCs and from 169 bps to 26 bps for corporates between March 2020 and March 2022. The narrowing of spreads was also visible across the rating segments of corporate bonds. Liquidity infusion by the Reserve Bank played a key role in supporting primary corporate bond issuances which increased to a record `7.82 lakh crore during 2020-21 before moderating to `6 lakh crore during 2021-22 (Chart V.5a). Further, the number of Sources: SEBI, CSO and RBI Staff Calculations. issuances by ‘A’ and ‘BBB’ rated borrowers market capitalisation to GDP ratio and the cyclically increased sharply during 2020-21 (Chart V.5b). adjusted ‘P/E 10’ (or the Shiller P/E ratio) reached Thus, Reserve Bank’s measures helped in above their respective long-term averages by bringing normalcy to various segments of financial the end of 2021 (RBI, 2021b). The recent price markets and eased financial conditions which, corrections have, however, moderated the in turn, helped in kick-starting growth engines valuations. through the financial channel (Box V.1).THE ROLE OF FINANCE IN REVITALISING GROWTH Box V.1 Financial Conditions Index (FCI) and Growth The FCI for India is constructed by applying three different Chart 1: Financial Conditions Index aggregation techniques, i.e., Principal Component Analysis (PC), Quasi Maximum Likelihood (ML) estimator, and Two- step Estimator (TS) approaches to monthly data from March 2003 to March 2022 covering a set of five different market- based indicators which are directly or indirectly affected by the Reserve Bank’s monetary and liquidity measures (Table 1). Among the indicators, the market sentiment index captures forward-looking market expectations. Each indicator has been standardised and transformed to ensure comparability across market indicators. A higher FCI indicates tighter financial conditions and vice versa. The outbreak of COVID-19 immediately resulted in a surge in spreads and volatility. In response to the monetary, liquidity, regulatory and fiscal stimulus measures, there Source: RBI Staff Calculations. was a sharp decline in the FCI, indicative of easing of the immediate aftermath of the global financial crisis (GFC) financial conditions, similar to what was last witnessed in (Chart 1). Table 1: List of Variables used for FCI The empirical strategy adopted for evaluating the relationship between FCI and GDP is as under: Components of Measures of each component (and Source) FCI Term/Risk Term spread: 10-Yr G-Sec Yields minus 91 Day where, is the (i) seasonally adjusted, year-on-year Spreads T-bill rate (Bloomberg) growth in GDP in quarter t, (ii) seasonally adjusted, Corporate Spread: 5-Yr AAA Yields minus 5-Yr annualised quarter-on-quarter rate of growth in quarterly G-Sec Yields (Bloomberg) GDP in quarter t; FCI is the value of the FCI in quarter t t and h is the forecast horizon (Table 2). Market Volatility/ India’s Economic Policy Uncertainty [EPU] Sentiment (Baker et al., 2016) The results show that for every 1 percentage point easing of financial conditions, y-o-y GDP growth is estimated to Liquidity Weighted average call rate (WACR) minus improve in the range of about 1.1 to 1.3 percentage points; Repo Rate (Bloomberg) thus, the GDP growth would have been lower by about Exchange Rate Bilateral INR/USD exchange rate (Bloomberg) 1.1 to 1.3 percentage points without the support of easy WACR Weighted average call rate (DBIE) financial conditions. Table 2: Regression Results (1) (2) (3) (4) (5) (6) GDP Y-o-Y GDP Y-o-Y GDP Y-o-Y GDP Q-o-Q GDP Q-o-Q GDP Q-o-Q Seasonally Seasonally Seasonally Seasonally Seasonally Seasonally Adjusted Adjusted Adjusted Adjusted Adjusted Adjusted Own Lag 0.64*** 0.64*** 0.60*** -0.04 -0.04 -0.05 (0.088) (0.088) (0.089) (0.121) (0.121) (0.121) FCI_ML(-1) -1.11*** -2.88*** (0.385) (1.302) FCI_TS(-1) -1.12*** -2.96*** (0.383) (1.292) FCI_PC(-1) -1.26*** -3.15*** (0.386) (1.288) Constant 2.74*** 2.75*** 2.99*** 7.87*** 7.96*** (0.693) (0.693) (0.701) (1.17) (1.164) Note: Reduction of FCI indicates easing financial conditions. Reference: Baker, S. R. Bloom, N., & Davis S. J. (2016), “Measuring economic policy uncertainty’’, The Quarterly Journal of Economics, 131(4), 1593 - 1636. 121REPORT ON CURRENCY AND FINANCE 3. Pre-COVID Financial Intermediation Chart V.6: Flow of Resources-to-GDP Gap Challenges V.10 The pandemic’s financial fallout was superimposed upon some pre-existing vulnerabilities in India’s financial sector. Using a broader measure of flow of resources to commercial sector1 – rather than only bank credit – as recommended by the Basel Committee on Banking Supervision (2011), it is observed that India’s credit to GDP gap2 has been negative in most of the quarters since 2014 (Chart V.6). Year V.11 For more than a decade, India’s saving Flow of Resources to GDP ratio (RHS) HP Trend (RHS) rate, especially from the general government, has HP Gap been declining, with an 18-year low in 2020-21 Source: RBI Staff Calculations. (Chart V.7a). Moreover, the corporate sector’s demand for credit from the banking sector has V.12 Close to 35 per cent of corporate debt decelerated partly reflecting subdued GDP growth liability is owed to banks (Chart V.8a). Indian (Chart V.7b). corporates deleveraged during the pandemic Chart V.7: Trends in Savings and Deposits a. Savings to GNDI Ratio b. Deposit and Credit of Corporates Source: National Statistics Office. Source: RBI. 1 Taking into account credit from banking sources alone while neglecting other sources may lead to overestimation of credit gap. In order to correct this potential bias, debt and equity issuances by non-financial entities, net commercial paper issuances, credit from NBFCs, foreign direct investment, short-term trade credit from abroad and external commercial borrowings were also incorporated to create a broader definition of finance. 2 The credit to GDP gap is defined as the deviation of the flow of resources to GDP ratio from its long-term trend. It identifies any build-up of excess/shortfall in credit growth in the economy. 122THE ROLE OF FINANCE IN REVITALISING GROWTH Chart V.8: Corporate Leverage in India a. Composition of Debt of Indian’s Non-Financial Firms b. Debt-Equity Ratio 1.5 1.4 1.3 1.2 1.1 1 0.9 0.8 Source: CMIE. benefitting from the low-cost ample liquidity underlying assumptions about variables, conditions created by the Reserve Bank sample period for estimation, and the choice of (Chart V.8b). In the recovery from the pandemic, methodology. larger corporates with better balance sheets will V.15. After reaching a peak of 11.2 per cent in most likely move towards greater equity and low- March 2018, the GNPA ratio declined mainly due cost debt finance. Banks’ lending operations may to the resolution of stressed assets under the get skewed towards smaller and more financially Insolvency and Bankruptcy Code (IBC). Write- weaker borrowers. offs of bad loans also contributed to the decline V.13. The credit boom during 2003 to 2007 of stock of GNPAs. Although the GNPA ratio is and the bust post-GFC suggests that beyond a threshold, the credit cycle generally turns down and amplifies build-up of stress in the banking sector (Chart V.9). Empirical evidence suggests that in the case of India these thresholds range from 16 per cent to 18 per cent credit growth, controlling for various macroeconomic factors (Box V.2). V.14 Empirical estimates based on the average credit-to-GDP ratio (0.5), and lost growth over two years due to the pandemic led disruptions, suggest that an annualised growth of around 13 per cent in non-food bank credit will be required to achieve the target of US$ 5 trillion economy by 2026-27 – well within the estimated threshold. These estimates are, however, sensitive to 123 10-0002 20-1002 30-2002 40-3002 50-4002 60-5002 70-6002 80-7002 90-8002 01-9002 11-0102 21-1102 31-2102 41-3102 51-4102 61-5102 71-6102 81-7102 91-8102 02-9102 12-0202 Chart V.9: Credit Growth and Banking Sector Stress 14 35 12 30 10 25 8 20 6 15 4 10 2 5 0 0 Source: RBI Staff Calculations using Supervisory Data. tnecreP 2002-30-13 3002-30-13 4002-30-13 5002-30-13 6002-30-13 7002-30-13 8002-30-13 9002-30-13 0102-30-13 1102-30-13 2102-30-13 3102-30-13 4102-30-13 5102-30-13 6102-30-13 7102-30-13 8102-30-13 9102-30-13 