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INDIA

10%

Raising the growth bar

8%

6%

3%

January 2011


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India Raising the growth bar

A report by CRISIL Centre for Economic Research


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Analytical contacts

Dharmakirti Joshi

Sunil K. Sinha

Vidya Mahambare

Poonam Munjal

Parul Bhardwaj

Dipti Saletore

[email protected]

[email protected]

[email protected]

[email protected]

[email protected]

[email protected]

We would like to acknowledge the contribution ofKrishnan Sivaramakrishnan, Nishikant Gawade,

Rahul Srinivasan, Suresh Salunkhe and Dilip Chavan

who helped in preparing the report.


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Key Messages

India's growth prospects

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India's policy challenges

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CRISIL expects India's GDP to grow at 8.6 per cent in 2010-11, and at a sustained annual average rate

of 8.4 per cent over 2011-12 to 2015-16.

Domestic demand - spurred by a large, growing young population, rising middle-class household

consumption, and growing savings and investment rates - will support economic growth over the next

five years.

A likely increase in discretionary spending by India's middle-class households will boost demand for

durables such as automobiles and white goods, and services like hotels, restaurants and tourism.

Given reduced export opportunities to advanced economies, India will have to diversify its exports torapidly growing Asian markets and leverage more on domestic demand to support its growth.

Growing inflation, volatile capital inflows, and a fragile recovery in advanced economies that can

dampen exports, are immediate risks to India's growth prospects.

Can India attain and sustain 10 per cent GDP growth? To raise the growth bar, India will have to

remove supply-side constraints, the success of which will hinge on government initiatives of structural

reforms in infrastructure, agriculture and education, and enhanced private sector participation.

Provide adequate and good-quality physical infrastructure to sustain growth and reduce infrastructure

deficit.Create jobs and prepare the bulging youth population for these jobs.

Control inflation by improving the supply potential of agriculture, and thereby increase the effectiveness

of monetary policy.

Attract the right kind of capital inflows such as foreign direct investment which brings technology and

management expertise along with physical capital.

Build fiscal flexibility to enhance spending on physical infrastructure, health and education.

Promote public investment and land reforms for unlocking the potential of the agricultural sector.


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Contents

Demand drivers 6

Roadblocks to 10 per cent growth 28

Introduction 1

Growth enablers 22

Economic outlook 2

Expanding supply potential 14

Annexure - Developing Asia in the Global landscape 38


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Introduction

India has grown in stature over the past ten years. Its GDP growth accelerated steadily, after India

liberalised its economy in 1991, taking a decisive step towards open policies and relinquishing inward-

looking policies. The average annual GDP growth went up to 7.3 per cent in the 2000s from 5.7 per cent in

the 1990s. The near 9 per cent average annual growth over 2003-04 to 2007-08 was unprecedented, but it

has now become a benchmark for India to assess its performance. Growth-enhancing reforms, a structural

upward shift in savings and investment rates, and rising consumption power have together powered the rise

in India's growth.

Although its GDP growth dropped, due to the global financial crisis, to 6.7 per cent in 2008-09, India'seconomy emerged quite rapidly from the crisis. The economic recovery was aided by the inherent strength

of India's domestic demand that was complemented by Reserve Bank of India's monetary management

and the central government's fiscal stimulus measures. With its GDP likely to grow at 8.6 per cent in 2010-

11, India will be among the fastest growing economies.

The medium-term prospects for advanced economies, which were the epicenter of the crisis, have

weakened. Plagued by a fractured financial sector, the advanced economies are deleveraging, tightening

financial sector regulation and gradually shifting their focus away from consumption towards savings. These

developments are growth restricting. Prospectively, since there would be reduced opportunities for exports

to advanced economies, domestic demand becomes vital for supporting growth of developing economies.

The global crisis did not dent India's growth prospects the way it dented the prospects of the mature

economies. India, today, is well-positioned to sustain 8.0-8.5 per cent annual GDP growth over the next five

years. What will drive this growth? What can raise the growth bar to 10 per cent? These questions are

gaining more significance with a change in the global economic landscape, and consequently, a change in the

nature of economic growth drivers.

This report addresses these issues by systematically analysing the demand-side drivers of India's economy,

supply-related issues, growth enablers and constraints. The report begins with our outlook for Indian

economy in 2010-11 and our forecast for 2011-12. It also assesses the outlook for the Indian economy over

the next 5 years, i.e: 2011-12 to 2015-16. Chapter 1 examines the strength and likely role of domestic

demand (consumption and investment) and international trade in supporting growth in future. Constraint

on the supply potential of the economy can, however, limit India's ability to meet this growing demand.

This raises an important question - what policies does India need to adopt to strengthen the economy's

productive capacity? The issue is studied in Chapter 2. It reviews the evolving dynamics of agriculture,

industry and services sector and discusses some of the growth-enhancing structural reforms that could

potentially step up supply potential of these sectors. Chapter 3 analyses the growth-enablers, such as

favourable population demographics and high savings rate, which create the potential for India to grow at

double-digit rates. Finally, chapter 4 encapsulates the major risks that can hinder India's attempts to move

into the 10 per cent growth zone. This hinges on India's ability to establish good-quality physical

infrastructure and social infrastructure, enhance the education and skills of India's workforce, and improve

the potential of the agriculture sector.

1India: Raising the Growth Bar, January 2011


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Economic outlook

Outlook for 2010-11

CRISIL expects the Indian economy to grow by 8.6 per cent in 2010-11.

Two main domestic demand drivers, private consumption and investment, have

recovered from the slowdown during the global economic crisis.

WPI-based inflation is now expected to end the fiscal at 6.0 to 6.5 per cent.

Current account deficit as a percentage of GDP is expected to be higher (at 3.3 per

cent) in 2010-11 owing to higher trade deficit and lower invisibles surplus.

The Indian economy grew at a higher-than-expected 8.9 per cent in the first half of

2010-11, driven by strong growth in the services sector from the supply-side and

household consumption from the demand-side. Services grew at an accelerated rate

owing to increased government spending and a pick-up in trade, hotels, transport,

communication and related sub-sectors. Industrial growth, as measured by change in

index of industrial production was driven by robust private-consumption demand and

resurgence in investment demand. Industrial growth has however now become volatile

and is slowing in recent months - from an average 16 per cent growth in the fourth

quarter of 2009-10, industrial growth considerably slowed to 12 per cent in the first

quarter and 9 per cent in the second quarter of 2010-11. CRISIL expects the overall

decline in industrial growth to slow GDP growth to about 8.3 per cent in the second

half of 2010-11. Good monsoons during the year have benefited the agriculture sector.

With a support from a low base, this sector is likely to grow at about 5 per cent -

greater than its long-term average growth of 2.8 per cent over the last two decades.

In the first half of 2010-11, household consumption growth surged to almost 9 per

cent whereas investment growth crossed the double-digits to almost 15 per cent.

CRISIL expects growth in both these demand drivers to slow marginally in the second

half of 2010-11 in response to recent increases in bank lending rates. Government

consumption, another key domestic demand driver, has now been growing at a lesser

rate (of 9 per cent in first half of 2010-11 as compared to 22.4 per cent in the first

half of 2009-10) than during the global economic crisis as the government withdrew a

part of its stimulus.

Wholesale price index (WPI) inflation has come down to 7.5 per cent in November

from 11 per cent in April 2010. CRISIL expects increased farm output, a low base and

Reserve Bank of India's monetary tightening measures during the year to help bring

down inflation. Yet inflation could remain above RBI's expectation.

Although current account deficit, at present, is not a cause for concern, as India 's net

capital inflows are likely to exceed the current account deficit during the year, if thedeficit widens further it would increase India's dependence on external capital flows. A

wider current account deficit during this year has slowed rupee appreciation vis--vis

the US dollar, as the country used most of the capital inflows to fund the deficit.

