world bank document...reforms, anti-corruption initiatives, decentralization, and e-governance, with...

Document ofThe World Bank

FOR OFFICIAL USE ONLYReport No. P7453 IN

REPORT AND RECOMMENDATION

OF THE

PRESIDENT OF THE

INTERNATIONAL DEVELOPMENT ASSOCIATION AND THE

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

TO THE

EXECUTIVE DIRECTORS

ON

A CREDIT IN THE AMOUNT OF SDR 58.9 MILLION (US$75 MILLION EQUIVALENT)

AND

A LOAN IN THE AMOUNT OF US$75 MILLION

TO

INDIA

FOR THE KARNATAKA ECONOMIC RESTRUCTURING

May 25, 2001

Poverty Reduction and Economic ManagementSouth Asia Region

This document has a restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosed without World Bankauthorization.

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CURRENCY EQUIVALENTS

Currency unit: Rupees (Rs) as of May 21, 2001$1 = Rs 46.96

GOVERNMENT'S FISCAL YEAR

April 1 - March 31

ABBREVIATIONS AND ACRONYMS

AAA Analytical and Advisory Activity KERL Karnataka Economic RestructuringAusAID Australian Agency for International Loan/Credit

Development KPTCL Karnataka Power TransmissionC&AG Comptroller & Auditor General Corporation LimitedCAS Country Assistance Strategy KSBPE Kamataka State Bureau of PublicCDF Comprehensive Development Enterprises

Franiework MoU Memorandum of UnderstandingCM Chief Minister MTFP Medium Term Fiscal PlanDANIDA Danish International Development NGO Non Government Organization

Assistance O&M Operations and MaintenanceERC Expenditure Review Committee PE Public EnterpriseFDI Foreign Direct Investment PEM Public Expenditure ManagementFRP Financial Restructuring Plan PHC Primnary Health CenterGDP Gross Domestic Product PHDMS Poverty and Human DevelopmentGot Government of India Monitoring SystemGoK Government of Karnataka PRI Panchayati Raj InstitutionGSAP Governance and Strategy Action Plan PSAL Progranmnatic Structural AdjustmentGSDP Gross State Domestic Product Loan/LendingHDR Human Development Report PSU Public Sector UnitHUDCO Housing and Urban Development PWD Public Works Department

Company QRs Quantitative RestrictionsIDFC Infrastructure Development Finance TA Technical Assistance

Corporation VAT Value Added TaxIMF International Monetary Fund VRS Voluntary Retirement SchemeIT Information TechnologyKERC Karnataka Electricity Regulatory Commission

The World BankVice President Ms. Mieko NishimizuCountry Director : Mr. Edwin R. LimSector Director : Mr. Roberto ZaghaTask Managers : Mr. Stephen Howes

Ms. Lili Liu

FOR OFFICIAL USE ONLY

INDIAKARNATAKA ECONOMIC RESTRUCTURING LOAN/CREDIT

TABLE OF CONTENTS

I. SETTING: ECONOMIC SITUATION AND RECENT DEVELOPMENTS IN INDIA ................... I

II. KARNATAKA AND ITS REFORM PROGRAM .................................................................. 2

A. The State of Karnataka .................................................................. 2B. Kamataka's Reform Program .................................................................. 4

III. WORLD BANK ASSISTANCE STRATEGY ...................................................... 9

A. Country Assistance Strategy .................................................................. 9B. The Bank's Assistance Program in Kamataka .................................................... 10

IV. KARNATAKA'S FISCAL AND GOVERNANCE REFORMs . .12

A. Overview .12B. Fiscal Reforms and Public Expenditure Management .13C. Administrative Reforms .22D. Private Sector Development .25E. Poverty and Human Development Monitoring .27

V. THE PROPOSED LOAN/CREDIT ........................ ........................................ 28

A. Kamataka's Financing Needs .................................. .............................. 28B. Actions Activating the First KERL ................................................................ 29C. The Second and Subsequent KERLs ................................................................ 30D. Implementation Arrangements, Performance Monitoring and Outcomes ........... 33E. Loan/Credit Administration ................................................................ 35

VI. BENEFITS AND RISKS .35

A. Benefits .35B. Risks .36

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not be otherwise disclosed withoutWorld Bank authorization.

ANNEXES

A. Karnataka Letter of Development PolicyB. Kamataka Economic Restructuring Program MatrixC. Kamataka Medium-Term Fiscal PlanD. Kamataka Govemance Strategy and Action PlanE. Karnataka Policy on State Public Sector Reforms and PrivatizationF. Kamataka Deregulation of Business EnvironmentG. Poverty in KarnatakaH. Kamataka Poverty and Human Development Monitoring SystemI. Fiscal AnnexJ. Statistical Annex

Map

Task TeamTask Managers: Lili Liu; Stephen Howes (Senior Economists)Advisors: Edgardo Favaro (Lead Economist); Sanjay Pradhan (Regional Advisor, Public

Sector Management and Governance)Fiscal/Public ExpenditureManagement: Trichur K. Balakrishnan (Financial Analyst); Vikram K. Chand (Public Sector

Management Specialist); Kanishka Ghoshal (Research Analyst); Stephen Howes;Sanjay Pradhan; Vinod B. Sahgal (Lead Evaluation Officer)

Administrative Reforms: Robert Beschel (Senior Public Sector Specialist); Vikram K. Chand; Sanjay PradhanPrivate Sector Development: Sameer Akbar (Environmental Specialist); Paramita Dasgupta (Economist); Sunita

Kikeri (Lead Private Sector Development Specialist); Lili LiuPoverty Monitoring: Monica Jain (Research Analyst); Valerie Kozel (Senior Economist)

Salman Zaidi (Econorist)Sectoral Inputs: Lucio Monari (Senior Economist), Djamal Mostefai (Lead Energy Specialist), Judith

K. Plummer (Senior Financial Analyst), Sumeer Shukla (Financial Analyst) (energy);Guang Zhe Chen (Senior Economist, roads); Sajitha Basthir (Senior EducationEconomist, education); Hnin Hnin Pyne (Public Health Specialist), Tawhid Nawhaz(Lead Human Resources Specialist) (health)

Legal Counsel: Syed I. Ahmed (Senior Counsel)FMS/Disbursement Officer: Hyacinth D. Brown (Senior Financial Management Specialist)Team Assistants: Shunalini Sarkar; Rita Soni; Juliet Teodosio

INDIA

KARNATAKA ECONOMIC RESTRUCTURING LOAN/CREDIT

Loan and Credit Summary

Borrower: Govemment of India.

Implementing Agency: Government of Karnataka.

Beneficiaries: State of Karnataka.

Amount: Credit: SDR 58.9 million (US$75 million equivalent)Loan: US$75 million

Terms: IDA: Standard with 35 years maturity and 10 years grace periodLoan: Payable in 20 years, including 5 years of grace and annuityprincipal repayment; at six-month LIBOR for USD plus variable spreadfor Variable-Rate Single Currency Loans.

Onlending Terms: Standard terms of central resource transfers for state developmentalbudgets.

Description: Karnataka is a state of 53 million people in the south of India.Karnataka's poverty and social indicators are about average for India,but there are significant disparities within the state. Karnataka's growthrecord is good, but its prospects may be dimming due to: (i) a rapidlydeclining fiscal position; (ii) a bankrupt power sector and otherinfrastructural constraints; and (iii) policies and regulations which deterprivate investment. To meet these challenges, Karnataka has embarkedon a major reform program, and has already emerged as a leader amongIndian states with respect to fiscal and governance reforms. TheKarnataka Economic Restructuring Loan/Credit (KERL) would supportthe government's reform program in four areas. First, the fiscal andpublic expenditure reforms of the KERL include a multi-yearframework for fiscal adjustment and reforms to improve fiscaltransparency, tax and expenditure policies, public expendituremanagement, financial accountability, and procurement transparency,with the objectives of restoring the state's financial health, creatingadditional fiscal space for high-priority expenditures, and promotingmore efficient and transparent management of the government'sfinancial resources. Second, the KERL's administrative reforms focuson civil service reforms, freedom of information, service agencyreforms, anti-corruption initiatives, decentralization, and e-governance,with the objectives of improving the efficiency and transparency bywhich government conducts its business and delivers services. Third,the private sector development component focuses on improving thebusiness environment through deregulation and privatization/closure ofpublic enterprises. Finally, the KERL supports the establishment of apoverty and human development monitoring system to enable the state

to better track the impact of its services, policies and reforms onpoverty and social indicators. The proposed loan/credit will bedisbursed in one tranche, and is the first in a proposed sequence ofabout four operations. The actions triggering the presentation of thisoperation to the Board have all been completed.

Benefits: The operation would support and help finance the reform program ofthe Government of Karnataka. Expected benefits for Karnataka from itscomprehensive reforms include: (a) restoration of the state's financialhealth; (b) improved governance and service delivery; (c) higher levelsof investment; and (d) higher economic growth, reduced poverty andimproved social indicators. The operation reinforces recent initiativesby the Government of India to stimulate reforms in the states, and it isexpected that Kamataka's reforms will encourage similar reforms inother Indian states.

Risks: The major risks are: (a) non-adherence to the agreed fiscal framework;(b) delays in implementation of key sectoral reforms, especially in thepower sector; and (c) resistance to institutional and governancereforms.

Disbursement: The loan/credit would be disbursed in one tranche in an amountequivalent to US$150 million upon effectiveness.

Project ID Number: IN-P055490.

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I. SETTING: ECONOMIC SITUATION AND RECENT DEVELOPMENTS IN INDIA

1. India has seen a fundamental economic transformation over the last ten years which has put theeconomy on a higher growth path, and improved prospects for poverty reduction. Economic growthinitially surged to an unprecedented 7% for several years, with a decline to around 6% since 1996.Inflation has fallen in recent years to around 5-6% on an annual average basis. The current account deficitof the balance of payments has remained in the range 1-1.5% of GDP, while India's extemal debt to GDPratio (21% at present) and debt service ratio (20% of current account receipts) have declined continuously.

2. India's fiscal position improved in the first half of the nineties, but deteriorated in the second half, withincreases in both the central and state government deficits. Some fiscal adjustment can be observed at thecentral level since 1998-99, but the Government of India (Gol) has succeeded so far in preventing a furtherrise in the fiscal deficit, but not in bringing the deficit back down to the levels of the mid-nineties. Gol hasproposed a Fiscal Responsibility Act to provide legislative backing to its fiscal reform efforts. A key fiscalchallenge lies at the state level: combined state deficits now contribute almost half of India's generalgovernment deficit, up from less than one-third in the mid-nineties. While India's system of center-statetransfers is basically sound and provides a largely transparent, predictable and rule-based framework,certain weaknesses do exist in the fiscal federal arrangements. In particular, weak linkages betweenresources and performance have resulted in inadequate incentives for fiscal reforms at the state level.Building on initiatives started in 1999, and the report of the Eleventh Finance Commission, a Fiscal ReformFacility has been established by Gol to provide grant funds (about US$2.5 billion over four years) to stateswhich improve their fiscal performance.

3. The pace of reform at the central level has undoubtedly slowed from the early nineties where theimpetus of a macroeconomic crisis led to quick action and a number of "stroke-of-the-pen" reforms. India'sstrong performance since has significantly reduced the possibility of a macroeconomic crisis, but theremaining reform agenda is much more difficult to implement, with significant institutional and legislativechanges required. However, reforms have continued. Significant initiatives in the last few years include:trade liberalization, with a progressive lifting of quantitative restrictions (QRs) completed by April 1, 2001;further liberalization of normns governing FDI flows; deregulation of important sectors from restrictivesmall-scale industry reservations; the end of the public monopoly on insurance; and strengthening ofprudential regulations and enforcement in the banking system alongside with legislation presented toParliament to reduce to a minority holding the government stake in banks. Progress has been lacking or tooslow, however, with respect to privatization of public manufacturing enterprises, reforms in laborlegislation, and deregulation of agriculture, though the February 2001 budget speech proposed importantmeasures in each of these areas. The recent report of the Prime Minister's Economic Advisory Councilprovides a road map for structural reforms to accelerate growth to 7-9% which would in turn helpaccelerate the pace of poverty reduction.

4. State reforms. There is a consensus that many of the reforms required to accelerate India's growth andpoverty reduction need to be implemented by the states. These include not only fiscal reforms to addressthe resource constraints which are increasingly circumscribing the states' developmental role, but alsopower sector reforms to address a fundamental source of fiscal pressure and constraint to growth, andgovernance reforms to make state governments smaller, more accountable and effective in the delivery ofservices. The momentum for reforms is definitely growing at the state level as an increasing number ofstates embrace fiscal, governance and sectoral reforms.

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5. IMF perspective. In its May 2000 staff report, which was discussed by the IMF's Board in June, 2000,the staff noted that, notwithstanding India's recent strong growth performance, there remain importantimpediments to maintaining high growth and achieving the authorities' objectives for poverty reduction. Inparticular, failure to address the fiscal situation and implement needed structural reform could underminethe economy's growth potential and also leave it increasingly vulnerable to adverse shocks. On the fiscalfront, the staff stressed the need for an ambitious and time-bound program of fiscal deficit reduction, andsupported the authorities' stated objective of eliminating the revenue deficits of the central and stategovemments in order to achieve fiscal sustainability. To support this objective, the staff recommendedexpenditure and tax reforns, buttressed by fiscal responsibility legislation and reforms in center-staterelations. On the structural side, a broad range of reforms was considered needed in order to enable India tobenefit from the increased globalization of trade and investment flows. These measures includedliberalization and reform in the agricultural and power sectors, regulatory reforms to increase labor marketflexibility, improvements in the legal mechanism for debt recovery, continued financial sector reforms andtrade liberalization. The IMF Board consideration of the 2001 Article IV consultation is scheduled for lateJune.

6. Growth and poverty. Despite data inconsistencies and limitations, there is a growing consensus thatpoverty did fall over the nineties, though whether the decline has been as rapid as suggested by recentofficial statistics is a matter of debate. It seems that there is a rise in regional disparities, with the faster-growing southern and western states leaving the slower-growing northem and eastem states behind. Someincrease in regional disparities may be the inevitable result of greater policy responsibility passing to thestates, and a more direct link between state government performance and state development.

7. Recent political developments. India saw three elections in three years during 1996-99. The electionof September 1999 led to a relatively more stable coalition govemment, its members being elected on thebasis of a common program. On balance, this has led to some acceleration on the reform front. However,expectations of rapid reform have given way to the realization that the pace will still be gradual because ofthe political cost of reforms, coalition politics, and the diversity of opinions within the country. A numberof recently elected state govemments have begun to speak the language of reform and initiate importantchanges, with some outpacing the reforms of the central govemment. Several state governments haveshown considerable determination in backing reforms in the face of opposition and strikes.

II. KARNATAKA AND ITS REFORM PROGRAM

A. The State of Karnataka

8. Kamataka is India's 8th largest state with a population of about 53 million. It is one of India's stateswhich has most benefited from the liberalization of the nineties. As Table 1 shows, average growth in the1980s at 4.8% was below the all-India average of 5.4%; but growth in the 1990s averaged 6.9%, above theall-India figure of 6.1%. Agricultural, industrial and services growth in the 1990s were all up on the 1980sand exceeded all-India averages for the 1990s.

Table 1. Sector-Wide Growth of Real GSDP in Karnataka and All-India, 1980-81 - 1998-99 (%)Agriculture & Allied Industry Services Real GSDP

Services1980s 1990s 1980s 1990s 1980s 1990s 1980s 1990s

GrowthKamataka 2.1 3.8 6.0 7.7 7.1 8.8 4.8 6.9All India 3.1 3.4 6.9 6.6 6.4 7.5 5.4 6.1

Share in GSDPKamataka 40 32 25 27 35 41 100 100All India 36 30 25 27 39 43 100 100

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9. Despite this progress, Karnataka's per capita income (at US$410)is still slightly below the nationalaverage. The state is heavily dependent on agriculture, more so than India as a whole (Table 1). Literacy isat average levels for India. Infant mortality is lower than the India average, but above the more relevantcomparator of South India (Table 2). There are various estimates of poverty in Karnataka: poverty levels inthe state seem to be either at or above the all-India average. (Annex G, on poverty in Kamataka, providesmore detail.) Intra-regional disparities are sharp in Karnataka with the northern regions of the state havingthe highest concentration of poverty. There are also social divides: women and the population comprisingscheduled castes and scheduled tribes appear to be disadvantaged in accessing opportunities in the non-farm sector and on average suffer lower welfare outcomes.

Table 2. Selected Indicators of Economic and Social DevelopmentUnit Karnataka Southern All India

States*Rural Poverty Headcount Index ('93) % 41.0 34.4 36.7Urban Poverty Headcount Index ('93) % 29.7 28.7 30.5Infant Mortality Rate('97) per '000 53 45 71Overall Literacy ('97) \a % 63 70 62Female Literacy ('97) \a % 50 61 50Per capita income ('97) (1980-81 prices) Rs. 3073 3016 3251lafor population of age 7years and above * Average ofKarnataka, Tamil Nadu, Andhra Pradesh, KeralaSources: Infant Mortality Rate - Sample Registration System Bulletin, Oct '98; Overall Literacy and Female Literacy- National Sample Survey Press Brief 1997; Poverty Headcount Ratio - India: Achievements and Challenges inReducing Poverty, World Bank 1997.

10. Karnataka faces several developmental challenges:

* The first is to sustain growth. Karnataka's high growth rates hide a number of serious problems.The fastest growth sector over the last five years has been information technology, withBangalore known as one of the top ten high-tech cities in the world, and accounting for over 35%of India's software exports. However, many other industries are stagnating with an increasingnumber of sick firms. Karnataka's future growth will be within a more competitive environment,due to the phasing out of QRs on imports in April 2001 and the expected phasing out of the MultiFiber Agreement (MFA) by 2005, and the expected further reduction in import tariffs whichremain high. Improving the climate for investment in Kamataka - through, inter alia, improvinginfrastructure, deregulating, and reducing bureaucratic harassment - will be critical to improvinggrowth prospects.

* Accelerating growth and employment in rural areas is key to poverty reduction. Increasing thearea under irrigation is vital, but at most 1/3 of Kamataka's arable land can be brought underirrigation, so improving dryland productivity is just as important. The rural non-farm sector inKamataka is relatively underdeveloped, contributing only 20% of rural income, compared to anIndia average of 30% and 46% in neighboring Tamil Nadu. A massive expansion in ruralinfrastructure and connectivity will be needed to broad-base economic growth.

* Human capital and social infrastructure are still sadly lacking. A large percentage of the ruralpopulation in Kamataka has virtually no education. Some 74% of poor rural household heads areilliterate. Another 13% are educated only up to some level below primary. The rural poor arealso almost entirely unserved by modern sanitation infrastructure and reside in homes withearthen floors. Expanding social infrastructure and improving service delivery throughout thestate is the third challenge facing the Government of Karnataka (GoK).

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B. Karnataka's Reform Program

11. A Congress Party government was elected to power in Karnataka in November 1999 with acomfortable majority (132 out of 224 seats). The new Government's reform agenda for the "eradication ofpoverty through economic growth tempered with equity" is set out by the Chief Minister in his March 2000and 2001 budget speeches (Box 1).

Box 1. Karnataka's 10-Point Reform Program: Chief Minister's Budget Speech, March 2000

1 . The topmost priority, to eradicate poverty, empower women, and provide food and nutritional securityfor vulnerable sections.

2. To achieve a minimum 7-8% growth per annum for the next five years.3. To strengthen the foundations of agriculture and give it a new momentum.4. To expand irrigation and utilize irrigation potential created more effectively.5. To expand the state's infrastructure, through more resources but, equally important, through better

management, and innovative organizational mechanisms.6. To mount an assault on social backwardness.7. To provide a conducive climate for new investments.8. To provide the people of Kamataka with a transparent, responsible, responsive and decentralized

government.9. To mainstream the backward regions, particularly in the north, into the development process.10. To develop a fiscal system that serves the needs of the poor, a pattem of public expenditures that

addresses pressing socio-economic concerns, and that keeps the state away from a debt trap.

Fiscal and Governance Reforms

12. Karnataka has always been one of India's better managed states. Its fiscal indicators are among the bestof any Indian state, and its bureaucracy among the more capable. Law and order is not a serious issue.Nevertheless, Karnataka faces serious problems. Its fiscal position is rapidly deteriorating, and its powersector is hurtling towards bankruptcy. The Government of Karnataka is by no means immune from thegovernance problems which afflict both state and central governments in India. "Non-transparency, limitedaccountability, ... and inadequate performance appraisal weaken the civil service's administration, as do thestandard problems of political interference in specific situations and government's widespread and intricateinterventions that delay actions, create unwarranted power and provide opportunities for corruption."'

13. Karnataka has therefore embarked on a major program of fiscal and governance reform, and hasquickly established itself as one of the states leading reforms in these areas (Box 2). On the fiscal front,after two years of successive rises, the budgetary fiscal deficit is estimated to have fallen in 2000-01 as apercentage of GSDP on the back of strong revenue growth and expenditure restraint. The Government isnow building on this correction, to tackle off-budget sources of fiscal weakness, and to achieve itsannounced medium-term fiscal goals through a Medium Term Fiscal Plan (MTFP). Creation of anAdministrative Reforms Commission has given rise to a new Governance Strategy and Action Plan, whichsets out the govemment's goals for improved service delivery through civil service reform, greatertransparency, less official discretion, and a campaign against corruption. The Government has also startedto rid itself of the burden of state-owned commercial enterprises, and has launched a business deregulationdrive to improve the investment climate. The proposed loan/credit is designed to help broaden and deepenthe government's fiscal/governance reform program (Section IV provides more details). The followingparagraphs briefly outline Karnataka's sectoral reforms.

1 "India: Policies to Reduce Poverty and Accelerate Sustainable Development," World Bank, January 2000, also referred toas the Social and Structural Policy Review (SSPR), 2000.

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Box 2. Karnataka: One of the leaders in fiscal and governance reform among India's states

oI First state to enact a Transparency in Public Procurement Act - 2000.Q Has enacted India's most progressive Right to Information Act - 2000.E First state to introduce a legislative cap on government guarantees - 1999.o Leader in fiscal transparency (first state to publish monthly financial accounts, to release to the public

information on tax expenditures and tax arrears, and to introduce an "Action Taken Report" onprevious year's budget commitments; one of the first to publish an accessible fiscal overview) -2000/2001.

Li The most advanced state in terms of institutionalizing a medium-term budgetary perspective (e.g., thefirst to establish an Expenditure Review Committee) - 2000/2001.

o First state to commllit to introduction of Fiscal Responsibility Bill - 2001.o One of the leading states in respect of preparation for VAT introduction - ongoing.o One of the first states to publicly monitor and take measures to reduce premature transfers of civil

servants - 2001.

Power Sector Reforms

14. Power sector reforms are critical to Karnataka's growth and to the success of fiscal reform. Seriouspower shortages, unreliability, and losses and theft (officially estimated at 37%, but possibly much higher)have made the power sector the leading infrastructure constraint for the state. High-tension industrialconsumers have already started to leave the utility's grid. 80% of industries have back-up power,substantially reducing their competitiveness, particularly that of small and medium firms, and seriouslyreducing the opportunities for off-farm employment and broad-based growth. Half of the rural populationstill does not use electricity at home.

15. In addition, Karnataka's power sector deficit is increasing rapidly and poses the most serious threat tofiscal sustainability in the state. From about 1% of GSDP for the first half of the nineties, the power sectordeficit has more than doubled (reaching about 2.1% of GSDP in 2000-0 1). Losses in the power sector aremainly due to high theft and losses and a heavy subsidy to agriculture, estimated at Rs 18 billion, only partof which is met by cross-subsidies from industry. The causes for the recent financial deterioration in thepower sector include: increased reliance on thermal generation, and purchases from new and relativelyexpensive private power producers; higher fuel (coal) costs; and the departure of high-paying industrialconsumers from the grid. Tariffs were not increased from 1998 to January 2001.

16. Reforming the power sector has thus become an important part of GoK's comprehensive reformefforts. The ultimate objective of the power sector reforms is for the Government to withdraw from thepower sector as an operator and regulator of utilities. Consumers would be provided with reliable, high-quality and cost-effective electricity supply by creditworthy and commnercially operated, largely privately-owned utilities functioning in a competitive and appropriately regulated power market. The power sectorwould cease to be a drain on public finances, and a constraint on growth.

17. First Phase of Reforms Completed. Several key reforms have already been implemented:

* The Karnataka Electricity Reforrn Act, which embodies the above vision, was enacted in 1999,and the Cabinet has recently approved various amendments to this Act to strengthen it.

* The Cabinet approved in December 2000 a power sector reform policy based on the privatizationof distribution.

* An independent Karnataka Electricity Regulatory Commission (KERC) has been established andin December 2000 awarded Kamataka's first tariff increase since 1998.

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* The Cabinet has approved a new policy to rationalize its generation expansion consistent withfinancial viability. A decision not to provide any escrow cover for new independent powerproducers (IPPs) has been announced.

* Various policies to crack down on power theft have been introduced (a collection drive, use ofprofit centers), and collections have improved in recent months.

* GoK has commissioned environmental and social assessments of power sector reform, and hasdeveloped a reforms communications strategy.

* The Cabinet has approved a Financial Restructuring Plan (FRP) for the power sector, to map outa path towards reduction, and eventual elimination, of the power sector deficit, and the Board ofKamataka's main power sector utility, KPTCL, approved a budget for the utility for 2001-02consistent with this plan.

18. The FRP for the power sector has important implications for GoK's objective of restoring fiscal healthin the state. The FRP sets out a gradually declining path for the power sector deficit - from 2.1% of GSDPin 2000-01 to 0.8% of GSDP in 2004-05. This would significantly contribute to reducing the fiscal deficitover the medium term - from 7.2% of GSDP in 2000-01 to 3% of GSDP in 2004-05, as set out by theMTFP (see paras. 54-55 and Table 3). The declining power sector deficit as articulated by the FRP ispredicated on several important reform measures. Eliminating the power sector deficit is a challenge thatcan only be met in the medium term. In the near term, the FRP focuses on improving the sector'soperational performance based on expanding metering, improving billing and collection, tariff adjustments,and preparing for privatization.

19. Specifically, the measures underlying the FRP include: (i) a reduction in losses and theft from 37%currently to 28% over 5 years; (ii) an improvement in collection efficiency so that receivables fall from 95days currently to 85 days over 5 years; (iii) universal metering within three years; and (iii) annual tarifforders from the KERC so that the average tariff approaches cost recovery. The FRP also limits powersupply to agriculture below available levels, assumes limited new generation capacity, and contains capitalinvestment in transmission and distribution to about Rs 52 billion over five years all in line with thesector's financing capability. The FRP for the power sector is a rolling document which is realized throughthe annual budget of KPTCL. The Govemment plans to monitor the power sector deficit on a monthly basisso that it can take prompt action to keep the deficit within the prescribed limits.

20. Next Phase of Reforms. The 2001 budget confirms the Government's commitment to the next phaseof power sector reform, mainly via commitments to:

* The govemrnment meeting in full its financial obligation to the power sector, as set out in theMTFP.

* Universal metering within the next three years - this is a crucial step to capping the massivepower subsidy to agriculture (most farmers are currently not metered) and reducing theft ofpower.

* Introduction of new legislation in 2001 to curb the theft of power, including severe punishmentand the establishment of special courts to deal with such crimes.

* The privatization of distribution in 2002.

21. Near Term Outcome. By the end of calendar year 2001, significant progress in these areas isexpected:

* Progress towards privatization as measured by the adoption of a privatization strategy and theunbundling of KPTCL into separate transmission and distribution companies.

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* Submission of a tariff application by KPTCL and the implementation of KERC's second tarifforder.

* Loss and theft reduction as measured by (i) substantial progress in implementation of the 3-yearuniversal metering program, with a target of 150,000 meters installed, and (ii) an anti-theftlegislation enacted and anti-theft program intensified, with the aim of reducing loss and theftfrom the current 37% to 34% by the end of the fiscal year.

Other Sectoral Reforms, and Interlinkages

22. Reforms in the road sector. Inadequate road infrastructure and its deterioration have adverselyaffected the spread of growth beyond Greater Bangalore. The Government plans to expand spending onroads and bridges with increased reliance on the private sector for construction, maintenance and financing.Important institutional reforms are planned for the sector. An institutional strengthening action plan for thesector has recently been approved by GoK. The plan aims to transform the Public Works Department(PWD) from a traditional public-sector roads department to a performance-oriented and user-responsivemodem road agency. Major changes outlined by the Plan include:

* Separation of the roads and buildings function of PWD into two separate departments (Highwaysand Buildings).

* Expanded private sector participation in the road sector through outsourcing and oversight ofroad sector management by a Road Users Board.

* Improvements to financial management, audit and accountability, and a computerization programto support the modernization of road management.

23. Water Supply and Sanitation. A major thrust is being given to improving water supply andsanitation, now recognized as a maj or health determinant. Currently, only 72% and 24% of householdshave access to safe drinking water and toilets, respectively, with high costs in terms of both public healthand the environment. Both urban and rural water supply and sanitation sectors in Karnataka suffer fromchronic inefficiencies, unreliable service quality, limited coverage, and low cost-recovery.

e In the rural sector, the Government is turning to greater community participation and cost-sharingas the solution. Its new Rural Water Supply and Sanitation Policy (2000-2005) targets anincrease in rural areas in drinking water availability from 40 litres of water per capita per day to55 litres for all households by 2005, as well as improved quality (fluoridation is a majorproblem), and Total Village Sanitation through provision of better paving, drainage, solid wastemanagement practices and smokeless cooking fuels, as well as the construction of household,group and community latrines, and information campaigns. The strategy relies on a participatory,demand-driven approach with a target of 100% paymnent of O&M and 15% of capital costs byusers, organized into village Water Supply and Sanitation Committees.

* In urban areas, the Government is implementing private sector solutions. GoK is in the process ofpreparing a policy paper on Urban Water and Sanitation, which will serve as a basis for urbanwater reforms, including the introduction of private sector management, recently approved inprinciple by the Cabinet.

24. Education sector. GoK's target is to ensure that by 2007 all children in the age group 6-14 years are inschool and complete 8 years of elementary schooling. To achieve this goal, Government has taken up anumber of actions, including: hiring of additional teachers (15,000 in 2001-02); a large school andtoilet/drinking water construction program; and a new program to bring drop-outs back to school. In 2003,Karnataka will increase the elementary cycle from 7 to 8 years. Teacher quality is expected to improve

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with the introduction of a transparent exam-based recruitment system. Looking beyond elementaryeducation, GoK has established an Education Task Force, and is the first among Indian states to undertake asector study of education covering all levels of education. The report will provide recommendations forpolicy and institutional reforms to improve the effectiveness of public educational services as well as themanagement of government support to private educational institutions.

25. Health. GoK has set health and nutritional goals including reductions in infant and matemal mortality/sand malnutrition, and better control of communicable diseases, such as TB and HIV/AIDS. To achievethese goals, the recommendations of the Task Force on Health have already begun to be implemented,including the filling up of vacant posts of doctors and para-medics, and increased supply of essentialequipment to and enhanced budgets for Primary Health Centers (PHCs). As in education, transparency hasbeen introduced into the recruitment of medical personnel. Service delivery is being improved by greaterreliance on performance monitoring and user feedback. The Govemment has already begun to invite NGOsand the private sector to manage PHCs. To improve the supply of doctors to rural areas, compulsory ruralservice for post-graduate medical students is being introduced.

26. Agricultural productivity. An Agricultural Commission has been established, led by extemal experts,to recommend measures to boost agricultural productivity. GoK has also established a Global AdvisoryNetworking Group on Agriculture to draw on expertise from outside of India. 750 Farmer Contact Centershave been set up across the state to disseminate scientific and technical advice to farmers. New seeds arebeing developed and tried. A multi-disciplinary Watershed Development Department has been establishedto improve agricultural productivity in drylands. Programs for attracting private sector investment into coldstorage, agribusiness, barren lands, and biotechnology, with adequate safeguards, have been introduced,including a plan for the development of 5 agro-processing parks. A reform program has been initiated inthe irrigation sector, with a new ordinance to establish water-user groups, and increased funding beingmade available for O&M (matched by a more than doubling of water charges on the revenue side).

27. Public-private partnerships. Underlying all of these initiatives is a strong emphasis on consultationsand public-private partnerships. To promote private sector participation in infrastructure, the InfrastructureDevelopment Corporation of Karnataka has been established as a joint venture. Some 10 task forces havebeen established covering topics from health and education to infrastructure, IT and biotechnology toprovide the government with outside thinking. The Bangalore Agenda Task Force has been particularlyeffective in providing private-sector solutions for the Bangalore municipal government. The Govemment'spartnership with the Confederation of Indian Industries has resulted in, among other things, the GlobalInvestors Meet, which attracted firms and publicity around the world, and resulted in US$6 billion ofinvestment proposals. The Govemment has been consulting the business community in the formulation of amedium-term strategy for business deregulation. The Government has also sought partnerships with anumber of financial institutions, chief among them the World Bank, but also, from within India, IDFC andHudco for infrastructure financing.

28. Interlinkages. While the Government's reform program is most easily described under the variousfiscal, govemance and sectoral heads, the linkages between the various elements of the reform programcannot be over-emphasized. The inter-relationships between fiscal and power sector reforms werearticulated by the Kamataka Chief Minister in his 2001 budget speech: "We cannot attack poverty and wesimply cannot invest more in social and physical infrastructure if we do not improve the state 'sfiscalposition. And without a fundamental change in the way the power sector is organized, managed andfinanced today, fiscal improvement will be impossible. " Links between govemance reforms andimprovements in service delivery are equally important. Core governance reforms to promote transparencyin procurement and recruitment will result in practical benefits of better teachers and cheaper schools.Likewise, governance reforms piloted in individual sectors can be scaled up to benefit all sectors. This canbe seen through the transparency in recruitment initiative which began in the education department.

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29. Link to poverty reduction. Poverty reduction is GoK's central objective (para. 11). Overall, theGovernment's program appears to be well-designed to achieve this goal, based on the following policy-poverty links:

* The focus on improving agricultural productivity is well-justified given that 69% of Karnataka'spoor live in rural areas, and that 80% of rural income in the state is derived from agriculture.

* The Government's regional emphasis on investments in northern Karnataka derives strong supportfrom the large inter-district disparities in the state's poverty profile.

* The focus on expanding social and physical infrastructure is consistent with the poor's greatlyreduced access to such infrastructure (Annex G).

* The Government's fiscal and governance reforms hold various potential benefits for the poor,including a more pro-poor expenditure pattern, a better business environment for small business,greater opportunities for off-farm employment, and a lower burden of corruption on the poor (seepara. 123).

30. Implementation of the Government's reform agenda has been impressive, but difficult at times.Unpopular and controversial steps have been taken, in particular the hiking of various user charges. InJanuary 2001, GoK, while accepting the electricity regulator's tariff rulings for other customer categories,decided to provide another subsidy to agricultural customers rather than increase the agricultural tariff, thus"buying down" the tariff increase from 17% to 12%. Attempts to increase higher education fees and toreduce government support for private higher education institutions have also been partially rolled backafter protests. While the financial impact of these decisions is individually relatively small, the decisionsthemselves are significant, though not unusual for a reforming Indian state.

III. WORLD BANK ASSISTANCE STRATEGY

A. Country Assistance Strategy

31. The Country Assistance Strategy (discussed by the Board on April 5, 2001) aligns Bank Groupassistance with India's poverty reduction strategy, as defined by its Ninth Five Year Plan, the main themesof which are strengthening the enabling environment and supporting pro-poor interventions. This proposedLoan/Credit is aligned to the CAS theme of strengthening the enabling environment by improvinggovernment effectiveness and promoting private-sector led growth. The CAS highlights three strategicprinciples to guide the Bank Group's assistance program, namely, selectivity, reliance on partnerships, andadoption of a programmatic approach. Based on the selectivity principle, the strategy focuses on reformingstates, something which started with the previous CAS, and which has been endorsed by the recent CountryAssistance Evaluation for India.

