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India: Policies to Reduce Poverty and Accelerate Sustainable Development

India FY00 PA

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This Report is a pilot in the World Bank's new approach to country economic reports, embodying the Bank's Comprehensive Development Framework. Experience worldwide indicates that poverty reduction and sustainable development require sound macroeconomic policies, open trade relations, and increases in human and physical capital. But sustained development also requires a comprehensive framework that includes 1) good governance; 2) sound legal, incentive, and regulatory frameworks that protect property rights, enforce contracts and stimulate competitive markets, 3) a sound financial sector, adequately regulated and supervised with a basis in internationally accepted accounting and auditing standards; 4) health, education and social services that reach the poor, women and girls effectively; 5) quality infrastructure and public services to promote rural development and livable cities; and 6) policies to promote environmental and human sustainability (J. D. Wolfensohn, Address to the 1998 World Bank-IMF Annual Meetings).

The World Bank's new approach to economic reports provides a medium-term perspective on these elements and on the economy's potential vulnerabilities, including those in the short-run. Given the framework's breadth, this Report's coverage is limited to the most important issues. In other areas, it points out directions for further analysis. The Report begins with a chapter on reducing poverty the yardstick against which development is measured and the World Bank's principal concern. It is followed by a chapter on human development, which is both an indicator of poverty reduction and a way out of poverty. Chapter 3 focuses on the Indian states, which are key actors in human development and infrastructure provision, as well as in regulation and governance. Chapter 4 deals with governance issues, a major concern of the World Bank because of its links to poverty reduction and development. The next three chapters deal with ways to increase growth and its poverty reducing content through improvements in a) infrastructure; b) the incentive and regulatory framework to encourage efficiency and labor demand a key element in poverty reduction; and c) the financial system and corporate governance. Chapter 8 deals with recent developments, the sustainability of growth and ways to reduce vulnerability to macroeconomic crises that hurt the poor. Finally, Chapter 9 provides a brief forecast of India's prospects and summarizes policies that would accelerate poverty reduction and sustained development. The Report's discussion of agriculture (in Chapter 6) a sector critical for poverty reduction that is still of major importance for the economy summarizes the extensive analysis in the World Bank report India: Towards Rural Development and Poverty Reduction. The unifying theme for this Report is thus accelerating poverty reduction and sustained development.

Progress and Problems in Poverty Reduction

Steady Progress since Independence. India is an ancient civilization with a proud history. It is one of the world's largest and most heterogeneous countries. Prior to Independence, India suffered from frequent, devastating famines and secular stagnation. Hence, poverty reduction and agriculture were central themes of India's founding fathers. Uplifting the poor and integrating them into the mainstream is a recurrent theme of India's Five Year Plans. Universal access to education is enshrined in the Constitution. India has established a wide array of anti-poverty programs and much of India's thinking on poverty has been mainstreamed internationally. India has successfully eliminated famines and severe epidemics. It has made progress in reducing poverty and in its social indicators, which at the time of Independence in 1947 were among the world's worst. Its vibrant democracy and free press have been major factors in these achievements.

Poverty incidence began to decline steadily in the mid-1970s, which roughly coincided with a rise in growth in GDP and agriculture. Since 1980, India's 5.8% p.a. trend GDP growth is the highest among large countries outside East Asia. Empirical analyses suggest that agricultural growth and human development were key factors in the decline in poverty across states (Chapter 1). However, the development strategy of the 1970s and 1980s, based on an extensive system of protection, regulation, and public sector presence in the economy, and on worsening fiscal deficits in the 1980s, proved unsustainable.

Quick Recovery from 1991 Crisis. The 1991 balance of payments and fiscal crisis was met by stabilization and reforms that opened-up the economy, reduced the public sector's role, and liberalized and strengthened the financial sector over the next few years. The policies generated a surprisingly quick recovery and then an unprecedented three consecutive years of 7.7% p.a. average growth, led by increases in productivity at the macroeconomic level and a booming private sector. The 3.3% p.a. agricultural growth during the 1990s has been about the same as in the 1980s and much higher than the declining rate of population growth, currently estimated at about 1.6% p.a. (Chapter 8).

