ECONOMIC SURVEY 2012-13STATE OF THE ECONOMY AND PROSPECTS

While India's recent slowdown is partly rooted in external causes, domestic causes are also important. The strong post-financial-crisis stimulus led to stronger growth in 2009-10 and 2010-11. However, the boost to consumption, coupled with supplyside constraints, led to higher inflation. Monetary policy was tightened, even as external headwinds to growth increased. The consequent slowdown, especially in 2012-13, has been across the board, with no sector of the economy unaffected. Falling savings without a commensurate fall in aggregate investment have led to a widening current account deficit (CAD). Wholesale price index (WPI) inflation has been coming down in recent months. However, food inflation, after a brief slowdown, continues to be higher than overall inflation. Given the higher weightage to food in consumer price indices (CPI), CPI inflation has remained close to double digits. Another consequence of the slowdown has been lower-than-targeted tax and non-tax revenues. With the subsidies bill, particularly that of petroleum products, increasing, the danger that fiscal targets would be breached substantially became very real in the current year. The situation warranted urgent steps to reduce government spending so as to contain inflation. Also required were steps to facilitate corporate and infrastructure investment so as to ease supply. Several measures announced in recent months are aimed at restoring the fiscal health of the government and shrinking the CAD as also improving the growth rate. With the global economy also likely to recover somewhat in 2013, these measures should help in improving the Indian economy's outlook for 2013-14.GROWTH OF GDP AND OTHER MACRO AGGREGATESFollowing the slowdown induced by the global financial crisis in 2008-09, the Indian economy responded strongly to fiscal and monetary stimulus and achieved a growth rate of 8.6 per cent and 9.3 per cent respectively in 2009-10 and 2010-11 (Table 1.1). However, with the economy exhibiting inflationary tendencies, the Reserve Bank of India (RBI) started raising policy rates in March 2010. High rates as well as policy constraints adversely impacted investment, and in the subsequent two years viz. 2011-12 and 2012-13, the growth rate slowed to 6.2 per cent and 5.0 per cent respectively. Nevertheless, despite this slowdown, the compound annual growth rate (CAGR) for gross domestic product (GDP) at factor cost, over the decade ending 2012-13 is 7.9 per cent. The moderation in growth is primarily attributable to weakness in industry (comprising the mining and quarrying, manufacturing, electricity, gas and water supply, and construction sectors), which registered a growth rate of only 3.5 per cent and 3.1 per cent in 2011-12 and 2012-13 respectively. Growth in agriculture has also been weak in 2012-13, following lower-than-normal rainfall, especially in the initial phases (months of June and July) of the south-west monsoon.After achieving double-digit growth continuously for five years and narrowly missing double digits in the sixth (between 2005-06 and 2010-11), the growth rate of the services sector also declined to 8.2 per cent in 2011-12 and 6.6 per cent in 2012-13. In 2011- 12 the sector that particularly slowed within the services sector was Trade, Hotels, and Restaurants, Transport and Communications, and its growth further declined in 2012-13. Activities in this sector, being forms of derived demand, tend to grow at a slower rate with the slowdown of economic activity in the industry and agriculture sectors. Why has the economy slowed down so rapidly despite recovering strongly from the global financial crisis? A number of factors are responsible. First, the boost to demand given by monetary and fiscal stimulus following the crisis was large. Final consumption grew at an average of over 8 per cent annually between 2009-10 and 2011-12. The result was strong inflation and a powerful monetary response that also slowed consumption demand. Second, starting in 2011-12, corporate and infrastructure investment started slowing both as a result of investment bottlenecks as well as the tighter monetary policy. Thirdly, even as the economy slowed, it was hit by two additional shocks: a slowing global economy, weighed down by the crisis in the Euro area and uncertainties about fiscal policy in the United States, and a weak monsoon, at least in its initial phase.

ASPECTS OF GROWTHIn the last decade, growth has increasingly come from the services sector, whose contribution to overall growth of the economy has been 65 per cent, while that of the industry and agriculture sectors has been 27 per cent and 8 per cent respectively. Figure 1.1 shows the contributions of these sectors to the overall growth of the economy from 2003-04 to 2012-13. The general pattern over recent years has been that, in years of sharply higher growth, GDP growth at market prices exceeds GDP at factor cost and the reverse is true in years of slow growth.

INVESTMENTThe growth rate of the economy since 2003-04 has been strongly correlated with investment rate. The investment rate averaged 34.5 per cent between 2003-04 and 2011-12,

na: not available.1R: 1st Revised Estimates, 2R: 2nd Revised Estimates, AE: Advance Estimates.a Second advance estimates.b The Index of Industrial Production has been revised since 2005-06 on base (2004-05=100).c April-December 2012.d 2012-13 (April-January).e CAB to GDP ratio for 2012-13 is for the period April-September 2012.f At end January, 2013.g Average exchange rate for 2012-13 (April 2012- January 2013).h Provisional (up to December 28, 2012).i Fiscal indicators for 2011-12 are based on the provisional actuals (unaudited).j Budget estimates.k Census 2011.

much higher rate than before. As can be seen from Tables 1.1 and 1.2, the real growth rate in the economy averaged 9.5 per cent per annum during 2005-06 to 2007-08, which were also the years when the growth rate of investment in real terms averaged around 16 per cent. Similarly, the average growth rate of the economy was close to 9 per cent per annum in 2009-10 and 2010-11, with the growth rate of investment averaging around 16.2 per cent in these two years. The rate of growth of GDP was lower in the years when growth rate of investment was low, as was the case in 2008-09 and 2011-12.As per the First Revised Estimates released by the CSO in January 2013, gross domestic capital formation as a ratio of GDP at current market prices (investment rate) is estimated to be 35.0 per cent in 2011-12 as against 36.8 per cent in 2010-11. Both public and private investment declined as a share of GDP. Within private investment, investment by the private corporate sector registered a sharper decline. The reduction in private investment could be attributed to a number of factors. First is the increase in policy rates (to combat inflation and inflationary expectations). Between March 2010 and October 2011, the RBI raised the repo rate by 375 basis points (bps), thus raising the cost of borrowings in a bid to reduce demand. Another reason for lower private investment could be lower demand for Indian exports from the rest of the world, particularly the advanced countries. A third possible reason for lower corporate investment is policy bottlenecks (such as obtaining environmental permissions, fuel linkages, or carrying out land acquisition, see Box 1.1), which led to a number of large projects becoming stalled, which may in turn have discouraged new investment. Investment in the form of valuables increased by nearly Rs. 80,000 crore in 2011-12 vis-à-vis that in 2010-11. Valuables include works of art, precious metals, and jewellery carved out of such metals and stones. At current prices, investment in the form of valuables registered a nearly 4.5-fold increase between 2007-08 and 2011-12 and their share in total investment increased from 2.8 per cent in 2007-08 to 7.6 per cent in 2011-12. A part of the increase in this share can be explained by the surge in the prices of gold and other valuables. To summarize, overall investment would have slowed further were it not for non-productive investment such as in valuables. Particularly worrisome is the sharp slowing of corporate investment, which is the source of future supply (needed to quell inflation) and of future growth potential. Policies to remove investment bottlenecks as well as structural reforms to encourage productive investment and its financing are essential, as is more accommodative monetary policy, as inflation abates.

Box 1.2 : The Gold Rush1. Demand for gold has been rising worldwide : The global financial crisis, turned debt crisis, has seen a steep rise in commodity prices, especially gold. This, now in hindsight, rather

unsurprising fact, has mostly been driven by the meteorically increasing demand for safe havens to park the world's savings. Global gold prices, as denominated in US$, have doubled since 2008, and increased three times as denominated in Indian rupees. 2. India has traditionally been a major absorber of world gold : The last three years have seen a substantial rise in gold imports (the value of gold imports increased nine times between January 2008 and October 2012), contributing significantly to the current account deficit along with oil (Figure 2).3. Gold imports are positively correlated with inflation : High inflation reduces the return on other financial instruments. This is reflected in the negative correlation between rising imports and falling real rates (Figure 1). Even though real rates have started rising, they are barely in the positive territory.4. Reduce Gold Purchases to curb CAD : Given soaring energy and transportation needs, since there seems to be little we can do to temper oil imports, gold is the component that needs to be contained to bring the CAD back to a comfort zone.5. The demand for gold as an investment tool has been increasing over time : Gold has been a combination of investment tool and status symbol in India. With limited access to financial instruments, especially in the rural areas, gold and silver are popular savings instruments. The recent economic uncertainty has seen people across the board buy gold. Almost all of India's demand for raw gold is met through imports2. Figure 3 shows that the composition of gold has seen a steady movement towards non jewellery items. Anecdotally, this can be construed as a rising demand for pure investment, predominantly in the urban and semi-urban areas. In the last quarter, non-jewellery constituted 40 per cent of the total demand. This observation, in line with global trends, is easily explained by the declining real returns on the gamut of financial instruments available to the investor and soaring ones on gold (23.7 per cent annual average return between April 07 and March 2012 versus 7.3 per cent return on Nifty and 8.2 per cent on savings deposits, Sehgal et. al., 2012).6. The longer term way to address the rising demand for gold : The overarching motive underlying the gold rush is high inflation and the lack of financial instruments available to the average citizen, especially in the rural areas. The rising demand for gold is only a "symptom" of more fundamental problems in the economy. Curbing inflation, expanding financial inclusion, offering new products such as inflation indexed bonds, and improving saver access to financial products are all of paramount importance.1. Prepared by Mr. Rohit Lamba and Dr. Prachi Mishra. We would like to thank Amresh Acharya at the World Gold Council, Suresh Phadnis at PMEAC, Sneha Arora and Arun Narendhranath at ISB for many discussions.2. There are three active gold mines, which meet less than 1 per cent of domestic demand.DOMESTIC SAVINGSThe volume and composition of domestic savings in India have undergone significant changes over the years. The savings rate (gross domestic savings as percentage of gross domestic product at market prices) averaged 18.6 per cent in the 1980s and 23 per cent in the 1990s. The savings rate exceeded 30 per cent for the first time in 2004-05 and has remained above that level ever since. It peaked in 2007-08 at 36.8 per cent and reached an eight-year low of 30.8 per cent in 2011-12.Savings come from three sources, viz. households, the private corporate sector, and the public sector. On average, households accounted for nearly three-fourths of gross domestic savings during the period 1980-81 to 2011-12. The share declined somewhat in recent years, and in the period from 2004-05 to 2011-12, it averaged 70.1 per cent of total savings. Savings of the private corporate sector accounted for 15 per cent of total savings on an average between 1980-81 and 2011-12. However, during the years 2004-05 to 2011-12, their share increased to 23.2 per cent. The public sector accounted for 10 per cent of total savings on average between 1980-81 and 2011-12. It has been progressively declining and during 2004-05 to 2011- 12, public savings as a ratio of total savings averaged 6.7 per cent. Within households, the share of financial savings vis-à-vis physical savings has been declining in recent years. Financial savings take the form of bank deposits, life insurance funds, pension and provident funds, shares and debentures, etc. Financial savings accounted for around 55 per cent of total household savings during the 1990s. Their share declined to 47 per cent in the 2000-10 decade and it was 36 per cent in 2011-12. Household savings will also have to be raised. The financial savings of the household sector are likely to improve with lower inflation, especially as the real rate of return on financial savings rises. A greater variety of reliable financial savings opportunities (such as inflation-indexed bonds) and relative ease of

access to them could also help in raising the share of financial savings in total savings, reducing the attractiveness of alternatives like gold. In this context, regulators have to maintain a balance between what is of public importance and what is prudential. Areas of public importance, such as infrastructure, do deserve substantial support. However, these areas of activity may also be risky. Support should be given by de-risking the areas (policy to speed up infrastructure projects and ease their completion), through financial development (creating new financing institutions, attracting new investors), or fiscal means (interest subventions, tax breaks) but not by relaxing prudential norms (lower capital requirements, allowing un-hedged foreign borrowing) or riskier capital structures (allowing greater debt ratios). Ultimately, riskier financing for projects of public importance builds up greater risk for the country because if these projects fail to take off, they impinge on both growth and the financial system at the same time, at a time when the government has fewer resources to cope. ASSESSMENT AND POLICY MEASURES The strong post-financial-crisis fiscal and monetary stimulus in India led to spectacular growth in the immediate aftermath of the crisis. But with corporate and infrastructural investment not keeping pace, and food production constrained, the boost to consumption eventually led to higher inflation. And falling savings, partly as a result of government spending and partly as a result of high inflation, have led to a widening CAD. Monetary policy has been tightened, even as global headwinds to growth have increased. India has been caught in a vicious circle of falling growth and stimulus withdrawal that could well exacerbate the decline. Of some concern is India's increased dependence on foreign borrowing even as growth has slowed.Because of the slowdown and high levels of leverage, some industry and infrastructure sectors are experiencing an increase in non-performing assets (NPAs). Overall gross NPAs of the banking sector increased from 2.36 per cent of total credit advanced in March 2011 to 3.57 per cent of total credit advanced in September 2012. The increase is particularly sharp for the industry and infrastructure sectors. Sub-sectors particularly under stress include textiles, chemicals, iron and steel, food processing, construction, and telecommunications. The increase in gross NPAs is also significantly higher for public sector banks, which are typically more exposed to the distressed sectors.The way out, and the hope for starting a virtuous circle, lies in shifting national spending from consumption to investment, removing the bottlenecks to investment, growth, and job creation, in part through structural reforms, combating inflation both through monetary and supply-side measures, reducing the costs for borrowers of raising financing, and increasing the opportunities for savers to get strong real investment returns.In practical terms for government policy, this translates into containing the fiscal deficit especially by shrinking wasteful and distortionary subsidies. It means working on reducing the impediments to investment such as delays in getting permissions, clarifying difficult and non-transparent processes for land acquisition, and increasing access to good infrastructure such as power and roads. It warrants reworking the regulatory and incentive structure that keeps small businesses tiny and prevents them from creating good productive jobs. It calls for reducing the barriers to entry in various areas of business and allowing FDI, even while ensuring domestic companies are not disadvantaged. It entails providing the incentives and means for the farmer to increase production, even while improving the management and the logistics of food procurement and distribution. And it necessitates continuing financial sector reform to increase the entry of new institutions, reduce transactions costs for investors, increase access for borrowers and savers to one another, and improve the quality of regulation.The government has already taken some important steps in this direction, some of which we have already alluded to. In addition, two helpful potential developments are in sight, one on the revenue side and the other on the expenditure side. The goods and services tax (GST), if approved, would replace a number of state and central taxes, make India more of a national integrated market, and bring more producers into the tax net. By improving efficiency as well as revenues, it can add substantially to growth as well as helping government finances. On the expenditure side, the direct benefit transfer scheme that will allow the transfer of government benefits directly to targeted recipient bank accounts can help reduce transactions costs, prevent duplication, leakage, and fraud, and improve choices for the poor. By translating a number of subsidies into equivalent cash transfers, it can avoid

price distortions and can target subsidies better to the truly deserving. This will help contain expenditure.The government has also taken a number of steps to revive investment and growth. These comprise setting up the CCI headed by the Prime Minister to fast-track mega projects of over Rs. 1,000 crore; a scheme for restructuring the debts of state power distribution companies, which includes incentives for them to charge reasonable tariffs so that they do not get over-indebted again; movement towards a land acquisition bill that will clarify and make the process of land acquisition fairer; permitting FDI in a number of areas including multibrand retail, power exchanges, and civil aviation; increasing investment in irrigation, storage and cold storage networks; and undertaking programmes to improve the production of protein foods.Steps have also been taken on financial-sector reform. The Banking Laws (Amendment) Act 2012 strengthens the regulatory powers of the RBI and paves the way for grant of new bank licences by the RBI. The Financial Sector Legislative Reforms Commission is examining the laws governing the financial sector with a remit to suggest ways of modernizing them. A number of steps have been taken by the government, together with the financial sector regulators, for easing savings and investment in the country, both for domestic and foreign investors.AGRICULTURE AND FOOD MANAGEMENTIndian agriculture has performed remarkably well in terms of output growth, despite weather and price shocks in the past few years. Although agriculture, including allied activities, accounted for only 14.1 per cent of the GDP in 2011-12, its role in the country's economy is much bigger with its share in total employment as high as 58.2 per cent according to the 2001 census. The declining share of the agriculture and allied sector in the country's GDP is consistent with the normal development trajectory of any fast growing economy, but fast agricultural growth remains vital for jobs, incomes, and food security.India does not fare well, however, in terms of agricultural yields or productivity. Improvement in yields holds the key for India to remain self-sufficient in foodgrains. Another challenge is how to maximize agricultural income while adopting a more sustainable agricultural strategy. The concerns here are land and water degradation due to soil erosion, soil salinity, waterlogging, excessive application of nutrients, and overexploitation of water resources in some parts of the country. Better management practices for rehabilitation of degraded land and water resources hold the key. Expenditure on agricultural research also needs to be raised in the Twelfth Five Year Plan.A notable feature of the Indian agricultural sector is the domination of small farmers with small landholdings. This poses a challenge for the adoption of farm mechanization and generating productive incomes from farm operations. Land-related issues and implementation of land reforms require to be attended to on priority basis to revitalize the agriculture sector. Declining per capita availability of foodgrains is another major concern in India. For ensuring nutritional security, it is not only important to increase per capita availability of foodgrains but also to ensure the right amounts of food items in the food basket of the common man. A thrust on horticulture products and protein-rich items is required for ensuring nutritional security.Another critical issue is supply-chain management in agricultural marketing in India. It is necessary to evolve mechanisms for linking wholesale processing, logistics, and retailing with farm-production activities so as to generate enhanced efficiency, better farm prices, etc. Recently the government allowed FDI in retail, which can pave the way for investment in new technology and marketing of agricultural produce in India.There is need for stable and consistent policies where markets play an appropriate role, private investment in infrastructure is stepped up, the public distribution system (PDS) is revamped, food price and food stock management improves, and a predictable trade policy is adopted for agriculture. These initiatives need to be coupled with skill development and better research and development (R&D) along with improved delivery of credit, seeds, etc.In the overall context of the evolving macroeconomic situation in the country and global financial developments, the government in close collaboration with the RBI and Securities and Exchange Board of India (SEBI) has recently taken a number of initiatives to meet the growing capital needs of the Indian economy. Some of the initiatives taken in this regard are launching of the Rajiv Gandhi Equity Savings Scheme (RGESS) and SME exchange / platform, expansion of the Qualified Foreign Investors (QFIs ) Scheme to facilitate their access to the Indian capital

market, progressive enhancement in the quantitative limits for FIIs' investments in various debt categories, allowing refinancing rupee loans through ECB route for Indian companies in the power sector, reduction in the withholding tax on interest payments on ECBs, and introducing a new ECB scheme for companies in the manufacturing and infrastructure sector.HUMAN DEVELOPMENTEconomic growth though important cannot be an end in itself. The Twelfth Five Year Plan, with its focus on 'Faster, More Inclusive and Sustainable Growth', puts the growth debate in the right perspective. The government's targeted policies for the poor, with the prospect of fewer leakages, can help better translate outlays into outcomes.Expenditure on social services by the general government (centre and states combined) has increased in recent years reflecting the higher priority given to this sector. Expenditure on social services increased considerably in the Twelfth Plan, with the education sector accounting for the largest share, followed by health. As a proportion of GDP, expenditure on social services increased from 5.9 per cent in 2007-08 to 6.8 per cent in 2010-11 and further to 7.1 per cent in 2012-13(BE). Nevertheless, India's expenditure on health as a per cent of GDP is lower than in many other emerging and developed countries and the share of the public sector still lower.Poverty has declined in the country, though precisely how poverty is measured is currently being examined. Based on the methodology suggested by the Tendulkar Committee, the percentage of people living below the poverty line in the country declined from 37.2 per cent in 2004- 05 to 29.8 per cent in 2009-10. Even in absolute terms, the number of poor people declined by 52.4 million during this period. Of this, 48.1 million are rural poor and 4.3 million urban poor. Thus poverty has declined on an average by 1.5 percentage points per year between 2004-05 and 2009-10. The annual average rate of decline during the period 2004-05 to 2009-10 is twice the rate of decline during the period 1993-94 to 2004-05. In the last few years public expenditure on social programmes increased dramatically. In the Eleventh Plan period nearly Rs. 7 lakh crore has been spent on the 15 major flagship programmes. A number of legislative steps have also been taken to secure the rights of people, like the Right to Information Act, the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA), the Forest Rights Act, and the Right to Education (RTE). However, there are also pressing governance issues like programme leakages and funds not reaching the targeted beneficiaries that need to be addressed. Direct benefit transfer (DBT) with the help of the Unique Identification (UID) number can help plug some of these leakages.

Seizing the Demographic Dividend

Policymakers are usually focused on short-run economic management issues. But the short run has to be a bridge to the long run. The central long-run question facing India is where will good jobs come from? Productive jobs are vital for growth. And a good job is the best form of inclusion. More than half our population depends on agriculture, but the experience of other countries suggests that the number of people dependent on agriculture will have to shrink if per capita incomes in agriculture are to go up substantially. While industry is creating jobs, too many such jobs are low productivity non-contractual jobs in the unorganized sector, offering low incomes, little protection, and no benefits. Service jobs are relatively high productivity, but employment growth in services has been slow in recent years. India's challenge is to create the conditions for faster growth of productive jobs outside of agriculture, especially in organized manufacturing and in services, even while improving productivity in agriculture. The benefit of rising to the challenge is decades of strong inclusive growth.Every fast-growing Asian economy in recent years has accelerated as it underwent a demographic transition (see Figure 2.2). In India itself, Aiyar and Mody (2011) document that the high growth states (Tamil Nadu, Karnataka, and Gujarat) in the period 1991-2001 had a dependency ratio which was 8.7 percentage points lower than that of the low growth states (Bihar, Madhya Pradesh, and Uttar Pradesh) and an average annual growth rate that was 4.3 percentage points higher. Looking ahead, they argue, the low growth states will benefit more from the demographic dividend, as higher incomes and lower fertility alter demographics. Indeed, over the period 2001-11, the hitherto laggard states have grown at an average of around 5 per cent annually. The difference between their growth and the growth of the leaders in the period 2001-11 is just 1.5 percentage points. So demographic transition seems to be correlated with growth, with some reasons to believe that causality flows both ways--lower dependency ratios increase growth and higher growth reduces fertility and consequently dependency ratios.

Growth optimists point to another reason for cheer. Cross-country evidence suggests that productivity is an increasing function of age, with the age group 40-49 being the most productive because of work experience (Feyrer 2007). Nearly half the additions to the Indian labour force over the period 2011-30 will be in the age group 30-49, even while the share of this group in China, Korea, and the United States will be declining. That India will be expanding its most productive cohorts even while most developed countries and some developing countries like China will be contracting theirs in the coming decades can be another source of advantage.

COMPARATIVE GROWTH AND TRADEIn what follows, we start by analysing various economic outcomes for selected Asian countries around their dates of initial 'takeoff' into periods of high growth. We identify the year of takeoff for comparator Asian countries based on IMF (2006)1. The dates are 1979, 1973, and 1967 for China, Indonesia, and Korea respectively. For India, we define the year of takeoff as 1991, when major economic reforms began. Figures 2.3-2.4 weave together the following narrative: Figure shows that India was growing at similar rates as other Asian economies before takeoff. After takeoff, it kept pace with Indonesia, but China and Korea grew faster.

