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Country Report

India

September 2004

The Economist Intelligence Unit15 Regent St, London SW1Y 4LRUnited Kingdom

India at a glance: 2004-05

OVERVIEWThe Economist Intelligence Unit expects the United Progressive Alliance (UPA)coalition, led by the Indian National Congress, to remain in governmentthroughout the forecast period. However, the UPA is inherently unstable.Already a large coalition, it relies on the support of Left Front (far-left) parties toachieve a majority in parliament, and this is far from assured. The oppositionBharatiya Janata Party is weak (having been resoundingly defeated in the May2004 general elections) and currently does not have the strength to dislodge theUPA government. The Left Front therefore remains the crucial element in thepolitical equation. A late but generally adequate monsoon will ensure that GDPgrowth remains above 6% in 2004. Rising international oil prices will lead to awidening trade deficit, but this will be offset by larger surpluses on the servicesand transfers balances. The rupee will depreciate slightly against the US dollar inthe second half of 2004, and will continue on this trend in 2005. Consumerprice inflation, affected by rising oil prices, will rise to 5.7% in 2005.

Key changes from last month

Political outlook• The scandal over “tainted ministers” (those with criminal charges pending

against them) has yielded its first casualty: the coal minister, Shibu Soren, hasbeen forced to resign. The opposition has refused to rejoin parliament untilall tainted ministers are dismissed. Parliament will thus continue to bedisrupted for the foreseeable future.

Economic policy outlook• Rising international oil prices have added to India’s import bill, fuelling

wholesale price inflation. In order to stem inflation, the government hasreduced taxes on fuel imports. However, this will impact negatively on thefiscal deficit.

Economic forecast• The monsoon recovered in August and is now expected to be almost

normal, yielding a near-average harvest. However, higher international oilprices will offset some of the gains from the better than expected monsoon.Our economic growth forecast for 2004 therefore remains unchanged.

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India 1

Country Report September 2004 www.eiu.com © The Economist Intelligence Unit Limited 2004

Contents

India

3 Summary

4 Political structure

5 Economic structure5 Annual indicators6 Quarterly indicators

7 Outlook for 2004-057 Political outlook8 Economic policy outlook10 Economic forecast

13 The political scene

17 Economic policy

24 The domestic economy24 Economic trends25 Agriculture27 Infrastructure29 Oil and gas30 Financial markets31 Financial and other services32 Manufacturing33 Tourism

33 Foreign trade and payments

List of tables10 International assumptions summary

12 Forecast summary

20 Budget summary

24 Real GDP at factor cost

25 Inflation

26 Rainfall, June 1st-August 4th 2004

27 Performance of major information technology companies

31 Foreign institutional investors’ transactions in equities

31 Finances of IDBI and IDBI Bank, 2003/04

33 Vehicle sales and exports, April-July 2004

34 Current and capital accounts

35 Trade, reserves and the exchange rate

36 Cargo traffic in major ports

2 India


List of figures

12 Gross domestic product12 Consumer price inflation25 Consumer price inflation26 Rainfall, June-August 200431 Foreign institutional investors’ net transactions in equities

India 3


IndiaSeptember 2004

Summary

The Economist Intelligence Unit expects the United Progressive Alliance (UPA)coalition, led by the Indian National Congress, to remain in governmentthroughout the forecast period. However, the UPA is inherently unstable.Already a large coalition, it relies on the support of Left Front (far-left) parties toachieve a majority in parliament, and this is far from assured. The oppositionBharatiya Janata Party is weak, having been resoundingly defeated in the May2004 general election, and currently lacks the strength to dislodge the UPAgovernment. The Left Front thus remains the crucial element in the currentpolitical equation. A late but adequate monsoon will ensure that GDP growthremains above 6% in 2004.

The “tainted ministers” scandal continues to affect normal parliamentaryprocedure, and has claimed its first casualties—the minister of coal, Shibu Soren,and the chief minister of Madhya Pradesh, Uma Bharti. The prime minister,Manmohan Singh, has set out his new government’s policy agenda in atelevised speech. The government has pledged to act on religious violence, andhas also said that it will allow the Prevention of Terrorism Act to lapse.

The finance minister, Palaniappan Chidambaram, has presented the budget forfiscal year 2004/05 (April-March). A social-democratic budget, it increasesdevelopment expenditure as well as taxation, and raises investment limits inthree key industries—aviation, insurance and telecommunications. The budget’srevenue assumptions are ambitious, with corporate tax revenue estimated torise by 40% year on year. The Fiscal Responsibility and Budget Management Acthas been passed.

Real GDP growth in 2003/04 stood at 8.2% (at factor cost). Wholesale inflationrose above 5% year on year in the first quarter of 2004/05. The monsoonresumed in most parts of the country in August, and a near-normal crop isexpected. In July Tata Consultancy Services was floated, and was over-subscribed. India’s software exports rose to US$12.6bn in 2003/04. The IndianSpace Research Organisation has won a contract to launch an Italian satellite.

Strong GDP growth spurred imports. Nevertheless, owing to strong serviceexports and strong current transfers, the current account balance stood atUS$8.7bn in 2003/04. The capital account surplus rose to US$22.1bn in the sameyear. Foreign exchange reserves stood at US$118.3bn at the end of July 2004.

Editors: Ravi Bhatia (editor); Leo Abruzzese (consulting editor)Editorial closing date: September 1st 2004

All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] report: Full schedule on www.eiu.com/schedule

Outlook for 2004-05

The political scene

Economic policy

The domestic economy

Foreign trade and payments

4 India


Political structure

Republic of India

Federal republic, with 29 states and six union territories

President, currently Abdul Kalam, indirectly elected in 2002 for a five-year term bymembers of the central and state assemblies

The prime minister presides over a Council of Ministers chosen from elected members ofparliament

Bicameral. The Rajya Sabha, or upper house, has 245 members (233 elected by weightedvotes of the elected members of parliament and the legislative assemblies of states andunion territories, and 12 appointed by the president). The Lok Sabha, or lower house, has545 members, 543 elected from single-member constituencies (79 seats are reserved forscheduled castes and 40 for scheduled tribes) and two representatives of Anglo-Indiansappointed by the president

Unicameral or bicameral, with elected members; state governors are appointed by thepresident

Based on the 1950 constitution and English common law

The United Progressive Alliance (UPA), a coalition led by the Indian National Congress,obtained the highest number of seats and formed a minority government, installingManmohan Singh as prime minister. The UPA requires additional parliamentary support,and is currently being supported by the Left Front, a group of left-wing parties dominatedby the Communist Party of India (Marxist)

The last Lok Sabha election was completed on May 13th 2004; the next one is due byMay 2009

Indian National Congress (Congress); Bharatiya Janata Party (BJP); Communist Party ofIndia (Marxist), or CPI (M); Telegu Desam Party (TDP); Samajwadi Party; Shiv Sena;Bahujan Samaj Party (BSP); Dravida Munnetra Kazhagam (DMK); Janata Dal; Samata; All-India Anna DMK (AIADMK); Biju Janata Dal (BJD); Trinamool Congress (TC); NationalistCongress Party (NCP); Rashtriya Janata Dal (RJD); Rashtriya Lok Dal (RLD); ShiromaniAkali Dal (SAD)

Prime minister Manmohan Singh (Congress)Commerce & industry Kamal Nath (Congress)Communications & information technology Dayanidhi Maran (DMK)Defence Pranab Mukherjee (Congress)Education Arjun Singh (Congress)External affairs Natwar Singh (Congress)Finance Palaniappan Chidambaram

(Congress)Food & agriculture Sharad Pawar (NCP)Information & broadcasting Jaipal Reddy (Congress)

Interior minister Shivraj Patil (Congress)Parliamentary affairs Ghulam Nabi Azad (Congress)Petroleum & natural gas Mani Shankar Aiyar (Congress)Railways Laloo Prasad Yadav (RJD)

Yaga Venugopal Reddy

Official name

Form of state

Head of state

The executive

National legislature

State legislatures

Legal system

National government

National election

Main political organisations

Key cabinet ministers

Central bank governor

India 5


Economic structure

Annual indicators1999 a 2000 a 2001a 2002 a 2003 b

GDP at market prices (Rs bn)c 19,368.3 20,589.6 22,821.4 24,695.6 27,196.8GDP (US$ bn) 444.3 450.7 478.5 510.2 585.2

Real GDP growth (%)c 7.1 3.9 5.1 4.6 8.5Consumer price inflation (av; %) 4.7 4.0 3.8 4.3 3.8 a

Population (m) 997.9 1,014.0 1,030.0b 1,045.8 b 1,061.6

Exports of goods fob (US$ m) 36,877.0 45,636.0 45,399.0 52,743.0 58,879.1Imports of goods fob (US$ m) -45,556.0 -60,268.0 -58,231.0 -65,160.0 -76,068.0

Current-account balance (US$ m) -3,227.0 -2,639.0 1,761.0 4,656.0 3,924.2Foreign-exchange reserves excl gold (US$ m) 32,667.0 37,902.0 45,871.0 67,666.0 98,938.0 a

Total external debt (US$ bn) 98.3 99.1 97.5 104.4 112.4

Debt-service ratio, paid (%) 209.3 184.8 112.1 146.0 169.2Exchange rate (av) Rs:US$ 43.06 44.94 47.19 48.61 46.58 a

a Actual. b Economist Intelligence Unit estimates. c Fiscal year.

Origins of gross domestic product 2003a % of total Components of gross domestic product 2002a % of totalAgriculture 20.2 Private consumption 65.0Industry 24.2 Government consumption 13.0

Services 46.6 Fixed investment 22.9Statistical discrepancy 9.0 Stockbuilding 0.1

Exports of goods & services 14.9Imports of goods & services 15.4

Principal exports 2003ab US$ bn Principal imports 2003ab US$ bnEngineering goods (incl iron & steel) 12.2 Petroleum & petroleum products 20.6

Gems & jewellery 10.5 Capital goods 9.8Textiles 6.5 Electronic goods 7.5Chemicals 6.3 Precious & semi-precious stones 7.1

Readymade garments 6.1 Chemicals & related products 6.2

Main destinations of exports 2003 % of total Main origins of imports 2003 % of totalUS 21.9 US 7.7China 6.8 Belgium 6.4

UK 5.6 UK 5.8Hong Kong 5.1 China 5.2

a Fiscal years beginning April 1st of the year indicated. b Ministry of Finance, Economic Survey 2002-03.

