Poverty Reduction and Economic Management Unitsiteresources.worldbank.org/INTINDIA/Resources/TamilNadustudyreport.pdf · (MTFP). Tamil Nadu has little choice but to return to the

Poverty Reduction and Economic Management Unit

South Asia Region

Report No. 31789-IN

Disclaimer

All rights reserved. The findings, interpretations, and conclusions expressed herein are those of the author(s) and do not necessarilyreflect the views of the Board of Executive Directors of the World Bank or the governments they represent. Copying and/ortransmitting portions or all of this work without prior permission may be violation of applicable law. The World Bank encouragesdissemination of its work and will normally grant permission promptly. Any queries in this regard should be addressed to the Office of the Publisher, World Bank, 1818 H Street NW, Washington, DC 20433, USA, fax 202-522-2422, email: [email protected]

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Preface

3

Vice PresidentPraful C. Patel, SARVP

Country DirectorMichael F. Carter, SACIN

Sector DirectorSadiq Ahmed, SASPR

Sector ManagerIjaz Nabi, SASPR

Task ManagersLili Liu, PRMEP

Mohan Nagarajan, SASPR

CURRENCY EQUIVALENTS

Currency unit: Rupees (Rs)

US$1 = Rs 45.24

1billion = 100 crore

GOVERNMENT'S FISCAL YEARApril 1 - March 31

BPL Below Poverty Line

DVAC Department of Vigilance & Anti-Corruption

FMIS Tamil Nadu Farmers Management ofIrrigation Systems Act

GDI Gender Development Index

GoI Government of India

GoTN Government of Tamil Nadu

GSDP Gross State Domestic Product

HD Human Development

HDI Human Development Index

IPPs Independent Power Producers

LTU Large Tax Payers Unit

MDGs Millennium Development Goals

M&E Poverty Monitoring and Evaluation

MTFP Medium-Term Fiscal Program

NFHS National Family Health Survey

NMS Noon Meal Scheme

NSSO National Sample Survey Organization

O&M Operations and Maintenance

PDS Public Distribution System

PSU Public Sector Undertakings

RASI Rural Access to Services through Internet

RTI Right to Information

SC/ST Scheduled Castes and Scheduled Tribes

SERC Staff and Expenditure ReformsCommission

SME Small and Medium Enterprises

SSIR Small Scale Industries Reservation

STU State Transport Unit

TFC Twelfth Finance Commission

TNEB Tamil Nadu Electricity Board

ULB Urban Local Bodies

VAT Value Added Tax

ABBREVIATIONS AND ACRONYMS

Preface i

Overview iii

Executive Summary ix

I. Development Outcomes and Challenges 1Development Outcomes 3Development Challenges 6Reform Agenda 12

II. Achieving Fiscal Correction and Stabilization 17Tamil Nadu’s Fiscal Reform 19Initial Outcome of Fiscal Reform 31Medium-Term Adjustment Path 34Fiscal Sustainability and Risks 36

III. Improving Investment Climate for Manufacturing and Services 41Removing Regulatory Burdens 44Resolving Infrastructure Bottlenecks 47Institutionalizing Public and Private Sector Dialogue 51

IV. Reinvigorating Agriculture Growth 53Salient Features of Agriculture 55Efficient Water Resource Management 56Challenges of Agriculture Diversification 59

V. Improving Public Administration and Enhancing Service Delivery 63Rationalizing the Role of Government 65Streamlining Decision Making 66Improving the Stability of Staff Tenure 66Improving Critical Services with a Large Public Interface 67Procurement Reform 68Right to Information 68Enforcing Anti-Corruption 69

VI. Strengthening Poverty Monitoring and Evaluation 71

VII. Reform Challenges and Risks 77

ANNEXESAnnex 1 A Functional Reorganization Scheme for the Commercial Tax Department 85

Annex 2 Budget and Financial Management Reforms 89

Annex 3 Reforms to Improve the Investment Climate 95

Fiscal Data Annex 99

References 107

Page No.

i

This volume presents a synthesis of five policynotes prepared by the World Bank staff incollaboration with the Government of TamilNadu to support its reform program between2002 and 2004. The five notes span fiscalreform and sustainability, improving investmentclimate, agriculture development, governancechallenges, and poverty profile. An overview ofthe main messages of the five notes is alsopresented. The report reflects the status ofpolicy dialogue up to March 2004 with a fewselected updates.

ACKNOWLEDGEMENTThe notes were prepared by a team led by Lili Liuand Mohan Nagarajan, under the overallguidance of Sadiq Ahmad and Michael Carter,and with advice from Ijaz Nabi and StephenHowes. The peer reviewer is Shahid Yusuf.Major contributions to the notes are listed below.Ahmad Ahsan provided valuable comments onthe report.

Fiscal Reform and Sustainability: Lili Liu, MohanNagarajan (co-task managers), MichaelEngelschalk and Tuan Minh Le on tax policy andadministration, Anand Rajaram on expenditurereform, Mohan Gopalakrishnan and Peter Deanon financial management and accountability,Elena Ianchovichina on fiscal sustainability, YeeMun Sin on pension reform, Rajesh Sinha andRohit Mittal on power, and Smita Kuriakose onfiscal data.

Improving Investment Climate: Lili Liu, Simon C.Bell and Abha Joshi-Ghani (task mangers), TayeAlemu Mengistae on investment climate surveyand analysis, Andrew Singer on regulatoryconstraints, Nagavalli Annamalai on labor marketreform, Michael Engelschalk and Tuan Minh Le ontax policy and administration, David Dowall onurban land market, Rajesh Sinha and Rohit Mittalon power, Arnab Bandyopadhyay on roads, AbhaJoshi-Ghani on water, and Ted Liang on ports.

Agriculture Development: Paul A. Dorosh andMona Sur.

Governance Challenges: Vikram K. Chand.

Poverty Profile: Tara Vishwanath (coordinator),Peter F. Lanjouw (poverty profile), and RajiJayaraman (village studies).

Shahnaz Sultana Ahmad, Jyoti Sriram, ThelmaRutledge, and Oxana Bricha provided documentpreparation assistance.

The policy notes were developed in consultationwith the Government of Tamil Nadu. Thecounterpart was led by Mr. N. Narayanan, FinanceSecretary and Development Commissioner.Officials in the Finance Department, IndustryDepartment, Agriculture Department, PublicAdministration Department, Labor Department,Tamil Nadu Electricity Board and numerous othergovernment departments, agencies and statutory

EEccoonnoommiicc GGrroowwtthh aanndd PPoovveerrttyy AAlllleevviiaattiioonn iinn TTaammiill NNaadduuNNootteess oonn SSeelleecctteedd PPoolliiccyy IIssssuueess

PPrreeffaaccee

Economic Growth and Poverty Alleviation in Tamil Nadu

ii

boards provided unstinted help during thepreparation of the report. Special thanks areparticularly due to Mr. L. Krishnan, SpecialSecretary, Finance Department, Mr. AshishVachhani, Deputy Secretary, Finance Departmentand Mr. Brajendra Navnit, Deputy Secretary(Budget) for their unstinted generosity with allmanner of data and information. As always anyshortcomings lie squarely with the authors.

We are also grateful to the large number ofenthusiastic participants, too numerous to

name, who participated in the workshop in Chennai held in October 2004. Theircomments were all welcome. We are especiallythankful to Professor Rajah J. Chelliah,Chairman, Madras School of Economics, Dr. V.K. Natraj, formerly, Director of the MadrasInstitute of Development Studies, Mr. SubhashC. Garg, Joint Secretary, Department ofExpenditure, Ministry of Finance, Governmentof India and Mr. B. Santhanam, Saint GobainGlass India Ltd. for their support andperceptive comments.

Tamil Nadu has emerged as the fifth largesteconomy in India (its population of 62 million isthe seventh largest). Its GSDP is about US$38billion at official exchange rate or over US$100billion based on purchasing power parity. TamilNadu has achieved solid development outcomes,with economic growth higher, and povertyreduction faster, than the India average in the1990s. It is one of India's most urbanized states,with the third highest Human DevelopmentIndex (HDI) among 29 states. It also has aneducated, hard working and disciplinedworkforce, and a capable civil service.

But Tamil Nadu has an unfinished developmentagenda. The state has a relatively high povertyincidence of about 20% and intra-statedisparities in progress toward the attainment ofthe Millennium Development Goals (MDGs). Afiscal crisis that peaked in 1999/00-2000/01 andslowdown in economic growth since the late1990s threaten the prospects for sustainedpoverty reduction. Repeated droughts andgrowing water shortages heighten the importanceof structural transformation that would reducethe vulnerability of the economy to periodicdroughts through fluctuation in agriculture andits spillover to other sectors, and make availablescarce water resources to higher value-additionindustrial and service sectors. The faster growthof these two sectors would help absorb

agriculture's surplus labor and reduce highunemployment rate of the state.

Such structural transformation must beunderpinned by fiscal adjustment to put publicfinances on a sustainable path, while at the sametime reorienting public spending fromconsumption to growth-enhancing and poverty-reducing spending in critical infrastructure andsocial services. Power sector reforms to reduce thesector's claim on fiscal resources and improvepower supply is a high priority. Equallyimportant are enabling investment climateimprovement to promote private investment inmanufacturing and services, policies andinstitutional reforms to encourage agriculturediversification to high value and less water-intensive crops, and improving governance forservice delivery.

Spurred by the mounting fiscal crisis and slowinggrowth, the Government of Tamil Nadu (GoTN)started implementing wide-ranging fiscal andstructural reforms from late 2001 to 2003/04.Though a late comer, Tamil Nadu's fiscal reformproceeded at a rapid pace that stemmed the fiscaldecline. Several reforms were bold and pathbreaking both in the context of the past historyof the state, and in the national context.However, fiscal policy reversals by the GoTN inareas such as electricity tariff, the public

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EEccoonnoommiicc GGrroowwtthh aanndd PPoovveerrttyy AAlllleevviiaattiioonn iinn TTaammiill NNaadduuNNootteess oonn SSeelleecctteedd PPoolliiccyy IIssssuueess

OOvveerrvviieeww

distribution system and user charges - in theaftermath of electoral losses in the April-May2004 national elections - have the potential ofincreasing the revenue (current) and fiscal deficitand jeopardize the gains made thus far,threatening fiscal consolidation and thecredibility of the Medium Term Fiscal Program(MTFP). Tamil Nadu has little choice but toreturn to the path of fiscal consolidation if it is tomeet its development goals.i

Tamil Nadu was struck by a massive tsunami onDecember 26, 2004 leading to tragic loss of 8,010lives and loss of livelihood of 400,000 families.130,000 families were displaced. The Tamil Nadugovernment has estimated the financialrequirements for relief and rehabilitation to thevictims of this massive human tragedy and affectedinfrastructure at Rs. 4,800 crore. Rehabilitation andrestoration of livelihood is expected to be spreadover three years. This report was written before thetsunami struck Tamil Nadu. An assessment of theeconomic and fiscal impact of the tsunami hastherefore not been factored into this report.Preliminary estimates of the fiscal impact on thestate's finances of the expenditure on tsunami reliefand rehabilitation for 2004/05 are placed at 0.2percent of GSDP and over the next three years theimpact is estimated to be 0.7 percent of GSDP eachyear. However, the actual fiscal impact on TamilNadu will depend on the nature of the reliefassistance provided by the Government of India tothe GoTN and how much of that will be throughthe state's budget and/or through banks andcooperative institutions. To the extent that a grantelement will dominate central governmentassistance to tsunami affected states to meet the costof rehabilitation the fiscal impact on the state will beminimized. Some of the assistance will be passedthrough to the state budget, such as centralgovernment subsidy to fishermen to obtain loans

from commercial banks to repair and buy boats.For instance out of Rs. 2,347 crore assistanceannounced recently by the central government forpurchase of fishing vessels and nets grants of onlyRs. 441 crore would be routed through the TamilNadu government whereas the rest is to be providedas soft loans by commercial banks.

The other event that will have a great bearingon state governments' finances over the nextfive years beginning 2005/06 is the TwelfthFinance Commission's (TFC) awards for theperiod 2005/06 to 2009/10. The TFC hasfixed Tamil Nadu's share in the total divisiblepool of central taxes at 5.305% as opposed tothe prevailing 5.385%, a marginal decrease.But states' share in the centre's total divisibletax pool has been increased from 29.5% to30.5%. Tamil Nadu's effective share istherefore unaltered at 1.6% of central taxes.The total devolution of central taxes to TamilNadu over the five year period is estimated bythe TFC at Rs. 32,553 crore. The TFC hasdone away with normal central loan assistancefor state plans in favor of market borrowings.Tamil Nadu is not affected by this change.The TFC also recommended debt relief to thestates in the form of restructuring of all centralloans with state governments' as of March 31,2004 outstanding as of March 31st, 2005. Theloans will be consolidated and rescheduled at7.5% interest rate repayable over twenty years.This has been made conditional on states'enacting Fiscal Responsibility Legislationwhich Tamil Nadu government already has andis therefore straightway eligible for debtrestructuring. As a result, Rs. 6,872 crore ofoutstanding central loans on Tamil Nadugovernment's books will be restructured. TheTFC has also recommended debt write-offlinked to reduction in the revenue deficit of


iv

i Tamil Nadu's tenth plan (2002-2007) envisages a real economic growth rate of 8%. The Plan's goal is to make TamilNadu the best state in the country and provide opportunities for a healthy and productive life for all.

the state government. Under the scheme, acertain proportion of repayment ofrescheduled debt will be written off byGovernment of India over the period 2005/06to 2009/10. The quantum of write-off islinked to the absolute amount of reduction inthe revenue deficit each year with the ultimateobjective of eliminating the revenue deficit by2008/09. Tamil Nadu can benefit to the extentof Rs. 1,718 crore in debt write-off under thescheme. Tamil Nadu also gets Rs. 1,826 crorein special purpose grants over the TFC awardperiod. The TFC's recommendations and arevised Medium Term Fiscal Policy of theTamil Nadu government incorporating theTFC award became available after this reportwas prepared. This report has been updated

with information from these two documents tothe extent possible.

To provide context, this report begins by reviewingdevelopment outcomes and challenges, includingthe Millennium Development Goals, in TamilNadu (Section I). Section II focuses on fiscalcorrection and sustainability. Section III focuseson improving investment climate for promotingprivate sector development in manufacturing andservices. Section IV is devoted to reinvigoratingagriculture growth. Section V addresses challengesof strengthening public administration andimproving service delivery. Section VI discussesthe strengthening of poverty monitoring andevaluation. Section VII concludes with asummary of reform challenges and risks.