Improvement in social indicators, including gender related indicators, has continued in the 1990s. For example, literacy rates continue to rise and infant mortality rates continue to fall. Life expectancy at birth has increased, as have school enrollments. Gaps between male and female access to social services are diminishing.

Sluggish Poverty Reduction in Recent Years. Despite the improvements in human development and the higher GDP growth in the mid-1990s, India's household sample surveys suggest that poverty reduction has been sluggish recently. In the early 1990s, poverty worsened following the stabilization (correction) of the unsustainable policies of the 1980s, a poor harvest and a decline in food availability (Tendulkar). Soon, poverty began to fall again and by 1993-94 was somewhat below the 1987 level. However, from 1993-94 until 1997 (the last available survey), improvement has been limited in the rural areas which contain over 70% of the poor. Moreover, analysis suggests that the large poor states in the north and east, containing 40% of India's population, have lagged in reducing poverty since the late 1970s (Chapters 1 and 3).

The estimated slowdown in the overall reduction of poverty may merely reflect one of India's many statistical inconsistencies the estimates of consumption and foodgrains consumption in the national accounts suggest much faster consumption growth than the sample surveys, while the surveys suggest little worsening of distribution. The need to improve the consistency and quality of these and other statistics, in order to provide a firmer basis for policy-making, is a major recommendation of this Report.

Despite Achievements, Significant Challenges Ahead. More worrisome is the possibility that growth became less potent in reducing poverty in the 1990s. Further work is needed on this complex issue. Nonetheless, the characteristics of agricultural growth in the 1990s; the slowdown of growth in the poor states; and the problems of infrastructure, social services and poverty programs, especially in the poorer states which are linked to their increasing fiscal problems, poor incentive frameworks and weaknesses in governance and institutions, are all problems that may explain the lack of progress in reducing rural poverty (Chapters 1, 2, 3 and 8.) Note that statements made regarding individual states or the states' GDP as a group refer to the old (1980-81 based) GDP accounts; once they are rebased, like national GDP, to the new (1993-94 based) accounts, the growth rates of states could be different from what the old accounts show, since the new GDP accounts include a much higher estimate of national agricultural output.). Agriculture's average growth has remained roughly constant since 1980 according to the new series of GDP. However, productivity growth in the sector seems to be slowing, even in the Punjab and Haryana, where some analysts suggest that environmental issues are a concern. Further, agricultural growth in some of the poorer states seems to have lagged. Public spending on agriculture has focused on subsidies, which lead to inefficiencies and environmental problems and at best have limited impact on poverty. The implicit and explicit subsidies have crowded-out public investment and social spending in Governments' budgets and substantially worsened the fiscal problems of states. While private investment in agriculture has increased, to some extent this reflects inefficiencies and distortions that are partly related to the subsidies, such as the purchase of pumps to reach deep aquifers and generator sets to run them when free, low quality power fails. Moreover, the limited growth in agricultural productivity may also reflect the limited deregulation, which has left many distortions in the sector. For example, the restrictions on domestic and international agricultural trade contribute to occasional, sharp transitory increases in prices, which hurt the poor (Chapters 3, 6, and 8).

The poorer states have lower GDP growth, not just weak agricultural growth. Partly, of course, this reflects their structure agriculture is a large percentage of their GDP. However, the poor states' lower growth also reflects differences in initial conditions and state-level policies. The poorer states' problems in infrastructure, human development, and, in some cases, governance, have limited their ability to take full advantage of the post-1991 reforms. Moreover, catching-up is a problem because of their increasingly severe fiscal problems in the late 1980s the states began unsustainable increases in spending and large untargeted subsidies (explicit and implicit) that have never been adjusted, which has led to a large, costly debt build-up. Indian states are constitutionally prevented from external borrowing and limited in their domestic borrowing by the Central Government. Nonetheless, several states, including some of the poorest, now face unsustainable debt service obligations, mainly to the Central Government, which in turn had borrowed to fund these loans. Infrastructure and social spending have slowed in most states as a consequence of the high debt service particularly in the highly indebted and poorer states. The states' problems have worsened in the last two years, with the cascading down of the excessive central public sector wage settlement of 1997. (Chapters 2 and 3).