0202-30-13 1202-30-13 1202-21-13 tnecreP High Credit Increasing Stress Growth Restructured Standard Advances Ratio GNPA Ratio Growth inCredit (Y-o-Y) (RHS)REPORT ON CURRENCY AND FINANCE Box V.2 Optimal Credit Growth in India What is the threshold level of credit growth up to which it Table 1: Optimal Credit Growth fuels economic growth but beyond which it results in a build- Model 1 2 3 4 up of systemic risks? To answer this question, bank-level quarterly data from the Reserve Bank’s Basic Statistical Dependent variable = Gross NPA Ratio Returns (BSR) and Off-Site Surveillance and Monitoring lag (t-i) (t-2) (t-3) (t-4) (t-5) System (OSMOS) for 29 Indian banks from 2005 to 2021 was employed. Chart 1 shows that PSBs consistently had Bank Credit -0.08*** -0.06*** -0.03* -0.03* Growth (.02) (0.02) (0.02) (0.02) higher NPA ratios as compared with their private sector (t-i) (Bank Credit 0.0003*** 0.0003*** 0.00015** 0.00012* counterparts. Growth )2 (0.00) (0.00) (0.00) (0.00) (t-i) A panel regression is run to empirically evaluate the Control variables relationship between gross NPAs and credit growth while CRAR -0.25* -.35** -0.40*** -0.45*** controlling for various macroeconomic as well as bank- (0.13) (0.14) (0.15) (0.16) specific factors, such as capital to risk weighted assets ratio Return on Assets -3.02*** -3.00*** -2.96*** -2.81*** (CRAR), return on assets (RoA), operating expenses, and (RoA) (0.27) (0.28) (0.33) (0.32) the asset size of banks3. The results confirm the existence of Log Total Assets -0.44* -0.57** -0.67** -0.71** (Size) (0.27) (0.25) (0.27) (0.29) a non-linear relationship between GNPA and credit growth. Log Operating 0.07 As expected, the results also show that a higher capital Expenses (0.16) adequacy ratio, higher return on assets, size (measured by GDP Growth 0.02 0.04 0.01 0.01 (t-i) total assets), and lower operating expenses are associated (0.02) (0.02) (0.01) (0.03) with lower GNPA ratio (Table 1). Dummies: Results of a threshold regression in line with Wang (2015) Demonetisation 1.79*** 1.83*** 2.06*** 2.14*** suggest that there is no single global minimum but an ‘elbow Dummy (0.41) (0.43) (0.45) (0.47) curve’ exists, with multiple turning points in the range of 16 AQR Dummy 1.73*** 1.99*** 2.18*** 2.27*** (0.59) (0.51) (0.55) (0.52) to 18 per cent credit growth, beyond which, credit growth Constant 15.34 18.10 19.5 20.4 may lead to a rise in GNPA ratio. This is not surprising R2 0.69 0.65 0.61 0.60 No. of observations 1,484 1372 1260 1148 Chart 1: Bank Credit Growth (Y-o-Y) and Gross Prob>P 0.00 0.00 0.00 0.00 NPA Ratio: 2015-2021 Note: Growth: Y-o-Y growth in per cent; Parenthesis values report standard errors. since the period under consideration was characterised by structural regime shifts such as the Global Financial Crisis (GFC). Thresholds are lower for public sector banks (PSBs) than private sector banks. Although PSBs still claim the lion’s share in outstanding credit, much of the weakening of incremental momentum in total bank credit flows has occurred against the backdrop of elevated stressed assets in their balance sheets. Private sector banks (PVBs) have used this opportunity to increase their share in lending. Reference: Note: The blue-colored marks represent private sector banks, and the red- coloured marks represent public sector banks. Wang, Q. (2015), “Fixed-Effect Panel Threshold Model using Source: RBI Staff Calculations. Stata”. The Stata Journal, 15(1), 121-134. 3 To control for omitted factors that could result in biased coefficient estimates, a fixed-effects panel regression model is considered over random effect or pooled model and a 1 per cent trimmed dataset is used to rule out effects of outliers. 124 )tnec rep ni( secnavdA ssorG ot APNG Credit Growth (Y-o-Y)THE ROLE OF FINANCE IN REVITALISING GROWTH declining and provision coverage ratio is inching increasingly skewed towards investment in up, the stock of unresolved NPAs in banks’ Government securities and lending to retail balance sheet remains high. sector (Chart V.10b and Chart V.11a). While G-sec is a low risk investment, it carries the risk V.16 Latest stress test analysis in the Financial of transforming the system into ‘G-sec investment Stability Report, December 2021 suggests that oriented banking’ if sustained for a long period. banks’ GNPA ratio may be in the range of 8.1 Lending to retail sector yield comparatively better (baseline) - 9.5 (under severe stress) per cent by returns. However, its multiplier impact to kick- September 2022, from 6.5 per cent in December start economic growth is likely to be less than 2021, which will raise banks’ provisioning and, credit to industries. Moreover, rising NPAs in in turn, capital requirements. While regulatory the retail segment is another source of concern requirements like COVID-19 provisions and (Chart V.11b). restrictions on distribution of dividends have helped in boosting the provision coverage ratio, V.18 The corporate bond market in India has further capital infusion by the Government coupled been mostly restricted to top-rated bonds. 97 per with proactive resource raising efforts by banks cent of the issuances and trading in corporate bond would be necessary for strengthening their capital market is in just the top three rating categories of buffers. AAA, AA+ and AA. In contrast, in the US, only V.17 Increased provision and capital buffer 5 per cent of the corporate bond market trading requirements, which are essential for financial occurs in the top rating buckets of AAA and AA stability can lead to risk aversion in banks, and around 75 per cent of the trading happens in partially dampening credit growth (Chart the next three rating buckets of A, BBB and BB V.10a). In addition, banks’ portfolios are getting (Tyagi, 2020). Chart V.10: SCBs’ Investment and Credit a. Risk Aversion in Indian Banking b. Investments in G-Secs 25 23.0 20 22.5 22.0 15 21.5 10 21.0 5 20.5 0 20.0 Source: RBI. 125 tnecreP 11-raM 21-raM 31-raM 41-raM 51-raM 61-raM 71-raM 81-raM 91-raM 02-raM 12-raM tnecreP Y-o-Y growthin G-SecInvestments InvestmentsinG-Secs as%of TotalAssets(RHS)REPORT ON CURRENCY AND FINANCE Chart V.11: Sectoral Credit and Retail NPAs a. Credit Growth in Select Sectors b. Asset Quality of Retail Loans Source: RBI. 4. Reinvigorating Credit Growth – Policy coupled with the Insolvency and Bankruptcy Options Code (IBC), provide a framework for time-bound resolution through collective decision making by V.19 Empirical evidence suggests that while the creditors. During October-December 2021, low-cost liquidity may be necessary, that alone is 195 fresh cases were invoked under the IBC, often not sufficient for ensuring a robust recovery in marginally above the number of cases invoked in credit growth; rather, it also hinges on how quickly the two preceding quarters. Out of these, around the banking sector is de-stressed (Bhadury et al., 58 per cent cases were invoked by operational 2021). creditors while 35 per cent were initiated by financial creditors. Debt Restructuring V.22 The IBC has, however, faced its share V.20 World over, debt restructuring is used of teething troubles. Despite the central theme to help corporates weather financial crises. The being speedy resolution to kick-start the economic challenges are how to facilitate and incentivise growth cycle as opposed to ‘creative destruction’ timely debt restructuring while distinguishing through liquidation, 46.6 per cent cases resolved viable firms from the rest and how to attract new so far had to resort to liquidation. Also, as against capital. In India, the overall extent of restructured the deadline of 330 days, average time taken by accounts post-pandemic increased but still has cases for resolution was 512 days. remained low as compared to historical highs (Chart V.9). V.23 In the pre-pandemic period, the recovery rate4 under IBC was 46.0 per cent,5 which Insolvency and Bankruptcy dropped to 20.2 per cent6 during 2020-21, partly V.21 The Reserve Bank’s Prudential Framework reflecting suspension of initiation of fresh cases as 4 Since inception of IBC. 5 Insolvency and Bankruptcy Board of India Quarterly Newsletter, January-March, 2020. 6 RBI (2021a). 