2 CRISIL Centre for Economic Research


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Average for

2010-11 F 2011-12 F 2011-12 to 2015-16 F

GDP Growth (%) 8.6 8.3 8.4

Supply-side

Agriculture Growth (%) 5.0 2.7

8.2

3.0

Industry Growth (%) 8.6 8.5

Services Growth (%) 9.4 9.6 9.5

Demand-side

Private consumption % of GDP 60.1 59.5 58.5Gross domestic investment % of GDP 36.8 36.4 37.1

Government expenditure % of GDP 11.2 11.4 11.5

WPI Inflation % 8.0 -8.5 5.8 5.5

Gross domestic savings % of GDP 33.8 33.8 34.9

- Household % of GDP 22.8 22.9 22.6

- Corporate % of GDP 8.7 8.5 8.8

- Government

Note: The financial year refers to April to March, F: Forecast

Source: CRISIL estimate

% of GDP 2.3 2.4 3.5

Current account deficit/GDP % of GDP 3.3 2.6 2.2

Fiscal deficit % of GDP 5.0 5.5 4.6

Increased oil prices and a relatively slower economic recovery in advanced countries

that can reduce India's export and invisible earning, are the key risks to current account

deficit.

A partial roll-back of fiscal stimulus and sustained economic recovery are likely to

increase the government's tax revenue in 2010-11. The increased tax revenue and non-

tax revenue from spectrum sales would enable the government to reduce the fiscal

deficit to 5.0 per cent of GDP, even with higher than planned expenditure.

While rising cost of credit could slow industrial growth to 8.2 per cent, agriculture

growth, despite a normal monsoon, could decline due to a higher base. The servicesector, with a likely growth of 9.6 per cent, will remain the key driver of economic

growth in 2011-12. A further pick-up in trade, finance and communication, given a

resurgent economy, will drive the growth in services.

Revenue windfall would help restrict fiscal deficit to 5.0 per cent of GDP in 2010-11.

Outlook for 2011-12

With growth in industry and agriculture likely to slow, economic growth would step

down to 8.3 per cent



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With macroeconomic stability and improving consumer sentiment drivingconsumption and investment growth, demand-side pressures on inflation could

remain firm

CRISIL expects investment rate to stay strong around 36.4 per cent with continued

thrust on infrastructure

Fiscal deficit in 2011-12 is expected to be around 5.5 per cent of GDP.

The current account deficit to GDP in 2011-12 is expected around 2.6 per cent

Risks for 2011-12

Inflation-

Capital flows-

Currency-

We expect RBI's monetary policy to help keep demand-side pressures on inflation in

check. If monsoons are normal and oil prices stabilise at US$ 85-90 per barrel, average

WPI-based inflation would be 5.8 per cent in 2011-12. However, any supply shock

from commodity prices due to the quantitative easing by central banks in advanced

countries can trigger inflation. Owing to rising demand, manufacturing inflation,

excluding food articles, is increasing once again, and the risk of a further increase in

inflation remains.

Rising investments in infrastructure and certain consumer durable segments will drive

domestic investment in 2011-12. Domestic savings, which are expected to remain at

2010-11 level with increased corporate savings and a marginal deceleration in

government savings, will continue to fund a major proportion of domestic investment.

CRISIL expects the government's balance-sheet to deteriorate in 2011-12 as revenue

growth is likely to slow down relative to that in the current year. The one-off gains in

revenue in 2010-11, such as revenue from the 3-G spectrum auction, will be missing in

2011-12. To reduce fiscal deficit further, the government may step up disinvestment.

Rising inflow of invisibles - as advanced economies recover - and growing export

demand are likely to reduce current account deficit to 2.6 per cent of GDP in 2011-12.

l Inflation could rise beyond 5.8 per cent in 2011-12, if - i) global

commodity prices, especially oil prices, increase further with global economy

improving sooner than expected; ii) the Indian government, which has embarked

on fiscal restraint, passes on any unprecedented increase in global oil prices; or

iii) a truant monsoon leads to a sharp increase in food prices.

l Any slowdown in the economic recovery of advanced economies

could threaten a flight of capital from India. Since India's widening current

account deficit needs increased capital inflows, such a flight of capital could affect

India's economic recovery.

l Any unanticipated shocks to the global economic recovery could drive

capital outflows from India resulting in increased volatility in the Indian Rupee.



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Medium-term outlook

Risks to medium term outlook and barrier to 10 per cent growth

CRISIL expects the Indian economy to sustain an annual average growth rate of 8.4

per cent over 2011-12 to 2015-16, propelled by growth in the service and industrial

sectors. Economic growth in advanced countries, although below pre-crisis levels, will

support growth in sectors such as IT/ITeS whereas rising household spending in India

would benefit segments such as consumer durables and hotel and restaurants. A likely

increase in domestic demand and improvement in exports will support industrial

growth.

l Domestic demand - supported by a large and growing young population, middle-

class income dynamics, and rising savings and investment rates - will drive India's

economic growth. Investment rate is also likely to increase to around 37 per centof GDP over the forecast period. Increased consumer spending will help maintain

the share of private consumption in household income, thereby limiting the

increase in household savings rate.

l Owing to strong economic growth, demand-side pressures will tend to increase

inflation. CRISIL, however, expects timely actions from RBI, facilitating growth

and price stability, to keep average WPI-based inflation at 5.5 per cent over the

next five years.

l With its inflation rate in check and its economic growth robust, foreign inflows to

India are likely to rise during the period resulting in the appreciation of the

currency. Rising trade demand from advanced countries would push up exportand invisibles earnings of India's current account. CRISIL therefore expects

India's current account deficit to average at 2.2 per cent of GDP over the next

five years.

l With tax revenues increasing following the implementation of Goods and

Services Tax (GST), and the government refocusing on expenditure restraint,

CRISIL expects fiscal deficit to come down to 4.0 per cent of GDP by 2015-16

from 5.0 per cent in 2010-11.

l Inadequate physical infrastructure is regarded as a major risk to sustenance ofhigh growth in India. If the progress on infrastructure stumbles, even maintaining

8.4 per cent growth would be difficult.

l Skill shortage which accentuates with fast growth can also become a bottleneck

for sustaining growth.

l Unless fiscal reforms are carried out on the expenditure side, the government's

fiscal inflexibility to invest in physical and social (health and education)

infrastructure will only rise. This may not bite immediately but can become a

challenge to maintaining 8-10 per cent growth trajectory that India now aspires to

acheive.

'



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Demand driversKey points

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Private consumption expenditure, and within it

discretionary spending, is likely to rise since household

expenditure on necessities now accounts for less than

one-fourth of disposable income, and its share in

consumption could fall further. Private consumption

accounted for about 60 per cent of total demand in the

first six months of 2010-11. After a sharp decline

during the global economic crisis, consumption growth

has picked up strongly to reach the pre-crisis growth ofalmost 9 per cent and is leading economic revival.

India's economic growth, which had depended

predominantly on domestic consumption, became

more evenly dependent on consumption and

investment in the 2000s, as the rate of domestic

investment increased to almost 37 per cent in 2007-08

from a mere 24.5 per cent in 2000-01. To sustain 9 per

cent GDP growth, India needs to maintain investment

rate at the pre-crisis level of about 37 per cent.

External trade expanded rapidly in the past ten years.

India's merchandise and services exports grew from

US$ 60.9 billion in 2000-01 to US$ 272.5 billion in

2009-10, and imports too grew at a brisk pace.

Growing exports provided a stimulus to domestic

production whereas imports supported domestic

demand drivers by making available raw material,

technology, consumer goods and capital goods. In

future, India's challenge will be to increase its share in

world exports from a mere 1.2 per cent by expanding

into new, fast-growing markets.

Robust consumption and rising investment will

drive domestic demand over the next five

years.

Chapter 1


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ConsumptionPrivate consumption continues to be the largest demand driver of the Indian

economy

Government consumption rose during the economic slowdown to push up

domestic demand

After a sharp fall during the global economic crisis, private consumption growth

recovered to its pre-crisis rate by the second quarter of 2010-11. During 2005-06 to

2007-08, real private consumption growth stood at 9 per cent. During the global

financial crisis, however when consumer confidence diminished and lenders became

risk averse, private consumption growth fell to an average of 5.5 per cent in 2008-09

and 2009-10. By the second quarter of 2010-11, private consumption growth

recovered to 9 per cent. At present, private consumption accounts for nearly 60 per

cent of overall demand in the economy (Figure 1).

The growth in private consumption since 2005-06 was fuelled by an increase in funds

available with households for discretionary spending. Over time, as households'

incomes increased, consumption expenditure on necessities, as a share of disposable

income has come down sharply relative to total consumption (Figure 2). As a result,

the proportion of discretionary expenditure in disposable income has risen from 34.6

per cent in 2001-02 to 43.5 per cent in 2008-09.