32. Lessons learnt from state reforms. The Bank has been supporting comprehensive reforms at the statelevel for about three years, beginning with Andhra Pradesh, then Uttar Pradesh, and most recentlyKarnataka. The Bank's state-focus strategy is viewed as successful within India and by the donorcommunity. There has been growing competition by states for Bank support, which in turn has helpedcreate incentives for reforms. By focusing on reforming states, the Bank can use its resources moreeffectively by forging deeper, more focused, and longer-term partnerships for reforms and development.The use of programmatic adjustment lending in Uttar Pradesh for the first time (in April 2000) proved veryuseful for supporting reforms in that state. At the same time, state-level reforms have in general been moredifficult to sustain than expected. From three years of Bank support to state reforms the following lessonshave emerged:

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* A long-term perspective is needed both because the structural and institutional reforms facingthe states are long-term in nature and because the adjustments needed are so large that economicand political economy considerations imply that they be introduced in a phased manner.

* Correction of the distortions and fiscal excesses of several decades touches on many vestedinterests, and is often met with strong resistance, including strikes and riots. Governmentownership of the reform program is essential. Flexibility on the part of the Bank is alsoimportant, including the ability to intensify support when reforms build momentum, or todisengage when reforms go off track.

* Many of the reforms carry large short-term costs, and gains only in the longer run (e.g., utilitytariff increases before improvements in service delivery). Much needed increases in developmentspending, on deferred maintenance and health and education, and improvements in governance,all of which can have immediate effects on delivery of services, help bring forward the benefitsof reform and increase their acceptability.

33. While support for individual reforming states is central to the India CAS, it is only one part of thatstrategy. At the state level, in collaboration with the Planning Commission and other Indian institutions, theBank is trying to spread the lessons of reform across all states and to broaden and deepen the momentumfor reform. The Bank continues to engage with Gol on a range of national issues via a large AAA program.It also supports Gol initiatives to link central resources and performance (para. 2), which will strengthenincentives for reforms. Areas where joint action is needed by central and state governments are the reformof indirect taxes and modernization of financial management. The Bank can be effective in such areas byworking at both the state and national levels, by bringing in lessons from other countries, especially otherfederations, and by encouraging learning across states, and between the center and states.

34. The India CAS also reflects an increased emphasis on fiscal and governance reforms, the formerfollowing from India's fiscal deterioration in the second half of the nineties (para. 2), and the latter from anemerging consensus in India that without better performance, governments will have neither the credibilityto persuade their citizens to pay taxes, nor the capability to convert public resources into growth. As theSecretary of India's Planning Commission has recently remarked: "[S]tates will be neither able to end thefiscal crisis nor to restore growth unless they are able to address problems of governance."

35. The final aspect of the CAS relevant to this operation is an increased reliance on programmaticadjustment lending. Programmatic budgetary support combines the flexibility necessary in the Indianpolitical environment with a medium-term approach required to implement India's deep and difficultstructural reform agenda. It allows for a tighter focus on policies, a better link between Bank support andthe budget, and provides important financial backing to state-level reform programs. Under the CAS basecase scenario, US$500-900 million per annum is envisaged for use in adjustment lending to supportreforming states.

B. The Bank's Assistance Program in Karnataka

36. Karnataka approached the Bank through the Government of India for support in late 1999. Since then asubstantial program of assistance has been developed. In line with the CAS, it has a number ofdistinguishing characteristics: (i) it is aligned to the government's reform program; (ii) it is focused onpoverty reduction, with a particular geographical focus on the poorer, arid regions of the state; and (iii) it isprogrammatic in nature, with a sequence of interventions designed to further government reforms andgoals.

37. As mentioned (para. 32), working at the state level allows the Bank to take a CDF-approach, cuttingacross sectors and individual operations, in a way that is both comprehensive and integrated. The size andsequencing of the program depends on the extent and pace of overall reforms in the state. In particular, the

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experience of other states shows that power and fiscalgovemance reforms are critical to the Govemment'spoverty reduction efforts (para. 29). Progress with respect to these twin pillars of reform will determine thesize and scope of Bank assistance to Karnataka. Given the close link between the power sector deficit andthe success or otherwise of fiscal adjustment (paras. 15, 18), progress in power sector reforms (paras. 16-21) will determine the state's capacity to efficiently absorb Bank financial support, and thus will be a keydeterminant of the size and scope of Bank assistance to Kamataka.

38. Instruments. The program of support being provided by the Bank to Kamataka consists of analyticalwork, technical assistance, adjustment lending, and investment lending:

* Analytical work has informned the Bank's assistance and dialogue, and helped build consensusfor reform. In 1998, the Bank conducted a comprehensive economic report/public expenditurereview of Kamataka, Karnataka: Economic Reforms for Sustained Growth. More recently, theBank has completed a number of policy notes, including: a fiscal assessment; a poverty note; anote on growth prospects and the business environment; a prelimninary financial accountabilityassessment; and a draft rural policy review. A procurement assessment will commence shortly,and a State Financial Accountability Assessment will be undertaken this year. Two backgroundstudies on the financing of education, and on labour market and training needs are underway. Areport on rural decentralization in Kamataka has been completed.

* Technical assistance is being provided through the India Technical Assistance for EconomicReform Credit to support VAT introduction and power sector reforms. In the future, technicalassistance is expected to support civil service reform as well, and the govemment's povertymonitoring. Technical assistance from AusAID will be used to strengthen public expendituremanagement.

- Programmatic adjustment lending (PSAL) is proposed to support Kamataka's core fiscal andgovemance reforms (i.e., Kamataka Economic Restructuring Loans/Credits - KERLs). TheKERLs are envisioned to be a series of one-tranche loans/credits based on up-front fiscal andgovemance reforms. They would help provide financial backing to the state's reform program,and protect high-priority development expenditure. Because the pace of reforms determines thestate's capacity to use resources efficiently, each KERL will follow the adoption of reforms andbe based on the need for financing. This approach takes full advantage of the flexibility whichthe PSAL framework offers, with an expectation of annual or biannual loans/credits dependingon the pace of reforms and financing needs.

* Investment lending is also proposed to support Kamataka's reforms, including sectoral reformsin the power, infrastructure and social sectors and priority pro-poor rural interventions. Thereforms supported by these investment projects complement and deepen in each sector the fiscaland govemance reforms to be supported by the adjustment lending. Three loans/credits are at arelatively advanced stage: Kamataka State Highways Improvement Project, negotiated in April2001, the Kamataka Watershed Development Project and the Second Karnataka Rural WaterSupply and Sanitation Project.

39. Sectoral priorities. The Bank's support in Kamataka is spread over a number of priority sectors:

* In the power sector, the Bank is supporting reforms through the provision of technical assistanceand dialogue. Discussions are currently underway conceming a possible investment loan to helpthe rural sector adjust to commercial electricity pricing, by enhancing rural power supply andpossibly other infrastructure facilities, and accelerating metering (paras. 20-21).

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* In the urban sector, the Bank is supporting the government's policy shift towards private sectorparticipation in urban water: an urban water project under preparation will support private sectormanagement of urban water delivery in poorer northern towns (para. 23).

* A state highways project is underway to improve highway capacity and maintenance andsupport important institutional reforms in the roads sector (para. 22).

* A number of Bank-supported health projects are already underway in Karnataka, including forinfectious diseases, such as HIV/AIDS, for reproductive health, and for strengthening of thestate's health system. A follow-up health system project is under consideration to assist thegovernment implement its new health reform agenda (para. 25).

* In education, the Bank is helping Karnataka universalize education through the District PrimaryEducation Program, targeted at districts where female literacy is low (para. 24).

* Three community-based rural projects are under preparation to improve rural livelihoodsespecially in the poorer and arid north - rural water supply and sanitation, irrigation tankrehabilitation, and watershed development. The Bank also has a dialogue on rural policy andhave completed a draft rural policy review. Karnataka participates in the Bank-supported RuralWomen's Development and Empowerment Project.

- Environment. Kamataka participates in the Bank's Industrial Pollution Prevention Projectwhich is supporting institutional strengthening of the Karnataka Pollution Control Board.

40. Partnerships. The Bank is providing its assistance in partnership with other institutions. In the powersector, GoK has signed reform-based MoUs with both Government of India and the InfrastructureDevelopment Finance Corporation. In the watershed project, the Bank is collaborating with other bilateralswho have supported similar projects, including the Swiss Development Corporation and Danida. AusAID(Australia) is arranging technical assistance for public expenditure management reforms and is supportingwater sector reforms in Bangalore. The Institute for Social and Economic Change (ISEC) is carrying out alarge amount of analytical work to support the Government's reforms.

IV. KARNATAKA'S FISCAL AND GOVERNANCE REFORMS

A. Overview

41. Main issues. As mentioned (para. 12), Karnataka is one of India's better managed states, with astronger fiscal position and more robust and effective institutions than many states. However, a fiscalcrunch together with weaknesses in governance have undermined government effectiveness. In Karnataka,as in many other Indian states, critical problems that have undermined the quality of public administrationand service delivery include the politicization of the transfer process, the lack of openness in government,corruption in the tendering process, a weak performance evaluation system for government schemes andoperations, over-regulation of private businesses, and the failure to adequately prioritize and programexpenditures over time because of the absence of a medium-term fiscal framework.

42. Yet Kamataka also holds the promise of real improvement in public sector management. It is alreadyone of the leaders among Indian states with respect to fiscal and governance reforms (Box 2). Thechallenge is to deepen and broaden those reforms already underway, and thus ensure their success andsustainability.

43. Reform objectives. Karnataka's fiscal and governance reform strategy is two-pronged. As articulatedin the Governance Strategy and Action Plan, the strategy aims to: "(i) Rationalize the role of the state tofocus on the most critical public goods and services which the private market cannot effectively supply, and(ii) Enhance the effectiveness, transparency and accountability by which the state performs this role."

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44. Strategy formulation. The Govemment has invested heavily in analytical work to inform and shape itsreform program. In addition to work undertaken by the Bank (para. 38), the Government has receivedextensive reports from the Tax Reforms Commission and the Administrative Reforms Commission both ofwhich the Chief Minister established a year ago. The Govemment has also commissioned variousbackground papers and convened workshops in areas such as: subsidy targeting and management; povertymonitoring; governance reforms; improving the accuracy of budgetary estimates and forecasts; publicexpenditure management and business deregulation. On the basis of this work, the Government hasprepared a number of policy papers. The two most important ones for this operation are:

* The Medium Term Fiscal Plan (MTFP), the first version of which was approved by the Cabinetin September 2000, and a revised 2001 version of which was approved by the Cabinet in March2001 and will be laid in the Legislature as soon as it reconvenes (expected June 2001). TheMTFP sets out the government's medium-term fiscal policy (Annex C).

* The Governance Strategy and Action Plan (GSAP) has also been approved by the Cabinet andwill also be laid in the Legislature when it reconvenes. The GSAP sets out the Government'spolicies for improving governance and administration (Annex D).

45. Reform components. As per the Government's Letter of Development Policy, the variouscomponents of Karnataka's fiscal and governance reform program can be conveniently summarized underfour headings:

* The Government'sflscal and public expenditure reforms include a multi-year framework forfiscal adjustment as well as reforns to improve fiscal transparency, tax and expenditure policies,public expenditure management, financial accountability, and procurement transparency. Thecommon objective of these reforms is to restore the state's financial health, create additionalfiscal space for high priority expenditures, and promote more efficient and transparentmanagement of the government's financial resources.

* The Government's administrative reforns focus on civil service reforms, freedom ofinformation, service agency reforms, anti-corruption strategy, decentralization, and e-govemance, with the objectives of improving the efficiency and transparency by whichgovernment conducts its business and delivers services.

* The private sector development reforms focus on improving the business environment throughderegulation and privatization/closure of public enterprises.

* Finally, the Government is establishing a poverty and human development monitoring system toenable the state to better track the impact of its services, policies and reforms on poverty andsocial indicators.

The sub-sections which follow provide more detail, as does the Government's policy matrix (Annex B).

B. Fiscal Reforms and Public Expenditure Management

Fiscal Analysis

46. Understanding Karnataka's fiscal position requires looking well beyond conventional budgetarydeficits. Karnataka is one of several Indian states which, in order to gain access to additional sources offinance, make extensive use of off-budget borrowing for which debt servicing reverts fully to the budget. In1999-00, the budgetary fiscal deficit was 4.5% of GSDP. Consolidating on- and off-budget borrowingbrings the 1999-00 fiscal deficit to 5.6% of GSDP. In addition, Kamataka, again like many states, has a

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significant and rapidly growing liability in the power sector which is only partially funded by the budget(the remainder being financed by arrears and/or utility borrowings). In 1999-00, Karnataka's power sectordeficit was 1.5% of GSDP, and the consolidated fiscal and power deficit 6.2% of GSDP (Table 3).

47. Kamataka's fiscal position has traditionally been stronger than that of many states. Its fiscal indicatorshave been well above average. Karnataka has not, unlike many states, run out of cash and been forced toresort to overdrafts with RBI or liquidity support from Gol. However, the state's fiscal situation hasdeteriorated sharply in recent years. It is now reaching close to crisis proportions, with rapidly mountingdebt, and accumulating unpaid liabilities. For example, comparing 1990-91 with revised estimates for2000-01, the interest/revenue ratio has almost doubled from 12% to 20%, a revenue balance has become adeficit of 2.6%, and the debt stock (including off budget borrowing) has increased from 20.0% to 26.8% ofGSDP. This deterioration has come in the second half of the nineties: the state's public debt stock actuallyfell in the first half of the nineties.

48. The sources of fiscal decline in the second half of the nineties include a large and growing powerdeficit (see para. 15), other expenditure pressures, and a declining revenue-GSDP ratio:

* Apart from the power sector, there have been a number of other expenditure pressures on thestate. The overly generous national pay settlement of the late nineties undid the beneficial impactof Kamataka's hiring restraint through the nineties. It brought the salary bill back to the level ofthe early nineties as a percentage of GSDP, and also pushed up the pension bill. The combinedsalary and pension bill was 7.0% of GSDP in 2000-01 up from 6.5% in the mid-nineties. Interestpayments grew through the nineties by a percentage point of GSDP (up to 2.7% of GSDP in2000-01) due to the growing debt burden and higher interest rates. Finally, the increasing relianceby Kamataka on off-budget borrowing has prevented the compression of capital spending seen inmany other states (para. 53). While arguably good for the state's development, this has alsopushed the deficit up, as well as average interest rates, as the off-budget borrowing has beenrelatively expensive.

* On the revenue side, Karnataka is one of India's two or three highest-taxed states. However, thetax/GSDP ratio fell from 9.0% during the first half of the nineties to as low as 8.2% in 1999-00,on account of low buoyancy of Kamataka's two most important taxes, the sales tax and excise.The low sales tax buoyancy reflects in part the industrial recession of the late nineties, but alsointer-state competition, which drove down rates, and the proliferation of tax incentives. Non-taxrevenue has fallen by about half a percentage point over the nineties. The fall in non-tax revenueis partly due to less lending to public enterprises, and so lower interest receipts, and partly due tofalling cost recovery.

49. Fiscal outcomes for 2000-01. Revised estimates for 2000-01 indicate a reversal in the trend ofincreasing deficits over the late nineties, with a fall in the budgetary fiscal deficit from 4.5% of GSDP in1999-00 to 4.0% in 2000/01 (Table 3), corresponding to the deficit staying approximately flat in nominalterms at Rs 42 billion.2 However, Kamataka did not tackle off-budget sources of fiscal weakness in 2000-01. Net off-budget borrowing rose sharply in 2000-01 (from 1.1% to 1.8% of GSDP), as did the powersector deficit (from 1.5% to 2.1% of GSDP). As a result the consolidated fiscal deficit including powerrose in 2000-01 to 7.2% of GSDP from 6.2% in 1999-00. Bringing these off-budget items under control is

2 It is important to note that the 2000-01 figures are revised estimates. Revised estimates are often unreliable,though scrutiny in this case gives some comfort. Actuals will be available by December 2001, and will be usedto confirm progress. The financial management and reporting reforms are intended, among other things, toimprove the reliability of budget and revised estimates.

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critical to the state's fiscal health, and central to the govemment's fiscal reform strategy (see paras. 53 and54).

50. Fiscal reform and public expenditure management strategy. The strategy of the government aims toregain fiscal sustainability, improve the composition of expenditures, and strengthen the fiscal and financialarchitecture of the state. As a first step, a White Paper was issued in March 2000 to build a consensus forfiscal reforms. The Government's fiscal reform and public expenditure management strategy includes thefollowing elements outlined below: (i) development of a medium-term fiscal framework; (ii) promotion offiscal transparency; (iii) revenue reforms; (iv) expenditure restructuring; (v) improvements in publicexpenditure management; (vi) strengthening of financial accountability; and (vii) reforms in procurement.

Medium Term Fiscal Plan (MTFP)

51. The Medium Term Fiscal Plan (MTFP) is a rolling 4-year fiscal forecast. The first MTFP wasapproved by the Cabinet in September 2000 and was used to prepare the 2001-02 budget. This has nowbeen updated, approved by the Cabinet in March 2001, and will be presented to the Legislature when itreconvenes, expected in June 2001. Subsequent MTFPs will be presented with successive budgets, alongwith reports on performance against previous MTFP targets. GoK intends to provide the MTFP withlegislative backing - the March 2001 budget speech announces the intention of the state government totable a Fiscal Responsibility Bill. This is a first for an Indian state government (GoI has tabled such a Bill,but it has not yet been enacted), and could set a precedent which would significantly enhance fiscaldiscipline not only in Karnataka, but in all of India's states.

52. Medium-term objectives. GoK's fiscal objectives, as articulated in its MTFP, are to reduce the fiscaldeficit to 3%, the revenue deficit to zero, and to stabilize debt as a percentage of GSDP by 2004-05. Interms of composition of expenditures, the MTFP aims to reduce the share of wages, pension, and non-meritsubsidies and protect and promote high-priority development expenditures, particularly social sector andinfrastructure spending (para. 68). The MTFP assumes real growth of 7.5%, the average for the second halfof the nineties, and inflation of 6%.

53. Off-budget borrowing. The MTFP consolidates off-budget borrowing (defined in para. 46) withbudget borrowing, and sets targets for the consolidated figures. This is important given the sharp rise in off-budget capital outlays (para. 48), which now exceed on-budget capital outlays. The major use of such off-budget borrowing is for major irrigation investments on the Upper Krishna River, completion of which in atime-bound manner is forced on the state by an inter-state water award. But the Government has sinceextended the use of off-budget borrowings to include other irrigation investments on the Krishna River, andother investments such as for roads and housing. These borrowings are actual rather than contingentliabilities, as it is expected from the start that debt servicing will fall on to the budget. Off-budgetborrowing is non-transparent, and distorts and damages the integrity of the budget process. GoK hasdecided to reduce reliance on off-budget borrowing over time, and to eliminate it completely by the end of2004-05. The MTFP sets specific annual, declining nominal caps on off-budget borrowing. In addition, torestrict and discipline access to off-budget borrowing in the course of the year, the Government's March2001 Budget Overview for the first time sets out "budget estimates" for off-budget borrowing during 2001-02 - not only an aggregate cap, but itemized by borrowing agency.

54. MTFP and the power sector. The MTFP includes allocations for the power sector sufficient to fullymeet subsidy obligations and to reduce past arrears. As mentioned earlier (paras. 17-18), a FinancialRestructuring Plan (FRP) for the power sector has been approved by the Government. The MTFP and FRPare fully consistent in that the amounts allocated for the power sector in the MTFP are those assumed asgovernment inflows in the FRP. Just as the MTFP sets a declining path for the fiscal deficit to follow, sothe FRP defines a declining path for the power sector deficit.

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55. Adjustment path. The fiscal adjustment path set out in the MTFP is summarized in Table 3, whichshows the various relevant definitions of the fiscal deficit. The consolidated fiscal deficit (including thepower sector deficit), the broadest measure of fiscal health, falls annually starting in 2001-02. The fiscal(budgetary) deficit also falls annually, except in 2001-02 on account of a deliberate change in strategytowards funding the power sector deficit on budget, rather than funding it off-budget as in earlier years.Bringing the power sector deficit on to the budget and financing it in full, as against allowing the build upof arrears and maintaining budgetary support at its current inadequate level, represents a major claim on thebudget, one which is essential to enable the government to push through privatization and thus tum thesector around (paras. 14-21, 66). To abstract from this distorting impact, it is also useful to track the non-power fiscal deficit, which is the fiscal deficit less budgetary support to the power sector. This is estimatedto have fallen from 3.7% in 1999-00 to 3.2% of GSDP in 2000-0 1, and is projected to fall further to 2.4%in 2001-02.3

Table 3. Aggregate Fiscal Indicators for Karnataka, 1999-00 to 2004-05(% GSDP)

1999-00 2000-01 2001-02 2002-03 2003-04 2004-05RE BE Proj. Proj. Proj.

Fiscal Deficits

Fiscal deficit including off-budget borrowing and 6.2 7.2 6.4 5.2 3.9 3.0power sector (KPTCL) deficitFiscal deficit including off-budget borrowing 5.6 5.8 5.9 5.1 3.8 2.8Fiscal (budgetary) deficit 4.5 4.0 4.3 4.2 3.7 3.0Non-power fiscal deficit 3.7 3.2 2.4 2.5 2.4 2.2

Debt StockDebt stock (including off-budget borrowings) 23.2 26.8 28.9 30.3 30.4 29.5On-budgetdebtstock 19.9 21.9 23.1 24.4 25.1 25.0

Memo ItemsNet off-budget borrowing 1.1 1.8 1.5 0.9 0.1 -0.2Power sector (KPTCL) deficit 1.5 2.1 2.0 1.4 1.1 0.8

Notes: Figures calculated/taken from GoK MTFP / power sector FRP. The non-power fiscal deficit excludes gross budgetarysupport to the power sector. The fiscal deficit including off-budget borrowing adds net off-budget borrowing to the fiscal deficit.The fiscal deficit including off-budget borrowing and the power sector deficit adds to this the off-budget (unfunded) portion of thepower sector deficit, i.e., the power sector deficit net of budgetary support to KPTCL. The power sector deficit is the cash deficit ofKPTCL, Karnataka s main power utility. For more detailed definitions see Annex L

Fiscal Transparency

56. Karnataka is a leader among Indian states in terms of fiscal transparency. Steps taken to date include:publication of a White Paper on state finances; a Budget Overview, which, for the first time, makesavailable to the public summary fiscal indicators as well as data on public debt, guarantees, subsidies, off-budget borrowing and tax expenditures (i.e., the cost of tax incentives) and tax arrears; posting of monthlyfinancial accounts on the Internet; and publication of an "Action Taken Report," which reports on actionsagainst commitments made in the previous year's budget speech. Publication of the MTFP and annualreporting against it will also improve fiscal transparency.

3 In 2002-03, only a small fall in the fiscal deficit is projected. This is for two reasons: (i) an assumed temporarydrop in revenue associated with the introduction of VAT (para. 110); and (ii) an increased debt-servicing burdenfor off-budget borrowing which is counted above the line in the budget. The more relevant consolidated deficitsshow substantial decline in 2002-03: from 5.9% to 5.1% excluding the power sector deficit, and from 6.4% to5.2% including the power sector deficit.

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Revenue Reforms

57. Although Kamataka has one of the highest tax/GSDP ratios in India, this ratio has fallen since the earlynineties (para. 48). The goals of tax reform in the state are twofold: additional revenue mobilization, andreduced compliance costs. The strategies, covering both policy reforms and tax administration, are:rationalization, base broadening, simplification, and computerization. GoK has established a Tax ReformsCommission, chaired by a former Chief Minister, with an internationally renowned membership. Based onwide consultations with, and a survey of, tax-payers, the Commission has issued its first report which callsfor a revamping of the tax system.

58. Sales tax reforms. The sales tax is Karnataka's most important tax, accounting for 57% of the state'sown tax revenue. In line with the all-India agreement, sales tax incentives for new investments inKarnataka were abolished and floor rates for all commodities introduced in January 2000. These tworeforms attack the two main sources of low buoyancy in the sales tax. Kamataka is also one of the firststates to computerize its sales tax department. The above reforms, however, mark only a start. India hasprobably the most complex indirect tax system in the world. Rationalizing and simplifying it will requireeffort at both the central government and state level. At the state level, there is widespread agreement thatstates should convert their sales taxes into Value Added Taxes (VATs). VAT introduction, and associatedadministrative reforms, will have several benefits for Karnataka's tax payers:

* The Government proposes to base VAT on self-assessment, so that most businesses will be ableto file returns without direct interaction with government officials. The Government hasannounced an ambitious self-assessment scheme to start this year, with provision for randomaudit.

* The Government will also move to a functional VAT administration, which will reduceopportunities for official discretion.

* The VAT eliminates distortions caused by input taxation.

* The VAT will replace not just the sales tax, but also the smaller turnover and entry taxes, therebyreducing the burden of compliance and the likelihood of harassment. Simple forms of the VATwill be used for small businesses.

59. A target date of April 2002 has been agreed on by the states for VAT introduction. No Indian state hasyet successfully introduced a VAT.4 While the target date is ambitious, Karnataka is expected to be one ofthe first to introduce VAT. Although much more work remains to be done, including in coordination withother states and Gol on interstate and national issues, preparations in Karnataka are at a relatively advancedstage. The first phase of VAT introduction, now complete, included a number of administrative actions,namely the setting up of VAT working groups and a full-time VAT team, the selection of consultants toassist with VAT introduction, and the issuance of a VAT discussion paper. In addition, Karnataka has alsomade important policy progress towards VAT, in particular via the introduction of self-assessment. Thisnow applies to 90% of tax payers, putting Karnataka ahead of other states, significantly reducing dealer-official interaction, and freeing up staff time for audit and enforcement. Self-assessment has beenintroduced on a retrospective basis, with the aim of eliminating the three-year scrutiny backlog within amatter of months.

60. Other taxes. Karnataka's second most important tax is the excise on alcohol. This has been growingrapidly over the last three years after an earlier period of policy uncertainty (concerning possible movestowards prohibition) came to an end. The third and fourth most important taxes are the two weakest

4 Maharashtra introduced a VAT in 1997, but withdrew it in 1999.

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performing taxes in recent years, namely stamps and registration, and the motor vehicle tax. The TaxReforms Commission has come out with detailed plans for reform of these two taxes, and the Governmenthas decided to implement these starting in 2001-02. Reforms in stamps and registration concern the closingof various loopholes; those with motor vehicle taxation, rationalization and a shift to ad valorem rates.Implementation of these reforms is expected to yield substantial revenue, to improve transparency, andreduce compliance costs. Payment of the motor vehicle tax, and associated vehicle registration, is one ofthe pilot services GoK is re-engineering and releasing citizens' charters for (para. 87).

61. Tax administration. The above reforms include a number of important administrative reforms toimprove compliance, and reduce compliance costs. The Government has launched an initiative to upgradetax collecting departments via computerization, modernization of facilities, and additional manpower forenforcement and intelligence. Physical checkposts of the different tax departments will be integrated andcomputerized to combat evasion, and to cut down on the repetitive stoppage of goods vehicles.

62. Non-tax revenues and user charges. The main avenue open for increasing non-tax revenues is byincreasing user charges for services such as higher education, tertiary health, irrigation, water supply, andbuses, which are very low in Kamataka and have declined over the years. The MTFP envisions rateincreases for these services and cost recovery according to a pre-determined schedule over the mediumterm. Initial steps have already been taken (e.g., increases in user charges for canal irrigation; automaticlinking of bus tariffs to the cost of service provision). Higher education fees have also been increased,though the increase was reduced after protests.

63. Revenue performance in 2000-01. After four years of low tax growth (between 8-12%), analysis ofthe first eleven months of 2000-01 suggests tax growth for the year of about 18%. Consistent with this, therevised estimates show an increase in the tax/GSDP ratio in 2000-01 of 0.6 percentage points to 8.8%, thefirst increase in the tax/GSDP ratio in about four years. While partly attributable to the economic recovery,this rapid tax growth is also attributable to improved compliance in sales tax, and a more stableenvironment in excise, as well as rate increases in excise duty.

64. Medium-term revenue path. The MTFP assumes that the reversal of the decline in the tax/GSDPratio seen in 2000-01 can be sustained. Own-tax revenue increases in the MTFP as a percentage of GSDPfrom 8.8% of GSDP in 2000-01 to 9.4% in 2004-05 (Table 4). This is caused by rapid growth in sales taxfrom improved compliance, though it is also assumed that in the first two years of VAT introduction thereis a temporary dip in revenue owing to possible teething problems and to the end of tax exporting whichwill be associated with VAT introduction. Improved performance for motor vehicle tax and stamps isprojected. In 2001-02, an increase in total own-tax revenue of 0.4 percentage points of GSDP is targeted.This is based on the reforms in stamps and motor vehicle tax mentioned above (para. 60), as well asimproved compliance and selective increases in sales tax rates. The MTFP also assumes an increase inresources from the central government, in line with the Gol 2001-02 budget, and the recommendations ofthe Eleventh Finance Commission.

Table 4. Karnataka: Revenue Receipts in the Medium Term Fiscal Plan, 1999-00 to 2004-05(/o GSDP)


Revenue Receipts 13.1 14.0 14.7 14.6 14.7 15.0OwnRevenue 9.3 9.8 10.3 10.0 10.1 10.4

Tax 8.2 8.8 9.2 9.0 9.0 9.4Non- Tax 1.2 0.9 1.1 1.1 1.0 1.0

Central Resources 3.7 4.2 4.4 4.6 4.6 4.6Shared Taxes 2.2 2.5 2.6 2.7 2.8 2.8Grants 1.5 1.7 1.8 1.9 1.9 1.7

/a Figuresfrom GoK MTFP (Annex C) except that the infrastructure cess has been included under non-tax revenues.

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Expenditure Reforms

65. Controllng the wage bill. GoK does not appear to be over-staffed in the aggregate owing to a long-standing policy of hiring restraint (see Table 7). 20,000 vacant posts were abolished in 1999-00 and GoK isnow abolishing another 55,000 vacant posts - about 9% of the current size of the civil service. However, allvacant posts in priority departments (education, health, police and forestry) are being filled - the state plansin 2001-02, for example, to hire 15,000 new elementary teachers. As people retire through attrition,vacancies for front-line staff in priority departments will continue to be filled, but only two-thirds of suchvacancies in other departments will be filled. Restrictions on hiring are enforced by requiring that clearancefrom the Finance Department be obtained for all recruitment. The overall impact of these policies is a verygradual reduction in civil service size of about 0.5% per year. If Government is successful in itsadministrative rationalization (in terms of both functions and processes - see paras. 85-86), the rate ofdecline in the civil service size will be higher.

66. Power subsidy. Reduction of Karnataka's power sector deficit is crucial for the state's fiscalsustainability. The Financial Restructuring Plan for the power sector (para. 18) shows a turnaround in thesector starting in 2001-02 and a decline in the power sector deficit over time. Achieving this reduction inturn depends on the reforms described in the Cabinet-approved power sector reform policy (paras. 16-21).Even with these reforms, the decline in the power sector subsidy will be at best gradual - indeed the firstchallenge is to reverse the trend of rapid increases in the deficit. Even with an aggressive reform program,as assumed in the FRP, it is estimated that the Government will need to provide some Rs 90 billion offinancial support for the power sector over a five year period. If power distribution is to be privatized inKarnataka, it will have to be privatized with a government subsidy, which means that government must beable to credibly commit to payment of the power sector subsidy. The MTFP budgets for full payment of thepower sector subsidy and payment of arrears starting in 2001-02. A monthly payment schedule will beadhered to, and matched by monthly monitoring of KPTCL ' s adherence to its budget. Part of the remit ofthe power sector privatization consultants is to establish a subsidy mechanism for use after the distributioncompanies are privatized.

67. Other subsidies. Other explicit subsidies are smaller than that for the power sector by an order ofmagnitude. GoK has already taken measures to contain the food subsidy, its second largest, within anominal cap of Rs 3 billion, via tightening household eligibility requirements. Government support forsmall industries which had led the accumulation of some Rs 3.4 billion in liabilities has been virtuallywithdrawn. The Government has announced a policy of reducing subsidies to private higher educationalinstitutions, but has run into opposition on this, and has only been able to take mild action to reduce thissubsidy. Housing subsidies for disadvantaged households are being expanded. GoK has commissioned astudy to quantify all implicit and explicit subsidies and suggest reform measures, and the March 2001budget speech announces the govemment's commitment to implementation of its recommendations.

68. Priority development expenditures. The MTFP protects and promotes certain priority developmentalexpenditures - elementary and secondary education, health, roads and rural water supply, and non-wageO&M for irrigation and public buildings. However, the full increase will have to be spread out over severalyears in accordance with government's deficit targets. The priority in the early years is to protect prioritysectors from being cut. Spending in these priority areas is expected to rise gradually from 4.75% of GSDPin 2000-01 to 5.62% of GSDP in 2004-05 (Table 5).

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Table 5. High Priority Development Expenditures in the Medium Term Fiscal Plan2000-01 to 2004-05 (% GSDP)


High Priority Development Expenditure 4.80 4.75 4.74 4.99 5.14 5.62Elementary & Secondary Education 2.60 2.62 2.48 2.66 2.69 2.82Health 1.01 1.01 1.07 1.10 1.11 1.20Roads * 0.38 0.45 0.46 0.48 0.52 0.60Water Supply * 0.64 0.48 0.56 0.57 0.62 0.77Irrigation ** 0.07 0.07 0.07 0.08 0.09 0.10Public Buildings ** 0.09 0.12 0.10 0.11 0.11 0.12

* non-wage O&M and capital spending only** non-wage O&M only

69. Medium-term expenditure path. As a result of the above measures, expenditure (including thatfinanced by off-budget borrowing) is forecast to fall from 18.6% of GSDP in 1999-00 to 17.7% in 2004-05(Table 6). The greater part of the fall is due to salaries and pensions which decline by 1.6 percentage points.The budgetary support to the power sector is brought back under control and falls to less than 1% of GSDP,despite the shift in policy to fully fund the power sector deficit on budget. Non-wage O&M increases by0.5 percentage points. Capital outlays return to their earlier level of less than 3% of GSDP, as the largeirrigation projects now underway come to an end, and are only partially replaced by expenditures in otherinfrastructure sectors.

Table 6. Karnataka: Expenditure in the Medium Term Fiscal Plan, 1999-00 to 2004-05(% GSDP)1999-00 2000-01 2001-02 2002-03 2003-04 2004-05

RE BE Proj. Proj. Proj.

Total Expenditure 18.6 19.9 20.6 19.8 18.5 17.7Revenue Expenditure 15.9 16.5 17.5 17.1 16.2 15.1

Interest Payments 2.5 2.7 3.0 3.1 3.2 3.2Salaries & Pensions 7.3 7.0 6.8 6.5 6.0 5.7Subsidies & Transfers 1.9 2.0 3.2 2.9 2.5 1.9

Gross Budget Support to the Power Sector 0.8 0.9 2.0 1.7 1.3 0.8Non-Wage O&M 1.9 2.2 1.9 2.2 2.3 2.4Other Revenue Expenditure 2.3 2.7 2.6 2.4 2.2 2.1

Capital Expenditure & Net Lending 2.6 3.3 3.1 2.6 2.3 2.6

Note: Figures are after consolidating off-budget borrowing, and are all taken from GoK MTFP (see Annex C). Subsidies andtransfers include transfers to urban local bodies; non-wage O&M aggregates major and other non-wage O&M in the MTFP. Formore detailed definitions see Annex I.

Public Expenditure Management (PEM) Reforms

70. Strengthening the budgetary process. A main aim of Kamataka's public expenditure managementreforms is to institutionalize the Medium Term Fiscal Plan (para. 51), and with it bring a medium-termperspective and fiscal discipline to the budgetary process. This has already started through use of the MTFPto prepare the 2001-02 budget both to set aggregate resource envelopes and fiscal targets and to setdepartmental spending limits. GoK has also established an Expenditure Review Committee (ERC),comprising Finance, Planning and a few key spending departments, to identify the medium-term costs ofnew and existing policies and make recommendations on departmental hard budget constraints.

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71. Three departments have been selected as PEM pilots (PWD, Elementary and Secondary Education, andHealth) and have prepared policy notes on their medium-term objectives and policies consistent withMTFP resources. This process will be deepened in the coming year, and expanded to other departments.

72. One weakness is proliferation and insufficient screening of schemes. New schemes are now screenedby the ERC before inclusion in the budget. In the coming year, line departments will be given greaterflexibility to prioritize spending within their budgetary ceilings with scope to retain a significant portion ofany identified savings. To deepen performance orientation, impact and performance evaluation of ongoingprograms and schemes will be more widely used.