Overview

v

Tamil Nadu's DevelopmentAchievements and ChallengesSuccessful poverty reduction anddevelopment outcomesTamil Nadu's performance on poverty reductionwas above India's national average in the 1990sachieving an above-average reduction in povertyin both rural and urban areas. Tamil Nadu'spoverty headcount has reduced from 35.4% in1993/94 to 21.1% in 1999/2000 according toPlanning Commission's estimates. Notablesuccess has been achieved in human developmentoutcomes too in the state. From being a near-average state with a Human Development Index(HDI) of 0.343 in 1981, Tamil Nadu has movedto a high-performing state with the third highestHDI of 0.531 in 2001. Tamil Nadu is on track tomeet most of the Millennium DevelopmentGoals (MDGs), with trend performance betterthan required for such important MDGs aspoverty reduction, child malnutrition, schoolenrollment, and infant mortality.

Tamil Nadu's success is the result of sustainedeconomic growth and an effective humandevelopment strategy. The strategy has focused onthree main areas: (i) expanding the coverage ofsocial services, (ii) improving the quality of servicesprovided, and (iii) ensuring wide participation ofthe poor and other marginalized groups.

Notwithstanding positive developmentoutcomes, Tamil Nadu faces many developmentchallenges. Still a low-income state, Tamil Nadu

has a relatively high poverty incidence, andgender, caste, and intra-state disparities in keypoverty and social indicators. High drop-out andlow completion rates continue to reduce theeffectiveness of Tamil Nadu's secondaryeducation program. The crude birth rate hasbeen hovering around 19-20, neo-natal mortalityhas been stagnating, and female infant mortalityrate remains high. There are significant rural-urban differentials and inter-district variations.The state also faces a high rate of malnutrition inchildren, and confronts a high prevalence ofHIV/AIDS. Tuberculosis is reemerging inassociation with HIV/AIDS and non-communicable diseases are on the rise.

Growth has slowed down The liberalization in the 1990s acceleratedeconomic growth in Tamil Nadu. However, inrecent years growth has slowed, from an annualaverage of 6.6% from 1990/91 to 1998/99 to anannual average of about 3.7% from 1999/00 to2002/03. Much of the recent slowdown isattributed to the impact of the droughts onagriculture and their spillover to other sectors.Three annual droughts, led to an annual averageof -3.9% growth during 1999/00-2002/03compared with an annual average of 4.5% in theprevious nine years. Although droughts areexogenous shocks, there are structuralimpediments, overcoming which could puteconomic growth on a higher trajectory path of8% targeted by the GoTN to accelerate the paceof poverty reduction. Tamil Nadu's agriculture

ix

EExxeeccuuttiivvee SSuummmmaarryy

faces challenges of growing water scarcity, land-degradation, decline in farm sizes, and rising costof agricultural labor.

Although, Tamil Nadu has been one of the mostfavored foreign and domestic investmentdestinations in India accounting for 15% of all-India merchandise exports and 17% of all-India ITexports, the investment climate faces severalconstraints. Rigid labor regulations, a complex andcascading indirect tax system, protracted exit andbankruptcy procedures, and infrastructuredeficiencies are among the key constraints to bettermanufacturing performance in India and TamilNadu is not an exception. The World Bank's 2003investment climate survey of the manufacturingsector in Tamil Nadu reaffirms this assessment.Higher manufacturing growth, together with thegrowth of the service sector, is critical to absorbingsurplus agriculture labor and reducing rural poverty.

Fiscal ReformsFiscal crisis threatened prospects ofsustained poverty reduction interventionby the state The fiscal crisis beginning in 1998/99 andslowdown in economic growth since the late1990s not only seriously threaten the prospect forsustained poverty reduction in the future but alsoendanger the gains already made. The mostimmediate challenge that faced Tamil Nadu in2001/02 was to reverse the rapid fiscal declineand create fiscal space for development spending.With salaries and pension of governmentemployees (2% of the state's population)-accounting for government's entire own revenueduring the crisis there was little fiscal space leftfor essential infrastructure and social spending.

State Government launched ambitiousreforms targeting fiscal correction andrestructuring public expenditure Beginning from 2001, the government embarkedon ambitious reforms over the next two yearstouching a number of areas in both revenue and

expenditure. The government proceeded to do soat a rapid pace to catch up with other reformingstates such as Andhra Pradesh and Karnataka.Some of the reforms were bold and path breakingboth in the context of the past history of thestate, such as in the Public Distribution System(PDS) and agriculture power tariff, and in thenational context such as pension reform. Thereforms were undertaken, notwithstanding adifficult economic environment posed bysuccessive droughts and low economic growth.Significant gains were made over the next twoyears and aggressive fiscal reform targets were setfor the future. By attempting expenditurereallocation the program sought to improvegrowth and human development achievement.

Critical elements of the fiscal reform programincluded: the development of a multi-yearframework for fiscal adjustment through aMedium Term Fiscal Policy Statement (MTFP);improving legislative oversight and fiscaltransparency; restructuring high-cost public debtand management of guarantees; improving theefficiency of the tax administration; rationalizinguser charges; introducing a targeted PDS,introducing agricultural power tariff; reformingstate-owned manufacturing enterprises and ailingcooperatives; and strengthening public expendituremanagement and financial accountability toincrease the efficiency of public spending.

The impact of the fiscal adjustment program hasbeen impressive. While the revenue (current)deficit declined from 2.1% of Gross StateDomestic Product (GSDP) in 2000/01 to 0.9%of GSDP in 2003/04 and 2004/05(RE), thefiscal deficit declined from 4% of GSDP in2000/01 to 2.4% of GSDP in 2003/04; butincreased to 2.9% in 2004/05(RE). The state alsoachieved a primary surplus of 0.3% of GSDP in2003/04 as compared to a deficit of -2.5% ofGSDP in 1999/00. A key objective of fiscaladjustment was cleaning up of accumulatedarrears from prior years. A large amount of

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arrears, Rs. 3,062 crore equaling to 2% of GSDP,was cleared in 2002/03, including thesecuritization of Rs.1,962 crore of dues to centralelectricity utilities by the Tamil Nadu ElectricityBoard. The consolidated fiscal deficit (whichconsolidates the non-power budget fiscal deficitwith the Tamil Nadu Electricity Board'sfinancing requirements) was reduced from a peakof 6.7% of GSDP in 1999/00 to 4.8% of GSDPin 2002/03. The close to two percentage pointreduction from 1999/00 to 2002/03 was largelyattributed to an increase in the ratio of the state'sown tax revenue to GSDP (from 8.6% in1999/00 to 9.3% in 2002/03), and a reductionin the ratio of salaries to GSDP (from 6.5% in1999/00 to 5.2% in 2002/03). The consolidatedfiscal deficit decreased further to about 3.8% ofGSDP in 2003/04.

The composition of expenditure has shownimprovement with higher allocations for non-wage Operations and Maintenance expenditure,particularly in 2003/04 and 2004/05(RE). Theshare of capital outlay, net lending, non wageoperations and maintenance expenditure showedsharp recovery in 2003/04 and 2004/05(RE)after declining over the earlier two years.

Based on the fiscal turnout in 2004/05(RE) andtaking into account the Twelfth FinanceCommission's recommendations, theGovernment of Tamil Nadu has tabled a revisedMTFP along with the 2005/06 budget. TheMTFP revised along conservative lines seeks togenerate a revenue surplus by 2008/09 and bringthe fiscal deficit to below 3% of GSDP by2005/06. The MTFP targets are achievable.Getting the full benefit of the Twelfth FinanceCommission's recommendation on debt reliefand write-off is conditional on the state meetingthese revised targets.

The Government of Tamil Nadu has initiatedreforms of the systems and processes of budgetformulation and execution. However, reforms are

needed to achieve the Government'sdevelopment objectives and to adapt theinstitutional arrangements to support fiscalstrategy. The key challenge is to ensure that acomprehensive resource framework and amedium-term perspective effectively guide thethree objectives of budget management:aggregate fiscal discipline in line with themedium-term fiscal program, strategic policydecisions by the Government within theconstraints of the fiscal program, and efficientuse of public expenditure in governmentoperations. The Tamil Nadu Fiscal ResponsibilityAct (FRA), already passed by the government laysthe foundation for aggregate fiscal discipline byemphasizing transparency and disclosure of themedium-term fiscal program with each budget.But attention will be required to comply withFRA provisions.

Tamil Nadu needs to substantially strengthen itsupstream capacity for policy formulation. Theestablishment of a Policy Review Committee, tobe chaired by the Development Commissioner,could provide leadership and focus to this keycapacity-enhancing reform. The Policy ReviewCommittee can rely on a network of public andprivate institutions to undertake public policyresearch and analysis.

An early submission of the draft budget to thelegislature can help bring budget approval closerto the start of the fiscal year, facilitating budgetexecution. A review of budget executionprocesses can help identify and address currentweaknesses. Together with improvements ininternal control systems, the Governmentshould explore an increase in the scope forvirement within departmental budgets. TheGovernment should also plan to constitute astanding Expenditure Review Committee toundertake rolling annual reviews of departmentsto identify unproductive programs and torationalize and improve efficiency of existingprograms.

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Executive Summary

The framework for public financialaccountability in Tamil Nadu is generally sound.Nevertheless, several areas need strengthening.The need for reform is particularly evident in thearea of budget execution procedures, includingthe weaknesses in internal controls and the needto eliminate or reduce reliance on PersonalDeposit Accounts in the Public Accounts. TheGovernment also needs to develop measures toaddress key internal control issues such asreconciliation of accounts, reconciliation of loansand advances, timely submission of utilizationcertificates, and incentives for compliance.

Policy reversals after national elections of2004 impede accelerated progress in fiscalrestructuringFollowing the national elections in April-May2004, in the state, key policy reforms were rolledback. A series of quick reversal of significantreform measures was announced (power, PDSand reintroduction of free bus passes for studentsand withdrawal of other minor user charges).This has posed increased expenditure besidesmaking it more difficult in the future to return tothe policy reform path. Extension of free powerto all agriculturists and slashing power tariff todomestic consumers to pre-reform levels of 2001is expected to cost Rs. 920 crore in 2004/05,withdrawal of PDS targeting will raise foodsubsidy by about Rs. 130 crore in 2004/05 andrestoration of student bus passes & concessionfare would cost Rs. 125 crore in 2004/05.Additional expenditure on account of theseproposals in 2004/05(RE) is about Rs. 1,650crore. The impact of these is seen in the2004/05(RE) wherein despite higher revenueoutturn and large savings in salary and pensionexpenditure (as compared to the budget), thefiscal deficit increased to 2.9% of GSDP ascompared to 2.4% in 2003/04.

If the fiscal reform and MTFP are broadly ontrack, Tamil Nadu's debt stock is expected tostabilize around 31% of GSDP (from 28% in

2003/04), a level below that in many otherIndian states. However, due to fiscal burden ofrecent policy reversals, the debt to GSDP ratiomay increase to 32% of GSDP by 2008/09.

Improving the Investment Climate Complementary focus on improving theinvestment climate required foraccelerating growth Fiscal reform must be complemented with astrong program to improve the investmentclimate for accelerating economic growth andpoverty reduction. Findings from the investmentclimate surveys in Tamil Nadu suggest thatcumbersome and excessive regulation andinfrastructure bottlenecks are major or seriousconstraints to growth. Recognizing the role of theprivate sector as an engine of economic growth,the Government of Tamil Nadu has put emphasison streamlining complex government regulationsover private investment and production, and onstrong partnership with the private sector forsustainable infrastructure financing anddevelopment. A number of infrastructureprojects executed in the Public PrivatePartnership (PPP) format bear testimony togovernment's commitment.

The reform agenda before the government dealswith not only regulatory policies and practicesconcerning all factor markets (labor, land, andcapital), but also regulation of entry/exit forenterprises and tax policy and administration.There are 23 Union Acts and seven State Actsand Rules which are enforced by the LaborDepartment in Tamil Nadu. For each of thesesubjects there are different enactments by thecenter as well as implementing rules by the state.Many regulations are excessive and outdated(e.g., no overlapping of shifts, capping ofovertime, official permission required forworking on Sunday or holidays, specifiednumber of food cafeterias, and over 60 types ofminimum wages). Labor regulations are largelywithin the purview of the central government.

xii


Nonetheless, within the federal framework,Tamil Nadu can explore ways to rationalize andconsolidate implementing rules concerning thelegal framework governing labor and statutorycompliance requirements to create elbow roomfor contractual labor relationship and for easingthreshold for retrenchment.

Urban land market suffers from systemicweaknessesTamil Nadu's urban land market suffers fromsystemic weaknesses. Master plan designations inthe absence of complementary incentives andmeasures make the supply of land fordevelopment inefficient. Urban land issues arewithin the purview of the state government. It isimportant to rationalize regulations on urbanland zoning and development controls, projectapproval and land acquisition processes, anddevelop a more effective planning andmanagement system to facilitate infrastructuredevelopment.

Tax administration imposes highcompliance costsThe tax administration imposes high compliancecosts by, for example, lack of self-assessment inthe sales taxation for large businesses and ofelectronic filing, cumbersome registrationprocedures, and time-consuming disputeresolution, which all encourage undesirablefrequent contacts between businessmen and taxofficials. Some of these and tax issues will beresolved when VAT is implemented.

Streamlining Business EntryTamil Nadu has made progress in simplifyingregulations over business entry. The sequentialand protracted approval process involvingmultiple government departments/agencies hasbeen replaced by a streamlined and coordinatedone for large investment projects. Thestreamlined process for large investment projectsneeds to be extended to all medium-sized andsmall projects.

Infrastructure a constraint to improvingcompetitivenessPower has become a major infrastructureconstraint despite the relative efficiency of thestate power utility and having the secondlargest power market in India. High powertariff to industries and poor quantity andquality of power supply reduce thecompetitiveness of Tamil Nadu's industries.The financial stress of the TNEB, arisinglargely from cross subsidy to agriculture (andnow the domestic consumer segment also), hasincreasingly constrained its investment abilityto improve the quality of power supply. Likemany other states, Tamil Nadu will need to finda political solution to the metering ofagriculture pump sets and reduction of cross-subsidy to improve the competitiveness ofindustry and services.

A clear regulatory framework for support ofpublic private partnerships in infrastructureneeds to be put in place which would define therole of the government and the private sector, layout the risk sharing principles and also regulatethe tariff regime for private roads. An importantpriority is to press forward with fiscal reform tocreate fiscal space for investment in theinfrastructure sector.

Priority ReformsPriority reforms comprise the following areas:labor market flexibility; a more responsive urbanland supply system; more efficient tax policy andadministration; continuing reform to ease entryand operation; power sector reform; and scalingup PPP for sustainable infrastructuredevelopment. Some of which are not entirely inthe state's purview, but which the state canarticulate in its dialogue with the centralgovernment. The wide scope of issues is notsurprising and will thus require aninstitutionalized dialogue between theGovernment and the private sector for settingpriorities and finding solutions.

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Executive Summary

AgricultureTraditional sources of agricultural growthface major constraintsWhile agricultural sector growth rates in TamilNadu were among the highest in India during the1980s and early 1990s, deceleration in growthsince the mid-1990s is of increasing concern topolicymakers. During the 1980s agriculturalGSDP grew at 3.4 percent, exceeding the all-India agricultural growth of 2.9 percent. Butrepeated drought in the nineties meant that thestate's agricultural growth rate was only 2.9percent a year, compared with 3.2 percent for thenation. Analysis has shown that a one percentincrease in rainfall relative to the mean isassociated with a 0.3 percent increase in realagricultural GSDP relative to the trendagricultural GSDP.