In Figure we set date 0 as the year the country's per capita GDP in 2000 US dollars crossed $500; in Figure 2.3c, the year that the country's dependency ratio fell below 40 per cent. China's growth is more robust under both these alternatives, while India's matches that of Indonesia. Korea's trajectory is similar to India's in the initial years after takeoff, though after 10 years the slope of its trajectory increases steeply.The takeaway from the evidence we have examined thus far is that India's growth performance has been similar to that of some fast-growing Asian economies at similar stages after takeoff, but not as spectacular as China's. Interestingly, despite being seen as a trade laggard, India has grown more open to trade at about China's pace.Sources of GrowthA decomposition of per capita income growth during the 20 years after takeoff (see Figure 2.5) suggests that across countries, much of the increase in per capita income comes from greater labour productivity. Interestingly, except for Korea, labour force participation (LFP) has fallen on an average annual basis, so it subtracts from growth. Finally, the increase in the share of working age population (WAP) seems to add only a little to growth. Since the increase in working age population is what we call the demographic dividend, the fact that it contributes so little to growth (on average, 0.5 percentage points for India in the 20 years since 1991) may seem a puzzle.The resolution to the puzzle is quite simple. The increase in the fraction of people working is probably not the main consequence of the demographic dividend. Instead, the effects of the demographic dividend are channelled through the increase in labour productivity, which comes from more physical capital employed per worker (in turn resulting from greater saving and investment), more human capital per worker (which comes from more education as smaller families lead to greater spending on education per child), and greater total factor productivity (TFP). TFP measures how productive the job intrinsically is, capturing aspects such as the technology used, efficiency with which the work is carried out, and use of hard-to-measure aspects of work such as tacit knowledge, organizational capabilities, and trust.

It is therefore useful to see how much each of these factors contributed to labour productivity. As Figure 2.6 suggests, better human capital accounts for only a small part of the growth in labour productivity for Asian fast growers. Instead, the two biggest contributors are the growth in capital deployed per worker and growth in TFP. Indonesia and Korea relied much more on capital deepening. India did not have as much growth in capital per worker as these countries but had stronger growth in TFP. Finally, China grew both because of more capital deployed as well as strong increases in TFP.Interestingly, as Figure 2.7 suggests, in the years beyond the 20th year after takeoff which India is now entering, capital deepening slowed for both Indonesia and Korea but it increased for China. More interestingly, TFP slipped considerably for Indonesia and was not large for Korea to begin with. However, it increased for China.Increasing Labour Productivity and Sectoral ReallocationIMF (2006) suggests that a significant portion of China's increase in TFP has come as workers migrate from low-productivity sectors like agriculture to high-productivity sectors like manufacturing. What lies ahead for India? The sectoral pictures across countries suggest several important messages:

Unlike the conventional wisdom, India does not have more people in agriculture than other Asian countries at similar stages of development. The share of workers dependent on agriculture has been shrinking at a similar pace. However, the pace of shrinkage is set to increase if India is to follow the trajectory of these other countries.

One problem is that while industry is creating jobs, these have been relatively low-productivity jobs. As a result, per capita income in India has not benefited as much from inter-sectoral migration of workers out of agriculture as other Asian countries have.

A second problem is that the high-productivity services sector is not able to create employment commensurate with its growth in value added.

How many jobs will be missing?Clearly, there is a coming transition of workers out of agriculture if we follow the path of other Asian countries. In addition, the demographic dividend will ensure more workers joining the labour force. How many workers will industry and services have to absorb in the next decade? How many will they absorb if they continue creating jobs as they have in the past? Could the demographic dividend turn into a demographic curse as some have argued?In order to answer this question, we build a few simple scenarios using data from the World Development Indicators (WDI) and UN Population Division. In the baseline (Table 2.1, column I), we assume that employment in industry and services will grow during 2010-20 at the same rate as during the previous decade. The share of employment in agriculture will fall to 40 per cent by 2020 (the same level as that of China in 2010). Population in the working age group will grow based on projections by the UN Population Division. We assume the labour force participation rate and the unemployment rate to be unchanged at 2010 levels. Under this baseline scenario, 2.8 million jobs will be missing by 2020. To put this in perspective, this will only be 0.5 per cent of the labour force. While any shortfall in jobs is problematic, there does not seem an immediate cause for alarm.

WHY IS BUSINESS NOT CREATING MORE PRODUCTIVE JOBS?In India, too many small firms stay small and unproductive and are not allowed to die gracefully. Too many large profitable firms prefer relying on temporary contract labour and machines than on training workers for longer-term jobs. This section has two parts--in the first, we will examine the impediments to the formalization and growth of small businesses. In the second, we will examine the situation of labour, and why large formal businesses may be so averse to hiring. Impediments to the emergence and growth of businessAs a group, it is estimated that micro, small, and medium enterprises (MSMEs)3 employ 81 million people in 36 million units across the country4. Yet, many of these firms are unable to grow and/or even shut down. Hsieh and Klenow (2011) indicate that as compared to surviving small firms in the United States, which grow spectacularly, surviving small firms in Mexico grow moderately, while surviving small firms in India shrink. Productivity is commensurately lower in India. Indeed, within the MSME group, there is a strong concentration of small enterprises and near non-existence of medium enterprises (see Figure 2.12). And that is the real challenge of the MSME sector--to be able to not just start up, but also continue to grow, thereby becoming a source of sustainable jobs and value creation.Too many firms in India stay small, unregistered, unincorporated, largely informal, or in the unorganized sector because they can avoid regulations and taxes. These firms have little incentive to invest in upgrading skills of largely temporary workers or in investing in capital equipment that could bring them into the tax net, so their productivity stays low. Low productivity gives them little incentive to grow, completing the vicious circle. RegulationsThe regulatory environment plays an important role in the lifecycle--birth, growth, and death--of MSMEs. According to the World Bank's Doing Business 2013 data, India ranks 132 out of 185 countries in ease of doing business. Starting a business where India ranks 173, takes about 12 procedures, 27 days, and a paid up capital of 140 per cent of per capita income. By contrast, it takes only 7 procedures, 19 days, and 18 per cent of per capita income on average for our neighbours in South Asia.Getting fundingBanks and other financial institutions are wary of lending to MSMEs because they lack adequate credit histories or collateral. A cluster-centric approach is one way of addressing this because it reduces transactions costs for the lender, while repeated interactions for a lender with cluster members increases the scope for building trust. While there have been efforts to facilitate these, their coverage is still small. Schemes such as credit guarantees by the Small Industry Development Board of India (SIDBI) have been useful, but there are gaps. Getting access to quality infrastructure.

The absence of quality infrastructure—roads, utilities, real estate, logistics—increases transaction costs disproportionately for MSMEs which typically cannot create customized alternatives such as access roads and captive power plants which larger firms can. Lack of this supporting infrastructure causes greater cash burn and distraction of management from core business operations. One constraint in creating infrastructure or setting up businesses is land acquisition. Labour Practices as Possible Impediments to GrowthThus far we have not examined labour practices directly. India has a number of labour practices that, economists have argued, further impede the creation of productive jobs in the largescale organized sector. There exists considerable variation in hiring practices across firms of different sizes in India. Dougherty (2008) uses a methodology similar to Davis et al. (1998) and data up to 2004 to estimate the employment dynamics in the organized manufacturing sector in India. The study finds that the job creation rate is much bigger for small firms than for large ones; on the other hand the job destruction rate is higher in large firms, with the result that the net employment rate in large firms is negative and strikingly smaller than in small firms.

Box 2.2 : The DMIC: An Integrated Approach to Industrial Growth and Development*The DMIC is being developed by the Government of India with a view to using the high-capacity western Dedicated Freight Corridor as a backbone for creating a global manufacturing and investment destination. The project seeks to develop a series of futuristic infrastructure-endowed smart industrial cities that can compete with the best international manufacturing and industrial regions. The master plan has a vision for 24 manufacturing cities. Potential production sectors include general manufacturing, IT/ITES components, electronics, agro and food processing, heavy engineering, pharmaceuticals, biotechnology, and services. Investment is pegged at $90 billion. The DMIC was conceived by the Ministry of Economy, Trade, and Industry (METI) of Japan and the Ministry of Commerce and Industry (MoCI) of India. Possible socio-economic impact: The DMIC Project Influence Area of 436,486 sq. km is about 13.8 per cent of India’s geographical area. It extends over seven states and two union territories, viz. Delhi, Uttar Pradesh, Haryana, Rajasthan, Madhya Pradesh, Gujarat, Maharashtra, Daman and Diu, and Dadra and Nagar Haveli. Around 17 per cent of the country’s total population will be affected. The project goals are to double employment potential in 7 years, triple industrial output in 9 years, quadruple exports from the region in 8-9 years, and target 13-14 per cent growth per annum for the manufacturing sector on a sustained basis over next three years.Urban governance: The innovative urban governance framework corporatizes the urbanization process. The central government will create a corpus fund, the DMIC Project Implementation Revolving Fund, as a trust administered by a board of trustees. The fund will contribute debt and equity to the special purpose vehicles (SPVs) on a case-by-case basis. The

state government will make land available. The city SPVs will be vested with the responsibilities of planning and development and the power to levy user fees. The SPVs are to be companies under the Companies Act. The valuation increases from urbanization and development will accrue to the city-level SPVs, and will be reinvested in the cities. The initial construction of the cities will be done through project managers with global experience, who will control, monitor, review, and supervise the detailed engineering.Financing: The basic provision of trunk infrastructure is unlikely to be commercially viable. This would require government funding. Such internal infrastructure projects include land improvement, road works, earthworks, sewerage, storm water drainage, flood management, and solid waste management. Once such infrastructure is in place, the subsequent additions to the cities will be commercially viable and can be implemented through public private partnerships (PPPs). For major infrastructure activities such as power plants, integrated townships, and highways, PPP projects are planned. Various sources of finance including multilateral, bilateral, and domestic government funding are planned.Physical infrastructure: At the heart of the infrastructure is the Multi-modal High Axle Load Dedicated Freight Corridor (DFC), a high-capacity railway system. It will cover 1483 km and will have nine junction stations along which other railroad networks will connect allowing the system to extend its reach across a wide swathe. Other infrastructure plans include logistic hubs, feeder roads, power generation facilities, up-gradation of existing ports and airports, developing greenfield ports, environment protection mechanisms, and social infrastructure. Industrial infrastructure: The project seeks to upgrade existing industrial clusters and also develop new industrial facilities. These will be developed on the concept of node-based development based on Investment Regions (IRs) and Industrial Areas (IAs). These are proposed as self-sustaining industrial townships with world-class infrastructure including domestic/international air connectivity, reliable power, and competitive business environment. IRs will have a minimum area of 200 sq. km and IAs 100 sq. km. In all 24 manufacturing cities (IRs and IAs) are planned. Seven major manufacturing cities are being planned for the first phase. These will serve as the key nodes for overall growth and development.Skill development: The skill-building strategy underlying the DMIC is based on a hub-and-spoke model. There will be one Skill Development Centre in every state with subsidiary institutions linked to it. Curricula will be based on the types of industries located in the region and identified regional strengths.Land acquisition: Land acquisition appears to be a major challenge. Different state governments are adopting diverse approaches for dealing with the issue. Gujarat has a land-pooling model whereby 50 per cent of the land is acquired while the remaining 50per cent is left with the original owners giving them a stake in the upsides generated by land monetization. Maharashtra allows for negotiated purchase involving various stakeholders. In Haryana and Rajasthan, trunk and industrial infrastructure are created by the state governments but private developers directly participate in the other activities. The value increase is captured by the states through development fees. Furthermore, in the initial DMIC master-planning process, the attempt was made to identify large, easy-to-acquire land parcels that were either barren or government owned. Environmental clearances: The master-planning process has been applied for a general Terms of Reference clearance, which has already been obtained. This has reduced the compliance load for individual project clearances. The individual projects will now need to get their draft impact assessments cleared by the respective state pollution control authorities.Power infrastructure: Power for the industrial and residential zones is an essential requirement. The provision of world class power infrastructure will require 24X7 good quality supply. The major power inputs will come from six gas-based projects of around 1000-1200MW each. Other power options include the use of renewable energy sources integrated through a smart grid. Water management: The DMIC passes through relatively arid parts of the country. The various industrial hubs are to have integrated water resource management plans drawing upon lessons from countries such as Singapore. It is proposed to make each manufacturing city self-reliant and sustainable in terms of its water requirements. Recycling is a major strategy in all the industrial nodes.*Prepared by Supriyo De. Thanks are due to Amitabh Kant, Chief Executive Officer and Managing Director and Abhishek Chaudhary, Vice-President, Delhi-Mumbai Industrial Corridor Development Corporation Limited for valuable insights.

Box 2.3 : The Nuts and Bolts of Improving Business Climate for Small Businesses*There are several regulatory changes that can be made to improve the business climate for MSMEs. Formulate a common policy on business development and regulation: There are a vast number of business regulations that often overlap and sometimes contradict each other. A common policy and an institutional architecture overseeing all business regulations will help consolidate and enact changes.Help business facilitation: Establish independent facilitation and coordination agencies as PPP service companies with mandate from the state government, staffed with specialists and responsible for getting work done through various departments for starting up and running of businesses. These agencies will also help arrange services such as financing, finding raw material suppliers, and marketing products. They will charge a fee for some of the services provided, and be financially self sufficient.Simplify registrations for starting up: Create a one-stop online registration system for time-bound registrations for starting a business. The applicant will need to file a single application on the website, with the required information being picked up by each government department. Over time, this process can be extended to other activities such as trading across borders and paying taxes. This will require detailed mapping exercises and setting up of a ‘best practices’ framework. Ease burden of compliance as the firm grows: Enable compliance ratings of MSMEs (through ISO-like common standards) and allow easier compliance norms to firms with higher ratings. Easier norms can take the form of simpler procedures (such as self-certification) across government departments. For instance, a company with a good history of tax compliance should be treated as a good citizen when it deals with the pollution control board. Over time, high compliance ratings could also act as a signal to financiers and enable easier access to credit.Allow for easy exits: The arduous process of exit for unsuccessful companies needs to be made simpler, faster, and cheaper.Transform employment exchanges to enable effective job matching: Transform the 1,000-odd employment exchanges across states into career centres offering counselling, assessments, apprenticeships, training, and jobs. Improve value/benefits from statutory pre-emptions: Currently for low wage workers in formal employment, the plethora of statutory pre-emptions, especially for provident fund and health insurance, can lead to very low net salary and act as disincentive to formal employment. The value and benefits received from these pre-emptions can be improved by encouraging competition between different pension and health schemes.Reduce attractiveness of staying small: Growing bigger is unattractive because some of the benefits targeted at MSMEs are withdrawn even while new regulations and obligations kick in. Innovative approaches are needed for giving MSMEs the incentive to grow. For instance, new regulations could be kept in abeyance for a period after the MSME crosses the size threshold that would require it to meet the regulation. * Prepared by Pranjul BhandariBox 2.4 : Labour Regulations : Impediment to Growth and Size of Indian firms in Manufacturing*A rapid expansion of the manufacturing sector has been a key element of the growth experience of successful developing countries, especially labour-abundant ones. In this context, the Indian manufacturing sector exhibits many peculiarities: first, as also documented earlier in the chapter, it contributes a rather small and stagnant share to GDP; second, its composition is more skewed towards skill- and capital-intensive activities compared to countries at similar levels of development;1 third, only a small share of employment in manufacturing is in organized manufacturing (the unorganized manufacturing sector accounted for almost 70 per cent of total manufacturing employment in 2009-102); and fourth, employment is heavily concentrated in small firms (Figure 1). The degree of concentration is much higher than in other Asian countries. For example, the share of micro and small enterprises in manufacturing employment is 84 per cent for India versus 27.5 per cent for Malaysia and 24.8 per cent for China.These characteristics of Indian manufacturing are quite puzzling in that product market reforms since the early 1990s—including dramatic trade liberalization and virtual abolishment of the industrial licensing regime—have been primarily focused on removing various constraints on the manufacturing sector. How then does one explain the peculiarities of the Indian manufacturing sector? Several theories have been put forward to explain this puzzle,

ranging from strict labour laws that have hindered growth, especially of labour-intensive industries, infrastructure bottlenecks that have prevented industries from taking advantage of reforms, and credit constraints due to weaknesses in the financial sector which may be holding back small and medium sized firms from expanding.India’s labour regulations have been criticized on many grounds including sheer size and scope , their complexity, and inconsistencies across regulations. There are 45 different national- and state-level labour legislations in India (Panagariya 2008). The labour laws apply only to the organized sector. As the size of a factory grows, it increasingly becomes subject to more legislation. A few specific pieces of the legislation are particularly constraining. According to Chapter VB of the Industrial Disputes Act (IDA), it is necessary for firms employing more than 100 workers to obtain the permission of state governments in order to retrench or lay off workers. While the IDA does not prohibit retrenchment, states have often been unwilling to grant permission. Section 9A of the IDA lays out the procedures that must be followed by employers before changing the terms and conditions of work, which introduces additional rigidities for firms in using their existing workers effectively.3 In particular, worker consent is required in order to modify job descriptions or move workers from one plant to another in response to changing market conditions.How do these regulations affect the manufacturing sector quantitatively? Besley and Burgess (2004) find that industrial performance has been weaker in states with pro-worker labour laws. There have also been several recent studies that establish the importance of labour regulations.4 Estimates using plant-level data suggest that firms in labour intensive industries and in states with flexible labour laws have 14 per cent higher TFP than their counterparts in states with more stringent labour laws. Moreover, the impact of delicensing has been highly uneven across industries within India’s organized manufacturing sector. In particular, labour-intensive industries have experienced smaller gains from reforms. In addition, states with relatively inflexible labour regulations have experienced slower growth of labour-intensive industries and employment (Figure 2). Further, the difference in the performance of labour-intensive industries in states with flexible labour laws and states with inflexible labour laws has increased over time. Labour laws may also be an important factor responsible for the skewed distribution of size in Indian industries (Figure 3). Firms in states with more inflexible labour regulations tend to be smaller, especially in the labour-intensive subsectors of manufacturing.A contrarian view is that Indian businesses have learnt to get around the laws by hiring contractual labour, outsourcing noncore activities, etc.; it is thus argued that labour regulations are not a binding constraint to industrial performance and employment growth. Indeed, in surveys of firms, businesses do not list labour laws among the top constraining factors. One way of reconciling this response with the systematic empirical evidence discussed here is that firms have learned to adapt to the labour laws—by either not hiring permanent workers or by staying below the threshold of these laws—and therefore they do not see them as a constraint. As pointed out in Krueger (2007), the counterfactual of whether labour laws would constrain firms that would emerge in the absence of strict labour laws cannot be captured in the surveys. Moreover, the adverse consequences of the labour laws can be inferred from the low rate of job creation in the formal sector, low productivity in the informal sector, and small firm size, especially in labour-intensive industries and states with more inflexible labour laws. WHY ARE SERVICES NOT CREATING JOBS?As has been discussed earlier, while the share of employment in services was relatively high at take off, its growth has since then been slow. At the same time, the share in value added, which was high at take-off, has continued to rise quickly. This implies that while productivity in the sector has been high, the services sector is not creating many jobs--the opposite of the problem with industry.Some impediments to business creation such as regulatory hurdles and access to funding and infrastructure may be common between services and industry. Labour regulations are also likely to constrain creation of jobs in services. For example, 27 per cent of retail stores in India report labour regulations as a problem for their businesses (Amin 2008)5. But what stands out for the services sector is the importance of education and skilling. Suitable higher education is important for high-end services such as information technology, software development, and finance. Mid-level services such as retail trade, hotels, and restaurant services also require adequate skilling of the labour force.Schemes such as the formal apprenticeship programme of the government, which places employers at the heart of education, can play a powerful role in imparting job-relevant skills

and also retraining, preparing, and upgrading the labour force. In its current form, the Act and the rules governing apprenticeships are outdated and rigid from both the perspective of employers and employees. Box 2.7 discusses the current Act/rules and suggests changes that need to be made.The challenge is to address both quality and quantity issues in skill development and training so as to correct the mismatch between employers who do not get people with requisite skills and millions of job seekers who do not get employment. To this end, the National Skill Development Mission aims to impart employment-oriented vocational training to 8 crore people over the next five years by working with state governments/State Skill Missions and incorporating the private sector (through PPPs and for-profit vocational training) and NGOs. Basic education is also an important input for enhancing human capital. Recent government initiatives to expand access to quality primary education are important; however, more needs to be done Public Finance The fiscal outcome of the Central government in 2012-13 so far indicates significant improvement over 2011-12. The fiscal outcome in 2011-12 was affected by macroeconomic developments of growth slowdown, high global crude oil prices, and sluggish financial market conditions for effecting the budgeted disinvestment programme. These developments continued through the first half of the current year.

Public FinanceThe fiscal outcome of the Central government in 2012-13 so far indicates significant improvement over 2011-12. The fiscal outcome in 2011-12 was affected by macroeconomic developments of growth slowdown, high global crude oil prices, and sluggish financial market conditions for effecting the budgeted disinvestment programme. These developments continued through the first half of the current year.The government then pushed harder for reforms. An initial step was to set up the Kelkar Committee. Following its recommendations, the government unveiled a revised fiscal consolidation roadmap. The fiscal position of states has continued to progress with fiscal deficit budgeted at 2.1 per cent of gross domestic product (GDP). Staying on the indicated fiscal consolidation path is critical to sustaining the desirable macroeconomic outcomes not only in terms of higher growth in real GDP and lower inflation, but also in easing the financing of the widening current account deficit (CAD), for which India’s sovereign credit rating is important. Widening of the tax base and prioritization of expenditure are key factors in effecting the desired reduction in the Central government’s fiscal deficit over the medium term, and in reducing the key risks to fiscal marksmanship (the difference between actual outcomes and budgetary estimates as a proportion of GDP).Following the recommendations of the committee headed by Dr Vijay Kelkar to chalk out a roadmap for fiscal consolidation, the government unveiled a revised fiscal consolidation roadmap in October 2012. It targeted a fiscal deficit of 4.8 per cent of GDP for 2013-14 and through a correction of 0.6 percentage point each year thereafter, a fiscal deficit of 3.0 per cent of GDP in 2016-17. Controlling the expenditure on subsidies will be crucial. Domestic prices of petroleum products, particularly diesel and liquefied petroleum gas (LPG) need to be raised in line with the prices prevailing in international markets. A beginning has already been made with the decision in September 2012 to raise the price of diesel and again in January 2013 to allow oil marketing companies to increase prices in small increments at regular intervals. The number of subsidized gas cylinders has also been capped at nine. Efforts will also have to be made to contain subsidies through better targeting, limit other expenditures, and raise revenues over time so as to take the revenue to GDP ratio to 2007-08 levels. The disinvestment process has also been speeded up.

Balance from Current Revenues (BCR): It is the difference of revenue receipts and the non-plan expenditure.

