Download Sharing Experience in Growth Analysis

India Rising—Faster Growth,
Lower Indebtedness
“Sharing Experience in Growth Analysis”
Brian Pinto
PRMED
The World Bank
October 10, 2007
• Based on a paper with Gaobo Pang and Marina
Wes
[World Bank Policy Research WP 4241]
• Preliminary results from looking at firm
investment behavior (using the Prowess
Database) being done jointly with Taye
Mengistae and Nan Geng
•
•
•
A growth resurgence
India now in its fifth year of rapid growth
Most remarkable feature: was unanticipated!
Why?
a. Could not be anticipated?
b. Right kind of analysis not done?
•
Answer is related to transition over the 1990s and in
particular to the question:
How have high fiscal deficits and high growth coexisted
for so long in India?
Answer: (a) true on average BUT serious ups and downs;
(b) deterioration in public finances over 1997-2002 was
macro cost of post-1991 reforms; growth resurgence is
lagged benefit from better micro foundations
Last 25 years:
• Real GDP growth close to 6%
• Yet, general government debt/GDP rose by 34
percentage points!
– 48% of GDP in 1980/81
– 82% of GDP in 2005/06
• And no major crisis (when compared to other EMs)
– But a BoP in 1991 which proved a critical turning point (as
we’ll see)
• Paper concentrates on post-1991
Hypotheses to Explain
Coexistence
• Keynesian explanation, since no crisis after 1997
– But growth fell as deficits rose 1997-2002
• Big infrastructure push raised short-run deficits and
debt but raised growth with a lag
– But big cuts in government capital expenditure after 1991
• Financial repression
– Closed capital account
– Issue debt at artificially low interest rates
Buiter-Patel 2005
India solvent because:
• High nominal GDP growth
• Financial Repression
Hold it!!
• Real GDP growth high too
• Scope for financial repression down drastically
after mid-1990s
Let’s Look at Financial Repression
(briefly)
• A big factor in late 1980s, early 1990s
• Kletzer (2004) estimates FR revenues to be
negative in 2001 and 2002!
• India much more open economy – gross flows
on CA and KA to GDP risen from $96 bn and
40% in 1992/93 to $506 bn and 71% of GDP
in 2004/05 (Kelkar (2005)).
• Small savings – interest rates greater than the
market
Public Finances & Growth
• No satisfactory framework
• Easterly (2005) on growth empirics: “…national policies that
have received the most attention are fiscal policy, inflation,
black market premiums on FX, financial repression vs.
financial development, real overvaluation of the exchange rate,
and openness to trade.”
• Insufficient in at least three ways:
– misses government’s intertemporal budget constraint
– no cumulative, lagged effects allowed for
– ignores micro-foundations of growth.
• No easy ways to model:
– gradual reforms
– long lags in response of firms and banks
– endogeneity among fiscal deficits, debt and growth.
Our Explanation (Post 1991)
Reasons for high deficits and high growth overlap
• Big reform-induced revenue loss after 1991 from
customs, excise and financial repression taxes
• These very factors plus lower entry barriers have
increased competition and hardened budgets for firms
and banks
• We know from firm-level studies in transition
countries of CEE that the latter has a profound effect
on the microfoundations of growth
The Big Picture
Figure 1 Growth (%), Fiscal Deficit, and Debt Stock (% of GDP)
12
Debt stock
Fiscal deficit
Real GDP growth
90
10
80
8
70
6
60
4
50
2
Ninth Plan
(97/98-01/02)
Eighth Plan
(92/93-96/97)
Benchmark
(85/86-89/90)
Tenth Plan
(02/03-05/06)
0
40
30
80/81
82/83
84/85
86/87
Eighth88/89
Plan
Debt stock
90/91
92/93
94/95
Fiscal deficit
96/97
98/99
00/01
02/03
04/05
Real GDP Growth
Source: Handbook of Statistics on Indian Economy, Reserve Bank of India
Key Ideas
• Macro: 9th plan period outcomes
intensification of 8th plan period outcomes
– Reject “8th plan good, 9th plan bad” stereotype
– Reject “fiscal profligacy” argument
• Micro: serious restructuring began in
1996-97 (import competition began to bite)
– Key dates:
• 1991: opening up and tax reforms begin
• 1996-97: firm and bank restructuring starts
• 2003: visible results.
Fundamental Q
What enabled such a long transition without a
crisis?
– Slow approach to CAC and S-O banks
• Gradual loss of fin repression taxes
• Captive market for g-secs
– Debt tolerance
• 1991 especially
• 1997-98: shift towards domestic debt and FX reserve
build up after 1991 helped in “crisis” proofing
Table 1. Fiscal Adjustment 1985/86-2005/06
(based on period averages)
Benchmark
85/86-89/90
8th Plan
versus
85/86-89/90
9th Plan
versus
8th Plan
1. Revenues
2. Interest
3. Capital expenditure
19.4
3.8
6.6
-1.5
+1.3
-2.9
-1.0
+0.6
0.0
+1.7
+0.6
-0.3
-0.8
+2.6
-3.2
4. Net impact (3.+2.-1.)
5. Non-interest current exp.
6. Impact on GFD (4.+5.)
7. Primary deficit (3.+5.-1.)
8. Revenue deficit (2.+5.-1.)
Memo item: growth %/yr.