There are three salient features of Tamil Nadu'sagriculture that set the political economy contextfor searching a viable strategy for revitalizingagriculture growth: water scarcity; the large shareof rice and sugar cane (both water-intensivecrops) in total irrigated land; and the dominanceof small and marginal farmers in overallagriculture production. Faster growth inagriculture is central to rural development andpoverty reduction in Tamil Nadu. Althoughagriculture accounts for only 14% of TamilNadu's GSDP and non farm income accounts forabout 50% of rural household income, farmincome accounts for about half of householdincome for 35 million people (56 percent of thestate's population) who live in rural areas.

Traditional sources of agricultural growth,however, face major constraints includinggrowing water scarcity, increasing landdegradation and declining farm sizes, and risingcosts of agricultural labor. The agricultural sectorfaces increasing competition for water fromindustry and domestic users and intensifyinginterstate competition for surface waterresources. In many parts of the state, the rate of

extraction of groundwater has exceeded rechargerates, contributing to falling water tables.Efficient water resource management is a keypriority for not only agriculture but also theentire state economy requiring complexregulatory and institutional changes beyond themedium term.

Crop Diversification important for futureagricultural growthGiven water scarcity, diversification into less-water intensive higher-value products is the mostpromising avenue for future agricultural growth.Broader institutional and policy reforms arerequired to efficiently manage scarce waterresources, decentralize the agricultural extensionsystem, improve rural infrastructure to facilitateefficient markets, and reorient publicexpenditure towards growth-enhancing areassuch as rural roads, markets and agriculturalresearch.

Marginal Cost pricing of water andelectricity will rationalize water useGradual steps towards marginal cost pricing ofwater and electricity, (perhaps combined withcompensation to farmers in the form of incometransfers or more reliable electricity supply),would help rationalize water use in Tamil Nadu.The agricultural power tariff introduced inMarch 2003 included a flat rate for unmeteredconnections of Rs.250 per horsepower a year andRs.0.20 per kilowatt-hour for meteredconnections. Along with the reintroduction ofagricultural power tariff, the governmentannounced an income support scheme forsmallholders and marginal farmers. Under theincome support scheme, the Government ofTamil Nadu provided smallholders and marginalfarmers a transfer of up to Rs. 1,250 a year. Thiswas a significant step toward creating a moredirect and transparent system of subsidies tofarmers and other target groups and ensuring theseparation of commercial operation of the powerutility from the need for subsidy. However, these

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initiatives were rolled back after the nationalelections in 2004.

Metering of farmers is critical to link agriculturaltariffs to consumption levels. Metering will alsoenable power subsidy to be better targeted. Iffarmers costs and incomes varied according to theamount of electricity (and water) used with wellirrigation, farmers would have an incentive toshift some land from water-intensive cropstowards less water-intensive crops. Greaterattention to marketing infrastructure,strengthening the research and extension systemto meet the needs of diversified agriculture, thedevelopment of tools for farmers to bettermanage risks, improving irrigation pump setefficiency and putting in place safety net programto cushion against the risk of diversificationparticularly for small and marginal farmers whorely mainly on agriculture subsistence incomemay create an environment within which higherpower charges would be more palatable forfarmers.

Governance and Service DeliveryThe government's capacity to deliverservices needs strengtheningThe strengthening of public expendituremanagement and financial accountability wouldneed to be supported by public administrationreform to enhance service delivery. Tamil Naduhas done well in delivering key services: A recentsurvey conducted by the Public Affairs Centerreveals that the state has the country's best publicdistribution and school education systems, andthe second best public drinking water and roadtransport services after Gujarat. This, of course, isnot a uniform picture: health services, forexample, are ranked fifth.

Tamil Nadu faces several critical challenges thatneed to be addressed to preserve and extend thegains made so far. To support fiscal reform and thereform of the investment climate, service deliveryreform would also need to focus on strengthening

the effectiveness of the government byrationalizing its role and responsibilities,simplifying decision-making processes, improvingthe stability of staff tenure, and enhancing criticalservices delivery-which have a large publicinterface through a combination of measures suchas agency reform, e-governance, and publicprivate partnerships. Further, the reform wouldneed to address the transparency issues regardinggovernment and corruption, through a majoroverhaul of the public procurement system,enacting new "Right to Information" legislation,and strengthening the anti-corruption machinery.

Improving Civil Service productivity is keyto efficient government The civil service in Tamil Nadu has proliferated inthe last twenty years: Tamil Nadu today possessesthe highest ratio of civil servants per hundredpopulation in India of any major state afterPunjab. To rationalize and restructure the civilservice and improve its productivity, theGovernment constituted a Staff and ExpenditureReforms Commission (SERC) in December 2001to systematically review and realign the roles andresponsibilities of each of the 140 departments andidentify redundant departments/functions/posts,including areas where the government should exitand let the private sector take over. The exercisewas carried out with the benefit of extensiveconsultation within the government, includingwith staff associations and unions, as well asconsultation with the public. The SERC reportshave identified about 85,000 surplus posts, and113,000 vacant posts made feasible by hiringfreeze. The reduction in the core civil service size(posts) by 2007/08 (from 2002/03) can beachieved by abolishing 85,000 posts using2002/03 as the base year. The abolishing of thesurplus posts will enable a more efficient allocationof staff across departments within the targetedceiling.

To simplify the decision-making process, theSERC also reviewed the functioning of the

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Executive Summary

Secretariat, focusing on improving efficiencythrough delegation to heads of departments,level-jumping, the introduction of the single-filesystem, and computerized file monitoring andgreater flexibility for redeploying staff. Thegovernment has issued orders permitting leveljumping of files.

Responding to the problem of pre-maturetransfers, the Government introduced a system offormal counseling for transfers in both theHealth and Education Departments. TheGovernment has also issued orders regardingnorms to be followed in transfers covering theentire civil service. The order specifiestransferring authorities, established norms forthree- to seven-year tenure, limited transfers to20% of cadre strength and to the season only,and announced the creation of a public transferdatabase on the internet to track transfers overtime.

Room for improving Service DeliveryWhile Tamil Nadu has done well in servicedelivery in some key areas relative to the rest ofthe country, there is still room for improvement.A number of reforms are ongoing; these includeimproving the Registration Department byintroducing a computerized guidance valuecalculation software package for use in its sub-registries, and promoting the development ofkiosks in villages to improve rural service deliveryand empower rural citizens.

Over the next few years, in addition to policy andinstitutional reforms in critical sectors such aswater supply and sanitation, education andhealth to enhance service delivery, theGovernment plans to focus on improving 10critical services with a large public interface,including regional transport services, commercialtax, stamps and registration for propertytransfers, district administration, and localbodies. It plans to accomplish this through acombination of measures such as e-governance,

process reengineering, citizens' charters, andpartnerships with the private sector. Revision ofcitizen charters for agencies with large publicinterface must be done on a priority basis (e.g.district hospitals) and surveys used to providefeedback.

Systemic reforms required to improveTransparencyTamil Nadu was the first Indian state tointroduce legislation, in October 1998, toimprove transparency in public procurement andto regulate tendering and contracting proceduresof government departments, statutory bodies,public sector enterprises and other local bodies.The pace of procurement reform has beenaccelerated, focusing on the implementation ofthe Act. The government has completed a three-year comprehensive procurement reform action plan. This will include: setting up a complaint/challenge/appeal mechanism;finalizing and issuing five sets of StandardBidding Documents; finalizing the revision ofFinance, Accounts, and Public Works codes;improving works procurement procedures;introducing code of ethics for officials and the business community and tighteningenforcement; evaluation of reservation andexemptions with a view to provide a level-playingfield; enlarging the scope of rules to coverconsultant selection procedures; and issuingguidelines and directives on proceduralimprovements.

In addition to ongoing systemic reforms toprevent corruption (e.g., procurement reform,business deregulation, e-governance, and fiscaltransparency), enforcement efforts needstrengthening. The Vigilance Commission andits investigating agency, the Department ofVigilance and Anti-Corruption (DVAC)function as government agencies. Neither theVigilance Commission nor the DVAC possesseda public website to disseminate performanceinformation. The government needs to consider

xvi


the creation of an independent institutionalmechanism to focus on corruption and grievanceredressal in service delivery, and greatertransparency in the functioning of DVAC.

Tamil Nadu passed the country's first Right toInformation (RTI) Act in 1997; the Act itself,however, was flawed with numerous exemptions.The law falls below GoI's standards set in theFreedom of Information Act (2002), as well asthe standards of state laws in Delhi, Karnataka,and Maharashtra. The Government is currentlypreparing a new draft law that will provide forminimal exceptions, an independent appealsprocess, penalties for non-compliance, and moreautomatic disclosure of information bydepartments.

Poverty and Human Development The capacity to monitor the progress ofpoverty and human development remainscriticalAbout 12 million people live in poverty in TamilNadu. Scheduled castes and tribes are highlyrepresented among the poor due in part to theirowning less land, and of lower quality, as well asother assets (particularly human capital).Important challenges in the non-incomedimensions of poverty remain to be tackled inhealth, education, water supply and sanitationand nutrition.

The broad structural reform program thus needsto be supported by protecting the poor andvulnerable through targeted interventions. TheTenth Five-Year Plan provides a detaileddescription of the poverty-reduction programs,which are wide ranging, to cover health,education, water supply and sanitation, and foodsecurity. These programs include schemestargeted to particular social and demographicgroups such as scheduled castes and tribes,women and children. The specific interventionsbroadly match the spatial and social needsrevealed by the poverty diagnostics although

there is scope for improving the design andtargeting efficiency. To this end, strengtheningpoverty monitoring and evaluation for effectivetargeting is an important focus area. For example,developing strong institutional capacity forevaluation based learning is invaluable forimproving the targeting in schemes such as thePublic Distribution System. Similarly, buildinginstitutional capacity for an effective monitoringand feedback mechanism that ensures aligning ofbudgets to priority needs in education, healthand broader aspects of service delivery will beimportant in the coming years.

There appears to be a case for paying specialattention to the rural areas in the Coastal Northand the South, and possibly to the urban areas inthe Coastal North. Scheduled Castes andScheduled Tribes also appear to face particularbarriers to upward mobility, and the data suggestthat these stem at least in part from three sources:access to land, education, and regular non-farmemployment. Addressing them will therefore be avital part of any poverty alleviation strategypursued by the state.

Investment in poverty monitoring andevaluation important for developing acomprehensive poverty reduction strategyDeveloping a comprehensive poverty reductionstrategy will involve more investment in povertymonitoring and evaluation (M&E). This is not aproblem particular to Tamil Nadu: it is commonto all of the states in India, as it is to most of thedeveloping world. Monitoring of extant anti-poverty policies and social services more generallyis, however, important if one is to gauge whetherimplementation is proceeding according to planand achieving its stated objectives. TheGovernment of Tamil Nadu is an ideal agent forengaging in M&E, given its voluble commitmentto combating poverty, openness to receivingfeedback, and rich human capital resources.Impact evaluations are most appropriate toprograms which are innovative, replicable,

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Executive Summary

involve substantial resource allocations, and havewell-defined interventions.

The capacity to monitor the progress of povertyand human development and link that withoverall policy and poverty-reductioninterventions remains critical. There is also scopefor aligning the various programs listed in theTenth Plan to improve coordination andtargeting: many programs are not coordinated,with multiple, overlapping and sometimesdifferent objectives.

Capacity to manage a complex andgrowing reform agenda requiresstrengthening Substantial capacity building and broad-basedknowledge partnerships can help address themanagement of reforms in priority areas such as

water resources management, agriculturediversification, public expenditure management,and public-private partnerships in infrastructurefinancing and development.

In summary, much has been achieved but a lotremains to be done. Political economy andcapacity constraints may result in temporaryreform uncertainty. What is critical iscommitment to reform, as well as thesequencing and prioritization of reforms, andcareful managing of trade-offs in reform gains,costs, and risks. To do so, it is important tobuild a broadly-shared consensus throughpublic debate and to carefully design aminimum set of policies and programs tocompensate for the impact of reform, so as tomaintain a critical mass of support for reformsto proceed.

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3

Development OutcomesMillennium Development Goals (MDGs). Agraphical analysis of Tamil Nadu's performanceagainst six of the MDGs is presented below(Figure1.1). Tamil Nadu is on track to meetmost of the MDGs, with trend performancebetter than required for such important MDGs

as poverty reduction, child malnutrition,school enrollment, and infant mortality.Reduction in the discrepancy of male-to-femaleliteracy is slightly below the target.

Poverty outcome. Tamil Nadu's performance inpoverty reduction was above India's average in

DDeevveellooppmmeenntt OOuuttccoommeess

aanndd CChhaalllleennggeess

Note: The baseline for the MDGs is based on extrapolation from existing data to the MDG baseline year, 1990.

Figure 1.1: Progress in Tamil Nadu toward Key Millennium Development Goals (MDGs)

the 1990s (Figure 1.2), according to the Deatonand Dreze estimates (2002). Rural poverty inTamil Nadu fell from 38.5% in 1993/94 to24.3% in 1999/2000, compared with an all-India decline from 33% to 26.3% (Table 1.1).Rural poverty varied widely across regions in1993/94. As rural poverty has fallen, the sharpregional variation has also attenuated. Ruralpoverty is the highest in the coastal north.Poverty rates in urban areas also tend to be lowerthan those in rural areas. Urban poverty fell from20.8% in 1993/94 to 11.3% in 1999/2000,

compared with an all-India decline from 17.8%to 12%. Thus, compared with the all-Indiaperformance, Tamil Nadu achieved an above-average reduction in both rural and urban areas.Tamil Nadu ranks sixth out of the 15 major statesin per capita income.

It is important to note that poverty estimates inIndia based on the 55th round National SampleSurvey Organization (NSSO) ConsumerExpenditure Survey have been the subject ofmuch analysis and debate. Depending on the


4

Note: AP: Andhra Pradesh, BH: Bihar, GJ: Gujarat, HY: Haryana, KN: Karnataka, KR: Kerala, MH: Maharashtra, MP: MadhyaPradesh, OR: Orissa, PJ: Punjab, RJ: Rajasthan, TN: Tamil Nadu, UP: Uttar Pradesh, &WB: West Bengal. Angus Deaton andJean Dreze (2002), "Poverty and Inequality in India: A Reexamination," Economic and Political Weekly, September 7.

Source: CSO, NSSO, Planning Commission, Census of India.

