Special Feature

The performance of the economy in the last three years provides a strong base for optimism for the next five years. It is possible to raise the growth rate of incomes from the current level of 8% to 10% during the 11^th Plan with emphasis on creation of income opportunities.

Incremental policies are no longer relevant. A complete restructuring of present systems is imperative in most sectors for breakthrough results in development, sustainability and innovation.

CII’s Pre-Budget Memorandum for 2007-08 is predicated on its perspectives for the 11^th Plan, and aims to build a base for taking advantage of the unprecedented window of opportunity open for India at this period in time, based on expected population dynamics and global economic conditions.

CII expects that with growth rates averaging at least 8.5% during the 11^th Plan, the share of agriculture in the aggregate GDP will decline to below 15% by 2011-12. However, 60% of the workforce continues to be dependant on the sector for income. Therefore, urgent measures must be undertaken to move people off the land and into productive employment and self-employment in other sectors. This is critical for increasing prosperity as also for avoiding negative social implications. End-to-end solutions for employment and self-employment involve human capacity-building, vibrant markets, and promotion of manufacturing and exports.

Education and skill development are thus the centerpiece of CII’s proposals for Budget 2007-08.

Employment generation and entrepreneurship development in off-farm sectors is also promoted by reducing anomalies in factor and product markets to release latent investment and growth potential. It is thus crucial to adhere to the announcement in Budget 2006-07 of a single Goods and Services Tax by 2010 as well as to prioritise FRBM targets. It is imperative that the Government announce the key roadmap towards the establishment of the system of the single Goods and Services Tax in the forthcoming budget statement.

Only faster growth can generate sufficient revenues for social sector spending. This will require all sectors of the economy - the public sector, the private sector, and the household sector - to work together in tandem and partnership. The role to be played by each sector needs to be clearly articulated and targeted in order to achieve maximum efficiency.

One, the objective interplay of market forces will promote competitiveness and direct resources for optimal benefit. In other words, the role of the government must recede from commercial activities and limit itself to social protection and provision.

Two, the primary driver of the current growth trend is the private sector. It is therefore essential to amend the business environment in a manner that ignites entrepreneurship, encourages competition, rewards creativity, and stimulates growth and development through interplay of market forces. Business must be a partner, and not a passive bystander, in the development process for the country.

The two most critical sectors that need enhanced outlay and policy reforms to meet stated objectives relate to education and infrastructure, both requiring measures now for results to fructify by the end of the 11^th Plan.

Economic conditions in India are suitable for BOLD decisions. Factors for achieving the above objectives include enablers as well as roadblocks. The enablers are:

As per the growth figures released by the CSO for Q1 ’07, the GDP has posted a growth of 8.9%, which prompts us to think that the 8% plus growth rate that has been clocked in the last three fiscals will continue.

India’s demand-led growth impetus is driven by an expanding consumer base, increased integration with the global economy, competitive business entities and rising domestic and foreign investments. Rainfall has been near normal for the last four years, allowing non-agricultural sectors to flourish unimpeded on the base of agricultural stability and adequate demand.

The Manufacturing sector has proved itself a growth driver with growth rates climbing up from 8.1% in 2004-05 to 9.0% in 2005-06 and standing at 11.8% for April to August this year. Investment announcements in recent quarters indicate that manufacturing is high on the priority list of corporates. Within the Industry sector, the growth rates of capital goods and consumer durables and non-durables have been particularly impressive, emphasizing the drive to augment capacity and ride the consumer boom. At the same time, stagnation in mining and power generation is of concern.

The services sector has maintained near double-digit growth rates in the last two fiscals, and the first quarter of the current year witnessed continued growth of 10.6%. This has been led by rapid expansion in the Trade, Hotels, Transport and Communications category, and by the fast-growing telecom sector in particular. Financing, insurance, real estate, and business services are also increasing at rising rates.

The Agriculture sector continues to be heavily monsoon dependent and suffers from low investments, poor credit, and outdated technology, leading to low productivity of land and labour. Its declining share in GDP is unlikely to be reversed and there is urgency to provide adequate off-farm employment opportunities for the large proportion of the workforce dependant on the sector. Uneven rainfall in the current year is expected to result in decline in kharif output, and consequently, agricultural production is likely to be stagnant.