-18.3
-5.4
2.6
6.2
-0.1
-1.9
-2.0
-3.3
+0.9
+0.3
+1.6
+0.8
+2.4
+1.8
+2.4
-1.2
-1.4
+0.2
-1.2
-1.8
-0.8
+1.9
+0.2
-0.9
-0.7
-3.3
+2.5
+1.1
% of GDP
First 4 years of 10th Plan
versus
9th Plan 85/86-89/90
Note: Rounding off error present.
Source: Authors’ calculations based on Handbook of Statistics on Indian Economy, Reserve
Bank of India
Table 2. Factors Accounting for Rising Indebtedness, 1985/86-2005/06
(Annual average, % points of GDP)
1. Increase in debt
2. Primary Deficit
3. Real GDP growth
4. Real interest rate
5. Real exchange rate change
6. Financial Sector Recapitalization
7. Divestment
8. Residual (1. minus sum of 2. to 7.)
85/86- 90/9189/90 91/92
3.5
3.6
5.4
3.8
-3.7 -2.4
-0.3 -2.0
0.2
1.9
0.0
0.0
0.0 -0.2
1.8
2.4
92/93- 97/98- 02/0396/97 01/02 05/06
-2.5 2.5 0.2
2.1 4.0 2.2
-4.7 -3.6 -5.7
0.3 2.8 3.5
0.1 0.3 -0.3
0.3 0.0 0.1
-0.2 -0.1 -0.2
-0.4 -0.9 0.7
Source: Authors’ calculations based on Handbook of Statistics on Indian Economy, Reserve Bank
of India
Table 3. Changing Indebtedness, first 4 years of 10th Plan period
(% points of GDP)
1. Increase in debt
2. Primary Deficit
3. Real GDP growth
4. Real interest rate
5. Real exchange rate change
6. Financial Sector Recapitalization
7. Divestment
8. Residual (1. minus sum of 2. to 7.)
2002/03 2003/04 2004/05 2005/06
5.1
0.0 -2.1 -2.0
3.2
2.7
1.4
1.3
-2.8 -6.6 -6.7 -6.7
4.0
3.5
3.1
3.2
-0.3 -0.5 -0.3
0.1
0.1
0.2
0.0
0.0
-0.1 -0.6 -0.1 -0.1
1.1
1.4
0.4
0.1
Source: Authors’ calculations based on Handbook of Statistics on Indian Economy, Reserve
Bank of India
Our Explanation – 2
Macro deterioration in debt dynamics in late 1990s:
• Mainly because of tax losses and rise in interest payments, not
fiscal profligacy
• Decline in taxes possibly exacerbated by slowing growth as
private investment pulls back after initial binge
• Lagged effects of govt capex cuts on private investment
Micro transition has been slow and meandering:
• Reforms gradual, takes time to attain credible, critical mass
• Learning and adaptation involved:
– Investment boom during early years of reform likely to
have been of low quality
Three Stages in Micro
Transition
• First stage – investment boom in early
1990s based on existing relationships
instead of market fundamentals
• Second stage (1996-2003) restructuring
of balance sheets and real assets
• Third stage – broad-based growth
resurgence starting in 2003/04
Effective Customs Duty Rate (%)
Figure 2: Investment as a share of GDP, 1985–86 to
2004–05
30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
1985-86 to
1989-90
Private Investment
8th Plan
9th Plan
2002-03
Government Capital Spending
2003-04
2004-05
Gross Fixed Capital Formation
8th Plan period Investment surge
[…] largely because neither industrialists nor
bankers had any experience in operating in
liberalised environments, almost every project
that was submitted for financing was accepted.
[..] the system created capacity (which is quite
possibly what showed up as growth numbers) in
industry after industry – steel, man-made fibre,
paper, cement, textiles, hotels, and automobiles
received a major share of the large loans given
principally by the DFIs and partly by the CBs.
--Mor at al. (2005)
1996 start of “serious
restructuring”
It seems as if every Indian group .. invested
in power, telecom and finance ventures in
the 1993–95 period,.. where they usually
had no background. ..only in the last four
years as industrial growth has fallen and
industry has come under the ..pressure of
[import] competition ..and falling margins
that firms have been forced to look at
which activities they really wish to retain.
--Forbes (2002)
Tobin's Q for Companies in the Prowess Database
2.5
1.5
1
0.5
Year
20
04
20
02
20
00
19
98
19
96
19
94
19
92
19
90
0
19
88
Q
2
The movement in Q is consistent
with our hypothesis that
• The opening up and tax reforms of the early 90s gave
an initial and short lived boost to corporate
investment opportunities (1991-95)
• Sustained growth in capital stock could only follow
the restructuring (and correction) phase of 1996-2003
• Signs are that the upturn in from 2002 onwards is
going to be sustained for a while.