Table 1.1: State-Specific Poverty Headcount Ratios in the 1990s (%)

Reduction from Reduction from Reduction from1999/00 1993/94 1999/00 1993/94 1999/00 1993/94

Rural Urban Combined

Andhra Pradesh 26.2 3.0 10.8 7.0 21.7 4.5

Karnataka 30.7 7.2 10.8 10.6 25.1 8.1

Kerala 10.0 9.5 9.6 4.3 9.9 8.2

Maharashtra 31.9 11.0 12.0 6.2 24.2 9.5

Tamil Nadu 24.3 14.2 11.3 9.5 19.8 12.5

All-India 26.3 6.7 12.0 5.8 22.7 6.5

Source: Deaton and Dreze (2002). These figures differ from the GoI and WDI estimates since they make different adjustments forsurvey questionnaire changes and urban-rural price differentials. The GoI estimates show that Tamil Nadu's poverty headcountwas reduced from 35.4% in 1993/94 to 21.1% in 1999/2000.

Figure 1.2: Tamil Nadu's performance on economic growth and poverty reduction

specific model used to adjust for comparabilitybetween the NSSO rounds of 1993-94 and 1999-2000, there are different estimates on the extentof poverty reduction between these two years. TheGovernment of India's estimate shows that TamilNadu's poverty headcount was reduced from35.4% in 1993/94 to 21.1% in 1999/2000. Analternative estimate based on a model postulatinga relationship between poverty and householdcharacteristics (Kijima and Lanjouw, 2003, aBank policy research working paper) showspoverty declined from 30.3% in 1993/94 to28.9% in 1999/00. These different models alsoinduce variations in the rural and urbanheadcount rates. A resolution of this debate is notpossible for now, since there is no scientific way ofdetermining which of these models better reflectthe "true" picture - being essentially ex postmethods of adjusting consumption expendituresto achieve comparability between the two surveys,using alternate sets of assumptions that cannot betested. However, no matter which precise methodis used, Tamil Nadu has made progress in povertyreduction in the latter half of the 1990s.

Education and health outcomes. Tamil Nadu hasachieved notable success in human developmentoutcomes. It has moved from being a near-average to a high-performing state, as indicatedby the Human Development Index (HDI)measured in terms of longevity, education andcommand over resources. In 1981, its HDIranked seventh, at 0.343, only slightly above thenational average of 0.302. By 2001, however,Tamil Nadu's HDI rose to the third highest, at0.531, higher than the national average of0.472.1 Tamil Nadu has been a pioneer in Indiain integrating nutrition and increasingenrollment of children in elementary education.Education and health outcomes in the state havealso improved across gender, caste, income andregional dimensions, particularly in the access to

primary-level health and education services. Thewell-known Noon Meal Scheme (NMS), whichstarted in 1982, covers all children ages 2-15 inboth rural and urban areas. The main objective ofthe NMS was to ensure nutritional support tochildren but also to act as an effective incentivefor achieving universal education. The programhas been emulated by other states and hasrecently been viewed by the GoI as a model.

Tamil Nadu's success is the result of sustainedeconomic growth and an effective humandevelopment (HD) strategy. This strategy hasfocused on three main areas: (i) expanding thecoverage of social services, (ii) improving qualityof the services provided, and (iii) ensuring wideparticipation of the poor and other marginalizedgroups. A political consensus for investing inhuman capital by successive state governments'and the use of a multi-sectoral approach toaddressing human capital formation has alsocontributed to human capital gains.

Gender equity. Thirty-three percent of seats arereserved for women in all statutory and non-statutory committees of the state government.Tamil Nadu's performance with respect to femaleliteracy, female infant mortality rate, female lifeexpectancy and fertility rates shows that the statusof women in Tamil Nadu is higher than in mostIndian states. The Gender Development Index(GDI) for Tamil Nadu is 0.654 (2001), as againstthe all-India average of 0.560. Socio-economicempowerment of women through the provisionof opportunities for education, self-employmentand training are priorities. A key initiative is theTamil Nadu Women's Development Project(Mahalir Thittam); the project supports over187,000 Self-Help Groups, with membership of3.1 million and savings of about Rs.6 billion.Moreover, owing to assistance in establishingcredit linkages with financial institutions, the

Development Outcomes and Challenges

5

1 National Human Development Report, 2001, Planning Commission, Government of India.

Self-Help Groups have been able to access creditassistance amounting to Rs.10 billion.

Economic growth. The liberalization in the 1990saccelerated economic growth in Tamil Nadu,increasing average real GSDP growth rates to6.4% from 5.4% in the 1980s. Tamil Nadu's percapita income growth ranked the third highestamong Indian states in the 1990s. The fastergrowth of industry and services relative toagriculture has changed the shares of these sectorsin the GSDP (Figures 1.3 and 1.4). Tamil Naduhas been one of the most favored foreign anddomestic investment destinations in India; butIndia as a whole has lagged behind some othercountries. Tamil Nadu accounts for 60% ofmerchandise exports of four southern states, 15%of all-India merchandise exports and 17% of all-India IT exports; in 2001/02, it exported US$6.5billion worth of merchandise and US$1.2 billionworth of IT services. IT has been Tamil Nadu'sstrongest growth sector since 1997/98, growing bynearly 40% on an annual average basis. Traditionalexports, such as textiles, ready-made garments and

leather goods, have grown by only 3-6% on anannual average basis over the same period.

Economic growth has slowed since the late1990s. The slowing is mainly the result of adecline in agriculture largely on account of threestatewide droughts and their spillover impact onother sectors (see page no. 10 for analysis).

Development ChallengesNotwithstanding positive developmentoutcomes, Tamil Nadu faces many developmentchallenges. Still a low-income state, Tamil Naduhas a relatively high poverty incidence, andgender, caste, and intra-state disparities in keypoverty (Figure 1.5) and social indicators. Thefiscal crisis beginning in 1998/99 and slowdownin economic growth since the late 1990s not onlyseriously threaten the prospect for sustainedpoverty reduction in the future but also endangerthe gains made to date.

Poverty remains high. With GSDP per capita ofabout US$588 (2003/04), Tamil Nadu remains a


6

Figure 1.3: Tamil Nadu and all-India Economic Growth Trends

Figure 1.4: Sectoral Shares of Tamil Nadu GSDP

Source: CSO, National Accounts Statistics.

Source: CSO, National Accounts Statistics.

low-income state. About 12 million people livein poverty.2 Scheduled castes and tribes arehighly represented among the poor. This iscertainly due in part to their owning less land(Table 1.2), and of lower quality, as well as otherassets (particularly human capital), thanhouseholds which are not of the scheduled castes.

Rural poverty is concentrated among those withmarginal landholdings and dependent on rain-fed agriculture. As one moves from the lowest- tothe highest-income quintiles of rural household

income, the contribution of agricultural wageincome to total income decreases monotonically,while that of cultivation and non-farm sourcesincreases monotonically (Table 1.3).Reinvigorating agriculture growth andaccelerating industrial growth, together withsolid growth in the tertiary sector, remain criticalfor sustained poverty reduction. Data limitationprevents a fuller understanding of urban poverty.

Important challenges in the non-incomedimensions of poverty remain. High drop-out


7

Figure 1.5: Regional Dimensions -Poverty Rates

Source: Deaton (2003).

Table 1.2: Rural Poverty Incidence and Shares by Land Ownership among SC/ST’s

NSSO Round 50th 55thExtreme % of rural % share of % share Extreme % of rural % share of % sharePoverty Poverty SC/ST extreme of the Poverty Poverty SC/ST extreme of the

Incidence Incidence population poor poor incidence incidence population poor poor

No land 24 47 27 23 24 21 40 17 11 12

>0 & 0.4 ha 31 57 57 62 61 32 58 71 71 73

>0.4 & 1 ha 33 56 10 12 11 53 74 8 13 10

>1 & 2 ha 21 45 4 3 3 40 70 3 4 4

>2 & 4 ha 0 11 2 0 0 17 50 1 0 1

>4 ha 0 0 0 0 0 0 1 0 0 0

overall 28 53 100 100 100 32 57 100 100 100

Note: (i) Extreme poverty is defined as per capita consumption rank <20% in the total consumption distribution. (ii) Poverty is definedas per capita consumption rank <40% in the total consumption distribution.

2 Poverty incidence of 19.8% is based on Angus Deaton and Jean Dreze (2002).

and low completion rates continue to reducethe effectiveness of Tamil Nadu's secondaryeducation program. Completion and drop-outrates still mask disparities across the state(Figure1.6). For example, about 15 percent ofstudents drop out at the primary level, nearly athird by elementary school, nearly three-fifthsprior to completing Grade X (or SSLC) and

about three-fourths by Higher Secondary.There are still gender, caste, inter-district, andurban-rural disparities. The gender gap ineducation is especially larger among poorerhouseholds. Scheduled castes and scheduledtribes also have significantly lower educationalattainment than non-scheduled castes/scheduled tribes.


8

Figure 1.6: Education Status by Wealth Group

Source: Filmer and Pritchett (1999).

Table 1.3: Household Income Shares by Source in Rural Tamil Nadu

Quintile Cultivation Agriculture Non farm Non farm Self Non farm Total Non Other Real Perwage Labor wage Labor employment Regular farm sources Capita

Employment sources Income Rs.

Lowest 26.3 51.6 11.4 7.3 1.1 19.8 2.3 1093

Q2 27.8 27.5 18.2 14.1 10.9 43.2 1.6 2130

Q3 32.6 21.6 15.5 18.0 10.9 44.4 1.4 3377

Q4 35.7 14.9 14.2 7.8 23.4 45.5 4.0 5431

Highest 42.8 5.2 7.0 9.7 33.7 50.4 1.6 12292

Total 37.7 13.7 11.0 10.7 24.8 46.4 2.1 4867

Source: NCAER Human Development Survey 1993/4Note: i) Income from farm sources refers to cultivation income. ii) Agriculture wage labor income refers to income from wage labor on

another agricultural production unit (farm, plantation, etc.). iii) Non-farm wage labor income corresponds to income fromcasual, usually daily wage, employment in non-farm activities. iv) Non-farm self employment income corresponds to incomefrom home enterprises and entrepreneurial activities. v) Non-farm regular employment income refers to income from regular,medium to long-term, salaried employment in non-farm activities. vi) Income is expressed in annual, 1993, terms (adjusted forspatial price variation using the price indices proposed by Deaton and Tarozzi, 2000).

With regard to health challenges the crude birthrate (CBR) has been hovering around 19-20,neo-natal mortality has been stagnating, and thefemale infant mortality rate remains high. Thereare significant rural-urban differentials and inter-district variations. The state also faces a high rateof malnutrition in children, and confronts a highprevalence of HIV/AIDS. Tuberculosis isreemerging in association with HIV/AIDS andnon-communicable diseases are on the rise.

Rapid fiscal decline. Traditionally a fiscallybetter-managed state, Tamil Nadu experiencedan unprecedented fiscal crisis beginning in1998/99. The crisis manifested in rapid growthin revenue (current) and fiscal deficits, growingdebt and contingent liabilities, and worseningcomposition in expenditure favoring non-development expenditure. The fiscal crisisseriously crippled the state's ability to financedevelopment spending, which is essential foraccelerating growth, reducing poverty, andimproving social outcomes. The ratio of fiscaldeficit to GSDP increased from 2.3 percent in1997/98 to an estimated 4.5 percent in 2002/03,including the clearance of Rs. 3,062 crore in

payment arrears accumulated from prior years(Figure 1.7 & 1.8).

The increasing reliance on borrowing to financegrowing recurrent expenditure steadily increased thestate's debt burden. The debt-to-GSDP ratioclimbed from 16.2 percent in 1997/98 to 28 percentin 2002/03. The ratio of debt to revenue receiptincreased from 125 percent in 1997/98 to 212percent in 2002/03. Debt accumulation resulted inrapid increase in interest expenditure. Furthermore,guarantees as a percent of GSDP rose to support themarket borrowing of public enterprises. Addingguarantees to explicit public debt, the maximumliabilities of the Government as a percent of GSDPincreased from 21.4 percent in 1997/98 to about 34percent in 2002/03 (Figure 1. 9).

The rapid fiscal deterioration is attributed mainlyto: (i) rapid growth of expenditures on salaries,retirement benefits, and pensions, following theimplementation of the Sixth State PayCommission award along the lines of the CentralFifth Pay Commission's award (the previous stateGovernment implemented, in 1998, the awardwith retroactive effect to 1996); (ii) a growing


9

Figure 1.7: Tamil Nadu Fiscal, Revenue and Primary Deficits trends

Source: GoTN's Budget Documents.

burden of subsidies (particularly food subsidy);(iii) a further decline in Tamil Nadu's share incentral tax devolution following the EleventhFinance Commission's award; (iv) a growing debtand interest burden arising largely from increasedborrowing to support the growing revenuedeficit; and (v) higher contingent liabilitiesassociated with fiscal support to the public sectorunits, cooperatives, and the statutory boards. Itmust be recognized that these systemic factorswere undercurrent even before the crisis, and theimplementation of the Sixth State PayCommission's recommendations triggered the

fiscal risks. The fiscal crisis has been a factor inthe state's ability to respond to recent growthslowdown and real growth in capital outlay hasbeen negative in the period since 2000/01.

Challenges of accelerating economic growth.Growth slowed from an annual average of 6.6%from 1990/91 to 1998/99 to an annual average ofabout 3.7% from 1999/00 to 2002/03. Much ofthe recent slowdown is attributed to the impact ofthe droughts on agriculture and their spillover toother sectors. Tamil Nadu's agriculture is vulnerableto periodic droughts due to its dependency on


10

Figure 1.8: Revenue deficit as a Percentage of Fiscal Deficit

Figure 1.9: Debt and Guarantees

Source: GoTN’s Budget Documents.

Source: GoTN's Budget Documents.

rainfall. More frequent than in the recent past, threeannual droughts including the century's worststatewide drought in 2002, led to an annual averageof -3.9% growth during 1999/00-2002/03compared with an annual average of 4.5% in theprevious nine years. Despite vulnerability todroughts, Tamil Nadu's agriculture has done betterthan the Indian average in growth and productivityin the past two decades.3 The weak performance inthe agriculture sector has spilled over to the serviceand manufacturing sectors whose growth has alsorecently slowed down.

Although droughts are exogenous shocks, there arestructural impediments, overcoming which couldput economic growth on a higher trajectory path of8% targeted by the GoTN to accelerate the pace ofpoverty reduction. Tamil Nadu's agriculture faceschallenges of growing water scarcity, land -degradation, decline in farm sizes, and rising cost of

agricultural labor. Rigid labor regulations, acomplex and cascading indirect tax system,protracted exit and bankruptcy procedures, andinfrastructure deficiencies are among the keyconstraints to better manufacturing performance inIndia.4 The 2003 investment climate survey of themanufacturing sector in Tamil Nadu reaffirms thisassessment.5 Although manufacturing is recoveringin India and in Tamil Nadu,6 higher and sustainedmanufacturing growth requires second-generationreforms to improve the investment climate.