To maintain the growth momentum through the 11^th Plan, and to further speed it, Budget 2007-08 needs to strengthen the foundations of consumption-led growth and to set in motion processes to encourage investments that would enable long-term sustainable growth.

At the same time, it is essential to tap the robust global demand conditions and build increased linkages with the international economy, both for flow of goods and services, and for investments. Current FDI inflow is rather low, and prudent level has been estimated at 2.5% of GDP.

Convergence of skill levels and technology enables economies to shift growth trends upwards. CII believes that double-digit growth is attainable in the near term, provided key issues in agricultural, industrial and services growths are addressed. These issues relate to human capital, physical capital, financial capital and technological capital. All these factors need to function in an environment of maximum efficiency through more liberal market forces.

The critical factor for public sector investments in key sectors is revenue generation.

Of the additional expenditure (75%), a proportion of 35:35:20:10 should be spent on education, infrastructure, health and other development expenses.

There is need for a high initial loading dose of investments for a BIG PUSH to the economy.

The government must not compromise on adhering to FRBM targets during Budget 2007-08 and the 11^th Plan. Apart from credibility being at stake, there is fear of distortions of markets.

With these pre-conditions met, the following measures need to be urgently put in place:

i. Widen tax base – Bring more services in the tax net; make tax collection easier and simpler to allow more individuals to comply

ii. Incentivise savings for infrastructure projects – issue Infrastructure Bonds. Investments in Infrastructure Bonds should be tax exempt.

iii. PSU disinvestment and privatization – sell all PSUs sick over a certain time; privatise all PSUs making losses for a certain number of years; bring down shareholdings in profitable PSUs; sell high value unproductive assets of PSUs. A target of Rs. 10,000 crores from such offloading may be set. PSE privatization needs to be part of the government agenda once again for greater common good. It has been successful in different states, and is essential for the central government to raise resources for social and physical infrastructure.

iv. Increase expenditure efficiency and productivity – ensure minimal expenditure leakages, reduce corruption through stringent action; adhere to timelines; prevent cost overruns through on-the-ground surveys; outsource service delivery to private sector

v. Reduce subsidies – fertilizer subsidies; electricity; petrol and gas; agricultural subsidies have been increasing as percentage of GDP while public investments have correspondingly declined. Redirect subsidies to productive capital formation in agriculture. A target of reducing subsidies by Rs 15,000 crores can be set for the first year.

Often, subsidy targeting is inefficient, leading to higher costs being paid by the poor and subsidies reaching the middle or higher income groups. Some subsidies, such as on fertilizers and electricity, cause distortions in usage patterns and accentuate problems (groundwater depletion, runoffs, soil pollution). Other subsidies hinder resource generation for maintenance, modernization, and safety measures. Availability of inputs is often more critical than cost to the poor.

vi. Raise external debt to GDP ratio through long-term borrowings, for use in infrastructure.

Given India’s comfortable external debt position, borrowings from overseas for infrastructure projects has scope for expansion.

Items	2004R	2005R	2005 QE
External Debt to GDP	17.8	17.3	-
Short term debt to total External Debt	4.0	6.1	6.7
Short term to Foreign Currency Assets	4.0	5.6	6.1
Debt Service to current receipts	16.3	6.2	-
Concessional debt to total debt	36.1	33.3	31.6

In addition to raising revenue for its developmental expenditure, the government must also make it easier for private sector investments to be more productive and efficient through vibrant markets that smoothen demand and supply matching. For this it is essential to move towards a single market and a common Goods and Services Tax.

Social equity, individual potential and national economic needs are met through investments in education and health. While the government bears the responsibility of primary and secondary education, private investments must be attracted into higher education and skill development. A roadmap for the next five years should be announced to achieve universal primary and secondary education.

CII suggests a working model for such universalisation of education. It is estimated that additional revenues of Rs 25 thousand crores can be mobilized for educational infrastructure provision from additional tax revenues expected in 2007-08. These funds may be used to commence a common school system for primary and secondary education.