Box 3.4 : Direct Benefit Transfer (DBT)The DBT plan was introduced on 1 January 2013 with seven schemes in 20 districts. India has embarked on a DBT scheme in selected districts wherein it has been envisaged that benefits such as scholarships, pensions, and MGNREGA (Mahatma Gandhi National Rural Employment Guarantee Act) wages will be directly credited to the bank or post office accounts of identified beneficiaries. The DBT scheme will not substitute entirely for delivery of public services for now. It will replace neither food and kerosene subsidies under the TPDS nor fertilizer subsidies. The DBT is designed to improve targeting, reduce corruption, eliminate waste, control expenditure, and facilitate reforms. Electronic transfer of benefits is a simple design change and transfers that are already taking place through paper and cash mode will now be done through electronic transfers. This has been enabled by rapid roll out of Aadhar (Unique Identity) now covering 200 million people and rapidly growing to cover 600 million (nearly half of our population), with the National Population Register covering the other half of the populace. The DBT in tandem with such unique identification will ensure that the benefits reach the target groups faster and minimize inclusion and exclusion errors as well as corruption that are associated with manual processes.

GOVERNMENT DEBTThe high levels of fiscal deficit in the post crisis period added to the overall debt burden of the central government. Prolonged fiscal deficits lead to accumulation of debt beyond levels sustainable for an economy and can result in higher real and nominal interest rates, slower growth in capital formation, and potentially lower the rate of output growth. The outstanding liabilities of the central government were placed at Rs. 44,68,714 crore, equivalent of 49.8 per cent of GDP at end-March 2012 (Table 3.9). As a proportion of GDP, outstanding liabilities (adjusted) of the centre peaked at 67.0 per cent in 2002-3 and have fallen subsequently notwithstanding the rise in fiscal deficit in the post crisis years. This is on account of the fact that growth in incremental assumption of liabilities has been lower than that of nominal GDP and the debt to GDP ratio dynamics is aided by the differential between nominal GDP growth and nominal interest rates, which makes it possible to achieve a greater reduction through a given primary balance.Government of India has the following favourable features which provide some comfort. (a) Weighted average maturity of outstanding government securities at 9.8 years is high compared to international standards. At end- March 2012, the proportion of debt maturing in less than one year was only 3.5 per cent and 30.2 per cent of outstanding stock had a residual maturity of up to five years. (b) Most of the public debt in India is at fixed interest rates. Of the total outstanding dated securities, only 1.8 per cent was on floating rate. Thus interest payments are largely insulated from interest rate volatility, imparting stability to the Budget. (c) The average cost of the debt (interest payments/debt ratio) and interest payments as a percentage of revenue receipts are on a secular decline, though some rise was seen in the past two years. Ratio of interest payments to revenue receipts has declined to around 36 per cent in 2011-12 from about 50 per cent in the beginning of the 2000s. (d) A relatively stable weighted average yield of primary issuance indicates stability in interest

payments/revenue receipts and interest payments/debt ratios, pointing towards the sustainability of the debt in the country.

STATE-LEVEL FINANCESWhile there has been some stress in central government finances in recent years, the finances of states are in fine fettle. The combined gross fiscal deficit of states did not exceed 3.0 per cent of GDP even in the years of global crisis. After reaching a level of 1.5 per cent of GDP in 2007-8, the fiscal deficit of states rose to 2.9 per cent in 2009-10 but has moderated to 2.1–2.3 per cent subsequently With the exception of 2009-10, the combined position of states in terms of revenue deficit has been one of surplus. Besides, what is noteworthy is that there has been an improvement in the quality of expenditure with a rise in capital expenditure to GDP ratio and development expenditure.CONSOLIDATED GENERAL GOVERNMENTAs indicated earlier, fiscal deficit of the centre widened from 4.8 per cent of GDP in 2010-11 to 5.9 per cent in 2011-12 (RE). With the fiscal deficit of states exhibiting a modest deterioration to 2.3 per cent of GDP, the fiscal outcome in terms of centre and states combined was placed at 8.1 per cent in 2011-12 (RE) as against 6.9 per cent in 2010-11 (Table 3.10). In 2012-13 (BE), fiscal deficit is budgeted to come down to 7.2 per cent of GDP.The 14th Finance Commission was constituted on 2 January 2013 under the Chairmanship of Dr Y.V.Reddy, former RBI Governor. Other members of the commission are (i) Professor Abhijit Sen (ii) Ms Sushma Nath (iii) Dr M.Govinda Rao (iv) Dr Sudipto Mundle. The Commission’s mandate is detailed in Box 3.5.

Box 3.5 : Terms of Reference of 14th Finance CommissionThe following are the broad Terms of Reference and the matters to be taken into consideration by the 14th Finance Commission in making the recommendations: 1. (i) the distribution between the union and states of the net proceeds of taxes which are to

be, or may be, divided between them under Chapter I, Part XII of the Constitution and the allocation between the states of the respective shares of such proceeds; (ii) the principles which should govern the grants-in-aid of the revenues of the states out of the Consolidated Fund of India and the sums to be paid to the states which are in need of assistance by way of grants-in-aid of their revenues under article 275 of the Constitution for purposes other than those specified in the provisos to clause (1) of that article; and (iii) measures needed to augment the Consolidated Fund of a state to supplement the resources of the panchayats and municipalities in the state on the basis of the

recommendations made by the Finance Commission of the state. 2. The Commission has been mandated to review the state of finances, deficit, and debt

levels of the union and states and suggest measures for maintaining a stable and sustainable fiscal environment consistent with equitable growth including suggestions to amend the FRBMAs currently in force. The Commission has been asked to consider and recommend incentives and disincentives for states for observing the obligations laid down in the FRBMAs.

3. In making its recommendations, the Commission inter alia is required to consider: the resources of the central government and the demands on the resources of the central government; the resources of the state governments and demands on such resources under different heads, including the impact of debt levels on resource availability in debt-stressed states; the objective of not only balancing the receipts and expenditure on revenue account of all the states and the union but also generating surpluses for capital investment; the taxation efforts of the central government and each state government and the potential for additional resource mobilization; the level of subsidies required for sustainable and inclusive growth and equitable sharing of subsidies between the central and state governments; the expenditure on the non-salary component of maintenance and upkeep of capital assets and the non-wage-related maintenance expenditure on Plan schemes to be completed by 31 March 2015 and the norms on the basis of which specific amounts are recommended for the maintenance of capital assets and the manner of monitoring such expenditure; the need for insulating the pricing of public utility services like drinking water, irrigation, power ,and public transport from policy fluctuations through statutory provisions; the need for making public-sector enterprises competitive and market oriented; listing and disinvestment; relinquishing of non-priority enterprises; the need to balance management of ecology, environment, and climate change consistent with sustainable economic development; and the impact of the proposed goods and services tax on the finances of the centre and states and the mechanism for compensation in case of any revenue loss.

4. The Commission is required to generally take the base of population figures as of 1971 in all cases where population is a factor for determination of devolution of taxes and duties and grants-in-aid; however, the Commission may also take into account the demographic changes that have taken place subsequent to 1971.

5. The Commission is to review the present public expenditure management systems in place including budgeting and accounting standards and practices; the existing system of classification of receipts and expenditure; linking outlays to outputs and outcomes; best practices within the country and internationally and to make appropriate recommendations thereon.

6. The Commission is to review the present arrangements as regards financing of Disaster Management with reference to the funds constituted under the Disaster Management Act 2005(53 of 2005) and make appropriate recommendations thereon.

7. The Commission is to indicate the basis on which it has arrived at its findings and make available the state-wise estimates of receipts and expenditure.

Prices and Monetary ManagementInflation, as measured by the Wholesale Price Index (WPI), has remained above 7 per cent since December 2009. Food inflation has been particularly elevated over this period, contributing to an average of one third of total inflation. Consumer price inflation, with higher weights on food, have been generally higher than the headline WPI inflation. A moderation in WPI inflation is now clearly visible, but the moderation has largely been due to deceleration in the rate of inflation of nonfood manufactured products. Inflation pressures have eased globally. Global consumer prices rose at a 3.7 percent annualized rate at the end of 2012. Inflation for developing countries also moderated to a 5.4 percent annualized rate in the three months through November 2012, from an average 7.2 percent in 2011. Benign inflation in global commodity prices, with inflation for energy and non-energy commodities in base line scenario expected to be around (-) 2.6 per cent and (-) 2.0 per cent respectively in 2013, will check the inflation of tradeable commodities even in India. Apart from monetary policy attempting to control demand, supply side responses will be necessary to bring down inflation in a sustained way, and ongoing policy initiatives need to be pursued.

Seasonally Adjusted Annual Rate (SAAR)A rate adjustment used for economic or business data that attempts to remove the seasonal variations in the data. Most data will be affected by the time of the year. Adjusting for the seasonality in data means more accurate relative comparisons can be drawn from month to month all year.

Measures Taken and Proposed by the Government to Contain Price Rise1. Fiscal measures Import duties for wheat, onions, pulses, and crude palmolein were reduced to zero and

7.5 per cent for refined vegetable & hydrogenated oils. Duty-free import of white/raw sugar was extended up to 30 June 2012; presently the

import duty has been fixed at 10 per cent.2. Administrative measures Ban on exports of onions was imposed for short periods of time whenever required.

Exports of onions were calibrated through the mechanism of minimum export prices (MEP).

Futures trading in rice, urad, tur, guar gum and guar seed was suspended. Exports of edible oils (except coconut oil and forest-based oil) and edible oils in blended

consumer packs up to 5 kg with a capacity of 20,000 tons per annum and pulses (except Kabuli chana and organic pulses and lentils up to a maximum of 10,000 tonnes per annum) were banned.

I Stock limits were imposed from time to time in the case of select essential commodities such as pulses, edible oil, and edible oilseeds and in respect of paddy and rice up to 30 November 2013.

3. The government has undertaken various measures to insulate the vulnerable sections of society from price rise.

The central issue prices (CIP) for rice (at Rs 5.65 per kg for below poverty line [BPL] and Rs 3 per kg for Antodaya Anna Yojana [AAY] families) and wheat (at Rs 4.15 per kg for BPL and Rs 2 per kg for AAY families) have been maintained since 2002.

Under the targeted PDS (TPDS) allocation of foodgrains is being made to 6.52 crore AAY and BPL families at 35 kg per family per month at a highly CIP.

The government has allocated rice and wheat under the Open Market Sales Scheme (OMSS).

The scheme for imports of pulses which envisaged imports for distribution to BPL households through the PDS with a subsidy of Rs 10 per kg operated from November 2008 to June 2012. The government has decided to implement a varied form with a subsidy element of Rs 20 per kg per month for BPL cardholders for the residual part of the current year. The targeted BPL cardholders will be as estimated by the Department of Food and Public Distribution.

The Scheme for Distribution of Subsidized Imported Edible Oils has been implemented

since 2008-9 through state/union territory (UT) governments for distribution of 1 litre per ration card per month with a central subsidy of Rs 15 per kg. The scheme has been extended up to 30 September 2013.

4. Budgetary and other measures A number of measures were announced in Union Budget 2012-13 to augment supply and

improve storage and warehousing facilities. The government launched a National Mission for Protein supplements in 2011-12 with an allocation of Rs 300 crore. To broaden the scope of production of fish to coastal aquaculture, apart from fresh water aquaculture, the outlay in 2012-13 was stepped up to Rs 500 crore. Recently the government permitted FDI in multibrand retail trading. This will help consumers and farmers as it will improve the selling and purchasing facilities.

5. Monetary measures The RBI had also taken suitable steps to contain inflation with 13 consecutive increases

by 375 basis points (bps) in policy rates from March 2010 to October 2011. Inter-Ministerial Group (IMG) on Inflation An Inter-Ministerial Group (IMG) on inflation was set up on 2 February, 2011, on the recommendation of the Prime Minister, under the chairmanship of Chief Economic Adviser, Ministry of Finance to review the overall inflation situation, with particular reference to primary food articles. The IMG has so far had eight meetings between 15 February, 2011 and 31 January, 2012 covering various aspects, including information system on all aspects of price monitoring, Foreign Direct Investment (FDI) in multi-brand retail, reform in APMC Act, policy options for diesel pricing and inflation in protein rich products among others.Global Commodity Prices : ForecastThe broad assessment of inflation for commodity groups by the World Bank is as under: Nominal oil prices are expected to average US $102/bbl in 2013 and 2014 as supplies

accommodate moderate demand growth. Over the longer term, oil prices are projected to fall in real terms, due to growing supply, efficiency gains, and a substitution away from oil. While OPEC may continue to limit production, it probably will not let prices rise too high, for fear of inducing a search for alternative oil supplies or energy sources that alters the long-term price of oil.

Overall metal prices, except copper are expected to increase. Aluminum prices may increase by 3 percent in 2013 and remain at that level in the two subsequent years due to rising power costs, and the fact that current prices have pushed some producers at or below production costs. Copper prices may decline mostly due to substitution pressures, and slowing demand. Although there are no physical constraints in metal markets, declining ore grades, environmental issues, and rising energy costs may force prices higher.

Assuming that there are no major shifts for biofuels, agricultural prices are projected to decline in 2013. Specifically, wheat and maize prices are expected to be lower than their 2012 levels. Soybean and palm oil prices are also expected to be lower because of adequate availability.

FINANCIAL INTERMEDIATIONEfficient intermediation by financial markets leads to higher economic growth by increasing savings and their optimal allocation for productive uses. A shift of our growth trajectory to the pre-crisis level of over 8 per cent and above critically depends on efficient financial intermediation between savers and borrowers. Historically, banks have played this role. However, with the start of the reform process beginning 1990s, the importance and nature of financial intermediation has undergone a transformation with other intermediaries including non-banking financial companies (NBFCs), insurance and pension funds, and mutual funds(MF) emerging as the new mechanisms for channelling savings to investments. These developments have also been accompanied by the emergence of equity and debt markets, financial products like forwards, futures and other derivatives instruments which have the capacity of reallocating risks and putting capital to more efficient use. However, keeping in view India's growing integration with global financial markets, external-sector vulnerabilities have an increasingly large impact on India through the trade and capital account channels. It is therefore important that the development of an efficient and healthy financial market should also be accompanied by an effective regulatory mechanism that keeps track of external vulnerabilities.Priority-sector Lending In view of the need to ensure adequate institutional credit flow to the vulnerable sectors, the RBI has mandated that banks should lend a minimum of 40 per cent of their advances to the priority sectors. Priority sector broadly includes advances to agriculture, small scale industries, weaker section, exports, education, SHGs, etc. Details of priority sector are provided in Appendix

Revised guidelines issued by the RBI on priority sector lending (PSL) on 20 July 2012, mandates commercial banks and foreign banks with 20 or more branches to allocate 40 per cent of their adjusted net bank credit (ANBC) or credit equivalent amount of off-balance sheet exposures (OBE), whichever is higher, to the priority sector. Within this, sub-targets of 18 per cent and 10 per cent of ANBC or credit equivalent amount of OBE have been mandated for lending to agriculture and the weaker sections respectively. For foreign banks with less than 20 branches, the target PSL is 32 per cent of ANBC or credit equivalent amount of OBE, whichever is higher. Foreign banks have been given a period of 5 years beginning April 2013 to achieve their PSL target. Their action plan, however, is required to be approved by the RBI.Extension of Swabhimaan scheme Under the Swabhimaan financial inclusion campaign, over 74,000 habitations with population in excess of 2,000 had been provided banking facilities by March 2012, using various models and technologies including branchless banking through business correspondents (BCs). The Finance Minister in his Budget Speech of 2012-13 had announced that Swabhimaan would be extended to habitations with population more than 1,000 in the north-eastern and hilly states and population more than 1,600 in the plains areas as per Census 2001. Accordingly, about 45,000 such habitations had been identified for coverage under the extended Swabhimaan campaign. As per the progress received through the convenors of State Level Bankers' Committee (SLBC), out of the identified habitations, 10,450 have been provided banking facilities by end of December, 2012. This will extend the reach of banks to all habitations above a threshold population.Setting up of Ultra Small Branches Considering the need for close supervision and mentoring of the business correspondent agents (BCAs) by the respective banks and in order to ensure that a range of banking services are available to the residents of such villages, ultra small branches (USBs) are being set up in all villages covered through BCAs under financial inclusion. These USBs will comprise a small area of 100-200 sq. feet where the officer designated by the bank will be available with a laptop on pre-determined days. While cash services will be offered by the BCAs, the bank officer will offer other services, undertake field verification, and follow up banking transactions. The periodicity and duration of visits can be progressively enhanced depending upon business potential in the area. A total of over 40,000 USBs have so far been set up in the country.

Interest Subvention Scheme The Interest Subvention Scheme is being implemented by the Government of India since 2006- 7 to make short-term crop loans up to Rs. 3 lakh for a period of one year available to farmers at the interest rate of 7 per cent per annum. The Government of India has since 2009-10 been providing additional interest subvention to farmers who repay their loans in time. The additional subvention which was 1per cent in 2009-10 was gradually increased to 2 per cent in 2010-11 and 3 per cent in 2011-12 and 2012-13.FINANCIAL PERFORMANCE OF BANKS

Performance of Indian banks during the year 2011-12 was conditioned to a large extent by fragile recovery of the global financial markets as well as a challenging operational environment on the domestic front, with persistent high inflation and muted growth performance. In addition, stressed financial conditions of some State Electricity Boards and airline companies added to the deterioration in asset quality of banks. The consolidated balance sheet of SCBs grew at a slower pace during 2011-12 as compared to the previous year due to slower growth of credit as well as deposits. In addition, net profit of banks slowed down. Though Indian banks remained well-capitalized, concerns regarding growing nonperforming assets (NPAs) persisted. The operating performance of the SCBs can be summed up as follows:

PSBs had a dominant share and accounted for 72 per cent of the total income of the SCBs and 72.8 per cent of aggregate assets.

In 2011-12, there was a sharp increase in the expenditure on provisioning and contingencies; the rate of growth, however, varied across the bank categories. While contingency and provisioning expenses recorded a growth of 16.1 per cent for all commercial banks, the rate of growth was 21.3 per cent for PSBs and only 3 per cent for the new private-sector banks. As percentage of PSB assets, the provisioning expenditure increased from 1.04 per cent in 2010- 11 to 1.11 per cent in 2011-12.

PSBs were able to increase their interest spread from 2.55 per cent in 2010-11 to 2.59 per cent in 2011-12. The interest spread declined for old private-sector banks and foreign banks. An increase in interest spread for all SCBs during 2011-12 with a relatively moderate growth in credit disbursement is significant.

Net profit as percentage of assets remained sticky at 0.98 per cent in 2010-11 and 2011-12. However, in case of the PSBs, this declined from 0.85 per cent in 2010-11 to 0.82 per cent in 2011-12. Foreign banks and old and new private sectorbanks, however, were able to increase the ratio of net profit to assets.

The main reasons for increase in NPAs of banks are (a) switchover to system-based identification of NPAs by PSBs; (b) current macroeconomic situation in the country; (c) increased interest rates in the recent past; (d) lower economic growth; and (e) aggressive lending by banks in the past, especially during good times. Some recent initiatives taken by the government to address the rising NPAs include (a) appointment of nodal officers in banks for recovery at their head offices/ zonal offices/ for each Debts Recovery Tribunal (DRT); (b) thrust on recovery of loss assets by banks; (c) close watch on NPAs by picking up early warning signals and ensuring timely corrective steps by banks; (d) directing the state-level Bankers' Committee to be proactive in resolving issues with the state governments; and (e) designating asset reconstruction companies (ARCs) resolution agents of banks. Pursuant to the second review of the Monetary Policy, the RBI has also announced the following remedial measures:

the provision for restructured standard accounts is to be raised from the existing 2 per cent to 2.75 per cent;

the sanction of fresh loans/ad-hoc loans from 1st Jan 2013 will be made on the basis of sharing of information among banks;

banks will conduct sector- /activity-wise analysis of NPAs; banks will put in place a robust mechanism for early detection of sign of distress, amendments in recovery laws, and strengthening of credit appraisal and post credit monitoring.

The High Level Committee to assess the capitalization of PSBs in the next 10 years, headed by the Finance Secretary has inter alia recommended various options for funding of PSBs. Given the budgetary constraints, it may not be feasible for the government to infuse huge sums into the PSBs. The High level Committee has, therefore, recommended the formation of a non-operating financial holding company (HoldCo) under a special act of Parliament with the following key objectives:

to act as an investment company for the Government of India; to hold a major portion of the Government of India's holdings in all PSBs; to raise long-term debt from domestic and international markets to infuse equity into

PSBs; and to service the debt from within its sources. Insurance Penetration

The growth in the insurance sector is internationally measured based on the standard of insurance penetration defined as the ratio of premium underwritten in a given year to the

gross domestic product (GDP). Insurance density is another wellrecognized benchmark and is defined as the ratio of premium underwritten in a given year to total population (measured in US dollars for convenience of comparison). The Indian insurance business has in the past remained underdeveloped with low levels of penetration. Post liberalization, the sector has succeeded in raising the levels of insurance penetration from 2.7 (life 2.15 and non-life 0.56) in 2001 to 4.1 (life 3.4 and non-life 0.7) in 2011.CAPITAL MARKETSEBI (Alternative Investment Funds) Regulations 2012: With a view to extending the reach of regulation to unregulated funds, ensuring systemic stability, increasing market efficiency, encouraging new capital formation, and providing investor protection, SEBI has notified new regulations covering alternate investment funds (AIFs) under three broad categories:

Category 1: AIFs with positive spillover effects on the economy, for which certain incentives or concessions might be considered by SEBI or the Government of India or other regulators in India; and which shall include venture capital funds, small and medium enterprises (SME) funds, social venture funds, and infrastructure funds.

Category 2: AIFs for which no specific incentives or concessions are given by the government or any other regulator; which shall not undertake leverage other than to meet dayto-day operational requirements as permitted in these regulations

Category 3: AIFs with funds (including hedge funds) that are considered to have negative

externalitiesSME Exchange/Platform Separate trading platforms for SMEs were launched and became functional at the BSE and NSE in March 2012 and September 2012 respectively. As on 14 January 2013, the number of equities listed on the BSE and NSE SME platforms is 12 and 2 respectively. Regulatory framework for governance and ownership of stock exchanges, clearing corporations, and depositories Based on the recommendations of the Dr. Bimal Jalan Committee, new Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations 2012 were notified on 20 June 2012 to regulate recognition, ownership, and governance in stock exchanges and clearing corporations. Further, the Securities and Exchange Board of India (Depositories and Participants) (Amendment) Regulations 2012 have been brought into effect from 11 September 2012 to regulate ownership and governance norms of depositories.Financial Stability and Development Council With a view to strengthening and institutionalizing the mechanism for maintaining financial stability, enhancing inter-regulatory coordination, and promoting financial-sector development, the government has set up an apexlevel Financial Stability and Development Council (FSDC) in December 2010, in line with the G 20 initiatives. The Council is chaired by the Finance Minister and has heads of financial-sector regulatory authorities, the Finance Secretary and/or Secretary, Department of Economic Affairs, Secretary, Department of Financial Services, and the Chief Economic Adviser as members. Without prejudice to the autonomy of regulators, the Council monitors macro-prudential supervision of the economy, including functioning of large financial conglomerates, and addresses inter-regulatory coordination and financial-sector development issues. It also focuses on financial literacy and financial inclusion.