126THE ROLE OF FINANCE IN REVITALISING GROWTH also the overall economic slowdown. Data for the Chart V.12: NPA Recovery Channels pre-pandemic period suggests that realisation by (Amount recovered as per cent of amount involved) financial creditors varies significantly across firms 90 and sectors; typically, sectors deemed to have 80 70 better economic prospects, and companies which 60 have good organisational value received higher 50 realisations. As the contact sensitive industries 40 felt the brunt of the pandemic most severely, 30 realisation from them may be much lower than the 20 industry average, going forward. 10 0 V.24 There is a need to expand the ambit of pre-pack mechanism, presently available to MSMEs, to larger corporates. This mechanism combines the cost-effective nature of out-of-court Source: Report on Trend and Progress in Banking in India, settlements with the legal sanctity available in the various issues. IBC framework. V.25 Another major hurdle faced by the IBC was significantly higher in the initial years of process is lack of adequate infrastructure. their inception, in the recent years it dipped Although efforts have been made in recent years before getting revived to 41 per cent in 2020-21 to increase the number of National Company (Chart V.12). Law Tribunal (NCLT) benches and to train more V.27 Banks’ reluctance to assume haircuts, insolvency professionals, the capacity needs to be especially when the counterparty is a private enhanced further. ARC is one of the major hurdles behind subdued appetite for this route. As such, the ARC model Asset Reconstruction Companies (ARCs) and for debt resolution has had limited success in Bad Bank the Indian context. The recently established V.26 Apart from recovery through various National Asset Reconstruction Company Ltd. resolution mechanisms, banks also clean up (NARCL) has the potential to serve as an efficient balance sheets through sale of NPAs to asset mechanism to revive investor interest in primary reconstruction companies (ARCs) for a quick as well as secondary markets for stressed assets exit using provisions of the Securitisation and security receipts (SRs), respectively. Going and Reconstruction of Financial Assets and forward, however, continued policy support, Enforcement of Securities Interest Act, 2002 professional staff and transparency in operations (SARFAESI). While the amount recovered will be essential in making the exercise cost and through ARCs as per cent of amount involved time effective (Herwadkar et al., 2022). 127 tnecreP 40-3002 50-4002 60-5002 70-6002 80-7002 90-8002 01-9002 11-0102 21-1102 31-2102 41-3102 51-4102 61-5102 71-6102 81-7102 91-8102 02-9102 12-0202 Lok Adalats DRTs SARFAESIAct IBC TotalREPORT ON CURRENCY AND FINANCE Capital Infusion in Banks Bank Consolidation V.28 The Government has infused `2.9 lakh V.30 Notwithstanding some initial hiccups, crore in the last five years in PSBs, including factors like government ownership, similar pay the recapitalisation of ` 4,600 crores7 in 2021-22 structure and career progression avenues for (Chart V.13). This helped PSBs to improve their staff, and common core banking solutions helped CRAR to 14.3 per cent by December 2021 from smoothen the operationalisation of bank mergers 11.8 per cent in March 2016. Capital infusion has in India in recent years. Mergers helped strengthen also helped many weak PSBs to come out of the the capital buffers of banks. Although it is difficult prompt corrective action framework. to isolate the impact of mergers from other V.29 Absence of market discipline, implicit forces acting concomitantly, the improvement in government guarantees, and repeated provisions helped in containing the net NPA ratios unconditional recapitalisation of PSBs could (RBI, 2020c). pose a moral hazard problem. To deal with it, an V.31 In the Indian context, there are concerns incentive mechanism should be established and that such consolidation measures may increase banks with better performance in terms of loan the market power of merged institutions and could recovery and asset quality improvement should result in neglect of local needs leading to reduction be given priority in terms of access to fresh capital. in credit supply to some categories of borrowers, However, capital infusion should not become a particularly small firms, thereby, adversely affecting substitute for better governance and risk controls. financial inclusion8. Consolidation could also result in less competition by giving fewer choices to the Chart V.13: Capital Infusion by the Government in PSBs customer and may also result in non-competitive pricing of products. Going forward, to increase competition in the area and foster innovation, the Reserve Bank’s ‘on tap’ licensing policy for universal and small finance banks may be used effectively. The too-big-to-fail concerns will be addressed through additional Common Equity Tier-I (CET-I) capital requirements for domestic systemically important banks (D-SIBs). Development Financial Institutions V.32 While the existing financing models for Source: data.gov.in, Press Information Bureau and various Gazette infrastructure seem to be faltering, the credit notifications of Government of India. needs of the sector remain strong. Against this 7 The government had budgeted `20,000 crore for capital infusion in PSBs for 2021-22 which was revised to `15,000 crore in the revised estimates for 2021-22. The Government has infused `4,600 crore in Punjab & Sind Bank in February 2022 through non-interest bearing (non-transferable) special Government of India security. 8 RBI (2013), ‘Discussion Paper on Banking Structure in India - The Way Forward’, August. 128THE ROLE OF FINANCE IN REVITALISING GROWTH backdrop, the setting up of the National Bank volumes (Tyagi, 2020). There is a need to further for Financing Infrastructure and Development reduce the large number of International Securities (NaBFID) as a Development Financial Institution Identification Number (ISIN), facilitate more active (DFI) in India is expected to shift the burden of repo market and draw more players, particularly long-term financing away from commercial banks. institutional investors to improve liquidity in the Moreover, apart from extending long term credit, market. While institutional investors like insurance NaBFID is expected to play an active role in the companies, pension funds and provident funds development of bonds and derivatives market are typically allowed to invest in high-rated papers necessary for infrastructure financing. only, retail participation in the bond market is also limited in India, which needs to be enhanced. The V.33 International experience suggests that recent Credit Default Swaps (CDS) directions going forward, NaBFID will have to tread a fine issued by the Reserve Bank are expected to line between two contradictory goals: being go a long way in developing the corporate bond profitable as well as pursuing developmental market, especially the lower rated one, and pave goals of the economy. To meet the first goal, it the way for more and better resource allocation in will have to invest prudently and generate returns; long-term loan markets. on the other hand, balancing social and financial returns can be a complex, time-consuming, and V.35 Since inflows into debt markets help in sometimes contradictory affair, especially in light improving depth and liquidity, Foreign Portfolio of difficulties in measuring the social impact of a Investment (FPI) limit in government debt has project (Dickinson, 2019). been progressively expanded. Investment in State Development Loans (SDLs) has also been Development of Corporate Debt Market gradually liberalised to strengthen domestic V.34 Development of a vibrant corporate bond markets. FPI investment limits are under-utilised market in India remains crucial for meeting the due to liquidity considerations. The proposed financing requirement of corporates and the institutional framework to provide liquidity to mutual infrastructure sector and thereby achieving India’s funds and other participating institutional investors growth aspirations. In recent years, a slew of in the corporate bond market, particularly during reform measures have been undertaken in this times of stress, may instill confidence amongst area9. Despite these, the corporate bond market the market participants. A credit enhancement remains shallow and skewed in favor of larger mechanism offering partial or full guarantee on sized firms, high-rated and financial sector issuers corporate bonds can also help in moderating the (Ganguly, 2019). In the secondary bond market, risk perception of infrastructure projects to levels mutual funds are the only major active players, compatible with risk appetite of investors and contributing around 40 per cent of the trading attract greater fund flows. 