At the end of the 11^th Plan, there would be such centrally-funded school buildings across the country, progressively established in higher income districts, and creating a common school system with free compulsory education for all up to Class 8.

The same infrastructure can be utilized for imparting skill education in the afternoons or evenings.

In higher education, steps must be announced for encouraging private sector investments, reducing start-up formalities, establishment of independent credible accreditation bodies, setting in place regulatory and appellate authorities, quality upgradation and curriculum revision. A national policy on higher education must be examined and passed in the first year of the 11^th Plan to outline central and state efforts in the field. The central government must provide funds for upgrading 10 more institutions as announced for the three universities in Budget 2006-07.

In health, the government should consider beneficiary-based funding in private healthcare centres as opposed to government-run health centres. A payment system can be introduced where the state pays for health services to targeted segments of society provided by private sources. This would incentivise private health providers to set up health outlets in rural areas.

Infrastructure, or physical capital, requires funding, policy reforms, establishment of regulatory authorities, and speedy clearances. Fast decisions on these would lower the costs of doing business in India and promote investments from the private sector. The government may also consider more loans from international institutions, possible in the current foreign currency debt and assets position. Gross Capital Formation in Infrastructure must be progressively raised from 4.5% of GDP to 11%.

The Budget must start the process for several large ‘Innovative India’ projects with high visibility and new global benchmarks of scale and excellence. These are urgent to ignite latent nationalist passions, mark India’s arrival on the global economic stage, and inspire investor confidence. Short deadlines, stretch targets, and rapid deployment are essential for Innovative India projects.

At the recent Infrastructure Summit, a requirement of Rs. 14,50,000 crores or $320 billion for the next five years was laid out. Although it might be difficult to outline the exact break-up of this figure, an indication of the extent of resources to be raised from different sources must be presented.

To enhance regional equity, greater dialogue, cooperation and consensus between states and between the center and the states through an institutionalized regular mechanism on a neutral non-partisan platform is required to be put in place. Individual platforms for dialogue in crucial areas such as education, agriculture, and electricity must be set up with regular meetings to evolve time-bound fast solutions for moving forward.

Sectors with the most enabling policy environment, such as telecom, aviation and ports, have witnessed high participation from the private sector to great success. Thus, non-viable and uneconomical services must be separated from profitable services, with the latter left entirely to the private sector and the former providing adequate gap-funding to incentivise the private sector. Certain sectors such as energy and mining require urgent policy changes to facilitate private investments. The Model Concession Agreements need to be made more practical and suitable in a manner that the interest of private sector is retained in PPP models, including viability gap funding frameworks.

Efficiency of resource utilization and time-compression also need attention. Private sector can be a partner for techno-managerial expertise. The government must consider setting up an Infrastructure Development Board at the central and state levels as a one-stop fast-track mechanism for identifying projects, conducting feasibility studies, acquiring land and licenses, and inviting and selecting bids. Further, a system of infrastructure statistics at the central level would help monitor progress and conduct comparisons. Such a system would release data on progress of infrastructure projects on a quarterly basis.

Establishment of effective regulatory authorities is also critical to private sector participation in infrastructure provision and servicing. Priority in the Budget must be given to regulation in power, roads and highways, ports and airports. In power, projects for 60,000 MW additional capacity must be initiated for the 11^th Plan. State governments must be given adequate incentives to reform distribution of electricity.

There is a critical gap in the translation of aggregate savings into productive investments. Much of household savings does not reach the financial markets, while at the same time, government crowds out private sector in bank lending due to requirements for holding government securities. The huge rise in investments by the corporate sector in the previous quarters has been financed through retained earnings, equity, external borrowings, and bank borrowings. However, further growth may be restrained by the lack of access of the corporate sector to household savings. McKinsey Global Institute states that $48 billion of funds annually could be unlocked through financial market reforms.

Corporate bond markets, pension reforms, more privatization of banks, and changes in withholding tax will help channelise household savings to productive sectors. Introduction of STRIPS (Separate Trading of Registered Interest and Principal of Securities), short selling of government paper, and transparency in trading through simpler listing procedures need to move faster. A credible trading platform needs to be set up for the secondary bond market. FII trading norms in bonds also need to be relaxed.