Higher manufacturing growth, together with thegrowth of the service sector, is critical toabsorbing surplus agriculture labor and reducingrural poverty. The primary sector accounts for50% of total employment, industry accounts for24%, and the tertiary sector accounts for 26%.Tamil Nadu has had higher rural non-farmemployment than other Indian states (Table 1.4),


11

3 In 1998-99, Tamil Nadu had the highest rice, sugar cane and groundnut yields in India and cotton yields in the statewere second only to Gujarat. Increases in yields enabled land productivity to grow by 6.1 percent per year between1987/88 and 1993/94 from Rs 16,423/ha to Rs 23,459/ha (in constant 93/94 Rs), but by only 2.4 percent per yearbetween 1993/94 and 1999/00 (to Rs 27,099/ha in constant 93/94 Rs). Likewise, average labor productivity inagriculture increased by an average of 4.6 percent per year between 1987/88 and 1993/94 from Rs 6,881 per worker to Rs 9,024 per worker (in constant 93/94 Rs), but by only 2.4 percent per year between 1993/94 and 1999/00 to Rs 10,434 per worker (in constant 93/94 Rs).

4 The World Bank and the Confederation of Indian Industries, 2002, "Competitiveness of Indian Manufacturing: Resultsfrom a Firm-Level Survey."

5 The World Bank and the Confederation of Indian Industries, Second Indian States' Investment Climate Survey, 2003. 6 The increase in new investment commitments in manufacturing from April 2001 to April 2003 was highest in Tamil

Nadu compared with other major Indian states, based on data from the Center for Monitoring of Indian Economy.

Table 1.4: Rural Employment in Tamil Nadu and Neighbouring States

Proportion of Economically Tamil Nadu Andhra Karnataka Kerala All-IndiaActive with Primary Pradesh

Employment in

Cultivation and other 0.26 0.35 0.46 0.26 0.44

Agricultural wage labor 0.35 0.37 0.31 0.26 0.23

Non-farm casual daily wage labor 0.16 0.07 0.07 0.18 0.10

Non-farm self employment 0.10 0.14 0.09 0.16 0.23

Non-farm regular salaried labor 0.13 0.06 0.06 0.14 0.11

Source: NCAER Human Development Survey 1993/4.

and industrial activities are more spread acrossthe state than most Indian states. Non-farmactivities-manufacturing and services-account forabout 50% of rural household income (Table 1.3). Faster expansion of themanufacturing and service sectors would helpreduce the impact of seasonality of ruralemployment, with acute vulnerability during thedroughts, on rural incomes.

Reform Agenda Achieving fiscal correction and stabilization. Themost immediate challenge that faced Tamil Naduin 2001/02 was to reverse the rapid fiscal declineand create fiscal space for development spending.With salaries and pension of governmentemployees (accounting for 2% of the state'spopulation)-accounting for government's entireown revenue during the crisis, or salaries,pension, interest, and subsidies accounting for94% of the state's total revenue, there was littlefiscal space left for essential infrastructure andsocial spending. In fact, about 70% of the netborrowing of the state government in 1999/00was for debt repayment. The resultant liquiditycrisis, led to accumulation of arrears that reached1.7% of GSDP in 2000/01 and 2% of GSDP in2001/02.

The then newly elected Government tabled aWhite Paper in the state legislature in August2001. It analyzed the systemic causes of the fiscaldeterioration, and served as a platform to launcha fiscal reform program. To quote the WhitePaper, "Without a firm commitment to fiscaldiscipline and prudent management of Statefinances, no Government can fulfill the mandateto it by the people."

Over the next two years, the governmentambitiously embarked on reforms touching anumber of areas in both revenue and expenditure.It proceeded to do so at a rapid pace to catch upwith other reforming states such as its neighborsAndhra Pradesh and Karnataka. Some of the

reforms were bold and path breaking both in thecontext of the past history of the state, such as thePublic Distribution System or agriculture powertariff, and in the national context such as pensionreforms. The reforms were undertaken,notwithstanding a difficult economic environmentposed by successive droughts and the low economicgrowth. Significant gains were made over the nexttwo years and aggressive fiscal reform targets wereset for the future. These would have enabledimprovement in spending efficiency by makingfundamental changes to the way the budget wasprepared and executed. By attempting expenditurereallocation the program sought to improve growthand human development achievement.

But negative electoral results in the nationalelections in April-May 2004, in the state, broughtabout a number of policy changes involvingsignificant rollback of key policy reforms. Whatfollowed was a series of quick reversal ofsignificant reform measures (power, PDS andreintroduction of free bus passes for students andother user charges), adding increased fiscal cost tothe budget making it more difficult in the futureto return to the policy reform path. The fiscalreform effort suffered a setback jeopardizing therealization of the projected medium-term fiscaladjustment and expenditure restructuring in theMedium-Term Fiscal Program.

Critical elements of the fiscal reform programincluded: the development of a multi-yearframework for fiscal adjustment; improvinglegislative oversight and fiscal transparency;restructuring high-cost public debt andmanagement of guarantees; improving theefficiency and equity of the tax administration andrationalizing user charges; reorienting expenditurefrom current consumption to growth-enhancingand poverty-reducing investment; reforming state-owned manufacturing enterprises and ailingcooperatives; and strengthening public expendituremanagement and financial accountability toincrease the efficiency of public spending.


12

The most challenging part of the fiscal reformprogram continues to remain restructuringspending on salary and pension and on explicit andimplicit subsidies. The challenge is compoundedby the constraint on increasing revenue resources.

Improving investment climate for manufacturingand services. Recognizing the role of the privatesector as an engine of economic growth, the

Government has put emphasis on streamliningcomplex government regulations over privateinvestment and production, and on strongpartnership with the private sector for sustainableinfrastructure financing and development. TamilNadu is at the forefront of such partnership witha number of pilots that are the first in India (Box 1.1). The critical role of the private sector isfacilitated by increasing recognition of the


13

� The Tirupur Water Supply Scheme, the first water sector related project developed under the PPPframework in India. After a gestation period of almost 10 years, GoTN accelerated and completed legal,financial and management agreements between July 2001 and March 2003. The construction is onschedule. A total of Rs.45 crore equity and subordinated debt financing from GoTN has leveragedadditional equity financing of Rs.217 crore and leveraged a debt of Rs.700 crore including financing fromTirupur Exporters Association and foreign investors. The project will supply water to the fast-growinggarment export industry in Tirupur, domestic consumers in Tirupur Municipality and surroundingvillages, as well as a sewerage system for the Tirupur Municipality and onsite sanitation facilities for slums.User charges are based on cost recovery with cross subsidies between industrial and domestic consumers.

� The Alandur sewerage project is the first such project in India using a PPP framework (BOT format) toprovide underground sewerage to a town of 125,000 people near Chennai. Public awareness and supportwas sought through an extensive communication campaign. Some 15,000 households out of 17,000 havecontributed Rs. 5,000 per household representing one third of the project cost. A notable feature is thetariff structure, developed on full user charge recovery with cross subsidies for the poor. The firstcommunity participation project, has also suffered a number of set backs due to some lack of forwardplanning, i.e. delays in selection of an operator for O&M of the sewerage scheme; miscommunication onthe distinction between upfront payment of capital cost through community participation and a separateconnection fee to each house to be levied separately. These are lessons, which can be incorporated inrepeat or scaling up projects.

� The East-Coast Highway Project on road upgrading, operation and maintenance. The Tamil Nadu RoadDevelopment Company (TNRDC) was set up in 1998 to catalyze private sector investment in the roadsector and commercialize O&M. Its equity of Rs.10 crores was split 50:50 between public and privatefunds. The first upgrading project financed by TNRDC is the 113 Km. long East Coast Road (ECR)connecting Chennai and Pondicherry at a cost of Rs 60 crore. A Rehabilitate-Improve-Maintain-Operate-Transfer (RIMOT) framework was applied and commercial operations on the road commencedin March 2002. The RIMOT framework requires user charges to recover improvement and maintenancecosts only, leading to lower tolls; project returns are capped at 20% and surplus if any, is reinvested in theroad sector in Tamil Nadu.

� Tamil Nadu Urban Development Fund (TNUDF) for credit enhancement capital market financing ofurban infrastructure projects. Financed through a World Bank Loan, GoTN Line of Credit, and equityfrom banks in 1996, the Fund had approved loans of Rs.492.27 crore as of March 2003. Notable projectsare Karur Toll Bridge, Madurai Ring Road, and Pooled financing for smaller towns for water andsanitation, solid waste contracts and storm water drains. TNUDF has structured investments in basic civicamenities on the basis of debt servicing capabilities of Urban Local Bodies (ULBs) and assisted in technicaland financial capacity enhancement of ULBs. The few privately contracted projects have so far had a goodtrack record of implementation. TNUDF lends to those ULBs which are receptive to undertakinginstitutional and financial reforms.

Box 1.1: Public Private Partnership in Infrastructure Service Delivery

positive role of the private sector in infrastructuredevelopment; it is also necessitated by the fiscalcrisis and the large backlog in infrastructureinvestment and maintenance.

Reinvigorating agriculture growth. This remainscritical since a vibrant agriculture sectorencourages industrial growth and farm incomeaccounts for 78% of the income of the poorest 20percent of the rural population. Traditionalsources of agricultural growth, however, facemajor constraints including growing waterscarcity, increasing land degradation anddeclining farm sizes, and rising costs ofagricultural labor (Box 1.2). Given water scarcity,diversification into less-water intensive higher-value products is the most promising avenue forfuture agricultural growth. Broader institutionaland policy reforms are required to efficientlymanage scarce water resources, decentralize atraditionally top-down centralized extensionsystem to respond to diversified agriculture,improve rural infrastructure to facilitate efficientmarkets, and reorient public expenditure towards

growth-enhancing areas such as rural roads,markets and agricultural research and extension.This requires to be combined with appropriatelevels of cost recovery for water, power and otherinputs and safety nets for expected loss offarmers' income in the transitional period.

Improving public administration and enhancingservice delivery. Although Tamil Nadu has one ofthe better records in public administration andservice delivery among Indian states, the state isnot immune to problems common across Indianstates. To support the fiscal reform and thereform of the investment climate, the reformwould also need to focus on strengthening theeffectiveness of the government by rationalizingits role and responsibilities, simplifying decision-making processes, improving the stability of stafftenure, and enhancing critical services delivery-which have a large public interface through acombination of measures such as agency reform,e-governance, and public private partnerships.Further, the reform would need to address thetransparency of the government and anti-


14

Tamil Nadu is one of the driest states in India, with an average of only 925 millimeters of rainfall per year.The state has a dry season that extends over five months of the year (January through May) even in good years,and severe droughts occur in three out of every ten years severely limiting cultivation of crops between themonths of June and September. The per capita availability of water resources of Tamil Nadu is only 900 cubicmeters compared to an all-India average of 2200 cubic meters per annum. Irrigation through a combinationof canals, tanks, and wells, increases the reliability and availability of water for farming, and is essential forsuccessful cultivation of crops in much of the state. Nonetheless, seasonality of supply and scarcity of waterlimit cultivation to only one crop per plot for most of the state. In addition to growing water scarcity, theagricultural sector faces increasing competition for water from industries and domestic users and intensifyinginterstate competition for surface water resources. In many parts of the state, the rate of extraction ofgroundwater has exceeded recharge rates contributing to falling water tables. Water quality issues are also ofincreasing concern. Effluents discharged from industries as well as heavy use of pesticides and fertilizers havehad a major impact on surface water quality, soils and groundwater.

Agricultural land resources have also come under increasing pressure because of rapid population growth andincreasing urbanization. The available cultivable land per rural resident has declined from 0.22 ha/capita to0.15 ha/capita between 1971/72 and 1997/98. The growing pressures on land coupled with skewed pricingpolicies and rural poverty have contributed to land and soil degradation. As a result, poor soil fertility, salinity,water logging, over grazing, and deforestation are growing problems and pose serious constraints to theperformance of the agricultural sector in some parts of the state.

Box 1.2: Challenges to Sustaining Agriculture Growth in Tamil Nadu

Source: Tamil Nadu Agricultural Development, World Bank (2004).

corruption, through a major overhaul of thepublic procurement system, enacting new "Rightto Information" legislation, and strengtheningthe anti-corruption machinery (Box 1.3).

Strengthening poverty monitoring andevaluation. The broad structural reformprogram needs to be supported by protecting thepoor and vulnerable through targeted

interventions. The Tenth Five-Year Plan providesa detailed description of the poverty-reductionprograms, which are wide ranging, to coverhealth, education, water supply and sanitation,and food security. These programs includeschemes targeted to particular social anddemographic groups such as scheduled castesand tribes, women and children. The specificinterventions broadly match the spatial and


15

� Tamil Nadu has registered some of the best human development indicators in India after Kerala. A recentsurvey conducted by Bangalore's Public Affairs Center (PAC) reveals that it possesses the country's bestpublic distribution and school education systems, and the second best public drinking water and roadtransport services after Gujarat. This, of course, is not a uniform picture: health services, for example,are ranked fifth.

� One key issue is the proliferation of the bureaucracy which has grown exponentially in the last twentyyears. In order to get a grip on the problem, GoTN appointed a Staff and Expenditure Commission(SERC) to suggest ways of reducing the size of the civil service. SERC has submitted all its reports, whichpinpoint redundant positions in Tamil Nadu's 140 field departments, as well as the Secretariat;recommend strategies for rightsizing, such as redeployment, compulsory retirement, and a targeted formof VRS; and proposes broader reforms to enhance efficiency, such as faster file movement, moredelegation to field offices, and outsourcing several tasks.

� The civil service faces a problem of frequent transfers that undermine service delivery by disruptingmanagerial continuity and generate corruption. This is also a national phenomenon and different stateshave attempted to tackle it in different ways. For instance, GoTN has responded to this problem byintroducing a system of formal counseling for transfers in both the Health and Education Department toreduce discretion in the process. But further steps could be taken, particularly legislation to ensure anormal term of three years, place quantitative limits on transfers in the aggregate and by cadre, and createstatutory boards and/or transferring authorities to better streamline the transfer process. A database tosystematically monitor transfers is necessary.

� Tamil Nadu was the first state to pass a comprehensive law to regulate procurement and ensure access toinformation. The procurement law is sound and GoTN has recently begun further reforms, such ascreating standard bidding documents and harmonizing codes and rules across government with theprocurement law. Tamil Nadu was also the first state in the country to adopt a Right to Information(RTI) law in 1997: The law, however, was seriously flawed and GoTN has now decided to replace it witha new and better law. GoTN has also used its website to provide a wealth of information to the public,including Government Orders, laws and rules, and information on departments and agencies.

� On the other hand, Tamil Nadu's anti-corruption institutions need strengthening. GoTN's High LevelCommittee on Administrative Reforms and the Prevention of Corruption in its 1997 reportrecommended the creation of an independent Vigilance Commission. The best example of a successfulindependent anti-corruption institution is Karnataka's Lok Ayukta, who has the authority to investigateboth corruption cases and grievances arising out of maladministration involving civil servants andMinisters; exercises supervisory authority over the police wing of the Lok Ayukta (prior to 1984 the policewing functioned as the Vigilance Establishment under government control), and possesses a large budgetof Rs. 6.7 crore per annum.