9 These include, inter alia, introducing electronic book building mechanism for increasing transparency in the private placement market, tri-party repo trading on exchanges for encouraging trading interest, improving liquidity in secondary market trading through consolidation and re-issuances by the same borrower under the minimum number of International Securities Identification Numbers (ISINs) and mandating large corporates to raise one-fourth of their borrowings through the corporate bond market. 129REPORT ON CURRENCY AND FINANCE Development of Stock Market 5. Leveraging Digital Finance and Start-ups for Reinvigorating Growth V.36 Although India’s stock market capitalisation to GDP has witnessed a phenomenal rise, it is V.37 Digital finance encompasses a host of still lower than several other major economies, new financial products, financial businesses, suggesting an untapped potential of equity finance-related software, novel forms of customer markets in unlocking growth. Traditionally, Small communication and interaction delivered by and Medium Enterprises (SMEs) have relied FinTech companies and innovative financial on bank finance to meet their requirements, as service providers, which has been instrumental in they face several impediments in accessing the promoting growth, bolstering financial inclusion, equity market, such as admission cost and listing and combating inequalities (Gomber et al., 2017). requirements, lack of liquidity, educational gaps, Cross-country analysis indicates that increase in limited ecosystems, and tax treatment, all of digital financial inclusion is expected to boost real which require attention by regulators and policy GDP growth (Khera et al., 2021). makers alike (Nassr and Wehinger, 2016). The V.38 Digital lending allows lenders to grant establishment of the BSE SME platform in March collateral free loans while ensuring repayment 2012 and the NSE SME platform (also known as by relying on actual transaction data, individual Emerge) in September 2012 attempts to address characteristics, and repayment behaviour to these issues. Since the inception of these platforms, decide the borrower’s eligibility for loans. This may 633 small and medium companies have mobilised enable consumption smoothing of marginalised ` 7,777 crore of equity capital till 2021-22. These borrowers. In the US, FinTech lenders reduced developments could promote investment in SMEs processing time by about 10 days, or 20 per and, together with securitisation and other non- cent of the average processing time (Fuster bank debt financing instruments, encourage et al., 2019). In China, digital finance is found an enhanced allocation of risk and risk taking, to be positively correlated with food, clothing, thereby supporting growth. Going forward, with the house maintenance, medical care, education, proliferation of new age FinTech solutions resulting in ease of access, participation of individuals and entertainment expenditures (Li et al., 2020). in stock market may rise further, with greater Digital finance can also help boost output by allocation of their savings being channelised into making resource allocations easier. Many FinTech equity markets through direct participation as well companies provide working capital, relying on the as indirect participation through mutual funds. borrowers’ revenue or sales data to make their There has been a flurry of IPO listings of new- lending decisions. Digital lending can serve as an age technology companies on domestic stock alternate source of financing for capital strapped exchanges in 2021-22. As India is estimated Micro, Small and Medium Enterprises (MSMEs) to be the third largest start-up ecosystem in the that lack traditional collateral. Easing of MSME world (PIB, 2022), traction in their listings could be credit limits may have a positive influence on pivotal in India’s start-up growth story. general employment and equity. Governments 130THE ROLE OF FINANCE IN REVITALISING GROWTH may use FinTech to transfer salaries, conduct V.40 The Government of India played an active procurement, taxation, and payment for public role in the digital revolution, creating a robust and services through electronic modes. Adoption of highly scalable public infrastructure, popularly digital payment systems can induce increased known as India Stack, and incorporating data formalisation of enterprises (Klapper, 2019) and privacy and security in the design of these digital aid in combatting tax evasion. public goods (D’Silva et al., 2019). V.41 The Pradhan Mantri Jan-Dhan Yojana FinTech in India (PMJDY), launched in 2014, combined with a V.39 Over the past few decades, India has rapid reduction in mobile internet tariffs, and rising witnessed a remarkable growth in its digital interest of investors in Indian digital business, ecosystem, supported by a robust policy helped in expansion of access to financial services foundation, expansion of smartphones, internet (Chart V.14). The integration of Digital India coverage, digital literacy, as well as pro-active with real economic activity is expected to foster participation by the private sector (Saroy et al., technology-led economic growth. 2020; Gandhi, 2016). Banks and FinTech firms could be viewed as strategic complements, as Constraints to FinTech and Digital Payments they have different comparative advantages, and hence a collaborative partnership between the V.42 While digital finance can provide the two would permit them to focus on their respective much needed growth impetus, if unchecked, it core competencies (Mundra, 2017). The Reserve could result in certain concerns that need to be Bank, as the regulator and supervisor of the appropriately addressed. Since digital lending country’s payment and settlement systems, mainly originates from debt and equity rather than has been playing an active role in the digital from deposits, digital lenders’ supply of funds transformation of the country through timely and could be more procyclical and volatile due to calibrated impetus to payments infrastructure and lack of standard credit guidelines. Further, credit regulatory framework. activity outside the prudential regulation space Chart V.14: Moving towards Digital India a. Wireless Data Use and Tariff b. FinTech Funding in India 16 25 14 20 12 10 15 8 6 10 4 5 2 0 0 Source: Department of Telecommunications, GoI and Tracxn (accessed on April 5, 2022). 