6 India


Quarterly indicators2002 2003 20043 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr

Government finance (Rs bn)Revenue 685.49 645.24 990.89 381.14 839.73 877.81 1,221.08 480.10Expenditure 867.35 930.47 1,574.67 767.22 1,403.79 992.02 1,556.33 896.91Balance -181.86 -285.23 -583.78 -386.08 -564.06 -114.21 -335.25 -416.81OutputGDP at constant 1993/94 prices (Rs bn)a 3,000.8 3,502.9 3,566.1 3,278.4 3,258.6 3,869.9 3,860.2 n/aGDP at constant 1993/94 prices

(% change, year on year) 5.5 2.0 3.7 5.3 8.6 10.5 8.2 n/aIndustrial production index (1993/94=100) 171.9 178.5 188.7 177.1 183.3 191.5 204.0 190.5

PricesConsumer prices (1982=100) 483.3 486.7 484.7 494.7 499.7 503.0 504.0 508.0Consumer prices (% change, year on year) 4.0 3.6 3.8 4.7 3.4 3.4 4.0 2.7

Wholesale prices (1993/94=100)General index 166.7 167.4 169.6 173.6 174.2 176.6 179.6 182.5Fuel 238.3 240.2 246.7 248.6 251.2 255.8 262.4 267.8Manufactured goods 148.1 148.5 150.2 153.9 155.1 157.1 160.4 162.5Financial indicatorsExchange rate Rs:US$ (av) 48.60 48.29 47.77 47.06 46.01 45.49 45.25 44.90Exchange rate Rs:US$ (end-period) 48.38 48.03 47.55 46.47 45.85 45.61 43.39 45.98Bank rate (end-period; %) 6.50 6.25 6.25 6.00 6.00 6.00 6.00 6.00Lending rate (av; %) 12.00 11.67 11.50 11.50 11.50 11.33 11.00 11.00M1 (end-period; Rs bn) 4,206.8 4,324.9 4,518.9 4,780.2 4,805.8 5,011.9 5,477.3 n/aM1 (% change, year on year) 13.1 12.5 12.5 13.7 14.2 15.9 21.2 n/aM2 (end-period; Rs bn) 15,345 15,609 15,953 16,748 17,248 17,578 18,595 n/aM2 (% change, year on year) 17.4 16.8 15.4 12.3 12.4 12.6 16.6 n/aBSE Sensex (end-period; 1978/79=100) 2,991 3,377 3,049 3,607 4,453 5,839 5,591 4,795BSE Sensex (% change, year on year) 6.4 3.5 -12.1 11.2 48.9 72.9 83.4 32.9Sectoral trendsCrude oil (m barrels; production/day) 0.76 0.76 0.76 0.73 0.76 0.82 0.81 0.80Production index (1993/94=100)Manufacturing 178.0 184.5 196.8 183.4 191.5 199.2 212.5 197.9Mining 134.2 143.6 149.1 138.7 138.1 149.9 161.1 147.2Electricity 163.5 167.8 165.5 167.3 166.5 174.9 181.7 177.0Foreign trade (US$ m)Exports fob 13,047 12,447 13,942 12,893 14,080 15,970 18,024 16,498Imports cif -14,821 -15,637 -16,092 -17,167 -17,388 -20,594 -20,482 -22,417Trade balance -1,774 -3,190 -2,150 -4,274 -3,308 -4,624 -2,458 -5,919Balance of payments (US$ m)b

Merchandise trade balance fob-fob -2,661 -4,350 -3,147 -5,225 -4,156 -5,615 n/a n/aServices balance 1,541 2,655 1,675 2,062 2,188 4,564 n/a n/aIncome balance -967 -1,379 -1,271 -1,343 -1,462 -2,390 n/a n/aNet transfer payments 3,684 3,989 3,958 4,276 5,067 5,260 n/a n/aCurrent-account balance 1,597 915 1,215 -230 1,637 1,819 n/a n/aForeign reserves excl gold (end-period) 60,319 67,666 72,566 79,519 88,423 98,938 108,764 115,453

a At factor cost. b Reserve Bank of India.

Sources: Centre for Monitoring Indian Economy, Monthly Review of the Indian Economy; IMF, International Financial Statistics; International Energy Agency, Monthly Oil Market Report;

Financial Times; Reserve Bank of India.

India 7


Outlook for 2004-05

Political outlook

The Economist Intelligence Unit expects the United Progressive Alliance (UPA)coalition, led by the Indian National Congress, to remain in governmentthroughout the forecast period. However, the UPA is inherently unstable.Already a large coalition, it relies on the support of Left Front (far-left) parties toachieve a majority in parliament, and this is far from assured. The oppositionBharatiya Janata Party (BJP) is weak (having been resoundingly defeated in theMay 2004 general elections) and lacks the strength to dislodge the UPAgovernment. The Left Front therefore remains the crucial element in the currentpolitical equation.

Since the new government was formed in May, normal parliamentaryprocedure has been disrupted. The BJP, still bitter about its election defeat, hasattacked the government for appointing several ministers who are facingcriminal charges, mainly for corruption. The “tainted ministers” scandal hasdisrupted parliament as the BJP has blocked legislative action, walked out ofcommittee meetings and disobeyed the parliamentary speaker. The boycott hasalso led to the BJP inadvertently permitting the UPA to pass the budget withoutdebate. The scandal initially left the prime minister, Manmohan Singh, lookingineffectual. Eventually, the coal minister, Shibu Soren, who is underinvestigation for his role in the deaths of 11 people during a political protest in1975, was forced to resign. The UPA soon retaliated against the opposition byhighlighting the fact that criminal proceedings were pending against the chiefminister of Madhya Pradesh, Uma Bharti, a prominent BJP politician, for heralleged role in instigating a riot a decade ago. Ms Bharti was forced to resign.

These episodes have highlighted two risks to the government’s stability: first,that Congress will have a difficult time managing a diverse coalition (with thefirst cabinet resignation already having taken place), and second, that Congressand the BJP appear to be adopting a “take no prisoners” attitude towards eachother, foreshadowing more tension and agitation ahead.

Nevertheless, the greatest risk to the government remains its minority positionin parliament and its continuing reliance on the Left Front (mainly communist)parties for support from outside the government. The Left Front has, forexample, already criticised the government for proposing to raise the cap onforeign investment in three key industries. The Left Front, historically hostile toCongress, has in recent years come to view the BJP as its arch political enemy,and agreed to support Congress in part to prevent the BJP from returning topower. The Left Front, as well as several UPA coalition partners, performed wellin the general election, and are unlikely to withdraw their support from thegovernment for fear of losing their hard-won seats in the event of anotherelection being called. However, a minority coalition government will be subjectto conflicting demands from parochial interests. The government is and willremain unstable, and may not last its entire five-year term.

Domestic politics

8 India


The new cabinet, led by Mr Singh, a highly qualified economist, is tornbetween non-reformist Congress stalwarts, coalition alliance members and tworeformers in key positions—namely Mr Singh himself as prime minister andPalaniappan Chidambaram as finance minister. Forces within the cabinet willpull in a pro- as well as an anti-reform direction, and horse-trading on keyissues will be standard procedure. Furthermore, Sonia Gandhi, the widow of aformer prime minister, Rajiv Gandhi, and the de facto leader of the UPA, whodespite support from almost all the leading figures in the UPA declined the postof prime minister, will be the Congress party leader in parliament and willremain the party’s president. This unorthodox division of responsibilities(which required an amendment to the Congress party’s constitution) meansthat Mr Singh will continue to look to Mrs Gandhi for guidance, especially onpolitical matters. The cabinet is thus subject to conflicting forces, and is likely toremain so throughout the forecast period. Nevertheless, a change of primeminister is unlikely, as Mr Singh has in the past avoided questioningMrs Gandhi’s authority and will continue to follow her instructions onimportant issues.

India’s foreign minister, Natwar Singh, met Pakistan’s president, PervezMusharraf, on the sidelines of a regional political summit in July, and bothsides pledged to continue talks on their differences in a violence-freeatmosphere. This suggests that the new leadership may advance the progressinitiated by the previous Indian government. Even so, the future of Kashmirremains at the heart of antagonisms between the two countries; an eventualcompromise might involve greater autonomy for the Indian state of Jammu andKashmir, and the conversion of the Line of Control (which separates the Indian-and Pakistani-controlled areas of the region) into a permanent border. However,the obstacles to a lasting solution to the conflict remain formidable. A seriousattack by Islamist militants in India could derail the whole process. If peacetalks collapse, tension between India and Pakistan could quickly rise again.

The new government has pledged a more independent foreign policy stancetowards the US, in contrast with the BJP’s improved relations with that country.But relations will remain cordial, especially now that economic links are sodurable. India and China have also met again to discuss their border dispute;although a settlement is not imminent, relations are better than they have beenin years, and further progress looks likely.

Economic policy outlook

The new UPA government, which took office in May, pledged to increasespending significantly on social welfare programmes for the 200m Indians whoare largely destitute, while simultaneously liberalising the economy. The budgetfor fiscal year 2004/05 (April-March), released in early July, is social-democraticin style, and includes large expenditure programmes. It provides an additionalRs100bn (US$2.2bn, approximately 2.1% of total budgeted expenditure) in newspending for basic food, health and agriculture initiatives. A surcharge of 2% onall taxes, yielding Rs40bn-50bn a year, will also be imposed in order to financeeducation. More specifically, the government has guaranteed 100 days of

International relations

Policy trends

India 9


employment each year to one able-bodied person in every poor household,has promised to double credit to the agriculture sector over three years, and hassaid that it will provide wider access to drinking water, electricity and housingfor rural communities. By committing funds to the largely backward agriculturalsector, the government is investing in future productivity growth, but it will besome time before the benefits become apparent.

The government has also committed itself to fiscal consolidation, but this willbe extremely difficult to achieve, especially as it has reaffirmed an earlierpledge to limit tightly privatisation of state-owned assets. Its decision to reducetaxes on fuel imports as international oil prices have risen will also trimreceipts. More broadly, the budget seeks to broaden India’s narrow tax base andto shift more of the tax burden from manufacturing to the services sector. Theannouncement by Mr Chidambaram in June that consensus had been reachedamong states on the introduction of a state value-added tax on January 1st 2005suggests that progress on the economic policy front is possible.

The government will also take steps to open the economy further by increasingthe authorised level of foreign investment in telecommunications (from 49% to74%), insurance (from 40% to 49%) and aviation (from 26% to 49%).

The fiscal deficit, India’s principal macroeconomic risk, is likely to worsenunder the new government. Several of the underlying assumptions in the new2004/05 budget are unrealistic, especially on the revenue side. As a result, weexpect the deficit to deteriorate from 4.7% of GDP in 2003/04 to around 5.3%this year. The likelihood of slower economic growth resulting from a mildlybelow-par monsoon and weaker year-on-year agricultural growth rates willalso play a role in the fiscal deterioration by reducing tax revenue.

The budget’s main flaw is an overestimate of tax receipts (even before takinginto account a tax reduction on oil imports—required to reduce the inflationarypressure from increased global oil prices). The Ministry of Finance expects taxrevenue from corporations to increase by 40% year on year, yet company taxpayments rose by 39% last year; another increase of this magnitude seemsunlikely, especially since real GDP growth was always certain to slow from lastyear’s 8.3% rate. Even allowing for the new education surcharge, the figure forcorporation tax revenue still looks unrealistically high. The budget also assumesa very ambitious rise in revenue from both income tax and excise tax.Moreover, although the finance ministry is forecasting a decline in privatisationrevenue from US$3.3bn last year to US$890m in 2004, the figure for this yearstill looks optimistic. The deficit picture should improve slightly in 2005/06 asthe government, confronted with the reality of fiscal deterioration, is compelledto restrain spending.

The cycle of monetary easing in India and overseas has come to an end asinflation at home and abroad has showed signs of edging up. The ReserveBank of India (RBI, the central bank) is likely to leave its benchmark interest rateunchanged for the time being. Although capital inflows have slowed on theback of questionable economic policies announced by the new government,liquidity is more than ample: bank credit rose by 21% year on year in July.

Monetary policy

Fiscal policy

10 India


Rising oil and commodity prices have begun to feed through into higherwholesale price inflation, but have yet to affect consumer prices. However, theRBI is unlikely to react hurriedly to possibly transitory inflationary pressures.We believe that monetary policy will remain accommodative throughout 2004,before becoming more restrictive in 2005.