Real government consumption grew at an average of 13 per cent in 2008-09 and

2009-10, from an average of 5.6 per cent over 2004-05 to 2007-08, the period of

India's economic upturn. During the global crisis which began in late 2007, India's

government, following a traditional practice with governments worldwide, increased

its expenditure to support domestic demand.

Despite the increase in government expenditure, the pattern and direction of the

spending is a cause of concern from a longer term perspective. Most of the fiscal

stimulus, as reflected in the Indian government's expenditure, was directed at reviving


Source: Central Statistical Organisation Source: Central Statistical Organisation

Figure 1: Share of private consumption in GDP is dominant Figure 2: Share of necessities in disposable income has been falling

Private consumption

Gross capital formation

Necessities

Total Private Consumption

0

20

40

60

80

100

1972-73 1981-82 1990-91 1999-00 2008-09

%

30

50

70

90

110

1972-73 1981-82 1990-91 1999-00 2008-09

%

The global economic crisis disrupts India's

growth, but only temporarily

2000-01

% y-o-y

2005-06 2010-11F


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Source: Central Statistical Organisation

Figure 3: Private sector investment is rapidly expanding

Household

Private corporate

Public

% of GDP

0

10

20

30

40

1972-73 1981-82 1990-91 1999-00 2008-09

private consumption expenditure rather than on increasing corporate or publicinvestment in sectors such as infrastructure and education. A decline in development

expenditure, which has fallen to 1.4 per cent of GDP in the 2000s from 2.1 per cent in

the previous decade, is another concern about government expenditure.

Real private consumption will grow strongly and remain the largest demand driver in

India's economy. An increase in discretionary income is likely to boost household

spending on goods like consumer durables and automobiles, and services such ashotels and restaurants over 2010-11 to 2015-16.

The government would have to increase its development expenditure, especially in

education, healthcare and infrastructure, and encourage private sector participation to

boost the long-term growth prospects of the economy.

India's investment rate climbed sharply from around 26 per cent in 2003-04 to its peak

of 37.6 per cent of GDP in 2007-08, accelerating GDP growth to about 9 per cent

during the same period.

Private corporate investment rose rapidly in recent years . In 2007-08, it was

2.4 times the investment rate in 2003-04. The corporate sector's investment rose due

to two main reasons; i) the process of economic liberalisation, with reforms of

industrial policy and external sector, made the business environment conducive for

Outlook

Private consumption will remain the largest demand driver of the Indian economy

over the next five years, although its share in GDP will decline marginally.

The government would have to focus its expenditure on health, education and

infrastructure

Investment

A sharp increase in private corporate investment led to a structural shift in

investment rate

(Figure 3)


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investment; and ii) rising household demand, particularly on consumer durables,

accelerated private corporate investment (see section on domestic consumption for

further details).

The liberalisation process created a favourable environment for firms to increase their

manufacturing capacity by increasing the availability and reducing the cost of capital.

The initial focus of liberalisation was to lift internal controls to enable the private

sector to expand and improve its efficiency. Coinciding with the development and

expansion of the equity market, this supported the corporate sector's rising retained

earnings and increased domestic bank credit for financing corporate investment.

In the next stage, the focus was on partially removing restrictions on the external

sector, to allow Indian firms to import technology and capital inputs at a decreased

cost, and tap foreign financial markets for funding - by way of external commercial

borrowings and equity funding from overseas capital markets. The private corporate

sector's sources of funding therefore diversified. During 2007-08, internal sources of

funds (retained earnings) met almost 50 per cent, and borrowings 21 per cent, of the

total funding requirement of non-financial private sector companies.

Even as funding availability increased, the efficiency of investment, an equallyimportant input for economic growth, improved. India's average incremental capital

output ratio (ICOR), which was 4.1 during the 1990s, fell to 3.6 between 2004 and

2008, as per an RBI report. In contrast, China's investment, with its ICOR rising from

3.5 in the 1990s to 4.1 in the 2000s, became less efficient.

A cause of concern, however, is that India's investment is highly skewed towards

industrial and services sectors, with agriculture investment remaining stagnant (see

agriculture section).

India's investment efficiency also improved

Investment flows mainly to industries and services, agricultural investment remains

stagnant (Figure 4)


Figure 4: Sectoral investment is skewed towards industry and services

Services

Industry

Agriculture0

4

8

12

16

20

1999-00 2002-03 2005-06 2008-09

Rs million

Private

consumptionInvestment

Govt

Consumption

12.3

33.7

57.3

% in GDP

2009-10

Private consumption is the largest demand

driver, but investment rises rapidly


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Public investment remains low, limiting the scale of overall investment

Outlook

The significance of investments in economic growth will increase if public

investment rises

External trade

India's external trade has increased strongly over the past 10 years

As a share of gross fixed capital formation of central government, budgetary allocation

for physical infrastructure has fallen to 56 per cent as per 2010-11 budget estimates,

from 72.6 per cent in 2003-04, while allocation for investment in agriculture remains

dismally low at 2 per cent in 2010-11. Similarly, public sector allocation on social

services such as health care, education, urban development etc. is again low at 6 per

cent.

Investment will remain a key driver of economic growth over the next five years. If

India has to sustain GDP growth at 8.4 per cent, the investment rate will have to

increase to the pre-crisis level of 37 per cent. The cause for concern would continue to

be inadequate public investment in agriculture and services such as education,

healthcare and infrastructure. If the government steps up investment in these critical

areas, investments will become an even more significant driver of economic growth.

While the share of private corporate investment had fallen to 13 per cent of GDP in

2008-09 from 16 per cent in 2007-08, given the current momentum it is expected to

pick up and maintain its level in 2007-08 over 2010-11 to 2015-16.

India's exports more than quadrupled over 2000-01 to 2009-10, driven by sharp growth

in services exports. And, driven by rising domestic demand, India's imports

(merchandise and services) increased in the same period by over five times to US$

346.4 billion in 2009-10 (Figure 5).

Total exports of goods and services rose from US$ 60.9 billion in 2000-01 to US$


Source: Reserve Bank of India

Figure 5: A surge in India's external trade

Merchandise Services

2001

-02

2001

-02

2003-04

2003-04

2005-06

2005-06

2007-08

2007-08

2009-10

2009-10

0

50

100

150

200

250

300

350

ImportsExports

US$ billion


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272.5 billion by 2009-10. India's share of global exports therefore increased from 0.8per cent in 2003 to 1.2 per cent in 2009, as per World Trade Organization's estimates.

Growing at a compounded annual rate of 25.5 per cent, services exports crossed US$

100 billion in 2008-09, rising from a modest US$ 16.3 billion in 2000-01. And, exports

of manufactured goods more than tripled to US$ 115.3 billion in 2009-10 from US$

34.3 billion in 2000-01.

A conscious shift away from import substitution policies and an emphasis on

increasing exports, characterised India's external trade policy since 1991. And, that has

been a key driver of India's trade growth in the 2000s. Reduced customs duties and

simplified imports procedure allowed corporate India, particularly the manufacturingsector, to gain easy access to global technology and raw materials, at a competitive

price.

As imports picked up in 1990s, it became imperative to increase the country's exports

to keep trade deficit under control. The industrial deregulation and reforms that began

in 1991 subjected Indian industry to increased competition and raised their

productivity. As a result, when global growth picked up in the decade of 2000, some

segments of Indian industry were well positioned to capitalise on emerging export

opportunity. Export participation raised productivity of these industries further due to

technology transfer and continuous innovation. Also, exporting helped boostemployment. India's IT/ITeS sector is a prime example. The export-oriented IT/ITeS

sector is one of the largest employment generators in India's organized sector. As per

CRISIL Research, employment in this sector increased from 180 thousand in 2002-03

to nearly 830 thousand in 2009-10.

Even while India remains largely a domestic demand driven economy, India's exports

to GDP ratio increased to 21 per cent in 2009-10 from 13 per cent in 2000-2001.

India's rising exports gave a stimulus to domestic production whereas its growing

imports supported domestic production by supplying necessary raw materials,

technology, and consumer and capital goods.