Institutional weaknesses and governance issues exacerbate the lack of funds (Chapters 2 and 4). For example, not only are teacher-pupil ratios very low, teachers' absenteeism is common. Numbers working in employment programs or attending school appear to be much less in surveys than in official statistics for example, in 1995-96, the NSS showed gross attendance ratios of 85% versus the Department of Education's gross enrolment ratio of 104%. Large fractions of the poverty funds go to administrative costs or are diverted, leaving less for the poor. For example, a study in UP suggests that under the new, targeted public distribution system much of the grain that reached the public distribution centers went to the poor, but that there was a 40% shortfall between off-take and what reached the distribution centers. (Kriesel and Zaidi).

Thus despite its many achievements, India faces significant challenges and needs to take some difficult political decisions to realize its potential. Concerted policy action is needed to lift the more than 300 million poor, 34% of the population and increasingly concentrated in the poorer states, out of poverty. Better and more education and health spending is needed to provide better access for the poor, females, and other disadvantaged groups and improve basic services across the board. For example, major challenges in reducing poverty and getting India's population ready for the demands of the 21st century, are raising the literacy rate from the current 62% (50% for females); enrolling the over 30 million children, mostly poor, who are out of school; and increasing the overall average years of quality schooling. In addition, inequalities faced by women in participating fully in the political, legal and economic systems need to be addressed. The decline in infrastructure spending needs to be reversed, to increase the rate and spread of growth and to meet urban needs that will rise as the 73% of the population that still live in rural areas shift to the cities. Improvements at the state-level, particularly improved service delivery in the poorest states, will be critical in meeting these challenges. At the national level, implementation of the often discussed second phase of reforms, to complete the external and internal deregulation of goods and factor markets, will speed the growth of better paying jobs.

The East Asian countries, despite the recent crisis, still have a much lower poverty incidence and better social indicators than India. For example, Indonesia, which in the mid-1960s had a similar per capita income to India and which was the hardest hit by the East Asian crisis, has a literacy rate of 80% and less than 20% of its population were below the poverty line in 1998 (World Bank 1999a). Moreover, except for Indonesia, the crisis countries are rebounding surprisingly rapidly, reflecting their strong underlying base of infrastructure and human development.

Potential Problems in Accelerating Poverty Reduction, Sustaining Growth

The East Asian experience of the 1970s and 1980s, and the differential experience of India's states, suggest that India needs to get back to a higher growth path, which is also more effective at reducing poverty through improved public spending and a strengthening of incentives, institutions and governance, particularly in the poorer states. To make a significant dent in poverty, growth needs to be at least maintained in India's high growth states and increased significantly in the poorer states.

India's Future Growth and Poverty Reduction. India's growth of 6% in 1998-99 was one of world's best. However, it mainly reflected good harvests; all major non-agricultural sectors grew less than in 1997-98 when overall GDP growth was 5%. The reversion back to the average post-1980 growth trend during the last two years may partly reflect a sluggishness related to the shake-out of excess capacity and partly the slowing world economy. However, another important factor in slowing growth is probably the slowing of reforms, along with a worsening of the fiscal deficit and rises in tariffs reforms that had earlier contributed to higher productivity, a higher share of world trade, and rapid growth (Chapters 6 and 8 and Annex 8.1). Also, the delivery of social services and anti-poverty programs, necessary to include India's poor in the growth process and largely a state function, would have benefited not only from higher funding but improved institutions and governance.