73. The accuracy of budget estimates is poor in Karnataka - actual deficits often exceed budget estimatesby a large amount. Tax forecasts are typically over-optimistic resulting in cash rationing during the year,and either under-spending or an accumulation of arrears. This both limits departmental flexibility andmakes any forward planning of limited value. Revised estimates, prepared at the end of the year, are oftenalso inaccurate, reflecting a lack of up-to-date financial information. The financial management reformsdetailed in the paragraphs following will help improve the situation, and GoK has also contracted a study todevelop forecasting tools to reduce the discrepancies between budget and revised estimates and actuals -this will be one of the important performance indicators for the proposed operation.

74. Reforms in liability management. In the past, Karnataka has, like most if not all Indian states,borrowed as much as it could rather than as much as it could afford, at the cost of delaying needed policyreforms. It now plans to reverse this strategy, and in particular to reduce reliance on high-cost formns ofborrowing. GoK is also cutting its costs on bond issues, by auctioning its own bonds separately from thegeneral RBI issue of state bonds, and obtaining lower interest rates. There is a legislative cap onguarantees, and guarantee fees have already been introduced. Guarantee management will be improvedover time, with the introduction of better reporting and allocational rules.

Public Financial Accountability and Management

75. A preliminary public financial accountability assessment has been carried out for Karnataka, includingreview of the state's latest external audit reports. This indicated that GoK has reasonable foundations for asatisfactory public financial accountability system. Major strengths of the system include: (i) the well-established role of the legislature as the principal watchdog over public finances; (ii) existence of detailedguidelines for budgeting and monitoring of the use of public funds, and legislative approval of annualbudgets; (iii) regular preparation and compilation of accounting information, and presentation of annualstate accounts which provide comprehensive information on expenditures and revenues - public debts,guarantees, loans and advances, investments, etc. are also presented with varying quality; (iv) goodprocedural controls over expenditures; and (v) the well established independence of the public auditor(C&AG) from the executive and its broad mandate. However, there is also need to significantly strengthenand modernize the system to improve transparency, enable better financial and operating performancemeasurement and reporting, more effective legislative oversight and follow-up on audit observations, andaddress identified weaknesses in internal control and public accountability. Actions to address these havebeen initiated. In 2001-02, the Bank and GoK plan to jointly carry out a State Financial AccountabilityAssessment (SFAA, covering Government departments, rural and urban local bodies, public enterprises,and other government entities), whose findings and recommendations will be used to develop GoK'smedium-term public financial accountability modernization strategy and program, and define medium-termbenchmarks.

76. Accounting and audit. Karnataka's published accounts are compiled not by the Government ofKarnataka but by the Accountant General of the C&AG. Karnataka plans to develop its own accountingcapability to improve the timeliness and ownership of financial management and public reporting. To dothis, it has identified two pilot departments to prepare parallel accounts and related financial statements.

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Work has also begun in a number of critical areas to strengthen the accounting function, such as clearingthe backlog of accounts and responses to external audits of government agencies, and plugging key internalcontrol weaknesses (e.g., reconciliations). Audit is the responsibility of the C&AG, which also publishesthe audit reports on its web site. The 1999-00 audit was received from C&AG in March 2001, and will bemade public as soon as the Legislature reconvenes (expected June 2001). In future years, GoK willcontinue to table in the Assembly and make available the annual audit reports as soon as possible afterreceipt from C&AG (usually within 12 months of the fiscal year end, as has been the case for the last fouryears). GoK plans to improve its responsiveness to audit observations, and in particular to cut down on timelags in this regard.

77. Financial reporting has traditionally been slow, at the cost of both financial management and fiscaltransparency. However, GoK has now become the first state to publish annual and monthly financialstatements on the Internet. The monthly statements are produced within two months of the end of eachmonth, while GoK aims to make available its annual Finance Accounts and Appropriation Accounts within9 months of the end of the fiscal year, rather than 12 as previously: while the compilation of accounts are,as mentioned, a C&AG responsibility, achieving this goal will require the active collaboration of GoKTreasuries and Departments.

78. Computerizing key accounting functions is key to improving the timeliness of financial reportingand to reducing opportunities for fraud, waste and abuse of public resources. Computerization of treasuries,through which most government payments are made, is the top priority. This is now under implementationand the pilot phase is expected to be completed by March 2002.

79. Karnataka is completing the first phase of its public financial accountability and managementimprovement program with the following actions: establishment of a 'Controller's Office' and task force tolead the program; posting of monthly financial accounts on the Internet; and initiation of treasurycomputerization.

Procurement reforms

80. GoK has passed an important Transparency in Public Procurement Act, requiring all governmentdepartments to follow more transparent procurement practices. For instance, details of all tenderapplications received and accepted are now required to be published in a Tender Bulletin maintained bydepartments at both the state and district levels. The Rules, notified in October 2000, also lay down clearprocedures for Tender Inviting and Tender Accepting Authorities, and provides for an appeals process andpenalties for officials who contravene the provisions of the Law. GoK is now starting to place its TenderBulletins on the Internet, and to undertake sample audits of selected procurement processes and contracts.Further procurement reforms will be identified based on the state-level procurement assessment the Bank isinitiating in Karnataka as part of its Country Procurement Assessment Review.

C. Administrative Reforms

81. The medium-term objectives of GoK's administrative reforms are: (i) a smaller but more effectivepublic administration; (ii) a higher level of transparency and accountability, accompanied by feweropportunities for corruption; and (iii) more efficient and responsive delivery of essential public services.GoK is approaching this exercise in a phased manner in order to build consensus for the overall reformprocess. To this end, the near-term actions focus on curbing politicization in the transfer process,enhancing transparency through the adoption of a pioneering Right to Information Act, and introducingpilot service delivery reforms through the use of e-governance, citizen charters, and improved feedbackmechanisms.

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82. The Administrative Reform Commission's first report (para. 44) provides detailed analysis andrecommendations for the government to improve govemment efficiency and transparency. Building on thisreport, the Govemment's own strategy, the Governance Strategy and Action Plan, is designed to provide aroad-map for reforms in the coming year and beyond.

Civil Service Reforms

83. The Kamataka civil service is not overstaffed in aggregate terms relative to other Indian states (Table7). Kamataka's civil service appears to have avoided many of the problems that have beset other states.Staffing norms allocate fewer support staff to secretaries and section officers. Department of Financeclearance is required for all recruitment. This relatively good starting point notwithstanding, Karnataka'scivil service is nevertheless performing well below potential.

Table 7. Civil Service Size in Different Indian States

Core Total Gov. Total Gov. & PE

State Population Civil Service Ratio Employees* Ratio Employment Ratio

Andhra Pradesh 73,000,000 553,972 0.76 1,052,055 1.44 1,369,721 1.88

Karnataka 53,000,000 296,315 0.56 639,331 1.21 801,593 1.51

Orissa 35,000,000 510,000 1.46 581,400 1.66 658,178 1.88

Rajasthan 51,000,000 607,240 1.19 631,240 1.24 672,440 1.32

Uttar Pradesh 162,000,000 880,000 0.54 1,242,000 0.77 1,390,500 0.86

*Total Government employees combines the core civil service with local government employees and employees at government-aided institutions.

84. Civil service transfers. The most important immediate priority is to drastically reduce the politicizedand premature transfers of civil servants that disrupt the functioning of public administration, underminethe ability of civil servants to commit themselves to the job, and lead to significant opportunities forcorruption. The Chief Minister publicly announced in his March 2001 budget speech that there will be nogeneral transfers in 2001-02, and this has since been put into effect through the new transfer policy for2001-02, approved by the Cabinet in April 2001. A new system is in place to monitor and publicly reporton the number of transfers and average tenure by key positions by department and district. In addition, theGovemment has decided to opt for a system of civil service boards to control transfers, and to introduce arequirement that reasons for premature transfers be publicized in Transfer Orders. The Govemment alsoplans to enhance the transparency of recruitment via mainstreaming recent departmental initiatives toreduce the importance of interviews, and thus the element of discretion, in the recruitment process.

85. Over the medium term, reforms will focus on the rightsizing and rationalization of publicadministration, and the institutionalization of more effective performance monitoring and accountabilitymeasures. GoK also intends to begin the process of reducing overlapping and duplicating organizationalstructures, and streamlining business processes. A start has already been made in this regard with theannouncement of a merger between the Departments of Finance and Institutional Finance, and with theannouncement of the abolition of all Divisional level posts by July 2001 (divisions are an intermediatelayer between districts and the state). The Administrative Reforms Commission has commissionedfunctional reviews of 15 major departments to be conducted by outside agencies. These will be ready bythe end 2001 to provide guidelines for reducing staff size and rationalizing the functioning of keydepartments.

86. Speeding up internal transactions. The government plans to improve the efficiency of its operationsby reducing the number of layers through which a file passes for approval by introducing new proceduressuch as the single-file system, which allows for field Heads of Departments to send a file directly for action

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by the relevant Secretary, as well as the desk officer system in the Secretariat, which eliminates sectionofficers from the chain of file movement which will now stop at the higher Under-Secretary level. Thesereforms will be introduced on a pilot basis this year. Changes in human resources policies to bring outgreater flexibility for redeployment, and creation of a human resource database are also part of theGovernment's medium-term civil service reform strategy.

Service Delivery

87. Citizen charters initiatives. Improving the delivery of services to the public both delivers largewelfare gains and builds support for the reform program. GoK has initiated the public dissemination ofcitizen charters for a number of agencies, and has ambitious plans to extend citizen charters to much ofgovernment. To ensure that citizen charters are credibly implemented, GoK is focusing first on pilots inBangalore involving three services with a large public interface (such as vehicle registration andlicensing). These services have engaged in a process of seeking user feedback through surveys and/orconsultations, carrying out business process re-engineering and/or computerization to meet stipulatedservice standards, and specifying improved standards and a grievance redressal mechanism through thepublication of citizen charters. Report cards or beneficiary surveys from users of public services - such asthose pioneered by the Bangalore Public Affairs Center (an NGO) - will be subsequently undertaken by theparticipating departments to see if customer satisfaction with the pilot services has increased. Over themedium tern, GoK plans to roll out its initial pilot agency reforms to other parts of the state, and introducethese reforms in other services that have wide impact, such as primary health care and the publicdistribution system.

88. Parallel to this, efforts are underway to mainstream cross-cutting fiscal and governance issues into thedesign of sectoral projects to improve the delivery of essential public services. Examples include:institutional reforms in the Public Works Department (para. 22); enhanced service delivery through theapplication of better performance monitoring standards and feedback from user groups in the health sector(para. 25); and efforts to promote grass-roots participation and strengthen accountability mechanisms inparticipatory rural projects, such as for watershed development, rural water supply, and irrigation (para.23).

Freedom of Information

89. Improving the access of public to governmental information is increasingly recognized in India as acritical reform for reducing corruption and improving service delivery. The freedom of informationmovement began in Rajasthan as a result of NGO agitation. Rajasthan was the first state to pass freedom ofinformation legislation and now several other states are following suit. The Government of Kamataka hasrecently enacted and notified India's most far-reaching Right to Information Act. The Act is striking in thevery limited number of exemptions, and represents a major step towards a more transparent form ofgovernment in Kamataka. The key next step now required is the formulation of rules under this Act so thatit can be made effective. GoK is also starting to catalogue and index its records, and plans to conduct publicsurveys to identify the specific forms of information that the public would most like to see.

E-governance

90. GoK has launched a number of initiatives in the area of electronic governance for public transparencyand for better functioning of departments. These include the computerization of agricultural titles andtenancy information, treasury computerization, and computerization of the sales tax department. A numberof GoK departments now have web pages. The scope for e-governance is much greater, however, and GoKwill prepare a status report and action plan on e-governance initiatives.

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Anti-corruption strategy

91. The enforcement dimension of Karnataka's anti-corruption effort is spearheaded by the Lok AyuktaOffice which is one of the best resourced institutions of its kind in India in terms of staff size and budgetaryallocations. The Government plans to computerize the Lok Ayukta Office for greater effectiveness, and toreview the Lok Ayukta Act to see how it can be strengthened. GoK also plans to establish an Ombudsmanto deal with complaints against local government.

92. The focus on enforcement is being complemented by a significant emphasis on corruption preventionand systemic reform. A number of measures being taken by GoK will address key underlying sources ofcorruption, including reductions in patronage-based transfers, strengthened financial management andaccountability, more transparent public procurement, deregulation, and right to information. To monitorthe implementation of these anti-corruption measures as well as to identify and implement other measureson an ongoing basis, GoK plans to set up an inter-departmental Corruption Prevention Committee (CPC).The CPC will consult with civil society, the private sector, the media and other branches of government andthe Lok Ayukta. It will oversee surveys of households, enterprises and public officials on corruption, andwill publicly report on the progress of the government's anti-corruption program.

Decentralization

93. India has separate local governments for rural and urban areas. Rules for transfer of resources to bothsets of governments are set every five years by the State Finance Commission, Karnataka's second ofwhich will report by end-2001.

94. Urban local governments are stronger than rural, but are nevertheless often ineffective and starved ofrevenue. Their most important source of revenue is the property tax, and the most important reform forurban local governments is strengthening of the property tax. Bangalore introduced self-assessment lastyear for property taxes. As a result, property tax revenues have risen by some 30%. GoK now plans tointroduce legislation to make self-assessment possible in all of the state's urban areas. It has alsoannounced a new funding scheme for Bangalore and other major cities, which will provide incentives totheir municipalities to improve financial and operational efficiency.

95. GoK has a long tradition of rural decentralization stretching back to the 1870s. In 1987, GoKimplemented an ambitious rural decentralization program. A large number of staff- including all teachers- and the largest share of public expenditures of any state have been transferred to rural local governments,known as Panchayati Raj Institutions (PRls). The Government has announced significant initiatives toenhance the autonomy of PRIs, with the recent annual budget announcing a 75% increase in the allocationof untied funds, and important reforms to enhance the tax base of PRIs (doubling of land revenue rates, andremoval of property tax ceilings). The Government is also taking measures to enhance the effectiveness ofPRIs, including through computerization and capacity building. Nonetheless significant issues remain to beclarified about the functioning of the panchayat system - including concerns that the state-levelbureaucracy and political establishment exercise a disproportionate role in panchayat governance, that thePRIs still have a very limited amount of untied funds, and that the quality of local governance is very low.A state study of rural decentralization in Karnataka has been undertaken by the Bank, and a workshop onthis subject is planned to better define issues and build consensus.

D. Private Sector Development

96. The importance of state governments in determining and improving the investment climate is beingincreasingly recognized. Research carried out by the Bank and the Confederation of Indian Industrysuggests that the cost differential between operating in "good" and "bad" investment climate states is asmuch as 30%. The same research suggests that Karnataka already has one of the better investment climates

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among India's states. However, India significantly lags other emerging economies with respect to itsinvestment climate, and there is much Kamataka can do to improve the climate for private sectordevelopment in the state through business deregulation and public enterprise reform.

Business deregulation

97. Business deregulation seeks to reduce excessive regulations that create impediments to private sectorinvestment and growth and generate significant opportunities for corruption. Surveyed investors inKarnataka ranked the number one constraint to investment and growth as excessive bureaucraticinterference in business operations.5 The Government's strategy in this regard is contained in its policypaper "Deregulation of Business Environment," (Annex F) which has been approved by the Cabinet. Box 3summarizes how the Government plans to simplify the business environment in Kamataka. Implementationof the policy paper will follow in the coming months. Progress will be tracked via use of regular businesssurveys, the first of which will be undertaken in 2001.

Box 3. Simplifying the Business Environment in KarnatakaIssue Current Situation Proposed Reform Measures a/

Starting a Investor needs to obtain many, often repetitive, One application form for starting abusiness permits/licenses/registration from various departments and business to be submitted to single Nodal

agencies using multiple application forms. Agency/contact point with rules set outin one handbook.

Prolonged process of approval. Streamlined and time-bound clearanceprocess.

Running a Multiple rolls, registers, and returns required under various Consolidate and combine (in some casesbusiness acts and rules. abolish) rolls, registers and returns.

Frequent, excessive, discretionary inspections from various One annual inspection combiningdepartments which interface with business, giving rise to departments based on comnputer-corruption. generated random sampling. All other

inspections will be restricted to specificcomplaints.

a/From the GoK "Deregulation of Business Environment" Policy Paper. The measures deal only with thoseprovisions of laws which are under the purview of the state.

Public Enterprise Reform

98. Based on March 1999 data, Kamataka has 78 public enterprises (PSUs or Public Sector Units), with atotal of 162,000 employees. Five are utilities (power and public transport) and are being dealt with throughseparate reform programs. Of the remainder, 32 are manufacturing (ten of which are non-operational), 23are service and marketing, 16 are development enterprises, and two are financial institutions. In 1998/99,25 PSUs had negative net worth. Excluding the public utilities, the sector made an aggregate net loss of Rs.1.1 billion. Reducing the PSU burden will not only help the state's fiscal position (loss-making PSUs donot repay government loans, and many survive through salary payments from the budget) but will also helpthe govemment to focus on the challenge of improving the business environment: the Department ofCommerce and Industry, whose main job this should be, has to supervise some 30 enterprises, very few ofwhich have a legitimate claim of government attention.

99. The GoK Cabinet has recently approved a Policy Paper on Public Sector Reforms and Privatization(Annex E), the basic principle of which is that the state will withdraw from all commercial activitiesthrough sale or closure. Non-commercial PSUs will be restructured through mergers and reorganization,

5 Investors' Survey, Public Affairs Center, Bangalore 1999.

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including the involvement of strategic partners where feasible. Phase 1 of the program targets the sale orclosure of 10 enterprises by March 2002. Phase 1 consists predominantly of manufacturing PSUs, with amix of small (mostly closed), medium and large PSUs, including four with employment of over 1,300 andthree with a tumover of more than Rs. 1 billion. With the completion of Phase I, it is expected that some ofKarnataka's major loss-making public-sector manufacturing units will have been closed or sold. GoKplans to close or privatize the remaining commercial PSUs in yearly batches of about 10 PSUs by 2005while rationalizing and restructuring the rest. It is expected that only those PSUs providing mainlypromotional and social services will remain beyond 2005.

100. A Public Sector Restructuring Commission has been established to give recommendations onindividual firms. A High Powered Committee has been set up to monitor and coordinate the overallprogram. Detailed privatization procedures and proper safeguards on social safety net and environmenthave been established and are contained in the policy paper. An environmental screening process is beingfollowed for each of the PSUs targeted for closure and/or sale. Those enterprises which are shown to haveenvironmental risks are then subjected to a more detailed audit. The social impact of closures anddownsizing will be mitigated by a safety net, including retraining opportunities.

101. The Govemment also manages a large number of co-operatives, originally intended to operate as self-managed, independent businesses. GoK has drafted, and plans to introduce shortly, a new cooperative lawwhich will allow cooperatives to operate with greater autonomy. Subsequent work will focus on helpingco-operatives to take advantage of this new framework.

E. Poverty and Human Development Monitoring

102. Despite its impressive growth record, poverty in Kamataka may be higher than prevailing All-Indialevel (see the poverty note attached as Annex G). GoK's reform program has as its over-riding objective"the eradication of poverty through economic growth tempered with equity" (para. 11) and the linksbetween the overall reform program, as well as specific fiscal and govemance reforms with povertyreduction are explained elsewhere (paras. 29, 123). This sub-section details the efforts of the Govemmentto improve its ability to monitor poverty, and to better evaluate the impact of its policies and reforms onpoverty in the state.

103. GoK has taken important steps recently both to enhance its poverty and human developmentmonitoring capacity as well as to demonstrate its willingness to leam from and act on the basis of theinformation collected. The state was one of the first in India to publish a Human Development Report(HDR) in 1999. The findings in that report conceming inter-district disparities within Kamataka are startingto influence govemment policies and allocations. GoK is now working towards institutionalizing that one-off effort with the creation of a Poverty and Human Development Monitoring System (PHDMS - AnnexH) to be managed by a Human Development Division within the Department of Planning, under theguidance of an Advisory Group with outside experts. The objectives of the system are to help theGovemment make more informed policy decisions, better determine the impact of its policies, reforms, andservices on the poor, as well as to inform public debate from the perspective of poverty reduction. ThePHDMS will do this by systematically monitoring progress, as well as any emerging problems, in key areasrelated to poverty reduction and human development, and by making this information available to thegovemment and the public on a regular and timely basis. Following a public workshop in February 2001,the Govemment has finalized the key indicators and terms of reference for the PHDMS (Annex H).

104. The PHDMS will focus on both consumption and non-consumption dimensions of poverty, includingrelated issues such as agricultural prices and service delivery. It will be survey-based. Kamataka madeexcellent use of the 1993-94 national household survey in the 1999 HDR, and processing of data from the1999-00 survey is now underway. The 2001 decennial census has just been completed. Other availablehousehold surveys include: the National Family Health Survey, the Reproductive and Child Health Survey,

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and the state's own recently-concluded literacy survey. As part of the PHDMS, Karnataka will strengthenits statistical system by: quicker processing and greater utilization of data from these surveys; strengtheningof other existing data collection systems such as the Civil Registration System (CRS); improvedcoordination and better linkages with data collection units in other line-ministries; and commissioning newannual surveys, starting in 2001-02, to fill remaining data gaps, as well as to cross-check the accuracy andreliability of existing data collection systems.

105. The PHDMS reporting system will include: (i) a new chapter on poverty and human developmentmonitoring in GoK's Annual Economic Survey; (ii) a comprehensive Human Development Report to beprepared every 3-5 years - the next is targeted for 2002/03 based on the findings of the Census as well asother household surveys recently conducted in the state; (iii) monthly reports focusing on district-levelchanges in wages and agricultural prices, to track short-term indicators of deprivation and vulnerability;and (iv) special studies. The first such special study is a district-level HDR for one of the state's poorestdistricts, Gulbarga in the far north of the state. As part of this, a survey of users, facilities and publicofficials in relation to key government services - rural water supply and primary education in particular -will be carried out using the report-card approach pioneered by the Public Affairs Center in Bangalore(para. 87). This survey - the first of its type to be carried out in rural areas - will be completed by October2001 and will provide a diagnostic and base-line for improvements in rural service delivery.

106. Work under the PHDMS will reinforce the focus of Karnataka's governance reforms in several areas.The production of district-level HDRs will help strengthen rural local governments (para. 95). Theemphasis on performance monitoring complements the government's public expenditure managementreforms (paras. 72-73), and the statistical strengthening will help make a performance orientation feasible.

V. THE PROPOSED LoAN/CREDIT

107. The Bank proposes to support the initial phrase of Karnataka's fiscal and governance reforms througha PSAL (para. 38). The first Karnataka Economic Restructuring Loan/Credit (KERL) is proposed for theamount of US$150 million. Given the Government of Karnataka's projected financing gap for 2001-02 ofabout US$250 million (see Table 8), it is envisioned to submit a second KERL to the Board for approval inthe 2001-02 fiscal year, subject to satisfactory reform progress. Subsequent KERLs would likely be on anannual basis, again subject to satisfactory reform progress.

108. This section presents: (i) Karnataka's financing needs, (ii) activating actions for the first two KERLs,and themes/benchmarks for subsequent KERLs; (iii) implementation arrangements; (iv) performancemonitoring and outcomes; and (v) details of loan/credit administration.

A. Karnataka's Financing Needs

109. Total Bank support to Karnataka is based on the state's ability to absorb resources, as measured bythe strength of its reforms (para. 37). Bank assistance in the form of budgetary support depends on thestates' financing needs and availability of other sources of finance. The state's financing needs over thenext few years will be influenced by the financing needs of the power sector, the costs of reforms such asretrenchment or tax reform, and the need to bnrng developmental spending to a level consistent with thestate's poverty reduction and growth objectives. The current forecast embedded in the Government'sMTFP is that Kamataka will need about Rs.47 billion (about US$1 billion) of Bank budgetary support overthe next four years to close its financial gap.

110. The power sector's claim on the budget over the four year period starting in 2001-02 is about Rs 81billion. This is some Rs 44 billion above historical levels, reflecting the decision of the Government to fullyfund the power sector deficit on budget (paras. 55, 66). Implementation of VAT may lead to an initial loss

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of sales tax revenue (para. 64). The MTFP assumes about 95% recovery of sales tax estimates for the first 2years following VAT introduction (2002/03-2003/4), resulting in a loss of revenue of Rs 8.5 billion.Voluntary retirement (VRS) payments to help closure/sale of public enterprises will also constitute a majorreform cost. VRS payments to an estimated surplus employment of 35,500 over four years would costabout Rs 4.5 billion. In total, the above claims come to about Rs 57 billion (about US$ 1.2 billion) over thenext four years, or about 1% of GSDP a year.

111. For the first year of the program, 2001-02, the key financing challenges facing GoK are to shift thepower sector deficit on budget and to reduce reliance on off-budget borrowing. Table 8 shows how this isproposed to be achieved. Off-budget borrowing in 2001-02 falls marginally from Rs 20 billion (25% of thegross borrowing requirement) in the previous year to Rs 19 billion (22% of the gross borrowingrequirement), while financing by the power utility, previously mainly through accumulation of arrears, fallsdramatically from 18% to 7% of the gross borrowing requirement. Reliance on conventional on-budgetborrowing sources increases, but still leaves a financing gap of about Rs 12 billion (about US$250 millionor 13% of the gross borrowing requirement).

Table 8. Karnataka: Gross Borrowing Requirement and Sources of Financing, 1999-00 to 2001-02(Rs billion)

1999-00 % of total 2000-01 % of total 2001-02 % of totalactual RE BE

Gross borrowing requirement /a 6450 8083 8635Gross borrowing requirement as a % of GSDP 6.8 7.8 7.3Sources of Financing 6450 100 8083 100 8635 100Off-budget borrowing 1047 16 1987 25 1885 22On-budget borrowing 3771 58 4230 52 4613 53

Government of India 1878 29 2276 28 2502 29Small savings 950 15 1205 15 1200 14State Plan loans etc. (excl. World Bank 928 14 1072 13 1302 15adjustment loan)

Market borrowing 904 14 826 10 826 10Loans from fmancial institutions 391 6 358 4 438 5Provident fund (net) 599 9 770 10 847 10

Change in reserves and deposits & cash balances 996 15 435 5 417 5Net financing by KPTCL (the power utility) 636 10 1431 18 570 7

Borrowing 630 8 900 10Change in working capital 801 10 -329 -4

World Bank adjustment loan 0 0 0 0 1150 13la Adjustedfrom fiscal deficit to include principal repayments, 30% grant component in pass-through of Bank adjustment lendingfrom Gol, off-budget borrowing and power sector deficit financing.

B. Actions Activating the First KERL

112. The Govemment of Karnataka has already taken a large number of important reforms, many of themcontroversial, such as increasing irrigation charges and other user fees. It has improved the state's fiscalposition over the last year (2000-01), and has launched a wide-ranging program of govemance reforms,including specific measures such as business re-engineering and release of citizens' charters for pilotagencies to improve service delivery, the introduction of procurement sample audits, the publication ofinformation about individual procurement processes, and the introduction of a general ban on prematuretransfers of civil servants. A listing of actions taken by the Govemment to date in its fiscal and govemancereform program is given in the policy matrix (Annex B) - see also Table 1 of the Govemment's Letter ofDevelopment Policy "Kamataka's Economic Restructuring Programme: a summary." Of the many reforms

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taken, those selected as upfront actions to activate the first Karnataka Economic Restructuring Loan/Creditare shown in Box 4 below.

Box 4. Activating Triggers for the First KERLMeasures For details

see....Fiscal Policy and Public Expenditure Management1. Reduction in the budgetary non-power fiscal deficit from 3.7% Table 3 and

of GSDP in 1999-00 to 3.2% of GSDP in 2000-01 para. 55(corresponding to stabilizing the non-power deficit in nominalterms below Rs 35 billion).

2. Approval by Cabinet of a Medium-Term Fiscal Plan (MTFP) to Para. 51achieve the Government's fiscal goals.

3. Presentation of a 2001-02 budget consistent with the MTFP, Table 3 andincluding a targeted reduction in the non-power budgetary fiscal para. 55deficit from an estimated 3.2% in 2000-01 to 2.4% of GSDP in2001-02.

4. Completion of key steps towards institutionalization of the Paras. 70-Medium-Term Fiscal Plan into the budgetary process. 72

5. Completion of the first phase of preparation for VAT Para. 59introduction.

6. Completion of first phase of financial management Para. 79modernization.

7. Passage of Karnataka Transparency in Public Procurement Act. Para. 80Administrative Reforms8. Cabinet approval of a Governance Strategy and Action Plan, Paras. 13,

including measures to reduce transfers within the civil service. 82, 849. Passage of Kamataka Right to Information Act. Para. 89Private Sector Development10. Cabinet approval of the Policy Paper on Deregulation of the Para. 97

Business Environment.11. Cabinet approval of Policy Paper on Public Sector Reforms and Para. 99

Privatization.Poverty Monitoring12. Establishment of Poverty and Human Development Monitoring Paras. 102-

System. 106

C. The Second and Subsequent KERLs

113. The proposed series of KERLs will be timed according to the pace of reforms, and the need forfinancing, taking full advantage of the flexibility which the PSAL framework offers, with an expectation ofannual or biannual loans/credits, as articulated in the assistance strategy for the state (paras. 36-37). Asalready stated, the first two KERLs have been structured to make it possible for GoK to access both withinthe same 2001-02 (government) fiscal year (para. 107).

114. The second KERL focuses on implementation of reforms, and on reforms where more time is neededfor the government to develop a track record. Indicative triggers for the second KERL are as follows:

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Fiscal Policy and Public Expenditure Management1. Progress towards agreed fiscal targets, as indicated by: (i) actuals for 2000-01; (ii) monthly fiscal

accounts data for 2001-02; and (iii) progress in implementation of revenue and expenditurereforms.

2. Further development of the MTFP, including greater use of sectoral/departmental ceilings,development of three departmental MTFPs, and greater integration of performance evaluations.(paras. 70-74).

3. Draft Fiscal Responsibility Legislation (para. 51).4. Wider Internet posting of Tender bulletins and additional sample procurement audits (para. 80).

Administrative Reforms5. Drastic reduction in number of civil servant transfers (para. 84).6. Implementation of pilot reforms to reduce elapsed time in government administrative transactions

(para. 86).7. Completion of functional reviews for major departments to rationalize the government

administration (para. 85).8. Establishment of the Corruption Prevention Committee to monitor and publicly report on the

Government's anti-corruption program. (para. 92).9. Roll out of pilot agency reforms to other parts of the state (para. 87).10. Notification of rules for, and effectiveness of, Right to Information Act (para. 89).

Private Sector Development11. Implementation of reform measures in the Karnataka Policy Paper on Deregulation of the

Business Environment (Annex F, Box 3).12. Closure or sale of 3 Public Enterprises (para. 99).

115. Subsequent KERLs after the first two would likely be on an annual basis. If Karnataka is able toproceed this far along the reform path, it will have a very impressive reform track record, and the Bankshould be willing to disburse larger amounts at less frequent intervals. Depending on progress made, it isexpected that the objectives of KERLs would be met by 2004-05. Reforms intended to be supported underthese later KERLs are indicated in the Government's policy matrix (Annex B) and summarized in Box 5below.

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Box 5. Benchmarks/Themes for Future KERLs (2002/03-2004/05)Reform Area Benchmarks/themes for future KERLs (2002/03-2004/05)Fiscal and Public Expenditure Management ReformsFiscal Continued fiscal adjustment as indicated by budgetary outcomes and targets.Sustainability Annual publication of Medium Term Fiscal Plan, including reporting of results against targets.and Application of and adherence to new fiscal responsibility legislation.Transparency Reduced reliance on off-budget borrowing.

Improved contingent-liability management.Improved methodologies for budget estimation and pension forecasting.

Reform VAT introduction in 2002. Reforms of motor vehicle tax, stamps and registration.Revenue Computerization of tax administration.System Increases in user-charges.Expenditure Completion of subsidy study, and implementation of sector strategies to improve subsidy targeting.Composition Continued reduction in power sector deficit as indicated by utility budgetary outcomes and targets.

Annual issuance of power sector Financial Restructuring Plan, with reporting of results vs. targets.Annual increases in priority sector spending (health, education, rural infrastructure).

Public Institutionalization of the MTFP in the context of the 2002-03 and successive budgets. including at theExpenditure departmental level.Management Expanding use of performance evaluations for government schemes.Financial Formulation and implementation of Public Financial Accountability Improvement Program.Account- Departments to start maintaining/compiling parallel accounts, beginning with 2 pilots.ability Improved response to audit accounts.

Complete treasury computerization, and extend computerization to other accounting functions.Public Implementation of Transparency in Public Procurement Act.Procurement Widespread publication of Tender Bulletins on the Internet and use of sample procurement audits.

Completion of Procurement Assessment, with additional measures arising from this.Administrative ReformsGovernance Annual updating of the Governance Strategy and Action Plan, including reporting of results against plans.StrategyCivil Service Implementation of strategies to reduce transfers of civil servants and improve transparency in recruitment.Reforms Rationalization/consolidation of government activities and staffing based on functional reviews.

Measures to improve internal efficiency of government decision making.Installation of computerized humnan resources data base.

Citizen Monitoring of performance of pilot surveys, including through user surveys.Charters Expansion of geographical and service coverage of agency reforms.Decent- Roll out of property-tax self-assessment.ralization Further measures to strengthen rural local government to be identified based on studies/workshops and

second State Finance Commission Report.E-govemance Completion of e-govemance status and action plan. Expansion of e-governance.Freedom of Publicizing of Right to Information Act.Information Use of information technology and survey of information needs to improve flow of information to

citizenry.Anti- Measures to strengthen anti-corruption enforcement (strengthening of Lok Ayukta, creation ofCorruption Ombudsman for local governments).Strategy Inter-Departmental Corruption Prevention Committee to oversee and publicly report on progress against

corruption.Private Sector DevelopmentPE Reform Progressive closure/sale of public enterprises.Business Implementation of the Policy Paper on Deregulation of Business Environment.Deregulation Institutionalization of public/private sector dialogue, including through regular surveys.Poverty and Human Development Monitoring.

Annual Poverty and Human Development Monitoring chapters in Economic Survey.District-level Human Development Reports.Second Human Development Report incorporating 2001 Census Results.Surveys of rural service provision and other special topics.

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D. Implementation Arrangements, Performance Monitoring and Outcomes

1 16. Implementation arrangements for the KERL are shown in detail in the GoK Letter of DevelopmentPolicy (Annex A). The overall program will be coordinated by the Chief Secretary. The nodal agency forthe fiscal and public expenditure management reforms is the Finance Department. Administrative reformsare the responsibility of the Departments of Personnel and Administrative Reform - a number of otherdepartments are also important in this regard and overall coordination for this component will be providedby the Additional Chief Secretary. Under the private sector development component, business deregulationis the responsibility of the Department of Commerce and Industry, while the Karnataka State Bureau ofPublic Enterprises is the nodal agency for public enterprise reforms. Finally, the Planning Department isresponsible for the newly-created Poverty and Human Development Monitoring System.

117. Performance monitoring. Strengthening of monitoring and public reporting is a theme of theGovernment's reform program. The Govemment's two basic reform policies, the Medium Term Fiscal Planand the Govemance Strategy and Action Plan, will both be published annually, and subsequent versionswill include the reporting of results against stated intentions. In addition, the following measures in theGovernment's reform program will strengthen performance monitoring and reporting:

* The establishment of the Poverty and Human Development Monitoring System (Annex H) is animportant effort to improve availability of data about poverty, and the impact of Governmentpolicies and reforms on the poor.

* Financial/fiscal reporting: various measures, from the regular provision of a wider range of fiscalinformation to the public to the posting of monthly financial accounts on the Intemet and thedevelopment of the Government's accounting capability, will greatly improve the extent, accuracyand timeliness of the Govemment's public fiscal and financial reporting.

* Performance evaluations are being taken up for various government schemes and projects as part ofthe public expenditure management reforms, as are a number of sample procurement audits.

* Monitoring of premature transfers of civil servants on the Internet is being introduced to promotetransparency, and as a tool to reduce the number of such transfers.

* The Government's citizen charter initiatives rely on the use of systematic feedback from users topromote good performance.