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Source: Directorate General of Commercial Intelligence and Statistics

Figure 7: Top 10 partners in India's commodity imports

Source: Directorate General of Commercial Intelligence and Statistics

Figure 6: India's diversifying export basket

%


India's diversified export products

India's imports from China and Middle-East rise

Among India's exports of manufactured goods, exports of engineering goods have

grown most rapidly, followed by exports of machinery and instruments, and transport

equipment (Figure 6). The share of engineering products increased from 14 per cent

in 2000-01, to 21.5 per cent in 2009-10, contributing more than one-fifth of India's

total merchandise exports. During the recent years, petroleum and crude products

have emerged as important export items

India's top six imported items are petroleum and crude products, gems and jewellery,

non-electrical machinery, coke coal and briquettes, iron and steel and organic

chemicals. The share of these items in India's total imports increased from more than65 per cent in 2000 to 72 per cent in 2009. The share of crude and petroleum

products in total imports grew at a steady 30 per cent from US$ 15.7 billion in 2000-

01 to US$ 86.8 billion in 2009-10, driven mainly by a 115 per cent jump in crude oil

prices. Among non-oil items, imports of capital goods (including electronic goods and

non-electrical machinery goods) grew at 22.6 per cent over the period.

Adoption of regional and bilateral free trade agreements helped India diversify its

export destinations and products. After signing the trade pacts, India's trade with

SAARC countries, Singapore, China and Brazil increased significantly. Despite themarket diversification, UAE and USA - India's top two export destinations - still

accounted for about 25 per cent of India's total merchandise exports in 2009-10. With

a share of 6.5 per cent in 2009-10, China emerged as India's third largest exports

destination, with India's exports to the country rising from US$ 674 million in 2000-

01 to US$ 11.5 billion in 2009-10 (Figure 7).

China has also emerged as India's largest import partner, with its share in total imports

rising from 3 per cent in 2000-01 to 10.7 per cent in 2009-10. Electronics and non-

electrical machinery goods are the main items imported from China. Interestingly, two

0

5

10

15

20

25

Engineering

goods

Gems &

jewellery

Petroleum

products

Agriculture

& allied

products

Chemicals

& allied

products

Textile

& textile

products

Ores &

minerals

Leather &manufactures

2000-01 2009-10%

0

2

4

6

8

10

12

China UAE Saudi

Arabia

US Switzerland Australia Iran Germany Indonesia South

Korea

2000-01 2009-10


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middle-east economies - UAE and Saudi Arabia - are now among India's top threeimport partners. UAE's share in India's total imports increased from 1.3 per cent in

2000-01 to 6.8 per cent in 2009-10. India mainly imports oil, oil products, gold, pearls

and precious stones from UAE. USA's share in India's total imports remained stable at

6.5 per cent over the period.

CRISIL expects India to achieve its export target in the current year. Although sluggish

recovery in the US and European economies may not allow exports to pick up in the

current year to the extent that it grew before the global financial crisis, India is likely tomitigate the shortfall by focusing on fast-recovering developing economies in Asia.

After declining by 3.6 per cent in 2009-10, India's exports have been growing at more

than 10 per cent since the start of 2010-11. Thus, despite sluggish global recovery,

India's exports will rise to US$ 200 billion in 2010-11.

However, to achieve its Foreign Trade Policy target of 25 per cent annual exports

growth over 2009 to 2014, India would need to remove infrastructure constraints such

as inferior power services and low turnaround time of cargo in ports, simplify complex

administrative processes, and minimise delays in clearing imported inputs necessary for

exports that substantially push up transaction cost for exports.

Although external trade has been a relatively less important contributor to India 's

economic growth, India will need to increase its share of 1.2 per cent in world exports,

by focusing on the rapidly growing markets of China and South-East Asia.

Although imports will outpace exports, a healthy surplus in the capital account will

enable India to address its widening trade deficit. As domestic demand growth is likely

to be robust over 2011-12 to 2015-16, India's imports of crude oil and petroleum

products and technology, which are critical inputs to industry, and imports of

consumer goods will continue to rise strongly. Since growth in merchandise imports

would outpace exports growth, CRISIL expects India's trade deficit to widen over the

next five years.

Outlook

Only reforms can take India's manufactured goods' exports closer to their potential

Imports will continue to outpace exports, but widening trade deficit may not be a

concern



20/48

Key points

l

l

l

Agricultural growth will remain volatile in future, with

an excessive dependence on the monsoons. During the

past decade, various structural factors - decline in

public expenditure on capital formation, and research

and extension; and a rising share of economically

unviable land holdings - adversely affected agricultural

productivity. As a result, agricultural growth became

more volatile in the 2000s than in the 1990s. The per

capita availability of food grain has therefore reduced,exerting pressure on food prices.

Industry will be a key driver of India's GDP growth

over 2011-2012 to 2015-2016. With appropriate policy

support and investment in technology, certain sectors -

notably automobiles, chemical and chemical products

and basic metals - have grown rapidly during economic

upturn. To realise the true potential of industrial

growth however, the government would have to

upgrade infrastructure, and introduce reforms that

speed up business operations and reduce transaction

cost.

Given its 55 per cent share in overall GDP and its

resilience during the economic crisis, services will

remain the most significant contributor to GDP

growth. Over 2000-01 to 2009-10, services grew at an

average of 8.9 per cent whereas GDP grew at an

average of 7.2 per cent. Growth in services, which can

be sustained mainly by the availability of trained and

skilled manpower, will hinge on the quality of highereducation.

Services and industry will remain the key

drivers of economic growth but agriculture will

have to ensure adequate food supply to keep

inflation rates manageable.

Chapter 2

Expanding supply

potential


21/48

Volatile agriculture growth still depends on

monsoons

1980-81 1993-94 2010-11F


Figure 8: Agriculture growth is more volatile

Agriculture

GDP

-12

-8

-4

0

4

8

12

1990-91 1994-95 1998-99 2002-03 2006-07 H12010-11

y-o-y%

AgricultureA falling share of GDP does not undermine the importance of the agriculture

sector

A combination of structural factors have adversely affected agricultural growth

The average growth of agriculture has dropped from 3.2 per cent in the 1990s to 2.5

per cent in the current decade. Agricultural growth, unlike GDP growth, has also been

increasingly volatile in the current decade, than in the previous decade (Figure 8).

After a good run from 2005-06 to 2007-08, when the average growth was 4.6 per cent,

agricultural growth fell to 1.6 per cent in 2008-09, and was near zero in 2009-10.

CRISIL now expects agriculture growth to rise sharply to 5.0 per cent in 2010-11 on

account of low base and good monsoons. While the coefficient of variation for

annual GDP growth has remained at 0.3 in the current and the previous decades, foragricultural growth it has increased from 1.2 in the previous decade to 2 in the current

decade.

The share of agriculture in GDP therefore declined from nearly 19.0 per cent in 2005-

06 to about 15 per cent in 2009-10. Despite the decline in its share in GDP, agriculture

remains an important sector of the Indian economy. Agriculture contributed 9.9 per

cent of total exports, and employed 45.5 per cent of India's workforce in 2009-10.

Although erratic monsoons have been a direct factor in the sharp decline inagricultural growth, a combination of three structural factors have shackled India's

agriculture sector;

i) stagnant capital formation

ii) fragmentation of land holding

iii) decline in public expenditure on agricultural research and extension services


Figure 9: Low capital formation in agriculture is affecting output

Private

Public

Rs million

0

2000

4000

6000

8000

1980-81 1989-90 1998-99 2007-08



22/48

Source: 'Some aspects of operational land holdings in India 2002-03',

National Sample Survey Report no. 492

Figure 10: Shrinking farm size affects agriculture

Marginal and Small (2)

0

20

40

60

80

100

1960-61 1970-71 1981-82 1991-92 2002-03

% share

This has increased the dependence of agriculture on monsoons and shrouded itsgrowth potential in uncertainty.

Aggregate capital formation in agriculture, after stagnating in the 1980s and the 1990s,

revived towards the end of 1990s (Figure 9). Public capital formation declined through

the 1980s and the 1990s, and started rising only after 2003-04. Private capital

formation, which collapsed with the onset of the economic reforms in 1991, revived

since the second half of the nineties, more sharply since 1998-99.

Capital formation in public and private sectors are not substitutes and therefore theycontribute differently to the production process. Public investment, unlike private

investment, is in the nature of a public good, e.g. creating roads, embankments,

irrigation networks etc. Therefore, the impact of the depressed state of public capital

formation is quite unlikely to be fully offset by the rising private investment. Moreover,

as the public investment has a longer gestation period its impact gets realized with a

considerable lag. In other words, the way the decline in public capital formation of

eighties and nineties has adversely impacted the agricultural output in the current

decade, the rise in public capital formation of the current decade is likely to impact the

agricultural output positively in the coming decades.