BALANCE OF PAYMENTSIndia’s external sector exhibited resilience during the global financial crisis of 2008. The balance of payments however has been under increasing stress recently. Exports have declined while imports have not fallen significantly, resulting in increasing trade and current account deficits. Though capital flows are bridging the gap, the nature of portfolio capital may lead to greater potential financial fragility and also rupee volatility. India’s growing external exposures can also be attributed to the increasing integration of the Indian economy with the rest of the world, which is reflected in both current and capital account transactions. The combined share of exports and imports of goods increased from 14.2 per cent of GDP in 1990-91 to about 43.0 per cent in 2011-12. Two way external sector transactions (i.e, gross current

account plus gross capital account flows) have risen from 30.6 per cent of GDP in 1990-91 to about 108.0 per cent in 2011-12. Therefore, while the globalization of Indian economy has helped raise growth, it has also meant greater vulnerability to external shocks. A focus on domestic macroeconomic rebalancing will help reduce vulnerability.GLOBAL ECONOMY

There are early signs of a turnaround in the global economy. A series of measures by the euro zone authorities and the European Central Bank have allayed fears of an imminent meltdown. The fiscal cliff in the US has been deferred, albeit temporarily, and there are green shoots of recovery in China and India. As a result, growing investor optimism has translated into ‘risk on’ behaviour, which has led to a surge in capital flows to emerging economies. The renewed confidence has also led to ‘great rotation’, with investors shifting money from ‘safe haven’ government securities to equities in search for yield. The change is reflected in the equity market boom in advanced and emerging economies. However doubts still exist about the sustainability of the recovery. The eurozone still faces problems such as the continuing recession; the existence of a monetary union without fiscal union; the slow progress of the proposed European banking union; the continuing need for austerity in many advanced economies. In addition, fiscal tensions in the United States might re-surface in the next few months. Japan has still to find a reasonable way out of its decade long slump. Emerging markets continue to face problems of overheating. All these cast a shadow on the prospects of the global economy.

The Indian economy is exhibiting early signs of recovery, as indicated by improvements in purchasing managers index (PMI), moderation in inflation, return of investor confidence through surge in portfolio investment flows and buoyant equity markets. The balance of payments, however, is under strain with current account deficit (CAD) widening to 4.6 per cent of GDP in the first half of 2012-13, after touching 4.2 per cent in 2011-12. The CAD is being financed by capital flows and not by running down reserves. However, a sizeable share of capital is in the nature of Foreign Institutional Investors (FIIs) investment that could moderate or even reverse if investors switch to risk-off mode. The balance of payments position therefore is more vulnerable, which has been reflected in high rupee volatility.

The International Monetary Fund (IMF), in its January 2013 World Economic Outlook Update, reduced global growth forecast for the year 2012 to 3.2 per cent from its October 2012 estimate of 3.3 per cent. Advanced economies are expected to grow at 1.4 per cent in 2013, while emerging and developing economies are projected to grow at 5.5 per cent in 2013 India’s BoP during 2011-12

India’s BoP was under stress during 2011-12, as the trade and current account deficit widened. Though capital inflows increased, it fell short of fully financing current account deficit, resulting in drawdown of foreign exchange reserves. The trade deficit increased to US$ 189.8 billion (10.2 per cent of GDP) in 2011-12 as compared to US$ 127.3 billion (7.4 per cent of GDP) during 2010-11. This increase of 49.1 per cent in trade deficit in 2011-12 was primarily on account of higher increase in imports relative to exports. Net invisible balances showed significant improvement, registering 40.7 per cent increase from US$ 79.3 billion in 2010-11 to US$ 111.6 billion during 2011-12. Net invisible balance as per cent of GDP improved to 6.0 per cent in 2011-12 from 4.6 per cent in 2010-11. The current account deficit widened to US$ 78.2 billion

The CAD in the first half of 2012-13 has been 4.6 per cent of GDP. Available indications do not seem to suggest any improvement in the current account balance in the second half. There is a case for discouraging imports of commodities like gold and making efforts to raise exports. While the government has 'thrown sand in the wheels' by raising the tariff on gold from 4 per cent to 6 per cent in order to discourage imports and tried to unlock passive gold holdings through gold loans, gold purchases are likely to come down primarily when households see attractive alternative investment avenues. Lower inflation will be the key. In the meantime, increasing exports at the present juncture is proving to be a more difficult task, given the slow global recovery. Greater competitiveness of exports through greater corporate productivity as well as better logistics infrastructure will help, as will diversification towards fast growing emerging and frontier markets--which is under way. But a return to strong export growth will depend on the revival of growth in industrial countries.Box 6. 1 : Impact of Euro Zone Crisis on Current AccountThe unfolding of euro zone crisis, the austerity measures in advanced economies, recession in many euro zone countries, risk on/ risk off behaviour of investors and the uncertainty surrounding the future of euro zone have adversely affected the global economy.The fallout for the Indian economy has been a sharp deceleration in exports and a slowdown in GDP growth. Import demand however has remained resilient because of the continued high international oil prices that did not decline, unlike what happened after the Lehman meltdown of September, 2008. The high value of gold imports, driven mainly by the 'safe haven' demand for gold that has led to a sharp rise in prices, contributed to the high import bill and widening of the trade deficit.The trade deficit, as a result, increased to US$ 189.8 billion in 2011-12, which was 10.2 per

cent of the GDP. With invisible surplus of US$ 111.6 billion (6.0 per cent of GDP), the current account deficit widened to record 4.2 per cent of GDP. This is unlike the situation during the 2008 crisis, when the high trade deficit of 9.8 per cent of GDP in 2008-09, was partly offset by an invisible surplus of 7.5 per cent, lowering CAD to 2.3 per cent of GDP.The signs of strain on BoP continued in the first half of 2012-13 (April-September 2012) with the trade deficit of US$ 90.7 billion increasing to 10.8 per cent of GDP and CAD of US$ 39.0 billion at 4.6 per cent of GDP. The high CAD has had implications for rupee volatility and business confidence in the economy. A positive development is that high CAD has latelybeen financed by capital inflows, which explains why the downhill movement of rupee, witnessed till July 2012, has been largely arrested. There has however been high dependence on volatile portfolio flows and external commercial borrowings. This makes capital account vulnerable to a 'reversal' and 'sudden stop' of capital, especially in times of stressCapital Account and Financial Account during 2011-12The net inflows of US$ 67.8 billion under the capital account (bifurcated into capital account and financial account under BPM6) were moderately higher than that of US$ 63.7 billion in 2010-11. This was primarily on account of a revival in FDI flows to India, a surge in NRI deposits and higher overseas borrowings by banks. However, there was a decline in inflows under FII investments, ADRs/ GDRs, external assistance, ECBs and short term trade credit. Risk on/risk off behaviour significantly influenced capital flows to India. Even though the FDI to India (inward FDI) of US$ 33.0 billion in 2011-12 was significantly higher than US$ 29.0 billion in the preceding year, net inflows on account of portfolio investments at US$ 17.4 billion were lower as compared to US$ 31.5 billion in 2010-11 reflecting trend towards risk aversion among FIIs due to global economic uncertainty. Rise in inward FDI reflected flows received under BPReliance deal of US$ 7.0 billion in 2011-12. Sectorwise, manufacturing, construction, financial services, business services and communication services received significant amount of inflows. Country-wise, investment routed through Mauritius remained, as in the past, the largest component, followed by Singapore and the UK. FDI by India (i.e., outward FDI) in net terms moderated by 37.0 per cent to US$ 10.9 billion in 2011-12 compared to US$ 17.2 billion a year ago. Sector-wise, moderation in outward FDI was observed in agriculture, hunting, forestry & fishing, financial insurance, real estate & business services, manufacturing and wholesale, retail trade, restaurants & hotels. Furthermore, sectors, viz. financial, insurance, real estate & business services and manufacturing continued to account for more than 50 per cent of total outward FDI during 2011-12. Net FDI (inward FDI minus outward FDI) at US$ 22.1 billion in 2011-12 showed a significant increase of about 87.0 per cent as against US$ 11.8 billion in 2010-11. Among the debt creating capital flows, net flows under NRI deposits of US$ 11.9 billion surged more than three-fold in 2011-12 vis-à-vis US$ 3.2 billion in 2010-11 because of the higher interest rates prevailing in India. Net flows under external commercial borrowing and trade credit showed a decline in 2011-12 vis-à-vis 2010-11. According to the Balance of Payments Manual (BPM 6, 2009) of the IMF, the capital account comprises capital transfers receivable and payable between residents and non-residents and the acquisition and disposal of non-produced non-financial assets between residents and nonresidents.The financial account records transactions relating to financial assets and liabilities and that take place between residents and non-residents. Some of the major components of financial accounts include direct investment, portfolio investment, financial derivates (other than reserves) and employees stock options, other investments, reserve assets (monetary gold), equity and investment fund shares, debt instruments and other financial assets and liabilities. The overall balance on the financial account is called net lending/net borrowing depending on the outflow or inflow of resources.

Liberalization of FDI normsForeign Direct Investment (FDI) is preferred to the foreign portfolio investments primarily because FDI is expected to bring modern technology, managerial practices and is long term in nature investment. The Government has liberalized FDI norms overtime. As a result, only a handful of sensitive sectors now fall in the prohibited zone and FDI is allowed fully or partially in the rest of the sectors. Despite successive moves to liberalize the FDI regime, India is

ranked fourth on the basis of FDI Restrictiveness Index (FRI) compiled by OECD. FRI gauges the restrictiveness of a country's FDI rules by looking at the four main types of restrictions viz. foreign equity limitations; screening or approval mechanism; restrictions on the employment of foreigners as key personnel; and operational restrictions. A score of 1 indicates a closed economy and 0 indicates openness. FRI for India in 2012 was 0.273 (it was 0.450 in 2006 and 0.297 in 2010) as against OECD average of 0.081. China is the most restrictive country as it is ranked number one with the score of 0.407 in 2012 indicating that it has more restriction than India. As there is moderation in FDI inflows to India in the current fiscal vis-à-vis last year it is imperative therefore to rationalize FDI norms further.At present, defence sector is open to FDI subject to 26 per cent cap. It also requires FIPB approval and is subject to licensing under Industries (Development & Regulation) Act, 1951 and guidelines on FDI in production of arms & ammunition. Within the 26 per cent cap, FII is also permissible subject to the proviso that overall cap is not breached. India needs to open up the defence production sector to get access and ensure transfer of technology. The existing FDI policy for defence sector provides for offsets policy. The offsets policy has been revised recently but its direct and indirect benefits have not had visible impact on the domestic defence industry. There is a strong case for a hike in the 26 per cent FDI limit in the defence production sector. By beginning to produce defence goods that advanced countries currently produce, there is scope for productivity improvement, strengthening of manufacturing, generation of employment and lowering of imports in the country.There is need to review increasing of FDI cap in insurance and public sector banks. By raising cap to 49 per cent in the insurance sector, there is scope for substantial growth in the coming years. Competition and adoption of best practices could strengthen this sector, reduce the premium and expand the services to the vast untapped rural India. This sector could be one of the major sources of long-term investment in infrastructure. Similarly, FDI limit in public sector banks could be increased to 26 per cent. Further, there is also a need to review existing approval mechanisms, operational restrictions and conditions in other sectors to attract foreign investment.

Box 6. 2 : Risk on/Risk off Behaviour and Capital Flows to IndiaThe main fallout of euro zone crisis is global uncertainty. This has led to investors' alternating between risk-on/risk-off behaviour, with consequent implications for surge and reversal of capital to emerging economies. A risk-on, prompted by new policy initiatives, creates a favourable disposition towards emerging economy investment, leading to surge in FIIs flows and vice versa.While change in investor attitude is generally observable in the long-run, the fallout of euro zone crisis has been quick shift between risk-on/risk-off behaviour that has immediate implications for capital flows. An additional factor has been quantitative easing in the US. This increases the supply of liquidity in the system and together with low interest environ and better growth prospects in emerging economies, contributes to increase in capital flows.A closer look at the global risk-on/off events and FII flows to India shows strong correlation between such events and surge and reversal of capital. For example, the US credit rating downgrade in early August 2011, together with worsening of euro crisis, created a risk-off environment. As a result, there was net withdrawal of FII investment of US$ 3.7 billion during August-October, 2011.The Long Term Refinancing Operation (LTRO) of European Central Bank that injected more than euro 1 trillion in the banking system in two tranche in December, 2011 and February, 2012 again created a risk-on environ. As a result, there was a net FII inflow of US$ 16.9 billion during December 2011-February 2012. The investor euphoria soon evaporated as the euro crisisworsened and the spectre of Greek exit loomed. Consequently, the investor behaviour again became risk-off, leading to net FII outflow of US$ 2.3 billion during March-June 2012.The investment climate began improving in July, 2012 with (i) announcement by European Central Bank President that the euro would be saved at all cost; (ii) proposal to set-up Banking Union in the euro zone; (iii) launch of permanent European Stability Mechanism and (iv) launch of QE3 in US. The resulting risk-on atmosphere has seen a net FII inflow of US$ 10.8 billion during July-October, 2012.FOREIGN EXCHANGE RESERVES India's foreign exchange reserves comprise foreign currency assets (FCA), gold, special drawing rights (SDRs) and reserve tranche position (RTP) in the International Monetary Fund (IMF). The level of foreign exchange reserves is largely the outcome of the Reserve Bank of

India (RBI) intervention in the foreign exchange market to smoothen exchange rate volatility and valuation changes due to movement of the US dollar against other major currencies of the world. Foreign exchange reserves are accumulated when there is absorption of the excess foreign exchange flows by the RBI through intervention in the foreign exchange market, aid receipts, interest receipts and funding from the International Bank for Reconstruction and Development (IBRD), Asian Development Bank (ADB), International Development Association (IDA) etc. Foreign currency assets are maintained in major currencies like the US dollar, euro, pound sterling, Canadian dollar, Australian dollar and Japanese yen etc. Both the US dollar and the euro are intervention currencies, though the reserves are denominated and expressed in the US dollar only, which is the international numeraire for the purpose. The movement of the US dollar against other currencies in which FCA are held, therefore impacts the level of reserves in US dollar terms. The level of reserves, denominated in US dollars declines when US dollar appreciates against major international currencies and vice versa. The twin objectives of safety and liquidity have been the guiding principles of foreign exchange reserves management in India with return optimization being embedded strategy within this framework.In the current fiscal, foreign exchange reserves have fluctuated between US$ 286.0 billion and US$ 295.6 billion. At end January 2013, reserves stood at US$ 295.5 billion, indicating a marginal increase from US$ 294.4 billion at end March 2012. The rupee, however, has been more volatile. Between April 2012 and January 2013, the monthly average value of the rupee per US dollar fluctuated significantly, touching an all-time low of Rs. 57.22 per US dollar on 27 June 2012, thus depreciating by 10.6 per cent from Rs. 51.16 per US dollar on 30 March 2012. In the subsequent months of July to September 2012, the rupee appreciated, touching Rs. 51.62 per US dollar on 5 October 2012. It began depreciating again thereafter and the monthly average exchange rate has since been in the range of Rs. 53.02 to Rs. 54.78 per US dollar during October 2012 to January 2013.Box 6.4 : Building up Foreign Exchange ReservesThe distinction between convertible and non-convertible currencies is important for emerging economies, as most transactions with the rest of the world are in convertible currencies like US dollar, euro, pound sterling, yen, Swiss Franc etc. The need for increasing the availability of convertible currency for self-insurance has also been behind the race to build-up foreign exchange reserves (FER) in emerging economies after the Asian Crisis of 1997. Such FER accumulation, however, is constrained by the fact that it is possible only in times of currency appreciation.Following the BoP crisis of 1990-91 that was essentially due to depletion of foreign exchange reserves, there was a conscious effort by the RBI to build up FER. This was done through buying foreign currency in the market during periods of surge in capital flows. As a result, FER levels increased from US$ 5.8 billion in 1990-91 to US$ 314.6 billion at end May 2008. The RBI is however following a hands-off policy in foreign exchange market after the 2008 global crisis, with intervention limited to curbing excess rupee volatility. As a result, during 2009-10 and 2010-11, when rupee was appreciating due to increase in capital flows, there was virtually no intervention to build up FER.The sharp decline in rupee in 2011-12 however led the RBI to inject foreign exchange to the extent of US$ 20.1 billion to stem the rupee slide. The pressure on currency has continued in the financial year 2012-13 because of the ongoing euro-zone crisis.The import cover of FER, as a result, has declined from 14.4 months of imports in 2007-08 to 7.1 months in 2011-12. There are costs to intervention. The main cost is the release of corresponding rupee liquidity, when RBI intervenes in the market to buy foreign exchange. This may stoke inflation, which may not appeal in the current inflationary situation.Past experience however shows that measures like Market Stabilization Scheme (MSS) have been effective in draining excess liquidity from the system. Countries like China and Turkey use cash reserve ratio (CRR) for the same purpose. The cost of a particular policy, however, has to be weighed against the benefits, which are manifold. First, intervention to buy FER during surge in capital leads to build-up of reserves, which provides self-insurance against external vulnerability. Second, the higher reserve levels restore investor confidence and may lead to an increase in foreign direct and portfolio investment flows that spurs growth and helps bridge the current account deficit. Third, in a scenario of high trade and CAD, as in India, allowing the currency to appreciate through non-intervention during times of surge in capital, could have further negative fallout for the BoP by making exports less competitive and imports cheaper. Lastly, buying foreign exchange provides more ammunition for intervention when the currency is declining, which could potentially lower currency volatility.

Foreign exchange reserves of other countries India continues to be one of the largest holders of foreign exchange reserves. Country-wise details of foreign exchange reserves reveal that India is the eighth largest foreign exchange reserves holder in the world, after China($3,310bn), Japan ($1,304bn), Russia ($539bn), Switzerland ($532bn), Brazil ($373bn), Republic of Korea ($326bn) and China P R Hong Kong($305bn) at end-December 2012.

Box 6.5 : Reasons for High Volatility in Rupee Exchange RateThe rupee has experienced unusually high volatility in the past few months. The currency touched the low of Rs. 57.22 per US dollar on 27th June, 2012, before appreciated to Rs. 51.62 per US dollar on October 05, 2012. It again began declining thereafter and has since been in the range of Rs. 53-54 per US dollar. Such volatility has introduced a measure of uncertainty in the domestic market and has impacted business confidence.The rupee has been under pressure since August 2011, when US sovereign rating was downgraded and the euro zone crisis escalated. The currency went steadily downhill till the end of July, 2012, except for intermitted respite and appreciation in January-February 2012, mainly due to European Central Banks Long Term Refinancing Operation (LTRO) that injected more than euro 1 trillion in three-year loans to banks and created a risk-on environment.The rupee fell due to decline in exports on account of euro-zone crisis and widening of trade deficit, as imports remained resilient due to high oil prices and gold imports. The widening of trade deficit to 10.2 per cent of GDP in 2011-12 had upset the supply-demand balance in the domestic foreign exchange market, placing downward pressure on the currency. The trade deficit has remained high at 10.8 per cent of GDP in the first six months of the current financial year (April-September 2012), with current account deficit at 4.6 per cent of GDP. Improved capital flows in recent months, particularly FII flows, however have dampened the downward pressure on the rupee. Such an increase in portfolio flows is partly due to the risk-on behaviour of investors, following series of policy initiatives in the euro zone that lowered the 'tail risk' of euro zone disintegration. The launch of quantitative easing (QE3) by the US Federal Reserve further helped the process. Capital flows have also been attracted by the confidence -inducing effects of major policy reforms that have been announced recently. The resulting increase in capital flows has more than balanced the widening current account deficit in recent months, curbing the rupee slide. Volatility however remains high because of high share of FII flows in total capital flows, and the week-to-week variation in such flows.Another contributory factor is the fluctuation in the dollar exchange rate vis-a-vis other international currencies. Since bulk of global trade is invoiced and settled in US$ and most capital flows are denominated in US dollar, the volatility in the value of US dollar exchange rate in the international market has an immediate impact on rupee-US dollar exchange rate. Thus, the fall in the US dollar exchange rate in the international market leads to rupee appreciation, unless offset by widening trade deficit/ changes in the volume of capital flows and vice-versa

EXTERNAL DEBTIndia's external debt stock stood at US$ 365.3 billion at end-September 2012, recording

an increase of about US$ 20.0 billion (5.8 per cent) over the end- March 2012 level. This increase has been primarily on account of higher NRI deposits, short-term debt, and ECBs. These three components together contributed 94.7 per cent of the total increase in the country's external debt.

The maturity profile of India's external debt continues to be dominated by long-term loans. At end-September 2012, long-term external debt at US$ 280.8 billion, accounted for 76.9 per cent of total external debt, while the remaining 23.1 per cent was short-term debt. Government (sovereign) external debt stood at US$ 81.5 billion, while non-government debt amounted to US$ 283.9 billion at end- September 2012. India's external debt has remained within manageable limits as indicated by the external debt-GDP ratio of 19.7 per cent and debt service ratio of 6.0 per cent in 2011-12.

But the trends in size, source, maturity, and hedging of external debt bear careful monitoring. In particular, regulators will have to be careful about the tendency of some Indian corporations or entities without substantial foreign exchange earnings to leave foreign exchange borrowings un-hedged so as to get 'cheap' foreign financing. Low un-hedged foreign interest rates can be deceptively enticing, leaving the borrower exposed to significantly higher repayments if the rupee depreciates unexpectedly.

In this context, regulators have to maintain a balance between what is of public importance and what is prudential. Areas of public importance, such as infrastructure, do deserve substantial support. However, these areas of activity may also be risky. Support should be given by de-risking the areas (policy to speed up infrastructure projects and ease their completion), through financial development (creating new financing institutions, attracting new investors), or fiscal means (interest subventions, tax breaks) but not by relaxing prudential norms (lower capital requirements, allowing un-hedged foreign borrowing) or riskier capital structures (allowing greater debt ratios). Ultimately, riskier financing for projects of public importance builds up greater risk for the country because if these projects fail to take off, they impinge on both growth and the financial system at the same time, at a time when the government has fewer resources to cope.Box 6.6 : Risks in Foreign Currency BorrowingsCorporate borrowers in India and other emerging economies are keen to borrow in foreign currency to benefit from lower interest and longer terms of credit. Such borrowings however, are not always helpful, especially in times of high currency volatility. During good times, domestic borrowers could enjoy triple benefits of (i) lower interest rates, (ii) longer maturity and (iii) capital gains due to domestic currency appreciation. This would happen when the local currency is appreciating due to surge in capital flows and the debt service liability is falling in domestic currency terms. The opposite would happen when the domestic currency is depreciating due to reversal of capital flows during crisis situations, as happened during the 2008 global crisis.A sharp depreciation in local currency would mean corresponding increase in debt service liability, as more domestic currency would be required to buy the same amount of foreign exchange for debt service payments. This would lead to erosion in profit margin and have mark-to-market implications for the corporate. There would also be 'debt overhang' problem, as the volume of debt would rise in local currency terms. Together, these factors could create corporate distress, especially because the rupee tends to depreciate precisely when the Indian economy is also under stress, and corporate revenues and margins are under pressure.In this context, it is felt that one of the factors contributing to faster recovery of Indian economy after the 2008 global crisis was the low level of corporate external debt. As a result, the significant decline in the value of rupee did not have major fallout for the corporate balance-sheets. Foreign currency borrowings, therefore, have to be contracted carefully, especially when no 'natural hedge' is available. Such natural hedge would happen when a foreign currency borrower also has an export market for its products. As a result, export receivables would offset, at least to some extent, the currency risk inherent in debt service payments. This happens because fall in the value of the rupee that leads to higher debt service payments is partly compensated by the increase in the value of rupee receivables through exports. When export receivables and the currency of borrowings is different, the prudent approach is for corporations to enter currency swaps to re-denominate asset and liability in the same currency to create natural hedge. Unfortunately, too many Indian corporations with little foreign currency earnings leave foreign currency borrowings unhedged, so as to profit from low international interest rates. This is a dangerous gamble for reasons described above and should be avoided.