Real GDP growth at factor cost (%)
Agriculture, forestry & fishing
Industry
of which, manufacturing
Services
85/86 8th 9th
-89/90 Plan Plan
(avg.) (avg.) (avg.)
3.1 4.7 2.3
7.6 7.6 3.4
7.8 9.8 1.2
7.6 7.6 8.6
10th
Plan
02/03
-05/06
(avg.) 02/03 03/04 04/05 05/06
1.9 -6.9 10.0 0.7 3.9
8.0 7.0 7.6 8.6 8.7
7.7 6.8 7.1 8.1 9.0
8.9 7.3 8.2 9.9 10.0
GDP
6.0 6.7 5.5
7.0 3.8 8.5 7.5 8.4
Source: Authors’ calculations based on Handbook of Statistics on Indian Economy, Reserve Bank of India
Growth rebound: Cyclical vs.
Structural
• Excellent survey in Ouri (2007):
– Medium-run g forecast at 8%
– TFP g has gone up since 2003!
– TFP g over 2003-05 more than double that over
1980-9 or 1990-99
– (if you can believe the results)
• Took 12 years for the reforms which began in
1991 to yield tangible results.
2004-05
2003-04
2002-03
2001-02
2000-01
1999-00
1998-99
1997-98
1996-97
1995-96
1994-95
1993-94
1992-93
1991-92
Figure 5: India’s Export Performance
(Rupees billion, constant prices)
3500
3000
2500
2000
1500
1000
500
0
A large part of this adjustment is that firms are
becoming more and more export oriented
Exports as a ratio of corporate sales(Prowess
database)
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
0.35
0.3
0.25
0.2
0.15
0.1
0.05
0
The Infrastructure Gap
• Everyone agrees infrastructure (esp. in elec, roads,
urban) is the biggest constraint on continued rapid
growth
• Then why not just borrow and fill the gap even if
short-run deficits go up?
• Two reasons why not:
– Investments required are huge, debt already high
– Marginal financial ROR to govt (user charges plus higher
future taxes) may not be enough to recoup the marginal
cost (Serven-Burnside 2006)--SEBs an example
• Thus, real possibility that government’s net worth
could go down without accompanying reform
Growth rate needed to maintain debt-to-GDP with
Rise in Capital Expenditure
7.0
6.5
6.0
5.5
5.0
4.5
4.0
3.5
3.0
2.5
2.0
18
16
14
11.6%
12
10.6%
11.3%
10
8
6
6.5%
4
7.3%
5.4%
Actual Capital Exp.
Counterfactual Capital Exp.
Actual growth
Counterfactual growth
2005/06
2004/05
2003/04
2002/03
2001/02
2000/01
1999/00
1998/99
1997/98
1996/97
1995/96
1994/95
1993/94
1992/93
0
1991/92
2005/06
2004/05
2003/04
2002/03
2001/02
2000/01
1999/00
1998/99
1997/98
1996/97
1995/96
1994/95
1993/94
1992/93
1991/92
2
Less Risky Option
Create fiscal space for infrastructure by:
1. Implementing fiscal reforms
• Revenue adjustment
• States’ fiscal adjustment
• Subsidy reform (food, power, fertilizer = 3% of GDP)
2. Defining role for private sector while monitoring
contingent liabilities
India’s Revenue Adjustment
Key point: big potential for raising revenues without
raising marginal tax rates (Poirson (2006))
• Average Effective Tax Rates are low
• AETR = Statutory tax rate X [Actual tax
base/Potential tax base]
• GoI 2004 Road Map for FRBMA: Corporate tax
collections to go from 2.3% of GDP in 2003/04 to
4.2% in 2008/09 WHILE CIT rate goes down from
35% to 30%!
• VAT holds great potential too.
States’ Fiscal Adjustment
• 12th FC recommendations to play major role
– Lower indebtedness
– Reform borrowing regime
– Eliminate revenue deficit by 2008/09
• VAT implementation key (revenue mobilization)
• SEB losses a serious problem (off-budget)
• With current trends in growth and interest rates,
simulations show TFC targets can be reached with a
cross-sectoral program of state and center reforms
Summing Up
Once you take into account:
• Macro-micro linkages
• Lags
You come up with:
• More positive interpretation of post 1997 macro
outcomes
• Strong likelihood that growth surprise of past few
years is based on strong microfoundations and
therefore durable
BUT infrastructure constraint remains. India is not yet
out of the woods.
Lessons
• Rules of thumb on “prudent” debt-to-GDP levels of
limited use
• India’s self-insurance after 1991 has echoes in other
EMs post 2000. In all cases, public investment has
been cut, fueling concerns about LR g
• Long lags may need to play out before it becomes
obvious whether public debt is sustainable
(indictment of unit root tests)- market myopia might
derail the process
• India was helped by going slow on CAC and
domestic financial liberalization.
Things needing further
analysis
• Impact of cuts in cap exp
• Ways of closing the infrastructure gap and
government’s role
• Likely response of states to 12th FC
• Micro restructuring in real and financial sector
consequent upon 1991 reforms.
THANK YOU!