* Karnataka's new Right to Information Act is intended to enable the public to be better informedabout and thus be better equipped to monitor the government's performance.

* Various computerization/e-governance initiatives will greatly improve the flow of data (e.g.,treasury computerization, human resource database).

* Survey-based monitoring will be emphasized, with regular new surveys planned of businesses,officials, and households.

* A separate social assessment is being undertaken for the power sector reforms, including surveys ofconsumers, to establish a base-line for monitoring the impact of this important reform on the poor.

118. In addition to these governmental initiatives, Kamataka benefits from significant NGO monitoringboth of specific services and of overall performance. For example, the Public Affairs Center has recentlycompleted a report card on the first year of Kamataka's new government, based on a citizens' surveys.

119. Performance indicators for the Government's reform program are included in the Government'sPolicy Matrix in Annex B. Box 6 below summarizes the key outcomes sought and performance monitoringmechanisms that will be used to assess progress under the four components of the Govemment's fiscal andgovemance reforms, as well as under its overall economic reform program. As the various monitoring and

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strengthening initiatives take root, the database for judging performance will be greatly improved, andassessments of government performance will be increasingly able to be based on achievements of outcomes(such as education and health levels) rather than progress with respect to inputs (such as policy changes).

Box 6. Outcomes and Performance Indicators for Karnataka's Fiscal and Governance ReformsReform Area Outcomes Sought Performance Indicators/Monitoring Mechanism

Overall 7-8% economic growth Administrative data.Government Universalization of elementary education (by 2004, all Census data.Reform children aged 6-10 years to be in school; by 2007, all National Accounts Statistics.Program (see children aged 6-14 years to be in school.) Household survey data.Section ILb) 55 litres per day drinking water availability for all Traffic surveys.

rural households by 2005, up from 40 currently.Health targets (IMR, MMR, nutrition, infectiousdiseases (including <3% AIDS infections),immunization, client satisfaction).Improvements in state highway quantity and quality.

Fiscal and Fiscal deficit less than 3%. Annual publication of Medium Term Fiscal Plan, andPublic Off-budget borrowing and power sector deficit to be power sector Financial Restructuring Plan includingExpenditure brought under control, reduced over time and reporting of results against targets.Management eliminated in the medium-term. Monthly and annual monitoring of fiscal performanceReforms Improved revenue performance. and of cash-flow position, including of the power sector

More effective pattems of government expenditure. and off-budget borrowings.More transparent, public and timely financial/fiscal Tax/GSDP ratio.reporting. Feedback from taxpayers via regular surveys ofMore transparent and competitive procurement. business.

Expenditure allocation figures, as well as regularsurveys of households to gauge progress on the ground.Timeliness and frequency of financial reporting, andauditing cycle; reduction in defined financialirregularities.Number of published Tender Bulletins, and sampleprocurement audits.

Administrative A smaller but more effective public administration. Annual publication of Govemance Strategy and ActionReforms A higher level of transparency and accountability, Plan, including reporting of results against intentions.

accompanied by fewer opportunities for corruption Size of the civil service, number of departments andMore efficient and responsive delivery of essential layers, average time taken for administrativepublic services. transactions.

Regular surveys of public officials to gauge changes inperceptions of corruption, quality of administration, etc.Systematic feedback for individual services as part ofthe citizen's charter initiatives.Household surveys to provide regular feedback for bothstate and local-government provided services.Greater reliance on e-governance, especially in deliveryof services.

Private Sector Withdrawal of state from direct involvement in Number of public enterprises closed or privatized.Development commnercial activities. Quality of Kamataka's investment climate as judged by

Reduction in administrative and fiscal burden of regular surveys of business.public enterprises.Improved business environment, with less bureaucraticinterference.

Poverty and A better information base for pro-poor policy making Functioning of the Poverty and Human DevelopmentHuman and program design. Monitoring System.Development Use of its results by policy makers.Monitoring

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E. Loan/Credit Administration

120. Funds flow arrangements for the Loan/Credit are as follows. Upon effectiveness, GoK through Golwill submit to the Bank a withdrawal application. The US Dollar proceeds of the Loan/Credit will betransferred from the Bank to GoI's account held at the Reserve Bank of India, into which all Bankdisbursements are deposited. The account is controlled by the Office of CAAA (Controller of Aid,Accounts and Audit) of the Department of Economic Affairs, GoI, and is part of GoP's general foreignexchange reserves. The Rupee equivalent funds will be promptly transferred by GoI to the ConsolidatedFund of the GoK in one tranche on standard terms for central resource transfers for state developmentalbudgets (30% as grant and 70% as loan, with Gol bearing the foreign exchange risk). GoK will promptlyconfirm to the Bank the receipt of these funds, and its credit to the Consolidated Fund of the GoK.

121. Procurement. Disbursement of the loan/credit proceeds will not be linked to specific purchases.However, GoI will not use the loan/credit proceeds to pay for certain expenditures included in the Bank'sstandard negative list which includes expenditures on military hardware, luxury goods as defined in theStandard International Trade Classification, and environmentally hazardous goods.

122. Financial accountability environment. In preparing this project, the Bank supplemented the 1998public expenditure review of Karnataka (para. 3 8) with a preliminary public financial accountabilityassessment for the state. The results are described in para. 75 and show that, although there are weaknesses,the foundations of Karnataka's public financial accountability system are reasonable. Key actions forimprovement and strengthening are included in the policy matrix (Annex B). Procurement and financialaccountability assessments of the state will be carried out later this year, leading to the adoption of amedium-term action program by the government. The funds flow arrangements for the Loan/Creditdescribed in para. 120 above are satisfactory to ensure that the proceeds of the Loan/Credit are used for theintended purposes.

VI. BENEFITS AND RISKS

A. Benefits

123. Impact on poverty. Kamataka's reforms are expected to have a strongly positive impact on povertyreduction through various channels. Many of the links between the state's overall reform program andpoverty reduction (para. 29) lie in the benefits Kamataka's fiscal and governance reforms will have for thepoor. Specifically:

* Karnataka's deregulation will improve the investment climate, especially for small and mediumenterprises. This will help generate non-farm employment, of great benefit to the poor, but whereperformance has been lagging in Karnataka.

* Karnataka's governance reforms seek to improve the delivery of public services at local levels (e.g.,through citizen charters, user surveys, and performance monitoring. The governance reforms shouldalso reduce corruption and harassment, which tend to hurt the poor disproportionately.

* Karnataka's fiscal reforms will enable a greater share of resources to be focused on poverty-relatedexpenditures. The MTFP seeks to reorient public spending towards high priority developmentspending (primary and secondary education, primary health care, drinking water, basicinfrastructure) that will provide basic social services to the poor and help agricultural growth.

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* Increasing user charges is also a progressive, though controversial, policy. In the case of electricity,about 50% of Kamataka's rural households make no use to electricity at all. There is also a life-linetariff, which about 20% of Kamataka's consumers benefit from, and which is expected to remain inplace. (Out of a total of about 8 million households with electricity connection, there are about 1.6million electricity consumers with a single-bulb connection. These households pay a charge ofequivalent to about 20% of the cost of supply.) Regarding the farming community, and the impacton marginal and small farmers, Bank research conducted in other states suggests that the negativeimpact of tariff increases would remain limited and is expected to be mitigated by an improvementin the quality of power supply.

* The emphasis being given to improving poverty monitoring will help the govemment to bettertrack poverty, and to adjust its policies and programs accordingly. This includes the Poverty andHuman Development Monitoring System (Annex H), as well as sector-specific studies such as thesocial assessment being undertaken in the power sector (para. 17).

124. Support for reforms. Bank backing for the Government's reform program helps provide support forimplementation, and the lessons of international experience. Success with respect to the Govemment'sfiscal and govemance reform program will improve the enabling environment for Bank-supported andother sectoral investments in Karnataka (paras. 38-39). The additional financing which the Bank canprovide will help ensure that high-priority expenditures are protected and expanded rather than crowded-out at a time of fiscal stress. It also provides financial backing for the state's reform program (para. 109),and in particular helps fill the financing gap which arises from fully funding the power sector deficit onbudget (paras. 55, 66) - an important component of the state's power reform strategy (para. 16).

125. Impact beyond Karnataka. Kamataka is a state with a considerable potential demonstration effect.Given its traditionally strong fiscal and govemance position and its already-established position as one ofthe states leading reforms in these areas (Box 2), Karnataka has the potential to set precedents in manydifficult areas, and thereby to generate competition and reform momentum across Indian states.

B. Risks

126. Non-adherence to the agreed fiscal framework could worsen Kamataka's deteriorating fiscal position.Experience in some other states shows the difficulties in adhering to agreed medium-term frameworks. Thisrisk is being mitigated by institutionalization of the MTFP (paras. 70-72) and the announced provision oflegislative backing to the MTFP (para. 51). Nevertheless, both the fiscal and power sector deficits caneasily be larger than planned due to developments outside the state's control, such as reduced resourcetransfers from the center, or, in the case of power, accidents and weather. These risks will be mitigated byclose monitoring. There is a particular risk in the coming year that a growth slowdown in India will meanthat GoK's ambitious revenue targets are not achieved. This will possibly require adjustments on theexpenditure side to ensure that deficit targets are not breached.

127. The planned introduction of the VAT also carries with it substantial risks. Successful introductionwill require co-operation from Government of India and other states, and good planning andcommunication within Karnataka. The consultancy GoK is engaging should reduce risks within the state,while the Bank will need to highlight state VAT issues which require a national solution.

128. The political commitment to reform could weaken due to resistance to institutional and governancereforms which tackle vested interests. This risk is mitigated by broad ownership of key institutionalobjectives among senior political leaders, bureaucrats and civil society. Careful consideration has beengiven in the design of the reform programs to broaden public support for the reforms. Some keygovernment services with wide interface with the public have been chosen to improve service delivery in a

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visible manner to help generate public support for the reform process, particularly as these pilot initiativesare extended to other parts of the state (para. 87).

129. Challenges remain regarding the government's capacity to fully implement deep reforms across awide range of sensitive areas. Although Karnataka has a competent bureaucratic apparatus, the reformsproposed are complex and the government's capacity for managing reforms is limited. To address this,close attention is being paid to sequencing issues in the context of a flexible, medium-term programmaticframework, and trying to avoid an over-loaded agenda. Provision of technical assistance is also critical inthis regard. GoK is using about $10 million of TA for its fiscal, governance, and related power sectorreforms (para. 38), and this amount is expected to grow. The infusion of the lessons of intemationalexperience will strengthen the government's capacity for managing the medium-term reform programs.

130. Finally, the achievement of fiscal sustainability is conditional on sustained and successful sectoralreforms (paras. 14-28), but there are risks associated with these, especially with power sector reforms - forexample, tariff increases are politically controversial, and foreign investors are increasingly cautious aboutinvesting in the India power sector. The measures the govemment is taking in each sector (e.g. in the powersector, the launch of a communications campaign and the use of highly experienced advisers), as well asthe close links between GoK's sectoral and core fiscal and governance reform programs will help mitigatethese risks, as will the integrated, comprehensive approach the Bank is taking in Kamataka (paras. 36-37).

131. For all the mitigating measures built in to this operation, and mentioned in the above paragraphs, thisis nevertheless a high-risk operation, primarily on account of the controversial nature of some of thereforms the government is pursuing. If some of the risks identified above become a reality then thedevelopment impact the operation seeks to achieve may fail to materialize. In this case, the program ofBank support will have to be re-assessed. However, at this juncture, Kamataka's record to date and promisefor the future clearly warrant Bank support.

James D. WolfensohnPresident

by Zhang Shengman

Washington, D.C.May 25, 2001

Annex A

Letter of Development Policy(A signed Letter of Development Policy is forthcoming)

Annex B Page I of 9

KARNATAKA ECONOMIC RESTRUCTURING PROGRAMME: May 2001Reform Area Government Strategy Actions Already | Future Milestones (Indicative target dates) Performance

l- I Taken December 2001T April 2002 April 2003.2005 benchmarks

I. FISCAL REFORMS & PUBLIC EXPENDITURE MANAGEMENTA. Establish Develop a Medium-Term Fiscal Plan to guide White Paper on State's Fiscal Revised MTFP to Medium-term fiscal plan to MTFP to be issued FiscalperformanceFramework for fiscal adjustment to avoid a debt-trap, and Position issued and medium-term provide basis for be issued with 2002-03 annually including reporting Annual deficit reductionFiscal Sustainability issue it annually with the budget, including fiscal targets announced. 2002-03 budget. budget, including reporting of outcomes against targets targets derived from& Transparency reporting of outcomes against targets. Medium Term Fiscal Plan (MTFP) Draft Fiscal of 2001-02 outcomes Off-budget borrowing to be Government's MTFP for

Objective Provide legislative backing to the MTFP approved by Cabinet and made Responsibility against targets. eliminated after 2004-05. both budgetary deficits andthrough a Fiscal Responsibility Act. public. Legislation to be Fiscal Responsibility including off-budget

Fiscal adjustment to Identify and consolidate all off-budget prepared. Legislation to be tabled in borrowing and the poweravoid a debt trap. sources of borrowings into fiscal indicators; the House. sector deficit; monthly

Fiscal transparency move away from reliance on off-budget reduced disparitiesto promote public borrowing, and develop a Financial between budget reviseddebate and Restructunng Plan to reduce the power sector and actual estimates.awareness. deficit. Cash /hiabiCity management

Number of days of overdraftAdhere to contingent liability cap and better Legislation on capping contingent Guidelines for sectoral with RBI (target of zero);manage contingent liabilities. liability passed, Guarantee fees allocations of guarantees. reduced borrowings from

made mandatory. public account; borrowingMake as much fiscal information as possible Overview of Budget expanded to Further expand the based on fiscal targetsavailable to the public. include information on off-budget information released in the rather than availability.

borrowing, tax expenditures and Budget Overview. Contingent liabilitytax arrears. Publication of monthly managementaccounts on the internet Compliance with Ceiling oncommenced. Guarantees Act; low/zero

Improve estimation and forecasting of key Completed study on Complete study on Improved methodologies for devolution of guarantees tovariables (major taxes, pensions, other budget estimation and pension forecasting. budget estimation and GoK.expenditure items) forecasting (fiscal pension forecasting in

marksmanship) place.

B. Reform Revenue Establish Tax Reform Commission to set out Tax Reform Commission first Tax Reforms Growth in tax revenue andSystem road map for tax reforms - both on policy and report submitted. Commission to submit tax/GSDP ratio.

administrative arrangements. final report. Reduction in tax arrears.Objective:Policy and Replace sales tax, entry tax and tumover tax Sales tax concessions for new Draft VAT legislation. Approve VAT legislation. Introduce VAT (2002-03) Positive feedback from

administrative by Value-Added Tax based on self- investments abolished and floor Complete VAT taxpayers.reforms to raise assessment and a functional organization. rates for sales tax introduced. preparation.additional revenue, VAT preparation: VAT workingimprove efficiency, groups functional; full-time VATand reduce team in place; VAT consultantscompliance costs. selected; VAT discussion paper

issued; self-assessment andpartial rebating of inputs.

Annex B Page 2 of 9

KARNATAKA ECONOMIC RESTRUCTURING PROGRAMME: May 2001Reform Area Government Strategy Actions Already Future Milestones (Indicative target dates) Performance

Taken December 2001 April 2002 -Apnil 2003-2005 _ benchmarksB. Reform Revenue Overhaul stamps & registration, and motor Changes in stamps & registration Implement reforms and modernizationSystem (Cont.) vehicle tax to close loopholes, boost and motor vehicle tax announced.

buoyancy, as well as to improve service tocustomers/tax-payers.Improve cost-recovery for 'non-merit' Rates increased for canal Continue to increase user charges.government services, such as irrigation, irrigation, higher and technicaltransport, higher and technical education, education. Automatic indexation ofhospital services, and water supply. bus fares introduced.

C. Improve Control wage bill while staffing-up in high- Recruitment strategy established, Find opportunities for tighter control of wage bill. Wage bill and civil serviceComposition of priority areas (education, health, police, including high-level control size.Public Spending forestry). procedure. Spending in priority sectors

Shift spending towards high-priority areas: Spending in priority sectors Further increases in Additional annual increases Power sector deficithealth, elementary & secondary education, protected in the 2001-02 budget. priority sector spending in in priority sectors. (monthly monitoring).rural water supply, roads; and maintenance in 2002-03 budget. Spending on subsidies.irrigation and public facilities.Shift spending from salaries & subsidies tonon-wage O&M.Protect capital spending during fiscaladjustment.Make power sector less dependent on Financial Restructuring Plan (FRP) Revised FRP issued, with Annual issuance of FRP forgovernment, develop and implement a for the power sector approved by consistent utility budgets power sector.Financial Restructuring Plan to reduce the Cabinet.power sector deficit over time, KPTCL budget consistent with

FRP approved,Reduce and better target subsidies via Study commissioned to develop Study on subsidy Implement recommendations of subsidy studyindividual reform strategies. individual subsidy reforms reforms completed

Food subsidy redesigned toimprove targeting, and fundingcapped in nominal terms.

Annex B Page 3 of 9


Taken December 2001 April 2002 April 2003-2005 benchmarksD. Strengthen Institutionalize the Medium Term Fiscal Plan FY02 expenditure ceilings Revised MTFP Further institutionalize Fully institutionalize rolling Shifts in expenditurePublic Expenditure into the annual budgetary process. allocated to line departments available to guide MTFP in context of 2002- MTFP process in priorities over the mediumManagement Establish up Expenditure Review Committee consistent with MTFP. budget preparation for 03 budget government's policy term.

(ERC) to debate priorities and rigorously Three pilot line departments 2002-03. making, planning and Closure or restructuring ofObjectives: review any new schemes for consistency with (Health, Education, PWD) initiated budgeting process schemes following

Institutionalize a MTFP before inclusion in budget. expenditure programming Three pilot line independent evaluationmedium-term consistent with MTFP, including departments (Health, Better delivery ofperspective into the identification of objectives, Education, PWD) to expenditure programs asbudgetary process priorities and monitoring. prepare measured by beneficiary

Tighten the link Expenditure Review Committee comprehensive assessments in evaluationsbetween expenditure set up, and made operational. departmental MTFPs and household surveyscomposition and New proposals scrutinized by ERC Expenditure savingspolicy priorities before presentation to Cabinet for identified by line

Greater focus on inclusion in the budget. departmentsperformance of 2001-02 budget consistent withexpenditure MTFP.programs. Subject an increasing number of schemes and Govemment Order issued to Initiation of Completion of evaluation Institutionalize performance

projects to independent evaluation, and create institutionalize independent Independent pilot pilots. monitoring and evaluationmechanisms for acting on the findings of evaluations of Government evaluations of Evaluation findings system in all governmentthese. projects and schemes. schemes across reflected in budgetary departments.

major departments. submissions.

Increase the flexibility of spending Committee for Elimination and Complete scheme/budgetdepartments to provide them with incentives Rationalization of Redundant head merger/to seek efficiency savings. Schemes created rationalization for at least

2001-02 budget eliminated, 10 Departments in themerged or rationalized many 2002-03 budget.schemes of several departments. Strengthen incentives for

Departments to identifybudgetary savings as partof the budgetary process.

Annex B Page 4 of 9

KARNATAKA ECONOMIC RESTRUCTURING PROGRAMME: May 2001Reform Area Government Strategy Actions Already Future Milestones (Indicative targetdates) Performance

Taken December 2001 April 2002 April 2003-2005 benchmarksE. Strengthen Develop accounting capability Controller's Office established to Complete State Approve 2 pilot departments More timely GoK financialPublic Financial lead the public financial Financial Public Financial maintaining/compiling statementsManagement and Improve timeliness and disclosure of financial accountability improvement Accountability Accountability parallel accounts (April Reduction in backlog ofAccountability reporting program. Assessment (SFAA) Improvement Program, 2003). accounts and audits of local

Study Clear baklo of aconsDemonstrate capacity to bodies and PS Us.Objective: Published summarized budget Study Car backlog tof acou handle own accounting and Modies and PSUs.Improve information (based on monthly controls in priority of PRIs (ZPs, TPs, GPs), payroll functions More timely and completetransparency, enable accounts) on Internet. areas: rioritiof PsU s, KGI P) (mainstreaming of responses to auditbeKter financial areas: reconciliations, PSUs, KGID. departmental accounting). observations prepared andperformance Clearing of backlog of accounts for Personal Deposit Further clear and eliminate disclosed.measurement and local governments and PSEs Accounts,repoureming anddres initiatgoved mentsandP loans/advances, and backlog of accounts and Reduction in auditweaknesses in guarantee/debt audits. qualifications.intemal control and recording/ reporting. GoK to prepare financial Better internal controlspublic accountablity statements according to demonstrated throughand enable better accepted public sector reduction in un-reconciledlegislative oversight. accounting standards; and items, reduction in

disclose timely financial magnitude of Personalstatements. Deposit account.Robust internal controlsystem operational.Transparency andaccountability of localbodies improved.

Improve audit responsiveness Provide official response to the Implement measures to GoK and all governmentCAG's letter on the 1998-99 Audit ensure timely responses entities to take timelyReport. to audit findings. follow-up on audit findings,

Prepare GoK's response including disclosureto 1999-00 audit report,

Computerize key accounting functions Computerization of treasuries Complete pilot Computerization of payrollinitiated. computerization of and DDOs.

Treasuries. Complete computerizationAward contracts for ZP of Treasuries, ZPs andand TP computerization. TPs.

F. Reform Public Legislate to enforce transparency in Transparency in Tenders and Review efficacy of Increased number ofProcurement procurement Procurement Law passed. Procurement Act and take Tender Bulletins onObjective More corrective action Intemet. Increased numbertransparent and of procurement audits.competitiveprocurement Perception of reducedprocesses that corruption in procurement,improve efficiency, as measured by survey oflower costs and offcials and public.reduce corruption.

AnnexB Page 5 of 9


Taken December 2001 F April 2002 April 2003.2005 benchmarksF. Reform Public Make procurement decisions public by use of First Bulletins on Net by KBJNL Expand number of departments/agencies All departments/agenciesProcurement Tender Bulletins, also to be placed on and KNNL.(Cont.) Intemet.

Undertake sample procurement audits by First sample audits in pilot Expand sample audits Extend sample audits throughout Governmentindependent agencies in a widening range of departments and PSUs (KBJNL to other PSUs andgovernment agencies. and Minor Irrigation). Departments,

including KPTCL.Further measures to strengthen procurement Introduce further procurement reform measures based

on the Karnataka Procurement Assessment.

11. ADMINISTRATIVE REFORMSA. Define Articulate Government strategy to define the Administrative Reforms Final ARC report to be Second GSAP approved Continue updates of GSAP, Monitoring of action takenGovemance role of Govemment and for improving Commission established. received. by Cabinet, with action monitor and publicly report against proposals inStrategy efficiency and transparency of govemment First ARC report received, taken report on the first on progress. successive GSAPs.

operations. Governance Strategy and Action GSAP.

Plan (GSAP) approved and madepublic.

B. Reform the Civil Reduce and rationalize transfers of civil Governments public commitment Approval of new rules Public reporting on Monitor progress in Drastic reduction in numberService and Public servants through (i) a monitoring system; and to reduce transfers drastically. under the Civil progress in implementing reducing transfers and take of transfers, starting inAdministration (ii) putting in place new institutional Monitoring system introduced and Service Act to reduce transfer policy, including corrective actions 2001-02.

mechanisms. placed on the intemet. transfers. number of transfers, Stability and increase inObjective: General Transfers for 2001 average tenure by tenure for key positions inImprove banned department, district and monitoring systemtransparency, reduce bne.positions, against targets Reduced corruption incorruption, rationalize New government policy on recruitment and transfers,departments and transfers included in GSAP. and improved employeefunctions, improve Increase transparency in recruitment. Weight given to and motivation, asinternal efficiency, interviews to be measured by surveystrengthen human reduced vis-a-vis Elimination andresource competitive/ qualifying consolidation ofmanagement. examinations. departments

Rationalize the civil service, and reduce it in Functional reviews for 15 Completion of Announce and begin Revise CSR terms and Reduction in size of civilsize, by restructuring and reducing the size of departments initiated. functional reviews for elimination and conditions to promote service, particularly in areasmajor departments. Mines & Geology Department major departments. consolidation of restructuring and where functions are

consolidated with Major Irrigation overlapping functions and redeployment eliminated and consolidatedDepartment. Announcement made departments based on Complete rationalization Greater meritocracy into merge Institutional Finance findings of functional based on functional recruitment, promotion andDepartment with Finance reviews. reviews. personnel evaluation.Department.

Annex B Page 6 of 9

______ KARNATAKA ECONOMIC RESTRUCTURING PROGRAMME: May 2001Reform Area Government Strategy Actions Already Future Milestones (Indicative target dates) Performance

Taken December 2001 April 2002 April 2003-2005 benchmarksB. Civil Service and Speed up Government administrative Introduction of desk Introduction of single filePublic transactions/decision-making time. officer system for system on a pilot basis.Administration selected departments(Cont.) in Secretariat.

Monitoring ofreduction of timetaken foradministrativetransactions.

Human resource reforms: Initiate computerized Initiate participatory Installation of computerized* Improve personnel review (ACR) HR database project. personnel review process HR database.

processes - supervisors meet withemployees and review

* Survey public officials to benchmark and their ACR.monitor CSR. monitor CSR. ~~~~~~~~~~~~~~~~~~~~~~~Public officials' surveys to

* Install computerized human resource benchmark and monitordatabase progress

C. Citizen Charters Improve services in a widening number of Agency reforms, up to issuance of Roll out pilot reforms Monitor and provide report Carry out independent Improved service delivery,& Agency Reforms agencies through agency reforms citizens' charters for three pilot to cover broader on the performance of the evaluation of pilot agency as measured by userto Improve Service consisting of: (i) user surveys or services with large public interface geographical areas. three pilot services, reforms. surveys and reduction inDelivery consultations to identify problems and in maternity wards of Bangalore, including user surveys. time to deliver services

benchmark progress; (ii) improvement in police, and motor vehicle Expand coverage ofObjective business process/ computerization; (iii) registration, driving license and tax agency reforms(e.g., PDS,Improved service establishment of grievance redressal payment stamps and registration).delivery in services mechanisms; (v) publication of citizenwith large public charters.interface Usedemonstration effectfor scaling-up.D. Enhance For urban local govemments, increase their Self-assessment in property tax Roll-out self-assessment Extend self-assessment to Increase revenue base atEffectiveness of revenue base introduced in Bangalore to 5 major cities. all municipalities. local levels.Decentralization Strengthen other tax bases

for Municipalities. More efficient delivery ofObjective local services, as measuredMore effective local by household surveys.govemments bystrengthening For rural local govemments, strengthen Untied element of PRI funding Give Gram Panchayats responsibility for larger numberaccountability administration and financial capability. increased. of development programmes.mechanisms at the Land revenue and property tax Further measures to decentralize local governmentlocal levels while Devolve larger funds and greater powers to rates in rural areas increased. based on studies/workshopsenhancing autonomy. the Gram Panchayats.

Undertake training programs for panchayat functionariesin planning and budgeting.

Annex B Page 7 of 9

KARNATAKA ECONOMIC RESTRUCTURING PROGRAMME: May 2001

Reform Area Government Strategy Actions Already Future Milestones (Indicative target dates) PerformanceI Taken December 2001 April 2002 April 2003-2005 benchmarks

E. Enhance Provide legislative basis to right to Right to Information (RTI) Act Notify rules and make Evaluate functioning and Increased public access toFreedom of information. passed. RTI Act and Rules impact of RTI law. information, measured byInformation effective. surveys ofObjective Greater Make government records accessible. Cataloging, indexing, and computerizing of government records households/officials.flow of information to Apply information technology to improve flow of information to citizens. Makepublic to increase indices of govemment documents available on the intemet. Train informationparticipation, officers.transparency andaccountability, and to Focus on areas of public demand for Survey on public Put resources into makingreduce corruption. information. information needs information available where

there is high publicdemand.

F. Use Electronk- Expand the use of e-governance throughout E-governance initiatives underway Prepare e-governance Mainstream e-governance Greater use of e-Govemance to govemment. in sales tax, revenue, and status and action plan initiatives more broadly governance in departments.improve efficiency treasuries. Implement more far- within and acrossand transparency reaching initiatives to use departments

Objective Use IT to electronic governancereduce delays &corruption, andenhancetransparency.

G. Implement and Strengthen anti-corruption enforcement Measures included in the Implementation of measures to strengthen Lok Ayukta. Perception of reducedMonitor a Govemance Strategy and Action Establish office of 'Ombudsman' to look into complaints corruption, as measured byComprehensive Plan (GSAP). against functionaries of local bodies. surveysAnticorruption

Program Strengthen corruption prevention measures. Govemment's corruption Establish inter- Monitor implementation of corruption preventionObjective prevention strategy included in the departmental initiatives, assess progress, and take deeper measuresEnhanced public GSAP Corruption Prevention as necessary.monitoring, reduced Committee, to consult Undertake surveys to identify principal areas ofcorruption and with the media and corruption and the scope for system-wide reforms aimedenhanced credibility legislators to monitor at prevention.of the state and publicly report on

progress in anti-corruption anddeepen systemreforms.

Annex B Pag 8of 9

KARNATAKA ECONOMIC RESTRUCTURING PROGRAMME: May 2001Reform Area Government Strategy Actions Already I Future Milestones (Indicative target dates) Performance

Taken December 2001 A _il 2002 Api 2003-2005 benchmarks

III. PRIVATE SECTOR DEVELOPMENTA. Restructure and Set up policy framework and durable Public Sector Restructuring Number of PSUsPrivatize Public institutional mechanism to support PSU Commission established and sold/closed/restructured.Enterprises closure/privatization. functional.Objective Govemment approval of policy

Withdraw state from paper on PSU Reform andcommercial activities Privatization and relatedto reduce procedures, with 15 PSUsadministrative and identified for first phase offiscal burden of PSU. program.

High-Powered Committeeestablished for implementation ofnew PSU policy.

Close/privatize PSUs Operations closed, environmental Close/privatize an Close/privatize an Close/privatize 10screening complete, and VRS additional 4 PSUs. additional 5PSUs additional PSUs by March,payment offered in 1 PSU. 2003.

Close or privatize remainingPSUs covered by policypaper by March, 2005.Restructure the remainingPSUs.

B. Deeglaio Policy reforms to improve the business Cabinet approval of Approach Introduction of rules Complete implementation of proposed reform measures Feedback from industry viaB. Deregulas on and environment: Paper on Business Deregulation and operating of the Approach Paper. surveys (e.g. on number of

Busiessprocedures as per the inspections, time to set up aEnvironment * Reduce excessive regulations related to Approach Paper. business).

starting or running a business.Objective Ratio of investmentsImproved business * Reduce and rationalize inspections. grounded to investmentenvironment; less Get regular feedback from the private sector. Conference on business Undertake and publish Institutionalize the proposals.bureaucratic environment with stakeholders and first survey of industry public/private dialogueinterference; more the private sector. interface with governmentprivate investment department.and higher growth.

Annex B Page 9 of 9

KARNATAKA ECONOMIC RESTRUCTURING PROGRAMME: May 2001

Reform Area Government Strategy | Actions Already | Future Milestones (indicative target dates) Performance

Taken December 2001 April 2002 I April 2003-2005 benchmarks

IV. POVERTY AND HUMAN DEVELOPMENT MONITORING

Objective Develop Poverty and Human Development Human Development Division StafFing with Functioning of the PHDMS.

A better information and Poverty Monitoring System (PHDMS) constituted, and Advisory Group consultants and Use of its results by policybase for policy- appointed. experts. Users.making and program Institutionalize the 1999 Human Development After consultations, finalize terms District-level poverty Human Development Publication of second edesign Report with regular tracking of and reporting of reference of the proposed estimates to be Monitoring Report to be Human Development Human development

More information in on poverty and social indicators monitoring system and list of prepared based on included as a chapter in Report following the targets to judge success ofthe public domain. indicators to be tracked (including the analysis of the the annual Economic processing of data from the overall program (including

baseline estimates where pooled central & state Survey published by GOK. 2001 Census Data. health and educationA more pro-poor available). samples of the 55m targets)development strategy round NSS Consumerand better-informed Expenditure Survey.policy making madepossible by high- Institute monthlyquality data being reporting system foravailable on a timely tracking district-levelbasis changes in

agricultural wagesand prices.

Initiate additional datacollection/strengtheningexercises.

Undertake special studies to focus policy Gulbarga (District) Human Surveys of rural Publish Gulbarga District HDR.attention on critical poverty-related issues Development Report initiated. drinking water and

primary education in Carry out other special-purpose studies as neededI Gulbarga.

Annex CPage I of 24

MEDIUM TERM FISCAL PLAN FOR KARNATAKA,

2000-2001 to 2004-05

I. Introduction:

1. Economic reforms, under way since 1991, have posed important challenges

as well as opportunities to the state governments. Accelerating economic growth

and reducing poverty call for releasing resources for strengthening infrastructure

facilities in the states and making substantial allocation of resources to rural

development, health and education. State governments have a predominant role in

the task of strengthening physical infrastructure and, more particularly, in human

development. Besides, the greater role assigned to the private sector has

confronted the states with the challenge of creating an accommodating

environment in the wake of fierce inter-state competition. Karnataka has to

participate in this competitive environment. This calls for the creation of a climate

for realising the growth potential by attracting private investment. However, to be

a favourable destination for private investment the State government should not

only follow investment-friendly policies but also create high quality infrastructure

and finance it through an efficient tax system. The challenge is particularly severe

because the fiscal condition of the State has been deteriorating sharply. Although

the fiscal situation in Karnataka, unlike in many other states, has not yet reached

the crisis point, it will not be long before it becomes unsustainable if the present

trend continues.

2. The State government is seized of the problem and is keen to undertake

immediate corrective measures to put its finances back on the rails. To promote

wider discussion on the fiscal health, the State government placed a White Paper

on Karnataka State finances in the last budget session of the Assembly (March

2000). The White Paper has identified the sources and causes of stagnancy in

1

Annex CPage 2 of 24

revenues and the reasons for the proliferation of public expenditures, and has

indicated directions and guidelines for undertaking corrective measures. The

White Paper has also stated that it is necessary to calibrate the reforms carefully to

achieve the required fiscal correction.

3. The fiscal deterioration in the State is not the result of fiscal operations in

one or two years but is a culmination of problems accumulated over several years.

Given the magnitude of the problem, fiscal correction cannot be achieved within

one or two years. Besides, fiscal decisions of one year are not confined to that

year, but have multi-year consequences. Thus, a road map for corrective measures

will have to be drawn up carefully in the medium term. The medium term

framework allows designing implementable reforms, and applying remedies

depending on changing situations and imperatives. Therefore, the White Paper

has emphasised the need to have an explicit medium-term fiscal framework for the

State Government.

4. The preparation of Medium Term Fiscal Plan (MTFP) is part of the State

Government's commitment to greater fiscal transparency. Other important steps

already taken in this direction include publication of an "Overview of the Budget"

which provides basic fiscal data and information on guarantees. To further

improve transparency, the Govt has included in this publication information on

off-budget borrowings, tax arrears and tax expenditure (cost of tax incentives)

from the current year. The Govt has also started publishing monthly financial

accounts on the Internet (http://kar.nic.in/statebudget).

5. The medium-term framework should set fiscal targets and detail the policy

package necessary to achieve them. These targets and policies will have to be

dovetailed to the annual budgetary exercises to operationalise the restructuring

plan. The budgetary exercise also provides an opportunity for the State

government to update the medium-term fiscal framework every year. This

2

Annex CPage 3 of 24

framework sets the targets for all the years up to 2004-2005 and details the

important policy measures to achieve these targets.

6. It must be mentioned at the outset that bringing about fiscal rectitude entails

hard decisions. This has to be a rational community choice to achieve the

common good on a sustainable basis. Difficult but unavoidable measures will

have to be taken to raise revenues, to weed out unproductive expenditures,

rationalise and target subsidies, enhance efficiency and accountability in public

spending, and to stabilise debt. Postponing these measures will only compound

the problems, necessitating much harsher remedial measures in the future. After

carefully considering the available options, the State government has decided to

embark on the medium-term plan to achieve fiscal balance by reforming policies,

processes and institutions.