Economic forecast

International assumptions summary(% unless otherwise indicated)

2002 2003 2004 2005GDP growthWorld 2.8 3.9 4.9 4.2US 1.9 3.0 4.2 3.1EU25 1.2 1.1 2.4 2.4

Exchange ratesUS$ effective (1990=100) 105.5 93.4 86.8 84.4¥:US$ 125.3 115.9 108.7 107.5US$:€ 0.94 1.13 1.24 1.30Financial indicatorsUS$ 3-month commercial paper rate 1.70 1.10 1.38 3.00¥ 2-month private bill rate 0.10 0.03 0.00 0.05Commodity pricesOil (Brent; US$/b) 25.0 28.8 35.3 31.0Gold (US$/troy oz) 310.3 362.8 421.3 375.0Food, feedstuffs & beverages

(% change in US$ terms) 12.7 6.6 10.6 -0.7Industrial raw materials (% change in US$ terms) 2.2 12.7 19.2 0.9

Note. Regional GDP growth rates weighted using purchasing power parity exchange rates.

A global economic recovery is well under way, and we expect world GDPgrowth (on a purchasing power parity basis) to average 4.9% in 2004 and 4.2%in 2005. Growth in the US is forecast to average around 3.7% in 2004-05,underpinning world GDP growth and increasing demand for India’sinformation technology (IT)-related and back-office service exports. Higheraverage oil prices in 2004 will raise India’s import bill and could underminegrowth. The interest-rate cycle has turned in developed countries, and thedifferential between Indian rates and those in industrialised countries willnarrow during the forecast period.

Our forecast for real GDP growth (at factor cost) in 2004/05 stands at 6.1%.Agriculture contributes more than 25% of GDP, and the June-Septembermonsoon is crucial to strong agricultural output and robust private con-sumption. The monsoon started erratically, but heavy rains in late August haveensured that the monsoon will turn out to be almost normal, and a near-normal harvest is forecast. Even so, we expect a small year-on-year contractionin agricultural growth. Rising international oil prices are also a concern—approximately 30% of India’s import bill consists of oil.

The rate of growth in lending to consumers and businesses, which has beenrising this year, could weaken if the government succeeds in doubling bankcredit to the farming sector (thus diverting credit away from prospering urban

International assumptions

Economic growth

India 11


consumers), as it has promised to do. Liquidity could also be reduced if thesharp reduction in capital inflows since May continues. Even with these risks,however, the economy should still perform reasonably well. Momentum fromlast year’s extremely strong economic growth is still flowing through intoconsumer spending, and the cost of credit remains low by historical standards(although it is likely to begin rising in 2005). More importantly, the servicessector, which is now the main engine of economic growth, will continue toperform well, and should in 2004/05 exceed the 8.8% year-on-year rate ofgrowth recorded in 2003/04.

Strong external demand on the back of faster growth in the US, the EU andmuch of Asia should boost India’s exports, especially those of IT services.Infrastructure spending will support the construction sector, and businessinvestment will rise as corporations tap strong retained profits. Although long-standing structural barriers to growth have not been tackled, growing foreigninvestment in India will gradually boost productivity growth in the servicesand industrial sectors, lifting the economy’s potential growth rate. Moreimmediately, the economy will receive a significant boost this year from asharp rise in government consumption as the new administration implementsits social spending plans.

Wholesale price inflation was subdued during the early part of 2004 andrecorded an eight-month low of 4.3% year on year in April. But prices began torise sharply in June, and the index reached 8% in mid-August. Rising prices forfuel, manufactured goods and food were largely responsible. Higher wholesaleprices will be the primary source of inflationary pressure in 2004-05, reflectingbottlenecks in the industrial sector, higher commodity prices and stubbornlyhigh energy prices. The rupee has depreciated noticeably in recent months,reintroducing the risk of import-led inflation, after a long period during which astrong currency shielded the economy from rising oil and commodity prices.However, oil prices continue to be heavily subsidised by the government, andhigh world oil prices are feeding through into rising consumer prices to alimited extent only—although consumer price inflation exceeded 4% year onyear in June, the highest level in more than a year. Consumer price inflation isexpected to average 4.2% this year and 5.7% in 2005.

The rupee has depreciated since the May election, as portfolio inflows haveturned negative owing to uncertainty over the new government’s economicpolicies and the general withdrawal of funds from Asian markets. This hasforced the RBI to intervene in the foreign-exchange market, selling US dollars tocontrol depreciation—in August the central bank ensured that the rupeeremained above Rs46.5:US$1.

The central bank’s decision in July to reduce the level of foreign ownership ofIndian banks has raised new concerns about government policy, exerting afurther drag on foreign inflows. A narrowing interest-rate differential betweenIndia and major OECD countries during the forecast period will makeinvestments in India relatively less attractive. Rising inflation and doubts aboutthe pace of economic reform are also likely to act as a brake on capital inflows

Inflation

Exchange rates

12 India


in the short term. We forecast that the rupee will average around Rs45.9:US$1 in2004 and Rs47.5:US$1 in 2005.

Exports should continue growing at double-digit rates in 2004 as demand fromthe US, India’s largest market, remains strong. Services exports—software and IT-enabled services, such as call centres—will continue to expand at a rapid pace,but Indian goods exports, especially cars and pharmaceuticals, are also likely tocarry on performing well. That said, the goods trade deficit will remain sizeablethroughout the forecast period. It will, however, be offset to a significant extentby a surplus on the transfers balance (mainly thanks to remittances fromIndians working overseas) and a rising services surplus (contributed largely bysoftware exports).

We expect the current-account surplus to rise from an estimated 0.7% of GDP in2003 to 0.9% in 2005 as external demand remains vibrant. Import growth wasstrong last year, as a robust economy boosted demand for intermediate andconsumption goods while higher oil prices raised the energy import bill. Bothof these factors will persist in 2005, even though the economy will slow andaverage oil prices will fall. Beyond the forecast period, the current-accountsurplus is likely to dwindle as import demand again gathers pace.

Forecast summary(% unless otherwise indicated)

2002a 2003 b 2004c 2005c

Real GDP growth 4.6 8.5 6.5 7.5Industrial production growth 4.9 6.6 a 7.4 7.0Unemployment rate (av) 9.9b 9.5 9.2 9.2

Consumer price inflation (av) 4.3 3.8 a 4.2 5.7Consumer price inflation (year-end) 3.2 3.7 a 5.8 5.7

Short-term interbank rate 11.9 11.5 a 11.5 11.8Government balance (% of GDP) -5.9b -4.7 -5.3 -4.9

Exports of goods fob (US$ bn) 52.7 58.9 69.2 77.2Imports of goods fob (US$ bn) -65.2 -76.1 -89.3 -98.5Current-account balance (US$ bn) 4.7 3.9 4.9 6.7

Current-account balance (% of GDP) 0.9 0.7 0.8 0.9Total foreign debt (year-end; US$ bn) 104.4 112.4 117.2 119.9

Exchange rate Rs:US$ (av) 48.61 46.58 a 45.87 47.50Exchange rate Rs:¥100 (av) 38.78 40.19 a 42.19 44.19Exchange rate Rs:€ (av) 45.93 52.74 a 56.71 61.63

Exchange rate Rs:SDR (av) 62.97 65.26 a 67.77 71.98

a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.

External sector

India 13


The political scene

The Bharatiya Janata Party (BJP)-led opposition has boycotted parliamentaryprocedure since its defeat in the May general election. The boycott is a protestagainst the appointment by the new government of several ministers facingcriminal charges, including murder. Its protests focus on the appointment offive ministers in particular—Shibu Soren (minister of coal and mines, who hasnow resigned), Lalu Prasad Yadav (minister of railways), Prem Chand Gupta(minister of state for company affairs), Mohammad Taslimuddin (minister ofstate for heavy industries) and Jay Prakash Narayan Yadav (minister of state forwater resources).

In the last week of July a magistrate in Jharkhand issued a warrant againstMr Soren for inciting a crowd in an incident that took place in 1976 and whichled to a number of deaths. The delay of over 25 years is characteristic of India’scriminal courts. Mr Soren resigned by sending a fax from an unidentifiedlocation, and after going into hiding for a few days eventually surrendered tothe authorities. The opposition hailed the move as a major political victory.

The ruling United Progressive Alliance (UPA) coalition quickly retaliated. A caseagainst a prominent BJP politician, Uma Bharti, the chief minister of MadhyaPradesh (whose state legislature is controlled by the BJP), was reopened and herarrest ordered by the presiding magistrate. Ms Bharti had been charged withinciting violence between Hindus and Muslims at a political rally in Karnatakain 1994. On the 23rd of August she resigned from her chief minister’s post inBhopal and travelled to Karnataka to give herself up. The arrest was followedby widespread protests and large public rallies. Fearing that the BJP was makingpolitical capital from the affair, the Karnataka government reversed its stanceand dropped all charges against Ms Bharti; the state’s advocate-general evenstated that if her release was delayed Ms Bharti was at liberty to request a bailpetition. This affair too was claimed as a victory by the opposition.

The opposition protests against“tainted ministers”

One tainted minister isarrested

The UPA retaliates and forces aBJP resignation

14 India


Alongside the “tainted ministers” scandal, the new government was alsorocked by violence in the state of Manipur, in the north-east of the country.Protestors alleged that a woman had been raped and murdered by soldiersfrom the Assam Rifles, a regiment of the army. The protesters demanded therepeal of the Armed Forces Special Powers Act, a draconian law allowing thesecurity forces wide-ranging powers to arrest and detain people, which waspassed in 1958 to deal with rising insurgency in the north-east. The federalgovernment summoned the chief minister to the capital, New Delhi, andpromised to repeal the law and investigate the alleged crimes. The governmentalso offered to withdraw the Assam Rifles from the state.

Despite the turmoil, on the 30th of August the UPA government celebrated itsfirst 100 days in office—although the prime minister, Manmohan Singh, statedthat he had been denied the honeymoon that most prime ministers aregranted. The UPA is a new coalition, and has never governed before. For theIndian National Congress, the UPA’s main component, it is also a newexperience both because it did not expect to win power and because it hasnever previously worked as part of an active coalition with other parties atnational level. Falling short of a majority, after the election Congress was forcedto enlist the support of the Left Front parties, the largest of which are theCommunist Party of India and the Communist Party of India (Marxist). Theypromised to support the government in parliament but did not requestministerial posts—Congress is their main opponent in the state of Kerala, andthey therefore felt that actively joining the government would undermine theirelection prospects at state level. The first step towards enabling the UPA and theLeft Front to work together was the agreement of a Common MinimumProgramme (CMP), drafted by the UPA and the communists before thegovernment was formed in May. The CMP sets out the new government’spolicy on both political and economic affairs.

With the parliamentary process in turmoil, Mr Singh made a televised speechon June 24th setting out the new government’s policies. He said that reformswere not just about removing controls, but also about making the governmentefficient and people-friendly. He reiterated the government’s emphasis oneducation, health, drinking water, sanitation, power, roads and railways, andalso said that his government would stress effective governance. He added thatthe government would invest more in irrigation (but would address theproblems of each river basin separately, instead of linking rivers andtransferring water between them at great expense, as the previous governmenthad planned to do). Mr Singh promised more agricultural credit, and called forrural industrialisation and the creation of more non-farm rural employment.Highlighting the new government’s policies (as required by law) in his openingaddress to the new parliament on June 7th, the president, Abdul Kalam, addedthat the government would repeal the Prevention of Terrorist Activities Act(POTA), and that it would draft a new law on communal violence and wouldurge states to adopt it. Mr Kalam said that the government would alsointroduce reservations, or affirmative action, for scheduled (lower) castes andtribes in private-sector employment after consulting with the private sector.