Indeed these and other issues raised above raise concerns about maintaining even the current pace of development. Current rates of investment have supported GDP growth 5-6% p.a. in the last two years, but can continue to do so provided the productivity of resources continues to increase in the macroeconomic sense. However, the deterioration of infrastructure (Chapter 5); the slower pace of reforms (Chapters 6, 8) and the resulting uncertainty for investors; the lack of agricultural deregulation (Chapter 6); the still-low indicators of human development; and the governance and institutional issues, particularly in the social sectors (Chapters 2, 4), all pose potential problems for the growth of productivity in an economy-wide sense.

Large Central and State Deficits, related to Large Explicit and Implicit Subsidies. Another major issue for sustained development is the large General Government (consolidated Central and State) deficit. India's fiscal deficit has been among the world's largest and in 1998-99 it deteriorated by roughly 2% of GDP. The consolidated public sector deficit of 9.6% of GDP in 1998-99 was not much lower than the peak of 10.9% registered in the crisis year of 1990-91. The Center's deficit deteriorated by 0.8% of GDP to 6.5% of GDP in 1998-99 (including net loans to the states) and was far higher than the 5.3% budgeted figure (all figures exclude disinvestment revenues). The current (revenue) deficit increased to 4% of GDP, the highest in the decade, meaning India is increasingly borrowing to finance current expenditure. Meanwhile, the states' combined deficit rose to 4.2% of GDP, the worst deficit ever of the states. (Chapter 8). Reflecting the recent fiscal deterioration, the ratio of Central Government debt to GDP, which fell in the mid-1990s, has now risen to about 60% of GDP, and has led to comment from the RBI (Report on Currency and Finance 1998-99, pp. V-12 to V-17). The large and rising fiscal deficit and the large public sector debt (mostly internal) raises investors' concerns about macroeconomic instability and inflation (which would hurt the poor), and crowds-out private credit in the banking system.

The 1999-2000 Union Budget projected a cut in the central deficit of 0.9% of GDP. Achieving this target depends on a substantial rise in tax revenue, and containing revenue expenditure growth to only 9%. Preliminary data from the first seven months of 1999-2000 suggest taxes are growing slower than projected and expenditure faster, partly because of support for and lending to the states to finance their high deficits. The Union Budget also changed the accounting treatment of the growing small saving funding of the states deficit from a Central Government loan to an item in the "National Small Savings Fund" in the Center's Public Accounts. This accounting change reduces the Center's deficit figures by about 1.3% of GDP but leaves the (consolidated) General Government fiscal deficit unchanged. It will be important to pay close attention to the policy on small savings, as the Center sets the rates and implicitly guarantees the deposits. A positive fiscal development was the sharp upward adjustment of domestic diesel prices in October 1999, an attempt to correct for the potential deficit in the oil pool; it also maintained the liberalization of the sector. The states' and the Public Enterprises' deficits are likely to suffer continued pressure from the cascading effect of the excessive central wage settlement of 1997 on wages and pensions. As noted, the interest costs of the debt have increasingly crowded-out infrastructure, maintenance, and social spending in central and state budgets.

Implicit and explicit subsidies at the Center and, especially, the state levels are a major factor in the deficit. The Ministry of Finance estimated these subsidies at over 14% of GDP in 1994-95. In addition to increasing the deficit, they are distortionary, non-transparent, and at best have uncertain equity consequences, at worst they are anti-equity. While the states are directly responsible for many of the subsidies, the Center's funding of the states supports them indirectly. Another structural factor in the deficit is the tax system, with central taxes declining by over 1.5% of GDP over 1991-98. The growing services sector is inadequately taxed and agriculture, part of the state tax base, remains outside the system. The tax base has been widened recently, but nonetheless remains fairly narrow, with under 15 million tax payers. As various experts have noted, the approach to sharing of taxation revenues, the lack of a full fledged VAT (including services), and the failure of the states to tax agriculture h
ave complicated fiscal decentralization and generated tax-based inefficiencies (Chapters 3 and 4). Expenditure management and efficiency could be improved, as recognized in the last two finance ministers' calls for an Expenditure Reforms Commission. The civil service is large. Many public enterprises continue to operate at low efficiency in areas where the private sector could function more effectively and generate more taxable revenues.