Il. The Problem:

7. The White Paper on the State's finances has brought out significant

deterioration in the fiscal position in Kamataka over the last decade particularly

since 1995-96. The fiscal position was transformed from a revenue surplus of

Rs.159 crores in 1995-96 (accounts) to a revenue deficit of Rs.2325 crores in

1999-2000 (accounts). Similarly, during the period from 1990-91 to 1999-2000,

the fiscal deficit increased from Rs. 513 crores to Rs.4276 crores. This has created

an unstable fiscal situation characterised by a vicious cycle of increasing interest

payments feeding into deficits and debt stock. The continuation of the prevailing

trend will surely land Karnataka in a crisis within the next few years.

8. An important cause of deteriorating fiscal situation in the State is declining

share of revenues to Gross State Domestic Product (GSDP). The ratio of tax

revenue to GSDP has fallen from 9.3% in 1990-91 to 8.2% in 1999-2000. The

ratio of non-tax revenue to GSDP has shown a decline from 2.2% in 1990-91 to

1.17% in 1999-2000, mainly due to low and declining cost recoveries from non-

3

Annex CPage 4 of 24

merit public services and poor performance of the public enterprises. Implicit

subsidies due to uneconomic pricing of irrigation and drinking water supply,

higher and technical education and urban health services amount to about 1.2 per

cent of GSDP. Cost recovery in irrigation in the State is only a fraction of the

corresponding figures prevailing in the neighbouring states.

9. An equally worrisome issue of the State finances in Kamataka is the dismal

financial performance of public utilities and enterprises. In 1998-99, the State

Government paid Rs.914 crores to Karnataka Electricity Board by way of explicit

subsidy alone. The losses from Karnataka State Road Transport Corporation in

1997-98 amounted to Rs.54.6 crores (after payment of a State Govt subsidy of

Rs.41.2 crores). Besides these, there are a number of public enterprises, many of

which are of commercial nature, which have been making significant losses. Out

of 78 Govt companies, 33 made losses in 1997-98 amounting to Rs.197 crores. In

case of 22 companies, the accumulated loss exceeds the share capital, reserves and

surpluses put together.

10. Another important reason for the fiscal problem is the fast expansion of

public expenditures within the revenue account during the last few years. The

significant increase in salary and pensions, interest payments, subsidies and

transfers has pre-empted a high and increasing proportion of borrowed funds for

meeting current expenditures. Interest payments as a proportion to GSDP

increased from 1 per cent in 1989-90 to about 2.12% per cent in 1999-2000.

During this period, the subsidies and transfers as a ratio of GSDP also increased

by about one percentage point.

11. The problem is accentuated by the declining productivity of public

expenditure, which in turn has come about due to a sharp increase in

administrative expenditures, poor maintenance of public assets, declining

proportion of capital expenditures and long gestation periods in completing

4

Annex CPage 5 of 24

infrastructure projects. Moreover, increase in indebtedness has resulted in higher

and higher amount being set apart for debt servicing, leaving a relatively less

amount for productive expenditure.

III. Objectives and Targets:

12. The medium-term fiscal restructuring plan will have to reverse the

historical trend of the deteriorating fiscal situation in order to phase out public

dissavings in the medium term so that borrowed funds are invested to create

productive assets and shore up the fiscal situation. The strategy in the medium

term should also enhance productivity in public spending to ensure efficient and

equitable delivery of public services. Finally, increasing requirements of public

expenditure should be financed through an efficient and equitable tax system and

proper cost recovery. Thus, the medium-term fiscal plan, while ensuring

satisfactory levels of infrastructure should also pave the way for increased private

sector investments, which will result in accelerating economic growth and

reducing poverty in the State.

13. The State government places emphasis on substantially achieving the above

objective in the medium term. With this in view, its main target under the

medium-term fiscal plan for 2004-05 is as follows:

(i) Phasing out revenue deficits by 2004-05 from 1.49 per cent of GSDPin 2000-01 (BE), so that borrowing is not used to finance currentexpenditures.

(ii) Reducing fiscal deficit from the present level of 3.66 per cent ofGSDP (2000-01 BE) to 3 per cent of GSDP during the same period tostabilise debt stock, and prevent an ever-increasing burden of interestpayments.

(iii) Safeguarding adequate allocation to social sectors like basic healthcare and primary and secondary education and for physical infrastructurerequirements, both for investment and for maintenance.

5

Annex CPage 6 of 24

14. These objectives will have to be achieved by initiating a concerted

programme of tax reform, reform in the structure and management of

expenditures, levying appropriate user charges, public enterprise reform and

reform in administration and governance. Specifically, achieving the above

objectives will require:

* improving the revenue productivity of the taxes by bringing aboutsystemic changes in the base, rate structure and administration andenforcement mechanisms. The simplification of the sales tax systemleading to the introduction of value added tax (VAT) would be one ofthe major reform initiatives. This would not only rationalise theconsumption tax system, but would also improve revenue productivity;

* enhancing productivity of non-tax revenues. In case of user charges, thisis to be brought about by greater community participation inmaintenance of assets and by ensuring quality and reliability of services.Public enterprise reforms would help to achieve productivity gains forgenerating better receipts;

- reducing budgetary support to public enterprises. This has to beachieved by disinvesting and restructuring public enterprises. While insome cases it may be necessary to introduce voluntary retirementschemes (VRS) to reduce over-employment, government may have toclose down or privatise some of the enterprises;

* drastic reduction of implicit and explicit subsidies to electricity andtransport sectors through economic pricing, improving productivity ingeneration, transmission and distribution and metering the consumptionof electricity by the agricultural sector and privatisation of distribution;

* achieving significant improvement in cost recoveries and reducingimplicit subsidies in respect of services, such as drinking water supply,irrigation, higher and technical education, and secondary and tertiaryhealth care, particularly those not directed to the poor;

* reducing the quantum of food subsidies by eventually targeting itstrictly to persons below the poverty line;

* improving the efficiency of government expenditures by increasingallocation to the creation and maintenance of infrastructure facilities andaugmenting outlay on human development;

6

Annex CPage 7 of 24

* compressing unproductive government expenditures by reducinggovernment employment and re-deployment to social sectors such asprimary and secondary education and health;

* assessing expenditures in irrigation, and public works departments byclosely scrutinising the schedule of unit rates. Sequencing expenditureson major projects to minimise time and cost overruns and improvingpublic expenditure management and control systems by increasing thelevel of public participation and investment (e.g. through creating wateruser associations);

* ensuring a careful debt management plan to reduce the composition ofhigh cost borrowing and to limit contingent liabilities. In particular, aclose scrutiny of contingent liabilities, moving away from borrowing athigh cost from small savings loans and from specialised financialinstitutions like HUDCO, LIC and NCDC; borrowing on the basis ofrepayment capacity rather than availability as in the past;

* improving governance, putting in place a sound public expendituremanagement programme to improve the efficiency of expenditure andtargeting.

15. The State government has already initiated a number of reform measures in

many of the above areas. These include establishment of the Tax Reforms

Commission, Administrative Reforms Commission and Public Sector

Restructuring Commission, initiating measures to restructure and privatise the

power sector, adoption of a new policy for restructuring of public sector

undertakings, increases in user charges for various services, hiring restraint and

abolition of positions, and initiating action towards introduction of Value Added

Tax. Revised estimates for 2000-01 already show a substantial improvement in

fiscal performance, for example a reduction in the fiscal deficit from 4.5% of

GSDP in 1999-2000 to 4.03% and a reduction in the revenue deficit from 2.45%

of GSDP in 1999-2000 to 2.11%.

16. Since it is the responsibility of the State Government to repay the loans

contracted by two specialised irrigation finance corporations, i.e., KBJNL and

KNNL, a set of "consolidated" fiscal indicators have been worked out by adding

7

Annex CPage 8 of 24

the off-budget borrowings and repayments to the traditional budgetary figures.

The "consolidated" figures also capture the borrowings by State undertakings, e.g.,

from HUDCO or through raising bonds, where the liability for repayment is on the

State Government. These are actual repayment liabilities of the Government and

not in the nature of contingent liabilities. MTFP assumes that such exceptional

borrowings by KBJNL and KNNL to complete the Krishna river projects will

cease by 2004-05. It is also the intention of the State Government to reduce off-

budget borrowings and to move all such borrowings back on to the budget by end-

2004-05. No additional recourse to off-budget borrowing will be made beyond the

current beneficiaries. At present, these "consolidated" figures have greater

relevance in the assessment of the true fiscal situation of the State. An important

objective of the MTFP is to stabilise consolidated debt as a ratio of GSDP, besides

reducing consolidated fiscal deficit to 3% of GSDP.

17. One important method of limiting debt service payments is to adopt a

borrowing strategy to move away from short-term/high-cost loans to long-

term/low-cost borrowings. Admittedly, small savings loans are one of the high-

cost sources of borrowing and the State Government, in order to ease its hard

budget constraint, has been encouraging borrowing from this source. This has

been one of the factors in the fast escalation of debt service payments. As a part of

debt management strategy, the government will substitute these high-cost loans

with low-cost/long-term borrowings from agencies such as the World Bank, ADB

and bilateral donor countries. Setting these targets and deciding on an appropriate

mix of borrowings would also help in stabilising public debt.

18. The fiscal restructuring plan should cover all contingent liabilities

including guarantees issues by the government. The State government has already

passed the Ceiling on Government Guarantees Act, has introduced guarantee fee,

will make budgetary provisions to meet the eventuality of possible discharge of

8

Annex CPage 9 of 24

contingent liabilities, and is presently working on the rules for sectoral allocation

of guarantees every year.

19. The next stage in working out the medium-term fiscal plan is to project the

fiscal scenario during the period on the basis of a reasonable growth of revenues

and expenditures. The target growth rates chosen for projections should take into

account the degree of fiscal correction required. These targets should be realistic

and achievable. For Karnataka, all the targets are expressed as percentages of

GSDP in the State. In order to obtain the target in absolute values, GSDP is

projected by assuming 7.5 per cent growth per year in real terms. This is in

keeping with the recent growth performance in the State, which has averaged 7.4

per cent during the 5 years ending 1998-99. The inflation rate is assumed to be 6

per cent.

20. As already mentioned, the basic reason for the fiscal imbalance in the State

is that the growth rate of revenue receipts was significantly lower than that of

revenue expenditures. During the last decade, the average annual growth rate of

revenue receipts in Kamataka was 14.9 per cent whereas revenue expenditures

grew at 15.9 per cent per annum. The actual plan of phasing out fiscal imbalance

in the State will have to combine the strategies of increasing the growth of

revenues and compressing expenditures, keeping in view the efficiency in raising

revenues and productivity of public expenditures.

21. In the medium-term fiscal plan worked out for Kamataka, a combination of

the strategies to accelerate the growth of revenues and decelerating expenditures

has been adopted. Taking the baseline fiscal situation as in 2000-2001,

expenditure and revenue projections are simulated to arrive at an implementable

plan of achieving the targets. The policy package necessary to achieve the targets

for accelerating the growth of revenues as well as decelerating the growth of

expenditures has been worked out. The detailed assumptions used for making the

9

Annex CPage 10 of 24

final set of projections of individual items of revenues and expenditures are listed

in the Annex. The policy imperatives for restoring fiscal balance in Karnataka are

discussed in the following sections.

IV. Revenue Projections and Reforms:

22. Improvement in the fiscal situation in the State cannot be achieved unless

concerted action is taken to reform the tax system. A comprehensive package of

tax reforms will be undertaken after receiving the final recommendations of the

Tax Reforms Commission, which are due in June, 2001. The Commission's

report is expected to provide a blueprint for reforms not only to minimise

distortions, but also to enhance the revenue productivity of the tax system. The

first report of the Commission submitted to the Government in February, 2001 has

highlighted the fall in growth rate of the tax revenue from 1980's to 1990's and

also the fall in the ratio of tax revenue to GSDP. At the same time, the

Commission is of the opinion that tax rates are generally high. The crucial issues

that need to be addressed are to expand the tax base, i.e., improve coverage and

reduce exemptions, rationalise tax structure, improve tax compliance and

strengthen tax administration and enforcement. The Commission has

recommended simplification of the sales tax system with a view to introducing a

Value Added Tax and has provided a road map for the same. It has also given

concrete recommendations to improve revenue productivity in case of State Excise

Duties, Motor Vehicles Tax, stamp duties and registration fees and the profession

tax. Some of the recommendations have already been incorporated into the budget

of 2001-02. The State Government will prepare an implementation programme

based on the Commission's recommendations to improve the tax buoyancy.

23. In the mean time a number of steps have already been taken to improve the

buoyancy of commercial taxes. The recent imposition of floor rates in all the

States and Union Territories is likely to reduce revenue loss due to trade diversion.

10


The abolition of tax incentives for industries too will improve the revenues and

reduce distortions. A decision has been taken to bring about a phased introduction

of Value Added Tax (VAT) in 2002. The introduction of VAT, though predicated

to be revenue neutral, may result in a small decline in the revenue in the short run.

The government will have to improve the administration and enforcement of the

taxes to make sure that this decline is confined to only the initial period of 2 years.

24. The reform measures already initiated and those that will be taken up are

expected to improve revenue productivity of the tax system. The historical

buoyancies and those that are assumed in our projection are given in the Annex.

Implementation of tax reforms in the coming years and better administration and

enforcement of the taxes are expected to improve revenue productivity at least to

the extent assumed in this exercise, and will also result in an improved tax-GSDP

ratio (from 8.15% in 1999-2000 to 9.42% in 2004-05). Tax-GSDP ratio has

already improved from 8.15% in 1999-2000 to 8.95% in 2000-01 (RE).

25. In regard to non-tax revenues, the Government's objective is to improve

cost recovery in general and to ensure full recovery of operating costs for non-

meritorious economic services. However, it will take time to achieve this goal, and

will be attempted in a progressive manner. In order to inculcate a sense of

ownership of assets and services, beneficiaries should contribute towards the

capital costs, either at the initial stage of the project, or later during the operation

of the services. Appropriate policy measures will have to be taken to increase user

charges from higher and technical education, health, irrigation and drinking water

supply. This will be easier to achieve if simultaneous steps are taken to enhance

the quality of service provided to the users. Higher cost recoveries in respect of

these services are necessary not merely to improve the fiscal situation but also to

reflect their economic values with appropriate adjustment made for social

obligations. Thus, in the case of the health sector, proper pricing of secondary and

tertiary health care services and various clinical and other medical tests conducted

11


in the hospitals and dispensaries should help in achieving higher cost recovery.

Similarly, cost recovery in secondary education is estimated to increase from

0.95% (2000-01 RE) to 2.13%, in higher education from 0.3% to 2.2%, in

technical education from 3.2% to 22.5%, in major and medium irrigation from

33% to 82%, in minor irrigation from 5.26% to 20%, and in rural drinking water

supply from 0.61% to 2%. Other non-tax revenues are assumed to grow at their

historical rates. The detailed cost recovery rates in each of the five years from

2001-05 for these sectors are presented in the Annex. The State Government has

already revised the irrigation water rates during 2000-01 to about 2.5 times of the

earlier rate. In case of rural water supply and health, the improved recovery will be

used at the field level to meet part of the O&M expenditure and will not come

back to the Government. This envisages progressively greater participation of the

community in maintaining the assets.

26. Another area where concerted effort is needed is to enhance recoveries

from the beneficiaries of housing provided by the government. While the

expenditure on housing has increased substantially over the years, cost recovery

from beneficiaries is negligible. Only when loans are recovered from beneficiaries

will it be possible for the Government to repay the loan to the Housing Finance

Agencies and obtain more loans for new beneficiaries. It is therefore proposed that

on housing loans, the recovery will be stepped up from 18% in 2001-02 to 31% in

2004-05.

27. Karnataka state has been a pioneer in democratic decentralisation. Rural

and Urban Local Bodies receive funds from the State Government as per the

recommendations of the State Finance Commission. However, these bodies are

short of funds and are unable to provide satisfactory standards of services.

Government will explore possibilities of augmentation of revenue of these local

bodies. A system of self-assessment of property tax has shown considerable

promise in Bangalore city. This will be gradually extended to other cities.

12


28. Revenue from central transfers accruing to the State depends on the

recommendations of the Finance Commission, policies of the Planning

Commission and programmes of the central ministries implemented through the

States. The Eleventh Finance Commission has already made its recommendations

regarding tax devolution, non-plan grants, and calamity relief. The State's

entitlement for the five years has been worked out on the basis of these estimates.

The second report of the Finance Commission deals with an incentive-linked

additional transfer based on the fiscal reforms undertaken by the States. Since the

present MTFP is fully consistent with such fiscal reforms, the allocation made for

Karnataka on this account has been assumed in the MTFP.

29. The State Government recognises the importance of an accurate model for

arriving at revenue projections for each year during the budgetary exercise. To

improve revenue and expenditure forecasting, a study on fiscal marksmanship has

been commissioned. Its results will be used from the budgetary cycle of 2002-03.

V. Expenditure Reforms

30. Restoring fiscal health in Karnataka critically depends upon compressing

unproductive expenditures and improve public expenditure prioritisation to

enhance efficiency and effectiveness. It is also necessary to provide adequately

for maintenance of existing assets. Continuously increasing the plan expenditures

on the assumption that they are necessarily productive will only result in

negligence of maintenance, which reduces technical efficiency in spending, as has

been the case in the past. The expenditure policy, thus, will have to be calibrated

to conform closely to the fiscal targets, commitments and priorities.

13


31. One of the most important components of expenditure expansion in recent

years has been wages and salaries. The government has already announced its

intention of abolishing 80 per cent of the vacant posts as per the Finance

Minister's budget speech of 2000-01. This implies that almost 10 per cent of the

posts of the State government would have to be reduced. However, while drawing

up the medium term fiscal plan, liberal exemptions have been allowed in case of

primary and secondary education, health, police, forest and wildlife protection as

indicated in the Annex.

32. Another measure in the downsizing agenda is to leave posts vacant when

the incumbents retire. The State government intends to abolish one-third of the

retiring posts (other than primary and secondary education, health, police, forest

and wildlife protection) in each of the ensuing four years. This would require

detailed department-wise personnel planning, which will be undertaken as soon as

possible. The two measures taken together will reduce the number of government

posts by more than 12 per cent by 2004-05. Similarly, measures have already been

initiated to reduce grants-in-aid to private higher educational institutions.

33. Unfortunately, there is not much flexibility in regard to expenditure on

pensions and interest payments. Nevertheless, in the case of the latter, attempts

will be made to reduce the composition of loans bearing high interest rates. Since

a regime of falling interest rate prevails now, efforts are on to retire high cost debts

of KBJNL by using fresh low-cost borrowings. Government will improve its

pension forecasting capability through, inter alia, establishment of a human

resources database.

34. As already mentioned, it is necessary to improve the productivity of public

spending even while reducing expenditures. A major target of the medium term

plan is to ensure adequate investments in the creation and maintenance of physical

infrastructure. This is necessary to ensure a competitive edge to the economy.

14


Therefore, the medium-term fiscal plan makes adequate allocation to maintenance

of roads, buildings and irrigation works. In order to ensure this, the framework

has provided for gradually enhancing the allocation so as to match the Eleventh

Finance Commission norms. This involves significant stepping up of expenditures

in these sectors. From the viewpoint of expenditure efficiency, stepping up

expenditures in these sectors is highly desirable.

35. Another important area of fiscal correction is in compressing subsidies.

This is an area where significant effort is necessary. As outlined in the White

Paper, the State government has already commissioned a detailed study to quantify

the volume and composition of implicit and explicit subsidies and to formulate

appropriate strategies to reduce them in a phased manner, inter alia, through better

targeting.

36. The power sector represents a huge drain on the Government's resources

and poses the biggest fiscal risk in the near future. It will be impossible to

eliminate revenue deficit without comprehensive structural reforms in this sector.

Recognising this, the State Government has set up a regulatory commission, which

has already issued its first tariff order. The electricity board has been corporatised

and generation has been separated from transmission and distribution. Key to

eliminating power sector subsidy is loss reduction, which will be done through

universal metering and privatisation of distribution, and regular tariff increases to

achieve full cost recovery. The MTFP assumes progressive decline in T&D losses

from 37% in 2000-01 to 28% in 2004-05. The power sector reforms will bring

back fiscal sustainability to the sector and make power supply more reliable for

the consumers thus spurring economic growth. In the interim period, Government

is fully_committed to meeting its financial obligations to the sector. Consistent

with the MTFP, the Government has drawn up a Financial Restructuring Plan for

the power sector, which gives a road map for elimination of subsidy over the next

10 years.

15

Amex CPage 160of24

37. Among explicit subsidies that need to be properly targeted is the food

subsidy being given to ration cardholders. At present there are about 65 lakh green

cards meant for families below poverty line. These cards entitle the families to buy

food grains at a subsidised rate. The total subsidy stands at Rs.300 crores in 2000-

01. The actual number of families below poverty line (BPL) in the State is much

lower than this number and is estimated at about 30 lakh. Thus there were 35 lakh

EBPL (extra BPL) cards, which could avail of food grain at BPL rate, but for

which the State Government had to pay to FCI at a much higher APL (above

poverty line) rate. Government has issued orders in July 2000 to remove 8 lakh

ineligible cards from this category. This will significantly reduce the subsidy

burden. Constant efforts will be made to target the subsidy to deserving

beneficiaries in future. With this in mind, a new category of yellow cards for only

BPL families is being introduced to target the really needy beneficiaries. For

others left over under green card scheme, average prices of commodities will be

higher requiring less subsidy per family. It is assumed that in each of the years

from 2001-02 onwards, additional cards would be removed from EBPL category,

The Government intends to cap the food subsidy in nominal terms to the level

prevailing in 2000-01 and would work out a detailed strategy to make this happen.

38. In the case of the transport sector too, significant reduction in subsidies is

envisaged by rationalising the pricing policy and improving productivity. The cost

recovery from concessional pass holders is targeted to improve from 6% to 15%

while permitting cross subsidisation from 74% at present to 82% in 2004-05

thereby reducing the subsidy obligation. The State Government has already

permitted Road Transport Corporations to modify tariff automatically based on

change in costs of inputs like diesel and salary.

39. Government used to give subsidies to encourage establishment of small

scale industries. It was not possible to discharge the liabilities from year to year on

this account. The liability has been discharged as a one-time measure through

16


raising of bonds by KSFC, where the repayment obligation is on State

Government. This has been captured in the Medium Term Fiscal Plan. From April

2000, this subsidy is limited to only tiny industries thereby bringing down the

annual liability to a large extent.

40. Social welfare expenditure is meant to benefit the scheduled castes,

scheduled tribes, backward classes, minorities and other weaker sections of the

society. The State Government will try to ensure that assistance to these

disadvantaged sections will be continued and in some cases expanded to enable

them to access the benefits of growth. Thus, strength in social welfare hostels is

assumed to increase at the rate of 2 per cent per year. Anganwadi expenditures are

projected on the assumption of the number of children increasing at 2 per cent, the

unit rate increasing by 20 per cent in 2001-02 and the remaining at that level till

2004-05. Social pensions too are projected to increase by 2 per cent per year and

all other items of social welfare expenditure are assumed to grow at the rate of

inflation.

41. Given that the State government has predominant responsibility in

development of human capital, while compressing expenditure growth, it is

necessary to protect allocations to the social sectors like primary and secondary

education and health. As already mentioned earlier, 50 per cent of the vacant

posts to be filled are assumed to be transferred to education and health sectors. In

estimating the salary expenditures of these sectors, this additional employment has

been taken account of. This additional provision of posts in these sectors is

expected to ensure better spread and improvement in the quality of social services.

The non-salary component of expenditure in education and health is assumed to

increase significantly. With these projections, there would be adequate allocation

for elementary education to achieve 100% enrolment by 2006-07. Specifically,

the State Government's target is to ensure that by 2007, all children in the school

going age group of 6-14 years are not only enrolled, but are enabled to complete 8

17


years of schooling. Similarly, the enhanced allocation in health sector would be an

important step in ensuring universal access to primary health care, and achieving

the State's health targets.

42. A major target of the medium term fiscal plan is to ensure adequate

investment in physical infrastructure, which has a catalytic effect on economic

growth. In the Medium Term Fiscal Plan, reduction of revenue expenditure would

result in more funds being freed for capital outlay. In turn, better physical

infrastructure would attract larger private investment into the State to complement

the efforts of the State Government. Another important feature would be

completion of most of the irrigation works in Krishna Basin by 2003-04, which

would free resources for capital expenditure in other critical sectors. Thus the on-

budget capital expenditure (actual expenditure on capital formation) will go up to

a healthy 2.41% of GSDP, while off-budget capital expenditure will decline. It

will also ensure that the size of the annual plan grows at a healthy rate and a

greater portion of the plan is used for capital formation rather than on revenue

account. More specifically, capital expenditure on drinking water supply, roads

and bridges, education and health would receive a very significant boost.

43. The MTFP projections will result in significant increase in high priority

development expenditures in a progressive manner throughout the five-year

period. These expenditures can basically be classified into two types: (i)

expenditure on social sectors and human capital formation, and (ii) expenditure on

creation and maintenance of physical infrastructure. The projections on this count

are given in the Annex.

44. An important component of expenditure reform is establishment of a

system of accountability and incentives in expenditure implementation. This calls

for a thorough overhaul of the public expenditure management system. Fixation

of responsibilities to individual agents and ensuring the establishment of a system

lX


to ensure effective implementation are necessary to impart efficiency in public

spending. The system should ensure that the expenditures are indeed incurred for

the intended purpose in a productive manner to ensure creation of value for money

spent. The system should create enough disincentives for rent seeking behaviour.

As a first step, the Government has already constituted an Expenditure Review

Committee with a mandate to scrutinise all new expenditure proposals and

underlying policies, particularly with reference to their medium term implications.

The policy paper on governance will consider the issue of public expenditure

management in greater detail.

45. The policy changes envisaged when translated in terms of projection of

revenues and expenditures show phasing out of the revenue deficit in Karnataka as

a part of the set target. In fact, the projections based on the assumptions detailed

in the Annex are estimated to improve the revenue deficit from 1.49% (2000-01

BE) to a revenue surplus of 0.42% in 2004-05, and the consolidated revenue

deficit of 2.01% of GSDP (2000-01 BE) to 0.17% in 2004-05. Similarly, as per

the target, the on-budget capital expenditures are estimated to increase from the

present level of 1.66% of GSDP (2000-01 BE) to 2.41% in 2004-05. Consolidated

fiscal deficit during the same period would decrease from 5.44% of GSDP to

2.76%. The consolidated debt stock, after showing an initial increase from the

current level of 30.61% (2000-01 BE) to 32.65% in 2001-02, will decline to

31.03% in 2004-05 and will continue to fall thereafter. The main fiscal indicators

in terms of rupees and as percentage of GSDP are given in Tables 1 & 2

respectively.

19


TABLE - 1

KARNATAKA MEDIUM TERM FISCAL PLAN

(Rs. Crores at current prices)

1999- 2000- 2000- 2001- 2002- 2003- 2004-Item 2000 2001 2001 2002 2003 2004 2005

Accts. BE RE BE Proj. Proj. Proj.1. Revenue Receipts 12410 15090 14429 17328 19680 22513 26105

1 (a) State' Own Tax Revenues 7744 9399 9214 10851 12066 13854 164351(b)NonTaxRevenues 1115 1239 850 1304 1419 1551 17211 (c) Resources from the Centre 3551 4452 4365 5173 6196 7108 7949

2. Revenue Expenditure 14735 16626 16604 19952 22036 23719 253682 (a) Interest 2012 2393 2417 2849 3233 3847 44772 (b) Salaries 4576 5005 4765 5290 5789 6137 64992(c)Pensions 1539 1578 1569 1811 1980 2120 24102 (d) (i) Subsidies (Food, Housing,

Transport, & Industry) 599 624 664 756 840 831 8342 (d) (ii) Power Subsidy 771 878 879 2300 2339 2065 14152 (e) Major O&M (Roads, Buildings &

Irrigation) 342 404 468 452 545 633 7402 (f) Other O&M (Edn, Health, RD, WS,

Agriculture & Forest) 1502 1827 1755 1835 2368 2839 33942 (g) Devolution to ULBs 416 537 510 676 756 863 10172 (h) Administrative Expenditure 470 438 441 455 487 516 5482 (i) Other Revenue Expenditure 2509 2942 3136 3528 3701 3868 4034

3. Revenue Deficit {(2) - (1)} 2325 1536 2175 2624 2336 1206 -7374. Capital Receipt (Non-debt) 145 168 163 202 202 202 2025. Capital Expenditure /a 1701 1707 1612 1947 2267 2837 42106. Fiscal Deficit 4276 3767 4148 5127 5670 5665 52347. Total Debt Stock 26271 26545 26545 31673 35465 41130 463648. Debt Service 2503 2905 2934 3555 4061 4927 5757

9.Salary+Pension-Hrnterest 8127 8976 8751 9950 11002 12104 13385

10. Consolidated Revenue Deficit 2721 2072 2525 3296 3340 2277 29511. Consolidated Fiscal Deficit 5288 5601 6017 6926 6855 5841 481812. Consolidated Capital Expenditure 2712 3695 3599 3832 3738 3767 472413. Consolidated Interest 2407 2928 2766 3564 4218 4918 551014. Consolidated Debt Stock 28406 31525 31525 38497 43474 49315 5413215 Off-budget Borrowings 1011 1987 1987 1885 1450 930 514

16 Interest/Revenue 16.21% 15.86% 16.75% 16.44% 16.43% 17.09% 17.15%17 Consolidated Interest/Revenue 19.40% 19.40% 19.17% 20.57% 21.43% 21.85% 21.11%18 Debt Service/Revenue 20.17% 19.25% 20.33% 20.52% 20.63% 21.89% 22.05%

19 Salary+Pension+lnterest)/Revenue 65.49% 59.49% 60.65% 57.42% 55.90% 53.77% 50.27%

/a Capital expenditure is actual expenditure on capital formation, and excludes debt-servicing of off-budget borrowing,which is included in capital expenditure under budgetary definitions. Thus, in this table, the fiscal deficit does not equalthe revenue deficit plus capital expenditure (net receipts).

20


TABLE - 2

KARNATAKA MEDIUM TERM FISCAL PLAN

(as percentage of GSDP)

1999- 2000- 2000- 2001- 2002- 2003- 2004-Item 2000 2001 2001 2002 2003 2004 2005

Accts. BE RE BE Proj. Proj. Proj.

GSDPatCurrentPrices(Rs.crores) 94991 102994 102994 117915 134364 153108 174467Inflation 7.50% 6.50% 6.50% 6.50% 6.00% 6.00% 6.00%GSDP Annual Real Growth 7.50% 7.50% 7.50% 7.50% 7.50% 7.50% 7.50%

1. Revenue Receipts 13.06% 14.65% 14.01% 14.70% 14.65% 14.70% 14.96%1 (a) State' Own Tax Revenues 8.15% 9.13% 8.95% 9.20% 8.98% 9.05% 9.42%1 (b) Non Tax Revenues 1.17% 1.20% 0.83% 1.11% 1.06% 1.01% 0.99%1 (c) Resources from the Centre 3.74% 4.32% 4.24% 4.39% 4.61% 4.64% 4.56%

2. Revenue Expenditure 15.51% 16.14% 16.12% 16.92% 16.40% 15.49% 14.54%2 (a) Interest 2.12% 2.32% 2.35% 2.42% 2.41% 2.51% 2.57%2 (b) Salaries 4.82% 4.86% 4.63% 4.49% 4.31% 4.01% 3.72%2 (c) Pensions 1.62% 1.53% 1.52% 1.54% 1.47% 1.38% 1.38%2 (d) (i) Subsidies

(Food,Transport, 0.63% 0.61% 0.64% 0.64% 0.62% 0.54% 0.48%Housing & Industry)

2 (d) (ii) Power Subsidy 0.81% 0.85% 0.85% 1.95% 1.74% 1.35% 0.81%2 (e) Major O&M (Roads,Buildings &

Irrigation) 0.36% 0.39% 0.45% 0.38% 0.41% 0.41% 0.42%2 (f) Devolution to ULBs 0.44% 0.52% 0.50% 0.57% 0.56% 0.56% 0.58%2 (g) Other O&M (Edn, Health,

RD, WS, Agri, Forest) 1.58% 1.77% 1.70% 1.56% 1.76% 1.85% 1.95%2 (h) Administrative Expenditure 0.49% 0.43% 0.43% 0.39% 0.36% 0.34% 0.31%2 (i) Other Revenue Expenditure 2.64% 2.86% 3.05% 2.99% 2.75% 2.53% 2.31%

3. Revenue Deficit 2.45% 1.49% 2.11% 2.23% 1.75% 0.79% -0.42%

4. Capital Receipt 0.15% 0.16% 0.16% 0.17% 0.15% 0.13% 0.11%5. Capital Expenditure /a 1.79% 1.66% 1.56% 1.65% 1.69% 1.85% 2.41%6. Fiscal Deficit 4.50% 3.66% 4.03% 4.35% 4.22% 3.70% 3.00%7. Total Debt Stock 27.66% 25.77% 25.77% 26.86% 26.39% 26.86% 26.57%

8. Debt Service 20.17% 19.25% 20.33% 20.52% 20.63% 21.89% 22.05%9. Salary+Pension+lnterest 65.49% 59.49% 60.65% 57.42% 55.90% 53.77% 51.27%

10. Consolidated Revenue Deficit 2.86% 2.01% 2.63% 2.80% 2.49% 1.49% 0.17%11. Consolidated Fiscal Deficit 5.57% 5.44% 5.81% 5.87% 5.10% 3.82% 2.76%

12. Consolidated Capital Expend. 2.86% 3.59% 3.49% 3.25% 2.77% 2.46% 2.71%13. Consolidated Interest 2.53% 2.84% 2.87% 3.02% 3.14% 3.21% 3.16%14. Consolidated Debt Stock 29.90% 30.61% 30.61% 32.65% 32.35% 32.21% 31.03%15 Off-budget Borrowings 1.06% 1.93% 1.93% 1.60% 1.08% 0.61% 0.29%

/a Capital expenditure is actual expenditure on capital formation, and excludes debt-servicing of off-budget borrowing,which is included in capital expenditure under budgetary definitions. Thus, in this table, the fiscal deficit does not equalthe revenue deficit plus capital expenditure (net receipts).

21


46. In the MTFP, the fiscal deficit and the revenue deficit fall every year till the

Government's targets are reached in 2004-05. The only exception is the year

2001-02, when the revenue and fiscal deficits rise. This happens because the

Government is providing full funding for the power sector subsidy, which was not

the case in the previous years. Over time, the power sector restructuring will

greatly reduce the power subsidy, but in the interim period, full funding of this

subsidy is essential to improve the quality of supply and to enable the restructuring

to succeed. If the power sector requirement had been fully met in 2000-01 (RE),

the fiscal deficit would have been Rs.5335 crores. This shows that in 2001-02, the

underlying fiscal position does in fact improve, as the fiscal deficit with full

funding of the power subsidy requirement is lower at Rs.5 127 crores.

VI. Conclusion:

47. As stated in the White Paper, the State government is determined to restore

fiscal balance, improve the standards of physical and social infrastructure and

ensure a competitive advantage to Karnataka. The medium-term fiscal plan

detailed above provides a blueprint for the state government to undertake

necessary reforms to move in the desired direction.

48. The assumptions made in this exercise are realistic and the correctives

considered are feasible. It is imperative to undertake these reforms in all

seriousness if the objective of ensuring a sustainable fiscal situation in the State

has to be achieved. In fact, if the reforms detailed above are implemented

effectively, it will also enhance the competitive edge of the State.

22


49. While effective implementation of reforms on the lines explained in this

document should enable the State government to meet the objectives of achieving

fiscal rectitude, stabilising debt and creating quality infrastructure, it must be

noted that many of the reform measures can involve some cost to the exchequer in

the short and long terms. The power sector reforms will have to be calibrated

carefully, and substantial initial government support will be needed to unbundle

and restructure the sector. The beneficial results of the reform measures will only

accrue in the medium term. Introduction of a workable voluntary retirement

scheme for public sector enterprises would require initial financial support from

Government to a large extent, though a part of the cost will be recovered from the

disinvestment and sale proceeds of assets of the enterprises and the rest from the

savings of implicit subsidies being doled out to PSUs. Design of VAT will assume

revenue neutrality but in the initial couple of years there could be a loss of

revenue, which has been explicitly provided for. To achieve fiscal sustainability in

the medium term, these costs of reforms are inevitable and have been taken into

account while preparing the fiscal plan. It is expected that these costs will be more

than made good in the long run through attainment of fiscal sustainability and by

imparting greater competitiveness to the economy. The cost can also be minimised

through additional efforts in the direction of broad-basing of tax and non-tax

revenue streams and putting in place an effective enforcement mechanism and

through constant vigil on the expenditure side, particularly on compression of non-

productive expenditure and on improvement of composition and effectiveness of

expenditure.