The new government survivesits first 100 days

The prime minister sets out hispolicy agenda

Tensions in the far east of thecountry lead to violence

India 15


POTA, enacted by the previous government, was designed to tackle terrorismbut was misused by some state governments to imprison political opponentsand people critical of the government. Congress campaigned against the lawwhile in opposition, and promised to repeal it if elected. Instead of repealing it,however, the government has decided to wait for the law to lapse on October23rd 2004 (as repealing it would actually take longer). The government hasappointed a panel to review the cases of prisoners currently held under POTA.It has also stated that it will amend the Unlawful Activities Act of 1967 so that itcovers terrorism, in order to fill the void left by the expiry of POTA. In its initialreport of December 4th 2003, the panel reviewing prisoners’ cases reported alack of co-operation from state governments, and had asked for powers (as theNational Human Rights Commission has done) to demand information fromstate governments. The government said that it would consider the request.

The findings of a new enquiry into the Godhra train deaths have implied thatthe fire in the train was an accident. In 2001 a railway carriage was set on firein Godhra and 58 people, mostly Hindu activists returning from Ayodhya, wereburnt to death. Following the deaths, the BJP state government in Gujarat saidthat a mob from a neighbouring Muslim locality had surrounded the traincarriage and burnt it. This led to a backlash in Gujarat, and several thousandMuslims were killed in one of the worst episodes of communal violence inindependent India’s history. The recent enquiry’s findings suggest that thequantity of fuel in the carriage was too large to have been thrown in fromoutside, and that the fire must have started inside the carriage in which thevictims died. The new railway minister, Lalu Prasad Yadav, made a statement inParliament on July 14th to this effect, and announced another departmentalenquiry to shed more light on the new claims. In 2001 Congress had allegedthat the BJP-led state government in Gujarat turned a blind eye to the anti-Muslim backlash and failed to impose order. A judicial commission appointedby the Gujarat state government is to continue its enquiry into the riots thatfollowed the burning of the railway carriage. The Gujarat governmentcontinues to hold a number of Muslims whom it alleges are responsible forthe arson.

The new government, as is customary, reversed a number of measures andpolicies of its predecessor. Of the state governors appointed by the previousgovernment, the governor of Pondicherry, N N Jha, resigned when it becameclear that the BJP had lost the election. The new UPA government dismissed thegovernors of Goa, Gujarat, Uttar Pradesh and Haryana—all viewed to besympathetic to the previous political regime—and appointed replacements. Itwas unable to dismiss the governor of Rajasthan, Madanlal Khurana, as thestate is still controlled by the BJP.

The education minister in the previous government, Murli Manohar Joshi, wasviewed by Congress as a strong advocate of the BJP’s Hindu-nationalist agenda.He introduced new history textbooks in schools, which altered what Congressclaims to be conventional historiography (although this conventional historio-graphy had been drafted by Congress appointees throughout the many years of

The new government makesits presence felt

The government plans torepeal POTA

The findings of a politicallycharged enquiry are presented

Congress attacks religiousreferences in education

16 India


Congress rule, and the BJP viewed it as biased toward Congress). A committeeappointed by the new minister of human resource development, Arjun Singh,said that correcting the new textbooks was too large a task to be practicable. Itsuggested that instead of prescribing textbooks the government should circulatea set of model questions, which would define what teachers should teach.Instead of taking up this radical suggestion, the government decided that in2005-06 it would reintroduce the textbooks that were used before the BJP cameto power. However, education is a state matter under the constitution. WhenArjun Singh called a meeting of the state education ministers in early August,the meeting broke up after a walk-out by the education ministers of BJP-ruledstates. It appears that only non-BJP states and schools run by the centralgovernment will return to the old textbooks.

One of the first acts of the new defence minister, Pranab Mukherjee, was totable a statement in parliament based on an enquiry into the controversysurrounding the 1999 Kargil incident, in which militants from Pakistan,supported by Pakistani artillery fire, occupied positions inside Indian territory.The controversy was focused on whether the slow response of the cabinet inresponding to the military’s request for air support had led to excessive loss oflife on the part of the Indian army. The report stated that between May 8th andMay 25th, while the Indian cabinet was debating the use of air power, therewere only 35 casualties, whereas between May 26th (when the cabinetapproved the use of air power) and July 26th there were 439 casualties. Giventhese figures, the controversy was laid to rest.

Experts from India and Pakistan met in June this year to discuss nuclearconfidence-building measures. Following the meeting, it was decided that thehotline that has for some years connected the two countries’ directors-generalof military operations would be upgraded, dedicated and secured, and thatanother hotline would be established between the two countries’ foreignsecretaries. The moratorium on nuclear tests declared by both countries wasreaffirmed. Work has begun on an agreement on pre-notification of missileflight tests. The experts’ meeting was followed a week later by a meeting offoreign secretaries (the senior civil servants in the two countries’ foreignministries). They agreed to restore the strength of their high commissions to 110staff on each side, and to reopen the Indian consulate in Karachi and thePakistani consulate in Bombay. They also agreed to release all fishermen incustody (fishermen often stray across the unmarked border off the coast ofGujarat and are arrested), and to work for the early release of civilians whohave strayed across the border by accident. The foreign secretaries will meetagain on 4th September, followed by a meeting of the foreign ministers on 5th-6th September.

In a sign of improving security, there were no registered cases of robbery orextortion in Jammu and Kashmir in April-June 2004. This may be related to adecline in terrorist activity and a sign of more peaceful times in Kashmir.However, critics have argued that it may also be owing to the fact that Kashmiris enjoying considerable investment in infrastructure—and that enough of this

Indo-Pakistani talks makesome progress

Crime in Kashmir falls

The Kargil controversyis laid to rest

India 17


money is misappropriated to keep militants busy. Investment has flowed intothe Jammu-Srinagar railway line, roads, bridges and power projects.

Jammu and Kashmir: money lost through robbery and extortion(Rs ‘000)

2001 2002 2003 2004Jan 280 293 865 12

Feb 0 62 1,029 651Mar 1,000 9 179 8

Apr 22 288 100 0May 400 59 35 0

Jun 11 114 0 0Jul 510 889 7 –Aug 80 272 200 –

Sep 153 1,147 150 –Oct 954 0 13 –

Nov 82 1,950 50 –Dec 65 291 30 –

Source: The Hindu.

On July 12th the legislative assembly of Punjab unanimously passed an actabrogating all existing agreements on the sharing of river waters. The governorof Punjab, Om Prakash Verma, gave his assent to the act. The law defies a hostof existing water-sharing agreements that force Punjab to transfer water toneighbouring states. The agreements were based on discussions that beganbefore 1960. By 1992 a canal diverting water from Punjab to Haryana was beingbuilt, and Rs8bn had been spent on the work. However, construction stoppedlater the same year, following the shooting by terrorists of two canal workers.In 2003 the Supreme Court demanded that the central government appoint anagency to oversee the completion of the canal’s construction within a year.Punjab appealed against this ruling, but was unsuccessful. The act passed bythe Punjab assembly follows the Supreme Court’s verdict, and lawyers aredebating its validity. However, politically it is acutely embarrassing for the newgovernment. Congress rules Punjab, and the media and the opposition viewthe move as a humiliation of the central government by its state-level affiliate.

Economic policy

The finance minister, Palaniappan Chidambaram, presented the UnitedProgressive Alliance (UPA) government’s budget for fiscal year 2004/05 (April-March) on July 8th. It was approved without debate in late August, as theopposition was boycotting parliament over the appointment of cabinetministers facing criminal charges. The budget was social-democratic in style,containing large government expenditure programmes funded by increasedtaxation. It differed from Mr Chidambaram’s budgets during the 1990s, whichwere known primarily for drastic reductions in income tax rates and wereregarded by some analysts as right-of-centre. The 2004/05 budget was a productof the new political alliance between the Indian National Congress and thepredominantly communist Left Front parties, and aims to achieve the seveneconomic objectives set out in the UPA’s Common Minimum Programme

Water-sharing agreementscollapse

The finance minister unveils asocial-democratic budget

18 India


(CMP), which highlights the coalition’s policies. During the elections, the largestcoalition member, Congress, had promised billions of rupees in extra spendingfor the poor. The seven objectives are as follows.

• A growth rate of 7-8% per year for a sustained period;

• universal access to quality basic education and health;

• the generation of gainful employment in agriculture, manufacturing andservices, and the promotion of investment in these areas;

• employment creation, including 100 days’ employment to each family atminimum wage provided by the government;

• a focus on agriculture and infrastructure;

• accelerating fiscal consolidation and reform; and

• ensuring higher and more efficient fiscal devolution.

The new budget provides Rs100bn (US$2.2bn) in new spending for basic food,health, drinking-water and agricultural initiatives. A surcharge of 2% on alltaxes, yielding Rs40bn-50bn a year, will be imposed to finance education. Thebudget also takes steps to open the economy further by increasing theauthorised level of foreign investment in three important industries: tele-communications (from 49% to 74%), insurance (from 40% to 49%) and aviation(from 26% to 49%). More broadly, the budget seeks to broaden India’snotoriously narrow tax base, and to shift more of the tax burden frommanufacturing to the services sector. Although outlays for poverty reductionand employment programmes are rising substantially, total spendinggovernment-wide is forecast to increase by just 0.7% year on year. Nevertheless,several of the budget’s underlying assumptions are unrealistic, especially on therevenue side. As a result, the budget deficit—by far the country’s greatestmacroeconomic risk—is likely to worsen this year.

Reform measures in the 2004/05 budget

Financial reforms

• Private companies in three industries—telecommunications, civil aviation andinsurance—are growing rapidly and have been running out of capital. Thefinance minister, Panaliappan Chidambaram, announced that permissibleforeign investment would be raised. However, he reduced the allowable shareof foreign equity in airports from 74% to 49%. Limits applying to portfolioinvestment will be reviewed and raised.

• Since 1993 the Foreign Investment Promotion Board (essentially an inter-ministerial committee) has sat in judgement over foreign investment proposalsand, having approved them, has facilitated the approvals required by otherministries. Mr Chidambaram announced that he would simplify the approvalsprocess. A new investment commission will be set up, with the specific aim ofattracting foreign investment.

• The limit of foreign institutional investment in the debt market has been raisedfrom US$1bn to US$1.75bn. Banks are allowed to invest 5% of their assets inequity markets; this limit will be raised for stronger banks.

The budget contains fewradical measures

India 19


• Previous efforts to create a special stock exchange for small firms have failed;one further effort will be made.

Industrial reforms

• A total of 75 types of goods will be removed from the list of those that onlysmall firms are allowed to produce; the total will fall to 485.

Privatisation

• The ruling United Progressive Alliance coalition and its allies are againstprivatising a controlling stake in state enterprises that are viable. The centralgovernment will raise Rs4bn (US$87m) from a part-privatisation (via a publicissue) of National Thermal Power Corporation, but apart from this it is notplanning any major disinvestments. Instead, it will give Rs14.2bn in equity andRs2.1bn in loans to public enterprises to aid them to restructure.

• The government will appoint a Board for the Reconstruction of Public SectorEnterprises to advise it on what to do with loss-making state-owned companies.(An earlier Congress government appointed a similar Disinvestment Commis-sion in 1996; it made a series of reports on public enterprises, which were notacted upon.)

