Tackling poverty in India and making its economic growth more inclusive requires sustained investment in people - in health and education as well as in areas such as transport and energy infrastructure, according to a new OECD report.
Titled 'India: Sustaining High and Inclusive Growth', the report recommends a review of the poverty reduction programmes, their targeting and efficiency. It was released following the OECD's World Forum on 'Measuring Well-Being for Development and Policy-Making' from October 16-19, in New Delhi in association with the Ministry of Statistics and Programme Implementation. Excerpts from the report:
The pace of economic growth in India has weakened in recent months, and institutions, regulation and economic governance need to adapt to sustain the economic transformation required for India to address its social and economic challenges. The bottlenecks that are bearing down on growth will have to be addressed for India to continue to narrow its major gap in living standards with middle income and OECD economies, to reduce widespread poverty, to reverse rising inequality and to improve the wellbeing of all Indians. This is essential for India but also for the world economy at large.
The potential for sustained strong growth is high. The Indian population is young by international comparison and this together with declining fertility has led to a falling youth dependency rate. The national savings rate is also high and, given favourable demographics, could well rise further in the medium term, providing the capital needed to fund investment in infrastructure as well as strong expansion in private enterprise.
Furthermore, despite employment rising in the industrial and service sectors, around half of all workers remain in low value-added agriculture. The scope is therefore enormous for economy-wide productivity gains from the further migration of workers into modern sectors.
Weaknesses in the business environment and very restrictive labour legislation have prevented India from reaping the benefits of its large population, notably through the labour-intensive manufacturing boom. To fully reap the benefits of this demographic dividend and support a return to high growth, India needs to continue to address important obstacles to stronger growth.
Following the 2009 global downturn, the Indian economy enjoyed a recovery. However, growth began to fade again in 2011 and new macroeconomic challenges began to emerge. GDP rose by 6.5 per cent in 2011-12, the slowest annual growth in almost a decade, and has continued to weaken more recently. The composition of growth has also become less resilient. Capital formation, which underpinned the heady growth prior to the slowdown, has languished while manufacturing, another key engine of growth, has been chronically weak.
This current economic slowdown is only partly cyclical and reflects the emergence of energy, infrastructure, human capital and institutional bottlenecks. The rapid economic growth in the two last decades has indeed accentuated the demand for energy and natural resources, for transport infrastructure and skills. But supply of these key engines of growth has not been able to keep pace. Institutions and public as well as private governance also need to adapt to the development of India and the progressive transformation of its economy.
While severe poverty gradually but persistently veered downwards, today large sections of the Indian population still remain below national and international poverty lines; and, inequality has increased. A large share of the population is employed in the informal sector generally in low-paid, low-productivity jobs with no access to training. Access to basic services including health care and electricity is limited. Widespread informality limits tax collection and in turn the ability of public spending to expand in social areas, innovation and infrastructure. There has also been growing disparity in performance between the different states, which reflects differences in the product and labour market regulations across states.
Unlocking India's potential
In order to fully reap the benefits of the demographic dividend and support a return to high and more inclusive growth, India needs to renew its commitment to sound macroeconomic policy and implementation of reforms. These efforts will have to be undertaken at all levels of government, starting by putting public finances on a sound footing and improving the fiscal framework so that persistent large deficits do not undermine macroeconomic stability and investor confidence.
To boost productivity and promote the development of the formal sector, steps need to be taken to strengthen business environments and support the introduction of new technology, including through fostering competition, further reducing international trade and investment barriers and improving corporate and public governance. Steps to reform the financial sector can also support productivity gains by facilitating the entry of new enterprises and improving the efficiency of capital allocation (chapter Reforming the financial market).
To ensure that rising human capital is harnessed effectively, labour market reforms are needed to boost dynamism and support job creation in the formal sector. Inclusion could also be promoted through policies to improve productivity in the agricultural sector and by strengthening rural financial institutions.
A stronger and wider formal sector means higher tax revenues that could help unlock supply-side bottlenecks, notably in infrastructure and innovation and increase social public spending including on health care where India is among the lowest in the world.
Nonetheless, existing government spending should be made more inclusive and better support the poorest groups.
Welfare programmes, notably those that provide subsidised food and other goods, suffer from major inefficiencies and often they do not reach their intended recipients. Important energy subsidies also benefit primarily the better-offs and harm the environment.