International Comparison A cross country comparison of external debt of twenty most indebted developing countries, based on data from the World Bank's 'International Debt Statistics, 2013' which contains the debt numbers for the year 2011 and has a time lag of two years, showed that in 2011 India was in fourth position in terms of absolute external debt stock after China, the Russian Federation and Brazil. The ratio of India's external debt stock to gross national income (GNI) at 18.3 per cent was the third lowest with China's being the lowest at 9.4 per cent.

INTERNATIONAL TRADEAfter moderating in the two years following the global economic crisis, world trade in both goods and services reached and surpassed pre-crisis levels in 2011. However, the deceleration in world growth and trade in 2012 and forecast of only a gradual upturn in global growth by international institutions, portend a weak and slow recovery for world trade. India's exports, which had surpassed pre-crisis levels within a year in 2010-11 with a record 40.5 per cent

growth, continued growing even in 2011-12, but were finally affected by the global slowdown in 2012-13 with exports declining even more at - 4.9 per cent in the first ten months than the -3.5 per cent recorded during the crisis-ridden year of 2009-10 (full year).INDIA'S MERCHANDISE TRADE7.4 India's merchandise trade increased exponentially in the 2000s decade from US$ 95.1 billion in 2000-1 to US$ 620.9 billion in 2010-11 and further to US$ 793.8 billion in 2011-12. India's share in global exports and imports also increased from 0.7 per cent and 0.8 per cent respectively in 2000 to 1.7 per cent and 2.5 per cent in 2011 as per the WTO. Its ranking in the leading exporters and importers improved from 31 and 26 in 2000 to 19 and 12 respectively in 2011. While India's total merchandise trade as a percentage of the gross domestic product (GDP) increased from 28.2 per cent in 2004-5 to 43.2 per cent in 2011-12 as per provisional estimates, India's merchandise exports as a percentage of GDP increased from 11.8 per cent to 16.5 per cent during the same period.

Box 7.2 : Gold Imports and Policy MeasuresIndia is one of the largest importers of gold in the world, with import growth of 11.2 per cent in terms of quantity and 39.0 per cent in terms of value during 2011-12. Gold is the second major import item of India after POL and constitutes 11.3 of its imports in 2011-12 in value terms. The rise in imports of gold is one of the factors contributing to India's high trade deficit and CAD in 2011-12, forming 30 per cent of its trade deficit. The RBI in its draft report of the working Group to Study 'Issues Related to Gold Imports and Gold Loans by NBFCs in India' has stated that if gold imports in India had grown by 24 per cent (an average of growth in world gold demand during past three years) instead of 39 per cent in 2011-12, the CAD would have been lower by approximately US$ 6 billion and the CAD-GDP ratio would have been 3.9 per cent instead of 4.2 per cent. Globally, the demand for gold is rising, mainly due to demand from emerging economies like China and India. The major source countries for import of gold include Switzerland, responsible for 52 per cent of the total imports by India of raw gold during 2011-12 (which has led to an unfavourable bilateral balance of trade for India), followed by the UAE (17.6 per cent), and South Africa (11.5 per cent). The rise in gold imports is due to many factors.The love of Indians for the yellow metal is well known. India is one of the largest consumers of gold in the world with consumption increasing from 721.9 tonnes in 2006 to 933.4 tonnes in 2011 and 612 tonnes in the first three quarters of 2012, accounting for around 27 per cent of world gold consumption in 2011, and 26.4 per cent in 2012 (total of first three quarters). As per the Annual Report 2011-12 of the Ministry of Mines, domestic production of gold is estimated at only 2.8 tonnes in 2011-12 and can meet around 0.3 per cent of the demand. This has inevitably led to its import. Gold is also used for trading/investment. Net retail investment constitutes 39.2 per cent of the India's total gold consumption in 2011 and 32.5 per cent during the first three quarters of 2012 in terms of quantity. As stated in the RBI report, one of the major components of gold demand in recent years has been investment demand at global level. Rising gold prices in recent years have not deterred the acquisition of gold in India, implying that investment in gold is becoming price inelastic. India also imports gold for manufacturing purposes and exports a portion of it as jewellery. In the case of export of gold jewellery, the major export destinations include the UAE (57.9 per cent), Hong Kong (14.1 per cent), and the USA (12.0 per cent). International gold price movements which have been volatile in recent years also have a bearing on the value of the country's gold imports. During the 2000 to 2012 period, international gold prices have grown at a CAGR of 16.2 per cent. In 2011-12 they increased by 23.4 per cent though they moderated to 4.3 per cent during April-November 2012 over the corresponding period in the previous year. Even with this moderation, gold prices were at a high level of US$1721 per troy ounce in November 2012 and currently at US$ 1672.3 per troy ounce (as on 5th February 2013). As stated by the RBI report, volatility in international gold prices in recent quarters is positively skewed, implying that it provides fewer large losses and a greater number of larger gains. The worsening global situation has also led to a rise in purchase of gold as a safety metal and a further rise in its price. Fluctuations in international gold prices get automatically reflected in India's gold prices along with the markup due to duties and taxes. Substantial increase in gold prices seems to have fuelled positive price expectations also contributing to sharp rise in the value of gold imports in recent years.To restrict the rising trend in gold imports which is adversely affecting India's balance of payments, measures were and are being taken by the government. In Budget 2012-13, import duty on standard gold and platinum was raised from 2 per cent to 4 per cent and non standard

gold from 5 per cent to 10 per cent. On 21 January 2013, the Import duty on gold and platinum was increased from 4 per cent to 6 per cent. It has also been proposed to provide a link between the Gold ETF (Exchange Traded Fund) and Gold Deposit Scheme with the objective of unfreezing or releasing a part of the gold physically held by mutual funds under Gold ETFs and enabling them to deposit the gold with banks under the Gold Deposit Scheme.The value of gold imports during April-December 2012 declined by 14.7 per cent to US $ 38.02 billion and quantity of imports fell by 11.8 per cent compared to same period of previous year. Total gold consumption has also declined by 23 per cent during the first three quarters of 2012. While the supply of gold through organized channels can be constricted, there is need to be vigilant regarding gold inflows through unauthorized channels. Ultimately, the best way to reduce gold imports in a sustainable way will be to offer the public financial investment opportunities that generate attractive returns.This means bringing down inflation as well as expanding the range of investments investors have easy access to. Source: Compiled from reports and data of the RBI, EXIM Bank of India and the Gems and Jewellery Export Promotion Council.Export composition Compositional changes in India's export basket have been taking place over the years. While the share of primary products in India's exports fell over the years from 16 per cent in 2000-1, in 2012- 13 (April-November) it regained the share of 16 per cent mainly due to the export of agricultural items like rice and guar gum meal. The share of manufacturing exports fell drastically from 78.8 per cent in 2000-1 to 66.1 per cent in 2011-12 and further to 64.5 per cent in 2012-13(April-November) mainly due to the fall in shares of traditional items like textiles and leather and leather manufactures even though the share of engineering goods and chemicals and related products increased. Share of gems and jewellery fell marginally. Share of petroleum, crude & products exports, which also include refined items, increased from 4.3 per cent in 2000-1 to 18.3 per cent in 2011-12 and 18.6 per cent in 2012-13(April- November). The destination-wise exports of major items to the major trading partners from 2009-10 to 2012- 13 (April-November) show great changes in the composition of exports to USA and China (Table 7.4). In the case of India's exports to the USA, the share of exports of primary products has increased from 6.8 per cent in 2009-10 to 21.3 per cent in 2012-13 (April-November), mainly due to the rise in share of agriculture and allied products, while the share of manufactured goods in India's exports to the USA has fallen from 89.1 per cent to 74.2 per cent during the same period. This decline has been mainly due to the fall in growth rates of exports of textiles and Import composition

7.24 There have been some significant compositional changes in India's import basket in recent years. The share of POL imports increased from 28.7 per cent in 2010-11 to 31.7 per cent in 2011-12 (with a very high growth rate) and 34.6 per cent in 2012-13 (April-November). The share of gold and silver imports increased from 9.3 per cent in 2000-1 to 12.6 per cent in 2011-12 with a high import growth rate of 44.5 per cent. However, in part due to policy measures like raising import duty on gold, there was a moderation in gold and silver imports in 2012-13 (April-November) with its share falling to 10.5 per cent following a negative growth of - 20.4 per cent. The import share of pearls, precious and semiprecious stones also fell sharply in 2011-12 to 6.1 per cent following a negative growth of -13.3 per cent and further to 4.1 per cent in 2012-13 (April- November), with a high negative growth rate of - 32.3 per cent. Another important development is related to the share of capital goods imports which increased from 10.5 per cent in 2000-1 to 13.6 per cent in 2010- 11 and further to 14.1 per cent in 2011-12, declining thereafter to 11.9 per cent in 2012-13 (April-November) following a negative growth rate of - 6.5 per cent. Among capital goods, the import shares of all items machinery except electrical and machine tools, transport equipment, project goods, and electrical machinery fell, clearly signaling a slowdown in industrial activity. The share of electronic goods, which includes both consumer electronics and capital goods, also fell in 2012-13 (April-November) (See Table 7.5 and Appendix Table 7.2(B).Direction of Trade

7.25 There has been significant market diversification in India's trade. Region-wise, while India's exports to Europe and America have declined, its exports to Asia and Africa have increased (See Box 7.3). However, in 2012-13 (April- November), the share of India's exports to the USA increased to 13.5 per cent. Within Asia, while the share of North East Asia (consisting of China, Hong Kong, Japan) and ASEAN (Association of South East Asian Nations) fell from 14.8

per cent and 12.0 per cent in 2011-12 to 13.1 per cent and 10.3 per cent respectively in 2012-13 (April- November), there was a noticeable rise in the share of West Asia-GCC (Gulf Cooperation Council) countries from 14.9 per cent in 2011-12 to 17.7 per cent in 2012-13 (April- November). 7.26 In 2012-13 (April- November), compared to 2000-01, the share of India's imports from Europe has declined to 16.7 per cent from 27.6 per cent, while that from Asia has increased substantially to 61.1 per cent from 27.7 per cent. The share of America in India's imports also increased to 11.5 per cent from 7.9 per cent. India's top 15 trading partners have nearly 60 per cent in share in its trade with the top three contributing nearly half of this share. While Iran and UK are out of this top 15 list in 2011-12, Iraq and Kuwait are the new entrants. The musical chairs for the top slot among the top three trading partners seems to be continuing with the USA relegated to third position in 2007-8 from first, UAE relegated to second position from first in 2011-12 by China, and China in turn relegated to second position by the UAE in 2012-13 (April-November). The final word for 2012-13 is not yet out as the USA is inching closer to China with its share increasing by around one percentage point and that of China falling.

Special Economic Zones7.39 Since the Special Economic Zones (SEZ) Act and Rules were notified in February

2006, formal approvals have been granted for setting up of 579 SEZs, of which 384 have been notified. Of the total employment provided to 9,45,990 persons in SEZs as a whole, that to 8,11,286 persons is incremental employment generated after February 2006 when the SEZ Act came into force. This is apart from the million mandays of employment created by the developer for infrastructure activities. While in 2010- 11 physical exports from SEZs were worthRs. 3,15,867.85 crore, in 2011-12 the figure had gone up Rs. 3,64,477.73 crore in 2011-12, registering a growth of 15.4 per cent. The total physical exports from SEZs in the first half of the current financial year have been to the tune of Rs. 239628.78 crore approximately, registering a growth of 36 per cent over exports in the corresponding period of the previous year. The total investment in SEZs till 30 September 2012 was Rs.2,18,795.41 crore approximately, including Rs. 2,14,759.90 crore in the newly notified zones. As per the provisions of the SEZ Act 2005, 100 per cent FDI is allowed in SEZs through the automatic route. A total of 160 SEZs are exporting goods and services. Of this 93 are IT/ ITES, 17 multi-product and 50 other sector-specific SEZs. The total number of units in these SEZs is 3308.

WTO NEGOTIATIONS AND INDIA7.43 The Doha Round of trade negotiations in the WTO which began in 2001 remains unfinished due to differences among members on various issues. The Eighth Ministerial Meeting of the WTO which was held in December 2011 in Geneva provided political guidance to the members to resolve the issues involved. However, there was no significant progress in 2012. Efforts are being made for an early harvest on some issues in time for the Ninth Ministerial Conference of the WTO (MC9) to be held in December 2013. India is of the view that any early outcome of the negotiations should invariably address issues of interest to the developing countries, especially the least developed countries (LDCs) and the small vulnerable economies (SVEs). 7.44 A Draft Consolidated Negotiating Text on Trade Facilitation was worked out by the WTO members on 14 December 2009. The Draft Text has since been revised fourteen times (till December 2012) through discussions in the meetings of the Negotiating Group on Trade Facilitation (NGTF). India is actively engaged in these negotiations and has also tabled a few proposals on 'Customs Cooperation', 'Rapid Alerts System of

Customs Union', and 'Appeal Mechanism'. The Draft Text, however, lacks internal balance. The developed countries are holding up the laws and procedures of their own countries as benchmarks and want the developing countries to replicate them. Developing countries have by and large adopted a defensive approach in the negotiations. The developed countries and a few developing countries are making efforts to harvest 'Trade facilitation' for an early outcome, in time for MC9. India along with most of the developing countries wants issues of market access and trade facilitation to be balanced with developmental issues such as duty free quota, free market access for LDCs, and acceptance of the modalities for reducing cotton subsidies. The G33 group of countries, which is a coalition of 46 developing countries, including India, has tabled a proposal on food security in the WTO on 16 November 2012. The proposal is for an amendment to certain provisions of the WTO Agreement on Agriculture to allow developing countries greater flexibility in their public stockholding operations for food security purposes. The issue of food security is very important for India and any concession on the trade facilitation front needs to be balanced by acceptance of the G33 proposal in any package deal for MC9.7.45 During the current year, some of the developed country members of the Information Technology Agreement (ITA) of WTO viz. the USA, European Union, and Japan, have proposed expansion of the agreement (called ITA-2) to increase the coverage of IT products on which customs duty would be bound at zero, addressing non-tariff measures, and expanding the number of signatory countries to include new signatories such as Argentina, Brazil, and South Africa. The proponents of ITA expansion have prepared a consolidated list containing around 350 IT products (combining products of interest to all proponents of ITA-2) on which tariff reductions are being sought. This is under active discussion in the WTO and India is carefully examining the proposal.

INDIA'S REGIONAL TRADING ARRANGEMENTS: RECENT DEVELOPMENTS

Agreement on South Asia Free Trade Area (SAFTA): The SAFTA Agreement was signed on 6 January 2004 and came into force on 1 January 2006. Under SAFTA, India has granted zero basic custom duty to all LDCs, viz. Afghanistan, Bangladesh, Bhutan, and Maldives, on all items except 25 items relating to alcohol and tobacco. Under the SAFTA Agreement, India has reduced the SAFTA Sensitive List for non-LDCs from 878 to 614 by reduction of 264 tariff lines w.e.f. 6 September 2012. As per the schedule of Tariff Liberalisation Programme (TLP) under SAFTA, India has brought down its peak tariff rates to 5 per cent w.e.f. 1.1.2013

India-Thailand FTA, Early Harvest Scheme (EHS) under the Framework Agreement for establishing India-Thailand FTA: On 9th October 2003, India and Thailand signed a Framework Agreement for establishing an India-Thailand FTA, which includes trade in goods, trade in services, investment, and other areas of economic cooperation, to be concluded as a single undertaking. Under the EHS, tariff has gradually been eliminated on a list of 82 common items simultaneously by both sides between 1 September 2004 and 31 August 2006. Under the India-Thailand FTA, it is proposed to provide ASEAN plus tariff concessions. So far 26 rounds of the India-Thailand Trade Negotiation Committee (ITTNC) meetings have been held. The last round was held on 26-27November 2012 in New Delhi.

India-ASEAN Comprehensive Economic Cooperation Agreement (CECA): Services and Investment Agreements. The Trade in Goods Agreement, which was signed on 13 August 2009 under the broader framework of the CECA between India and ASEAN has already come into force. Conclusions of negotiations for the Services Agreement and Investment Agreement have been announced during the ASEAN-India Commemorative Summit held on 20 December 2012 in New Delhi. Legal scrubbing for these Agreements will be finalized by February,2013. The Agreement will be signed during ASEAN Economic Ministers (AEM)-India Consultations in August 2013.

Regional Comprehensive Economic Partnership (RCEP) Agreement among ASEAN + 6 (Australia, China, India, Japan, Korea, and New Zealand): During the 20th ASEAN Summit held in Cambodia in April 2012, ASEAN States agreed to move towards establishing an RCEP involving ASEAN and its FTA partners. The objective of launching RCEP negotiations is to achieve a modern, comprehensive, high-quality, and mutually beneficial economic partnership agreement among the ASEAN member States and ASEAN's FTA partners. The RCEP will cover trade in goods, trade in services,

investment, economic and technical cooperation, intellectual property, competition, dispute settlement, and other issues.

India - EU Broad Based Trade and Investment Agreement (BTIA): Fifteen rounds of negotiations and a number of intersessional and Chief Negotiator level meetings have been held till date. The 15th round was held during 4-7 December, 2012 in New Delhi. Chief negotiator level meeting was held on 29-30 January, 2013 in New Delhi.

Global System of Trade Preferences (GSTP): The Agreement establishing the GSTP among developing countries was signed on 13 April 1988 at Belgrade following the conclusion of the First Round of Negotiations. Forty-three countries have ratified the Agreement and become participants. India has offered tariff concessions on 70.08 per cent of dutiable tariff lines with an across-the-board margin of preference (MoP) of 20 per cent on the applied tariffs prevailing on the date of import. India has also unilaterally offered special concessions to LDC participants by granting an MoP of 25 per cent on 77 per cent of all its dutiable tariff lines. The Cabinet Committee on Economic Affairs (CCEA), in its meeting on 23 August 2012, has granted approval for implementing India's schedule of concessions. The tariff concessions are to be implemented thirty days after a minimum of four participants ratify their schedules of concessions. So far India and Malaysia have ratified their schedules.

Source: Department of Commerce, Ministry of Commerce and Industry, Government of India.

Agriculture and Food Management Indian agriculture is broadly a story of success. It has done remarkably well in terms of

output growth, despite weather and price shocks in the past few years. India is the first in the world in the production of milk, pulses, jute and jute-like fibres, second in rice, wheat, sugarcane, groundnut, vegetables, fruits and cotton production, and is a leading producer of spices and plantation crops as well as livestock, fisheries and poultry. The Eleventh Five Year Plan (2007-12) witnessed an average annual growth of 3.6 per cent in the gross domestic product (GDP) from agriculture and allied sector against a target of 4.0 per cent. While it may appear that the performance of the agriculture and allied sector has fallen short of the target, production has improved remarkably, growing twice as fast as population. India's agricultural exports are booming at a time when many other leading producers are experiencing difficulties. The better agricultural performance is a result of: a) farmers' response to better prices; b) continued technology gains; and c) appropriate and timely policies coming together. Yet India is at a juncture where further reforms are urgently required to achieve greater efficiency and productivity in agriculture for sustaining growth. There is need to have stable and consistent policies where markets play a deserving role and private investment in infrastructure is stepped up. An efficient supply chain that firmly establishes the linkage between retail demand and the farmer will be important. Retionalization of agricultural incentives and strengthening of food price management will also help, toegether with a predictable trade policy for agriculture. These initiatives need to be coupled with skill development and better research and development in this sector along with improved delivery of credit, seeds, risk management tools, and other inputs ensuring sustainable and climate-resilient agricultural practices. Finally, while the sharp increase in prices of food articles, especially proteins, fruits and vegetables, and the growing foodgrains stocks in public sector continue to be subjects of debate, these may be the pointers towards the need for both relative price shifts responding to shifts in demand and reconsidering traditional instruments of food management.

Industrial PerformanceAfter recovering to a growth of 9.2 per cent in 2009-10 and 2010-11, growth of value added in industrial sector, comprising manufacturing, mining, electricity and construction sectors, slowed to 3.5 per cent in 2011-12 and to 3.1 percent in the current year. The manufacturing sector, the most dominant sector within industry, also witnessed a decline in growth to 2.7 per cent in 2011-12 and 1.9 per cent in 2012-13 compared to 11.3 per cent and 9.7 per cent in 2009-10 and 2010-11, respectively. The growth in electricity sector in 2012-13 has also moderated. The growth of the mining sector in 2012-13 is estimated at 0.4 per cent, though it showed an improvement over a negative growth of 0.63 per cent recorded in 2011-12. With improved business sentiments and investor perception and a partial rebound in industrial activity in other developing countries, industrial growth is expected to improve in the next financial year.Why has growth moderated?9.7 The moderation in industrial growth, particularly in the manufacturing sector, is largely attributed to sluggish growth of investment, squeezed margins of the corporate sector, deceleration in the rate of growth of credit flows and the fragile global economic recovery.