The farm size in India is continuously shrinking. The share of marginal and small farm

holdings of less than two hectares rose from nearly 62 per cent in 1960-61 to 86 per

cent to 2002-03 (Figure 10). A significant increase in the share of land holdings in the

smallest size category, and a clear decline in the share of holdings in all other sizes is

likely to adversely affect India's agricultural output.

With little scope to increase area under cultivation, agricultural growth then needs to

be driven by productivity increases. Uneconomic size of land holdings makes it

i) Stagnant capital formation

ii) Fragmentation of land holding

Source: Pulapre, Golait and Kumar (2008), Agricultural Growth in India since 1991,

Reserve Bank of India

Figure 11: Slow growth in public expenditure on research & development

y-o-y%

-2

0

2

4

6

8

10

12

6.5

10.79.5

6.37.0

-0.1

4.8

2.0

1960s 1970s 1980s 1990-2005

Research & Education Extension & Training



23/48


Figure 12: Robust industrial growth provides resilience to GDP growth

Industry GDP

Overall GDP

0

2

4

6

8

10

12

1970s 2000-01 2003-04 2006-07 2009-10

y-o-y%

difficult for a majority of Indian farmers to get bank credit for funding newtechnology or investing on more capital-intensive land improvement programmes that

are vital to restore farm productivity.

Growth in real public expenditure on agricultural research and extension services

slowed since 1990. Growth of expenditure in extension and training services was the

highest in the 1960s, the last time when agricultural decadel growth rate accelerated

(Figure 11).

In future, sustained agricultural growth will hinge on the government's ability to push

land holding reforms and increase public investment in key agricultural inputs such as

irrigation. Until then, agricultural growth will remain predominantly dependent on

monsoons. CRISIL expects average agriculture growth at 3.0 per cent over 2010-11 to

2015-16, if monsoons remain normal during the period.

The liberalisation process initiated in the industrial and trade regime since 1991 led to

impressive industrial growth in the 2000s (Figure 12). Industrial growth, which

exceeded 10 per cent between 2004-05 and 2007-08, nose-dived to 3.9 per cent in

2008-09 with the onset of the global financial crisis, before staging a dramatic

recovery at 8.2 per cent in 2009-10. In the first half of 2010-11, average industrial

growth was estimated at 10.1 per cent; CRISIL expects the average growth for 2010-

11 at 8.6 per cent. The resilience of the industrial sector after the global financial crisis

iii) Decline in public expenditure on agricultural research and extension services

OutlookSustained investment and reforms would be critical for unlocking the potential of

agriculture

Industry

Despite its rapid growth, the potential growth of industry has not increased

significantly



24/48

of 2008 is a reflection of its growing innate strength, shaped by the economic reformsinitiated in India since 1991.

Despite the rapid industrial growth, the share of industry in overall GDP has remained

fairly unchanged for decades. From an average of 22.6 per cent in 1970s, its share rose

to 26.4 per cent during the 1990s, and crept to 28.6 per cent in 2009-10. The current

share of industry in India's GDP does not reflect its potential, especially when

compared with the transformational industrial growth in other Asian countries (Figure

13).

Yet, the remarkable growth in certain sectors of industry, notably automobiles,chemical and chemical products and basic metals, suggest that the true potential of

industrial growth can be unlocked by increasing the scale of operations and investment

in technology. These sectors, which successfully leveraged India's competitive

advantage in labour cost, integrated themselves with global production chains and

realised rapid export growth.

The share of industry in total workforce rose from 15.4 per cent in 1993-94 to only

18.8 per cent in 2004-05, according to NSSO's (National Sample Survey Organisation)series of large sample surveys, largely as a result of strict labour laws. This is a cause of

concern since India, over the next decade, has to create gainful employment

opportunities for a large section of its population that has varying degrees of skill and

qualification. And, the industrial sector would have to be the backbone of this

employment creation initiative. For a country with the largest young population in the

world, this is a challenge of a significant order.

Industry has not been able to generate adequate employment opportunities to a

larger section of the population

Source: 'World Development Indicators', World Bank

Figure 13: Share of industry in India's economy remains low

0

10

20

30

40

50

60

1970s 1980s 1990s2000s 1970s 1980s1990s 2000s 1970s 1980s 1990s 2000s1970s 1980s 1990s2000s 1970s 1980s1990s 2000s

Malaysia China Thailand South Korea India

% of GDP



25/48

Source: Annual Survey of Industries and CRISIL estimates

Figure 14: Polluting industries have increased in output value terms...

More polluting industries Somewhat polluting industries Less polluting indsutries

0.0 20.0 40.0 60.0 80.0 100.0

1990-91

2001-02

2007-08

Source: Annual Survey of Industries and CRISIL estimates

Figure 15: ...and in terms of number of workers employed

More polluting industries Somewhat polluting industries Less polluting indsutries

0.0 20.0 40.0 60.0 80.0 100.0

1990-91

2001-02

2007-08

OutlookIndustrial growth could be sustained at about 8.5 per cent over the next five

years, but improved infrastructure and structural reforms would be key to

accelerate growth

India's industrial growth has come at the price of environmental degradation

Given a regime of liberalised trade, deregulated interest rate, and the increasing

competitiveness of domestic producers, CRISIL expects industrial growth to be

about 8.5 per cent over 2011-12 to 2015-16. However, the outlook for growth will

largely depend on the government's ability to remove infrastructure constraints,

labour market rigidities and entry and exit barriers for business, and relax land

acquisition norms.

If liberalised industrial policies in developing countries are not safeguarded by

stringent environmental policies, pollution-intensive industries would tend to flourish

in those countries. Has this been the case in India?

Data from the Annual Survey of Industries analysed using United Nations Industrial

Development Organisation's classification, shows that the share of highly polluting

industries in manufacturing increased substantially during the post-reform period,

since 1991. This holds true irrespective of whether industrial expansion is measured

in value of output (Figure 14) or gross value added or by the number of workersemployed (Figure 15). For instance, the share of highly polluting industries in value

of output increased from 36.9 per cent in 1990-91 to 49.2 per cent in 2007-08. Their

share in gross value added rose from 34.3 per cent to 48.1 per cent, and in number of

workers, from 20.4 per cent to 28.8 per cent, during the period.

Although less polluting industries show a similar pattern, but due to their meager

share in total manufacturing, an increase in their share does not hold as much

significance from the standpoint of industrial pollution as that of more polluting

industries.


Industrial growth was high in phases

1980-81 1993-94 2010-11F


26/48


Figure 16: Services grow faster than the economy

Services

GDP

0

2

4

6

8

10

12

1970s 2001-02 2005-06 2009-10

y-o-y%

While it may be difficult to say whether industrial policy pursued since 1991 had a biasin favour of more polluting industry or not, the structural shift in the relative share of

the type of industry in the total manufacturing indicates that clearly the more polluting

industries have expanded much faster than somewhat polluting industries between

1990-91 and 2007-08. Apparently, due to weak environmental policies, the more

pollution intensive industries generally flourish in developing countries taking

advantage of the liberalised industrial regime.

Growth of the services sector in India has not only been impressive but has also been

more resilient and shockproof than in industry and agriculture. Services grew at 8.9 per

cent on an average as against the average GDP growth of 7.2 per cent during the

2000s (Figure 16). After the global crisis erupted in September 2008, services growth in

India, unlike industrial growth, did not nosedive. Although it slowed from an average

of 10.4 per cent between 2005-06 and 2008-09 to 8.5 per cent in 2009-10, services

growth remained strong enough to be the key driver of India's GDP growth.

Owing to its rapid growth, the share of services in India's GDP grew from 38.4 per

cent in the 1970s to 45.9 per cent in the 1990s, and further to 56.9 per cent in 2009-10.

The share of the services sector in GDP is thus comparable to that of developed

upper-middle income countries.

The growth of the services sector, similar to industrial growth, benefited from the

economic reforms initiated since 1991. In addition, technological breakthroughs in IT

(information technology) and telecommunications, and availability of low-cost,

educated 'knowledge workers' made India an attractive destination for business

process outsourcing (BPO) and software services exports. (In simple terms, knowledge

workers are those who work in high-technology industries such as information and

Services

Over the past decade, the resilient services sector has emerged as the most

significant contributor to India's economic growth



27/48

communication technologies. CRISIL defines knowledge workers as those whoharness and use existing and new knowledge to improve productivity in an economy.)