The revenue projections contained in the budget are very optimistic. By thegovernment’s own reckoning, total revenue is likely to fall by 0.5% year on yearin 2004/05. (This is partly owing to the fact that in 2003/04 the centralgovernment reaped a Rs646bn windfall in loan repayments as states swappedold, expensive debt for newer, cheaper borrowing. Given that far less debt islikely to be prepaid this year, loan repayments will fall substantially.) Thegovernment expects to compensate for this shortfall by collecting more in taxes.But its projections—including a huge rise in company tax receipts—areunrealistic. As a result, the Economist Intelligence Unit believes that thegovernment will not meet its projected target for a budget deficit equal to 4.4%of GDP in 2004/05 (which would be an improvement on last year’s 4.7%).Instead, we expect the deficit to be around 5.3% of GDP, and even this assumesthat the economy performs well. The government’s fiscal position will also bestrained by a sharp rise in defence spending. India has long been pursuing adefence modernisation programme, and the military is keen to push ahead.

The Ministry of Finance expects tax receipts from corporations to increase by40% year on year. Company tax payments rose by 39% last year; anotherincrease of this magnitude seems unlikely, especially since GDP growth willslow from last year’s exceptionally high rate of 8.3%. Even allowing for theeducation surcharge, the figure for corporation tax still looks very high. Thebudget also assumes a large rise in income tax revenue. India is, admittedly,increasing its small tax base through tougher enforcement, better automationand lower tax rates (thus reducing tax evasion). Even so, the government’sforecast of an increase in income tax of nearly 27% looks unrealistic. Duringlast year’s boom, income tax receipts rose by only around 10%. Thegovernment is likewise expecting a much bigger increase in excise taxes thanseems reasonable. It has made matters worse by backing away from theprevious government’s privatisation programme. The Bharatiya Janata Partyadministration generated around US$3.2bn in revenue from selling government

Revenue assumptions areambitious

Corporation tax receipts areforecast to rise by 40%

20 India


assets last year. The new government expects to raise only about US$890m thisyear, and even that forecast could be optimistic. The government has vowednot to sell profitable enterprises, and potential bidders will not pay much forthe weak ones on offer.

Budget summary(Rs bn)

2002/03 2003/04 2004/05outturn budget outturn budget

Revenue 2,317 2,539 2,630 3,093 Taxes 1,594 1,842 1,875 2,339 Excise – 968 924 1,092 Customs – 494 494 523 Corporation tax – 515 630 884 Income tax – 441 403 509 Service tax – 80 83 142 Other revenue 723 698 755 754 Interest – 392 360 370 Dividends and profits – 179 221 189 Capital receipts 1,824 1,849 2,112 1,686 Borrowings 1,450 1,536 1,321 1371 Market borrowings – 1,072 830 1,504External aid – 36 -117 81Loans recovered 341 180 646 271

Proceeds of disinvestment 32 132 145 40Total receipts 4,142 4,388 4,743 4778Revenue expenditure 3,396 3,662 3,629 3,855 Interest – 1,232 1,205 1,295 Defence – 443 434 435 Subsidies – 499 447 435 Economic services – 112 141 118 Social services – 68 71 68

Capital expenditure 745 726 1,114 923 Capital expenditure on defence – 210 169 335Total expenditure 4,142 4,388 4,742 4,778Revenue deficita 1,079 1,123 999 762Fiscal deficitb 1,451 1,536 1321 1,374

Primary deficitc 273 304 75 79% of GDPRevenue deficit 4.4 4.1 3.6 2.5Fiscal deficit 5.9 5.6 4.8 4.4Primary deficit 1.1 1.1 0.3 0.3

a Revenue expenditure minus revenue receipts. b Total expenditure minus all receipts other thanborrowings. c Fiscal deficit minus interest payments.

Source: Ministry of Finance.

India’s economy is increasingly dominated by services, which now account fornearly 50% of GDP. The new budget raises the existing tax on services, whichcovers such things as telecoms, insurance, banking and engineering, from 8% to10%. More importantly, the tax net will be widened to include a new range ofservices. However, even with the budgeted increases, the services tax will raise

India increases taxes onservices

India 21


just 4.4% of projected gross tax revenue. Services are taxed only lightly, reducingthe potential revenue take.

Major expenditure proposals in the 2004/05 budget

Education

• The budget imposes a 2% surcharge on all taxes, yielding approximatelyRs40-50bn (US$870m-1.1bn), earmarked exclusively for education.

• A scheme to provide nutritious lunches for schoolchildren has been launched.• Banks have begun providing loans for college education. Henceforth, they will

give loans of up to Rs750,000 (US$16,300) without collateral.• Many years ago, the government had set up 500 Indian Technology Institutes

(ITIs) to train workers. Since then, the industrial structure and skill requirementshave changed, and industry does much of its own training. As a consequence,ITIs have been languishing. They are now to be re-equipped and modernised.

Health

• The government subsidises the premiums of standard, small-sum healthinsurance policies. The finance minister, Palaniappan Chidambaram, willconfine the scheme to people below the poverty line, and will increase thepremium subsidy. Mr Chidambaram announced another health insurancepolicy, which would be available to self-help groups.

Agriculture

• The budget allocates Rs28bn for completion of 150 delayed irrigation projects.• A pilot project will be launched to repair and restore ponds, tanks and other

water bodies that have been traditionally used for local irrigation—some500,000 are estimated to exist. Once the repair programme is completed, morefunds are to be channelled into irrigation. They will include modest sums tostart 100,000 water-harvesting schemes, in which villagers build bunds (dikes)and ditches to prevent run-off and help percolation of rainwater, as well as forflood control.

• One of the factors behind the return of the Indian National Congress to powerwas the discontent of southern farmers indebted to moneylenders, over 1,000 ofwhom have committed suicide in the past three years. Mr Chidambaram haspromised that banks will triple agricultural credit in three years.

• Most regional rural banks (RRBs) and co-operative banks have been leftbankrupt by misappropriation and mismanagement. Every RRB has a govern-ment bank as its sponsor. The sponsor banks are to be asked to tighten upadministration in the RRBs assigned to them, and the salvageable RRBs will berestructured.

Infrastructure

• A channel will be dug through Adam’s Bridge, a sandstone reef which connectsIndia and Sri Lanka, to enable ships sailing between the east and west coasts toavoid having to go around Sri Lanka, thereby incurring extra costs.

• South India suffers from a shortage of container-landing capacity; much of itstraffic is routed through the Sri Lankan capital, Colombo. Mr Chidambaram hasannounced that another container terminal will be constructed in Cochin.

22 India


Three days before the budget, the Fiscal Responsibility and Budget ManagementAct, which was passed last year, came into effect. Under the act, thegovernment is bound by law to reduce the fiscal deficit to 2.8% of GDP by2008/09. The fiscal deficit, which stood at 5.9% of GDP in 2002/03, fell to 4.8%last year (owing in part to a number of privatisations just before the end of thefiscal year). Mr Chidambaram has budgeted for a fall in the deficit to 4.4% ofGDP in 2004/05—an optimistic assumption.

Major taxation policies in the 2004/05 budget

Education levy

• All taxes have been raised by 2%, with the proceeds to be spent on education.

Direct taxes

• A tax of 15 basis points has been introduced on securities purchased throughstock exchanges. After protests from brokers, it was confined to equity deliveriesand transactions in mutual-fund units. The tax on undelivered equity wasreduced to 1.5 basis points, and that on futures and options was brought downto 1 basis point. Transactions on bonds and debt mutual-fund units have beenexempted from the tax.

• Income tax rates remain unchanged, but the exemption limit has been raisedfrom Rs50,000 (US$1,100) to Rs100,000 a year. Those earning Rs50,000-100,000a year will continue to submit returns; those earning Rs100,000-150,000 willpay Rs8,500 plus 20% of income over Rs100,000. The tax on income aboveRs150,000 a year stands at 30%.

• Long-term capital gains tax on securities has been abolished, and short-termcapital gains tax has been reduced to 10%. No capital gains tax will be chargedon agricultural land that is compulsorily acquired.

• Tax holidays have been given for the next five years to rural hospitals, housingprojects and the processing of fruit and vegetables, and for ten years to powertransmission and distribution projects and research in biotechnology.

Indirect taxes

• Value-added tax (VAT) will be introduced by state governments from April1st 2005.

• Customs duty has been raised on refined palm oil from 70% to 75%, and onstarches (other than from wheat and potatoes) from 30% to 50%. Duty has beenreduced from 20% to 15% on copper mill scale, zinc spelter, cadmium, cobalt,copper, ferro-alloys, lead, magnesium, stainless and other alloy steels, titanium,tungsten, zinc, asbestos, fluorspar, felspar, graphite, gypsum, mical and otherminerals, refractories and catalysts; from 15% to 10% on iron and steel other thanseconds and defectives; from 10% to 5% on silk textile machinery; and fromRs55/g to Rs20/g on platinum. Diamond roughs and patent leather have beenexempted.

• Excise duty has been raised from 8% to 16% on cakes and pastries, plastic-insulated wire, vacuum flasks, scented supari, prefabricated buildings, clocksand watches under Rs500, black-and-white television sets, imitation jewellery,laboratory glassware, machine-made matches and candles. Excise duty has beenrevised from 8% to 12% on iron and steel. It has been reduced from 16% to 8% on

The Fiscal Responsibility Acttakes effect

India 23


gas stoves under Rs2,000 each and on packaged meat, and from 32% to 16% onfood-grade hexane. An 8% duty has been imposed on contact lenses and playingcards. Computers, central processing units (CPUs), tractors, hepatitis diagnostickits, non-alcoholic beverages sold from vending machines, agricultural hand-tools, newsprint, dairy and plantation machinery, and shoes under Rs250 a pairare exempted.

• Last year the then finance minister, Jaswant Singh, introduced a VAT regime forall textiles under which duties on intermediate inputs were rebatable againstduty on finished goods. Mr Chidambaram has overturned this regime; he hasexempted cotton goods, and has imposed a 16% duty on synthetic yarns.

Service tax

• Service tax has been extended for business exhibition services, airport services,goods transport by road or air, mineral exploration, opinion polls, intellectualproperty services (but not copyright), forward contracts, wedding tents, outdoorcatering, television and radio programme production, industrial and commercialconstruction, travel agents (but not vendors of air and rail tickets), stockbrokers,tour operators, safe deposit vaults, computer maintenance, commission agents(excluding those dealing with agricultural goods) and television cable operators.

• Officials of defaulting firms will no longer be prosecuted, but interest rates havebeen raised for delayed payment of tax, and now depend on the length ofthe delay.

The World Bank drafted a new four-year country assistance programme forIndia in August. The Bank agreed to lend India a maximum of US$12bn overfour years. The strategy identified three priorities: to help improve governmenteffectiveness, to support investment in people and communities, and topromote private-sector growth. To achieve these priorities, the Bank willexpand lending programmes in infrastructure, human development and ruralareas. In an attempt to leverage its relatively small resource base in India, theBank has resorted to co-financing with other development partners. It has alsoaltered its regional focus: it has highlighted a disparity of opportunity in India,and wants to target India’s poorest states—Orissa, Bihar, Jharkhand andUttar Pradesh.

The railway minister, Lalo Prasad Yadav, presented the financial statement ofthe Indian railways—known as the railway budget—on July 6th. Mr Yadav madeno changes in tariffs, except for a small increase in parcel rates. However, heintroduced free second-class travel for unemployed youths travelling tointerviews for jobs in the central government, a 75% concession for widows ofsoldiers killed in action and a 50% concession for escorts to physically disabledpersons. The unwillingness of the government to raise charges or restructurethe railways has led to a progressive worsening of the railway finances, whichare now a constant drain on the exchequer.