50. The Medium Term Fiscal Plan is an attempt by the State Government to

achieve fiscal sustainability over the next 5 years. The implementation of the plan

will create an appropriate enabling environment for higher investment in critical

infrastructure and social sectors, which in turn will spur economic growth. This

23


will result in a virtuous circle of higher revenue receipt and increased capacity of

the Government to spend more on desirable activities. This in turn will enable the

State to put up a relentless struggle on poverty and backwardness. Keeping in view

the objectives and targets of the Medium Term Plan, the Government will design a

matrix of reforms measures for implementation so as to achieve the desired end.

Government is also committed to tabling a Fiscal Responsibility Bill in the

Legislature, so that the MTFP can receive adequate legal backing. It is extremely

important to ensure that the contours of the plan are kept in sight while preparing

annual budgets. The Medium Term Fiscal Plan is essentially a dynamic document,

which will have to be updated every year based on the performance of the

previous years to monitor the progress of reforms. In the interest of fiscal

transparency, MTFPs from next year onwards would also include a report of

performance against targets in the previous year in addition to a summary of

economic prospects as well as a statement of fiscal policies and forward

projections. This will enable the Government to take additional measures to set the

reforms programme in course. These fiscal reforms accompanied by governance

and sectoral reforms are expected to project the State to a path of high trajectory

growth and are expected to result in substantial reduction of poverty.

24

Annex DPage 1 of 12

Governance Strategy and Action Plan in Karnataka.

While Karnataka has made considerable progress on various frontssince it gained statehood, and while it is cited as one of the better-administered states in India, it is being increasingly felt that in order to meetthe legitimate aspirations of the citizens, to cope effectively with the complexactivities which the Government needs to undertake, to meet the challengesposed by the revolutionary changes taking place in the world and to enableKarnataka to remain in the forefront in a highly competitive environment, it isessential for the State to evolve a strategy for governance and to implementit in a time-bound manner.

2. Indeed, today, all nations of the world and states in India aretaking a fresh look, inter-alia, at their goals and objectives, at the activities inwhich they are involved and at the existing machinery and systems fordelivering services, in order to devise ways and means to make theadministration more transparent, efficient and responsive.

3. From the financial point of view, there is an urgent need to seehow, by cutting down on non-productive expenditure, resources can befound for sectors like infrastructure, agriculture, education, health, povertyalleviation. An embarrassingly large percentage of the revenue realized isbeing utilized for payment of salaries and wages at a time when more fundsare required for improving the quality of life of the common man. Thissituation calls for a reorientation of the fiscal system of the state so that thepattern of public expenditure supports the achievement of the pressingsocio-economic concerns.

4. It is in this background that the Government had requested theIndian Institute of Management to conduct a study on an overall frameworkfor the governance strategy. The Government had also constituted theAdministrative Reforms Commission, which has submitted its interim report.

5. Now the Government is taking the initiative of pronouncing itsgovernance strategy. The strategy highlights the areas, which will receivespecial focus and where reforms will be introduced. While an action planfor implementing the strategy is also envisaged, for some of the areas theactual implementation schedule will be drawn up after the required studieshave been completed and after the final report of the AdministrativeReforms Commission is received.

6. Government of Karnataka's governance reforms strategy is twopronged (i) Rationalize the role of the state to focus on the most criticalpublic goods and services which the private market cannot effectivelysupply, and (ii) Enhance the effectiveness, transparency and accountabilityby which the state performs this role.

Annex DPage 2 of 12

7. The rationalization of the role of the state will be achieved by: -

(a) Development and implementation of a MediumTerm Fiscal Plan (MTFP): -

The basic objective of the MTFP, which has beeninitially drawn up for a period of five years, is tointroduce fiscal discipline. It will chart out how thefiscal recovery will take place. Revenue deficit willbe brought down to zero by 2004-5 and the fiscaldeficit to 3% of GSDP by the same year. Toreinforce progress in this area, the Governmentintends to bring forward a Fiscal Responsibility Bill.Success in making the power sector commerciallyviable will play a crucial role in the fiscal recovery.Therefore a financial restructuring plan for the powersector consistent with the MTFP has also beendrawn up. The MTFP and the financial restructuringplan for the power sector will be placed before theLegislature.

(b) A review has been made of out-dated State Actsand amendments and action taken to repeal them.Progress has been made in this direction and twelveActs and more than a thousand amendment Actshave been repealed. This process will continue.

(c) A high level committee has already scrutinized theexisting schemes of various Departments. Basedon the recommendations of the Committee, morethan 21 schemes have been eliminated during thebudget for 2001-2002. Over all, as a result ofmerger, consolidation and outright elimination therehas been a reduction of 78 schemes during thecurrent year.

(d) Public enterprise privatization and restructuring: -

The Government has already issued a PolicyDocument and action plan for reforms to be broughtabout in the State Public Sector.

The main ingredients of the poiicy are-

(i) Privatizing or closing those PSEs whoseactivities are commercial in nature or whichproduce consumer goods and in which there is astrong private sector presence;

Annex DPage 3 of 12

(ii) PSEs not involved in commercial activities wouldbe restructured by induction of strategic partnersor through merger and reorganization;

(iii) While bringing about efficiency in the PSEsproviding utilities through such regulatoryauthorities as may be necessary, private sectorparticipation in ownership and management ofutility services would also be encouraged andfacilitated;

(iv) Voluntary retirement schemes and redeploymentwill be provided for and a suitable mechanism ofsocial safety net would be developed to ensurethat the interests of the labour are adequatelyprotected.

(v) Suitable measures would be taken to mitigateenvironmental aspects.

By March 2002, action will have been taken toprivatize, disinvest in or close at least tenenterprises.

(e) Restructuring and Reorganization of GovemmentDepartments: -

Functional reviews of Government Departments isbeing undertaken to identify possibilities of reductionor consolidation. The Mines and GeologyDepartment has already been consolidated underthe Water Resources Department. A decision hasbeen taken to merge the Institutional FinanceDepartment with the Finance Department. Thepossibility of outsourcing certain services will beexamined. All departments will be required toidentify activities from which the State can withdraw.

8. The second major plank of the governance strategy would be tobring in effectiveness, transparency and accountability in the functioning ofvarious agencies. This would include

(i) administrative and civil service reform aimed at reducing excessivepatronage and enhancing the productivity of the civil service

(ii) sound public expenditure, financial management and accountabilitysystems to enable the Government to achieve fiscal discipline,allocate resources in line with its strategic priorities and ensureefficient and effective use of public resources. (iii) Greater publictransparency and oversight on government functioning through

Annex DPage 4 of 12

right to information, citizen charters, service delivery surveys, publicmonitoring of Government's anti-corruption programme and (iv)simplification and decentralization by strengthening accountabilitymechanisms at the local levels while enhancing autonomy.

9. Reforms in the administrative and civil service would include: -

(a) Drastic reduction in the politicized and prematuretransfers that disrupt the functioning of the publicadministration, undermine the ability of civil servants tocommit themselves to the job, and lead to significantopportunities for corruption. Government shall amendthe rules under the Karnataka State Civil Services Act,1978 in order to bring in objectivity and transparencywhile effecting transfers. Transfers will be effected byCommittees, the constitution of which will be specified;the maximum and minimum tenures for variouscategories of officers will be prescribed and a systemwill be put in place to monitor and publicly report on thenumber of transfers department-wise and district-wise.Reasons for effecting pre-mature transfers will beclearly specified in the Transfer Order. At a subsequentdate, a legislation on the subject will also be taken up.

(b) Merit based recruitment will be further strengthenedand transparency in recruitment increased. In theMedical and Health Department, the EducationDepartment and for some posts like Stenographers,First Division Assistants etc., recruitment is alreadymade on the basis of marks obtained in the qualifyingexamination or the special written competitiveexamination. This system will be extended to otherrecruitments to reduce\eliminate weightage tointerviews.

(c) The relevant provisions of the Karnataka CivilService Rules will be amended to enable compulsoryretirement of inefficient government employees evenbefore they complete 25 years of service.

(d) After necessary studies, the manpower in variousdepartments will be right-sized and systems introducedto "de-layer" and ensure disposal of files withinprescribed time limits. The Secretariat Manual of OfficeProcedure will be revised and amended to reflect thenew systems, which will be put in place.

10. Reforms in the area of public expenditure, financialmanagement and accountability systems would cover: -

Annex DPage 5 of 12

(a) To identify the medium-term costs of new and existingpolicies and make recommendations on departmental hardbudget constraints, an Expenditure Review Committee(ERC) has been set up comprising of representatives fromFinance, Planning and a few key spending departments.No new major scheme will be introduced without scrutiny ofthe ERC. It is proposed to allow line departments toprioritize spending within hard budgets with a scope toretain a significant portion of any identified savings but witha requirement to report on key outputs and outcomes.Ultimately, adequate incentives will be provided foradhering to the MTFP fiscal targets. Three pilotDepartments (Health and Family Welfare, Primary andSecondary Education and PWD) have prepared sectoralpolicy notes consistent with the MTFP.

(b) Focus on performance will be reinforced through animpact and performance evaluation study of ongoingprogrammes and schemes and through introduction ofPerformance Monitoring and Improvement Initiatives. AGovernment Order has already been issued earmarkingfunds for evaluation of major schemes.

(c) A Controller's Office is being established in the FinanceDepartment to spearhead public financial accountability. ATask Force has been established to guide themodernization programme. Financial reporting is beingmade more timely, and monthly and annual accounts arenow published on the internet. Key accounting functionssuch as Treasury, DDOs, payroll, and ZillaPanchayats/Taluk Panchayats accounting are beingprogressively computerized. Backlog of accounts andaudit in public sector enterprises, local bodies,Departmental Undertakings and other institutions is beingcleared. Measures will be taken to provide and discloseresponses to audit observations and ensure follow-upaction, in a timely manner. Measures will also be taken toimprove internal controls in areas such as reconciliation,Personal Deposit accounts, loans/advances, andguarantee/debt recording and reporting.

(d) The process of public procurement will be made moretransparent. The "Karnataka Transparency in PublicProcurement Act" has been put in place. The Act laysdown clear procedures for Tender Inviting and TenderAccepting authorities. Details of all tender applicationsreceived and accepted are now required to be published ina Tender Bulletin maintained by departments at both theState and district levels. Some of the agencies have put

Annex DPage 6 of 12

the tender bulletins on the Internet for easy accessibility.Other Departments will adopt this practice.

11. The effectiveness of the state institutions will beconsiderably enhanced by facilitating much greater publictransparency, participation and oversight. Measuresinclude:

(a) G.O.K. has passed a far-reaching Right toInformation Act. The Act has very limited number ofexemptions, and represents a major step towards amore transparent form of government in Karnataka. Tostrengthen this initiative, G.O.K. will initiate the processof cataloging and indexing its records and seek inputsfrom the public - through periodic surveys - to identifythe specific forms of information that the public wouldmost like to see. Rules under the Karnataka Right toInformation Act will be framed by November 30th,2001.

(b) G.O.K. has initiated the public dissemination ofcitizens' charters (specifying standards of servicedelivery and grievance redressal mechanisms) for anumber of agencies, including the BangaloreMetropolitan Transport Corporation and the KarnatakaPower Transmission Corporation Limited. G.O.K. hasambitious plans to extend citizens' charters to much ofGovernment. To ensure that citizens' charters arecredibly implemented, G.O.K. will focus first on fourpublic services with large public interface (e.g., stampsand registration, maternity patients in BangaloreMahanagar Palike, regional transport and police),specify improved standards through citizens' charters,provide managerial flexibility to these service providersin exchange for accountability to achieve intendedresults; initiate business process re-engineering to meetstipulated service standards; and conduct initial usersurveys to establish baseline data. Beneficiary surveysfrom users of public services will also begin to beinitiated by Government departments themselves withpublic interface to assess user satisfaction, identifyproblems and take corrective actions. This will beginwith a survey for the four focus services with citizencharters indicated above.

(c) G.O.K. has launched a number of initiatives in thearea of electronic governance for public transparencyand for better functioning of departments. These

Annex DPage 7 of 12

include initiation of agricultural titles and tenancyinformation computerization, treasury computerization,computerization of the sales tax departments, and anumber of G.O.K. departments now have web sites.The scope for e-governance is much greater, andG.O.K. will prepare a status report and action plan on e-governance initiatives.

(d) Government of Karnataka has constituted theHuman Development Division in the PlanningDepartment which will (i) Monitor progress in key areasrelated to poverty and human development, (ii) Identifyemerging problems that may have an adverse impacton the poor (iii) Help the Government, through itsmonitoring, to take more informed decisions. The list ofpoverty and human development indicators has beenfinalized. Special surveys and studies will be initiated.Strategic guidance and advice to this division will beprovided by an advisory group chaired by the ChiefSecretary.

(e) (i) The Lok Ayukta plays an important role in theenforcement of Karnataka's anti-corruption efforts.Measures to increase the effectiveness of the LokAyukta will be identified. The records of the Office ofthe Lok Ayukta will be computerized and a reviewundertaken of the procedures under the Lok AyuktaAct.

(ii) The focus on enforcement is beingcomplemented by a significant emphasis onprevention and systemic reform. A number ofmeasures being taken by the Government will addresskey underlying sources of corruption, includingreduction in patronage-based transfers, financialmanagement and accountability, public procurement,deregulation, right to information and publictransparency. To monitor the implementation of theseanti-corruption measures as well as to identify andimplement other measures on an ongoing basis, Govt.of Karnataka will set up an inter-departmentalCorruption Prevention Committee. The CPC will alsoconsult with civil society; the private sector, otherbranches of government and the Lok Ayukta; undertakebaseline and repeat surveys of households, enterprisesand public officials on corruption; and publicly report onresults and progress of the anti-corruption programme.

iii) The number of local bodies is increasing. Allegationsof corruption are being received against such bodies.

Annex DPage 8 of 12

The institution of "Ombudsman" will be created toenquire into these allegations. The Ombudsman wouldbe encouraged to visit the districts for the conduct ofthe enquiries.

12. Simplification and decentralization shall be brought aboutthrough the following measures: -

(a) Govt. of Karnataka has a long tradition ofdecentralization. In 1987, Govt. of Karnatakaimplemented an ambitious decentralization program -followed more recently by the 1993 reforms introducedafter the passage of the 73rd and 74th amendments bythe Central Govt. A large number of functions - andperhaps amongst the largest share of state publicexpenditure - have been transferred to Panchayat RajInstitutions (PRIs) at the district, taluk and village levels.Guided by the cardinal principle that what is appropriateat a given level of the three tier Panchayati Raj systemshould be done at that level and not at a higher level,the Government is determined to devolve larger fundsand greater powers to the Gram Panchayats. The newinitiatives will include -

i. The annual untied grant to GramPanchayats will be enhanced from Rs. 2lakh per annum to Rs.3.5 lakh per annum.

ii. The land revenue rates will be doubledand 50% of the total collection will betransferred to the Gram Panchayats.

iii. The Karnataka Panchayati Raj Act will beamended to provide for levy and collectionof property tax at a higher rate and forlevy of development charges on use ofland for certain purposes.

iv. Gram Panchayats will be given theresponsibility of implementing a number ofdevelopment programmes likemanagement of primary schools,anganwadi centres, village irrigation tanksetc.

v. Gram Panchayats will be empowered toform Village extensions and, if necessary,borrow funds for this purpose fromfinancial institutions.

Amnex DPage 9 of 12

b. Government is concerned about the plethora ofclearances and approvals required for setting upbusiness. This multiplicity of approvals,inspections and complicated rules andprocedures have impeded private sectorinvestment in the State. There is a clear need tosimplify procedures and reduce the paper work.The Department of Industries and Commerce ispreparing a proposal, which will provide forsubmission of a single form, self-certification,minimal statutory returns and reducedinspections. A bill, incorporating the revisedsystem will be brought before the Legislature.

c. The Government recognizes that Urban LocalBodies (ULBs) have an important role to play inthe decentralized set up. However, they need togenerate additional resources. In Bangalore,one of the ways identified to do this was tointroduce the Self-Assessment Scheme forproperty tax. It has been well received. To givethe scheme a legal backing and in order tointroduce it in other ULBs, the necessaryamendment bills have been introduced in theLegislature. Further, in order to bring about amore equitable and performance based systemfor transfer of resources from the StateGovernment to the ULBs, the Government willexplore the possibility of entering into aMemorandum of Understanding with the majorULBs.

d. With the objective of achieving more efficientservice delivery and of making things easier forthe citizen, all Departments will identify areaswhere decentralization can be introduced andsystems put in place for transparent, time-boundhandling of grievances, applications etc. at thelowest level possible.

13. The Statement at Appendix-1 summarizes the action to be takenduring the year 2001-2002 to implement various parts of the governancestrategy.

14. The process of reforms is a continuing one. As mentioned earlier,based on the various studies being undertaken, an examination of therecommendations made by the Administrative Reforms Commission in itsfinal report and of other commissions and Task Forces set up by the

Annex DPage 10 of 12

Government, action plans will be drawn up for implementation duringsubsequent years.

APPENDIX-1

GOVERNANCE STRATEGY ACTION PLAN FOR 2001-2002(April 2001 to March 2002)

1) TRANSFERS:

DPAR to keep track of and monitor all transfers.Rules to be framed under the Karnataka State Civil ServicesAct.Thereafter, action to be taken to introduce a legislation ontransfers.

2) RECRUITMENT:

* Weightage given to interviews to be reduced / eliminated

3) ORGANISATIONAL RESTRUCTURING:

Functional review of 15 departments of the Government.Manpower requirement estimation.Rationalization of staff and redeployment.Outsourcing of services (house keeping, horticulture,transportation etc).

4) CITIZENS' CHARTERS TO BE PUBLISHED FOR -

* Stamps and Registration: Twelve Sub-registrars' offices wherecomputerization is being introduced.

* Transport: All RTO officesPolice: Registration of CrimesBangalore Mahanagara Palike - (1) Maternity Homes(2) Registration of Births and DeathsThree other sectors/Departments which have a large interfacewith the public will be identified for issuing Citizens Charters.


5) PUBLIC EXPENDITURE MANAGEMENT

* The functioning of the Expenditure Review Committee will bestreamlined.

* Medium term frame work for three pilot departments, Health,PWD, EducationRationalization of schemes

* Independent evaluation of ongoing programmes.

6) FINANCIAL MANAGEMENT AND ACCOUNTABILITY:

Computerization of Treasury DepartmentReconciliation of accounts, through a working groupTask force on modernization of financial management.Computerization of Zilla Panchayats and Taluk Panchayataccounts.Fund based accounting system in Bangalore Mahanagar

Palike.

7) PUBLIC PROCUREMENT REFORMS:

* Tender bulletins to be placed on the Internet* Sample audits for selected contracts to be conducted by the

KBJNL, KNNL, PWD and Irrigation Department.

8) FREEDOM OF INFORMATION:

* Frame rules under the Karnataka Freedom of Information Act.Conduct a survey of public information needs.Begin the process of indexing, cataloging, and computerizingdata on a selective basis

9) DECENTRALIZATION AND DEREGULATION

Increase share of untied funds to Panchayat Raj Institutions.Empower Panchayat Raj Institutions to augment resources,Enable Panchayati Raj Institutions to take up village leveldevelopment worksLegislation on Deregulation in industry.Annual survey of perception of Government by Industries.All Departments to identify areas where by deregulation anddecentralization, relief can be given to citizens.

10) E-GOVERNANCE:

Information Technology plan for each departmentHuman Resource Database


* Computerization of R.T.Cs. in all Taluks.

11) ANTI CORRUPTION PROGRAMME:

* Inter-departmental Corruption Prevention Committee to beconstituted.

* Computerization of Lokayukta records and review ofprocedures under the Lokayukta Act.

* Ombudsman to enquire into corruption allegations againstlocal bodies.

12) RESTRUCTURING AND PRIVATISING PUBLIC SECTORUNDERTAKINGS:

* Closure of ten units, by March, 2002

Annex EPage I of 9

POLICY ON STATE PUBLIC SECTOR REFORMS AND PRIVATIZATION

1. EVOLUTION OF PUBLIC SECTOR ENTERPIRSES IN KARNATKAAND NEED FOR A POLICY ON PUBLIC ENTERPRISES REFORMAND PRIVATIZATION.

1.1 The erstwhile Mysore State launched industrial ventures as GovernmentUndertakings to primarily exploit the available resources of raw materialand power in certain localities, thus creating pockets of industrializationwhich gave rise to cumulative employment opportunities and a variety ofother economic spin-offs.

1.2 The rapid expansion in the number of variety of Public Sector Enterprises inthe State, sometimes without sufficient socio-economic justification oradequate financial, technical and managerial resources to back them up, hasled to a situation where many became sick within a short span of time. TheKarnataka State Bureau of Public Enterprises was therefore set up in 1980as a nodal agency for monitoring the functioning of all Public SectorEnterprises in Kamataka and providing them with consultancy and othersupport services of general nature.

1.3 Much time has elapsed since then and the economic scenario has undergonemomentous changes. In many cases, the circumstances and considerationswhich provided the initial justification for setting up these ventures haveeither changed beyond recognition or do not exist at all. Their raison d'etre,after decades of economic change and development, is no longer confinedto the needs of the local economy, while the pricing and marketing of theirproducts are factors dictated almost entirely by national and internationalmarket compulsions.

...... .1.2

Annex EPage 2 of 9

- I.2 -

1.4 The policies of the Government of India in terms of Industrial PolicyResolutions from time to time as also those of the State Government moireor less remained unchanged until 1991-92. With the advent of liberalization/ globalization the relative roles of the public and private sectors havechanged dramatically. The recent policies of economic liberalization havenecessitated a total reconsideration of the justification of investment in thepublic sector and raised issues of the relative priorities of investment insocial sectors. In particular, the fact that the returns from the public sectorhave not been commensurate with investment has induced a process ofappraisal of the Public Sector Enterprises from a different perspective interms of privatization, rationalization/restructuring, merger, disinvestmentor winding-up/ closure. It is now considered that investment in PublicSector Enterprises should be restricted to strategic sectors or sectors ofsocial concern and that Government need not continue to involve itself inproduction of consumer products and marketing enterprises, particularly ifthey are not generating profits.

1.5 The State Public Sector Enterprises coming under the control of 18Administrative Departments can broadly be grouped into seven categoriesas follows:-

(i) Public Utilities.(ii) Financial Institutions.(iii) Development Enterprises (Non-Commercial)(iv) Development Enterprises (Commercial)(v) Service Enterprises(vi) Manufacturing Enterprises(vii) Marketing and Advertising Enterprises.

1.6 The State Government has taken several steps to bring about improvementin the performance of Public Sector Enterprises to equip them to face thechallenges of the changed economic environment and globalization and togradually shed those products and activities that have proved to beunproductive and unviable. In this context, the Government constituted a

....... 13

Annex EPage 3 of 9

- 1.3 -

Committee in August 1988 under the chairmanship of the then Chief Secretaryto undertake a thorough review of the State Public Enterprises. The Committeegave its report in October 1988. The salient recommendations were as under:-

(i) Total privatization of 5 Companies.(ii) Winding up of 15 Companies.(iii) Merger of 4 Companies with other major Companies having

similar activities.(iv) Rationalization and improvement of management of the

remaining Companies.1.7 In September 1990 the State Government constituted a Cabinet Sub-

Committee to review the recommendations of the Committee on PublicEnterprises. The Cabinet Sub-Committee felt that those Public Enterprisewhich were not serving any useful purpose and were suffering losses shouldbe wound up and that multiplicity of Corporations in the welfare fieldshould be avoided. The Cabinet generally agreed with therecommendations of the Cabinet Sub Committee but authorized the ChiefMinister to take a final decision on each enterprise. However, the follow upaction by the Administrative Departments is yet to yield tangible resultsexcept in the case of Vikrant Tyers.

1.8 At present there are 81 Public Sector Enterprises in the State. The totalinvestment in the 78 PSEs existing as on 31.03.99 was of the order of Rs.18, 331 Crores. The share of the Government of Karnataka was Rs. 6, 393Crores. The turnover of the enterprises during 1998-99 was Rs. 8,890Crores, contributing an amount of Rs. 506 Crores to the exchequer. Out ofthe 78 PSEs only 35 Companies have shown profits amounting to Rs. 265Crores and 33 Companies have suffered losses to an extent of Rs. 204Crores. The remaining Companies have no profit or no loss or are defunct.In as many as 25 Companies the accumulated losses have exceeded sharecapital and reserves.

1.9 With the new policy of liberalization which envisages an increasingly largerrole for the private sector and a limited role for the State only in essential ordevelopmental sectors, there is need to evaluate the PSEs in terms ofproductivity and other parameters. It is also necessary to evaluate theperformance of the PSEs to determine their utility or need for retention as

....... .1.4

Annex EPage 4 of 9

- 1.4 -

Public Sector Enterprises. The State has had to commit itself to largeinvestments in many of these PSEs, with little benefit to the economy of tlheState. It is recognized that the commitment of such large funds to PSEs, haseroded the ability of the State to provide adequate funds for essentialdevelopment activities in the Social sectors, including meeting of minimulmbasic needs.

1.10 It is in this context that the State Government considers it necessary toevolve a policy with regard to the Public Enterprises in the State. It isconsidered essential that these PSEs need to be restructured and thatGovernment should restrict its direct investment in PSEs from the funds ofthe State to strategic sectors or sectors that involve social responsibility ofthe State. It has become imperative to the State Government to have asecond look at the role and performance of the Public Sector Enterprisesparticularly in the context of near nil return on huge investments, with sormeof the PSEs having become a recurring burden on the public exchequer.

2. NEW INITIATIVE.

2.1 These issues have been under consideration of Government for some time.It is the firm view of Government that it has become imperative to giveurgent attention to the restructuring of the State PSEs throughrationalization, disinvestment, merger, privatization or closure. With thLisobjective the Government has constituted a Public Sector RestructuringCommission in G.O. No. DPAR, (BPE) 23 ARU 2000 dated 15th March2000 and corrigendum dated 30th March 2000. The broad Terms ofReference of the Commission are as follows.

(i) To evaluate the State PSEs and suggest measures which would promotegreater productivity and profitability in them within the next five years.(ii) Suggest measures which would

a) reduce or eliminate budgetary support by the State,b) promote autonomy and enhance profitability of the strongerundertakings so as to increase their returns to the State.

(iii) Evolve a long term reform programme which would enable

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Government to identify-

a) Those PSEs which would require financial support from theGovernment to enhance long term profitability and the extent towhich such support may be appropriate;

b) PSEs which would benefit by the induction of strategic partners andthe modalities of doing so;

c) PSEs for which restructuring measures would be desirable extendingto alternative systems of management including privatisation,disinvestment, merger and the modalities of doing so.

(iv) Evolve appropriate principles of rationalisation of employment in thePSEs, ensuring that the interests of labour are adequately safeguarded.Such principles may include schemes relating to voluntary retirement,creation of rationalisation fund for the purpose etc.,

(v) Suggest measures for management of a rationalisation fund, includingthe composition and procedures of a High Power Committee for thepurpose;

(vi) In making its recommendations, take into consideration the interestsof stakeholders, employees, consumers and others as may beappropriate in the case of each PSE.

3. POLICY INGREDIENTS.

3.1 As a firm commitment towards Public Enterprises Reform throughrestructuring, the Government has evolved a specific policy on publicEnterprises Reform and Privatization with the following main elements:-

(i) The PSEs whose activities are commercial in nature or which produceconsumer goods and in which there is a strong private sector presence would berestructured through privatization or closure. No further infusion of funds fromState budgetary resources would be made in such PSEs for the purposes ofmodernization, expansion or taking up new activities.

(ii) The PSEs not involved in commercial activities would be restructured

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by the induction of strategic partners or other appropriate systems ofmanagement, including mergers and reorganization, so as to eliminatethe dependence on the budgetary support of the Government. Wherejoint partners are inducted the management role of the State would beminimal and restricted to specified crucial areas to safeguard the interestof the State and to prevent speculative activities;

(iii) Duplication of activities, if any, between PSEs, Government Agenciesand Co-operatives would be minimized by suitable rationalisation.

(iv) The improvement of the efficiency of the PSEs providing utilities wouldbe achieved through such regulatory authorities as may be necessary,with the objective of providing quality services to customers at econornicand reasonable prices. Private sector participation in ownership endmanagement of utility services would also be encouraged and facilitated.

(v) No new PSEs would be established with rare exceptions of appropriateinstitutional mechanisms for the expeditious execution of specific majorprojects that relate to development of infrastructure where also increasedprivate sector participation in infrastructure activities will be encouragedand facilitated. Even when a strong institutional mechanism is needed forexpeditious execution of infrastructure development project, firstpreference will be for achieving it through private sector, failing which itwill be through joint sector of an existing PSE along with private sectorparticipation. Only in rare circumstances when neither of them is feasiblecan a new PSE be though of.

(vi) Rationalisation of employment in the PSEs would be ensured throughimplementation of schemes relating to voluntary retirement and possibleredeployment among PSEs. In this process the interests of labour wouldbe adequately protected and a suitable mechanism of social safety netwould be developed.

(vii) Suitable measures would be taken to mitigate environmental aspects,particularly in the case of PSEs identified for privatization or closure sothat these processes are environmentally sound. Guidelines would

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be developed for Environmental Liability Assessment and Remediation.

(viii) The net proceeds realised from privatization or closure would be used oninfrastructure development, rural development and welfare activities.

4. IMPLEMENTATION OF THE POLICY

4.1 The Government is committed to successful implementation of the policywithin a time frame of end of March 2005. It is proposed to privatize orclose at least ten PSEs in the first phase of its implementation by end ofMarch 2002. Action would be taken to see that two of them are privatizedor closed by end of March 2001 itself. At least ten more PSEs would beprivatized or closed during 2002-2003. Thereafter the PSEs remaining forprivatization or closure would be covered by end of March 2005. Therestructuring of the other PSEs which are required to be continued wouldalso be completed well before the end of March 2005. The first phase wouldcover privatization or closure of PSEs which are either no longer servingany purpose or which are causing a big drain on the State exchequer. A listof PSEs identified by the Public Sector Restructuring Commission out ofwhich at least ten would get privatized or closed in the first phase isenclosed as Annexure II which also contains the names of four of them, ofwhich two will be closed by 31.03.2001.

4.2 To achieve successful implementation of this policy, the Government wouldensure that the Public Sector Restructuring Commission with its mandateand wide-ranging responsibilities arrives at conclusions and makesrecommendations with regard to the State PSEs in an independent manner.While doing so, it would take into consideration the views of allstakeholders, including Government, but it would formulate its own viewsindependently, keeping in mind the best interests of all concerned. TheCommission would draw upon expertise both within itself and external to itfor appraisal and evaluation of the PSEs and for evolving recommendationsthat would be conducive to industrial and financial strength while ensuringequity to the employees. It would ensure that due regard is paid to socialand environmental concerns and issues of concern to the employees of thePSEs. It would also make recommendations with regard to the constitution

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Annex EPage 8 of 9

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and management of the fund that may be established for rehabilitation ofpersonnel and for meeting commitments under the voluntary retirementschemes that may be evolved.

4.3 The recommendations of the Commission would be considered byGovernment at the highest level. A system with suitable procedure for dueconsideration of such recommendations would be evolved. For this purpose,a High Power Committee would be established to examine t]herecommendations of the Commission. This would expedite thneconsideration of the Commission's recommendations and assist in theevolving of comprehensive proposals to Government for consideration atthe highest level. The High Power Committee would submit itsrecommendations to the Cabinet for its consideration, through t]herespective Administrative Department. On receipt of the Cabinet decisionon the recommendations, the Administrative Department wouldimmediately initiate action to implement the process of restructuring,privatization or closure in close collaboration with the Karnataka StateBureau of Public Enterprises and the management of the PSE concerned. ACore Committee in the Administrative Department headed by itsSecretary/Principal Secretary would be responsible for implementation ofthe Cabinet decision.

4.4 The restructuring, privatization or closure will be executed in accordancewith detailed procedures to be prepared by the Commission on the basis ofthe guidelines enclosed in Annexure-III. Similarly the VoluntaryRetirement Scheme will be executed in accordance with detailed proceduresto be prepared by the Commission following the guidelines enclosed asAnnexure-IV.

4.5 The High Power Committee would periodically review the progress of therestructuring process and would be empowered to take such action as mlaybe necessary to ensure expeditious and successful implementation of theCabinet decision. KSBPE will be the nodal agency in the Government withregard to the policy on Public Enterprises Reform. It will function as thesecretariat of the High Power Committee.

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4.6 All-out efforts would be made to complete the process much earlier than thetime limits included in the implementation schedule.

(ABHAY PRAKASH)Director General,

Kamataka State Bureau of Public Enterprisesand ex-officio Principal Secretary to Government,

Department of Personnel and Administrative Reform.

Annex FPage 1 of 12

De-regulation of Business Environment - Reforming Measures

Part A

1.0 Preamble

The State Government is committed to provide an efficient, responsive andtransparent regulatory framework to promote growth of a market-driven, efficientand competitive industrial/commercial sectors in the State. In the context ofeconomic liberalisation, industries and other establishments are facing severalchallenges. Despite certain strategic advantages Karnataka provides to industries/other establishments, a plethora of rules and procedures and the multiplicity ofregulatory departments/authorities constitute barriers to growth and newinvestment.

1.1 Entrepreneurs encounter difficulties at three stages:

(a) Entry level(b) Implementation level(c) Operation level

1.2 With the objective of simplifying the regulatory framework, removing proceduralimpediments, reducing maintenance of records, submission ofunnecessary/repetitive documents and of helping projects to be implemented withease the following measures are proposed.

1. To make required changes in the respective rules framed under dilferentacts providing for the proposed reform measures.

2. Karnataka Udyog Mitra(KUM) to be made the Nodal Agency at the Statelevel, to guide and to provide assistance to the entrepreneurs as well as toobtain the required clearances / allotments / consents / approvals /permissions / registrations / enrolments / licences and the like clearanceetc. from various departments / authorities at the entry andimplementation stages of a project. Similarly, the DICs to be made theNodal Agency at the District level for this purpose.

3. To reduce the multiplicity of application forms, a Combined ApplicationForm(CAF) for obtaining clearance / allotments / consents / approvals /permissions / registrations, enrolments, licences and the like, to beintroduced.

4. Industries which are in restricted list and are dangerous, hazardous andhighly polluting, will continue to be subjected to the present normal

Annex FPage 2 of 12

approval procedure and all other industries and establishments notincluded in the restricted list to be eligible for fast track clearancesunder the simplified procedures.

5. Under 'Fast Track Clearance', entrepreneurs will be required to completethe CAF and submit it to the Nodal Agency - KUM / DIC for obtainingnecessary clearances etc., from various departments / authoritiesconcerned.

6. The multiplicity of Registers/Records to be maintained under differentprovisions of applicable Acts/Rules, to be simplified and rationalised byintroducing Combined Registers/Records, as set out in this note.

7. The multiplicity of periodical Returns to be filed under different provisions ofapplicable Acts/ Rules, to be simplified and rationalised by introducingCombined Monthly/Yearly Returns, as set out in this Note.

8. Inspections, by various departments/authorities under different provisionsof law to be minimised and rationalised and to be conducted annually basedon random sampling ,with due notice. However, surprise inspections willcontinue to be conducted on the basis of specific complaints.

9. Providing for a provision of self-certification by the entrepreneurconforming compliance of the extant laws and rules. Failure to comply withthe undertaking made in such self-certification will be subjected topenalty, prosecutions and punishment as provided under differentSections of respective Acts.

Part-B

2.0 The following measures are proposed to simplify procedures for obtainingclearances etc. at the entry and implementation level.