Box 9.2 : Government's key initiatives to Boost ManufacturingApart from the government's recent steps to uplift overall business sentiment and boost investment, several specific initiatives have been initiated to strengthen industry and in particular the manufacturing sector in the country. The Twelfth Five Year Plan document lays down broad strategies for spurring industrial growth and recommends sector specific measures covering micro, small, medium and large industries in the formal as well as informal sector. Some of major initiatives that can change the manufacturing landscape of the country are announcement of National Manufacturing Policy (NMP),implementation of the Delhi Mumbai Industrial Corridor (DMIC) Project (see Chapter 2) and policy reforms to promote foreign direct investment (FDI) and an e-Biz project. National Manufacturing Policy (NMP) The NMP was approved by the government in October, 2011. The major objectives of the policy are enhancing the share of manufacturing in gross domestic product (GDP) to 25 per cent and creating an additional 100 million additional jobs over a decade or so. The Policy also provides special focus to industries that are employment intensive, those producing capital goods, those having strategic significance, small and medium enterprises, and public sector enterprises besides industries where India enjoys a competitive advantage. The NMP provides for promotion of clusters and aggregation, especially through the creation of national investment and manufacturing zones (NIMZs). Out of twelve NIMZs so far announced, eight are along the DMIC. Besides, four other NIMZs have

been given in-principle approval (i) Nagpur in Maharashtra, (ii) Tumkur in Karnataka, (iii) Chittoor district in Andhra Pradesh, and (iv) Medak district in Andhra Pradesh.DMIC ProjectIndustrial development initiatives under DMIC project presently cover eight industrial cities that are proposed to be developed along the railway corridor. The Master Planning for the investment regions and industrial areas taken up initially to be developed as new cities in Gujarat, Madhya Pradesh, Haryana, Rajasthan and Maharashtra have been completed and master planning in Uttar Pradesh has started. The State governments have initiated the process of obtaining land for the new industrial regions/areas as well as for the Early Bird Projects. Environmental impact assessment (EIA) studies have been initiated for five industrial cities. Details of the overall DMIC project have been discussed in Chapter 2.FDI Policy initiativesAs a part of policy reform process, the FDI policy is being progressively liberalized on an ongoing basis in order to allow FDI in more industries under the automatic route. Some recent changes in FDI policy, besides consolidation of the policy into a single document include FDI in multi-brand retail trading up to 51 per cent subject to specified conditions; increasing FDI limit to 100 per cent in single-brand retail trading; FDI up to 49 percent in civil aviation and power exchanges; FDI up to 49 percent in broadcasting sector under the automatic route and FDI above 49 percent and up to 74 percent under the Government route both for teleports and mobile TV.Setting up of the e-Biz Project to promote ease of doing business The government has announced the setting up of -'Invest India'-, a joint-venture company between the Department of Industrial Policy and Promotion and FICCI, as a not-for-profit, single window facilitator, for prospective overseas investors and to act as a structured mechanism to attract investment. In addition, the Government has initiated implementation of the e-Biz Project, a mission mode project under the National e-Governance Plan (NeGP) for promoting an online single window at the national level for business users. The objectives of setting up of the e-Biz portal are to provide a number of services to business users, covering the entire life cycle of their operation. The project aims at enhancing India's business competitiveness through a service oriented, event-driven G2B interaction.ENTERPRISES (MSME) SECTOR9.24 The MSME sector covers both the registered and informal sectors. The classification of micro, small and medium enterprises at present is based on the criterion of investment in plant and machinery by each enterprise. Detailed information for the registered MSMEs on the various economic variables such as employment, investment, products, gross output, and exports is available based on the Fourth Census of MSME (2006-07). The size of the registered MSMEs was estimated to be about 15.84 lakh units with sub-sector wise composition in the proportion of 94.9 per cent micro enterprises, 4.89 per cent small and 0.17 per cent medium enterprises. The total registered MSME sector comprised of 67.1 per cent manufacturing enterprises and 32.9 per cent services enterprises. About 45 per cent of these registered enterprises were located in rural areas. More detailed information based on the Fourth Census on the unorganized sector units, constituting about 94 per cent of the entire MSME sector is awaited.9.25 In the recent past the Prime Minister's Task Force on MSMEs and the Twelfth Plan Working Group on MSMEs have discussed issues related to the MSME sector. The Twelfth Five Year Plan policy framework is guided by the recommendations of these key committees. The Plan covers various aspects of the MSME sector and its key recommendations fall under six broad verticals, viz. 1) finance and credit (ii) technology (iii) infrastructure (iv) marketing and procurement (v) skill development and training, and (vi) institutional structure. The Plan has a separate set of recommendations for the khadi and village industries and the coir sector. In order to boost the MSME sector, several schemes are under operation including the following ones. 1. Procurement Policy: The government has notified a Public Procurement Policy for Goods Produced and Services rendered by Micro & Small Enterprises (MSE) order, 2012 effective from 1st April, 2012. The policy mandates that all the central ministries / departments / central public sector undertakings (CPSUs) shall procure a minimum of 20 per cent of their annual value of goods / services required by them from MSEs. Further, policy has earmarked a subtarget of 4 per cent procurement out of this 20 per cent from MSEs owned by scheduled caste/ scheduled tribe (SC / ST) entrepreneurs.Foreign Direct Investment (FDI)

9.28 The government has put in place an investor friendly policy on FDI, under which equity participation of up to 100 per cent, is permitted through the automatic route, in many sectors/activities. FDI policy is reviewed on an ongoing basis, with a view to making it more investor friendly. For ease of reference, all press notes/circulars issued since 1991 have been consolidated into a single document which is available in the public domain on the website of Department of Industrial Policy and Promotion (www.dipp.nic.in). Significant changes have been made in the FDI policy regime in recent times, to ensure that India remains increasingly attractive and investor-friendly. Some of the changes made to the policy during 2012 are as follows:(i) Significant changes effective from 10.4.2012 include: (i) mandating FIPB approval only

for investment made under the FDI scheme in commodity exchanges (ii) clarification that the activity of 'leasing and finance', covers only 'financial leases' and not 'operating leases' (iii) clarification that raising of the aggregate limit of 24 per cent, to the sectoral cap/statutory ceiling, would be subject to prior intimation to RBI.

(ii) Reviewing the policy relating to calculation of downstream investments by a banking company incorporated in India, which is owned and/or controlled by non-residents/ a non-resident entity/non-resident entities, the government has exempted downstream investments made by such companies, under corporate debt restructuring (CDR), or other loan restructuring mechanism, or in trading books, or for acquisition of shares due to defaults in loans, from being counted as indirect foreign investment.

(iii) The government amended the policy on singlebrand retail trading, amending the conditions relating to : (i) the foreign investor being the owner of the brand: it has been specified that, henceforth, only one non-resident entity, whether owner of the brand or otherwise, shall be permitted to undertake single brand product retail trading, for the specific brand, through a legally tenable agreement, with the brand owner and (ii) mandatory sourcing of at least 30 per cent of the value of products to be done from Indian 'small industries/ village and cottage industries, artisans and craftsmen', applicable in respect of proposals involving FDI beyond 51 per cent: It has been specified that, sourcing of 30 per cent of the value of goods purchased, will be done from India, preferably from MSME, village and cottage industries, artisans and craftsmen, in all sectors.

(iv) The government has decided to permit FDI up to 51 per cent, with FIPB approval, in multi-brand retail trading, subject to specified conditions.

(v) In the civil aviation sector, the government has decided to permit foreign airlines also to invest, in the capital of Indian companies, operating scheduled and non-scheduled air transport services, up to the limit of 49 per cent of their paid-up capital.

(vi) The government has decided to permit foreign investment up to 49 per cent, in power exchanges, registered under the Central Electricity Regulatory Commission (Power Market) Regulations, 2010. The foreign investment would be in compliance with Securities and Exchange Board of India (SEBI) Regulations; other applicable laws/ regulations; security and other conditionalities.

SERVICES SECTORIndia’s services sector expanded quickly with double-digit growth in the second half of the 2000s. As the Euro-zone crisis has worsened, growth has slowed, though the sector is still growing at a much higher rate than the other two sectors of the economy.SERVICES SECTOR : INTERNATIONAL COMPARISON10.3 In world GDP of US$70.2 trillion in 2011, the share of services was 67.5 per cent, more or less the same as in 2001. Interestingly the top 15 countries in terms of services GDP are also the same in overall GDP in 2011. This list includes the major developed countries and Brazil, Russia, India, and China. Among the top 15 countries with highest overall GDP in 2011, India ranked 9th in overall GDP and 10th in services GDP. A comparison of the services performance of the top 15 countries in the eleven-year period from 2001 to 2011 shows that the increase in share of services in GDP is the highest for India (8.1 percentage points) followed by Spain. While China’s highest services compound annual growth rate (CAGR) of 11.1 per cent was accompanied by marginal change in its share of services for this period, India’s very high CAGR (9.2 per cent) which was second highest was also accompanied by the highest change in its share. This is

also a reflection of the domination of the industrial sector along with services in China in its growth, while India’s growth has been powered mainly by the services sector (also see Chapter 2). Despite the higher share of services in India’s GDP and dominance of industry over services in China, in terms of absolute value of services GDP as well as growth in services ( both decadal and annual in 2001, 2010, and 2011) China is still ahead of India.

Box 10.1 : Performance of Services Firms : A Sectoral AnalysisThe Centre for Monitoring Indian Economy’s (CMIE) analysis of the sector-wise performance of services activities based on firm-level data show that the performance of sectors such as transport logistics, aviation and construction in the year 2012-13 is subdued in comparison to with the previous year. High negative PAT in hotel sector continued. The health services and telecom sectors are projected to have rebounded in the year 2012-13. Overall the year 2013-14 is projected to be better for most of the sectors, except retail trading, which is projected to have negative growth in profitability. This negative growth is contributed by two factors—one is the base effect with high profit after tax (PAT) growth in the year 2012-13; and the other is an expected shrinking of margins in 2013-14 due to increase in operating costs and price cuts driven by high competition Box 10.2 : FDI in Multibrand Retail Trading FDI in multibrand retail trading has been permitted subject to specified conditions like the following:• Fresh agricultural produce, including fruits, vegetables, flowers, grains, pulses, fresh

poultry, fishery, and meat products, may be unbranded; • Minimum amount to be brought in as FDI by the foreign investor, would be US $ 100

million;• At least 50 per cent of total FDI brought in shall be invested in ‘backend infrastructure’

within three years of the first tranche of FDI;• At least 30 per cent of the value of procurement of manufactured/ processed products

purchased shall be sourced from Indian ‘small industries’ which have a total investment in plant and machinery not exceeding US $ 1million;

• Retail sales outlets may be set up only in cities with a population of more than 10 lakh as per Census 2011and may also cover an area of 10 km around the municipal/urban agglomeration limits of such cities;

• Government will have the first right to procurement of agricultural products. State governments/UTs would be free to take their own decisions in regard to implementation of the policy as retail trade is a state subject. Eleven states/UTs, viz. Andhra Pradesh, Assam, Delhi, Haryana, Jammu and Kashmir, Maharashtra,

Manipur, Rajasthan, Uttarakhand, Daman and Diu, and Dadra and Nagar Haveli have agreed to permit establishment of retail outlets under this policy. Constitution of a high-level group under the Minister of Consumer Affairs has also been announced to look into various aspects relating to internal trade and to make recommendations on internal trade reforms to the government, whenever required. FDI in multibrand retail trade would benefit stakeholders across the entire span of the supply chain. Farmers stand to benefit from the significant reduction in post-harvest losses expected to result from the strengthening of the backend infrastructure, which would enable the farmers to obtain a remunerative price for their produce. Small manufacturers will benefit from the conditionality requiring at least 30 per cent procurement from Indian small industries, as this would enable them to get integrated with global retail chains. This in turn will enhance their capacity to export products from India. As far as small retailers are concerned, organized retail already coexists with small traders and the unorganized retail sector. Studies indicate that there has been a strong competitive response from the traditional retailers to these organized retailers, through improved business practices and technological upgradation. Global experience also indicates that organized and unorganized retail coexist and grow. Consumers stand to gain the most, first, from the lowering of prices that would result from supply-chain efficiencies and secondly, through improvement in product quality due to the combined effect of technological upgradation, efficient grading, sorting and packaging, testing and quality control, and product standardization. Implementation of the policy is also likely to lead to greater FDI inflows, quality employment, and adoption of global best practices.Source: Based on Inputs from the Department of Industrial Policy and Promotion (DIPP)

ENERGY, INFRASTRUCTURE AND COMMUNICATIONSThe Twelfth Five Year Plan lays special emphasis on development of the infrastructure sector including energy, as the availability of quality infrastructure is important not only for sustaining high growth but also ensuring that the growth is inclusive. The total investment in the infrastructure sector during the Twelfth Five Year Plan, estimated at Rs. 56.3 lakh crore (approx. US$1trillion), will be nearly double that made during the Eleventh Five Year Plan. This step up in investment will be feasible primarily because of enlarged private-sector participation that is envisaged. Unbundling of infrastructure projects, public private partnerships (PPP), and more transparent regulatory mechanisms have induced private investors to increase their participation in infrastructure sectors. Their share in infrastructure investment increased from 22 per cent in the Tenth Five Year Plan to 38 per cent in the Eleventh Plan and is expected to be about 48 per cent during the Twelfth Five Year Plan. Yet, more than half of the resources required for infrastructure would need to come from the public sector, from the government, and the parastatals. This would require not only the creation of the fiscal space but also use of a rational pricing policy. Further, scaling up private-sector participation on a sustainable basis will require redefining the contours of their participation for the development of infrastructure sector in a transparent and objective manner with a comprehensive regulatory mechanism in place. This chapter summarizes recent developments in the infrastructure sector, particularly the energy scenario in India, and the challenges and opportunities in the context of the targets and milestones envisaged in the Twelfth Five Year Plan.OVERVIEW OF PERFORMANCE11.2 Infrastructure projects take a long time to plan and implement. Delays in the execution of projects not only lead to shortfalls in achieving targets but widen the availability gaps. Time overruns in the implementation of projects continue to be one of the main reasons for underachievement in many infrastructure sectors. The status report of major central-sector projects costing Rs. 150 crore and above for the month of September 2012 shows that out of the 566 projects, five were ahead of schedule, 226 on schedule, and 258 had been delayed with respect to their latest scheduled date of completion. The remaining projects do not have fixed dates of commissioning. Delays in land acquisition, municipal permission, supply of materials, award of work, operational issues, etc. continued to drag down implementation of these projects. Sector-wise, in the coal sector 21 projects were delayed out of 51, in the petroleum sector 37 out of 71, in the power sector 45 out of 98, in the railways 40 out of 127, and in the road sector 86 out of the total 146 projects. The overall cost overrun amounted to 16.8 per cent of the original cost and till September 2012 only 45.5 per cent of the anticipated cost of the projects had been incurred.11.3 Major sector-wise performance of core industries and infrastructure services shows a mixed trend so far in the current financial year. Production of coal, cement, petroleum refinery was marginally higher during the current year as compared to the corresponding period of the previous year while steel and power-sector production was comparatively lower. Fertilizer, crude oil, and natural gas production also declined during the first nine months of this financial year. Among the infrastructure services, growth in freight traffic by railways has been comparatively higher so far, while the civil aviation sector and cargo handled at major ports have witnessed negative growth. In the road sector the National Highways Authority of India (NHAI) achieved 17.3 per cent growth during the current financial year upto November 2012.Box 11.1 : Energy PricingThe government appreciates the economic role of rational energy pricing. Rational energy prices provide the right signals to both the producers and consumers and lead to a demand-supply match, providing incentives for reducing consumption on the one hand and stimulating production on the other. Aligning domestic energy prices with the global prices, especially when large imports are involved, may be ideal option as misalignment could pose both micro- and macroeconomic problems. At microeconomic level, underpricing of energy to the consumer not only reduces the incentive for being energyefficient, it also creates fiscal imbalances. Leakages and inappropriate use may be the other implications. Underpricing to the producer reduces both his incentive and ability to invest in the sector and increases reliance on imports. Over the years, India's energy prices have become misaligned and are now much lower than global prices for many products. The extent of misalignment is substantial, leading to large untargeted subsidies.The government has taken several initiatives for rationalizing the energy prices in different sectors. The Integrated Energy Policy has outlined the broad contours of the pricing system for

coal. The pricing of coal is done now on gross calorific value (GCV) basis with effect from 31 January 2012, replacing the earlier system of pricing on the basis of useful heat value (UHV) which takes into account the heat trapped in ash content also, besides the heat value of carbon content. The revision in the GCV is likely to increase the prices of domestic coal to some extent, but this is a desirable adjustment because domestic thermal coal, adjusted for quality differences, continues to be underpriced.In case of petroleum products pricing, the government dismantled the Administered Pricing Mechanism in 2002. This decision, however, was not fully implemented and domestic pass through of global price increases remained low for petrol, diesel, kerosene, and LPG. On 25 June 2010, the government announced that the price of petrol was fully deregulated and the oil companies were free to fix it periodically. However, diesel price deregulation was deferred. In January 2013, the government announced the new roadmap providing for a gradual price increase for reducing diesel under-recoveries. Admissibility of subsidized number of liquefied petroleum gas (LPG) cylinders and prices of LPG have also recently been revised. Pricing of gas is presently done under the New Exploration Licensing Policy (NELP). The government provides the operator freedom to sell the gas produced from the NELP blocks at a market-determined price , subject to the approval of pricing formula. The government is reviewing pricing under the price sharing contract (PSC) to clarify the extent to which producers will have the freedom to market the gas. Dedicated Freight Corridor ProjectThe Eastern and Western Dedicated Freight Corridors (DFC) are a mega rail transport project being undertaken to increase transportation capacity, reduce unit costs of transportation, and improve service quality. The Eastern DFC (1839 route kilometres [RKM]) extends from Dankuni near Kolkata to Ludhiana in Punjab, while the Western DFC (1499 RKM) extends from the Jawahar Lal Nehru Port (JNPT) in Mumbai to Dadri /Rewari near Delhi. A special purpose vehicle, the Dedicated Freight Corridor Corporation of India Limited has been set up to implement the project. Out of 10,703 ha of land to be acquired for the project, 7,768 ha (73 per cent) has already been awarded under the Railway Amendment Act (RAA) 2008. The Eastern and Western DFC projects are being funded through a mix of bilateral/multilateral loans, gross budgetary support (GBS), and PPP. The Western DFC is being funded by the Japan International Cooperation Agency (JICA) up to 77 per cent of the total cost.Funding has been tied up and award of civil contract of 900 km is in process. The remaining portion of the project construction cost will be borne by the Ministry of Railways as equity funding. The Ludhiana to Mughalsarai section (1183 km) of the Eastern DFC is being funded by the World Bank up to 66 per cent of the project cost. Funding for the first sector, viz. Khurja-Kanpur (343 km), has been tied up and award of civil contract is under way. Funding tie up with the World Bank for the remaining sectors is also in process.The Mughalsarai-Sonnagar sector (122 km) will be funded by Indian Railways' own resources. Civil construction work of this sector is in progress. The Dankuni-Sonnagar section (534 km) of the Eastern DFC will be implemented through PPP mode. Apart from the Eastern and Western DFCs, a feasibility study has also been undertaken on four future freight corridors, viz. East-West Corridor (Kolkata-Mumbai), North-South Corridor (Delhi-Chennai), East Coast Corridor (Kharagpur- Vijayawada) and Southern Corridor (Goa-Chennai). A pre-feasibility study of the Chennai-Bangalore Freight Corridor is also being proposed. After commissioning of the Eastern and Western DFCs, it is planned to upgrade the speed of passenger trains to 160-200 kmph on the existing routes. A feasibility study for upgradation of speed of passenger trains to 160-200 kmph on the existing Delhi-Mumbai route has been undertaken with co-operation from the Government of Japan in 2012-13.

Box 11.4 : NTP-2012The Government approved National Telecom Policy (NTP) 2012, which addresses the vision, strategic direction, and the various medium- and long-term issues related to the telecom sector, on 31 May 2012. NTP-2012 is aimed at maximizing public good by making affordable, reliable, and secure telecommunication and broadband services available across the country. The objectives of NTP-2012 include the following:

Provide secure, affordable, and high-quality telecommunication services to all citizens. Strive to create One Nation-One Licence across services and service areas. Achieve One Nation-Full Mobile Number Portability and work towards One Nation-Free

Roaming.

Increase rural tele-density from the current level of around 39 to 70 by the year 2017 and 100 by the year 2020.

Recognize telecom, including broadband connectivity, as a basic necessity like education and health and work towards 'Right to Broadband'.

Provide affordable and reliable broadband-on-demand by the year 2015 and to achieve 175 million broadband connections by the year 2017 and 600 million by the year 2020 at minimum 2 Mbps download speed and make available higher speeds of at least 100 Mbps on demand.

Provide high-speed and high-quality broadband access to all village panchayats through a combination of technologies by the year 2014 and progressively to all villages and habitations by 2020.

Recognize telecom as an infrastructure sector to realize the true potential of information communication technology (ICT) for development

Address right-of-way (RoW) issues in setting up of telecom infrastructure. Mandate an ecosystem for ensuring setting up of a common platform for

interconnection of various networks for providing non-exclusive and non-discriminatory access.

Strive for enhanced and continued adoption of green policy in telecom and incentivize use of renewable resources for sustainability

Achieve substantial transition to the new Internet Protocol (IPv 6) in the country in a phased and time-bound manner by 2020 and encourage an ecosystem for provision of a significantly large bouquet of services on the IP platform.

PPP initiatives in IndiaThe Government of India is promoting PPPs as an effective tool for bringing private-sector efficiencies in creation of economic and social infrastructure assets and for delivery of quality public services. India in recent years has emerged as one of the leading PPP markets in the world, because of several policy and institutional initiatives taken by the central government. By end December 2012 there were over 900 PPP projects in the infrastructure sector with total project cost (TPC) of Rs. 5,43,045 crore as compared to over 600 projects with TPC of Rs. 333,083 crore on 31 March 2010. These projects are at different stages of implementation, i.e. bidding, construction, and operational. Approval of Central-sector PPP projects Since its constitution in January 2006, the Public Private Partnership Appraisal Committee (PPPAC) has approved 307 central project proposals with TPC of Rs. 2,97,856.58 crore. These include NHs (242 proposals), ports (29 proposals), airports (2 proposals), tourism infrastructure (1proposal), railways (1 proposal), housing (27 proposals), and sports stadia (5 proposals). VGF for PPP Projects Under the Scheme for Financial Support to PPPs in Infrastructure (Viability Gap Funding Scheme), 145 projects have been granted approval with TPC of Rs. 80,203.28 crore and VGF support of Rs. 1,56,72.68 crore and Rs. 902.96 VGF crore has been disbursed.Thirteen new sub-sectors have been included in the list of sectors eligible for VGF support under the Scheme. These include:i. Capital investment in the creation of modern storage capacity including cold chains and post-harvest storage. ii. Education, health, and skill development. iii. Internal infrastructure in National Investment and Manufacturing Zones. iv. Oil/gas/liquefied natural gas (LNG) storage facility [includes City Gas distribution (CGD) network]; oil and gas pipelines (includes CGD network); irrigation (dams, channels, embankments, etc); telecommunication (fixed network) (includes optic fibre/ wire/cable networks which provide broadband/internet); telecommunication towers; terminal markets; common infrastructure in agriculture markets; and soil-testing laboratories.Support for Project Development of PPP ProjectsThe India Infrastructure Project Development Fund (IIPDF) was launched in December 2007 to facilitate quality project development for PPP projects and ensure transparency in procurement consultants and projects. So far, 51 projects have been approved with IIPDF assistance of Rs. 64.51 crore of which Rs. 25.00 crore has been disbursed. Capacity Building and Strengthening of State and Central Institutions The National PPP Capacity Building Programme was launched by the Finance Minister in December 2010, and was rolled out last year in 15 States and two central training institutes, viz. the Indian Maritime University and Lal Bahadur Shastri National Academy of Administration. A comprehensive curriculum has been prepared and 11 training programmes conducted to train 154 trainers, who have trained over 1975 public functionaries, who deal with PPPs in their domain. Online toolkits for PPP projects for five sectors were developed and were launched by the Finance Minister. These are available on this Department's website on PPPs, i.e. www.pppinindia.com. The PPP toolkit is a web-based resource that has been designed to help improve decision-making for infrastructure PPPs in India and to improve the quality of the infrastructure PPPs that are implemented in India. In the

past one year, 720 national and international users have availed of this one-of-a-kind web-based resource to structure better PPP projects.PPP Rules and PPP Policy:Following the recommendations of the Committee on Public Procurement, the Prime Minister's announcement regarding transparency and accountability in procurement, and preparation of the Public Procurement Bill, and to ensure that PPP projects are procured and implemented by following laid down processes and observing principles of transparency, competitive bid process, affordability, and value for money, the draft PPP Rules and PPP Policy have been prepared. These have undergone extensive consultation process at central and state government levels for finalization. Global experience indicates that PPPs work well when they combine the efficiency and risk assessment of the private sector with the public purpose of the government sector. They work poorly when they rely on the efficiency and risk assessment of the government sector and the public purpose of the private sector. India should be careful not to undertake PPPs that do not apportion risks and responsibilities sensibly. Moreover flexibility needs to be built into arrangements so that the contract can be withdrawn and put up for rebid when the private party underperforms. The government needs to study the PPP experience and build some central capacity to help ministries, authorities, and states structure contracts and renegotiate troubled ones.