In late August the commerce minister, Kamal Nath, unveiled India’s first everNational Foreign Trade Policy, a package of trade incentives aimed at helpingexports grow by 20% a year for the next five years. The government said that itwould set up free-trade zones where foreign companies could invest withoutpaying duties. It also announced a list of incentives for small-scale industrial

India unveils a new policy onforeign trade

The railway minister presentsa populist railway budget

World Bank pledges US$12bnto India

24 India


exports, which included waiving duty on the import of capital goods foragricultural producers.

On July 2nd the Reserve Bank of India (RBI, the central bank), acting in itscapacity as regulator of the banking sector, issued a draft policy on theownership and governance of private banks. The new regulations would limitforeign investors to a 5% stake in any other private bank. If the policy isimplemented, a UK-based bank, HSBC, which was recently given permission tobuy 14.6% of UTI Bank, will not be allowed to proceed with the purchase.Other transactions will also be affected. The RBI plans to disperse ownershipand create a banking industry structure similar to that in the UK and the US,where bank ownership is widely spread. Nevertheless, the RBI has stated thatit is open to negotiation with the banks and that its new regulations are not yetset in stone.

The domestic economy

Economic trends

The fourth quarter of fiscal year 2003/04 (April-March) saw real GDP (at factorcost) grow by 8.2% year on year. Agricultural production increased by 10.5%year on year, although this figure was inflated by the drought in the previousyear. The rest of the economy also performed well: industry grew by 7.8% yearon year, and services expanded by 7.6%. On the basis of the fourth-quarterfigures, the Central Statistical Office issued early estimates of growth for thewhole of 2003/04, which also came to 8.2%. The annual figures showsomewhat slower growth in industrial output and faster growth in servicesthan those for the fourth quarter, but are otherwise similar. The overall growthrate was the highest since 1996/97. However, growth in 2003/04 was boosted bythe rebound in agricultural output from a low base in the previous year. Thisbase effect will not be present in 2004/05, which is therefore likely to showsomewhat slower growth. If agricultural growth slows to 2% and that inother sectors remains the same, the economy should expand overall by 6-7%in 2004/05.

Real GDP at factor cost(% change year on year; fiscal years Apr-Mar unless otherwise indicated)

Jan-Mar Jan-Mar2002/03 2003/04 2003 2004

Agriculture -5.2 9.1 -6.3 10.5Industry 6.4 6.7 6.4 7.8

Mining 8.8 4.4 6.3 9.0Manufacturing 6.2 7.3 7.3 7.6

Electricity 3.8 5.5 2.2 9.5Construction 7.3 6.2 5.5 7.6Services 7.1 8.7 6.9 7.6

Real GDP growth in 2003/04stands at 8.2%

RBI makes foreign ownershipof banks more difficult

India 25


Real GDP at factor cost(% change year on year; fiscal years Apr-Mar unless otherwise indicated)

Jan-Mar Jan-Mar2002/03 2003/04 2003 2004

Trade & hotels 7.0 7.7 13.8 9.6

Finance 8.8 6.8 7.5 8.8Others 5.8 6.0 5.1 -3.1

GDP 4.0 8.2 3.7 8.2

Source: Central Statistical Office.

The industrial workers’ cost-of-living index continues to post low inflationfigures. It rose above 4% early in 2004, but fell below 3% towards the middle ofthe year. This is lower than the rise in wholesale prices. The difference arisesfrom the composition of the two indices. The cost-of-living index is dominatedby consumer goods, especially foodgrains and textiles, and these prices are littledifferent from a year ago. In the wholesale price index, however, industrialproducts, inputs and fuels have a heavy weighting. The wholesale price indexhas been pushed up in particular by the rising prices of steel and oil, which areincreasing in part owing to the current boom in Chinese commodityconsumption. The wholesale price index showed inflation to be 7.9% in the firsttwo weeks of August.

Inflation2003 2004

Aug Sep Oct Nov Dec Jan Feb Mar Apr May JunConsumer price index 499 499 503 504 502 504 504 504 504 508 512 % change, year on year 3.1 2.9 3.3 3.1 3.8 4.3 4.1 3.5 2.2 2.8 3.0

Source: Labour Bureau.

Agriculture

The south-western monsoon arrived on time in the first week of June in Kerala,and travelled northwards. The rains were excessive in north-eastern India(which, compared with the rest of the country, receives a considerable amountof rain anyway), and caused extensive flooding in Bihar and Assam. But as the

The monsoon has resumed inmost parts of the country

Cost of living index andwholesale prices diverge

26 India


monsoon travelled north-westwards it weakened, and the rains becameseriously deficient. They stalled in the middle of July, raising the spectre ofdrought. By early August the monsoon had revived, and the north-west of thecountry received heavy showers; there were extensive floods in southernGujarat. The monsoon can continue until the end of September, and itsprogress so far suggests that the country as a whole will end up with amonsoon that is close to normal—as of September 1st, monsoon rainfall was10% below normal overall. However, by early September Punjab, Rajasthan,western Uttar Pradesh and parts of central and southern India were still shortof the rain required for a normal harvest.

The area under cultivation has increased compared with last year. Normally,farmers sow after there has been sufficient rain to ensure germination. Sincethe rains reach different parts of India at different times, the area sown seldomapproaches 100%. This year it stands at only 80%, although it is higher for rain-fed crops—coarse grains, lentils and oilseeds. Rice is largely grown in areas in

A near-normal crop isenvisaged

India 27


the south and the north-east, which receive abundant water from rains orirrigation, and its production is therefore unlikely to be seriously affected bypoor rainfall. Overall agricultural production is forecast to be close to normal,and may even exceed normal.

Rainfall, Jun 1st-Aug 4th 2004Av rainfall (mm) % of normal rainfall

North-western India 247 78Central India 491 90South peninsular India 371 91

North-eastern India 824 98

Source: Ministry of Agriculture.

Infrastructure

Tata Consultancy Services (TCS) has always been India’s biggest softwarecompany and the crown jewel of the Tata Group, a sprawling conglomerate.Until recently it was fully owned by the group via a holding company, TataSons. In July 2004 Tata Sons launched a public issue of 55.5m shares in thecompany, with an option to issue 8.3m more shares. Qualified institutionalinvestors were permitted to buy 60%, non-institutional subscribers (richindividuals and companies) 15% and retail investors 25%. The issue wasoversubscribed six times—the retail allocation three times, and the non-institutional allocation 22 times. Retail investors bought their shares at Rs850(US$18) each. At that price, the Tata Group will have collected Rs54.2bn(US$1.2bn), which it will use to fund investments and acquisitions in steel,vehicle manufacturing and telecommunications. The listing will also provideTCS with the wherewithal to grow, unhindered by the slower pace of growthof the Tata Group as a whole.

Performance of major information technology companies(Rs bn unless otherwise indicated; fiscal years Apr-Mar)

Net worth Cash balance Return on net worth2002/03 2003/04 2002/03 2003/04 2002/03 2003/04

Infosys 28.6 32.5 15.9 20.3 33.5 38.2

Wipro 33.3 35.1 14.9 14.9 24.1 26.4Satyam 21.3 25.8 14.5 17.2 21.5 21.3

Digital Globalsoft 3.2 5.0 2.1 3.4 32.8 28.1MphasiS 2.3 3.5 0.7 1.2 28.4 28.1Geometric 0.7 0.9 0.4 0.8 17.6 18.4

Source: Business Line.

India’s software exports increased from Rs465bn (US$9.6bn) in 2002/03 toRs580bn in 2003/04. Exports of software services rose from Rs360bn toRs415bn; exports of IT-enabled services increased from Rs105bn to Rs165bn. Thebusiness continued to be highly profitable; returns on net worth of 20-30%were normal. However, high cash reserves suggest that the software companieshave more funds than they know what to do with. High liquidity has alwaysbeen a characteristic of this industry. But in its early phase, the industryinvested heavily in acquiring a presence in its major markets—principally the

Tata Consultancy Servicesgoes public

Software exports increase toUS$12.6bn in 2003/04

28 India


US, Britain, Hong Kong, Singapore and Australia. Now that they have achievedthe geographical spread they need, companies are experiencing difficulty infinding new investment opportunities. Some have gone into IT-enabledservices, but there too earnings are high, and they continue to generate largeprofits. Nevertheless, their problems are those arising out of success ratherthan failure.

A telecommunications entrepreneur, Thiru Sivasankaran, bought RPG Cellularfrom the RP Goenka group in December 2003. He renamed it Aircel Cellular,and in June 2004 sold the company to the Hong Kong-based multinational,Hutchison Whampoa, for Rs16bn. Aircel holds a licence in Tamil Nadu, and has1.1m subscribers in the state. This is another step toward Hutchison’s becomingan all-India telecoms provider. At present it is in partnership with a localcompany, Essar, in Delhi, Gujarat, Calcutta, Andhra Pradesh, Karnataka, Madras,Punjab, West Uttar Pradesh and West Bengal, and with a diversifiedconglomerate, Max, in eastern Uttar Pradesh, Haryana and Rajasthan. It has5.6m subscribers across the country. Hutchison has applied to the ForeignInvestment Promotion Board to be allowed to amalgamate all of its companiesand joint ventures into one nationwide entity. A joint venture betweenSingapore Technologies Telemedia and Telekom Malaysia has bought AT&T’s33% stake in Idea, the telecoms operator jointly floated by the Tata and Birlaconglomerates, for US$220m. They are seeking to raise their share to 49%.

An Indian company, Data Access, which entered the market as an Internetservice provider five years ago, has become the largest carrier of internationalcalls to and from India, with a market share of 30%. However, it failed topersuade the Security and Exchange Board of India (SEBI), the stockmarketregulator, to allow it to float an initial public issue. SEBI pointed to the Rs840m(US$18.3m) owed by Data Access to Bharat Sanchar Nigam Limited (BSNL), thegovernment telecoms operator, and to the violation by Data Access of theForeign Exchange Regulation Act. Data Access is now likely to sell about one-third of its holding to a global investment fund in a private deal. The companyhad revenue of Rs6.2bn in 2003/04; it has subsidiaries in the US, the UK andSri Lanka.

Power Grid, the government corporation engaged in power transmission, willsoon emerge as a telecoms wholesaler, having acquired an InfrastructureProvider Category II (IP-II) licence. With this licence Power Grid is limited toselling bandwidth only to telephone companies, and cannot enter the telecomsmarket directly. By December 2004 the company plans to lay 20,000 km ofcable and to connect 60 cities. Of this total cable length, 13,500 km has alreadybeen laid and is being offered to telecoms operators. In June the governmentreduced the fee for IP-II licences.

Although the Indian Space Research Organisation (ISRO) has built up thecapacity to launch satellites into orbit and has launched three of its own, it hasfound it difficult to penetrate the world market for launches. ISRO has launchedfour 100-kg satellites—for Korea and Germany in 1999, and for Germany andBelgium in 2001. It recently won a US$10m contract to launch an Italian 600-kg

Hutchison consolidates itstelecoms holdings

Data Access becomes India’slargest international carrier

Power Grid enters thewholesale telecoms market

India gets an order tolaunch satellites

India 29


Agile satellite into low earth orbit. ISRO’s 1.3-tonne Polar Satellite LaunchVehicle (PSLV) rocket is too powerful for this small satellite, so some of its sixstrap-on boosters will be taken off. One more small satellite will be launchedlater this year, for Singapore.