131 htnomrepresurepsetybagiG 71-nuJ 71-peS 71-ceD 81-raM 81-nuJ 81-peS 81-ceD 91-raM 91-nuJ 91-peS 91-ceD 02-raM 02-nuJ 02-peS 02-ceD 12-raM 12-nuJ 12-peS BG /` 1800 1600 1400 1200 1000 800 600 400 200 0 GB perSubcriber perMonth Tariff(RHS) )noilliM$SU( tnuomA 81-raM 81-nuJ 81-peS 81-ceD 91-raM 91-nuJ 91-peS 91-ceD 02-raM 02-nuJ 02-peS 02-ceD 12-raM 12-nuJ 12-peS 12-ceD 22-raMREPORT ON CURRENCY AND FINANCE could render credit-related countercyclical policies related disasters on the economy. Such risk less effective. evaluations, however, are complex as they must incorporate interactions among all the stakeholders V.43 Data privacy poses concerns in the having portfolio and balance sheet exposures to absence of adequate legislation and demarcation natural calamities and carbon pricing. of statutory rights and obligations of service V.46 The Reserve Bank has taken proactive providers and other stakeholders. Data mining policy measures to promote green finance. It has driven by sheer profit maximization objective joined the Central Banks and Supervisors Network could reproduce and perpetuate existing patterns for Greening the Financial System (NGFS) in April of discrimination and exclude vulnerable sections 2021. The Indian government has committed to (Barocas and Selbst, 2016). As the Indian reduce the total projected carbon emissions from population becomes data-rich with increasing now till 2030 by one billion tonnes, reduce carbon internet and mobile coverage, the next challenge intensity of the economy by more than 45 per might be empowering consumers through cent by 2030, and achieve ‘Net Zero’ emissions adequate legal and regulatory support. by the year 2070. The Reserve Bank is actively V.44 With increasing dominance of BigTechs in sensitising the public, investors and banks digital payments, there could be an acceptance of regarding the need, opportunities, and challenges data-fueled oligopoly for cheap services. Digital of green finance through its regular reports and literacy and healthy competition could alleviate other communications. The Google Trends Data, some of these concerns, and therefore, there is that analyses the popularity of top search queries a need for re-aligning incentives to foster smaller, in Google Search, indicate that awareness about more innovative firms (Saroy et al., 2020). Since green finance and climate risks has been gradually FinTech unbundles services across a wide improving in India (Chart V.15). number of domains, it is necessary to clearly V.47 The Reserve Bank has included small demarcate responsibilities of various regulators renewable energy projects under its Priority Sector over relevant aspects of the business entity and Lending (PSL) scheme in 2015, and its guidelines to ensure the existence of adequate avenues for were further revised in 2020 to suit market regulatory collaboration. This may be done with conditions. SEBI recently revised its sustainability the overarching goal of facilitating innovation and social responsibility reporting requirements through competitiveness, while ensuring a level for top-listed companies, starting in 2022-23. playing field. Future Environmental, Social and Governance (ESG) research will require authentic data, as well 6. Green Finance for Sustainable growth as benchmarks and alerts (Ghosh et al, 2021). V.45 For a smooth transition to ‘Net Zero’, V.48 Once the current health crisis ends, the green finance has become a public policy priority focus could shift to climate change and carbon world over as climate risks are believed to be far pricing (RBI, 2021d). The Union Budget for 2022-23 reaching, non-linear, and mostly irreversible in announced the issuance of sovereign green bonds nature. Appropriately adapted macro-financial as part of its overall market borrowing programme, models may help to generate and analyse various with revenues going to public sector projects that scenarios involving transition risks of climate- help reduce the economy’s carbon intensity. Given 132THE ROLE OF FINANCE IN REVITALISING GROWTH Chart V.15: Google Searches on Green Finance a. Google Search Related to Green Finance: b. Distribution of Keywords (per cent of total): 2013-2020 average India’s Comparative Score Source: RBI Staff Calculations using google search data. the large size of the domestic market and low V.51 The Reserve Bank has already taken penetration of green instruments, the potential for several regulatory initiatives aimed at promoting green finance is vast. Considering that a climate- sustainable finance, mitigating climate risk, related mitigation plan may result in a change and establishing the necessary foundations for in financial valuation or credit rating for certain conducting climate scenario analysis and stress business entities or sectors, a well calibrated policy testing. The stress tests could be designed by framework is required to pursue the target. using a Dynamic Stochastic General Equilibrium (DSGE) model capable of assessing the V.49 From a regulatory perspective, banks differential impact of climate risks on brown versus have a sizable portion of their portfolios invested green industries and banks. The other possibility in industries that are indirectly but heavily reliant is to harness machine learning algorithms for on fossil fuels. Several of these, including basic generating alternate stress scenarios. These metals, electricity, and textiles have a low interest exercises will provide an insight into possible coverage ratio and high outstanding NPAs. policy designs and implementation, paving the This underlines the vulnerability of the banking way for a sustainable and enduring recovery. sector to climate risks, that may require constant monitoring (Ghosh et al., 2022). 7. Conclusion and Way Forward V.50. Effective co-ordination among policy V.52 The pandemic’s financial fallout was stakeholders is essential to reduce information superimposed upon pre-existing vulnerabilities asymmetries. This can be accomplished through in India’s financial sector, constraining the dissemination of high-quality data by policymakers, possibility of a finance-led growth. The underlying stakeholders, and market participants. It would conditions are favourable and finance led growth significantly contribute to greater public awareness, is a viable option, but it must be driven forward reducing maturity mismatches, borrowing costs by strategic initiatives that rejig and convert pre- and re-establishing efficient resource allocation existing weaknesses as well as architecture into (Ghosh et al., 2021). opportunities. 133REPORT ON CURRENCY AND FINANCE V.53 Banks need to be de-stressed from legacy V.56 For the NARCL exercise to be cost burden and nudged to direct greater credit towards and time effective, continued policy support, productive sectors of the economy. Priority sector professional staff and transparency in operations norms and Statutory Liquidity Ratio (SLR) have will be essential. NaBFID will have to tread a been viewed by some analysts as preemptive, fine line between two contradictory goals: being distorting efficient resource allocation. While the profitable as well as pursuing developmental SLR requirements are being gradually reduced goals of the economy. It may avoid past mistakes to align them with the Liquidity Coverage Ratio of erstwhile development finance institutions to (LCR), reforms in the PSL space have been also rely on subsidised finance and instead focus undertaken. Of late, the PSL norms are used on developing the corporate debt market and to channel resources for a greener and more attracting resources from insurance, pension, and sustainable finance. provident funds. V.54 To avoid the moral hazard problem of V.57 Reforms in the corporate bond market government recapitalisation of PSBs, an incentive could aim at broadening the domestic and foreign mechanism should be established and banks with investors’ base, providing greater choices for better performance in terms of loan recovery and investment suitable for varying risk appetites and asset quality improvement should be given priority developing a liquid secondary market. in terms of access to fresh capital. However, V.58 New-age companies, which often have capital infusion should not become a substitute for riskier business models, are increasingly resorting better governance and risk controls. In the medium to IPOs. It is important to ensure adequate term, it is necessary to wean away PSBs from disclosures about risk factors affecting their their dependence on government recapitalisation; business to maintain investors’ confidence in the this will be an important pre-condition to achieve primary market. It is imperative for the regulator greater privatisation of the sector. To increase the to ensure transparency and good corporate competition in the banking sector and to introduce governance practices so that the secondary innovation, the Reserve Bank’s ‘on tap’ licensing market functions smoothly, and the process of policy for universal and small finance banks may IPO is not used only as an exit mechanism. be used effectively. V.59 Going forward, the economy’s growing V.55 For quicker and more effective resolution, reliance on the digital ecosystem will be the IBC infrastructure needs to be strengthened by helpful in harnessing the benefits of low-cost increasing the number of NCLT benches and by resource allocation and distributive efficiency. training more insolvency professionals. Lenders Care however needs to be taken to protect the need to accept haircuts to kick-start the economic stakeholders from digital frauds, data breaches recovery process. The pre-pack mechanism— and digital oligopolies. Recognizing the vastly which combines the cost-effective nature of altered financing requirements of start-ups out-of-court settlements with the legal sanctity and unicorns, a policy framework for attracting available in the IBC framework—is presently risk capital needs to be put in place. While the available to MSMEs. It needs to be extended to financial sector withstood the pandemic shock larger corporates as well. well, climate change risks and frequent natural 134THE ROLE OF FINANCE IN REVITALISING GROWTH calamities call for inclusion of green finance and Fuster, A., M. Plosser, P. Schnabl, J. Vickery, other sustainable growth objectives in financial (2019). The Role of Technology in Mortgage sector policies. These measures are expected to Lending. The Review of Financial Studies. 