Comfortable BOP but Domestic Policies Continue to Constrain Competitiveness. In contrast to the fiscal situation, India's balance of payments (BOP) remains comfortable. In 1998-99, the balance of payments strengthened substantially, with the current account deficit improving to 1% of GDP. This improvement reflected the low oil prices that prevailed for much of the year and a $4 billion drop in non-customs imports that reduced imports by over 7%. However exports also declined, by 4% in dollar terms, reflecting not only weak markets but a loss of share of world markets for the second consecutive year. Regarding the capital account, the Resurgent India Bond raised $4.2 billion despite the turmoil in international markets. However, foreign direct investment declined and portfolio flows turned negative. The net impact of these developments was a rise of about $3.9 billion in international reserves (including SDRs and IMF reserves but not gold), to a comfortable end-fiscal year level of $30.2 billion (7.6 months of imports, and comfortably larger than potential short term claims). The projection for 1999-2000 is a slight widening of the current account deficit, to 1.4% of GDP, reflecting continued high oil prices. On the capital account, increases in portfolio investment (despite the continued low levels of private capital flows worldwide) and "other" capital inflows which appear strong thus far in 1999, will offset a decline in net long-term borrowings after the one-time Resurgent India Bond issue in 1998-99. These inflows will finance much of the larger deficit and permit some increase in reserves, although the reserve cover is likely to decline marginally to 7.2 months of imports (Chapters 8 and 9). The external debt situation remains comfortable, and the external debt to GDP ratio as well as the debt to current receipts ratio have fallen steadily since 1992-93. A large proportion of external debt is to multilateral and bilateral lenders and/or is long-term. Careful monitoring by the Government and changes in the underlying economic factors have led to a substantial fall in short-term debt, from over $8.5 billion (10% of external debt) in 1991 to an estimated $4.3 billion (4.4%) in March 1999.

The fundamentals of India's slow export growth lie in the lack of further tariff reform, high infrastructure and transactions costs, and continued domestic regulations such as small-scale sector reservation and labor laws that reduce India's comparative advantage in labor intensive products and, consequently, the demand for labor. As a result, India may find it difficult to take advantage of the next upsurge in world trade and the international agreement to phase out textile and garment quotas by 2005, and is not well-prepared for greater competition that will arise from the elimination of remaining quantitative restrictions on imports no later than April 2001 (of which half, mainly the special import license restrictions, are due to go by April 2000). Indeed, India already faces growing competition from a recovering East Asia. A bright spot in the current account is the rapid growth of computer service exports, which do not suffer from the anti-export biases mentioned above, but even they may be hurt if telecom infrastructure lags.

Financial System Remains a Concern. The public sector-dominated financial system is another major issue impinging on sustained growth and, indirectly, poverty reduction. The financial sector mobilizes substantial resources but still invests a large part of them in the government debt, in the case of banks about 40% of deposits. This pattern of asset holding by the financial sector does reduce India's susceptibility to financial crises but it also reduces credit availability to the private sector. From a macro-economic standpoint, these large holdings levels of debt are simply the reflection of the long history of high fiscal deficits and the need for someone to hold the resulting debt; funds can be made available to the private sector at reasonable cost only as the public debt declines relative to GDP. A second factor raising the cost of private sector credit is non-performing assets. Non-performing assets are a low fraction of total bank assets (3% net of provisions) or GDP (under 2%), but are large relative to lending to the private sector (or to bank capital). The large NPAs in turn require large provisions, another factor pushing up real lending rates. Regulation and supervision have improved substantially since the 1980s and are largely up to international standards, but they remain well below the steady evolution of international best practices. The payments system continues to lag international standards, according to participants in the sector. The capital markets are deep for a low-income country and improvements have been made notably the set up of the electronic National Stock Exchange and the creation of a depository that has reduced transactions costs by dematerializing an increasing number of shares. Nonetheless, transparency needs improvement, notably in the activities of the dominant Unit Trust of India and in settlements, to help avoid payments crises such as hit the Bombay Stock Exchange in June 1998. More fundamentally, accounting, auditing, and corporate governance also could benefit from improvement to make India a more attractive to domestic and foreign investors (Chapter 7).