Reducing them would free up resources for essential welfare and growth enhancing programmes and support India's necessary efforts to increase energy and resource efficiency and make its growth cleaner.
Fiscal challenges
Fiscal policy has an important role to play in supporting India's long-term development. Higher spending on social care, including basic health care, on education and innovation could help make growth stronger and more inclusive. The current fiscal situation however does not allow for such spending. Despite some improvement of the fiscal situation up to the global crisis, India has been characterised by large public deficits. Although they have not resulted in sizeable increases in the debt-to-GDP ratio thanks to high nominal GDP growth, they are a major drain on national savings and tend to crowd out private investment. They also put pressure on the current account deficit, which has widened considerably in recent years.
Up to the crisis, good progress had been made in reducing large fiscal deficits at central and state levels, under the auspices of the Fiscal Responsibility and Budget Management Act (FRBMA), and related state laws. By 2007-08, the general government deficit had reduced to around 4 per cent of GDP, down from nearly double-digit levels earlier in the decade. This reduction was driven by the expansion of the corporate sector, which boosted corporate tax receipts, and a new tax on services, that broadened the tax base.
In addition, personal income tax receipts peaked towards the end of the period with the strength of the economy. Government consumption also declined, reflecting in particular public sector wage restraints.
However, since then, government finances weakened substantially, largely on account of a widening central government deficit. This was partly due to discretionary measures implemented to support the economy, including tax cuts, as well as a cyclical weakening in tax revenues. Still, some of the largest spending measures were more structural in nature, including hikes in public-sector salaries, debt writeoffs for small farmers, subsidies for oil-related products, and expansion of the National Rural Employment Guarantee Scheme.
In the 2012-13 budget, the central government announced plans to reduce its deficit to around 5 per cent of GDP. Nevertheless, tax receipts are being affected by the economic slowdown while spending, particularly on energy subsides, threatens to overshoot.
India's central government deficit has increased in recent years. To promote stronger fiscal policy, fiscal frameworks need to be improved, especially since the targets set out under the FRMBA have expired. Having an institution that monitors progress in implementing medium-term fiscal targets and reports directly to parliament would help.
This could build on the expertise of the Finance Commission which currently reports once every five years on revenue sharing between the Centre and the states and other fiscal concerns of the government. Revised legislation should set binding targets for the medium term. In particular, the whole budget should be set on a rolling three-year basis to make it clearer how medium-term fiscal targets are to be met. This should include detailed forward estimates rather than just a statement of future expected revenue and expenditure.
More efficient, inclusive spending
Given the limited room for higher expenditure in the short term, there is a pressing need to improve spending efficiency and targeting, particularly in the area of subsidies. While intended to help the poor, they often remain poorly targeted and a significant proportion accrues to households above the poverty line. This is especially true of some energy subsidies that benefit primarily the better-offs, who consume the most energy, and harm the environment. The reduction of these subsidies would not only remove incentives for environmentally harmful activities, but would also free up resources for poverty reduction and basic health care. The food subsidy system is also highly inefficient, with large amounts of grain finding their way into parallel distribution systems. The government is moving towards replacing some of the in-kind subsidies with direct cash transfers to households. This has the potential to reap considerable savings and improve targeting and it ought to be broadened to cover all subsidies. The Universal Identity Card, which continues to be rolled out, can also help ensure that benefits accrue only to those who are entitled to receive them.
Tax reforms can play a decisive role in supporting growth, by removing distortions and enhancing transparency and predictability of tax systems while increasing the efficiency of tax administration and boosting revenues. The central government, in co-operation with state governments, seeks to implement important tax reforms, including the introduction of a Goods and Services Tax (GST). The current indirect taxation system is complex and involves cascading taxes that bias production decisions and hinder inter-state trade. A national GST, coupled with a state GST, would rationalise indirect taxes while preserving states' financial autonomy. To keep the overall rate low, the base should remain as broad as possible. Ideally, a single tax rate should apply in each state and where differential rates apply they should be kept as low as possible and confined to a limited range of products. A major effort is now required to finalise implementation details.
The central government is also seeking to reform direct taxes and negotiations are continuing on a revised Direct Tax Code. The proposed changes would increase the tax-free threshold, releasing many low-income taxpayers from the tax net, thereby reducing administration costs. They would also reduce the corporate tax rate and broaden the corporate tax base. A further proposal is to reduce the tax on savings, including by making contributions to pension schemes free of taxation.