Box 1.3: Some important Governance and Service Delivery Challenges in Tamil Nadu

Source: Tamil Nadu: Governance Challenges. World Bank, 2004.

social needs revealed by the poverty diagnosticsalthough there is scope for improving the designand targeting efficiency. To this end,strengthening poverty monitoring andevaluation for effective targeting is an importantfocus area. For example, developing stronginstitutional capacity for evaluation basedlearning is invaluable for improving thetargeting in schemes such as the PublicDistribution System. Similarly, buildinginstitutional capacity for an effective monitoringand feedback mechanism that ensures aligningof budgets to priority needs in education, healthand broader aspects of service delivery will beimportant in the coming years.

Impact of reform on growth and poverty:� Fiscal correction and sustainability can

exert a positive impact on economicgrowth and poverty reduction in fourways: (i) by reallocating publicexpenditures from consumption togrowth-enhancing and poverty-reducingproductive spending; (ii) by strengtheningpublic expenditure management to helpincrease the efficiency of public spending;(iii) by achieving a sustainable andtransparent fiscal environment andincreased spending on infrastructure thatencourages private investment, includingprivate spending on critical infrastructureand basic services; and (iv) by creating andprotecting the fiscal space for the various

targeted poverty-reduction programsenvisaged in the Tenth Plan.

� Streamlining business regulations andimproving infrastructure will improve theinvestment climate for private sectordevelopment. This particularly benefitsmedium and small enterprises as complexregulation and infrastructure bottleneckstend to disproportionably affect smallerbusinesses. The acceleration of economicgrowth led by the private sector remainsfundamental to poverty reduction.

� The reform component of publicadministration and service delivery will helpaddress issues of common concern for allcritical infrastructure and service deliverysectors relevant to poverty reduction.Streamlined government functions, simplifieddecision making, the stability of staff tenure,and transparency and anti-corruptionmeasures would all contribute to improvedservice delivery and poverty reduction.

� The government's strengthened capacityto manage the reform process-includingthe capacity to evaluate and monitor majorpoverty-reduction interventions and linkpolicy, expenditure and poverty reduction-will help strengthen targeted poverty-reduction interventions to the poor anddisadvantaged groups.


16

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Tamil Nadu's Fiscal ReformFacing an unprecedented fiscal crisis, theGovernment of Tamil Nadu launched a programof fiscal correction and stabilization in 2001. Toquote the August 2001 White Paper of theGovernment of Tamil Nadu: "Without a firmcommitment to fiscal discipline and prudentmanagement of State finances, no Governmentcan fulfill the mandate to it by the people."7 TheWhite Paper, tabled and debated in the statelegislature, analyzed the systemic causes of thefiscal deterioration and articulated the need forfiscal reform and stabilization. Substantivereforms were undertaken from late 2001/02 to2003/04. However, electoral defeat in thenational election in April-May 2004 led to therolling back of reforms. The rollbacks haveresulted in: free power being restored to allfarmers, substantial reduction in electricity tarifffor domestic consumers, restoration offree/subsidized bus travel to private school andcollege students, and withdrawing PDS targetingby imposing income ceiling and rice coupons infavor of universal coverage. Minor ones haveincluded withdrawing hospital visiting fees andoutpatient charges. It is uncertain how far the rollback would go. The rollback of key subsidyreform policies mean the government's projectedmedium-term fiscal adjustment will provedifficult to achieve unless policy reforms thatunderpinned the MTFP are persevered with.

Paragraphs below summarize critical elements ofthe fiscal reform: the development of a multi-yearframework for fiscal adjustment; improvinglegislative oversight and fiscal transparency;improving the efficiency and equity of the taxadministration and rationalizing user charges;reorienting expenditure from currentconsumption to growth-enhancing and poverty-reducing investment; reforming state-ownedenterprises and ailing cooperatives; andstrengthening public expenditure managementand financial accountability to increase theefficiency of public spending.

Development of a medium-term fiscal program.The annual budget of the state Government, asin other states, did not reflect a medium-termperspective. The budgeting process was anincremental exercise with no clear links betweenpolicies, budget, and outcomes. Fiscalaccounting, being on the mandated cash system,did not fully capture deterioration in the fiscalcondition, owing to non-reporting of accruedliabilities (arrears and nonpayment of actualexpenditures as in 1999/2000, 2000/01, and2001/02) and contingent liabilities, such asguarantees. Financial losses of the state-ownedenterprises were not consolidated with the stategovernment's accounts, which thereforeprovided an incomplete picture of theunderlying fiscal trend.

AAcchhiieevviinngg FFiissccaall CCoorrrreeccttiioonn

aanndd SSttaabbiilliizzaattiioonn

7 White Paper on Tamil Nadu Government's Finances, Government of Tamil Nadu, August 2001.

The state legislature enacted a FiscalResponsibility Act in May 2003, the third Indianstate to do so. The Act set fiscal targets forreducing the budget fiscal deficit to 3% of GSDPand the revenue deficit to revenue receipts ratioto a level below 5% by March 31, 2008, andcapped risk-weighted guarantees at 75% ofrevenue receipts of the previous year, or 7.5% ofGSDP. The GoTN also signed a Memorandumof Understanding (MOU) with the GoI on theState's Fiscal Reform Facility in September 2003,which set a path for sustained reduction in theratio of the revenue deficit to revenue receipts.

Guided by the Fiscal Responsibility Act, theGovernment of Tamil Nadu developed its firstmedium-term fiscal program (MTFP), a five-yearframework, which was envisioned to be anannual rolling document institutionalized intothe budget formulation process. The first MTFPwas presented to the state legislature in February2004, along with the state's budget for 2004/05.Subsequent MTFPs were envisioned to bepresented with subsequent annual budgets, alongwith reports on performance against targets.

The MTFP explicitly incorporated importantoff-budget activities and other contingentliabilities into the multiyear adjustmentframework. First, the accounts of the Tamil NaduElectricity Board were consolidated with theGovernment's budget to arrive at a consolidateddeficit. Second, off-budget borrowing serviced bythe Government of Tamil Nadu was integratedwith the state's public debt.8 Third, capital workexecuted from the Public Account but financedfrom off-budget borrowings through PublicDeposit Accounts, thus distorting the fiscaldeficit, were fully integrated within the fiscalframework. Fourth, comprehensive and robustestimation of accrued pension liabilities andemerging cash flow needs based on the inherent

demographics of the workforce replaced ad hocincremental budgeting.

The process is not complete and steps need to betaken to further improve fiscal transparency. Thecurrent practice of reporting cash deficits byIndian states limits the scope for reportingaccrued liabilities. The fiscal deficit and itsfinancing need to be consistent withinternational practice. Budget documentationneeds to be improved to present departmentalpolicy objectives, major programs, performancegoals, and associated funding, together withsubhead- and program-level budget estimates fordepartment grants. All essential fiscalinformation will need to be posted on the Webfor public access, including the AccountantGeneral's fiscal accounts for the state, withsupplementary comments on guarantees,payment arrears, off-budget borrowings,accounts of the state-owned enterprises, and theoutcomes of periodic reviews of subsidies. TheGovernment has begun tabling a bi-yearly reviewof the budget in the state's legislature, which hasalso been publicly released on the Government'swebsite.

Prudent management of guarantees is an essentialpart of the medium-term fiscal adjustment. The2002/03 budget classified and reportedguarantees by risk weight for the first time. Thenext step would be to establish an institutionalframework for screening competing demands forthe issue of guarantees while staying within thelimits set by the Fiscal Responsibility Act.

The MTFP is underpinned by a continuationand deepening of taxation and expenditurereform, and reforming state-owned enterprisesand cooperatives to reduce subsidies andliabilities. But recent decisions extending freepower to all agriculturists, slashing power tariff to


20

8 The stock of off-budget borrowings in the public account, though unsubstantial relative to other states' (for exampleKarnataka and Maharashtra), constituted 2 percent of 2002/03 GSDP.

domestic consumers to pre-reform levels of 2001(expected to cost government about Rs. 920crore in 2004/05), withdrawal of PDS targeting(will raise food subsidy by about Rs. 130 crore in2004/05), restoration of transport subsidy(student bus passes & concession fare will costRs. 125 crore in 2004/05), constitute reformsetbacks. They bring into question the validity ofthe MTFP and the commitment of thegovernment to fiscal reform.

Reforming the taxation system. The potential forsubstantially increasing the tax revenue in TamilNadu is limited for three reasons. First, TamilNadu's own tax revenue effort is already amongthe highest in Indian states. Second, India'sConstitution places limitations on the taxationpower of states. The fastest growth sector inTamil Nadu is the services sector, taxation ofwhich is reserved for the central Government.Third, successive central Finance Commissionshave reduced the share of Tamil Nadu in the pool

of net shareable central taxes, from 8 percent(Seventh Finance Commission) to 5.4 percent(Eleventh Finance Commission). Thecontribution of the share of central taxes to TamilNadu's revenue declined from 21 percent in1992/93 to 15 percent in 2002/03.

There is, however, considerable scope to improvethe efficiency, equity, and administration of thestate tax system (Box 2.1). In particular, thestate's sales tax (63 percent of the state's ownrevenue) consists of sales tax, entry tax, resale tax,additional tax, and surcharges, which imposeshigh effective tax on inputs with no rebates andresults in a negative cascading impact onmanufacturing costs. The entry tax on goods intolocal areas from outside Tamil Nadu negativelyaffects trade and investment. The relatively highstamp duty on immovable property encouragesevasion and value under-reporting in propertytransactions. The tax administration imposeshigh compliance costs because of its lack of self-

Achieving Fiscal Correction and Stabilization

21

Some estimates based on tax data for 50 top commodities in 2002/03 indicate that the complex web ofmultiple layers of state sales taxes induces a number of equity, effectiveness, and efficiency problems.

The final effective tax burden varies widely across commodities and the distribution of the burden is notdesirable. For example, some essential goods such as medicines and medical appliances, toothpaste andtoothbrushes bear a relatively high tax burden (effective rates of the combined state sales taxes, including theTamil Nadu general sales tax, additional sales tax, surcharges, and CST, are in the range of 9% and 18%,respectively), whereas gold and silver bear relatively low tax burden (subject to effective sales tax rate of just 1percent).

On the other hand, the existing exemptions and leakages (through administration and valuation process) leadto huge revenue losses. The general sales tax revenues foregone-estimated as the product of the average generalsales tax rate (or the ratio between the general sales tax collection and taxable turnover) and the differencebetween reported and taxable turnover-are high: 22% in 2002-03. As the calculations are based on the officialtax returns data, the estimate of the revenue loss does not include any leakage attributable to evasion andavoidance, but is based simply on the statutory exemptions and leakage during the assessment.

The imposition of multiple taxes without an effective mechanism for offsetting the input taxes-and especiallythe recent levy of the resale tax-risk the problem of cascading. A simple effective tax rate estimation confirmsthis risk. Inputs bear more than 30% of the total general sales tax collection. The effective rate of the generalsales tax alone, on inputs-defined as the ratio between the tax on inputs and taxable turnover of inputs-isapproximately 5.7%. The total general sales tax, additional sales tax, and surcharges on inputs account foralmost 32 percent of the total collection, and the effective tax rate is 6.7%.

Box 2.1: Incidence, Effective and Efficiency Costs of the State's Sales Tax Regime

Source: Tamil Nadu: Improving Investment Climate, World Bank, 2004.

assessment for large businesses, lack of electronicfiling, and protracted dispute resolutionprocedures, which encourage undesirablefrequent contacts between businessmen and taxofficials.

To provide an overall policy framework forreforming tax policy and administration, theGovernment established a Tax Reform andRevenue Augmentation Commission in June2002, headed by the well-known Dr. RajahChelliah. The Government has begunimplementing key recommendations of theCommission (e.g., the stamp duty on immovableproperty). The introduction of the VAT toreplace the current sales tax system should resolvethe main problems related to the state's sales taxsystem. Tamil Nadu is at an advanced stage ofpreparing for the introduction of the VAT set fornational introduction on April 1, 2005.

On the next important reform area, theGovernment of Tamil Nadu has reduced thestamp duty on immovable property to a uniform6 percent, from 8 percent in urban areas and 7percent in rural areas. The transfer duty onimmovable property, which was set at a uniform5 percent, has also been reduced to 2 percent.The effective stamp duty is hence a uniform 8percent, down from 12-13 percent. To identifymeasures to maintain revenue neutralityfollowing the rate change, the practice of dutyavoidance and evasion schemes and the impact ofthe reduced rate on conveyance of immovableproperty on revenue collection will need to bereviewed. Reforms also need to be planned forother taxes and duties (such as stamp duties onother dutiable instruments) based on systematicreview of these taxes, taking into considerationefficiency, equity, and collection costs.

Excise revenues are derived mainly from privilegefees on Indian-made foreign spirits, excise duties,and fees on liquor. The Tamil Nadu StateMarketing Corporation has the exclusive right of

wholesale and retail supply of Indian-madeforeign spirits for the state and is responsible forcollecting the excise duty. The overall tax burdenon liquor is high but largely comparable withthose in other states in India. Given that TamilNadu maintains a public monopoly responsiblefor collecting excise duty directly from a smallnumber of distilleries, there is no evidence thatthe high effective tax rate induces widespreadevasion that would put the revenues on thewrong side of the Laffer curve. Reforms could beenvisaged regarding the calculation of exciseduties, switching from a specific to an ad-valoremexcise, following the Maharashtra example.

Entry taxes on motor vehicles and goods riskhaving an unintended negative impact on tradeand investment. They hinder inter-state trade,induce a high-cost state economy, and negativelyaffect the competitiveness of Tamil Nadu as aninvestment location. As a revenue source, they areinsignificant and are justified primarily as anadditional means of fostering sales taxcompliance. The business community in TamilNadu has asked that the entry taxation beabolished once the VAT is introduced. Thisrequest is fully justified.

Building on the ongoing efforts to improve thetax administration, a medium-term action plan isbeing formulated to reform the taxadministration. It focuses on improvingcorporate planning, strengthening humanresources, and restructuring the taxadministration, moving it from focusing onenforcement to service-oriented compliance.Annex I has details of a suggested plan forimproving Tamil Nadu's Tax Administration.

Improving non-tax revenue. Revenue collectionin Tamil Nadu relies primarily on the state's owntax system (70 percent of total revenue). Another15 percent of revenue comes from shared centraltaxes devolved to Tamil Nadu. Only 7 percent oftotal revenue is from non-tax revenue. Tamil


22

Nadu ranked low in non-tax revenue relative to14 major Indian states (1985-2000). Some usercharges (such as bus fare) do not go directly tothe state's treasury but are collected by state-owned enterprises, and regular revisions of thesecharges could reduce the required budgetarysupport. Although low non-tax revenue indicatesthe potential for increases, such decisions arefrequently constrained by political difficulties.