Capitalisation of banks must be addressed so that borrowings are not hampered due to lack of capital adequacy. For this, the government needs to reduce its share in public sector banks to 33%. Bank credit grew at 30% in 2005-06, and maintained this rate for the first half of 2006-07, but already accounts for 72% of deposits.

Deposits must be increased by widening the depositor base rather than raising the interest rates. Hikes in interest rates impact consumer retail lending and would reduce the pace of growth in consumer durables sector, which has been a growth driver of the IIP.

To attract depositors, innovative banking for the rural and poorer sections of society is needed. Microfinance institutions must be scaled up. Stronger linkages between the formal and informal sectors are needed so that more income generating opportunities are created. Micro and small entrepreneurship in rural areas have to be aggressively promoted to bring more people into the banking net.

Pension and insurance fund reform must be set in motion to widen and deepen capital markets, expand investor base and add to resources for infrastructure creation. Pension funds must have access to the equity market and should be delinked from revenue inflow. Insurance product basket also needs diversification.

At the same time, the high rates of public sector borrowings and the consequent impact on revenue expenditure for interest payments are a cause for concern. The government must give highest priority to reducing its revenue and fiscal deficits in line with the FRBM Act. This expands fund availability to the private sector, offers comfort to investors, supplies an image of a responsible and mature government, and improves macroeconomic fundamentals.

There is need to also utilize funds in a more cost-efficient manner for optimal spending on social sector programs. Expertise of the corporate sector must be leveraged even in social programs of the government as the current efforts of companies have proved efficient and viable even in education, health, awareness generation and other areas.

India has a particular advantage arising from its human resource in becoming a knowledge and innovation hub for the world. However, India’s current R&D spend is grossly below that of many countries.

The proportion of R&D expenditure to GDP in India should be increased to 1% in the first year of the 11^th Plan to conform to the aspirations for making India a knowledge economy. This proportion must be progressively increased to 3% by the end of the Plan period, so that India evolves into a world class hub for R&D.

Innovation regimes need to be strengthened, corporate-academia cooperation enhanced, and intellectual property rights made credible. A clear-cut demarcation of the roles and responsibility between different organizations promoting R&D is essential. Administrative procedures and time required in clearing proposals must be reduced.

For technology commercialization, suitable mechanisms to monitor, support and hand-hold should be put in place. Patent protection regime needs to be strengthened to promote new technologies and innovation. Suitable policies are required to be drafted on patent rights by the scientists working in R&D institutes.

R&D support in terms of fiscal incentives like tax credits and other benefits should be extended to all sectors of the economy, including agriculture. Further, SMEs should be provided additional benefits to promote innovation. A central autonomous fund for R&D by SMEs needs to be instituted, started by a corpus contribution from the government. Industry contributions should further deepen this fund. Industry contributions would have to be voluntary and the contributing companies should get 200% tax deduction on their contributions. This scheme would run parallel to the existing scheme to extending 150% weighted tax deduction on R&D expenditure by companies.

The government should give grants on the basis of proposals for significant R&D, particularly to SMEs.

Industry-institute interactions must be made more intense through information sharing mechanisms and venture capital incentives. There needs to be an institutionalised mechanism for transfer of ideas to the marketplace between entrepreneurs and scientists.

A significant part of India’s economy lies outside formal markets. There is need to widely expand markets so that more and more people are subsumed into the formal marketplace, as well as to deepen and strengthen existing markets. Connectivity and information are necessary for smooth clearing of demand and supply so that resources are allocated optimally.

Barriers in the marketplace add to transaction costs and lower competitiveness. Product markets as well as factor markets need to be liberalized to promote movement of goods and services. Labor and capital mobility must also be addressed.

It is estimated that the burden of indirect tax structure adds 14-16% to costs of manufactured products over those in China. Administrative hassles, slow movement of goods, and poor logistics support raise costs further. Thus the costs of doing business in India are high, as is indicated by its ranking on the World Bank ‘Doing Business" report. Although the ranking overall has improved from 138 in 2005 to 134 in 2006, this is still very low in a list of 175 countries. Therefore, Budget 2007-08 must focus on increasing competitiveness and facilitating greater market functioning.