Titled 'India: Sustaining High and Inclusive Growth', the report recommends a review of the poverty reduction programmes, their targeting and efficiency. It was released following the OECD's World Forum on 'Measuring Well-Being for Development and Policy-Making' from October 16-19, in New Delhi in association with the Ministry of Statistics and Programme Implementation. Excerpts from the report:
The pace of economic growth in India has weakened in recent months, and institutions, regulation and economic governance need to adapt to sustain the economic transformation required for India to address its social and economic challenges. The bottlenecks that are bearing down on growth will have to be addressed for India to continue to narrow its major gap in living standards with middle income and OECD economies, to reduce widespread poverty, to reverse rising inequality and to improve the wellbeing of all Indians. This is essential for India but also for the world economy at large.
The potential for sustained strong growth is high. The Indian population is young by international comparison and this together with declining fertility has led to a falling youth dependency rate. The national savings rate is also high and, given favourable demographics, could well rise further in the medium term, providing the capital needed to fund investment in infrastructure as well as strong expansion in private enterprise.
Furthermore, despite employment rising in the industrial and service sectors, around half of all workers remain in low value-added agriculture. The scope is therefore enormous for economy-wide productivity gains from the further migration of workers into modern sectors.
Weaknesses in the business environment and very restrictive labour legislation have prevented India from reaping the benefits of its large population, notably through the labour-intensive manufacturing boom. To fully reap the benefits of this demographic dividend and support a return to high growth, India needs to continue to address important obstacles to stronger growth.
Following the 2009 global downturn, the Indian economy enjoyed a recovery. However, growth began to fade again in 2011 and new macroeconomic challenges began to emerge. GDP rose by 6.5 per cent in 2011-12, the slowest annual growth in almost a decade, and has continued to weaken more recently. The composition of growth has also become less resilient. Capital formation, which underpinned the heady growth prior to the slowdown, has languished while manufacturing, another key engine of growth, has been chronically weak.
This current economic slowdown is only partly cyclical and reflects the emergence of energy, infrastructure, human capital and institutional bottlenecks. The rapid economic growth in the two last decades has indeed accentuated the demand for energy and natural resources, for transport infrastructure and skills. But supply of these key engines of growth has not been able to keep pace. Institutions and public as well as private governance also need to adapt to the development of India and the progressive transformation of its economy.
While severe poverty gradually but persistently veered downwards, today large sections of the Indian population still remain below national and international poverty lines; and, inequality has increased. A large share of the population is employed in the informal sector generally in low-paid, low-productivity jobs with no access to training. Access to basic services including health care and electricity is limited. Widespread informality limits tax collection and in turn the ability of public spending to expand in social areas, innovation and infrastructure. There has also been growing disparity in performance between the different states, which reflects differences in the product and labour market regulations across states.
Unlocking India's potential
In order to fully reap the benefits of the demographic dividend and support a return to high and more inclusive growth, India needs to renew its commitment to sound macroeconomic policy and implementation of reforms. These efforts will have to be undertaken at all levels of government, starting by putting public finances on a sound footing and improving the fiscal framework so that persistent large deficits do not undermine macroeconomic stability and investor confidence.
To boost productivity and promote the development of the formal sector, steps need to be taken to strengthen business environments and support the introduction of new technology, including through fostering competition, further reducing international trade and investment barriers and improving corporate and public governance. Steps to reform the financial sector can also support productivity gains by facilitating the entry of new enterprises and improving the efficiency of capital allocation (chapter Reforming the financial market).
To ensure that rising human capital is harnessed effectively, labour market reforms are needed to boost dynamism and support job creation in the formal sector. Inclusion could also be promoted through policies to improve productivity in the agricultural sector and by strengthening rural financial institutions.
A stronger and wider formal sector means higher tax revenues that could help unlock supply-side bottlenecks, notably in infrastructure and innovation and increase social public spending including on health care where India is among the lowest in the world.
Nonetheless, existing government spending should be made more inclusive and better support the poorest groups.
Welfare programmes, notably those that provide subsidised food and other goods, suffer from major inefficiencies and often they do not reach their intended recipients. Important energy subsidies also benefit primarily the better-offs and harm the environment.
Reducing them would free up resources for essential welfare and growth enhancing programmes and support India's necessary efforts to increase energy and resource efficiency and make its growth cleaner.