Under the fiscal reform program, user chargeswere increased on a variety of services providedby the state and state-owned enterprises: bus faresincreased by 27 percent; irrigation rates andwater supply rates applicable to commercialconsumers and to local bodies that meetinfrastructure costs were increased; and seweragecosts for non-domestic connections have alsoincreased. In addition, two revisions of powertariffs have been undertaken and a power tarifffor agriculture was reintroduced after 12 years offree power (as of July 2004 to be compensated bythe government budget to the power utility),hospital visiting fees and a charging system foruse of diagnostic equipment have beenintroduced, and court fees have been increased.But in recent actions the state restored free powerto agriculture and slashed power tariff todomestic consumers by 32-36%, restored freebus passes to students, withdrew hospital visitingfees and restored ex gratia payments to STU andTamil Nadu Electricity Board (TNEB)employees at 1.67% (in addition to the bonus of8.33%) besides announcing wage negotiationswith the workers of these entities and restorationof 15 days earned leave encashment that wasearlier suspended. These constitute a setback tocost recovery and restructuring initiatives.Further increases in user charges will thereforecontinue to be politically challenging.

Reforming the pension system and rationalizingsalary expenditure. Tamil Nadu has the highestnumber of civil servants per hundred people ofany major Indian state after Punjab: 2.13

compared with 1.4 for the country as a whole.While the roots of overstaffing can be traced todecisions made in the 1980s, its negative impacton the current salary and pension structure addsto the current fiscal stress. As a result ofimplementing in April 1998 the Sixth State PayCommission, pension and salary growthaccelerated and appropriated an ever larger shareof the state's revenue in 1999/2000: 56 percentof the state's revenue expenditure, 68 percent ofthe state's total revenue, and 91 percent of thestate's own tax revenue. Worse, these sharesunderestimate real liabilities, as a liquidity crisisin 1999/2000 forced the Government topostpone sizable payments of salary and pension(Rs. 1,823 crore to employees who retiredbetween January 1996 and March 1998) for fiveyears. The present Government started to clearthese dues in 2003/04.

To address the rapid growth of salaries andpensions, the most serious threat to fiscalsustainability, the Government adopted anumber of measures. A Staff and ExpenditureReform Commission was established inDecember 2001 to systematically identify surpluspositions, posts, functions and departments forredeployment and streamlining (Box 2.2). TheCommission has identified about 85,000 surplusposts and 113,000 vacant positions, while 10departments have been identified for closure.The Commission's reports on 140 departmentsand agencies are under review.

A ban has been imposed on the creation of newposts and a freeze declared on the creation andfilling of vacancies through direct orcompassionate appointments, except foressential staff (teachers, health workers, police).In another move, 23,123 live posts (road gangworkers and people's welfare workers) wereabolished. After the Commission's review, theGovernment issued orders to abolish 40,500surplus posts in vacant positions created by thehiring freeze. The remaining surplus posts are to


23

be abolished over the next few years mainlythrough attrition and redeployment of staff. TheGovernment also rationalized employeecompensation and benefits by withdrawingsurrender leave encashment and the annualPongal Bonus, and has delayed theannouncement of additional DearnessAllowance installments (always with prospectiveeffect). However, in a recent setback (postnational elections) the Government decided toretain the services of 15,500 temporaryemployees who were recruited during a civilservants' strike in 2003 making furtheremployee restructuring efforts more difficult.

The Government also carried out pension reformto reduce current and contingent pensionliabilities: a defined contribution system foremployees hired after April 1, 2003, has beenintroduced, the qualifying tenure of servicerequired to receive full pensions has beenincreased by three years, and the basis forcalculating eligible pensions was changed to thelast 10 months average pay rather than the lastdrawn pay. The Government of Tamil Nadu hascarried out a massive exercise to collect data andproject pension liabilities and cash flows underthe various retirement programs, not only for thestate civil service but also for local bodies and


24

� There are four key features of the SERC's working that bear comment. First, the SERC experience isfundamentally an in-house assessment of redundancy, unlike the externally-driven assessments conductedby consultants supervised by the Administrative Reforms Commission (ARC) in Karnataka, the Instituteof Public Administration in Punjab, and consultants in Orissa.

� Second, the SERC reports, which focus on both the Secretariat and 140 field departments provides themost targeted identification of surplus posts in any state that has attempted such an exercise, far morepin-pointed than the externally-conducted analyses in Karnataka, Punjab, and Orissa, which have provenless useful in identifying opportunities for pruning staff. The criteria for regarding a post as surplusinclude: (a) assessing posts in relation to existing work norms, (b) establishing new work norms in thelight of technological change, and a concomitant reduction in staff, (c) analyzing whether a departmentneeds to perform a particular function at this time and adjusting staff size accordingly, and (d) reducingposts by promoting outsourcing across government.

� The Commission pared about 23% of all Group A posts, which constitute only 1.7% of the core civilservice (excluding non-pensionable employees); 12% of Group B posts (10.04% of core), 9% of GroupC posts (75.3% of core), and 40% of Group D (13% of core). Staff cuts were thus highlydisproportionate for Groups A and D and mildly so for Group B; Group C, including a large contingentof teachers, faced only a small cut relative to its share of the civil service.

� Third, the process of formulating the reports was marked by extensive consultation. The SERC reviewedapproximately 10 departments a month; for each department, the process involved an initial round ofconsultation with the Secretary and Departmental Heads (HoD's), followed by intensive discussions withlower-level officials and unions, and a concluding wrap-up session with the Secretary.

� Staff associations were asked to fill out a separate questionnaire asking them to evaluate the merits of thesingle-file system and level-jumping; identify areas for decentralization of authority within departments;re-evaluate work norms in the light of new technology; indicate areas of excess or inadequate staffing; andclassify functions best done only by government, by government and NGO's or the private sectortogether, and the private sector alone. Staff Associations were also asked to suggest ways of reducingadministrative costs generally. The Commission received hundreds of suggestions on rationalization fromthe public via its website. The expert probing of the SERC Chairman in in-depth interviews withdepartment officials, high and low-level, combined with data derived from the questionnaires, yieldedinside information on redundant and/or vacant posts, and conferred legitimacy on the exercise.

Box 2.2: Staff and Expenditure Reforms Commission

Source: Tamil Nadu: Governance Challenges, World Bank 2004.

major state-owned entities such as the TamilNadu Electricity Board and the State TransportCorporations.9 This has enabled a comprehensiveand robust estimation of pension liabilities andemerging cash flow needs, which take intoconsideration the demographics of the workforce.

The Government of Tamil Nadu has alreadyissued a Government Order establishing a newdefined contribution scheme for all civil servantshired with the status of pensionable service afterApril 1, 2003. The Government of Tamil Naduis looking to developments at the Governmentof India level, both for detailed parameters andrules and institutional arrangements(recordkeeping, investment policy). But giventhe relatively slow state of progress, it may benecessary to develop interim arrangements sothat the new scheme can be implemented soonafter the new entrants recruited since April 2003will have passed through their probationaryperiod and become eligible for pensionableservice. The implications and potential costs ofdifferent options are being reviewed.

Rationalizing subsidies and improving targeting.Direct subsidies were the third fastest growingrevenue expenditure, next to pension and interestexpenditure. The largest subsidy went to food (ofwhich the rice subsidy accounts for 90 percent)distributed through the public distributionsystem (PDS). Food subsidies accounted for 67percent of direct subsidies or 8.5 percent of thestate's revenue in 2000/01. The PDS is probablythe most important safety net program in India. Asurvey conducted by the Public Affairs Center10

shows that Tamil Nadu's PDS ranks first in thecountry on several parameters, including access,usage, and reliability. Tamil Nadu's PDS haduniversal coverage until 2002, with all 16 millionfamilies in the state entitled to the PDS.

Substantive PDS reform was undertaken from2002 to 2003, but the reform has suffered asetback. Rice procurement by the state throughthe Tamil Nadu Civil Supplies Corporation hasbeen replaced by purchases from the FoodCorporation of India, saving milling andinventory costs and lowering the cost ofpurchase. Production incentives given by thestate over the minimum support price set by theGovernment of India have been eliminated.About 4 million out of 16 million families choseto opt out of PDS rice through a self-selectionscheme. Rice coupons were then introduced toreduce the number of households eligible forPDS rice further to 10.4 million. Income criteriato determine PDS eligibility-monthly householdincome of Rs.5,000, income tax and sales taxassesses-was introduced in 2003 for voluntarycompliance. But both rice coupons and incometargeting have been withdrawn by the GoTNafter the national election in April-May 2004.The PDS coverage is likely to increase to 12million and the food subsidy bill to Rs. 930 crorein 2004/05, which is below the maximumsubsidy amount of Rs.1,540 crore incurred in2000/01 but higher than the projected Rs. 768crore in the MTFP.

Reforming public sector units and cooperatives.Implicit subsidies and fiscal support to the publicsector enterprises and cooperatives (through, forexample, low user charges, interest subsidies, andloan write-offs) and guarantees to these entitieshave led to growing contingent liabilities. Statetransport units, with 120,000 employees and anaccumulated loss of Rs.2,090 crore as of March2002 (Rs. 2,166 crore as of March 31, 2004),accounted for about 70 percent of employmentand 73 percent of accumulated losses of all publicsector units in 2001/02. The 18 cooperativespinning mills and 16 cooperative sugar mills,


25

9 The pension exercise is the largest among the Indian states the Bank has been working with. The quality and speed ofdata collection are impressive.

10 A well-known NGO in India.

employing 20,000 people, dominate the financiallosses incurred by the cooperative sector. Thereare also nine public Statutory Boards formedunder independent legislative acts, spanningfrom electricity to maritime transport topollution control. The TNEB, accounts for 80percent of employment of the nine StatutoryBoards, and dominates the balance sheets.

The state's strategy for reforming the statetransport units (STUs) comprises improvinginternal efficiency, downsizing the work force,adjusting the fare structure, and implementingpartial privatization. Public transport bus farewas increased by 27 percent and annual bonusand ex gratia payments to STUs employees werecut from about 20 percent to the statutoryminimum of 8.33 percent. The crew-to-bus ratiohas been reduced from 7.9 to 7.6. The STUshave been consolidated from 18 state transportunits to 7 which is expected to result in a savingof 10 percent on overhead cost. As a result, thefinancial performance of the state transport unitshas improved somewhat though not consistently.In 2002/03, the STUs incurred a loss of Rs. 4crore showing an improvement in performance,but in 2003/04 there appears to have been a slidein performance with a pre-audit loss figure of Rs.32 crore. Further reform plans include:rationalizing the crew-to-bus ratio to reach atarget level of 6.5, and implementing a phasedprogram of privatizing 20 percent of routes.

The Government announced a policy decision toexit all manufacturing public sector undertakings(PSUs) and sick cooperative spinning and sugarmills, following the GoI framework andguidelines for Voluntary Retirement Scheme(VRS) prior to closure and divestment. Tofacilitate divestment, institutional mechanisms,the Cabinet Committee on Divestment and ahigh-powered Interdepartmental Committee onDivestment have been established. A legislativeamendment to the Tamil Nadu CooperativeSocieties Act, enabling sale of assets of sick

cooperatives, has also been passed by the statelegislature. All cooperative spinning/sugar millsidentified for closure are sick mills.

Eight public sector undertakings, eleven out ofeighteen cooperative spinning mills and two outof sixteen cooperative sugar mills have beenclosed. The VRS has been accepted by 8,426employees. The VRS has also been accepted by2,554 employees in twelve more public sectorundertakings enabling restructuring of theseentities. The Tamil Nadu Industrial ExplosivesLimited was chosen to be privatized first butprogress has been slow. Counseling has beeninitiated for the retrenched employees.

The Tamil Nadu Electricity Board. The TamilNadu Electricity Board (TNEB), a statemonopoly, is relatively efficient in the Indiancontext. With the second largest power market inIndia, per capita consumption of electricity inthe state is 567 kilowatts a year (national averageof 355 kilowatts). In 2001/02, 61 percent of theelectricity was sold on a metered basis-muchbetter than in other states (34 percent inKarnataka, 41 percent in Andhra Pradesh, 39 percent in Gujarat, and 47 percent inMaharashtra). Technical and distribution lossesare about 18 percent, much lower than those inmany other Indian states. The TNEB has anactive enforcement system to penalize powertheft. Collection efficiency has been consistentlyhigh (about 98 percent).

Yet financial losses rose steadily from 1997/98 to2001/02. Earnings before interest, depreciation,tax, and amortizations (EBIDTA) turnednegative in 1999/2000, reaching negative Rs.1,225 crore in 2001/02 (Figure 2.1). The distressis attributed to increasing power purchases costsand increasing cross-subsidization. Sales tosubsidized categories (residential, agriculture)grew rapidly while the subsidizing High Tensionindustrial sales remained stagnant with increasingdependence on self-generation. The state has a


26

2,475 megawatt captive generation capacity.From 1996/97 to 2002/03, the proportion ofpurchased power to total power input increasedfrom 31 percent to 48 percent.

At the same time, the average cost of purchasesincreased from Rs.1 per kilowatt-hour to Rs.2.68per kilowatt-hour, largely because of high-costIndependent Power Producers (IPPs). The severedroughts in 2001 and 2002 depleted cheaperhydro resources, forcing their replacement withmore expensive thermal power.

The financial distress constrains the TNEB'sability to make investments, resulting ingeneration shortage and uneven quality ofsupply. As in many other Indian states, long-termPPAs for contracting generation capacity havenot worked well and have resulted in high IPPtariffs. In its recent tariff order, the Tamil NaduElectricity Regulatory Commission directed theTNEB to explore options for reducing IPP tariffsto more reasonable levels.

A number of initial steps were undertaken fromlate 2001 to 2003. The Government made theTamil Nadu Electricity Regulatory Commissionfunctional in 2002. Two tariff adjustments-a 16.5percent increase in December 2001 and a 13.5percent increase in March 2003 (latter by theCommission)-have helped to reduce cross-subsidies and improve the financial health of the

TNEB. All new agriculture consumers weremetered from July 2002. The Government alsobrought onto its budget Rs. 1,962 crore of theTNEB's past dues to central power utilities toclean up the TNEB's balance sheet.

Reducing agriculture cross subsidies in the powersector has proven to be extremely difficult. Ifcross-subsidy issue is not addressed, then eitherthe state budget would have to bear anincreasingly larger subsidy burden or the tariff ofsubsidizing users (e.g., industrial and commercialusers) would have to be increased. Increasingindustrial power tariff, which is already high,would force more industrial and commercialconsumers to leave the state utility grid, puttingfurther pressure on the state utility's finances.When implementing the agriculture tariff set bythe regulator in March 2003, to reduce thenegative impact of the tariff on small andmarginal farmers, the Government implementeda direct subsidy scheme for smallholders andmarginal farmers (Rs.100 crore) and hut dwellers(Rs.14 crore), a significant experiment toward adirect and transparent subsidy system. Even thenthe bulk of the subsidy burden (about Rs. 3,500crore) rested with the TNEB. Agriculturemetering and the introduction of power sectortariff for agriculture became contentious politicalissues in Tamil Nadu during the May 2004national elections. Following the elections,GoTN followed Andhra Pradesh in announcing


27

Figure 2.1 : TNEB's Financial Performance Trend

(in

Rs.