Legal and Environmental Issues. Enforcement of property rights and contracts are increasingly identified by analysts as critical institutional elements in development. Clarity and security of property and land rights and timely recourse to an efficient legal system are important not only to investors but to sustainable increases in living standards for the poor. Surveys indicate a respect for India's adherence to the rule of law and the independence and quality of the judiciary. However, the appellation "justice delayed is justice denied" is a critical concern, particularly for the poor. The enormous case backlog and the legal processes can delay decisions 10-20 years. These delays add to the problems of the poor in obtaining protection from the legal system. All these problems, as well as the bankruptcy and liquidation processes, raise credit costs, increase non-performing assets (Chapters 4 and 7), hinder good credit allocation and limit the ability of the poor to use their limited real assets effectively.

Finally, the environmental dimension needs to be kept in mind. The Finance Ministry's 1998-99 Economic Survey farsightedly included a chapter on environment, which points out the disproportionate burden of environmental and resource degradation on the poor, a concern which this Report shares. As noted above, environmental degradation and unsustainable usage of resources, encouraged by subsidies and unclear property rights, may be a factor in slowing agricultural growth in some states and a limitation on improvements in the quality of life generally. Often the poor suffer from the environmental problems associated with unclear allocation of property rights to clean air, water, etc. The human sustainability of the cities is threatened by water and air pollution, which partly reflects distortionary pricing and partly lack of funding for public infrastructure (Chapter 8 and Annex 8.2).

A Second Wave of Reforms to Reduce Poverty Faster

All recent Governments have discussed the need for a second wave of reforms to launch India onto a higher growth path that reduces poverty faster. However, as noted, reforms have slowed, creating some uncertainty among investors. Many excellent suggestions for reform are contained in such reports as the Hussain Committee on Small-scale Sector Reservation, the Rakesh Mohan Committee on Infrastructure, the Tenth Finance Commission on intergovernmental finances, the Fifth Pay Commission on downsizing the civil service, the Tarapore Committee on the capital account and its implications for the macroeconomic framework, the Narasimham Committees on the financial sector, the Disinvestment Commission reports, recent Economic Surveys, RBI Annual Reports, and the 1999 Export-Import Policy. In addition to these contributions, the comprehensive framework outlined above may provide some assistance. While a basic consensus on the need for the Second Wave of Reforms has emerged, for example in the programs of the two major political parties, it needs to be translated into substantive action.

Broadly speaking the reforms would be most effective to the extent they reduce the risk of macroeconomic instability, increase the access of the poor to human development, improve governance and reduce distortions and improve the demand for labor. Poorer states in particular will need to enact these reforms to overcome the initial lags and accelerate development.

Perhaps the most effective, cross-cutting reform would be cuts in the explicit and implicit subsidies together with privatization in power to raise the current low collections of user charges (that represents a major part of the implicit subsidies). Cutting the subsidies would cut the fiscal deficit and thereby reduce risks of macroeconomic instability and the crowding-out of private borrowers; it would free up public funds for social and infrastructure spending to help the poor and speed growth; it would encourage private sector interest in infrastructure; it would reduce distortions and environmental degradation; and it would probably improve equity (Box 5.2 and Chapter 8). In the petroleum sector, the link that was established between domestic and international prices with the September 1997 liberalization has been an important factor in cutting subsidies, and needs to be sustained. Another policy to reduce subsidies that could be enhanced further is the increasing use of cesses on fuels to fund road infrastructure. Obviously, state governments will play a major part in cutting power and irrigation subsidies. There have been welcome movements toward reform in some states, including some of the poorer states such as Andhra Pradesh, Haryana, Orissa and UP. However, state governments are not always prepared to embark on the reform path. In this context, increasing emphasis on states' performance in Central Government transfers, increasing the proportion that states borrow directly from markets, and without central guarantees (and reducing State borrowings from the Center), and limiting the states' ability to ease their hard budget constraint, such as reducing access to high cost small-savings and limiting guarantees, would provide important incentives for reform. A welcome development along these lines is the recent use of Memorandums of Understanding to encourage fiscal discipline between the Ministry of Finance and states that receive extraordinary financing to ease the impact of the recent hefty pay revision. And, issues of links between Center-State finance and state performance appropriately form part of the Eleventh Finance Commission's terms of reference.