32(5), pave the way for a more developed and efficient 1854–1899. doi: https://doi.org/10.1093/rfs/ financial system, which in turn should help in hhz018 greater financial inclusion, reduce vulnerabilities Gandhi, R. (2016). Evolution of Payment Systems to shocks and promote investment and growth. in India: Or is it a Revolution?. Speech delivered References at the Banaras Hindu University, Varanasi on October 22. 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Capital Market Conference, July. 136A POLICY AGENDA FOR VI POST-COVID-19 INDIA VI.1 History is dotted with pandemics that as adaptation to digitalisation, biomedical, mankind has suffered but endured: “The oak pharmaceutical and healthcare innovation and fought the wind and was broken, the willow bent initiatives underway for a cleaner and greener when it must and survived.”1 This pandemic too world. shall pass. In its wake will arise both challenges VI.3 Some useful insights about alternative and opportunities. The post-pandemic strategy medium-term growth trajectories can drive this of revival and reconstruction will shape India’s agenda. Drawing on two alternative growth renewed tryst with its developmental aspirations. models, i.e., (i) a standard growth model in the neo- Three lessons are stark. First, never again should classical tradition (Sinha, 2017; Hevia and Loayza, we be taken unprepared. Pandemics will recur and 2012), which involves decomposing different remain hard to predict. Hence, we must build policy components of growth into total factor productivity space in good times and public health must be its (TFP), human capital growth and growth in capital, centre-piece. Second, structural transformation is and (ii) an endogenous economic growth model a process not an event; so structural reforms must (Barro and Sala-i-Martin, 1992; Alogoskoufis and be continuous, aimed at building resilience against Kalyvitis,1996) [Annex 1], the steady-state growth shocks. Third, crises like pandemics leave scars, works out to 6.5 per cent (Chart VI.1). Scenario including on the psyche, such as deprivation and analysis suggests a feasible range for the medium- poverty. Healing them must be a policy priority. term steady state growth of 8.5 per cent to 6.5 per The post-pandemic recovery must embrace all. cent for GDP under the first approach and 8.6 per It calls for designing a new growth frontier, which cent to 6.5 per cent under the second approach. could be strong, inclusive, resilient, durable, and The upper estimate of the growth trajectory is sustainable over the medium-longer horizon in consistent with reform measures outlined in this line with overall development goals of a country chapter*. (Das, 2021). VI.4 Timely rebalancing of monetary and fiscal VI.2 Economic progress rides on seven wheels - policies will likely be the first step in this journey. aggregate demand; aggregate supply; institutions, First, the large surplus liquidity overhang has to intermediaries, and markets; macroeconomic be withdrawn - every percentage point increase stability and policy coordination; productivity and in surplus liquidity above 1.5 per cent of NDTL technological progress; structural conditions; and causes average inflation to rise by 60 basis points sustainability. The blueprint of reforms proposed in a year. Monetary policy has to assign priority in this chapter broadly covers these seven areas to price stability as the nominal anchor for the as the future gets reshaped by new forces such future growth trajectory. Second, growth is at *A team comprising Sarat Chandra Dhal, Debojyoti Mazumder and Saurabh Sharma worked on growth models for this chapter. 1 Jordan, R. (1993), “The Fires of Heaven: Book Five of ‘The Wheel of Time’.” Macmillan. 137REPORT ON CURRENCY AND FINANCE Chart VI.1: Medium-term Growth Scenarios GDP Growth Scenario (Approach 1) GDP Growth Scenario (Approach 2) Note: Dotted and dashed lines indicate intermediate scenarios. Source: RBI staff estimates. risk once general government debt exceeds a by fiscal prudence, the assignment rule is satisfied, threshold of 66 per cent of GDP. Reducing debt to bringing in its train macroeconomic stability to more sustainable levels that are compatible with support sustainable growth. the growth trajectory being envisaged for a post- VI.5 Addressing structural constraints is pandemic Indian economy will be daunting. Even central to reviving and reconstructing the Indian under best possible macroeconomic outcomes, economy from the ravages of the pandemic. general government debt may not decline below The Government has announced privatisation 75 per cent of GDP over the next five years. If and asset monetisation; tax reforms (GST and adverse scenarios materialise, debt may, in fact, corporate tax rationalisation); targeted sector- rise to 90 per cent of GDP in 2026-27. A medium- specific incentives to raise production and term strategy of debt consolidation aimed at reducing debt to below 66 per cent of GDP over exports under the production-linked incentive the next five years is, therefore, important to (PLI) scheme; insolvency and bankruptcy secure India’s medium-term growth prospects. code (IBC) to improve the credit culture and With monetary policy prioritising price stability and resource allocation mechanism; labour reforms pursuing output stabilisation in an environment in (four codes); and a fiscal policy focus on capex which debt sustainability is sought to be achieved and infrastructure. These reforms need to be 138A POLICY AGENDA FOR POST-COVID-19 INDIA augmented with other measures to reverse VI.7 Boosting India’s participation in global value the sustained decline in private investment chains (GVCs) and raising export competitiveness and low productivity in the economy. What is hinges on greater adoption of technology. Policy needed includes access to litigation free low- support for this drive must emphasise (i) an cost land; raising the quality of labour through ecosystem that increases the adaptability of large scale expansion of public expenditure on domestic firms to state-of-the-art technology; (ii) education, health and the Skill India Mission; ensuring policy certainty on royalty payments reducing the cost of capital for industry and for technology transfer by foreign companies; improving resource allocation in the economy by and (iii) improving domestic R&D infrastructure promoting competition; encouraging industries for innovations. The industrial revolution 4.0 and and corporates to scale up R&D activities with committed transition to a net-zero emission target an emphasis on innovation and technology; will create new investment opportunities powered creating an enabling environment for start-ups by technology and environmentally sustainable and unicorns; encouraging corporate investment production processes. Building on “Start-up India, in agriculture; addressing the challenges Stand-up India”, the policy ecosystem for the start- faced by the debt-ridden telecom industry and ups needs a dynamic framework with provision DISCOMs; rationalisation of subsidies that for adequate access to risk capital and globally promote inefficiencies; encouraging urban competitive environment for doing business. The agglomerations by improving the housing and PLI scheme recognises growth opportunities in physical infrastructure. 