1. At present, industries/other establishments are regulated by a large numberof Acts, Regulations, Rules and Procedures administered by differentdepartments/authorities. In order to consolidate the regulations andminimise the procedures, the need for certain changes in the respectiverules has been felt. The proposed changes will provide for consolidation ofvarious rules, regulations, procedures, and other reform measures whichthe Government proposes. The changes will deal with only those provisionsof laws which are within the Legislative Powers of the State Government tomake/ change rules.

Annex FPage 3 of 12

2. In order to guide and render necessary assistance to entrepreneurs atentry stage and to facilitate in obtaining required clearances etc.at theimplementation stage, Karnataka Udyog Mitra (KUM) may be designated asthe Nodal Agency at the State level and DICs at the District level. KUM/DICs will be single contact point for all new entrepreneurs/investors. TheKUM/DICs will also be the single point contact for alldepartments/authorities in liaisoning, processing, issuing the requiredclearances etc.

3. At present entrepreneurs are required to submit separate applications; undereach applicable Act for obtaining the required clearances, allotments,consents, approvals, permissions, registrations, enrolments, licences andthe like. With the objective of reducing the task of entrepreneurs, aCombined Application Form(CAF) is devised. This CAF will be in lieu ofthe existing different application forms, as indicated in the specimen.

Specimen CAF is given in Annexure I.

4. Industries which are included in Restricted list, are considered to bedangerous, hazardous and highly polluting in nature. Such industries willcontinue to be subjected to the present normal approval procedures and allother industries and establishments which are not included in theRestricted list, to be eligible for Fast Track Clearance under the simplifiedprocedures.

The Restricted list of industries is given in Annexure II

5. Entrepreneurs will be provided with a Booklet by KUM/DICs, highlightingindustrial policies, incentives and concessions; infrastructure facilities andadvantages available in Karnataka; list of governmentdepartments/authorities and others concerned with the factories, businessand other establishments; list of applicable Acts/Rules along with theirsalient features; check-list of requirement of each department/authority;location, extent of availability and approximate cost of lancl/shedsdeveloped by the government agencies like KIADB, KSSIDC and KEONICS;availability and cost of power; educated and trained manpower; technicaland other professional institutions etc.

6. An application form shall be provided to the entrepreneurs enabling themto apply to Single Window Agency(SWA) (both at State and District Level)High -Level Committee [HLC] for clearance of the project.

Annex FPage 4 of 12

7. Once the project is cleared by the SWA/HLC, entrepreneurs will beprovided with the CAF. Entrepreneurs are required to submit two sets ofduly filled in CAF along with the required enclosures, payment of fees /deposits as prescribed, to KUM/DICs for obtaining necessaryclearances/allotments, consents, approvals, permissions, registrations,enrolments, licences and the like. KUM/DICs will arrange for the requiredclearances/licences etc. from different departments/authorities and handover the same to the entrepreneur within 35 days of submission of CAFcompleted in all respects. However, separate time-limits to be prescribedfor each department to facilitate early stage-wise implementation ofprojects. To this end the applicable Rules will be amended suitably.

8. Since the SWA (for projects below Rs.50 crores) and HLC (for projectsabove Rs.50 crores) have representation from all departments/authoritiesconcerned and the clearances etc. granted by these bodies, to beconsidered as final and the required notifications/orders by individualdepartment/authority to be issued immediately thereafter without loss oftime.

9. In case of failure of any department/ authority to issue the requiredclearance, allotments, consents, approvals, permissions, registrations,enrolments, licences and the like, within the period specified, suchclearances shall be deemed to have been issued allowing the entrepreneurto proceed with the implementation of the project. The deemedclearances will be subject to 'Self Certification' and commitments madetherein. The proposal of 'deemed clearance' and 'Self Certification' is toenable the entrepreneur to implement the project without delays onaccount of non-receipt of the required clearances etc. by the respectivedepartments/authorities.

Self Certification Format is in Annexure III.

10. Permission for building and installation of machineries by the GramaPanchayats/ Local Authorities.

The entrepreneurs are required to obtain approval for the site, buildingplan and layout of plant and machineries from the Inspectorate ofFactories & Boilers [IFB] under the Karnataka Factories Rules 1969.Once such approvals are obtained from the IFB, seeking permission toconstruct factory building and installation of machineries separately fromthe Grama 'Panchayats or other Local Authorities is duplication of work.Therefore the entrepreneurs who obtain the required approvals from theIFB for site, factory building plan and layout of plant and machineries, inconformity with the prescribed provisions of the Karnataka FactoriesRules, 1969, may be exempted from seeking such approvals again from

Annex FPaze 5 of 12

the Grama Panchayats and Town Panchayats. However in the interest ofmaintaining the financial stability of Grama Panchayats and TownPanchayats to provide and maintain basic infrastructure facilities, thetaxes and fee prescribed from time to time under the KarnatakaPanchayat Raj (Grama Panchayat Taxes & Fees) Rules will be collected bythe IFB from the entrepreneurs and remitted to the respective GPs/TPswithin 15 days of receipt of such fee. However, IFB will ensurecompliance of building byelaws and related regulations before issue ofsuch approvals. The Jurisdictional Inspector of Factories shall bedelegated with powers to approve the plans of Factory building of non-hazardous Factories employing upto 100 persons.

11. Approval of Factory Building Plan by KIADB

At present, in respect of KIADB land, the entrepreneur is required toobtain approval of factory building plans from the KIADB. Since the IFBis responsible for approval of factory building plan, the requirement ofobtaining approval from the KIADB can be discontinued.

Part - C

3.0 At the operational stage, employers are required to maintain a large number ofRegisters/Records prescribed under different Rules. In addition to this, ernployersare also required to maintain and submit a number of Returns periodically. In mostof the cases these registers/records /returns are repetitive in nature. Factories arealso subjected to frequent inspections by different authorities under various Actsto verify such registers/records/returns etc.

3.1 With the objective of eliminating unnecessary and repetitive maintenance ofregisters/records, the following simplification measures are proposed:

1. At present, separate Muster Roll/ Attendance and Payment Registers arerequired to be maintained under:

Form No. Rule No. Rulesi) Form 22 (Muster Roll) Rule 137 of Karnataka Factories Rules, 1969ii) Form V (Wages) " 29(1) of Kamataka Minimum Wages Rules, 1958iii) Form VII (Muster Roll) " 29(5) -do-iv) Form -(Wages) " 5 of Kamataka Payment of Wages Rules, 1963v) Form XVI (Muster Roll) "78(1) (a) (i) of Contract Labour (Regulation

& Abolition)Kamataka Rules, 1974vi) Form XVII (Wages) " " -do-

Annex FPage 6 of 12

Maintenance of different registers of attendance and wages to serve therequirement of each Rule, is a time consuming unnecessary and wastefulexercise. It is therefore proposed to maintain a Combined Muster Roll cumRegister of Wages/Salary(CMR cum RWS) in lieu of above said registers.

Specimen of Muster Roll cum Register of Wages/Salary is in Annexure IV

2. Though KST, KTEG and KTPTC & E are handled by the Commercial TaxDepartment, separate applications under KST, KTEG and KTPTC & E arerequired to be filed along with almost same set of documents/enclosures toobtain separate registration numbers. In the interest of simplification, it isfelt that three different applications may be combined into one singleCombined Application Form and one single authority may grant registrationnumbers and annual assessments under KST ,KTEG and KTPTC&E. Theannual assessment is presently done at the office of the Jurisdictionalassessing authority and the entrepreneurs is required to produce all therequired documents at his office for verification. Production of such largenumber of registers, records, applications etc., is burdensome. In order tofacilitate faster annual assessment, it is proposed to carryout the annualassessment at the premises of the establishment/trade/dealer. TheCombined application form is included in the CAF.

3. An employer is required to submit Monthly Returns to the CommercialTaxes Department under the Karnataka Sales Tax, Karnataka Tax on Entryof Goods and Professional Tax Acts separately. In addition to monthlyreturns, an employer is required to submit annual returns, based on whichthe final assessment of Tax is made. It is proposed to eliminate individualmonthly returns under KST, KTEG and KTPTC & E Acts and adopt acombined Monthly Return Form to be submitted to Commercial TaxDepartment

Specimen Combined Monthly Return Form is in Annexure V

4. More than 10 registers relating to overtime work payment, fines, deductionsfor damages, loss and advances etc. are required to be maintained underdifferent Rules, as detailed below:

Annex FPage70fl2

Form No. Rule No. Rulei) Form 9 under Rule 107 of Karnataka Factories Rules, 1969

ii) Form XIII under Rule 78(1) (a) (iii) of Contract Labour(Regin. 3Abolition) Karnataka Rules, 1974

iii) Form IV under Rule 28(2) of Karnataka Mini. Wages Rules, 1958

iv) Form I under Rule 3(1) (Fine), of Karnataka Payment of Wages4 (Deduction) and Rules, 196319 (4) (Advances)

v) Form II -do- -do-

vi) Form III -do- -do-

vii) Form XXI under Rule 78(1) (ii) of Contract Labour (Regulation &Abolition) Karnataka Rules, 1974

viii) Form XX -do- -do-

ix) Form XXII -do- -do-

x) Form B under Rule 29 of Karnataka Labour Welfare Fund Rules,1968 Payment of Wages Rules, 1963

The information sought by the above said registers can be made availablein two combined registers which will serve the requirements of the Rules.It is therefore proposed that the two Combined Registers may beaccepted in lieu of the existing registers.

Specimen of Combined Registers are given in Annexure VI-A& B

Annex FPage 8 of 12

5. Separate Annual Returns are required to be sent under the provisions offollowing Rules:

Form No. Rule No. Rulei) Form 20 Rule 134 Karnataka Factories Rules, 1969ii) Form XXV Rule 82 (2) Contract Labour (Regulation And

Abolition) Karnataka Rule, 1974iii) Form III Rule 22(4) Karnataka Minimum Wages

Rules, 1958iv) Form 'D' Rule 5 Payment of Bonus Rules, 1975v) Form IV Rule 20 Karnataka Payment of Wages Rules,

1963It is proposed to combine these returns into one to serve the requirementof the above said rules .

The Combined Annual Return may be replaced as Form No. 20 under Rule134 of Karnataka Factories Rules, 1969 and be accepted in lieu of annualreturns as prescribed under other relevant rules.

Specimen of Combined Annual Return is given in Annexure - VII

6. The returns, registers, documents, clearance, approvals and inspections ifany under following miscellaneous Acts/ Rules may not be insisted upon:i) Karnataka Industrial Establishments (National & Festival Holidays)

Act, 1963.ii) Karnataka Labour Welfare Fund Act, 1965iii) Weekly Holiday Act, 1942iv) Personal Injuries (Compensation Insurance) Act, 1963v) Employees liability Act, 1933vi) Children (Pledging of Labour) Act, 1933vii) Weights and Measurement.

The entrepreneur will be required to file a self-certification confirming compliance of theapplicable provisions of the above said laws.

Part- D

4.0 Industry Associations, in Karnataka have from time to time represented to thegovernment to simplify/modify/liberalise certain restrictive/regulatory provisions ofdifferent acts. Such simplification/modification is essential to maintain therequired discipline and run their enterprises in the competitive market drivenenvironment.

Annex FPaj,e9of12

4.1 After examining the requests/suggestions of the associations, the followingsimplifications/modifications are proposed, which are within the powers vested inthe State government under the relevant Acts/Rules.

1. Conciliation

Under Section 4[1] of Chapter II of Industrial Disputes Act, 1947 the StateGovernment, may, by notification in the official gazette appoint persons asit thinks fit to be conciliation officers to mediate and to promote settlementof industrial disputes.

At present only officials working in the Labour department are appointed asconciliation officers. Due to lack of industrial experience and exposure suchofficers are often unable to act effectively resulting in non-settlement ofdisputes. The role of conciliation officers will be better served by personswho have served at Senior positions in the HRD/HRM field. The HRM/HRDpersons have practical experience of handling industrial disputesunderstanding the problems of both management and ermployees.Therefore a panel of officers drawn from the field of HRD/HRM, TradeUnions and Legal Practitioners in Labour laws be created with the sameduties and powers of departmental conciliation officers. Such experts will beable to play an effective role in helping the parties to solve their disputeswithout loss of time. Section 4(2) of Chapter II of Industrial Disputes Act,1947 provides scope for appointment of such experts.

2. Public Utility Services

The Karnataka Government has added a few industries to the list of PublicUtility Services included in First Schedule under Section 2(n)(vi) of ][ndustrialDisputes Act, 1947.

Under Section 22(1)(a) and (2)(a) a notice of six weeks has been madecompulsory before going on a strike or declaring a lock-out in Public UtilityService Industries.

For industries other than public utility services no notice is required to go onstrike. As a result, many wild-cat strikes take place in such industries.Therefore, it is proposed that the industries coming under the followingsectors:

i) Information Technology and IT Enabled Services.ii) Bio Technologyiii) Food Processing Industries (Only those set up in Agro Food

Processing parks)iv) Electronics & Communication

Annex FPage 10 of 12

v) Export Oriented unitsvi) Garmentvii) Auto ancillary units (only those set up in Auto Industrial Parks)

be declared as 'Public Utility Services' by the State Government.

3. Industrial Employment Standing Orders

Under Section 3(1) of Industrial Employment (Standing Orders)Act, 1946,an employer employing 50 or more persons is required to submit DraftStanding Orders(DSO) within six months of employing 50 persons, forcertification and adoption.

The Certification takes a long period. The draft standing orders can beframed only on matters provided in the Schedule to the Act. The subjectmatters in the schedule are limited and have not been changed to therequirements of the present day. The employer is required to follow theModel Standing orders(MSO) in the interim period of certification. It isproposed that provision of certification of DSO may be repealed and MSOmay be updated within three months and strictly be followed by the labourdepartment.

4. Creche

At present under Section 48(1) of the Factories Act, 1948, providing acreche is compulsory where more than 30 women workers are employed.Employer may be permitted to engage the services of NGOs / privateorganisations to manage the creche, at the cost of employer(s). Sucharrangement may be permitted by the State Government under Section48(3).

5. Rationalisation of Inspections:

It is proposed that the number and periodicity of inspections done byvarious departments/agencies be rationalized. Under the provisions ofvarious Acts, different authorities are created and it is common to findalmost all such authorities keep visiting industries in the name ofinspections which has become counter productive. In order to allow theentrepreneurs to concentrate more on their chosen business it is suggested,henceforth, industries may be subjected to one combined and joint annualinspection by the departments such as Inspectorate of Factories andBoilers, Karnataka State Pollution Control Board and Labour department inrespect of registered Factories under the Factories Act. The Inspectorate ofFactories and Boilers shall be the Nodal Agency. The selection ofIndustries for Inspection shall be on a random basis. A random number

Annex FPage 1 1 of 12

sampling generated through a computer - data base shall constitute theannual programme of inspections and shall be notified to the industriesconcerned, in advance. All other departmental inspections will be restrictedto only specific complaints and self-certification of compliance filed by theentrepreneur may be accepted. To further simplify Inspection by multipleagencies, it is proposed to entrust the Inspectorate of Factories with theenforcement of some of the labour legislations presently being enforced bythe Labour Department on the lines of State of Tamilnadu in respect ofregistered factories. The legislations are The Contract Labour Act, TheMinimum Wages Act, National and Festival Act, Workmen CompensationAct, Interstate Migrant workmen Act, Equal remuneration Act, Labourwelfare fund Act. However Labour Department will continue to enforce thesaid legislations in the areas other than the registered factories.

6. Upon approval of the above said proposals by the Cabinet, the C & IDepartment will draft the required changes in the respective Rules andforward to respective departments through the Law department fornecessary amendment /notification.

The implementation of deregulation measures will be reviewed and astatus report will be submitted to the Cabinet periodically by the PrincipalSecretary C & I.

7. Other issues:

The deregulation of business environment has attempted to simplify rulesand regulations, which are within Legislative powers of the StateGovernment.There are still a few issues, which need to be addressed for simplificationand streamlining. These pertain to:

i) Establishment of Industrial Township Authorities.ii) Inspection by the Electrical Inspectorate.iii) Permission for change of land use and land conversion.iv) Empowering DCs to permit purchase of agricultural lands by industrial units

as per provisions of Section-109 of the Land Reforms Act.v) State level environment clearances.

A Separate proposal on the above issues will be brought before theCabinet for consideration with in eight weeks.

Part-E

5.0 Keeping the overall objective set in the preamble to this Cabinet Note, the abovereferred reform measures have been proposed. These proposals have been

Annex FPage 12 of 12

discussed with the related departments and authorities and their views have beenincorporated. Further, representatives of major industry associations have alsobeen consulted and taken into confidence.

5.1 The Administrative Staff College of India, Hyderabad has prepared a detailed studyreport on 'simplification of procedures governing industries' at the instance of theDepartment of Industrial Policy and Promotion, Ministry of Industry, Governmentof India. Suggestions and findings given in the above said report have also beentaken into consideration.

5.2 Even after these reform measures, the powers of granting mandatoryclearances/approvals required for setting up industries shall continue to be vestedwith the administrative departments concerned.

5.3 The reform proposals suggested are expected to provide an enabling environmentand a level playing field to the entrepreneurs/investors to set up their projects inKarnataka and to run them successfully.

Annex GPage 1 of 5

Poverty in Karnataka

1. Kamataka deservedly receives wide attention for its remarkable achievements in the rapidlygrowing information technology sector. Yet attacking poverty, particularly in certain chronically poorpockets of the state, remains an important developmental imperative. The publication in 1999 of theHuman Development Report for Karnataka marked an important step forward in the establishment ofa baseline understanding of the achievements in, and remaining challenges for, human developmentand poverty reduction in the Karnataka. The report brought together a wealth of detail on the diversedimensions of human development during the 1990s, providing policy makers and other interestedparties with a comprehensive information base upon which to draw. This note summarizes some ofthe main findings of the HDR, as well as of the poverty note prepared by the World Bank based onanalysis of the 1993-94 National Sample Survey (NSS) data as well as the 1993/1994 NationalCouncil for Applied Economic Research (NCAER) rural household survey.'

2. Kamataka is India's 9th largest state (population: 53 million) with considerable physical,cultural, and linguistic diversity. It has 4 natural regions, (i) the coastal region, (ii) the ghats ormalnad region, (iii) the southern maidan, and (iv) the northern maidan, all extending over 700 km.from north to south, and 400 km. from east to west. The state was formed in 1956, when Kannada-speaking territories of Bombay, Madras, Hyderabad, Coorg and Mysore were merged together intoone state. Partly on account of their dispersion in different political units, as well as partly due todifferent natural resource endowments and climactic factors, considerable disparity in livingconditions prevail across different regions in the state. The Kamataka HDR included a disaggregatedpoverty "map" across 20 districts in the state, distinguishing between urban and rural areas in each,which revealed a remarkable degree of variation in poverty across districts - an important finding forpolicy makers considering where to focus their poverty alleviation efforts. For instance, in thenorthem more arid districts of Bidar, Gulbarga, and Raichur that border Andhra Pradesh, povertylevels continue to be considerably higher than in the rest of the state.

Table 1: Mean consumption and Poverty in Karnataka and India, 1993-94

Karnataka IndiaUrban Rural Overall Urban Rural Overall

Mean per-capita monthly consuniption (Rs.) 423 269 313 456 281 325Head-count Estimates

(a) UsingExpertGroupPoverty Line 39.9 30.1 32.9 33.2 37.1 36.1(b) 1997 World Bank estimates 29.7 41.0 - 30.5 36.7 -

(c) Deaton & Tarozzi (1999) 25.7 40.6 - 22.5 38.3Sources: (a) Official figures (Planning Commission).

(b) India. Achievements and Challenges. Reducing Poverty, World Bank, 1997.(c) Deaton, A. and Tarozzi, A. (1999) Prices & Poverty in India, mimeo.

3. A profile of consumption-poverty in the state reveals that the poor in Kamataka do not look muchdifferent from the poor in other, less advanced, states of India. The poor are virtually withouteducation, have limited access to land, and are highly concentrated in low paying, physicallydemanding, and socially unattractive occupations such as agricultural wage labor (or in urban areas,in casual wage labor). In both urban and rural areas, the poor have very little access to modemsanitation services, and also commonly reside in houses of inferior quality. Scheduled castesconstitute a sub-group of the population with a particularly high level of poverty.

I Poverty in Karnataka: Profiles and Emerging Issues mimeo, World Bank, Washington D.C. 2000.

Annex GPage 2 of 5

4. There are several estimates of poverty in Karnataka. Even though these estimates use the samehousehold data, their use of different price indices leads to considerable variation in the extent ofpoverty in the state, both in absolute terms, and relative to the all-India average. The official povertyestimates for 1993-94 from the GOI Planning Commission show poverty in Karnataka to be lowerthan the All-India average (Table 1). Although mean urban consumption levels in the state areconsiderably higher than in rural areas, measured poverty was found to be higher in urban areas thanin rural areas (40% vs. 30.0% ). However, there may be strong grounds to suggest that thesestatistical results are not robust. The finding of higher urban poverty results from the urban povertyline being 63% higher than the rural line in Kamataka, much higher than the difference between thetwo poverty lines in most other states. For these two poverty lines to represent the same standard ofliving, it must be argued that the cost of living in urban areas is higher by a similar proportion as thedifference in the two poverty lines. Against a backdrop of free movement of goods and people, suchan argument is rather implausible. Alternative methodologies show rural poverty to be much higherand rural poverty lower: two such estimates are also included in Table 1. Many other indicators ofwellbeing (human development and other), suggest that rural areas are at a considerable disadvantagerelative to urban areas, and the general perception in Karnataka that poverty is a largely ruralphenomenon is very likely a robust conclusion. If poverty in rural areas is higher than that indicatedby official statistics, given that roughly 7 out of 10 residents of Kamataka live in rural areas, thiswould raise considerably the estimated number of poor in the state. While the official figures showlower levels of rural poverty in Kamataka than the all-India average, the other two estimates showhigher levels of rural poverty. (On progress in reducing poverty, see para. 11.)

Table 2: Poverty Incidence by Level of Education of the Household Head

Highest educational Incidence of Poverty Percentage of:Attainment of Head Urban Rural Overall Population Poor

Not literate 67.3 38.3 42.8 49 63Less than Primary 51.0 25.0 30.2 15 13Completed Primary 48.4 19.6 29.2 10 9Completed Middle 40.7 15.8 25.4 10 8Completed Secondary 21.2 12.0 17.8 9 5Completed Higher level 9.5 1.0 7.1 7 2Overall 39.9 30.1 32.9 100 100

Source: 1993-94 NSS Consumer Expenditure Survey

5. Education is a key dimension of welfare as well as an important determinant of rural incomesand economic livelihoods in Karnataka (Table 2). In urban Karnataka, the poverty rate of those wholive in households whose head is illiterate is 67% compared to an urban average poverty rate of 40%.The incidence of poverty declines as household heads are progressively more educated, such that lessthan 10% of the poor live in households where the head of the household has an education beyondsecondary schooling. In rural areas, the incidence of poverty for those in households with an illiteratehousehold head is 38.3% relative to an average poverty rate of 30.1%. This suggests that in ruralareas illiteracy is less clearly a defining characteristic of poverty as in urban areas. On the other hand,with an incidence of poverty of barely 1% among those where the household head has an educationbeyond secondary schooling, it is clear that those in rural areas who live in households with a highlyeducated household head run a very low risk of being counted among the poor.

Annex GPage 3 of 5

Table 3: Water source - by Sector and Poverty

Urban Rural All Poor Urban Poor Rural PoorTap 83 38 60 50 74 37

Tube well/Hand pump 10 34 22 35 20 43

Well 7 20 14 12 5 15

Tank/Pond/Reserve/Others 0 8 4 7 1 5

Source: 1993-94 NSS Consumer Expenditure Survey

6. Access to safe water and sanitation for the poor in Kamataka is considerably poorer than therest of the population. While a large majority (83%) of the urban population has access to tappedwater, for the urban poor, the corresponding figure is 74%. For the rural poor, nearly 50% are relianteither on tube-well/hand-pumps (43%) or tank/ponds (5%). while in the urban population as a wholeslightly over a quarter of the population (28%) of the population does not have access to any type ofsanitation, the corresponding figure for the urban poor only is nearly 60%. Similarly, while about40% of the urban population has access to a flush toilet, the percentage among the urban poor isbelow 20%. Such limited access to adequate sanitation services in urban areas may pose seriouspublic health risks in urban areas. In rural areas, access to modem sanitation services remains verylimited. The majority of the rural population (overwhelmingly in the case of the rural poor) have noaccess to modem services.

7. Poverty and access to land: In rural Kamataka, the connection between poverty and access toland is central to both understanding the causes of poverty as well as to designing policies to addresspoverty. The poor in Kamataka typically own less land than the non-poor and are highly representedamong the landless. Moreover, variation in land quality is of particular importance in the context ofthe state, where access to irrigation is far from universal. Consequently, while the incidence ofpoverty is clearly highest among the landless and marginal landowners, there remains a considerablepercentage of the rural population at risk of poverty even in the largest landowning category.

Table 4: Rural Poverty Incidence by Land Ownership

Poverty Percentage of:Amit. Of Land owned Incidence

Population* Poor* Non-Poor*Nolandowned 40.4 17 23 150-0.4 hectares 31.6 23 24 230.4-1 hectares 28.3 19 18 191-2 hectares 31.0 17 18 172-4 hectares 23.9 13 10 144+hectares 18.8 11 7 12

Overall 30.1 100 100 100Source: 1993-94 NSS Consumer Expenditure Survey * Column shows poor population in land ownership category

8. Poverty and Occupational status: A very strong correlate of poverty in rural areas isinvolvement in agricultural labor (Table 5). The incidence of poverty is considerably higher (46.7%)for the rural population in which the household head is engaged in agricultural wage labor. Villagestudies indicate that agricultural wage labor is often viewed as a "last-resort" option by villagers dueto the combination of hard physical labor which is involved plus a degree of loss of social statusassociated with working as a paid laborer for an outside employer. While agricultural labor is theoccupation of about 35% of all household heads in rural Karnataka, 54% of poor household heads areagricultural laborers. In urban areas, the incidence of poverty is particularly high when householdheads are employed as casual laborers. While only 16% of household heads in urban areas areengaged in casual labor, they make up nearly 30% of poor household heads in urban areas. There is

Annex GPage 4 of 5

also a slightly higher odds of poverty amongst those household heads engaged in self-employmentactivities.

Table 5: Poverty Incidence by Occupation of Household Head

Rural Areas Percentage of Urban Areas Percentage ofMain Occupation Main Occupadon

% Poor Popl'n Poor % Poor Popl'n PoorS.E. Non-agri. 29.1 13 13 SelfEmployed 44.1 36 40Agri. Labor 46.7 35 54 Regular Salaried 25.3 42 27Other labor 23.9 4 3 Casual Labor 71.8 16 29

S.E. Agriculture 20.7 41 28Other 7.8 7 2 Other 29.3 6 4

Overall 30.1 100 100 Overall 39.9 100 100Source: 1993-94 NSS Consumer Expenditure Survey S.E.: Self-employed

9. The non-farm sector in Kamataka offers a potentially important route out of poverty in ruralareas. However, evidence on income shares suggests that in Karnataka, perhaps somewhatsurprisingly given the State's high-tech profile, the rural economy remains relatively undiversified.Nonetheless, even in Kamataka as much as 20% of rural income accrues from non-farm sources.However, not all non-farm economic activity is equally productive, and at least some non-farmactivities, particularly casual wage employment in non-agricultural activities, may as readily be asymptom of poverty as a route out of poverty. Because of low education levels, the poor are not wellplaced to gain employment in the non-farm sector, particularly regular employment in well paid jobs.Accelerating growth and employment in rural areas will be key to poverty reduction. Increasing thearea under irrigation is vital, but since at most 1/3 of Karnataka's arable land can be brought underirrigation, improving dry land productivity is likely to play an equally important role in lifting thepoor out of poverty.

10. Poverty and Social Identity: Women and the population comprising scheduled castes andscheduled tribes appear to be disadvantaged in the competition for opportunities in the non-farmsector. Analysis of the 1993-94 NSS data reveals a significant structural component to the differencebetween average per capita incomes of scheduled castes versus majority households. This indicatesthat alongside clearly visible differences in human capital levels and ownership of productive assetssuch as land, the returns on those assets and human capital received by scheduled castes differ fromthe returns received by majority households. There appears to be disturbing evidence that returns toeducation for scheduled castes are generally lower than for majority households; addressing thisimportant dimension of social inequality thus poses additional, difficult, challenges to policy makers.

Table 6: Recent Trends in Monthly Per-Capita Consumption

NSS 43rd Round NSS 50"' Round NSS S5"' Round A 87-88 to A 93-94 to1987-88 1993-94 1999-00 1993-94 199940

Urban Rural Urban Rural Urban Rural U R U RMean per-capita monthly consumption (Rs.):

Karnataka 223 151 423 269 911 500 90% 78% 115% 86%Andhra Pradesh 228 159 409 289 774 454 79% 82% 89% 57%TamilNadu 245 156 438 294 972 514 79% 88% 122% 75%Kerala 262 209 494 390 933 766 89% 87% 89% 96%All-lndia 246 158 458 281 855 486 86% 78% 87% 73%

Source: NSS data, various years.

1 1. Progress in reducing poverty: There has been much debate and controversy in India recentlyaround the latest poverty estirnates released by the Government of India. While it is difficult toascertain the extent to which poverty in the country has declined in recent years, evidence from

Annex GPage 5 of 5

various sources suggests that progress at reducing poverty in Karnataka has been somewhat betterthan in the rest of the country. NSSO survey data suggest that growth in mean per capita consumptionin Karnataka, especially in urban areas, has been faster than in other states (Table 6). Similarly,results from the 1998-99 National Family Health Survey (NFHS) suggest that improvements in infantand child mortality, nutritional status, and other indicators of well-being have been more rapid than inthe rest of India (Table 7).

Table 7: Anthropometric Indicators and Mortality Rates

1992-93 1998-99All-lndia Karnataka All-India Karnabtka

Infant mortality 78.5 65.4 67.6 51.5Child mortality 33.4 23.5 29.3 19.3

Weight-for-age (% below 2 s.d.) 53.4 54.3 47.0 43.9

Height-for-age (% below 2 s.d.) 52.0 47.6 45.5 36.6

Weight-for-height (% below 2 s.d.) 17.5 17.4 15.5 20.0

Source: IIPS (1995,) and IIPS and ORC Macro (2000)

Annex HPage 1 of 4

Karnataka Poverty and Human Development Monitoring System(Government Order No. PD-1-HDD-2001. Dated 16.05.2001)

1. Human Development Division in the Planning Department will coordinate all theactivities relating to poverty and human development monitoring system in Karnataka with theactive involvement of concerned departments in the Government.

2. Human Development Division will closely liason with poverty cell of the World Bankbesides liasoning with All India Agencies like Census Department, National Sample SurveyOrganization etc.

3. List of indicators covering areas such as poverty, access to services, income, agriculturalprices, employment and unemployment, demography and health etc. are given in the Annexurealong with other details such as source of information, frequency, and present level ofdisaggregation, present status and name of the department to initiate action etc. Wherever nameof the department is mentioned against a particular indicator, such department shall providerequired information to the Human Development Division on a regular basis. The modality offurnishing of data will be finalised by the respective department in consultation with HumanDevelopment Division.

4. If any new indicator is required to be included or scope of the existing indicator is to bemodified or enlarged, the Human Development Division will take necessary steps to include thesame in the list of indicators with the involvement of the concerned department.

5. The Department of Economics and Statistics will take all necessary measures to strengthenthe Civil Registration System in consultation with the Human Development Division.

6. Wherever special surveys/studies are suggested in the list of indicators given in theAnnexure, the Human Development Division will take necessary steps to initiate actionobserving necessary formalities.

7. Action will be initiated to bring out State Level Human Development Report every 3 to 5years utilising the census data, NSSO survey and other household survey results etc.

8. Human Development Division will initiate action for the preparation of District LevelHuman Development Report initially on a pilot basis with involvement of concerned ZillaPanchayat and District Administration, concerned Zilla Panchayat and District Administrationwill extend all necessary support as and when required by the Human Development Division forfinalisation of the district level human development report.

9. Action will be take to include a chapter on poverty and human development in the annualeconomic survey of the State Government.

Annex HPage 2 of 4

Annexure

Poverty and Human Development Indicators for Monitoring

S. Level of Reporting DepartmentNo. Indicator disaggregation Data Source Periodicity Present Status / Comments to take

action1. Poverty:

Percentage of population a) State, Annual NSS Consumer Expenditure Survey Annual Most recent estimates in Department ofbelow the poverty line: Urban/Rural -Pooled central and State sample. Karnataka Human Development Economics

b) By district Quinquennial NSS Consumer Expenditure Every 5 Report (data for 1993-94). and StatisticsSurvey (thick sample) Pooled central and years Data from the pooled 5 5 th round (DES)state sample. (1999-2000) will be used to

compute new district-wisepoverty estimates later this yearonce unit-record data becomeavailable.

2. Access to services:

Percent households with: a) By taluk Population Census 10 years Baseline to be set as results from Rural

the 2001 Population Census are Developmentavailable, and

Panchayat Raj(i) Access to safe b) By district (i) Rural Development & Panchayati Raj 3 - 5 years Data Collection system to be (RDPR)

drinking water Department (RDPR) further strengthened.

Additional data to be collected(ii) Kutcha homes (ii) Sample surveys of households through new household surveys, Special

or through a special-purpose Survey(iii) Toilet facilities module canvassed in conjunction

with the combined central-state(iv) Electricity Quniquennial NSS Survey.

Annex HPage 3 of 4

3. Income, Wages & Prices:

(i) Wages (agricultural By district Department of Economics and Statistics Monthly A data series on real -grain DES& non-agricultural) equivalent of wages computed at

the district level will provide aninexpensive yet powerful tool formonitoring variation in livingstandards on a timely basis.

(ii) Retail prices of essen- By district Department of Economics and Statistics Monthly DES-tial commodities

(iii) District income & its By district Department of Economics and Statistics Annual DESsectoral composition

(iv) Wholesale prices of State Department of Economics and Statistics Monthly DESagricultural commodities

4. Employment:

(i) Employment status a) State, Annual NSS Employment and Annual Employment status classified as DES

Urban/Rural Unemployment Survey -- Pooled central (i) employed (ii) under-employedand state sample. (iii) unemployed & (iv) out of

labor force.

(ii) Composition of b) By district (i) Quinquennial NSS Employment/ 5 years Composition of employment DESemployment Unemployment Survcy. Pooled Central and classified as (i) self-employed (ii)

(iii) % of working children state sample salaried & (iii) casual.(iv) Labor Productivity (ii) Population Census of India 10 ycars (Working children: age group

monitored: 10-14 years).

5. Demography & Health:

Infant Mortality Rates State Samplc Registration System (SRS) Annual 1998-99 NFHS data to be used to Department ofUrban/Rural set baselines for monitoring. Health andMale/Female Anthropometric measures used to Family

track severe and moderate child Welfare(i) Malnutrition State, region & Sample surveys: e.g. the National Family 3 - 5 years malnutrition (i.e. measures such (DHFW)

gender Hcalth Surveys (NFHS), Rural Child Health as weight-for-age, height-for-age,Urban/Rural Surveys, etc. and weight-for-height to be used).

Couple protection rate State (i) Department of Health data Annual Methodologies to compute DHFWUrban/Rural maternal mortality rates and life-

Institutional delivery (ii) Sample surveys 3 - 5 years expectancy to be examined more DHFW

carefully to determine dataMatmalmorali e tate Not known at present requirements and explore DHFWUrban/Rural feasibility.

Life Expectancy at Birth

Annex HPae 4 of 4

6. Education:

Literacy (a) By taluk Population Census 10 years Additional data to be collected Specialthrough new household surveys, Survey

Gross enrolment ratio (b) By district (i) Quinquennial NSSO Survey or other 5 years or through a special-purposespecial-purpose survey module canvassed in conjunction Special

Proportion of children 6-14 (ii) Literacy Survey recently conducted by with the combined central-state Surveyyears out of school the Department of Education Quinquennial NSS Survey.

EducationDrop out rates (iii) Department of Education data Annual Department

7. Other Indicators, comments, etc.Wherever feasible, the above indicators will be collected through integrated household-survey instruments so as to permit disaggregation by important groups ofinterest, such as by gender, poor / non-poor, backward regions, socially disadvantaged groups, etc. Other important performance monitoring indicators such as moreeffective tracking of outcome indicators such as school learning achievement and behavioral outcomes, process indicators such as whether text-books and other materialreach schools in time, teacher attendance and regularity, etc., supplementing quantitative data with qualitative assessments, etc to also be eventually incorporated intothe monitoring system once present capacity within GoK to carry out such analyses has been developed. In addition, wherever feasible, technical expertise will bedeveloped to carry out more formal monitoring and evaluation of specific policy interventions.