The increase in share of services in India's total employment is however not

noteworthy - it has risen from 22.4 per cent in 1993-94 to only 25.1 per cent in 2004-

05. And, given that the jobs created in the sector are, by nature, mostly white collar

jobs, the services sector is unlikely to solve India's unemployment problem.

A steady supply of skilled manpower is crucial for sustaining the rapid run-rate of

services. Although India's large and educated labour pool has been the most

prominent growth driver for the services sector, it constitutes only a small proportion

of India's total workforce. In 2007-08 only 8.7 per cent of Indian workforce was

educated up to the graduate level. Further, the quality of India's educated workforce

remains below par. For example, CRISIL Research's study on India's education

services industry, August 2010, points out, that although engineer turnout from India's

institutes will almost double over 2011 to 2015 - from 0.37 million to 0.65 million

engineers, their employability will diminish further. India therefore does not have a

stable supply chain of knowledge workers who can sustain the rising growth in

services.

As the services sector contributed almost 57 per cent to India's total GDP in 2009-10,

overall GDP growth over the next five years will critically depend on the growth in

this segment. Although the services sector growth has yet to return to the pre-crisis

level of above 10 per cent, it is recovering fast and expected to be 9.4 per cent in

2010-11, nearly 1 per cent higher than in 2009-10. CRISIL expects average growth in

services at 9.5 per cent between 2011-12 to 2015-16.

To sustain the growth in services, much will depend on how effectively India reforms

its higher education system to bridge the supply gap of knowledge workers. For

instance, India would have to introduce structural reforms to improve the quality of

higher education, with an emphasis on learning and skill development.

Knowledge-based services face a shortage of skilled manpower that is crucial to its

growth

Outlook

As India's GDP growth will hinge on growth in services, much will depend on how

effectively India reforms higher education to bridge the supply gap of skilled

manpower


Structural break in services growth in the

early 2000s

1980-81 1993-94 2010-11F


28/48

Growth enablersKey points

l

l

l

Domestic savings will continue to fund a major

proportion of domestic investment. Domestic savings

rose from 23.7 per cent of GDP in 2000-01 to 36.4 per

cent in 2007-08. However, given a likely stagnation in

net household savings owing to rising consumption

expenditure, and a decline in public savings relative to

the pre-crisis level, the gap between the required

domestic investment rate and domestic savings is likely

to widen.

India will have to depend more on foreign savings,

preferably foreign direct investment, to bridge the gap

between domestic savings and the required investment

rate. The benefits of foreign direct investment would

go beyond providing funds, to improving efficiency

through technology transfer, giving Indian industry

exposure to better management practices, and enabling

Indian companies to gain entry to export markets.

A likely rapid increase in India's working-age

population has set the stage for increasing India's

labour force, another critical factor, apart from

investment, for improving the productivity of the

economy. India's working-age population (15-59 years)

is likely to swell from 1.21 billion in 2010 to 1.48 in

billion in 2030. If this large pool of people is educated

and its skills are developed, India could reap the

benefits of its demographic dividend.

Domestic savings and foreign direct investment

will support India's physical investment,

whereas its potentially large workforce could

provide the human capital for improving the

productivity of its economy.

Chapter 3


29/48



Figure 17: Household savings dominate domestic savings

Household

Private

Public

% of GDP

0

10

20

30

40

1970-71 1979-80 1988-89 1997-98 2006-07

Domestic savingsHistorically, domestic savings almost entirely funded India's domestic investment

Household savings as a ratio of household income stabilised, after rising rapidly

since the mid-1990s

Until 2008-09, investment in India was almost entirely financed by domestic savings.

India's domestic savings rate accelerated to 36.4 per cent in 2007-08 from 21.9 per

cent in 1993-94. During the first phase of its growth, from 1993-94 to 2003-04,

domestic savings were driven by sharply rising household savings fuelled by an

increase in household incomes . And, in the second phase, over 2003-04 to

2007-08, the period of India's remarkable economic upturn, the growth in domestic

savings was sustained by rapidly growing corporate and public savings, until the global

financial crisis affected India in 2008-09. Despite the increase in corporate and public

savings, household savings accounted for 68 per cent of India's domestic savings, withprivate corporate and public savings contributing 23 per cent and 9 per cent

respectively in 2008-09.

India's domestic savings rate fell during the global financial crisis, from 36.4 per cent

in 2007-08 to 32.5 per cent in 2008-09, largely due to a sharp decline in public savings.

Household sector savings jumped sharply from 17.3 per cent of GDP in 1993-94 to

24.1 per cent in 2003-04. The ratio of household savings to GDP stabilised after2003-04 due to relatively fast incremental consumption growth. Greater

macroeconomic stability and rising asset values increased household wealth whereas

easy availability and lower cost of and greater availability of retail credit pushed up

consumption growth after 2003-04, clipping the household savings rate. In the midst

of the crisis, households maintained their savings to GDP ratio of 22.6 per cent in

2008-09, as in the previous year.

(Figure 17)


30/48


Corporate savings rate, which rose sharply over 2003-04 to 2008-09, remainedsteady

Public savings, which had increased as an outcome of the government's fiscal

consolidation measures, fell sharply during the global financial crisis

With contribution from domestic savings slowing, increasingly foreign savings are

financing India's domestic investment

Outlook

To restore domestic savings to the pre-crisis rate of about 36 per cent of GDP, India

will need to significantly increase its public savings rate

As the economic upturn over 2003-04 to 2007-08 significantly shored up the retained

earnings of the private corporate sector, private corporate savings rate rose from 4.6

per cent in 2003-04 to 8.7 per cent in 2007-08. During 2008-09, when India 's domestic

savings rate dropped sharply, private corporate sector savings decreased only

marginally, by 0.3 per cent due to a sharper fall in input costs/expenditure relative to a

drop in sales.

Public savings increased sharply from -2.0 per cent of GDP in 2001-02 to 5.0 per cent

in 2007-08, as an outcome of the government's fiscal consolidation measures. During

the global financial crisis, when India's overall domestic savings rate dropped, public

savings too fell from 5.0 per cent of GDP in 2007-08 to 1.3 per cent of GDP in 2008-

09.

During India's high-growth phase from 2003-04 to 2007-08, foreign savings financed

less than 1 per cent of domestic investment, although foreign capital inflow remained

substantially higher than the funding requirement of domestic investment. Foreign

savings of a country broadly comprise net foreign capital inflows such as foreign direct

investment, external commercial borrowings and short term credit, among others. As a

result of relatively small gap between domestic investment and domestic savings, the

Reserve Bank of India was actively absorbing excess foreign savings up to 2007-08.

However, in 2008-09, as domestic savings, especially public savings, dropped, foreign

savings financed 6.8 per cent of domestic investment.

If India has to restore domestic savings to the pre-crisis rate of about 36 per cent of

GDP, government savings rate would have to climb to 3 per cent of GDP by 2014-15.

If the government fails to reverse the declining public savings rate, public investment

in sectors such as infrastructure, agriculture, health and education would be adversely

affected.

Corporate and public savings drive rising

domestic savings

1980-81 1993-94 2010-11F


31/48

Source: International Monetary Fund

Figure 18: FDI remains resilient

0

10

20

30

40

50

US$ billion

1995-2005 2006 2007 2008 2009

Inward FDI

Outward FDI


India will have to depend more on foreign savings to bridge the gap betweendomestic savings and the required investment rate

Foreign direct investment

FDI inflows in India have grown rapidly, doubling over three years

In 2010-11, foreign savings are expected to play a crucial role in funding the projected

domestic investment. The requirement of foreign savings, to bridge the gap between

domestic savings and the required investment rate, would be substantially higher over

2011-12 to 2015-16 than in the previous five years, given that household and

corporate savings rates are unlikely to rise sharply and government savings rate is

likely to remain lower than the pre-crisis level during the period.

Between 2006 and 2008, FDI inflows in India doubled from US$ 20 billion to US$ 40

billion (Figure 18). Unlike FII (foreign institutional investment) inflows which have

been volatile - rising sharply from US$ 24 billion in 2006 to nearly US$ 51 billion in

2007 before falling to US$ 18 billion in 2008 and again rising to nearly US$ 48 billion

in 2009, FDI inflows were fairly resilient.