Air Deccan, the low-cost local airline that began to fly late last year between thesmaller centres in the south, has decided to extend its services to the four“metro” areas—Delhi, Mumbai (Bombay), Chennai (Madras) and Kolkata(Calcutta). The carrier ordered three second-hand Airbus A-320s at the Singa-pore Air show. Air India (AI), the government-owned international airline, hasbegun facing pressure from low-cost airlines on international routes. GulfTraveller, the low-cost subsidiary of a Bahrain-based airline, Gulf Air, is alreadyflying to India. Air Arabia, based in Abu Dhabi, plans to begin flying to India.Air Malaysia, Singapore Airlines and Thai Airways are all about to set up low-cost subsidiaries that will serve India. AI is to launch its own low-cost carrier,AI Express. It plans to acquire six Boeing 737-800s, and will offer 60 flights aweek to the Middle East, which hosts a large number of Indian workers whomake periodic visits to India. AI Express plans to increase the number ofaircraft to 14 within a year.

Oil and gas

Oil and Natural Gas Videsh (OVL), the overseas subsidiary of India’s largest oilcompany, the Oil and Natural Gas Corporation (ONGC), has invested US$3.5bnin nine projects abroad. The Sakhalin field, in Sakhalin, Russia, in which it hasa 20% share, will go into production late in 2005, while projects in Sudan andAngola will come on stream in 2005 and 2006 respectively, and an offshore gasproject in Myanmar will begin output in 2008. OVL has also acquired stakes inprojects in Iran, Iraq, Syria, Libya and Vietnam. ONGC’s proven reserves standat 1.1bn tonnes. Oil India has reserves of 178m tonnes, Reliance Energy has 82mtonnes and a UK company with a large portfolio in India, Cairn Energy, has76m tonnes of proven reserves. ONGC, which owns a refinery in Mangalore,plans to set up a liquefied natural gas (LNG) terminal, a petrochemical plantand a power plant at the same site.

Reliance Energy (RE), the energy arm of India’s largest private-sectorconglomerate, the Reliance Group, has been finalising sales contracts for the gasit discovered off the east coast of India late last year—it owns 90% of the D6gasfield in the Krishna-Godavari basin. RE will invest US$500m in order topump 14m cu metres/day by August 2006, which will be delivered to the state-owned National Thermal Power Corporation’s 1,300-mw power plants atKawas and Gandhar as part of a 17-year contract. The company will investanother US$800m in the field to raise output to 40m cu metres/day by 2008,which will feed its own power plant in Uttar Pradesh. (RE has signed anagreement to sell 1,500 mw of electricity to Uttar Pradesh from a power plant itwill build in Dadri.) The first 1,200 mw will come on stream in two years. It isplanned that the output of the Krishna-Godavari basin will rise further, to60m cu metres/day, if RE wins the National Thermal Power Corporation’s

Air Deccan begins flyingto metros

OVL’s project portfolioexpands

Reliance Energy finalisessales of gas

30 India


tender for a 2,300-mw power plant at Kayamkulam in Kerala. Meanwhile, REhas made another gas discovery off the Orissa coast; its size is not yet known.

The Gas Authority of India (GAIL), India’s largest pipeline company, is to investRs40bn in fiscal year 2004/05 (April-March), consisting of Rs15bn from profitsand the rest from borrowings. (As a government company, GAIL cannot raiseequity.) GAIL plans to set up an 8,000-km national gas grid over the next sixyears. It has acquired a gas terminal at Hazira, in Gujarat, and a contract toimport 5m tonnes of gas a year from Qatar, and owns a pipeline running fromHazira to Jagdishpur in Uttar Pradesh. At Pata in Uttar Pradesh GAIL is buildinga Rs6.5bn, 100,000-tonne/year high-density polyethylene plant. It is laying apipeline from Jagdishpur to Haldia in the Bay of Bengal. In Haldia it has formeda joint venture with a local company, Haldia Petrochemicals, to invest Rs5bn ina styrene butadiene rubber plant. It will build a Rs14.5bn LNG terminal with acapacity of 2.7m tonnes per year (expandable to 5m tonnes per year) either atCochin or Kayamkulam in Kerala, and will link the terminal to a retail pipelinenetwork costing Rs20bn and a petrochemical complex in Kasaragode. Thecomplex will produce 800,000 tonnes of ethylene and 400,000 tonnes ofpropylene a year. GAIL expects to invest Rs70bn in Kerala over five years. InAssam it will invest Rs25bn to set up a gas cracker to produce 160,000 tonnesof low-density polyethylene (LDPE) and 160,000 tonnes of ethylene annually.

The prices of petrol, diesel oil and liquefied petroleum gas (but not that ofkerosene) were raised in the middle of June. These items are subject togovernment price controls. The rise in international crude oil prices dictated therises, but the previous government did not permit the oil companies to raiseproduct prices as it did not want to lose votes in the May general election.When the new petroleum minister, Mani Shankar Aiyar, took office, thequestion of whether to raise fuel prices was the most urgent decision awaitinghim. Early in July Mr Aiyar asked the oil marketing companies owned by thecentral government to bypass the public distribution system (run by the stategovernments) and to deliver kerosene directly to final consumers. However,because the subsidy makes kerosene much cheaper, it leaks out of the systembefore reaching the final consumer, and is mixed with diesel oil and sold onthe open market. Mr Aiyar’s aim is to halt this widespread racketeering.

Financial marketsAs industrial activity increased in 2003, the stockmarket in India wasincreasingly viewed as undervalued. Between June 2003 and April 2004,foreign investors poured in US$9.9bn and share prices rose by 79%. However,investors, who were accustomed to the previous government’s laisser-fairepolicies, were dismayed at the unexpected success of the Indian NationalCongress-led coalition in the general election in May. They were even moresurprised when they discovered that Congress would require the support ofcommunist parties in forming government. Panic selling began, and shareprices came down sharply in the third week of May. Statements made at thetime by the new prime minister, Manmohan Singh, to the effect that the sellersbehind the stockmarket collapse would be investigated, further frightened

Indian stockmarkets crash

GAIL sets up a pipeline grid

Fuel prices increase

India 31


investors, who feared excessive government intervention in the markets. TheS&P CNX Nifty Index, a diversified index of 50 stocks, fell by 17% in May. Sincethen, foreign investment inflows have been modest. The tax levies imposed inthe 2004/05 budget, and the threat of action to enforce tax collection made bythe finance minister, Palaniappan Chidambaram, depressed the market further.However, strong corporate performance has since dissuaded investors fromfurther selling, and the market has remained relatively static during recentmonths. Despite all the turmoil, one of the largest US mutual-fund managers,Fidelity, entered the Indian marketplace in August.

Foreign institutional investors’ transactions in equitiesPurchases Sales Net purchases

(Rs bn) (Rs bn) (Rs bn) (US$ m) S&P Nifty Indexa

2003Apr 50 46 4 90 934May 52 40 12 257 1,007Jun 67 42 26 548 1,134Jul 81 57 24 502 1,186Aug 89 66 22 480 1,357Sep 115 76 39 836 1,417Oct 152 85 67 1466 1,555Nov 99 66 33 724 1,615Dec 140 79 62 1404 1,8802004Jan 168 137 32 697 1,810Feb 150 126 24 527 1,800Mar 172 116 56 1234 1,772Apr 197 130 67 1493 1,796May 155 188 -32 -738 1,485Jun 106 101 5 118 1,506July 111 102 9 201 1,632Aug 42 39 3 67 1,607

a End-period.

Sources: Securities and Exchange Board of India; National Stock Exchange.

32 India


Financial and other services

The Global Trust Bank (GTB), a mid-sized financial institution, was declaredbankrupt and taken over by a government bank, the Oriental Bank ofCommerce, in July. established in the early 1990s, GTB ran short of capital inearly 2000 and began negotiating a merger with HDFC Bank and then withIndusInd Bank. However, the negotiations collapsed. Merger talks with UTIBank advanced much further; in early January 2001 the boards of both banksapproved a merger, but the Securities and Exchange Board (SEBI) launched anenquiry into the deal. Among other things, the SEBI alleged that a well-knownbroker, Ketan Parekh, had bid up the shares of GTB in the wake of the mergertalks. Investors began selling the bank’s shares and GTB’s share price fellrapidly. The merger talks eventually broke down. By 2002 the bank had run upunsustainable debts. An inspection by the Reserve Bank of India (RBI, thecentral bank) in September 2002 revealed that the bank’s net worth wasnegative, the RBI eventually asked the Oriental Bank of Commerce (OBC) totake GTB over.

Another bankrupt financial institution, the Industrial Development Bank ofIndia (IDBI), will be merged with its subsidiary, IDBI Bank. IDBI was granted alicence in 1994, and was the government’s principal vehicle for providing long-term industrial finance, but it was subjected to political interference. Severalloans that IDBI had extended to politically favoured companies turned into baddebts and by the late 1990s it was in trouble. The banks that were approachedfor assistance, including its own subsidiary, were not prepared to merge with itbecause of its burden of bad debts. Finally, at the end of July, the governmentforced a merger with its more viable subsidiary, and promised to take IDBI’sbad debts off its books and to hand them over to the Stressed AssetsStabilisation Fund.

Finances of IDBI and IDBI Bank, 2003/04(Rs bn unless otherwise indicated; fiscal year Apr-Mar)

IDBI IDBI BankCapital 6.5 2.1

Reserves 66.2 4.0Advances 480.0 85.0Investments 128.0 30.0

Borrowings 510.0 110.0Gross non-performing assets 175.0 2.7

Interest received 68.4 7.4Interest paid 47.2 4.1Provision for bad debts 15.4 0.7

Net profits 3.3 1.3Book value 111.0 29.0

Book value after adjustment for bad debts 21.0 28.0Market price of shares (Rs) 68.0 51.0


Global Trust Bank goesbankrupt

The government bails out IDBI

India 33


In July the RBI issued new guidelines on the ownership of private banksfollowing the collapse of GTB. They must have a minimum net worth of Rs3bn;no bank is to hold more than 5% of the equity of local banks; no single foreigndirect investor is to hold more than 10%; no single investor is to hold more than10%; and not more than one member of any given family can be on the board.Since most promoters’ holdings in existing banks are generally far above thislimit, they will be given three years to bring down their holdings. The measureis a response to the bankruptcy of GTB; however, it affects foreign banks aswell (see Economic policy).

The government announced in June that in districts affected by floods, droughtand other calamities, loans issued to farmers by government banks would berescheduled. All amounts owed to the government as of March 31st 2004 willbe turned into five-year loans with a two-year moratorium. The central bankand the National Bank for Agriculture and Rural Development will instruct thebanks to be more lenient towards defaulters and to raise lending. FromRs800bn in 2003/04, the flow of loans to agriculture will go up to Rs1.1trn(US$23.2bn) this year—Rs570bn from commercial banks, Rs390bn fromco-operative credit banks and Rs85bn from regional rural banks (RRBs). Everyrural branch of a bank will fund at least two or three new rural investmentprojects. On March 31st banks had just over 33,000 rural and semi-urbanbranches, while RRBs had slightly over 14,000. However, banks typically find iteasiest to locate borrowers in cities—their credit/deposit ratios are highest there.The average business level of semi-urban and rural branches is also very smalland it is difficult to send competent staff to such branches.