Realigning Central and State Governments to focus on core public activities would have high social payoffs. Basic education and health and infrastructure need better and more public spending to reduce poverty and speed growth. Withdrawal of Government from non-core activities through faster privatization (not just sales of minority shares) in manufacturing and service sectors, e.g. airlines and hotels, and increased private sector participation in infrastructure, would permit a downsizing, upgrading and focusing of Government and the civil service on truly public sector activities. It would also increase the current low returns on capital invested in these areas and raise taxable revenues. It also is worth noting that the current lack of attention and investment in these sectors is reducing their salability. The improvements in the budgets from reduced explicit and implicit subsidies and higher taxes from the formerly public enterprises would permit much needed increases in spending on infrastructure and basic human development at the Center and state level. At the state-level, the states mentioned above are embarking on much needed realignments of Government in varying degrees and sectors.

Better and more spending on health and education. Faster poverty reduction cannot be accomplished without improving the delivery of health and education services. This will involve more effective spending on elementary education and basic health systems, with better targeting on improving the quality and quantity of services to the poor and with more public funding to address the unfinished agenda. The effectiveness of public education and health services in poverty reduction can be improved by focussing on meeting consumer needs and the holistic needs of children, realigning the role of the state toward primary education and health, and making efforts to encourage improvements in and better use of private education and health services.

Governance could be improved in a variety of ways. In the public sector, tax structure and collection, and expenditure management would benefit from improvement. Effective decentralization including improving of state and local institutional capacity and greater "voice", a more efficient sharing of the tax base across different levels of government, and closer links of costs, revenues and service delivery would improve governance, outcomes and inclusion of the poor (Chapter 4). This is particularly the case in primary health and education delivery that impacts heavily on the opportunities for the poor to escape poverty. In this regard, it is worth noting that India's decentralization to the third tier of rural and urban local bodies already has a firm legal basis in the 73rd and 74th Constitutional Amendments (1992). Effective decentralization and greater deregulation would help to reduce corruption, a mounting concern of Central and state governments, as would improving public administration and procedures, incentives and disincentives, and accountability (Chapter 6). The legal system would benefit from a reduction in delays and disincentives to frivolous litigation and appeals, which would make legal remedies more accessible to the poor and help reduce the non-performing assets that burden the financial system and drive up borrowing costs. The state governments also need to enforce property rights and law and order, to provide an attractive environment for investment.

Completion of the deregulation of goods and factor markets, notably through deregulation of agriculture, articulation of a time-bound tariff-reduction program, completion of the WTO commitments, and development of a less negotiated/more rules-based treatment of foreign direct investment, would stimulate poverty reduction through higher, more labor using growth. It would also help get India ready to take advantage of the pickup in the world economy and the increased competition, domestic and international that is developing. Further deregulation of labor markets and the small scale sector would increase the demand for labor (Chapter 6).

In the financial system, India needs to speed up judicial resolution of cases and debt recovery and improve the bankruptcy and liquidation procedures. Accounting and auditing and financial system regulation and supervision, though much improved since the 1980s, need to move much closer to the steadily improving best international practices, especially as the financial system becomes more privatized and links increase with the international economy (Chapter 7). The RBI also needs to deal more rapidly with weak banks and prevent their non-performing assets from increasing. Lending to the private sector needs to improve, which will depend on a reduced fiscal deficit (to reduce crowding out) and better incentives to lend and collect, including privatization of banks. The payments system lags improvements elsewhere in the financial sector and would benefit from some quick improvements. Finally, more transparency , such as making the massive Unit Trust of India's activities more transparent, reducing settlement times in the capital market, and improving accounting, auditing and corporate governance, as laid out in the draft Companies Bill, 1998, would help reduce vulnerability and improve the allocation of scarce capital. (Chapter 7).