For a developing country like India, FDI is considered as the most preferred route

among sources of foreign capital. FDI acts as a catalyst to economic growth by

increasing the investment rate, and also improves total-factor productivity by allowing

technology transfer, enhancing efficiency of human capital, increasing competition,and contributing to exports growth.

India's share in total global FDI inflows however remains only at about 3 per cent

whereas the UNCTAD's (United Nations Conference on Trade and Development)

global investment prospect lists India among five most-favoured investment

destinations for FDI. This clearly highlights India's significant potential for attracting

more FDI.


32/48


India's FDI outflows have also risen sharply, reflecting in Indian corporates' mergersand acquisitions especially in the pharmaceutical and IT sectors, and also acquisition

of energy assets resulting in access to better technology and export markets.

Although FDI inflows in India have increased sharply over 2006 to 2010, the

distribution of FDI across sectors remains skewed, largely due to regulatory and

infrastructure constraints that vary widely across sectors and regions in India. Four

sectors - telecommunication, power, construction and commercial and residential real

estate which have the least regulatory hurdles for FDI and offer attractive returns oninvestment, account for almost 40 per cent of India's total FDI inflows (Figure 19).

Among Indian states, Maharashtra and the National Capital Region together account

for more than 50 per cent of FDI inflows over the same period due to better

infrastructure facilities among other reasons.

Even though rising FDI inflows in infrastructure sectors, despite the high gestation

period of such investments, is an encouraging sign, poor FDI inflows in export-

intensive, but less efficient manufacturing sectors like textile, leather and food-

processing is a cause of concern. These three sectors together account for less than 2

per cent of India's total FDI inflows.

Prospects of foreign direct investment inflows in India remain strong over 2010-11 to

2015-16 as the economy would continue to grow at a robust pace of around 8.4 per

cent. However, the regulatory conditions, policy barriers and the state of supply-chain

networks, especially those that serve the retail sector, would determine the extent of

FDI inflows in India over the next five years.

FDI inflows are skewed towards certain sectors and regions, reflecting regulatory

and infrastructure constraints

Outlook

India will need to introduce reforms and upgrade its supply-chain networks to

sustain the growth momentum of FDI inflows

Source: Department of Industrial Policy & Promotion

Figure 19: FDI inflows are skewed towards certain sectors

0

1

2

3

4

2005-06

2007-

08

2009-10

2005-06

2007-08

2009-

10

2005-06

2007-

08

2009-

10

2005-06

2007-08

2009-10

2005-06

2007-08

2009-

10

Construction Housing Telecom Power Textile

US$ billion

FDI has increased sharply i n recent years

1980-81 1993-94 2010-11F


33/48

Source: United Nations Population Projections

Figure 20: India's bulging working-age population

million

-200

100

400

700

1000

1300

1600

2010 2020 2030 2040 2050

60+ yrs

15-59 yrs

0-14 yrs


Working age populationSet to become the largest contributor to the global workforce in the next 20 years,

India will have a demographic advantage over advanced countries and China

Outlook

India will have to raise employment opportunities and provide quality education to

India's potential workforce

With a population growth rate of 1.2 per cent per annum, India will overtake China to

become the world's most populous country by 2030. Of India's 1.2 billion population

in 2010, 50 per cent are below 25 years of age and 62 per cent are in the working age

group of 15-59 years (Figure 20). India will continue to have the largest population of

youth in the next decade.

India is set to become the largest contributor to the global workforce over the next 20

years, with its working-age population likely to swell from 749 million in 2010 to 962million in 2030. India will hence add 213 million to the global workforce, far more than

China, Europe and Japan, where the working age population is set to shrink. During the

period, 28 per cent of the increase in global workforce will come from India.

Also, India's dependency ratio, conventionally measured as the ratio of children and

old-aged to working-age population, will fall in the coming decades. This implies that its

working-age population (roughly in the age-group of 15-59 years) will have to shoulder

a lesser burden of its dependents. Rising population in the age group of 45-60 years,

with higher propensity to save, would help garner household savings. As per cent to

total population, population in this age-group is projected to increase from 11.5 percent in 2000 to 17.2 per cent by 2030.

The rise in Indias working-age population is a necessary but not a sufficient condition

for India to raise its growth to 10 per cent. India will have to address the critical issues

of creating jobs and preparing its youth to participate in its economic growth.

India's edge in i ncremental workforce by

2030

340

213

14

-11-45 -54

Africa India US Japan China Europe

millions


34/48

Roadblocks to 10

per cent growth

Key points

l

l

l

l

l

With persistent supply shocks from low growth of

agricultural production and volatile global commodity

prices, monetary management will become increasingly

difficult. At the same time, rising domestic demand,

both consumption and investment, will continue to

exert pressure on inflation.

India continues to have a deficit in most segments of

its physical infrastructure. Narrowing it will depend on- i) mobilising funds for infrastructure expenditure, and

ii) removing policy hurdles in setting up infrastructure

projects, to attract private investment.

India faces a skill shortage, with twin challenges of

insufficient quantity and quality of its workforce. The

skill deficit could diminish India's productivity, increase

wage rates excessively and result in higher

unemployment.

India, unlike most advanced countries, has a favourable

debt position. India's fiscal challenge, however, lies in

addressing the root cause of the debt - in steering its

public expenditures from wasteful subsidies to

improving its inadequate physical and social

infrastructure.

Poor governance can limit India's growth possibilities.

Keeping inflation in check, reducing deficit in its

physical infrastructure, addressing the skill

shortage in its bulging population, improving its

flexibility to reduce fiscal deficit and

strengthening governance are the five key

challenges facing India.

Chapter 4


35/48

Note: BE- Budget estimates

Source: Budget documents and CRISIL estimatesSource: CRISIL estimates

Figure 21: Emerging need to restore fiscal discipline Table 1: Forecasts of fiscal deficit

5.5

2.6

2.0

3.0

4.0

5.0

6.0

7.0

2000-01 2005-06 2010-11 BE

Fiscal deficit % of GDP

Fiscal challengeTargeting a reduced fiscal deficit to GDP for 2010-11, India's government has

signaled a renewed focus on fiscal consolidation

Fiscal worsening, like plummeting growth, had synchronised across the world during

the global economic crisis which began in late 2007. Slowing growth shrunk revenues

across countries whereas an unprecedented quantum of discretionary fiscal stimulus

bloated expenditures, as governments worldwide tried to revive their economies. The

deterioration in government finances has however been more pronounced and is likely

to be more prolonged in advanced economies than in emerging countries such as

India. With India's GDP growth quickly returning to the pre-crisis levels, ahead of

advanced countries, the Indian government has signaled its renewed focus on fiscalconsolidation, targeting a lower fiscal deficit at 5.5 per cent of GDP for 2010-11 and

aiming to reduce it further through FRBM (Table 1).

Aided by sharp revenue growth and its traditional focus on fiscal discipline, India's

fiscal position improved over 2003-04 to 2007-08 (Figure 21). India had embarked on

a fiscal consolidation program since the early 1990s, strengthening it with the Fiscal

Reform and Budget Management (FRBM) Act of 2003. Lack of expenditure reforms,

notwithstanding, buoyant revenues, excellent corporate performance and tax reforms

together set off a phase of steady improvement in India's fiscal position since 2003-

04. Not surprisingly, the central government achieved the FRBM goal of 3 per centfiscal deficit in 2007-08, a year ahead of the targeted date. The more critical parameter,

revenue deficit, however, could not be trimmed to zero.

India's public finances worsened abruptly since 2008-09, as a series of domestic events

and external shocks bloated its public expenditure and brought its revenues down.

Over 2008-09 and 2009-10 implementation of the Sixth Pay Commission Report,

National Rural Employment Guarantee Act, farm loan waiver and various subsidies

fuelled the rising domestic expenditure. The external shocks came in two episodes -

first, the sharp commodity inflation in the first half of 2008-09, which increased the


as a % to GDP 2010-11 2011-12 2013-14 2015 -16

Fiscal Deficit 5.0 5.5 4.7 3.9

Revenue Deficit 3.7 4.4 3.1 2.3

Debt 54.0 52.9 49.5 47.1


36/48

oil, fertiliser and food-subsidy bill; and the second, the global financial crisis, whichslowed India's real economic growth and increased public expenditures as the

government tried to stimulate the economy by reducing taxes and duties and increasing

spending. As a result, India's fiscal deficit rose to 6 per cent in 2008-09 and 6.7 per cent

in 2009-10

To stabilise the economy from sharp growth contraction, the government postponed

the FRBM targets. The government now seems intent on restoring FRBM discipline, as

noted by the Thirteenth Finance Commission recommendations.