SUSTAINABLE DEVELOPMENT AND CLIMATE CHANGEThe year 2012 may arguably be considered a high water mark in the field of environment and sustainable development initiatives. The global community met at the UN Conference on Sustainable Development that took place in Rio in June 2012, also marking the 20th anniversary of the landmark first Earth Summit held in 1992. The Conference reviewed the progress made, identified implementation gaps, and assessed new and emerging challenges, which resulted in a political outcome called the 'The Future We Want'. In India, the Twelfth Five Year Plan was launched with a focus on sustainable growth. This along with sustainable development policies and programmes which are being followed signalled to citizens at home and the world at large that India is committed to sustainable development with equal emphasis on its three dimensions - social, economic, and environmental. A global comparative opinion survey shows that people in India and indeed all countries, have a marked and rising concern about sustainable development and climate change. However, the challenges are also formidable, especially in the context of finding the matching resources of the required magnitude given the economic conditions. Climate science has rightly taken up an important position in the public debate. Even as the science of climate change grapples with uncertanities the world is witnessing more extreme events. The urgency for action is felt more than ever before. In contrast, though the Doha Gateway on climate change agreed upon in December 2012 ensured that there is continuation of a multilateral and rule-based regime to reduce emissions, the emission pledges on the table by the developed country Parties lacked ambition. Now the Fifth Assessment Report of the Inter-governmental Panel on Climate Change (IPCC) is in the final stages of completion. With rising extreme events, and rising citizen demand, the world has little option but to listen to the voice of evolving science and respond adequately with strategies and policy rooted in the principles of multilateralism with equitable and fair burden sharing.Box 12.1: Twelfth Five Year Plan Approaches for Sustainable Development and Lower CarbonStrategiesThe Twelfth Plan strategy suggests that there are significant 'co-benefits' for climate action with inclusive and sustainable growth. India as a large responsible player with very low income has also to ensure that these efforts are matched by equitable and fair burden sharing among countries, taking into account the historical responsibilities for emissions. These issues are being discussed in the UNFCCC.India's approach to a lower-carbon growth strategy explicitly recognizes that policies have to be inclusive and differentiated across sectors according to national priorities, so as to lower the transaction costs of implementing the policy, and conform with a nationally fair burden-sharing mechanism. An Expert Group on Low Carbon Strategies appointed by the Planning Commission has outlined the lower carbon strategies for major potential carbon mitigation sectors:(i) Power: On the supply side, adopt super-critical technologies in coal-based thermal power

plants; use gas in combined heat and power systems; invest in renewable technologies; and develop hydropower in a sustainable manner. On the demand side, accelerate

adoption of super-efficient electrical appliances through market and regulatory mechanisms; enhance efficiency of agricultural pump sets and industrial equipment with better technology; modernize transmission and distribution to bring technical and commercial losses down to world average levels; universalize access to electricity; and accelerate power-sector reforms.

(ii) Transport: Increase the share of rail in overall freight transport; improve the efficiency of rail freight transport; make it price competitive by bringing down the levels of cross-subsidization between freight and passenger transport; complete dedicated rail corridor; improve share and efficiency of public transport system; and improve fuel efficiency of vehicles through both market-based and regulatory mechanisms.

(iii) Industry: Greenfield plants in the iron and steel and cement sectors adopt best available technology; existing plants, particularly small and medium ones, modernize and adopt green technology at an accelerated pace, with transparent financing mechanisms.

(iv) Buildings: Evolve and institutionalize green building codes at all levels of government.(v) Forestry: 'Green India Mission' to regenerate at least 4 million ha of degraded forest;

increase density of forest cover on 2 million ha of moderately dense forest; and overall increase the density of forest and tree cover on 10 million ha of forest, waste, and community lands.

Understanding Climate Change at a GlanceEver since the industrial revolution, manmade activities have added significant quantities of GHGs into the atmosphere. Climate change is a global negative externality primarily caused by the building up of GHG emissions in the atmosphere. The efforts needed to address the climate change include mitigation of GHG emissions on the one hand and building of adaptive capacities to cope with the adverse impacts of climate change on the other. From a developing country perspective, adaptation is of utmost importance as they are the ones who are most vulnerable to the adverse impacts of climate change.The incremental impact of a ton of GHG on climate change is independent of where in the world it is emitted. These emissions impose a cost on both the present and future generations, which are not fully recouped from the emitters of these emissions. This formed the starting point for a globally coordinated policy action and the need for an international climate change negotiating regime.

UNFCCC, set up in 1992, although global in scope, differentiates the commitments/ responsibilities of Parties on the basis of historic responsibilities, economic structures, and on the basis of the principle of 'equity' and CBDR which is at the core of the climate change debate. The largest share of historical and current global emissions of GHGs has originated in developed countries. Scientists attribute the global problem of climate change not to the current GHG emissions but to the stock of historical GHG emissions. Most of the countries, particularly the industrialized countries, having large current emissions are also the largest historic emitters and the principal contributors to climate change. The Convention therefore lays down legally binding commitments for the developed countries, taking into account their historical responsibilities and also squarely puts the responsibilities on developed countries for providing financial resources, including for the transfer of technology, needed by the developing countries. The Convention also acknowledges that climate change actions taken by developing countries are contingent on the resources made available to them.Box 12.4 : Key Doha Outcomes

It has been agreed that the KP, as the only existing and binding agreement under which developed countries commit to cutting emissions of GHGs, will enter a second commitment period that will run for eight years.

Governments have agreed to speedily work toward a climate change agreement under DP applicable to all countries from 2020, to be adopted by 2015. Further governments have decided to find ways to scale up efforts before 2020 to meet the gap in global ambition for emissions reduction.

Governments have launched a robust process to review the long-term temperature goal. This will start in 2013 and conclude by 2015 and is a reality check on the advance of the climate change threat and the possible need to mobilize further action.

The Work Programme on Long term Finance launched last year has been extended for another year to contribute to the ongoing efforts to scale up mobilization of climate

finance. Developed countries have reiterated their commitment to deliver on promises of mobilizing US$100 billion both for adaptation and mitigation by 2020.

Decision also encourages developed countries to increase efforts for providing finance between 2013 and 2015, and at least to the average annual level provided during the 2010-2012 fast-start finance period.

Finance pledges of about $ 6 billion for period upto 2015 announced by Germany, the UK, France, Denmark, Sweden and the EU Commission.

The selection of the Republic of Korea by the Board of the Green Climate Fund (GCF) to host the GCF has been endorsed.

The unresolved issues of Technology-related Intellectual Property Rights (IPRs) and the Unilateral Measures under the BAP are now part of the planned or continuing work of various bodies of the Convention. Based on the decisions, the

Technology Executive Committee (TEC) will initiate exploration of issues relating to enabling environments and barriers, including IPRs in its future work-plan. The TEC has already identified IPRs as one of the key messages on which further work is necessary. Similarly, a decision has been taken for facilitating discussion on the issue of unilateral measures under the existing forum on implementation of response measures

Box 12.6 : PAT and RPOPAT is a scheme for trading energy-efficiency certificates in large energy-intensive industries under the National Mission for Enhanced Energy Efficiency. Identified industries are required to improve their specific energy consumption (SEC) within the specified period of three years or face penalty provisions. At the same time this mechanism facilitates efficient industries to trade their additional certified energy savings (that go beyond the assigned target) with other designated consumers who could use these certificates to comply with their SEC-reduction targets. In the Twelfth Five Year Plan, the PAT scheme is likely to achieve about 15 million tonnes oil equivalent of annual savings in coal, oil, gas, and electricity (including 6.686 million ton of oil-equivalent energy savings of first phase) Similarly, the RPO is creating domestic markets for renewable energy through regulatory interventions at state level. The RPO is the minimum level of renewable energy (out of total consumption) the obligated entities (DISCOMs, Captive Power Plants, and Open Access Consumers) are entitled to purchase in the area of a distribution licensee. The obligation is mandated by the State Electricity Regulatory Commission (SERC). Since the renewable energy sources are not evenly spread across India, SERCs cannot specify a linear level of RPOs for all states. Renewable Energy Certificates (RECs) under the RPO mechanism is an instrument that enables the obligated entities to meet their Renewable Purchase Obligation by trading surplus or deficit RECs among themselves with the owner of the REC being able to claim to have purchased renewable energy.

HUMAN DEVELOPMENTEconomic growth though important cannot be an end in itself. Higher standards of living as well as of development opportunities for all, stemming from the greater resources generated by economic growth, are the ultimate aim of development policy. This implies the need to bridge regional, social and economic disparities, as well as the empowerment of the poor and marginalized, especially women, to make the entire development process more inclusive. The draft Twelfth Five Year Plan's subtitle 'Faster, More Inclusive and Sustainable Growth', puts the growth debate in the right perspective. The government's targeted policies for the poor, with the prospect of fewer leakages, can help better translate outlays into outcomes.HUMAN AND GENDER DEVELOPMENT: POVERTY13.10 The Planning Commission estimates poverty using data from the large sample surveys on household consumer expenditure carried out by the National Sample Survey Office (NSSO) every five years. It defines poverty line on the basis of monthly per capita consumption expenditure (MPCE). The methodology for estimation of poverty followed by the Planning Commission has been based on the recommendations made by experts in the field from time to time. The Expert Group headed by Professor Suresh D. Tendulkar which submitted its report in December 2009 has computed the poverty lines at all India level as MPCE of Rs. 447 for rural areas and Rs. 579 for urban areas in 2004-5. After 2004-5, this survey has been conducted in 2009-10. The Planning Commission has updated the poverty lines and poverty

ratios for the year 2009-10 as per the recommendations of the Tendulkar Committee using NSS 66th round (2009-10) data from the Household Consumer Expenditure Survey. It has estimated the poverty lines at all India level as an MPCE of Rs. 673 for rural areas and Rs. 860 for urban areas in 2009-10. Based on these cut-offs, the percentage of people living below the poverty line in the country has declined from 37.2 per cent in 2004-5 to 29.8 per cent in 2009-10. Even in absolute terms, the number of poor people has fallen by 52.4 million during this period. Of this, 48.1 million are rural poor and 4.3 million are urban poor. Thus poverty has declined on an average by 1.5 percentage points per year between 2004-5 and 2009-10. The annual average rate of decline during the period 2004-5 to 2009-10 is twice the rate of decline during the period 1993-4 to 2004-5 (Table13.5).13.11 Infant mortality rate (IMR) which was 58 per thousand in the year 2005 has fallen to 44 in the year 2011. The number of rural households provided toilet facilities annually have increased from 6.21 lakh in 2002-3 to 88 lakh in 2011-12. Similarly MPCE (at constant prices) has also increased from Rs. 558.78 and Rs. 1052.36 during 2004-5 to Rs. 707.24 and Rs. 1359.75 in 2011-12 in rural and urban areas respectively. The improvement in these social indicators is also a reflection of fall in deprivation. The Planning Commission has also constituted an Expert Group under the Chairmanship of Dr C. Rangarajan to 'Review the Methodology for Measurement of Poverty' in June 2012. (Also see inter-state comparison of poverty in Table 13.8).INEQUALITY13.12 HDR measures inequality in terms of two indicators. The first indicator is the income Gini coefficient which measures the deviation of distribution of income (or consumption) among the individuals within a country from a perfectly equal distribution. For India, the income Gini coefficient was 36.8 in 2010-11. In this respect, inequality in India is lower than many other developing countries e.g. South Africa (57.8), Brazil (53.9), Thailand (53.6), Turkey (40.8), China (41.5), Sri Lanka (40.3), Malaysia (46.2), Vietnam (37.6), as well as countries like USA (40.8), Hong Kong (43.4), Argentina (45.8), Israel (39.2), Bulgaria (45.3) etc., which are otherwise ranked very high in terms of human development index. The second indicator is the quintile income ratio, which is a measure of average income of the richest 20 per cent of the population to that of poorest 20 per cent. The quintile income ratio for India was 5.6 in 2010-11. Countries like Australia (7.0), the USA (8.5), New Zealand (6.8), Singapore (9.8), the UK (7.8), Argentina (12.3), Mexico (14.4), Malaysia (11.4), Philippines (9.0), Vietnam (6.2) had higher ratios. This implies that the inequality between the top and bottom quintiles in India was lower than a large number of countries.Unemployment13.16 The unemployment rate increased at a slow pace on UPSS basis and at a relatively higher pace on CDS basis from 1993-4 to 2004-5. However, in 2009-10 there was a fall in the unemployment rate which was relatively more on CDS basis (See Figure 13.1 and Table 13.8). Despite negligible employment growth, the unemployment rate (CDS method) fell from 8.2 per cent in 2004-5 to 6.6 per cent in 2009- 10. The decline in CDS unemployment rate implies a decline in unemployed persondays. The total number of unemployed persondays declined by 6.5 million persons, from around 34.5 million in 2004-5 to 28 million in 2009-10. 13.17 The fall in unemployment despite marginal growth in employment in 2009-10 could be due to the demographic dividend, as an increasing proportion of the young population opts for education rather than participating in the labour market. This is reflected in the rise in growth in enrolment of students in higher education from 49.25 lakh in 1990-91 to 169.75 lakh in 2010-11. Similarly gross enrolment ratio in class I-VIII has risen from 93.54 in 2004-5 to104.3 in 2010-11. Enactment of the Right to Education and programmes like the Sarva Shiksha Abhiyan could also have contributed to this.

CURRENT ECONOMIC ISSUESSetting up of Infrastructure Debt Funds (IDFs)

Broad guidelines have been issued vide a press release dated 23 September 2011 for setting up of IDFs to facilitate flow of funds into infrastructure projects. The IDF will be set up either as a trust or as a company. A trust-based IDF would normally be a mutual fund (MF), while a company-based IDF would normally be an NBFC. An IDF- NBFC would raise resources through issue of either rupee- or dollar-denominated bonds of minimum five-year maturity. The

investors would be primarily domestic and off-shore institutional investors, especially insurance and pension funds which would have longterm resources. An IDF-MF would be regulated by the Securities and Exchange Board of India (SEBI) while an IDF-NBFC would be regulated by the RBI. Detailed guidelines were issued on 21 November prescribing the regulatory framework for NBFCs to sponsor IDFs which are to be set up as Mutual Funds (MFs) and NBFCs. Such entities would be designated as “Infrastructure Debt Fund – Mutual Funds (IDF-MF) and “Infrastructure Debt Fund – Non-Banking Financial Company (IDF-NBFC)”. All NBFCs, including Infrastructure Finance Companies (IFCs) registered with the bank may sponsor IDFs to be set up as MFs. However, only IFCs can sponsor IDF-NBFCs.

Eligibility parameters for NBFCs as sponsors of IDF-MFs include a minimum NOF of Rs. 300 crore; CRAR of 15 per cent; net NPAs less than 3 per cent; the NBFC to have been in existence for at least five years and earning profits for the last three years in addition to those prescribed by SEBI in the newly inserted Chapter VI B to the MF Regulations.

Only NBFC-IFCs can sponsor IDF-NBFCs with prior approval of the RBI and subject to the following conditions: the sponsor IFC would be allowed to contribute a maximum of 49 per cent to the equity of the IDF-NBFC with a minimum equity holding of 30 per cent of the equity of IDF-NBFC, post investment, in the IDF-NBFC; the sponsor NBFC-IFC must maintain minimum CRAR and NOF for IFCs; there are no supervisory concerns with respect to the IFC. The IDF is granted relaxation in credit concentration norms and in risk weights.

In case of an IDF that issues bonds, credit enhancement inherent in Public Private Partnership (PPP) projects would be available. Such IDFs would refinance PPP projects after their construction is completed and they have successfully operated for atleast one year. Such projects would involve a lower level of risk and consequently a higher credit rating. Such a structure would enable flow of Insurance and Pensions Funds at competitive costs in order to channelize low cost long term debt in PPP projects in infrastructure sectors such as roads, ports, airports, railways, metro rail etc.

By refinancing bank loans of existing projects the IDFs are expected to take over a fairly large volume of the existing bank debt that will release an equivalent volume for fresh lending to infrastructure projects. The IDFs will also help accelerate the evolution of a secondary market for bonds which is presently lacking in sufficient depth.

Takeout Financing Scheme: The takeout financing scheme is aimed at encouraging commercial banks to lend more to the infrastructure sector. Under the scheme, banks lend to infrastructure projects but sell a part of that loan to a third party after a certain period of time. This is called takeout financing.

Credit enhancement Scheme: Through credit enhancement, a lender is provided with reassurance that a borrower will honour the obligation through additional collateral or third party guarantee. It reduces credit/default risk of a debt, thereby, enhancing credit rating and lowering interest rates on the debt.

Banking Laws (Amendment) Bill 2012 The Banking Laws (Amendment) Bill 2011 was introduced in order to amend the Banking Regulation Act, 1949, the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970/1980. The said Bill has been passed by both the Houses of Parliament in December 2012. This Bill would strengthen the regulatory powers of Reserve Bank of India (RBI) and to further develop the banking sector in India. The Bill would pave the way for new bank licenses by RBI resulting in opening of new banks and branches. This would not only help in achieving the goal of financial inclusion by providing more banking facilities but would also provide extra employment opportunities to the people at large in the banking sector. The salient features of the Bill are as follows:

Banking Bill will increase shareholders' voting rights from 10 per cent to 26 per cent in private sector banks, making investment attractive to foreign players. Raising of the voting cap will have a positive impact in attracting funds as it will help foreign investors to have more say in banks.

Government dropped a clause allowing banks to trade commodities futures amid fears it could lead to risky, speculative trading.

Bill will give the RBI greater regulatory oversight over local banks & the ability to overrule boards when the banks are facing financial difficulties.

Bill also enables the government to raise voting rights in state banks such as the State Bank of India to 10 per cent from the current one per cent, acceding partially to foreign investors' demands to have more say in Indian banking.

Bill will allow foreign banks to convert their Indian operations into local subsidiaries or transfer shareholding to a holding company of the bank without paying stamp duty

To enable banking companies to issue preference shares subject to regulatory guidelines by the RBI;

To empower RBI to collect information and inspect associate enterprises of banking companies

To empower RBI to supersede the Board of Directors of banking company and appointment of administrator till alternate arrangements are made

To provide for primary cooperative societies to carry on the business of banking only after obtaining a license from RBI

To provide for special audit of cooperative banks at instance of RBI by extending applicability of Section 30 to them

To create a Depositor Education and Awareness Fund by utilizing the inoperative deposit accounts;

To provide prior approval of RBI for acquisition of 5% or more of shares or voting rights in a banking company by any person and empowering RBI to impose such conditions as it deems fit in this regard

To enable the nationalized banks to raise capital through “bonus” and “rights” issue and also enable them to increase or decrease the authorized capital with approval from the Government and RBI without being limited by the ceiling of a maximum of Rs. 3000 crore under the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970/1980.

The bill will keep banking merger and acquisitions under the purview of the Competition Commission of India (CCI).

Credit Default Swaps (CDS)A specific kind of counterparty agreement which allows the transfer of third party credit risk from one party to the other. One party in the swap is a lender and faces credit risk from a third party, and the counterparty in the credit default swap agrees to insure this risk in exchange of regular periodic payments (essentially an insurance premium). If the third party defaults, the party providing insurance will have to purchase from the insured party the defaulted asset. In turn, the insurer pays the insured the remaining interest on the debt, as well as the principal.

National Food Security Bill

The National Food Security Bill was introduced in the Lok Sabha on 22 December 2011. As per the provisions of the Bill, it is proposed to provide 7 kg. of foodgrains per person per month belonging to priority households at prices not exceeding Rs. 3 per kg of rice, Rs. 2 per kg of wheat, and Rs. 1 per kg of coarse grains and to general households not less than 3 kg of foodgrains per person per month at prices not exceeding 50 per cent of the MSP for wheat and coarse grains and derived MSP for rice. It will benefit up to 75 per cent of rural population (with at least 46 per cent belonging to priority households) and up to 50 per cent of urban population (with at least 28 per cent belonging to priority households), besides providing nutritional support to women and children and meals to special groups such as destitute and homeless, emergency and disaster affected, and persons living in starvation. Pregnant and lactating women will also be entitled to maternity benefit of Rs.1,000/per month for six months. In case of non-supply of foodgrains or meals, entitled persons will be provided food security allowance by the concerned state/UT governments. Provisions for reforms in the TPDS such as doorstep delivery of foodgrains , application of information and communication technology (ICT) including end to end computerization, leveraging ‘aadhaar’ for unique identification of beneficiaries have also been made in the Bill. Provisions have also been made for transparency and accountability including disclosure of records relating to the PDS, social audits, and setting up of vigilance committees besides an elaborate grievance redressal mechanism.

Gold ETFs

Gold ETFs are exchange traded funds that are meant to track closely the price of physical gold. So gold ETF lets you own gold in your dmat account. Each unit of the ETF lets the investor own 1gm of gold without physically owning it. Thus investing in a gold ETF provides the benefit of liquidity and marketability which are a limitation of owning physical gold. Gold ETF is liquid because you can trade in it at any time during market hours. Gold ETF is marketable because you can trade any amount in it just like a normal stock including short selling and buying on margin. Owning gold ETF also is cheaper than owning physical gold because it has no cost of carry (the cost of storing physical gold).

Gold ETF can allow investors to easily participate in the gold market and the basic investment objective is designed to offer investors a simple, cost-efficient and secure way to access the gold market by providing a return equivalent to movements in the gold spot price less the relevant management fees. These funds not only tap the huge potential of gold, they also remove the Jewellery- making charges and the risks and liabilities of storing gold physically. And what's more, they are tax efficient and extremely easy to buy and sell. Invest in best form of gold there is. invest in Paper Jewellery today. Advantage

Diversification : Considered as an excellent diversification for your portfolio. Liquidity : Since it trades like a share, buying and selling happens quickly and

therefore it is highly liquid. Safety : Gold ETF ensures that the custody and quality of gold is consistent. Security : All transactions happen in electronic mode, so there is no risk in case of

unforeseen circumstances. Lower Cost : The expenses incurred in buying and selling Gold ETF are much lower

then the cost incurred in buying, selling, storing and insuring physical gold. Making Charges : You don’t have to pay any making or delivery charges.