Other sections of the Pre-Budget Memorandum focus on direct and indirect taxes. In the macroeconomic perspective, the emphasis is on creation of a single market. The deadline for a common goods and services tax was announced in the last Budget as 2010. Budget 2007-08 must announce clarity on the overall roadmap and timeline proposed for movement towards GST. Dismantling of Central Sales Tax must be urgently carried forward, along with compensation issues for states. Other duties hampering movement of goods also need to be addressed.

Services tax structure must align with taxes on goods and more services should be included in the tax net.

Market conditions in several sectors need to be urgently improved. In particular, mining, energy, and the agricultural goods sectors need enabling policies to unlock potential growth. Both the mining and electricity sectors are dragging down overall industrial growth. At the same time, the manufacturing sector needs to grow at 12-14% in order to absorb larger workforce and gain more share in overall GDP.

Mining sector needs deregulation for more competition and private sector operators with clear criteria for lease allocation, increased royalty payment to states, and establishment of independent regulators. Reconnaissance, prospecting and mining movement must be flexible, and approvals must be fast. Environmental guidelines must be clear and speedy.

In agriculture, the farmer must have the opportunity of choice for selling his produce. Vibrant produce markets need to be incentivised and contract farming must be encouraged. Greater linkages with the food processing sector are required to be promoted. Credit facilities and risk management mechanisms need to be strengthened. Standards and harmonization with international norms should be advanced in order to enhance exports.

b) Diversification into high-value crops and value addition to both traditional and diversified agriculture produces.

Thus agriculture needs to be linked to the markets by creating vibrant agricultural markets through implementing the APMC Act in the states and private sector participation in market development.

Agribusinesses and rural enterprises near farms need to be promoted. Private sector participation in agriculture research, extension and farmers’ training is required to link production to demand.

The government needs to invest in irrigation infrastructure and promote private sector participation in watershed development and micro-irrigation. Participatory user committees would further help manage water infrastructure.

Food processing sector: strengthen engines of agriculture growth such as the food processing industry, biodiesel, etc; shift the focus from a ‘classes’ product to a ‘masses’ product industry; improve industry viability through enabling industry to obtain ‘return on taste and time invested’ (ROTTI) as opposed to Return on Investment (RoI); position India as a preferred outsourcing hub for processed food products; support institution development for capacity-building in Food Safety and Quality. This sector needs a uniform-low rate of tax incidence.

The large numbers being added to the active working age population every year would prove to be a huge demographic and social liability, unless job creation is given special attention.

There are sectors of industry that are employment intensive. The government needs to come out with ways to promote these sectors in a manner that growth in these sectors create the necessary job opportunities.

Certain risks that threaten the growth environment need to be assessed and measures taken for mitigation. Some of the key issues that would need to be considered are:

Delivery mechanisms: Prospects of uncertainties in policies and dilatory administrative procedures impact current domestic and overseas investment decisions. Government needs to be more credible, transparent, accountable and outcome-oriented.

Slowing down of reform process: Political consensus must be built around the key areas of reform so that further liberalization is not impeded.

Government salary expenditure: While it is imperative to improve salaries of government officials in line with economic progress, there must be accompanying measures to reduce intake and trim staff for greater productivity.

Disaster prevention and management: A weather forecasting system must be established to mitigate disasters arising from weather conditions. Global warming and climate change factors need to be taken into account.

Diseases: Pandemics and HIV/AIDS, TB, malaria and other diseases must not be allowed to impact productivity and investment.

Depleting water resources: India has 18% of the World’s population, but only 4% of the water resources. Overstressed freshwater services may make already-scarce water more difficult to access, exacerbating the country’s health and humanitarian problems.

The government needs to maintain fiscal responsibility and restrain unproductive expenditure. It needs to focus on creation of long-term enabling measures to boost inclusive growth. Such measures would primarily concentrate on education and skill development, infrastructure and policy environment for better operation of market forces. Rapid and inclusive growth can be driven by the private sector rather than the public sector.

The business environment must encourage entrepreneurship, promote competition, reward creativity, and stimulate growth and development through interplay of market forces. Business must be considered a partner in the development process for the country.