Fiscal challenges
Fiscal policy has an important role to play in supporting India's long-term development. Higher spending on social care, including basic health care, on education and innovation could help make growth stronger and more inclusive. The current fiscal situation however does not allow for such spending. Despite some improvement of the fiscal situation up to the global crisis, India has been characterised by large public deficits. Although they have not resulted in sizeable increases in the debt-to-GDP ratio thanks to high nominal GDP growth, they are a major drain on national savings and tend to crowd out private investment. They also put pressure on the current account deficit, which has widened considerably in recent years.
Up to the crisis, good progress had been made in reducing large fiscal deficits at central and state levels, under the auspices of the Fiscal Responsibility and Budget Management Act (FRBMA), and related state laws. By 2007-08, the general government deficit had reduced to around 4 per cent of GDP, down from nearly double-digit levels earlier in the decade. This reduction was driven by the expansion of the corporate sector, which boosted corporate tax receipts, and a new tax on services, that broadened the tax base.
In addition, personal income tax receipts peaked towards the end of the period with the strength of the economy. Government consumption also declined, reflecting in particular public sector wage restraints.
However, since then, government finances weakened substantially, largely on account of a widening central government deficit. This was partly due to discretionary measures implemented to support the economy, including tax cuts, as well as a cyclical weakening in tax revenues. Still, some of the largest spending measures were more structural in nature, including hikes in public-sector salaries, debt writeoffs for small farmers, subsidies for oil-related products, and expansion of the National Rural Employment Guarantee Scheme.
In the 2012-13 budget, the central government announced plans to reduce its deficit to around 5 per cent of GDP. Nevertheless, tax receipts are being affected by the economic slowdown while spending, particularly on energy subsides, threatens to overshoot.
India's central government deficit has increased in recent years. To promote stronger fiscal policy, fiscal frameworks need to be improved, especially since the targets set out under the FRMBA have expired. Having an institution that monitors progress in implementing medium-term fiscal targets and reports directly to parliament would help.
This could build on the expertise of the Finance Commission which currently reports once every five years on revenue sharing between the Centre and the states and other fiscal concerns of the government. Revised legislation should set binding targets for the medium term. In particular, the whole budget should be set on a rolling three-year basis to make it clearer how medium-term fiscal targets are to be met. This should include detailed forward estimates rather than just a statement of future expected revenue and expenditure.
More efficient, inclusive spending
Given the limited room for higher expenditure in the short term, there is a pressing need to improve spending efficiency and targeting, particularly in the area of subsidies. While intended to help the poor, they often remain poorly targeted and a significant proportion accrues to households above the poverty line. This is especially true of some energy subsidies that benefit primarily the better-offs, who consume the most energy, and harm the environment. The reduction of these subsidies would not only remove incentives for environmentally harmful activities, but would also free up resources for poverty reduction and basic health care. The food subsidy system is also highly inefficient, with large amounts of grain finding their way into parallel distribution systems. The government is moving towards replacing some of the in-kind subsidies with direct cash transfers to households. This has the potential to reap considerable savings and improve targeting and it ought to be broadened to cover all subsidies. The Universal Identity Card, which continues to be rolled out, can also help ensure that benefits accrue only to those who are entitled to receive them.
Tax reforms can play a decisive role in supporting growth, by removing distortions and enhancing transparency and predictability of tax systems while increasing the efficiency of tax administration and boosting revenues. The central government, in co-operation with state governments, seeks to implement important tax reforms, including the introduction of a Goods and Services Tax (GST). The current indirect taxation system is complex and involves cascading taxes that bias production decisions and hinder inter-state trade. A national GST, coupled with a state GST, would rationalise indirect taxes while preserving states' financial autonomy. To keep the overall rate low, the base should remain as broad as possible. Ideally, a single tax rate should apply in each state and where differential rates apply they should be kept as low as possible and confined to a limited range of products. A major effort is now required to finalise implementation details.
The central government is also seeking to reform direct taxes and negotiations are continuing on a revised Direct Tax Code. The proposed changes would increase the tax-free threshold, releasing many low-income taxpayers from the tax net, thereby reducing administration costs. They would also reduce the corporate tax rate and broaden the corporate tax base. A further proposal is to reduce the tax on savings, including by making contributions to pension schemes free of taxation.