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The following OECD assessment and recommendations summarise chapter 1 of the Economic survey of India published on 9 October 2007.
Why has recent growth been so rapid?
Over the past two decades, India has moved away from its former dirigiste model and become a market-based economy. This process started in the mid 1980s and gathered substantial momentum at the beginning of the 1990s. Direct tax rates were significantly reduced, pervasive government licensing of industrial activity was almost eliminated, and restrictions on investment by large companies were eased. Furthermore, financial markets were reformed, with banks restored to health, entry barriers lowered, equity markets transformed and new supervisory bodies introduced. The process of reform has continued in this decade with a further opening of the economy to competition. The number of industries reserved for very small firms has been significantly reduced, and foreign suppliers have been encouraged to enter the market by a progressive lowering of tariffs to an average of 10% in 2007. The rules governing foreign direct investment have been markedly eased, notably in the manufacturing sector. Last but not least, fiscal discipline has been improved by the passage of fiscal responsibility laws for the central government and all but three of the 28 state governments.
These reforms have had a major beneficial impact on the economy. By 2006, the average share of imports and exports in GDP had risen to 24%, up from 6% in 1985. Inflows of foreign direct investment increased to 2% of GDP from less than 0.1% of GDP in 1990, with outflows of foreign direct investment picking up substantially at the end of 2006. The combined fiscal deficit of central and state governments has been reduced from 10% of GDP in 2002 to just over 6% of GDP by 2006, with the ratio of debt to GDP falling from 82% in 2004 to 75% by March 2007. There has been a massive increase in output, with the potential growth rate of the economy estimated to be around 8½ per cent per year in 2006. GDP per capita is now rising by 7½ per cent annually, a rate that leads to its doubling in a decade. This contrasts to annual growth of GDP per capita of just 1¼ per cent in the three decades from 1950 to 1980. Faster growth has resulted in India becoming the third largest economy in the world (after the United States and China and just ahead of Japan) in 2006, when measured at purchasing power parities, accounting for nearly 7% of world GDP. Moreover, with increased openness and rapid growth in exports of merchandise and IT related services, its share in world trade in goods and services had risen to slightly over one per cent in 2005, when measured at market exchange rates.
Past reforms have brought higher growth in GDP per capita
% per annum
The current expansion, which started in 2003, has not led to an imbalance between supply and demand, despite annual GDP growth reaching 9% in 2006. The non-agricultural GDP deflator, a broad measure of prices, has shown little tendency to accelerate and increased by less than 5% year on year in 2006. Some measures of inflation have moved above the authorities’ goal of keeping the annual inflation rate in the range of 5 5½ per cent, reflecting sharp increases for food in other commodity prices. However, the monetary authorities are acting to ensure that such increases do not become entrenched and announced, in April 2007, that monetary policy will aim at achieving an inflation rate of 4 4½ per cent per year over the medium term. In this respect, they are being helped by the appreciation of the currency. The current account balance has moved into a deficit, but only similar in relation to GDP to that of the second half of the 1990s and, moreover, is being financed by foreign direct investment. Such a benign outcome has been helped by increased domestic saving including the recent fiscal consolidation.
The fiscal reforms enacted in 2004 have permitted a significant reduction in the extent to which the government pre-empts national savings to finance consumption. The fiscal deficit, which has been reduced substantially, is on track to meet the legislated target of a combined central and state government fiscal deficit of 6% of GDP by fiscal year 2008. Already, the reduction in government dis saving contributed almost half of the increase in the net national saving rate between 2001 and 2005, which has now reached almost 22% of GDP, with the gross saving rate being some ten percentage points higher at 32%. Faster economic growth will require that a greater share of output be devoted to investment for both business expansion and infrastructure. This implies the need to raise savings further by continuing the fiscal consolidation strategy. At the same time, it is necessary to improve the quality of spending.
Increased growth since the mid 1980s has helped to substantially reduce the national poverty rate to 22% of the population in 2004, with the speed of poverty reduction appearing to increase between 1999 and 2004. Moreover, in this period, the absolute number of people living below the poverty line fell for the first time since independence. To meet one of its Millennium Development Goals, of halving poverty by 2015, the government is aiming to achieve an even higher medium-term economic annual growth rate of 10%. With additional structural reforms, this goal is achievable. In addition, growth needs to become more inclusive by increasing the prosperity of poorer states, whose economies have expanded at a slower pace than those of the richer states in the past decade, and so reducing their difficulties in lowering poverty. The analysis of this report suggests that the differences in economic performance across states are associated with the extent to which states have introduced market-oriented reforms. Thus, further reforms on these lines, complemented with measures to improve infrastructure, education and basic services, would increase the potential for growth outside of agriculture and thus boost better-paid employment, which is a key to sharing the fruits of growth and lowering poverty.
What are the key proprieties for further reform?
The next round of reforms needs to focus on a number of key areas that have the potential to further boost economic growth, while ensuring that the expansion becomes more inclusive. Recent reforms have made a number of sectors of the economy more dynamic, especially in the service sector. However, there are still a number of barriers to growth in product, labour and financial markets, and the provision of infrastructure, where reform is needed both at the central and state levels. While the optimal policy would be to remove these bottlenecks across the country, the creation of Special Economic Zones that aim to reduce a number of these barriers locally might demonstrate the benefits of such reforms and so act as a catalyst for more generalised change, but care needs to be taken as to the extent of tax concessions that are granted. Furthermore, taxation policies need to be reformed in order to create a truly national market and improve incentives and release resources for reducing bottlenecks in infrastructure, which are a key constraint on growth. In addition, education needs to be delivered more efficiently so as to improve human capital formation. There are undoubtedly further challenges facing the economy, but this report focuses on these areas which are key to boosting growth further.
Market-oriented reforms – which started in the mid 1980s and were followed by more fundamental reforms since the early 1990s and renewed in the 2000s – have lifted the Indian economy on to a significantly higher growth path, helping to reduce poverty. This success should encourage policymakers to continue with this strategy by, in particular: further reducing restrictions in labour and product markets; improving infrastructure, human capital formation and general public services; and further reducing tax distortions. Speeding up such reforms would help the government to achieve its objective of further raising India’s sustainable growth path and at the same time make growth more inclusive.
How to obtain this publication
The Policy Brief (pdf format) can be downloaded in English. It contains the OECD assessment and recommendations. The complete edition of the Economic survey of India 2007 is available from:
For further information please contact the India Desk at the OECD Economics Department at firstname.lastname@example.org. The OECD Secretariat’s report was prepared in the Economics Department by Richard Herd, Paul Conway and Sean Dougherty, under the supervision of Willi Leibfritz. Research assistance was provided by Thomas Chalaux.