Drawbacks: Most of the above-mentioned advantages come at a cost in the case of gold ETFs. A small asset management fee is charged by the fund house, so the return is slightly less than the actual increase in the gold price. Moreover, there are additional costs involved at the time of buying and selling in the form of brokerage or commission. Another drawback with gold ETFs is liquidity; some ETFs are illiquid, which impacts their buying and selling flexibility.  The Micro Finance Institutions (Development and Regulation) Bill, 2012 The Micro Finance Institutions (Development and Regulation) Bill, 2012 was introduced in the Lok Sabha on May 22, 2012. The Bill aims to provide for the development and regulation of micro finance institutions.A micro finance institution (MFI) is defined as an organisation, other than a bank, providing micro finance services. These services are defined as micro credit facilities not exceeding Rs 5 lakh in aggregate, or with the Reserve Bank’s (RBI) specification Rs 10 lakh, to each individual. Other services like collection of thrift, pension or insurance services and remittance of funds to individuals within India also come under micro finance services. The Bill allows the central government to create a Micro Finance Development Council with officers from different Ministries and Departments. This council will advise the central government on policies and measures for the development of MFIs.In addition, the Bill allows the central government to form State Micro Finance Councils. These councils will be responsible for coordinating the activities of District Micro Finance Committees and reviewing the MFIs in their state.District Micro Finance Committees review the development of micro finance activities within the district, monitor over-indebtedness and monitor the methods of recovery used by MFIs. These committees can be appointed by the RBI. The Bill requires that all MFIs to obtain a certificate of registration from the RBI. The applicant needs to have a net owned fund of at least Rs 5 lakh. By ‘net owned fund’ the Bill means the aggregate of paid up equity capital and free reserves on the balance sheet. The RBI should also be satisfied with the general character or management of the institution. Every MFI will have to create a reserve fund and the RBI may specify a percentage of net profit to add to this fund. There can be no appropriation from this fund unless specified by the RBI.At the end of every financial year, MFIs are required to provide an annual balance sheet and profit and loss account for audit to the RBI. They will also have to provide a return detailing their activities within 90 days of the Bill being passed.

Any change in the corporate structure of a MFI, such as a shut down, amalgamation, takeover or restructuring, can only take place with approval from the RBI.The RBI has the power to issue directions to MFIs. This could include directions on the extent of assets deployed in providing micro finance services, ceilings on loans or raising capital.The RBI has the authority to set the maximum annual percentage rate charged by MFIs and set a maximum limit on the margin MFIs can make. Margin is defined as the difference between the lending rate and the cost of funds (in percentage per annum).The RBI shall create the Micro Finance Development Fund. Sums raised by the RBI from donors, institutions and the public along with the outstanding balance from the existing Micro Finance Development and Equity Fund form this fund. The central government, after due appropriation from Parliament, may grant money to this fund. The fund can provide loans, grants and other micro credit facilities to any MFI.

RBI releases Guidelines for Licensing of New BanksThe Reserve Bank of India on 22 Feb 2013 released on its website, the Guidelines for “Licensing of New Banks in the Private Sector”.Key features of the guidelines are:(i) Eligible Promoters: Entities / groups in the private sector, entities in public sector and Non-Banking Financial Companies (NBFCs) shall be eligible to set up a bank through a wholly-owned Non-Operative Financial Holding Company (NOFHC).(ii) ‘Fit and Proper’ criteria: Entities / groups should have a past record of sound credentials and integrity, be financially sound with a successful track record of 10 years. For this purpose, RBI may seek feedback from other regulators and enforcement and investigative agencies.(iii) Corporate structure of the NOFHC: The NOFHC shall be wholly owned by the Promoter / Promoter Group. The NOFHC shall hold the bank as well as all the other financial services entities of the group.(iv) Minimum voting equity capital requirements for banks and shareholding by NOFHC: The initial minimum paid-up voting equity capital for a bank shall be `5 billion. The NOFHC shall initially hold a minimum of 40 per cent of the paid-up voting equity capital of the bank which shall be locked in for a period of five years and which shall be brought down to 15 per cent within 12 years. The bank shall get its shares listed on the stock exchanges within three years of the commencement of business by the bank.(v) Regulatory framework: The bank will be governed by the provisions of the relevant Acts, relevant Statutes and the Directives, Prudential regulations and other Guidelines/Instructions issued by RBI and other regulators. The NOFHC shall be registered as a non-banking finance company (NBFC) with the RBI and will be governed by a separate set of directions issued by RBI.(vi) Foreign shareholding in the bank: The aggregate non-resident shareholding in the new bank shall not exceed 49% for the first 5 years after which it will be as per the extant policy.(vii) Corporate governance of NOFHC: At least 50% of the Directors of the NOFHC should be independent directors. The corporate structure should not impede effective supervision of the bank and the NOFHC on a consolidated basis by RBI.(viii) Prudential norms for the NOFHC: The prudential norms will be applied to NOFHC both on stand-alone as well as on a consolidated basis and the norms would be on similar lines as that of the bank.(ix) Exposure norms: The NOFHC and the bank shall not have any exposure to the Promoter Group. The bank shall not invest in the equity / debt capital instruments of any financial entities held by the NOFHC.(x) Business Plan for the bank: The business plan should be realistic and viable and should address how the bank proposes to achieve financial inclusion.(xi) Other conditions for the bank :

The Board of the bank should have a majority of independent Directors. The bank shall open at least 25 per cent of its branches in unbanked rural centres

(population upto 9,999 as per the latest census) The bank shall comply with the priority sector lending targets and sub-targets as

applicable to the existing domestic banks. Banks promoted by groups having 40 per cent or more assets/income from non-

financial business will require RBI’s prior approval for raising paid-up voting equity capital beyond `10 billion for every block of `5 billion.

Any non-compliance of terms and conditions will attract penal measures including cancellation of licence of the bank.

(xii) Additional conditions for NBFCs promoting / converting into a bank : Existing NBFCs, if considered eligible, may be permitted to promote a new bank or convert themselves into banks.Procedure for application:In terms of Rule 11 of the Banking Regulation (Companies) Rules, 1949, applications shall be submitted in the prescribed on or before July 1, 2013.Procedure for RBI decisions:

At the first stage, the applications will be screened by the Reserve Bank. Thereafter, the applications will be referred to a High Level Advisory Committee, the constitution of which will be announced shortly.

The Committee will submit its recommendations to the Reserve Bank. The decision to issue an in-principle approval for setting up of a bank will be taken by the Reserve Bank.

The validity of the in-principle approval issued by the Reserve Bank will be one year. In order to ensure transparency, the names of the applicants will be placed on the

Reserve Bank website after the last date of receipt of applications.BackgroundIt may be recalled that after the announcement made by the Hon’ble Finance Minister in his Budget Speech for the year 2010-11, the Reserve Bank had put out a Discussion Paper on its website on August 11, 2010 inviting feedback and comments. Thereafter, the draft guidelines on the licensing of new banks were released on the Reserve Bank website on August 29, 2011 inviting views and comments. Comments and suggestions received on the draft guidelines were examined and some of the suggestions were accepted. After the vital amendments to the Banking Regulation Act, 1949 were carried out in December 2012 and after consulting with the Government of India, the guidelines for “Licensing of New Banks in the Private Sector” have now been finalised.Shome Committee Draft: Retrospective To ProspectiveIn October 2012, the Shome Committee submitted a draft report on retrospective amendments relating to indirect transfers. To put that in simple English, the Committee was asked to analyse the amended Section 9 of the Finance Act 2012 – which says transactions between non-residents involving underlying assets in India should be taxable in India with retrospective effect from April 1, 1962.  This amended Section makes several transactions such as the Hutch-Vodafone one taxable in India. The Shome Committee recommendations

Retrospective application of tax should occur in exceptional or rarest of rare cases and with particular objectives

It should not be done to expand the tax base, nor done without stakeholder consultations

That the retrospective amendments in finance act 2012 - relating to indirect transfers, are not clarificatory and  instead an effort to widen the tax base

These amendments should be applied prospectively after introducing clear definitions If the government must impose them retrospectively then they should apply only to the

seller and not to the buyer & no interest should be charged nor penalty leviedThe committee has also made recommendations on what types of indirect transfers should be taxed, whether retrospectively or prospectively; for instance

Only those transactions where at least 50% of the underlying assets are in India should be considered

Only capital gains attributable to the India assets should be taxed Transactions involving the transfer of less than 26% voting power should not be

considered Foreign companies listed on a recognised stock exchange and whose shares are

frequently traded should be exempt FII and some types of private equity transactions should be exempt And treaty exemptions should be respected

Report of the Committee on Roadmap for Fiscal Consolidation The Kelkar Committee (KC) set up by the government to outline a roadmap for fiscal consolidation released its report today. The KC recommends four pillars under which the government can lower its deficit to 5.2% of GDP in FY13, and further to 4.6% and 3.9% in FY14 and FY15, respectively.Tax measures and better administration. Review introduction of the direct tax code since that could lead to considerable revenue losses, penalize non-compliance on tax payments, review commodities that attract excise tax duty of 6% or lower and prune the negative list on services tax.Increase disinvestment proceeds. The KC suggests the government should consider disinvesting through multiple routes, including the exchange traded fund (ETF) route, sell minority stakes in private entities and calls for a special dividend from the central public sector enterprises (CPSE). It also suggests that the government could consider monetizing its land resources.Cut subsidies. Raise prices of diesel (Rs4/litre), LPG cylinder (INR50/cylinder) and kerosene (Rs2/litre), cap the number of LPG cylinders per consumer (already implemented) and hike urea (fertilizer) prices by 10% in FY13. Ensure better efficiency in food grain distribution and raise Central Issue Price to contain the food subsidy. The KC suggests regular revision of fuel and fertilizer prices to reduce the subsidy bill from 2.2% of GDP in FY13 to 1.5% by FY15.Right-size plan expenditure. The KC states that the increase in Plan expenditures (funding for five year plans) has seen a very rapid growth (of 26% y-o-y) in FY13. Reallocation of resources can lead to a saving of INR200bn in FY13 on plan expenditure. Further, it states that plan expenditures should rise at a slower pace of 15% and 18% y-o-y in FY14 and FY15 respectively, helping to create additional savings.

The Fiscal Cliff

The "fiscal cliff" is a term used describe a bundle of momentous U.S. federal tax increases and spending cuts that are due to take effect at the end of 2012 and early 2013. Among the laws set to change at midnight on December 31, 2012, are the end of last year’s temporary payroll tax cuts (resulting in a 2% tax increase for workers), the end of certain tax breaks for businesses, shifts in the alternative minimum tax that would take a larger bite, the end of the tax cuts from 2001-2003, and the beginning of taxes related to President Obama’s health care law. At the same time, the spending cuts agreed upon as part of the debt ceiling deal of 2011 will begin to go into effect. According to Barron's, over 1,000 government programs - including the defense budget and Medicare are in line for "deep, automatic cuts." In dealing with the fiscal cliff, U.S. lawmakers have a choice among three options, none of which are particularly attractive:They can let the current policy scheduled for the beginning of 2013 – which features a number of tax increases and spending cuts that are expected to weigh heavily on growth and possibly drive the economy back into a recession – go into effect. The plus side: the deficit, as a percentage of GDP, would be cut in half.They can cancel some or all of the scheduled tax increases and spending cuts, which would add to the deficit and increase the odds that the United States could face a crisis similar to that which is occurring in Europe. The flip side of this, of course, is that the United States' debt will continue to grow.They could take a middle course, opting for an approach that would address the budget issues to a limited extent, but that would have a more modest impact on growth.Can a Compromise be Reached?The oncoming fiscal cliff is a concern for investors since the highly partisan nature of the current political environment could make a compromise difficult to reach. This problem isn’t new, after all: lawmakers have had over a year to address this issue, but Congress – mired in political gridlock – has largely put off the search for a solution rather than seeking to solve the problem directly. Republicans want to cut spending and avoid raising taxes, while Democrats are looking for a combination of spending cuts and tax increases. Although both parties want to avoid the fiscal cliff, compromise is seen as being difficult to achieve – particularly in an election year. There's a strong possibility that Congress won't act until the eleventh hour. Another potential obstacle is that the next Congress won't be sworn in until January 3, after the deadline.The most likely outcome is another set of stop-gap measures that would delay a more permanent policy change until 2013 or later. Still, the non-partisan Congressional Budget Office (CBO) estimates that if Congress takes the middle ground – extending the Bush-era tax cuts but cancelling the automatic spending cuts – the result, in the short term, would be modest growth but no major economic hit.

Possible Effects of the Fiscal CliffIf the current laws slated for 2013 go into effect, the impact on the economy would be dramatic. While the combination of higher taxes and spending cuts would reduce the deficit by an estimated $560 billion, the CBO estimates that the policies set to go into effect would cut gross domestic product (GDP) by four percentage points in 2013, sending the economy into a recession (i.e., negative growth). At the same time, it predicts unemployment would rise by almost a full percentage point, with a loss of about two million jobs.The Fiscal Cliff DealThree hours before the midnight deadline on January 1, the Senate agreed to a deal to avert the fiscal cliff. The Senate version passed two hours after the deadline, and the House of Representatives approved the deal 21 hours later. The government technically went "over the cliff," since the final details weren't hashed out until after the beginning of the New Year, but the changes incorporated in the deal were backdated to January 1.The key elements of the deal are: an increase in the payroll tax by two percentage points to 6.2% for income up to $113,700, and a reversal of the Bush tax cuts for individuals making more than $400,000 and couples making over $450,000 (which entails the top rate reverting from 35% to 39.5%). Investment income is also affected, with an increase in the tax on investment income from 15% to 23.8% for filers in the top income bracket and a 3.8% surtax on investment income for individuals earning more than $200,000 and couples making more than $250,000. The deal also gives U.S. taxpayers greater certainty regarding the alternative minimum tax, and a number of popular tax breaks - such as the exemption for interest on municipal bonds - remain in place.The Congressional Budget Office estimates that current plan includes $330.3 in new spending during the next ten years, and it will increase the deficit by $3.9 trillion in that time period despite raising taxes on 77.1% of U.S. households. Bloomberg reports, "More than 80 percent of households with incomes between $50,000 and $200,000 would pay higher taxes. Among the households facing higher taxes, the average increase would be $1,635, the policy center said. A 2 percent payroll tax cut, enacted during the economic slowdown, is being allowed to expire as of (December 31)." The two-percentage point increase in the payroll tax is expected to take about $120 billion out of the economy, which should have a negative impact of about seven-tenths of one percent on GDP growth.

Human Development Report - 2013 The Rise of the South: Human Progress in a Diverse WorldPublished on 14 Mar 2013  The 2013 Human Development Report – "The Rise of the South: Human Progress in a Diverse World" – examines the profound shift in global dynamics driven by the fast-rising new powers of the developing world and its long-term implications for human development.  The Report identifies more than 40 countries in the developing world that have done better than had been expected in human development terms in recent decades, with their progress accelerating markedly over the past ten years. The Report analyzes the causes and consequences of these countries' achievements and the challenges that they face today and in the coming decades.  Each of these countries has its own unique history and has chosen its own distinct development pathway. Yet they share important characteristics and face many of the same challenges. They are also increasingly interconnected and interdependent. The Report calls for far better representation of the South in global governance systems and points to potential new sources of financing within the South for essential public goods. With fresh analytical insights and clear proposals for policy reforms, the Report helps charts a course for people in all regions to face shared human development challenges together, fairly and effectively.Highlights

Today, the South as a whole produces about half of world economic output, up from about a third in 1990.

Latin America, in contrast to overall global trends, has seen income inequality fall since 2000.

There is a clear positive correlation between past public investment in social and physical infrastructure and progress on the Human Development Index.

Developing countries trade more among themselves than with the North, and this trend can go much further.

Norway, Australia and the United States lead the rankings of 187 countries and territories in the latest Human Development Index (HDI), while conflict-torn Democratic Republic of the

Congo and drought-stricken Niger have the lowest scores in the HDI’s measurement of national achievement in health, education and income, published today in the United Nations Development Programme’s (UNDP) 2013 Human Development Report. Yet Niger and the Democratic Republic of the Congo, despite their continuing development challenges, are among the countries that made the greatest strides in HDI improvement since 2000, the Report shows. The new HDI figures show consistent human development improvement in most countries.

“Over the past decades, countries across the world have been converging towards higher levels of human development, as shown by the Human Development Index,” says the 2013 Report. “All groups and regions have seen notable improvement in all HDI components, with faster progress in low and medium HDI countries. On this basis, the world is becoming less unequal.”

Fourteen countries recorded impressive HDI gains of more than 2 percent annually since 2000—in order of improvement, they are: Afghanistan, Sierra Leone, Ethiopia, Rwanda, Angola, Timor-Leste, Myanmar, Tanzania, Liberia, Burundi, Mali, Mozambique, Democratic Republic of the Congo, and Niger. Most are low-HDI African countries, with many emerging from long periods of armed conflict. Yet all have made significant recent progress in school attendance, life expectancy and per capita income growth, the data shows.

Most countries in higher HDI brackets also recorded steady HDI gains since 2000, though at lower levels of absolute HDI improvement than the highest achievers in the low-HDI grouping.Hong Kong, Latvia, Republic of Korea, Singapore and Lithuania showed the greatest 12-year HDI improvement in the Very High Human Development quartile of countries in the HDI; Algeria, Kazakhstan, Iran, Venezuela and Cuba were the top five HDI improvers in the High Human Development countries; and Timor-Leste, Cambodia, Ghana, Lao People’s Democratic Republic and Mongolia were the HDI growth leaders in the Medium Human Development grouping.

The overall trend globally is toward continual human development improvement. Indeed, no country for which complete data was available has a lower HDI value now than it had in 2000.When the HDI is adjusted for internal inequalities in health, education and income, some of the wealthiest nations fall sharply in the rankings: the United States falls from #3 to #16 in the inequality-adjusted HDI, and South Korea descends from #12 to #28. Sweden, by contrast, rises from #7 to #4 when domestic HDI inequalities are taken into account.

“National averages hide large variations in human experience, and wide disparities remain within countries of both the North and the South,” the Report notes, citing the case of the United States, with an HDI value of 0.94 overall, but an average of 0.75 for Latino residents and 0.70 for African-Americans.“Similar ethnic disparities in HDI achievement in very high HDI countries can be seen in the Roma populations of southern Europe,” the Report says.

The new HDI rankings introduce the concept of the statistical tie for the first time since the HDI was introduced in the first Human Development Report in 1990, for countries with HDI values that are identical to at least three decimal points. Ireland and Sweden, each with an HDI value of 0.916, are both ranked seventh in the new HDI, for example, though the two countries’ HDI values diverge when calculated to four or more decimal points.

“We concluded after consultations with many leading experts in development measurement that differences beyond a thousandth of a percent are statistically insignificant,” said Khalid Malik, Director of UNDP’s Human Development Report Office. “When two countries are so close in their HDI values, sharing the same ranking is more accurate and fair.”

The 2013 Human Development Report—The Rise of the South: Human Progress in a Diverse World—is being launched in Mexico City today by UNDP Administrator Helen Clark and Mexican President Enrique Peña Nieto. The Report analyses more than 40 developing countries that have made rapid human development gains in recent years through sustained investment in education, health and other social services, and strategic engagement with the world economy.

The 2013 Report’s Statistical Annex also includes two experimental indices, the Multidimensional Poverty Index (MPI) and the Gender Inequality Index (GII). The GII is designed to measure gender inequalities as revealed by national data on reproductive health, women’s empowerment and labour market participation. The Netherlands, Sweden and Denmark top the GII, with the least gender inequality. The regions with the greatest gender inequality as measured by the GII are sub-Saharan Africa, South Asia and the Arab States.

The Multidimensional Poverty Index (MPI) examines factors at the household level that together provide a fuller portrait of poverty than income measurements alone. The MPI is not

intended to be used for national rankings, due to significant differences among countries in available household survey data.In the 104 countries covered by the MPI, about 1.56 billion people are estimated to live in multidimensional poverty. The countries with the highest percentages of ‘MPI poor’ are all in Africa: Ethiopia (87%), Liberia (84%), Mozambique (79%) and Sierra Leone (77%). Yet the largest absolute numbers of multidimensionally poor people live in South Asia, including 612 million in India alone. The Statistical Annex also presents data specifically pertinent to the 2013 Report, including expanding trade ties between developing countries, immigration trends, growing global Internet connectivity and public satisfaction with government services, as well as individual quality of life in different countries.Human Development Index (HDI) - 2012 Rankings

Cheque Truncation System Beginning 1st July 2013, Cheque Truncation System (CTS) would be implemented, whereby the flow of the physical movement of the cheque will be eliminated in the cheque clearing process. Instead, an electronic image of the cheque will be sent along with relevant information.While the existing cheque standard was supposed to be phased out from circulation beginning 2013, the Reserve Bank of India (RBI) extended the deadline to 31st March 13 based on representations by some banks as they needed more time to set up the systems.The shift from the old system to the new cheque format essentially means that if you have given any post-dated cheques to your banks for loan EMIs you will have to replace them with new cheque leaves. And if you hold any post-dated cheques beyond 31st June you will have to arrange to get it replaced with a new Cheque Truncation System cheque.CTS is an efficient way of clearing cheques. It is in fact, better than the existing method. This article attempts to explain CTS and its benefits both to account holders as well as banks.What is a Cheque Truncation System?Cheque Truncation System (CTS) is a cheque clearing system undertaken by the Reserve Bank of India (RBI) for faster clearing of cheques. As the name suggests, truncation is the process of stopping the flow of the physical cheque in its way of clearing. In its place an electronic image of the cheque is transmitted with key important data.Cheque truncation thus obviates the need to move physical instruments across branches. This effectively eliminates the associated cost of movement of physical cheques, reduces the time

required for their collection and brings elegance to the entire activity of cheque processing. It is a system which is practiced worldwide in the banking sector.Cheque Truncation System (CTS) was introduced and implemented in the National Capital Region (NCR) in February ’08 on a pilot basis. The number 2010 in 'CTS-2010' is because the guidelines for Cheque Truncation System came up in the year 2010.Why CTS?In India, the RBI has made available inter-bank and customer payments online in near-real time in the form of RTGS and NEFT. However, cheques still remain a prominent mode of payment in the country. Physical cheques still account for 75% to 80% of all transactions.So, the RBI has decided to focus on improving efficiency of the cheque clearing cycle. Thus, offering CTS is an alternative. CTS also reduces operational risks in banking operations as clearing is a highly fraud-prone operation. This explains CTS from the regulators’ perspective.Benefits to Account HoldersSince there is no physical movement of cheques, there is no fear of loss of cheque in transit. Usage of CTS cheques also means quicker clearance, shorter clearing cycle and speedier credit of the amount to your account. Depending on whether the cheque is local or outstation, the cheque can get cleared on the same day or within 24 hours. The biggest advantage is that CTS-compliant cheques are more secure than old cheques and, hence, less prone to frauds. Also, as the system matures, it is proposed to integrate multiple locations and reduce geographical restrictions in cheque clearing.Hence, there are chances of multi-city cheques getting cleared on the same day, going forward.For banks the benefits from CTS could be summarized as follows:

Shorter clearing cycle Superior verification and reconciliation process No geographical restrictions as to jurisdiction Operational efficiency for banks and customers alike Reduction in operational risk and risks associated with paper clearing

Also, to reiterate, scope for frauds are minimum under the CTS regime, which is good for banks. In addition to this, obviating the need to move physical cheques is extremely beneficial in terms of saving cost and time for banks. Certain benchmarks across the country have been prescribed like quality of paper, watermark, bank’s logo in invisible ink, void pantograph, etc, and standardization of field placements on cheques. This will achieve standardization of cheques issued by banks.