14 key manufacturing sectors of the economy. It is important that global quality benchmarks are VI.6 Recent labour reforms could enhance put in place for new capacities to be created in flexibility for firms to adjust their workforce identified sectors under the PLI scheme. according to economic cycles, thereby enabling VI.8 A comprehensive plan is necessary to them to use their resources more efficiently. This, revive the rural economy. Organising farmers’ however, could come only at the cost of lower clubs or agricultural cooperatives is a possible welfare/social security of the workers. One option solution to correct the pricing imbalances by could be to build an unemployment insurance reducing gaps between farm gate prices and fund during periods of economic boom at the firm retail prices. In this regard, the development of a level, which can be utilised to financially support modern supply chain infrastructure needs priority workers up to a limited period after retrenchment. attention. There is a need to adopt a viable ‘whole Further, many of the social security measures of business’ approach covering all aspects of apply to firms having a certain minimum number farming to break farmers’ dependence on money of workers, which creates incentives for firms lenders. not to scale up. To address this issue, a policy option could be universal access to social security VI.9 In order to benefit from the post- irrespective of firm size, with each firm required to pandemic global recovery in demand, certain earmark a certain percentage of their profits for preconditions such as improving the quality of the social security schemes for the workers. exports through greater emphasis on innovations 139REPORT ON CURRENCY AND FINANCE and R&D, easier access to critical inputs - both VI.11 Greater absorption of foreign capital in domestic and imported - and more effective the economy for productive investment within the FTAs based on trade complementarities would current sustainable level of CAD and raising the be essential. The growing focus on digitalisation sustainable threshold for CAD in the medium-run offers immense opportunities. The early adopters through higher FDI flows and export conducive of frontier technologies will have the first-mover imports can raise the benefits of financial advantage by becoming more cost efficient. openness for India. Further easing of outward Small and medium-sized businesses would FDI norms and incentivisation of capital goods need to gain access to global markets by using imports can contain the fiscal (sterilisation) cost digital platforms. IT companies can gain in the and/or appreciation pressure on the INR. It can world market by undertaking investments in also help strengthen India’s linkage in GVCs next-generation technologies. The use of frontier through a combination of trade, FDI and strategic technologies in delivery of services would also partnerships abroad. The policy focus should be increase the domestic value-added content in to attract FDI in more sectors, particularly those manufacturing and improve the competitiveness with domestic technological gaps, viz., defence, and exportability of domestic goods. In particular, industrial machinery, agricultural machinery, the MSME sector can benefit from business- electronics and earthmoving machinery. The FDI to-consumer e-commerce export opportunities policy also needs to incentivise the adoption and by improving operational and supply chain transfer of cleaner technologies for domestic efficiencies. companies which would enhance domestic firms’ ability to meet strict product specifications in VI.10 India’s ongoing and future free trade foreign markets. agreement (FTA) negotiations may focus not only on securing greater market access for VI.12 Stronger growth and associated domestic goods and services but also on better improvement in the outlook for income and trade terms for high quality imports from partner employment is critical for raising the savings of countries and transfer of technology. The focus households. As demand recovers on the back of bilateral trade agreements should be bilateral of policy stimulus, enhancing the capacity of the technology-sharing and forging partnership/ financial system to propel stronger and inclusive alliance in sectors where indigenous capabilities growth must be prioritised. may be weak. As the global trade environment VI.13 Broadening and deepening of financial is becoming increasingly complex and prone markets and increasing their liquidity and to more disputes, rules and provisions with resilience has to be the cornerstone of financial regard to digitally enabled trade, data security sector policies. The inherent objective is to help issues and intellectual property rights should get allocate resources and minimise risks that are adequate coverage in trade agreements. In order inherent to a finance-led growth strategy. to expand exports, India needs to rationalise its tariff and non-tariff rate structure on a reciprocal VI.14 It is necessary to wean away PSBs basis, and this should be accorded priority under from their dependence on the government for the ongoing FTAs. recapitalisation. On a positive note, a beginning in 140A POLICY AGENDA FOR POST-COVID-19 INDIA this direction has already been made with larger altered financing requirements of the start-ups and stronger PSBs raising significant resources and unicorns, a policy framework for attracting from the market. Stronger corporate governance risk capital needs to be put in place. Given the norms in the banking segment is a priority large long-term financing requirements of the infrastructure sector, NaBFID may have to scale up area. Efforts need to be made to strengthen the quickly and explore ways to attract resources from compliance culture that adapts to norms not only insurance, pension and provident funds. Climate in letter but also in spirit. change risks and frequent natural calamities call VI.15 Going forward, the economy’s growing for including green finance and other sustainable reliance on the digital ecosystem will be helpful growth objectives in future financial sector policies. in harnessing the benefits of low-cost resource These measures are expected to pave the way to allocation and distributive efficiency. Care, a more developed and efficient financial system however, needs to be taken to protect the which, in turn, should help in greater financial stakeholders from digital frauds, data breaches inclusion, reduce vulnerabilities to shocks and and digital oligopolies. Recognising the vastly promote investment and growth. 141REPORT ON CURRENCY AND FINANCE Annex 1: Alternative Growth Models and Medium-term Growth Scenarios Approach 1: Growth Decomposition output growth. Finally, ceteris paribus, the same level of investment share in output can lead to According to the neoclassical approach, a different output growth depending on the level standard production function entails that of the capital-output ratio (K/Y). Investment’s ...(1) contribution to growth reduces as the capital- to-output ratio goes up in the economy. So, an where, Y is output, K is the aggregate capital t t investment-led growth strategy may work at lower stock, h is the human capital per worker, L is the t t levels of capital stock accumulation but could total number of workers present in the economy, eventually exhibit diminishing returns unless A is the TFP and is the labour income share. The t supported by reforms that focus on growth of capital stock accumulation process is specified as productivity, human capital and higher labour ...(2) force participation. with : rate of depreciation, : new investment Approach 2: Endogenous Growth Model (capital formation). The labour-employment process takes the form of The model presented here follows the seminal works on endogenous growth owing to Barro and ...