Infrastructure constraints which amplified during India's economic upturn over 2004-

05 to 2007-08, would continue to plague the domestic economy in future. India's fiscal

challenge therefore would not be merely reducing its debt and fiscal deficit; another

spurt of high growth would accomplish that. India will have to expand its fiscal

flexibility to address the constraints that stifle its economy. And that is the fundamental

fiscal challenge for India.

India's long-pending expenditure reforms should cut expenditures in less productive

general consumption areas, and steer these to more productive areas - such asincreasing government investment in infrastructure, education and health, which would

have a multiplier effect on the economy. These measures would lend India the much-

needed fiscal flexibility for focusing investment in human development and

infrastructure, and mitigating the risks to its sustained economic growth.

Its likely swift recovery to economic growth would reduce India's fiscal stress, as it did

during 2003-04 to 2007-08. CRISIL expects the central government debt ratio to fall to

44.5 per cent in 2014-15 from 56.1 per cent in 2009-10. India's debt-GDP ratio (centre

and states), 76.6 per cent of GDP in 2009-10, is largely domestic debt with a long and

fixed tenure that will not expose India to the kind of external debt vulnerabilities that

countries such as Greece, Portugal and Spain are facing.

Also, unlike many developed nations, India, with a large proportion of youth in its

population, would not face the fiscal burden of an aging population in the next few

decades. It would however have to create an infrastructure for equipping its working-

Sustaining accelerated GDP growth will call for increased fiscal flexibility to addressvital constraints

Outlook

India's debt position is not as worrisome as in some of the advanced nations, but

unproductive expenses can diminish that advantage


High fiscal deficit warrants budgetary

restraint

1982-83

% of GDP

1996-97 2010-11F


37/48

age population with adequate education and directly-applicable work skills, to stem apossible rise in unproductive transfers to support its unemployed youth through social

schemes.

Since India's economy has historically been supply constrained, domestic supply

shocks have often triggered episodes of high inflation in India. At the same time,

demand-side pressures emanating from rising incomes (and specifically discretionary

incomes) have also been major contributors especially during cyclical upturns.

Barring the 1950s, India's inflation rates were the lowest, since independence, during

the 2000s. Average WPI (wholesale prices) based inflation declined to 5.3 per cent in

the 2000s, from 6.8 per cent in the 1980s and 8.1 per cent in the 1990s. Inflation

remained relatively benign through the 2000s, with the exception of 2000-01 and 2008-

09; the annual inflation in 2008-09, at 8.4 per cent, was the highest during the 2000s.

In India, food inflation tends to contribute significantly to overall inflation (Figure 22).

India's food inflation is currently driven more by structural than cyclical factors,

making inflationary management difficult for the Reserve Bank of India (RBI). Foodinflation has remained at an elevated double digit level now for almost two years since

October 2008. There are two main reasons for this stubbornness in food inflation.

Firstly, the persistently high demand and supply mismatch in 'protein-rich' food items

like pulses, milk, and eggs have resulted in sustained high prices for such 'protein-rich'

items. Secondly, due to structural factors there has been a steady decline in per capita

food grain production leading to decline in per capita availability of food grains. This

has resulted in widening the gap between production and consumption among major

food items (Figure 23). Thus when monsoons failed in 2009 and agriculture output

declined further aggravated

Inflation

Persistently high food inflation and volatile commodity prices pose challenges to

inflationary management

food inflation

Source: Ministry of Industry and CRISIL estimates

Figure 22: Inflation drivers across major sub-categories

y-o-y%

-2

5

12

19

Overall

2006-07

2006-07

2006-07

2006-07

2008-09

2008-09

2008-09

2008-09

H12010-11

H12010-11

H12010-11

H12010-11

Total food Non-food mfing Fuel group


While volatile, increased

remains a worry,

remains relatively stable

food inflation

manufacturing inflation

FY91 FY01 H11 FY11

Note: P- Projected

Source: Reserve Bank of India

Figure 23: Widening production-consumption gap in major food items

Million tonnes

-12

-6

0

6

12

2005-06

2007-08

2009

-10P

2005-06

2007-08

2009

-10P

2005-06

2007-08

2009

-10P

2005-06

2007-08

2009

-10P

2005-06

2007-08

2009

-10P

Sugar Oilseeds Rice Pulses Wheat


38/48


With greater integration into the global economy, India's inflation rate has becomevulnerable to changes in global factors - global commodity inflation now gets

transmitted to the domestic economy far more quickly than ever before. For instance,

the high annual inflation in 2008-09 was sparked by an unprecedented surge in

international commodity and oil prices.

These structural factors have made inflationary and monetary management difficult for

RBI as use of monetary instrument is not an effective tool for addressing inflation

arising from supply side bottlenecks. The effective and lasting solution will be to find

ways to increase the supply of agricultural output (see chapter titled 'Expanding supply

potential').

CRISIL expects inflation to decline from 7.5 per cent in November 2010 to around 6.5

per cent by March 2011, owing to favourable base effect, and a gradual decline in

inflation of food items (due to normal 2010 monsoon) and in manufactured goods due

to monetary tightening by the RBI.

If international crude and commodity prices firm up further and inflation in

agriculture commodities remains sticky, monetary management will remain a

complicated exercise for Reserve Bank of India.

Outlook

Inflation rate is likely to moderate in the short term

Any persistence in food inflation will complicate monetary management


39/48

4.39.5

86.2

3.05.9

91.1

0

20

40

60

80

100

Formally

skilled

Non-formally

skilledUnskilled Formally

skilled

Non-formally

skilledUnskilled

Male Femalest

Source: National Sample Survey Organisation, 61 round, 2004-05

Figure 25: Percentage of youth population with vocational training

Source: Barro-Lee data set, 2010

Figure 24: Share of population > 15 years of age, without schooling

0

14

28

42

56

70

1980 2010 1 980 2010 1980 2010 1 980 2010 1 980 2010

India China Malaysia Korea Thailand

%%


Skills shortage and mismatchDespite the rising literacy rate of its swelling population, India faces a skill

shortage, with twin challenges of insufficient quantity and quality of its workforce

Although India's literacy rate has increased over the past four decades - from 28.3 per

cent in 1961 to 52.2 per cent in 1991 and to 64.8 per cent in 2001 - it continues to

have a greater proportion of illiterate population over 15 years of age than most other

developing countries (Figure 24). Besides, India's school drop-out rate continues to be

alarming - in 2006-07, only 17 of 100 children who entered 1st grade completed 10th

grade. In addition, according to the latest statistics of 2008-09, 13 per cent of India's

primary schools are single-teacher schools. The lack of sufficient number of teachers

has adversely affected the quality of learning in India's schools.

India has an insufficient supply of skilled workers who have received vocational

training (Figure 25). In 2004-05, only 28 million of India's 255 million-strong job-

seeking population in the age group of 15-29 received some form of vocational

training (Source: Skilling India| The Billion People Challenge, 2010, CRISIL).

Opportunities in infrastructure, construction, mining and healthcare have increased

the demand for vocationally-trained workers such as technicians, welders, fitters and

paramedics. As formal vocational training has not been widespread, skilled workers to

meet the rising demand from these sectors has remained in short supply.

India's knowledge-based service industries face a different kind of challenge - that of

skill mismatch - where there are an insufficient number of workers with specialised

skill that available jobs require. For example, knowledge-based industries such as

IT/ITeS find it difficult to locate the kind of information technology specialists they

need. This implies that the workforce, despite being qualified, falls short of skills that

are required by the job market. Wages and attrition rates therefore continue to rise in

industries that face such skill mismatch.


40/48


Skill shortage could diminish India's productivity and increase wage rates

excessively

Outlook

India's labour participation and unemployment rate could increase, if thegovernment does not take policy measures to address the skill shortage

India would need to focus more on educating and developing skills of its workforce

and increasing jobs, than on increasing public expenditure on social welfare

schemes

As the demand for skilled workers increases, if relatively low-skilled workers are added

to the workforce, they would drag down overall workfor

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