Annex IPage 1 of 5

Fiscal Annex

Fiscal Deficits

In addition to the budget deficit, we define various more comprehensive deficits, which includethe power deficit and off-budget borrowings.

Budgetary non-power fiscal deficit = Budgetary fiscal deficit - Gross budget support to the powersector

Off-budget borrowing = Borrowing by KBJNL, KNNL and other state entities, the debt servicingof which will revert to the budget

Net off-budget borrowing = Off-budget borrowing - Off budget principal repayments

Fiscal deficit including off-budget borrowing = Budgetary fiscal deficit + Net off-budgetborrowing

Fiscal deficit including power sector deficit and off-budget borrowing = Fiscal deficit includingoff-budget borrowing + Power sector deficit - Gross budget support to KPTCL

Revenue Deficits

Revenue deficit including off-budget borrowings = Budgetary revenue deficit + Off-budgetinterest payments

Primary Deficits

Primary deficit including off-budget borrowings = Budgetary primary deficit + Off-budgetborrowings - Off-budget interest payments - Off-budget principal repayments

Power Sector Deficit

The power sector deficit is the deficit of KPTCL, the state's power transmission and distributionutility. Since accumulation of arrears is often used as a financing strategy, changes in workingcapital are treated as a deficit financing item.

Under the power sector deficit, pensions for existing pensioners are deducted from the cost side in2000-01, in anticipation of a trust fund being used from 2001-02 onwards to pay all pensionobligations. That portion of the GoK revenue subsidy equivalent to the cost of pensions thusdeducted is also excluded from the revenue side in anticipation of such payments being madefrom 2001-02 to the trust fund. GoK in fact plans to establish an endowment for the trust fund,and then to make good any shortfall in interest from the endowments to meet the annual pensionbill. Pension liabilities relating to pensioners already retired and past service of existingemployees as of March 1999, will thus be transferred outside of KPTCL, and are thus notincluded in the power sector (i.e. KPTCL) deficit.

Gross budget support to KPTCL = Revenue subsidy to KPTCL + Other revenue transfers +Capital transfers to KPTCL

Gross budget support to the power sector = Gross budget support to KPTCL + Debt service ontrade bonds + Cash payment to KPCL + Payments to pension trust fund

Annex IPage 2 of 5

Power sector deficit = Total revenue of KPTCL (excluding revenue subsidy and other revenuetransfers to KPTCL )+ Capital expenditure - Operating costs of KPTCL - Interest - Tax

Definitions of Consolidated Expenditure Variables (used in Table 6)

Definition

Revenue ExpenditureInterest Payments On-budget and off-budget interest paymentsSalariesGrants-in-aid of Salary Grants-in-aid of salary towards elementary and

secondary education and higher educationPensionsSubsidies & Transfers Power subsidy, devolution to urban local bodies,

food subsidy, transport subsidy, industry subsidy,housing subsidy (equals subsidies and devolution tourban local bodies in the MTFP)

Non-Wage O&M Roads, buildings, irrigation, elementary andsecondary education, health, rural development,water supply, agriculture, forestry (equals major andother O&M in MTFP)

Other Revenue Expenditure Social welfare schemes, police, administrativeexpenditure, infrastructure cess, natural calamities,prizes / commissions/ incentives, provision forcontingent liabilities, other schemes

Capital Expenditure & Net Lending On-budget capital expenditure and off-budgetborrowing less debt servicing on account of off-budget borrowing

Note: More detailed definitions are available on file.

Annex IPage 3 of 5

Table 1.1Karnataka Deficits, 1996/97 - 2004/05 /a

96-97 97-98 98-99 99-00 00-01 01-02 02-03 03-04 04-05RE BE Proj. Proj. Proj.

(Rs billion)Revenue DeficitsBudgetary revenue deficit 4.55 1.32 9.57 23.25 21.75 26.24 23.56 12.06 -7.38Revenue deficit including off-budget 5.15 2.75 11.99 27.21 25.81 32.96 33.40 22.77 2.95borrowingsFiscal DeficitsBudgetary non-power fiscal deficit 8.60 8.63 21.83 35.05 32.69 28.26 33.56 36.25 38.44Gross budget support to power sector 9.60 6.02 6.72 7.71 8.79 23.01 23.39 20.65 14.15Budgetary fiscal deficit 18.20 14.65 28.54 42.76 41.48 51.27 56.95 56.90 52.59Netoff-budgetborrowing 5.09 8.10 6.11 10.13 18.69 17.98 11.85 1.76 -4.16Fiscal deficit including off-budget 23.29 22.75 34.65 52.90 60.17 69.26 68.80 58.66 48.42borrowingPowersectordeficit 9.71 7.27 12.70 14.07 21.40 23.49 18.82 16.47 13.93

of which: funded off-budget 0.10 1.25 5.99 6.36 14.31 4.26 0.86 1.10 4.65Fiscal deficit including power sector 23.40 24.00 40.63 59.25 74.48 74.96 69.66 59.76 53.07deficit and off-budget borrowingPrimary Deficits and Debt StockBudgetaryprimarydeficit 6.12 0.72 12.38 22.64 17.31 22.78 24.62 18.42 7.82On-budget debt stock 114.82 130.84 155.82 188.63 225.76 272.87 327.58 384.23 436.56Primary deficit including off-budget 10.62 7.39 16.06 28.82 31.94 34.05 26.62 9.48 -6.67debtDebt stock including off-budget debt 121.72 145.83 176.92 220.08 275.90 340.99 407.54 465.96 514.13

(% GSDP)Revenue DeficitsBudgetary revenue deficit 0.7 0.2 1.1 2.4 2.1 2.2 1.8 0.8 -0.4Revenue deficit including off-budget 0.8 0.4 1.4 2.9 2.5 2.8 2.5 1.5 0.2borrowingsFiscal DeficitsBudgetary non-power fiscal deficit 1.3 1.2 2.6 3.7 3.2 2.4 2.5 2.4 2.2Gross budgetsupportto power sector 1.5 0.8 0.8 0.8 0.9 2.0 1.7 1.3 0.8Budgetary fiscal deficit 2.8 2.0 3.3 4.5 4.0 4.3 4.2 3.7 3.0Netoff-budgetborrowing 0.8 1.1 0.7 1.1 1.8 1.5 0.9 0.1 -0.2Fiscal deficit including off-budget 3.6 3.2 4.1 5.6 5.8 5.9 5.1 3.8 2.8borrowingPowersectordeficit 1.5 1.0 1.5 1.5 2.1 2.0 1.4 1.1 0.8

of which: funded off-budget 0.0 0.2 0.7 0.7 1.4 0.5 0.1 0.1 0.3Fiscal deficit including power sector 3.6 3.3 4.8 6.2 7.2 6.4 5.2 3.9 3.0deficit and off-budget borrowingPrimary Deficits and Debt StockBudgetary primary deficit 0.9 0.1 1.5 2.4 1.7 1.9 1.8 1.2 0.4On-budget debt stock 17.5 18.3 18.3 19.9 21.9 23.1 24.4 25.1 25.0Primarydeficit including off-budget 1.6 1.0 1.9 3.0 3.1 2.9 2.0 0.6 -0.4debtDebt stock including off-budget debt 18.6 20.3 20.7 23.2 26.8 28.9 30.3 30.4 29.5a/Projections from the GoK MTFP and power sector financial restructuring plan.

Annex I

Page 4 of 5Table 1.2

Historical Series of Budgetary Figures, 1990/91-2001/02 (Consolidated with Off-Budget Borrowing)(Rs billion)

1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02RE BE

Revenue Receipts 37.59 46.26 52.47 61.17 67.21 82.52 92.83 102.25 108.10 124.10 144.29 173.28

Own Revenue 27.16 33.72 37.25 43.38 48.88 62.18 67.71 72.88 79.93 88.59 100.64 121.55

Tax 23.32 29.01 30.98 38.12 42.89 52.74 57.68 64.12 69.43 77.44 90.94 108.51

Non- Tax 3.84 4.71 6.28 5.26 5.99 9.44 10.03 8.76 10.50 11.15 9.70 13.04

Central Resources 10.43 12.54 15.21 17.79 18.32 20.34 25.12 29.37 28.17 35.51 43.65 51.73

Shared Taxes 6.60 7.82 9.32 10.17 11.36 14.45 17.30 21.76 19.24 21.33 25.68 30.71

Grants 3.83 4.72 5.89 7.61 6.96 5.89 7.82 7.61 8.94 14.18 17.97 21.02

Revenue Expenditure 37.92 47.51 53.59 59.33 69.31 80.94 97.98 105.00 120.09 151.30 170.11 206.24Interest Payments 4.36 5.15 5.94 7.18 8.71 10.54 12.68 15.36 18.59 24.07 28.23 35.21

Salaries 13.21 14.42 17.08 19.67 22.13 24.81 28.71 35.16 39.29 45.76 47.65 52.90

Grants-in-aid of Salary 1.45 3.15 3.45 3.90 4.52 4.89 5.83 6.43 7.24 8.27 8.46 8.85

Pensions 2.60 2.97 3.49 4.10 4.70 5.59 7.16 8.09 9.72 15.39 15.69 18.11

Subsidies&Transfers 1.71 4.36 4.03 3.14 5.73 7.99 15.56 12.18 12.87 17.86 20.53 37.32

Budget Support to Power Sector 0.33 2.15 1.19 0.39 1.50 3.06 9.60 6.02 6.72 7.71 8.79 23.00

DevointoUrbanLocalBodies 0.98 1.18 1.25 1.24 1.47 1.15 1.94 2.75 3.32 4.16 5.10 6.76

Other Subsidies 0.39 1.03 1.59 1.51 2.76 3.78 4.02 3.41 2.83 5.99 6.64 7.56

Other 14.59 17.46 19.61 21.34 23.51 27.12 28.03 27.78 32.39 39.95 49.55 53.85

Revenue Deficit -0.33 -1.26 -1.12 1.84 -2.10 1.59 -5.15 -2.75 -11.99 -27.21 -25.81 -32.96

Capital Expenditure & Net Lending 4.80 7.39 12.16 13.70 12.17 16.92 18.15 20.00 22.65 25.69 34.36 36.30On-Budget Cap Exp&Nct Lending 4.80 7.39 12.16 13.70 12.17 15.12 13.05 11.91 16.55 15.56 14.48 17.45

Off-Budget Capital Expenditure 0 0 0 0 0 1.80 5.09 8.10 6.11 10.13 19.87 18.85

Primary Deficit -0.77 -3.50 -7.34 -4.69 -5.55 -4.79 -10.62 -7.39 -16.06 -28.82 -31.94 -34.05

Fiscal Deficit -5.13 -8.65 -13.28 -11.87 -14.27 -15.34 -23.29 -22.75 -34.65 -52.90 -60.17 -69.26

Total Debt Stock 49.94 56.93 65.17 74.19 88.77 102.11 121.72 145.83 176.92 220.08 275.90 340.99

Committed Exp as a % of Revenue 58% 56% 57% 57% 60% 56% 59% 64% 69% 75% 69% 66%

(Salary+GiA of Sal+Pension) as % Rev 46% 44% 46% 45% 47% 43% 45% 49% 52% 56% 50% 46%

Interest as %Revenue 12% 11% 11% 12% 13% 13% 14% 15% 17% 19% 20% 20%

Interest rate 10.3% 10.4% 11.0% 11.7% 11.9% 12.4% 12.6% 12.7% 13.6% 12.8% 12.8%

Budget Format (excluding off-budget borrowing)Revenue Surplus(+) / Deficit (-) -0.33 -1.26 -1.12 1.84 -2.10 1.65 -4.55 -1.32 -9.57 -23.25 -21.75 -26.24

Primary Surplus(+) / Deficit(-) -0.77 -3.50 -7.34 -4.69 -5.55 -3.06 -6.12 -0.72 -12.38 -22.65 -17.31 -22.78

Interest Payments 4.36 5.15 5.94 7.18 8.71 10.48 12.08 13.94 16.17 20.12 24.17 28.49

Fiscal Surplus (+) / Deficit(-) -5.13 -8.65 -13.28 -11.87 -14.27 -13.54 -18.20 -14.65 -28.54 -42.77 -41.48 -51.27

DebtStockofGOK 49.94 56.93 65.17 74.19 88.77 100.31 114.82 130.84 155.82 188.63 225.76 272.87

GSDP 250.21 323.13 354.75 410.64 479.02 562.01 655.85 716.85 852.86 949.91 1029.94 1179.15

Annex IPage 5 of 5

Table 1.2 continuedKey Results of the Medium Term Fiscal Plan of the Government of Karnataka (Consolidated with Off-Budget Borrowing)

(% GSDP)1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02

RE BERevenue Receipts 15.0 14.3 14.8 14.9 14.0 14.7 14.2 14.3 12.7 13.1 14.0 14.7

Own Revenue 10.9 10.4 10.5 10.6 10.2 11.1 10.3 10.2 9.4 9.3 9.8 10.3Tax 9.3 9.0 8.7 9.3 9.0 9.4 8.8 8.9 8.1 8.2 8.8 9.2Non- Tax 1.5 1.5 1.8 1.3 1.3 1.7 1.5 1.2 1.2 1.2 0.9 1.1

Central Resources 4.2 3.9 4.3 4.3 3.8 3.6 3.8 4.1 3.3 3.7 4.2 4.4Shared Taxes 2.6 2.4 2.6 2.5 2.4 2.6 2.6 3.0 2.3 2.2 2.5 2.6Grants 1.5 1.5 1.7 1.9 1.5 1.0 1.2 1.1 1.0 1.5 1.7 1.8

Revenue Expenditure 15.2 14.7 15.1 14.4 14.5 14.4 14.9 14.6 14.1 15.9 16.5 17.5Interest Payments 1.7 1.6 1.7 1.7 1.8 1.9 1.9 2.1 2.2 2.5 2.7 3.0Salaries 5.3 4.5 4.8 4.8 4.6 4.4 4.4 4.9 4.6 4.8 4.6 4.5Grants-in-aid of Salary 0.6 1.0 1.0 1.0 0.9 0.9 0.9 0.9 0.8 0.9 0.8 0.8Pensions 1.0 0.9 1.0 1.0 1.0 1.0 1.1 1.1 1.1 1.6 1.5 1.5Subsidies & Transfers 0.7 1.3 1.1 0.8 1.2 1.4 2.4 1.7 1.5 1.9 2.0 3.2

Budget Support toPower Sector 0.1 0.7 0.3 0.1 0.3 0.5 1.5 0.8 0.8 0.8 0.9 2.0Devoin to Urban Local Bodies 0.4 0.4 0.4 0.3 0.3 0.2 0.3 0.4 0.4 0.4 0.5 0.6Other Subsidies 0.2 0.3 0.4 0.4 0.6 0.7 0.6 0.5 0.3 0.6 0.6 0.6

Others 5.8 5.4 5.5 5.2 4.9 4.8 4.3 3.9 3.8 4.2 4.8 4.6

Revenue Deficit -0.1 -0.4 -0.3 0.4 -0.4 0.3 -0.8 -0.4 -1.4 -2.9 -2.5 -2.8

Capital Expenditure & Net Lending 1.9 2.3 3.4 3.3 2.5 3.0 2.8 2.8 2.7 2.6 3.3 3.1On-Budget Capital Expenditure 1.9 2.3 3.4 3.3 2.5 2.7 2.0 1.7 1.9 1.6 1.4 1.5Off-Budget Capital Expenditure 0.0 0.0 0.0 0.0 0.0 0.3 0.8 1.1 0.7 1.1 1.9 1.6

Primary Deficit -0.3 -1.1 -2.1 -1.1 -1.2 -0.9 -1.6 -1.0 -1.9 -3.0 -3.1 -2.9Fiscal Deficit -2.0 -2.7 -3.7 -2.9 -3.0 -2.7 -3.6 -3.2 -4.1 -5.6 -5.8 -5.9Total Debt Stock 20.0 17.6 18.4 18.1 18.5 18.2 18.6 20.3 20.7 23.2 26.8 29.0

Karnataka MTFP Fiscal Summary: Budget Format

Revenue Surplus(+) / Deficit (-) -0.1 -0.4 -0.3 0.4 -0.4 0.3 -0.7 -0.2 -1.1 -2.4 -2.1 -2.2Primary Surplus(+) / Deficit (-) -0.3 -1.1 -2.1 -1.1 -1.2 -0.5 -0.9 -0.1 -1.5 -2.4 -1.7 -1.9Interest Payments 1.7 1.6 1.7 1.7 1.8 1.9 1.8 1.9 1.9 2.1 2.3 2.4Fiscal Surplus (+) l Deficit (-) -2.0 -2.7 -3.7 -2.9 -3.0 -2.4 -2.8 -2.0 -3.3 -4.5 -4.0 -4.3Debt Stock of GOK 20.0 17.6 18.4 18.1 18.5 17.8 17.5 18.3 18.3 19.9 21.9 23.1

Annex JPage 1 of 7

Statistical Annex

India at a Glance

POVERTY and SOCIAL South Low-India Asia income Development diamond

19899Population, mid-year (millions) 997.5 1,329 2,417 Life expectancyGNP per capita (Atlas method, US$) 440 440 410 1GNP (Atlas method, US$ billions) 441.4 581 988

Average annual growth, 1993-99

Population (V.) 1.7 1.9 1.9 GNP GrLabor force (%l) 2.2 2.3 2.3 per Gpmary

Most recent estimate (latest year available, 1993-99) capita enrollment

Poverty (% of population below national poverty line) 36Urban population (% of total population) 28 28 31Life expectancy at birth (years) 63 62 60Infant mortality (per 1,000 live births) 71 75 77Child malnutrition (r/x of children under 5) 45 51 43 Access to safe waterAccess to improved water source (% of population) 81 77 64Illiteracy (% of population age 15l) 38 46 39Gross primary enrollment (/. ofschool-age population) 100 100 96 -India Low-income group

Male 109 110 102Female 90 90 86

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1979 1989 1998 1999Economic ratios

GDP (US$ billions) 150.1 290.5 419.1 447.3Gross domestic investmentlGDP 22.8 24.1 21.8 22.9 TradeExports of goods and services/GDP 6.7 7.3 11.3 12.1Gross domestic savings/GDP 20.7 21.8 19.2 19.9Gross national savings/GDP 22.2 21.4 20.8 21.9 TCurrent account balance/GDP -0.5 -1.8 -0.8 -1.0 Domestic Interest payments/GDP 0.3 1.1 1.1 1 2 SInvestmentTotal debtWGDP 12.0 26.0 23.3 2210 SavingsTotal debt service/exports 10.3 28.6 20.6 22.8Present value o debtVGDP 20.1Present value of debt/exports 143.3

Indebtedness197949 1989-99 1998 1999 199943

(real average annua/ growth)GDP 5.7 5.8 6.8 6.5 6.2 -India Low-incomegroupGNP per capita 3.3 3.9 4.9 4.8 4.5Exports of goods and services 4.9 11.9 12.5 3.6 10.1

STRUCTURE of the ECONOMY1979 1989 1998 1999 Growth of Investment and GDP I%)

(% of GDP) 30Agriculture 36.8 31.6 29.1 27.7 2,Industry 25.0 27.6 25.7 26.3

Manufactunng 17.4 17.4 15.6 15.9 0Services 38.3 40.8 45.2 460 .0 0 94 95 97 98 99

Private consumption 69.2 66.1 68.6 68.1 -20Generalgovemmentconsumption 10.0 12.2 12.3 12.0 GDI S GDPImports of goods and services 8.7 9.6 14.0 15.0

197949 1989-99 1998 1999 Growth of exports and Imports (%)(real average annual growth)Agriculture 3.4 3.3 7.2 1.3 4Industry 6.6 6.5 4.0 8.8 30

Manufacturing 7.0 7.0 3.6 8.5Services 6.7 7.5 8.3 7.9 __ _ _ _

Private consumption 5.5 5.2 3.2 2.8 oGeneral government consumption 7.8 5.9 14.5 10.3 94 ss ss 97Gross domestic investment 5.7 6.2 4.3 11.5 -1Imports of goods and services 6.5 8.9 -2.5 -1.8 Exports *OImports

Gross national product 5.5 5.8 6.7 6.7

Note: 1999 data are preliminary estimates.

The diamonds show four key indicators in the country (in bold) compared with its income-group average, If data are missing, the diamond willbe incomplete.

Annex JPage 2 of 7

India

PRICES and GOVERNMENT FINANCE1979 1989 1998 1999 infiatiorn

Domestic prices

(%l change)Consumer prices 6.2 12.7 3A4 ,rImplicit GDP deflator 15.8 83 8.9 33

Government finance(% of GDP, includes current grants) :--Current revenue . 23.5 22.3 23 6 d5 93 97 9

Current budget balance 0 A -1.2 -1 9 -GDP deflator 0CPIOverall surplus/deficit -12.5 -9.9 -11 3

TRADE1979 1989 1998 1999 --

(US$ millions) 1Export and import levels (US$ mill.)Total exports (fob) . 16,955 34,298 38,285 60UOC.

Tea 550 547 569 cIron .. 557 380 374 *Manufactures .. 12,730 26,870 31,321

ToJtal imports (cif) .. 24,411 47,544 55,383Food 714 2,543 2,450 r * ! *-Fuel and energy .. 3,768 6,435 10,682Capital goods .. 5,288 9,122 9,912 o

Export pnce index (1995=100) .. 113 94 90Import prce index (1995=100) .. 89 92 88 IEIIorts a mponsTerrnsoftrade(1995=100) 128 102 102

BALANCE of PAYMENTS1979 1989 1998 1999 -. - -

(USS millions) Current account balance to GDP I%)Exports of goods and services 9,980 21,201 47,484 54,006 oImports of goods and services 13,120 27,934 58,565 67,248 UResource balance -3,140 -6,733 -11,081 -13,242 jflNet income 527 -798 -2,955 -3,566 I 'llNet current transfers 1,852 2,281 10,587 12,256

Current account balance -761 -5,249 -3,449 -4,552

Financing items (net) 985 4,400 7,382 10,340Changes in net reserves -224 850 -3,933 -5,788 2 -

Memo:Reserves including gold (US$ millions) 7,581 4,582 33,584 38,150Conversion rate (DEC, locaLVUS$) 8.1 16.7 42.1 43.3

EXTERNAL DEBT and RESOURCE FLOWS1979 1989 1998 1999

(US$ millions) Composition of 1999 debt (US$ mill.)Total debt outstanding and disbursed 18,009 75,407 97,639 98,434

IBRD 728 6,615 7,990 7,816 G 4,r43 A: 7,816IDA 4,505 12,521 18,562 18,930

Total debt service 1,303 6,955 12,094 15,313IBRD 127 881 1,378 1,600IDA 43 188 423 1,432

Composition of net resource flows F: 38,336Official grants 717 698 307 382 C.26Official creditors 650 2,489 1,002 -1,088 D: 4,619Private creditors 13 2,870 3,175 2,245Foreign direct investment .. 350 2,462 2,155Portfolio equity 0 0 -61 3,026 E 24,664

World Bank programCommitments 766 2,987 1,543 727 A - IBRD E - BilateralDisbursements 695 2,011 1,421 1,461 B - IDA D - Olher mr,tilateral F - PivatePrincipal repayments 77 450 1,130 2,286 C-IMF G -Short-termNetflows 619 1,561 292 -825Interest payments 93 619 671 746Net transfers 525 942 -379 -1,571

Development Economics 4/24/01

Annex JPage 3 of 7

India Social Indicators

Latest single year Sam regionincome group

LOW.

1970-75 1980-85 1993-98 South Asia incom

POPULATIONTotal population, rid-year (rillions) 613.5 765.1 979.7 1,304.6 3,536.4

Growthrate(%annualaverage) 2.3 2.1 1.4 1.5 1.4

Urban populaton (%of population) 21.3 24.3 27.8 27.7 30.5

Total fertility rate (births per woman) 5.6 4.8 3.2 3.4 3.1

POVERTY(0/oofpopulation)National headcount index 35.0

Urban headcount index .. 30.5Rural headcount index .. 36.7

INCOMEGNPpercapita(US$) 190 300 440 430 520

Consunerpriceindex(1995=100) 21 41 132 131 136Foodpriceindex(1995=100) 38 132

LNCOMEJCONSUMPTION DISTRIBITIONGini index .. .. 37.8

Lowvest quintile (/o of incorm or consunption) 5.9 .. 8.1Hfighest quintle (% of incore or consumtion) 49.4 .. 46.1

SOCIAL ENDICATORSPublic expenditure

Health (% of GDP) .. .. 0.6 0.8 1.3

Education (%ofGNP) 2.7 3.5 3.2 3.1 3.2Social security and welfare (% of GDP)

Net prinary sdiool enrollrent rate(% of age group)

Total 60 75 77 77 86Male 72 85 83 83 89Female 48 64 71 70 82

Access to safe water(% of population)

Total 54 81 77

Urban 80 85 83

Rural 47 79 75Imnumization rate(% under 12 months)

Measles .. 1 81 81 80

DPT .. 41 90 87 82

Child rrlnutntion (% under 5 years) . . 53 53

[kfe expectancy at birth

Total 50 55 63 62 63

Male 5 1 56 62 62 62Femrle 49 55 64 63 64

MortalityInfant(perthousandlivebirths) 132 97 70 75 68Under 5 (per thousand live births) 206 177 95 89 92Adult (15-59)

Male (per 1,000 population) 324 261 215 220 235FenWle (per 1,000 population) 353 279 204 213 208

Maternal (per 100,000 live births) .. 410

2000 World Development Indicators CD-ROM, World Bank

Annex JPage 4 of 7

India Key Economic Indicators

Actual Estimate ProjectedIndicator 1996 1997 1998 1999 2000 2001 2002 2003

National accounts (as % of GDP)Gross domestic producte 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Agriculture 29.3 28.0 29.1 27.7 26.7 25.8 24.9 24.0Industry 27.1 27.1 25.7 26.3 26.3 26.5 26.9 27.4

Services 43.6 44.9 45.2 46.0 47.0 47.6 48.2 48.6

Total Consumption 81.8 80.1 80.8 80.1 79.0 78.6 78.5 78.2Gross domestic fixed investment 23.0 22.7 21.4 22.0 23.5 23.8 24.0 24.3

Government investment 6.9 6.5 6.5 6.6 7.7 7.2 7.4 7.4Private investment 16.1 16.2 14.9 15.4 15.7 16.6 16.6 16.9

Exports(GNFS)J 10.8 11.1 11.3 12.1 13.1 13.7 14.2 14.6Imports(GNFS) 14.5 14.5 14.0 15.0 16.5 17.1 17.7 18.1

Grossdomesticsavings 18.2 19.9 19.2 19.9 21.0 21.4 21.5 21.8Gross national savings' 20.5 22.0 20.8 21.9 23.2 23.6 23.6 23.7

Memorandum itemsGross domestic product 383640 407889 419070 447292 477417 514073 553699 597502(US$ million at current prices)GNP per capita (US$, Atlas method) 410 420 420 440 490 510 530 560

Real annual growth rates (%, calculated from 1993 prices)Gross domestic product at market prices 7.0 4.6 6.8 6.5 5.8 6.0 6.3 6.5Gross Domestic Income 6.9 5.3 5.7 5.9 4.8 6.5 6.7 6.6

Real annual per capita growth rates (%, calculated from 1993 prices)Gross domestic product at market prices 5.1 2.7 4.9 4.6 3.9 4.3 4.8 5.1Total consumption 11.7 1.2 3.0 2.2 0.9 4.4 5.0 4.9Private consumption 13.3 0.1 1.4 1.0 -0.3 5.3 7.2 5.9

Balance of Paymnents (US$ millions)Exports (GNFS)b 41607 45109 47484 54006 62699 70567 78846 87497

Merchandise FOB 34133 35680 34298 38285 45817 52588 59894 67553Imports (GNFS)5 55696 59297 58565 67248 78727 88087 98003 108331

Merchandise FOB 48948 51187 47544 55383 64531 74023 83763 94201Resource balance -14089 -14188 -11081 -13242 -16028 -17521 -19157 -20834Net current transfers 12367 12209 10587 12256 12747 13820 14512 15238Current account balance -5578 -5145 -3449 -4552 -5497 -6169 -7595 -9335

Net private foreign direct investmnent 2821 3557 2462 2155 2500 4000 4500 4500Long-tertn loans (net) 3424 1816 5918 4781 8133 4124 7250 4368Official 221 -398 1002 -1088 -1191 1037 961 1050Private 3203 2213 4917 5869 9324 3086 6289 3318

Other capital (net, incl. errors &onunissions) 4560 3368 -998 3404 -300 -300 -300 -300Change in reservesd -5227 -3596 -3933 -5788 -4836 -1655 -3855 766

Memorandum itemsResource balance (% of GDP) -3.7 -3.5 -2.6 -3.0 -3.4 -3.4 -3.5 -3.5Real annual growth rates ( YR93 prices)Merchandise exports (FOB) 7.4 2.5 2.8 16.7 20.9 10.7 9.9 10.0Primary -33.7 4.0 42.7 6.4 4.9 4.6 4.7 4.8Manufactures 10.1 6.2 1.9 19.2 24.9 11.9 11.0 11.0

Merchandiseirnports(CIF) 8.0 11.3 3.1 12.7 10.6 17.2 13.2 11.2

Annex JPage 5 of 7

India Key Economic Indicators


Public finance (as % of GDP at market prices)'Current revenues 21.7 22.8 22.3 23.6 24.3 24.4 24.5 24.6Current expenditures 21.3 22.7 23.5 25.5 26.1 25.7 25.2 24.7Current account surplus (+) or deficit(-) 0.4 0.1 -1.2 -1.9 -1.8 -1.3 -0.6 -0.1Capital expenditure 9.0 7.8 8.7 9.1 9.2 9.2 9.4 9.4Foreign financing 0.3 0.4 0.3 0.8 0.4 -0.1 0.0 -0.7

Monetary indicatorsM2/GDP 51.5 54.2 55.5 55.5 56.7 57.7 59.2 60.7Growth ofM2 (%) 16.2 17.0 19.2 9.9 15.6 15.0 15.6 15.7Private sector credit growth/ 50.7 57.6 52.2 25.7 61.9 53.6 73.0 57.1total credit growth (%)

Price indices( YR93 =100)Merchandise export price index 99.7 101.7 95.2 92.7 91.8 95.2 98.7 101.2Merchandise importprice index 110.9 105.7 103.5 121.4 127.9 125.1 125.1 126.5Merchandise terns of trade index 89.8 96.3 92.0 76.4 71.8 76.1 78.9 80.0Real exchange rate (US$/LCUJ 72.3 76.6 72.4 72.4 69.1 70.5 71.9 72.6

Consumer price index (%change) 9.4 7.2 12.7 3.4 7.0 6.5 6.0 6.0GDP deflator (% change) 7.7 6.4 8.9 3.3 7.0 6.5 6.0 6.0

a. GDP at factor costb. "GNFS" denotes "goods and nonfactor services."c. Includes net unrequited transfers excluding official capital grants.d. Includes use of IMF resources.e. Consolidated Non-financial public sector.f. "LCU" denotes "local currency units." An increase in US$/LCU denotes appreciation.

Annex JPage 6 of 7

India Key Exposure Indicators


Total debt outstanding and 93470 94320 97639 98434 106333 107457 111204 112074disbursed (TDO) (US$m) a.

Net disbursements (USSm) a. 778 -1602 3069 1312 4366 1787 4793 2157

Total debt service (TDS) (US$m) a. 11982 12415 12094 15313 13552 11042 12019 15801

Debt and debt service indicators

(%)TDO/XGSb. 171.9 161.6 166.0 146.7 137.7 124.5 116.6 106.9

TDO/GDP 24.4 23.1 23.3 22.0 22.3 20.9 20.1 18.8TDS/XGS b. 22.0 21.3 20.6 22.8 17.6 12.8 12.6 15.1

Concessional/TDO 43.7 41.2 41.1 45.4 41.3 41.0 39.2 38.2

IBRD exposure indicators (%)IBRDDS/publicDS 13.7 12.2 12.5 12.2 11.4 12.5 11.6 8.9Preferred creditor DS/public 29.4 24.0 23.6 31.6 31.3 26.8 25.1 19.3DS (%/.)IBRD DS/XGS 2.8 2.4 2.3 2.4 1.8 1.4 1.3 1.3IBRD TDO (US$m) c. 8768 8138 7990 7816 7216 7376 7892 8773

Share of IBRD portfolio (%) 7.9 6.8 6.5 6.4 5.8 5.7 6.0 6.8IDATDO(US$m)c. 17616 17912 18562 18930 20044 20813 21179 21252

IFC (US$m) 835.8 855.4 801.7 686.3 677.7Loans 654.9 662.8 569.1 436.0 411.9

Equity and quasi-equity d 180.9 192.6 232.6 250.3 265.8

MIGAMIGA guarantees (US$m)

Note: IBRD Data in this table differs from other annexes because this table is done based on the Indian FY.

a. Includes public and publicly guaranteed debt, private nonguaranteed, use of IMF credits and net short-term capital.

b. "XGS" denotes exports of goods and services, including workers' remittances.

c. Includes present value of guarantees.

d. Includes equity and quasi-equity types of both loan and equity instruments.

Annex JPage 7 of 7

Evolution of the Public Sector Deficit 1, 1990-02 (% of GDP at Market Prices)

90-91 91-92 92-93 93-94 94-95 95-96 96-97 97-98 98-99 99-00 00-01 01-02RE BE

Central GovernmentFiscal Deficit 2 6.6 5.2 5.1 6.4 5.3 4.3 4.1 4.9 5.5 5.4 5.2 5.2Primary Deficit3 4.1 2.0 1.5 2.7 1.9 1.0 0.6 1.6 2.3 0.8 0.6 0.6Domestic Debt Stock 49.9 48.6 48.1 50.1 48.2 46.7 45.4 47.5 47.5 50.2 51.1 n.a.Interest/Revenue 39.1 40.2 41.9 48.6 48.4 45.4 47.1 49.0 52.1 50.4 48.8 48.5

State GovernmentFiscal Deficit 3.2 2.8 2.8 2.4 2.7 2.6 2.7 2.9 4.3 4.8 4.2 4.0Primary Deficit 1.6 1.1 1.0 0.6 0.8 0.8 0.9 1.2 2.2 2.5 1.8 n.a.Domestic Debt Stock 19.4 19.3 19.0 18.6 18.2 17.9 17.8 18.5 19.4 20.9 n.a. n.a.Interest/Revenue 13.0 13.6 14.5 15.0 15.7 16.0 16.7 18.3 20.3 21.2 22.4 n.a.

General GovernmentFiscal Deficit 4 9.2 7.3 7.3 8.2 7.5 6.6 6.4 7.3 9.2 9.7 9.1 8.9Primary Deficit 4.8 2.6 2.4 3.2 2.4 1.6 1.3 2.3 4.1 4.3 3.7 n.a.Domestic Debt Stock 56.2 55.2 54.7 56.9 54.8 53.5 52.3 54.6 55.2 58.7 n.a. n.a.Interest / Revenue 21.5 22.1 23.2 25.0 25.8 25.2 26.5 26.6 29.7 28.7 28.9 n.a.

Consolidated Non-Financial Public SectorDeficit

Fiscal Deficit 5 11.2 9.4 9.3 10.3 9.0 8.2 8.7 8.2 9.9 11.3 10.3 n.a.

Notes: For States 1999-00 = RE; 2000-01= BE; 2001-02= Estimate1: All definitions pertain to World Bank definitions unless otherwise specified.2: Fiscal Deficit (Govt.of India new defh.) excluding disinvestment from revenues.3. : Fiscal deficit mninus interest payments4: General Govt. comprises Central (excl. divestment revenues), States Govermnents and excludes netlending from Center to States5. : Consolidated Public Sector includes General government, oil pool balance and market financed centralpublic enterprise deficit (on-lending from central government to central public enterprises is netted out)Source : Budget Documents, RBI State Bulletins, RBI Annual Report 1998-99, Staff Estimates, IMF

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