(3) Sala-i-Martin (1992) and Alogoskoufis & Kalyvitis where, : work participation rate; : working (1996). We consider a partial equilibrium model age population to total population ratio; and N: with unit measure of infinitely lived identical t total population. Using the above set up and log- competitive firms who take the available technology linear approximations, the derived per capita level and the available public infrastructure stock output growth path could be represented as, as given but individually choose the labour input and the investment level at time t. Firms face an investment adjustment cost. The production function is like the earlier specification. .. .(4) , = ( , ; ) = 1 ...(5) where, represents firms; all firms use the same where, represents the growth rate of the production function F with effective labour (L) variable j. and capital (K) and constant returns to scale. is The above equation offers some important the labour income share, which ranges between insights. First, the TFP growth (g ) has a direct 0 and 1. represents effective TFP level which A effect on overall GDP growth of the economy. is assumed to be given to the firms. Firms only Second, the larger labour share of income ( ) choose their labour input and take the investment implies higher contribution of the labour force (I) decision. Apart from the wage bill, firms participation rate, working age population to face an adjustment cost for investing. The total population ratio and human capital per worker to cost of investment is , where 142A POLICY AGENDA FOR POST-COVID-19 INDIA . Additionally, firms pay tax at the rate where, is real wage rate. to the government. The government uses the tax Average interest rate , which is revenue to spend on its own consumption and on policy determined. building public capital stock. The relevant technique to solve the problem is to The TFP ( ) represents an exogenous create a Hamiltonian function as technology level and implicitly captures the impact of public capital or infrastructure from which every firm gets benefits without the problem of congestion. More precisely, we assume . Therefore, a rise in public infrastructure stock increases productivity of ...(10) private capital and labour. Government spending where, is the shadow price associated with is financed by the tax revenue. So, the flow of capital, . The present value of that ...(6) shadow price is therefore, . The first order conditions are (a) , (b) where, shows additional capital invested for building public infrastructure, is the aggregate and (c) , which output, and is the share of government result into the following three equations:1 consumption expenditure to output. The flow of ...(11) the public capital is governed by the following rule, ...(12) ...(7) represents change in with respect to time ...(13) and is the public capital depreciation. Firm maximises its present discounted value of Given the same wage rate faced by the firms the lifetime profit by choosing its labour input and (equation 11), all firms make homogenous investment level for each period. Firms do this choices. That is, the variables chosen by firms exercise subject to the private capital flow rule as can be written independent of i which makes the ...(8) aggregation of output of all firms easy. After some algebraic rearrangements using the government where, is the rate of depreciation of the private budget (equation 6), private and public capital flow capital. The present discounted value of the equations (equations 7 and 8) and the first order lifetime profit is represented as conditions listed as equations (11) to (13) along with suitable log linearisation it can be shown that, there exists a (saddle path) stable steady state ...(9) growth rate, defined as . 1 The transversality condition is . 143REPORT ON CURRENCY AND FINANCE The model suggests that if private capital and in the recent PLFS reports of 2019-20 shows a public capital keep growing at a constant rate, then remarkable rise in the last two years. On the the economy can sustain a growth path which is other hand, there was a declining trend in LFPR endogenous to the economy, even by keeping the growth according to the World Bank database exogenous technology level and the size of the in the last decade. Taking cue from both sets of effective labour force constant. If the exogenous information, the representative central tendency technology improves, then the economy can of LFPR growth is used to simulate the model. maintain a higher long run growth path. Reduction To approximate the growth rate of working age in government’s consumption expenditure ratio population (WAP) and the population growth rate, also promotes higher growth in the long run. relevant data are sourced from the World Bank. Both being demographic parameters, they are not For generating medium-term growth scenarios, changed for building the best-case and worst-case the parameter values relevant for India in Table 1 scenarios. For investment to GDP ratio (I/Y), the are used. average gross fixed capital formation (GFCF) as a Under the first approach, historical KLEMS percentage of GDP is taken from the Handbook of data are used to identify feasible baseline and Statistics on the Indian Economy, RBI. The capital extreme scenarios. As per KLEMS data for the income share ( ) of the manufacturing sector period of post globalisation the median growth is assumed to be 0.7 as suggested by the KLEMS rate of TFP ( ) works out to 1.1 per cent which estimates. The depreciation rate of private capital is assumed for the baseline specification. The is taken as 10 per cent (Banerjee and Basu, labour force participation rate (LFPR) growth ( ) 2019). The depreciation rate of public capital ( ) Table 1: Parameter Specifications Sl. Parameters Baseline Case Best Case Worst Case No. Model 1 Model 2 Model 1 Model 2 Model 1 Model 2 1. (technology) 1.1% - 2.4% - -0.8% - 2. (labour income share) 0.3 0.3 0.3 0.3 0.3 0.3 3. (lfpr) 1.1% - 2.1% - 0.1% - 4. (wap) 0.4% - 0.4% - 0.4% - 5. (skill) 1.11% - 2.2% - 0.6% - 6. (population) 1.01% - 1.01% - 1.01% - 7. (dep) 0.1 0.1 0.1 0.1 0.1 0.1 8. 31% - 31% - 31% - 9. - 5.45 - 5.45 - 5.45 10. - 0.25 - 0.25 - 0.25 (tax-GDP) 11. (dep, pub) - 0.14 - 0.14 - 0.14 12. (revenue exp-gdp) - 0.16 - 0.157 - 0.163 13. - 1.01% - 1.01% - 1.01% 14. - 1 - 1.01 - 0.99 15. 1.6 1.6 1.6 144A POLICY AGENDA FOR POST-COVID-19 INDIA is assumed to be higher than and is set at 14 per Banerjee, S., and Basu, P. (2019), “Technology cent. While the real policy interest rate (r) remains shocks and business cycles in India”. negative during the recovery from the pandemic Macroeconomic Dynamics, Vol. 23(5), 1721-1756. shock, following Behera et al. (2017), a positive 1 Barro, R., and Sala-i-Martin, X. (2004), “Economic per cent real policy interest rate is assumed for the growth”, second edition. economy in the medium-term. The tax rate (T) is y pegged at 25 per cent and revenue expenditure of Barro, R. J., and Sala-i-Martin, X. (1992), “Public combined government (excluding interest payment finance in models of economic growth”. The and subsidies) to GDP is set at 16 per cent for Review of Economic Studies, Vol. 59(4), 645-661. the baseline case. The term which represents Behera, H., Wahi, G., and Kapur, M. (2017), technology augmented labour supply is set at “Phillips Curve Relationship in India: Evidence 1 for the baseline. The aggregate employment from State-level Analysis”. RBI Working Paper measure adjusted by labour income share is Series No. 08. estimated using the KLEMS manufacturing data. The marginal adjustment cost of investment (b) Das, Shaktikanta (2021), “Beyond COVID: is conventionally assumed to be high if human Towards a Stronger, Inclusive and Sustainable capital adjustment cost is not considered explicitly Economy”. Reserve Bank of India. https://www.rbi. in the model (Barro and Sala-i-Martin, 2004), and org.in/Scripts/BS_SpeechesView.aspx?Id=1128 accordingly is set at 5.45. Hevia, C., and Loayza, N. (2012), “Saving and References growth in Egypt”. Middle East Development Journal, Vol. 4(01), 1250002. Alogoskoufis, G. S., and Kalyvitis, S. C. (1996), “Public investment and endogenous growth in a Sinha, R. (2017), “Long-term growth scenarios small open economy”. Centre for Economic Policy for Bangladesh”. World Bank Policy Research Research. Working Paper, No. 7952. 145