Manufacturing

After the end of the Multi-Fibre Agreement on January 1st 2005, Indian textileexporters will have equal access to developed markets. They see a greatopportunity, and are on an investment spree. A large textile firm, Raymond, isinvesting Rs2bn to add 10m metres to its denim capacity, a suiting mill inBangalore and a fibre and garment plant in Thailand. The AV Birla group willexpand annual acrylic fibre production in Thailand from 57,000 tonnes to200,000 tonnes; it will also expand the capacity of its rayon units. Arvind Millshas raised its capacity from 4.8m to 7.2m shirts; it supplies leading brands, suchas Gap and Levi’s of the US. It will also expand its knitwear production. TheReliance conglomerate has bought Trevira, which has a 130,000 tonnes/yearpolyester capacity, from Germany’s Hoechst for €80m (US$97.5m). With thepurchase, Reliance will also gain access to Hoechst’s textile intellectual propertyportfolio. The purchase will make Reliance the world’s largest polyesterproducer, with a capacity of 1.8m tonnes a year. The company’s petrochemicalcapacity is 12.4m tonnes a year, and will rise to 15m tonnes in three years.

Vehicle sales continued to show rapid growth between April and July 2004:sales of passenger vehicles increased by 20% year on year, and sales ofcommercial vehicles by 36%. Utility vehicle sales grew by 25%, and sales oflarge trucks rose by 49%. Production of commercial vehicles has been through a

The central bank issues newprivate bank ownership rules

Concessions are granted todistricts affected by floods

Indian exporters prepare forthe end of the MFA

Vehicle sales continue togrow strongly

34 India


rough patch since the industrial slowdown in 1997: intermediate producerslocated closer to their customers, reducing distances, and the railways increasedtheir efficiency and drew traffic away. That phase now seems to be over,however. Surprisingly, sales of two-wheelers grew less than those of four-wheeled vehicles. Scooters and motor cycles have long been the favouritevehicle of the Indian middle class, but they now appear to be graduating tocars. While exports of other vehicles are still modest, car exports reached 18.7%of sales. Both Ford and Suzuki use India as a production base for the region.

Vehicle sales and exports, Apr-Jul 2004(no. of vehicles, unless otherwise indicated)

Export ratio Growth in sales Growth in exportsSales Exports (%) (%)a (%)a

Cars 252,525 47,165 18.7 20.5 31.5Utility vehicles 50,893 540 1.1 24.7 -64.1

Multipurpose vehicles 19,886 321 1.6 2.0 35.4Passenger vehicles 323,304 48,026 14.9 20.1 27.7Large buses 7,150 1,361 19.0 -5.3 62.4

Small buses 7,092 355 5.0 12.2 -28.9Large trucks 47,633 2,359 5.0 49.1 173.4

Small trucks 27,715 3,233 11.7 37.7 103.3Commercial vehicles 89,590 7,308 8.2 35.9 92.8

Three-wheelers 90,426 24,075 26.6 23.1 11.3Scooters 304,924 25,783 8.5 11.4 47.5Motorcycles 1,452,789 81,603 5.6 13.8 32.0

Mopeds 106,507 13,603 12.8 11.7 60.2Two- & three-wheelers 1,864,220 120,989 6.5 13.3 37.8

a Year on year.


Tourism

Tata’s Taj Group launched its first IndiOne Hotel in Whitefields, Bangalore, inJune. A new brand, IndiOne charges less than Rs1,000 a night for a hotel room.Taj plans to set up 150 such hotels throughout India. It also plans to acquireluxury hotels in China and South-east Asia. According to a survey by theFederation of Hotel and Restaurant Associations of India, the national averageroom rate went up from Rs2,000 a night in 2002/03 to Rs3,000 in 2003/04; theaverage rate in the capital, New Delhi, was Rs4,319 a night. Rates have risensharply, and new capacity has been slow to develop.

Foreign trade and payments

Although exports increased by 20% in fiscal year 2003/04 (April-March),imports rose even faster, and the trade deficit widened to US$16.7bn, fromUS$12.9bn. However, services exports are also rising, underpinned by thestrength of information technology (IT). The IT industry has overcome theimpact of the 2001 software slump in the US, and has added a new, rapidlygrowing business-process outsourcing (or “back-office”) subsector. India has a

The Taj Group goesdownmarket

India’s balance of paymentsremains strong

India 35


strong reputation in this industry, the country’s costs are low, and the subsectoris attracting investment from US companies. On the transfers account, Indiansworking abroad have increased their remittances to India despite the fall ininterest rates. The rise in services exports and transfers increased the currentaccount surplus to US$8.7bn in 2003/04, from US$4.1bn the previous year.

Current and capital accounts(US$ bn; fiscal years Apr-Mar)

2002/03 2003/042002/03 2003/04 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr

Goods: exports 52.5 63.0 14.6 13.3 14.6 16.4 18.6

Goods: imports 65.4 79.7 17.3 18.2 18.3 20.4 22.6Trade balance -12.9 -16.7 -2.7 -5.0 -3.7 -4.0 -4.0

Services: exports 25.0 27.6 6.4 5.2 6.1 5.9 10.4Services: imports 18.2 16.9 5.3 3.5 4.3 2.6 6.6Services: balance 6.8 10.7 1.1 1.7 1.8 3.3 3.8

Income: inflows 2.8 4.5 1.0 1.2 0.9 0.9 1.4Income: outflows 7.8 9.2 2.3 2.6 2.5 3.1 1.2

Income: balance -4.9 -4.7 -1.3 -1.4 -1.5 -2.2 0.2Current transfers: credit 15.6 19.8 3.8 4.3 5.5 6.1 3.7Current transfers: debit 0.4 0.4 0.2 0.1 n/a n/a 0.2

Current transfers: balance 15.2 19.4 3.6 4.2 5.4 6.1 3.5Current-account balance 4.1 8.7 1.0 -0.3 2.3 3.3 3.4Net direct investment 3.6 3.1 0.6 0.6 0.8 0.8 0.9Net portfolio investment 0.9 11.3 0.6 1.4 2.1 4.2 3.7

Official loans -2.5 -2.7 -2.6 -0.3 0.1 -1.6 -0.9Commercial loans -2.3 -1.9 0.3 0.2 -0.2 -3.8 1.9Bank funds 8.4 6.2 1.0 1.9 0.3 3.4 0.6

Deposits by non-resident Indians 3.0 3.6 0.4 1.8 0.4 1.3 0.1Other capital flows incl rupee debt service 3.0 4.4 0.9 0.9 1.6 0.9 0.9

Capital-account balance 12.1 22.1 1.8 5.6 5.9 4.2 6.3Errors & omissions 0.6 0.7 1.4 0.1 0.4 0.3 0.3Change in international reserves 17.0 31.0 4.3 5.5 8.6 7.3 10.1

Note. Totals may not sum owing to rounding.

Source: Reserve Bank of India.

The rise in the capital account surplus in 2003/04 was the result of a surge inportfolio investment as a spate of privatisations took place just before the endof the fiscal year. As industrial growth accelerated, global investors concludedthat the Indian market was undervalued: a record US$11.3bn of portfolioinvestment flowed in during 2003/04, and share prices nearly doubled in thesecond half of 2003. As a result of the surpluses on both the current and thecapital accounts, foreign-exchange reserves rose by an unprecedentedUS$31bn—one-third of the rise occurring in January-March 2004.

The capital accountsurplus rises

36 India


Trade, reserves and the exchange rate(US$ bn unless otherwise stated)

2003 2004Nov Dec Jan Feb Mar Apr May Jun Jul

Exports 4.7 5.5 5.2 5.6 7.3 5.0 – – –

Imports 6.3 7.2 6.6 6.8 7.1 6.7 – – –Trade deficit -1.6 -1.7 -1.5 -1.2 0.2 -1.7 – – –

Foreign direct investment 142 270 122 382 168 217 – – –Foreign portfolio investment 889 1,599 1,161 738 1,854 881 – – –Exchange rate (Rs:US$)ab 45.9 45.6 45.3 45.3 44.7 44.2 47.0 46.5 46.5

Reservesa 96.1 100.6 105.0 108.4 110.3 117.9 119.8 119.4 118.3

a Last Friday of the month. b Reserve Bank reference rate.

Source: Reserve Bank of India.

Although the Reserve Bank of India (the central bank) has published figures forforeign investment only up to April, figures put out by the Securities andExchange Board of India show that there was a massive outflow of foreignportfolio investment in May, and that the inflows since May have been small.Capital account movements since May have been dominated by outflows.Foreign-exchange reserves, which rose by US$17.3bn between January andApril, fell in the following three months. The rupee:US-dollar exchange rate,which stood at Rs44.2:US$1 at the end of April, depreciated to Rs46.5:US$1 bythe end of July—a depreciation of 5% in three months—but then remainedsteady in August, owing to central bank intervention. Rupee appreciation,which continued for almost two years, has now ended for the time being.

India’s international airports are poorly designed, congested and inhospitable;the government has long taken the view that international expertise isnecessary to build and run them. The first proposal for collaboration involvedthe building of a new airport in Bangalore, which was to have been built by theTata Group and Singapore Airlines (SA). But political opposition slowed theproject down, and Tata and SA eventually withdrew their bid. Since thengovernments have been aware that, if foreign investment is to flow into airportconstruction, it will require more attractive terms for foreign investors. Theprevious government relaxed the foreign-equity rules, and raised the share ofpermissible foreign equity to 74%. The new Indian National Congress-ledgovernment, by contrast, reduced the limit on foreign direct investment inairports from 74% to 49% at the end of June. On these terms, private investorsare unlikely to enter the airport construction sector.

The Indian government has taken note of the ambitious plans being made bythe Gas Authority of India (GAIL) and others to import liquefied natural gas(LNG), and sees in them an opportunity for Indian shipping. In June thegovernment announced that within a year of the introduction of tonnage tax(which is imminent), ships carrying LNG to India must have an Indian partnerwith at least a 26% share of the equity. Foreign vessels hired in the spot marketmay not carry more than 10% of shipments (calculated separately for eachproject and terminal). Every ship must have an Indian engineer officer, andanother Indian on the deck. One of the major beneficiaries of these rules is the

International investorconfidence is shaken

The foreign investment limit inairports is lowered

Import substitution in LNGtransport

India 37


government-owned Shipping Corporation of India, which has escapedprivatisation owing to the fall of the previous government. At present thecompany owns 29 crude carriers 11 product tankers. It has ordered two verylarge crude carriers (VLCCs) from Hyundai, and will take delivery of the firstship early next year and the second in the middle of the year. The corporationtried to order two 60,000-tonne tankers, but found no shipyards willing toaccept the order. It plans to order two more 170,000-tonne Capesize VLCCs, andis talking to shipyards in China and South Korea.

Cargo traffic in major ports(m tonnes; Apr-Jun)

2003 2004Calcutta 1.0 1.1

Haldia 7.4 7.8Paradeep 6.5 6.9

Vazagapatam 11.6 11.0Ennore 2.5 2.5

Madras 8.1 9.3Tuticorin 3.5 3.8Cochin 3.1 3.4

Mangalore 5.5 7.6Mormugao 6.5 6.5

Bombay 6.3 7.6Jawaharlal Nehru Port Trust 7.6 8.2Kandla 10.1 10.1

Total 79.8 85.8


In an interim ruling, the US Department of Commerce imposed anti-dumpingduties on Indian shrimp exports at the end of July—3.6% Devi Seafoods, 9.2% onNalakanti Seafoods and 27.5% on Hindustan Lever. Other Indian exporters willpay a weighted average of 14.2% in anti-dumping duties. The US importsaround US$400m-worth of Indian shrimp a year, accounting for about 29% ofIndia’s shrimp exports.

The US imposes duties onIndian shrimp

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