Improved infrastructure provision, both public and private, would help accelerate growth. The currently inadequate provision of high quality, reliable, and reasonably priced infrastructure services represents a major barrier to continued growth of the economy and services to the poor, and to the diffusion of the benefits of liberalization. The development of infrastructure needs an effective delineation of responsibilities between the regulator and the policy-maker, and the creation of independent regulators within a broader restructuring of the sectors. In many sectors, privatization and greater reliance on competition could improve service delivery in many areas. Above all, infrastructure improvement will depend on the removal of the implicit and explicit subsidies and a move to remunerative user charges (Chapter 5).

Circumstances Propitious for Reforms and Acceleration of Growth

Events at the end of 1999 seem favorable to the initiation of the second wave of reforms. The Central Government that took office in October 1999 has already made progress by passing legislation to open up insurance (the Insurance Regulatory and Development Authority Bill), liberalizing foreign exchange regulation (the Foreign Exchange Management Bill), allowing trading in derivatives (the Securities Contract Regulation (Amendment) Bill), and protecting trade marks (the Trademarks Bill). The Government enjoys a more comfortable majority than the previous one which will permit it to move forward more easily on subsidy-cuts (as it demonstrated by implementing a 40% diesel price hike in October, in spite of pressures for rollback), government realignment, and reform. At the state-level, reforming governments received electoral support and non-reforming governments seem to have lost support. Some of the poorer and most indebted state governments - such as Uttar Pradesh - are embarking on a path of comprehensive reforms, similar to the economic restructuring launched by the Government of Andhra Pradesh (that was re-elected in October 1999). These reform efforts are aimed at (a) restructuring state-level expenditure and improving governance so as to maximize the outcomes achieved by public spending and private investments in the state; and (b) enhancing the revenue base through tax policy and administrative reforms and improved cost recovery from publicly provided non-merit goods and services. These developments suggest that the chances of real reform happening are much brighter than they have been in the past; if these do occur, then, as this Report suggests, growth could accelerate to the 7.5% and higher levels of the mid 1990s. India would then have a real opportunity to reduce poverty substantially in the new millennium.

Issues for Further Analysis

In several places in the Report, gaps in the knowledge base and in country experience have been identified as issues deserving further analysis and research. Work on these and related issues will be important to reducing poverty in India.

Some of the issues are fundamental and involve cross-cutting work in various areas, and often these are the most important issues. These include:
  • improving the delivery of social services to the poor;
  • the links between growth, poverty reduction, and governance, especially at the state-level;
  • the nature, causes and cures of urban poverty;

Other issues involve examination and comparison of policy options, based on experience within India and internationally. These include:

  • possible policy paths for deeper restructuring of government at all levels, to help "right-structure and, as necessary, right-size" the state in India;
  • decentralization experiences that will be most effective in improving the quality and effectiveness of the decentralization process in the Indian context (including studies of states' devolution of revenue and taxing powers to local governments to decentralize services);
  • possible paths to fiscal adjustment at the central and state level, taking into account the linkage between fiscal deficits, growth, and poverty reduction, and drawing on international experiences;
  • approaches to corporate restructuring, public and private, and the constraints imposed by the labor market, drawing on international experience;
  • possible paths to privatization of banks, while decreasing the vulnerability of the banking system through regulation and supervision that approaches best practices and improvements in accounting, auditing and corporate governance;
  • further ways to strengthen institutions and modalities for delivery and repayments of micro-credits and agricultural loans;
  • options before India in the next round of trade negotiations;
  • linkages between trade, growth, employment and education.

Finally, as noted in various places in the Report, a key issue for policy-making is Improvement in the quality and consistency of various statistics.

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