Cro

res)

free power to farmers thus reversing the nascentreforms. The Government also reversed its earlier30% increase in the tariff for domesticconsumers. The experimental direct subsidy tofarmers was given up in favor of budget supportto the TNEB for costs incurred towards freepower to agriculture and hut dwellers (Rs. 114crore) as well as subsidized power to domesticconsumers.

The reversal in the tariff for domestic consumerswill have a much larger immediate fiscal impact:of about Rs. 720 crore. With tariff increaseunlikely in the next few years, given recentevents, overall losses could exceed the reformistbusiness plan by Rs.923 crore in 2004/05 to Rs.2,034 in 2006/07 under a conservative scenario.Under more aggressive assumptions, losses couldbe higher by Rs. 1,200 crore in 2004/05climbing to Rs. 2,681 crore in 2006/07. This ofcourse assumes there is no financing constraint.Budget support of this order to finance TNEB'sresource gap will strain fiscal recovery. FinancingTNEB's resource gap through state guaranteedborrowing would increase GoTN's contingentliabilities and financing costs of TNEB besidesthe high opportunity cost that this involves interms of resource misallocation. In any situationthe financial recovery of TNEB is unlikely to besustained, investments are likely to beconstrained, and finances and service quality arelikely to deteriorate. Further, in both scenarios,the consolidated fiscal deficit will be back at orabove pre-reform levels, and productive spendingwill be crowded out by power subsidies.

The long-term financial sustainability of the powersector in Tamil Nadu, as in other Indian states, willrequire the formulation and implementation of acomprehensive reform program that addresses therequirements of India's new Electricity Act 2003-including competition in the power sector andmetering all un-metered consumers. But detailedimplementation arrangement of the Act remainsunclear in key aspects.

Institutional reform of, and restructuringrequirements for, Tamil Nadu's power sectorneed to be developed and implemented inaccordance with the provisions of the NationalElectricity Act and the specific needs of the state.Key aspects to be addressed include thegeneration cost, the ability to attract sustainableprivate investment, and human resourcerequirements.

The experience of metering existing consumersin other states has generally been unsuccessfuland will remain politically challenging in TamilNadu as well. A consensus is emerging thatintroducing metering of agriculture pump setsrequires an integrated solution that incorporateswater and power issues and demonstratesimproved efficiency of pump sets and betterdelivery of paid-for services (power, irrigation,extension, post harvest marketing), resulting inhigher farm incomes.

Improving public expenditure management. TheGovernment of Tamil Nadu has initiated reformsof the systems and processes of budgetformulation and execution. While the existingannual budget system is functional, reforms areneeded to achieve the Government'sdevelopment objectives and to adapt theinstitutional arrangements to support the fiscalstrategy. The key challenge is to ensure that acomprehensive resource framework and amedium-term perspective effectively guide thethree objectives of budget management:aggregate fiscal discipline in line with themedium-term fiscal program, strategic policydecisions by the Government within theconstraints of the fiscal program, and efficientuse of public expenditure in governmentoperations. In each of these areas, theGovernment of Tamil Nadu has initiated orproposed major actions.

The Tamil Nadu Fiscal Responsibility Act (FRA)lays the foundation for aggregate fiscal discipline


28

by emphasizing transparency and disclosure ofthe medium-term fiscal program with eachbudget. In addition to the required politicalcommitment to the fiscal adjustment, crediblemedium-term fiscal planning will requirestrengthened government capacity to projectrevenue over a multiyear period, and keyindicators such as the fiscal deficit will have to bemade consistent with standard internationalpractice to be fiscally transparent and to facilitatemonitoring of fiscal trends. Internationalexperience suggests that fiscal responsibilitylegislation is neither essential nor sufficient forfiscal adjustment, but that it can be a usefulinstitutional complement to fiscal policy reforms.Performance in the four other Indian states thathave so far passed FRAs (Karnataka, Kerala,Punjab, and Uttar Pradesh) has been mixed withdifferent levels of ownership and commitment.More attention will be required both bygovernment and by outside parties to complywith FRA provisions post-adoption.

To improve the strategic budgetary tradeoffs onpolicy initiatives, Tamil Nadu needs tosubstantially strengthen its upstream capacity forpolicy formulation. Government departments inTamil Nadu prepare specific policy notes to set

out government sectoral objectives and articulatehow government expects to achieve its objectivesthrough service delivery, financing, partnership,or regulation of private activity (Box 2.3). Suchpolicy notes, appropriately strengthened inprocess and content, could form the basis forlinking the government's objectives in specificsectors with departmental budgetary preparationand financial requirements. This is necessary toensure that well-crafted departmental policyproposals, together with their financialimplications, are submitted for cabinet review anddiscussion during budget formulation. Theestablishment of a Policy Review Committee, tobe chaired by the Development Commissioner,could provide leadership and focus to this keycapacity-enhancing reform. The Policy ReviewCommittee can rely on a network of public andprivate institutions to undertake public policyresearch and analysis. An appropriately staffed cellof the Planning and Development Departmentcan be established to develop and maintain thenetwork relationship with institutions.

Current processes for budget formulation inTamil Nadu distinguish between existingexpenditure commitments (Part I) and newexpenditure commitments (Part II)-making them


29

The policy note begins with a clear statement of objectives-encompassing inputs and outputs, with an explicitindication of budget for 2003/04 of Rs. 4,203.8 crore, of which Rs.3946 crore is non-plan allocation andRs.257 crore is plan allocation. It identifies the "new schemes" under Part II, including various deferredmaintenance items (repairs to office buildings, etc.) and a listing of recent accomplishments (number of vacantteacher positions filled, orders issued for village libraries, counseling system for teacher transfers, etc.). Theprincipal thrust of the note, however, is covered by specific chapters for each topic- elementary education,secondary and higher secondary education, teacher training, etc. Under elementary education-the policy notecites the Compulsory Education Act of 1994/95 and identifies objectives (full enrollment, retention untileighth standard, quality education for learning competence, micro-level decentralized planning, andcommunity participation). The structure of the policy note suggests an informational purpose rather than adocument that seeks to make the case for a policy initiative or to justify a specific funding request. For themost part, it reports agreed objectives and indicates programs that are under way to achieve stated objectiveswith occasional discussion of financing being supplemented by central programs (such as the Education forAll program).

Box 2.3: Policy Note on Demand No. 41: School Education, 2003/04

Source: GoTN’s Budget Documents.

extremely amenable to adaptation to improvecabinet decision-making on policy prioritieswithin the medium-term fiscal program. TheStanding Finance Committee of Cabinet can bemade responsible for reviewing new policy andproject commitments under Part II of theproposed budget and ensuring that priorities arefunded within the agreed fiscal constraint.Current budget instructions require departmentsto submit multiyear budgets for both Part I andPart II. In subsequent years, the budgetdocumentation needs to be improved to providea clearer link between policy priorities and goals,budget allocations and performance.

The operational efficiency of governmentdepartments is a function, among other things,of the predictability of budgetary resource flows,appropriate incentives and managerial discretionfor department and project managers, andperiodic evaluations of the effectiveness ofgovernment programs. An earlier submission ofthe draft budget to the legislature can help bringbudget approval closer to the start of the fiscalyear, facilitating budget execution. A review ofbudget execution processes can help identify andaddress current weaknesses. Together withimprovements in internal control systems, theGovernment should explore an increase the scopefor virement within departmental budgets. TheGovernment should also plan to constitute astanding Expenditure Review Committee tooversee time-bound implementation ofexpenditure rationalization recommendations ofthe Staff and Expenditure Reform Commissionand to undertake rolling annual reviews ofdepartments to identify unproductive programsand to rationalize and improve efficiency ofexisting programs.

Strengthening financial accountability. Theframework for public financial accountability inTamil Nadu is generally sound. Its strengthsinclude the oversight role of legislature overpublic finances, regular compilation and timely

preparation of monthly accounts andpresentation of annual financial statements(usually within six months after close ofaccounts), and the constitutionally guaranteedindependence and broad mandate of theComptroller & Auditor General. Nevertheless,several areas need strengthening and enforcing tomake the public financial accountability systemeffective and to support the objectives of theGovernment's medium-term fiscal andgovernance reform program.

The need for reform is particularly evident in thearea of budget execution procedures, includingthe weaknesses in internal controls and the needto eliminate or reduce reliance on PersonalDeposit Accounts in the Public Accounts, whichdistort expenditure and the fiscal deficit. It is alsonecessary to modernize the existing computerizedtreasury systems with upgrading and networking,to improve the quality of internal audits, and tohave more effective legislative oversight andtimely responses and follow-up to auditobservations.

The Government of Tamil Nadu has startedclassifying and reporting details of guarantees inthe budget document with a risk rating of theguarantees. A committee headed by the ChiefSecretary was formed to review and discuss thestatus of responses to audit observations inbiyearly meetings.

The Government of Tamil Nadu has outlined anagenda for further strengthening financialmanagement, and has prioritized the followingactions from the year 2004/05 onwards.� Budget execution. The Government

intends to review budget executionprocedures to identify systemic constraintsto effective execution, and to define andimplement appropriate remedies.

� Internal control. The Government intendsto address and strengthen certain basic


30

financial management and internalcontrols that could affect the reliability offiscal and financial information, improvethe overall internal control environment,and reduce the risk of misuse of publicfunds. Proposed actions include takingstock of and formulating rules for writeback, opening, and validity of the PersonalDeposit Accounts in the Public Accounts.The Government also intends to developmeasures to address key internal controlissues such as reconciliation of accounts,reconciliation of loans and advances,timely submission of utilizationcertificates, and incentives for compliance.

� Treasury. Plans are to be drawn up andimplemented to upgrade and network thecomputerized setup for the Treasury(including departments under the letter ofcredit system), and develop a financialmanagement information system fordepartments. The plan would also addressthe need for extending computerization todrawing and disbursement offices toenable computerized bill preparation,recording, and control over commitments.

� Internal Audit. The Government of TamilNadu would create a working group toreview the scope, coverage, and focus ofexisting internal audit function, with aview to moving toward a "risk-based"audit approach and to implementing therecommendations of the working group ona pilot basis.

� External audit and legislative oversight. Tomake the proceedings of the committeeheaded by the Chief Secretary moreeffective, a database of all the auditobservations would be prepared tomonitor and improve the responsiveness tothe audit observations. One senior officialwithin the finance department would be

responsible for maintaining the databaseand following up on the audit responses.

Initial Outcome of Fiscal Reform This section reviews the initial outcome of thefiscal reform program. The projected adjustmentpath as prescribed by the MTFP is summarizedin the next section, along with the implicationsto the adjustment of the recent reform reversals(see page no. 19).

Revenue performance. Tamil Nadu already hasone of the highest own tax/GSDP ratios in Indiabut the ratio had fallen to less than the level of10% achieved in the early 1990s. TheGovernment made significant efforts to increasethe tax-to-GSDP ratio from 8.8% in 2001/02 to9.4% in 2003/04. Buoyancy in sales tax revenuewas restored, with near 14.5% average growth in2002/03 and 2003/04. The state's own annualincremental revenue almost trebled from Rs.538crore in 2001/02 to Rs.1,561 crore in 2002/03and Rs. 1,603 crore in 2003/04.

Expenditure composition. The composition ofrecurrent expenditure improved, with asignificant narrowing of the gap between revenueexpenditure and revenue receipts. Most notably,salaries and pensions as share of the state's owntax revenue was reduced from a peak of 100% in1999/00 to 71% in 2003/04, and as a share ofrevenue expenditure, reduced from 56% to 45%over the same period. The food subsidy wasreduced from a high of Rs. 1,540 crore (7.3% ofrevenue expenditure) in 2000/01 to Rs.800 crore(3.2% of revenue expenditure) in 2003/04. Non-wage O&M as a share of revenue expendituredeclined from 9.3% in 1999/00 to 8% in2001/02, but rose back up to 9.9% in 2003/04.Tamil Nadu's outstanding small savings debtstock as of March 31,2002, with interest ratesabove 13% was Rs.4,400 crore, or about 12% ofdebt stock. Over 2002/03 and 2003/04, GoTNswapped Rs. 3,100 crore of small savings debtunder the GoI debt swap scheme. The remaining


31

small savings debt stock has been swapped in2004/05. Annual interest savings will be over Rs.200 crore. Consequently, interest expenditure hasheld steady at 20% of revenue receipts in 2002/03and 2003/04. In addition, GoTN repaid aboutRs. 700 crore to NABARD and about Rs. 500crore in off budget borrowing in 2004/05.

Budget deficit improves. The impact of the fiscaladjustment program has been impressive. Whilethe revenue (current) deficit declined from 2.1%of Gross State Domestic Product (GSDP) in2000/01 to 0.9% of GSDP in 2003/04 and2004/05(RE), the fiscal deficit declined from 4%of GSDP to 2.4% of GSDP in 2003/04 but hasrisen to 2.9% in 2004/05(RE). The state alsoachieved a primary surplus of 0.3% of GSDP in2003/04 as compared to a deficit of -2.5% ofGSDP in 1999/00. But an attempt to boostcapital outlay by almost 22% over budgetedestimates in 2004/05(RE) will turn the primarysurplus of 2003/04 to a small deficit of 0.3% in2004/05(RE). It remains to be seen whether thestate is able to spend as much by the fiscal yearend as the higher outlay is unprecedented.

Consolidated fiscal deficit performance. A keyobjective of fiscal adjustment was cleaning up ofaccumulated arrears from prior years. A largeamount of arrears, Rs. 3,062 crore equaling to 2%of GSDP, was cleared in 2002/03, includingRs.1,100 crore arrears from 2001/02, and thesecuritization of Rs.1,962 crore of dues to centralelectricity utilities by the Tamil Nadu ElectricityBoard. There are pension arrears of Rs. 1,000crore from 1999/00 when the previousGovernment postponed these payments for fiveyears due to a liquidity crisis. These arrears areincluded in the MTFP for clearance by paying Rs.2,500 crore, Rs.300 crore and Rs.450 crore overthree years from 2003/04 to 2005/06 althoughtheir actual clearance can take a little longer.

Despite clearing up the arrears, the consolidatedfiscal deficit was reduced from a peak of 6.7% ofGSDP in 1999/00 to 4.8% in 2002/03 (Table 2.1).11 The close to two percentage pointreduction from 1999/00 to 2002/03 was largelyattributed to an increase in the ratio of the state'sown tax revenue to GSDP (from 8.6% in1999/00 to 9.3% in 2002/03), and a reduction


32

11 The consolidated fiscal deficit of 5.8% in 2000/01 and 5.2% in 2001/02 underestimated real levels owing toaccumulation of (non-pension) arrears: Rs.2, 345 crore (1.7% of GSDP) in 2000/01 and Rs.3, 062 crore (2% of GSDP)in 2001/02.

Table 2.1: Primary, Revenue, Fiscal and Consolidated Deficits as a Percent of GSDP

1997/98 1998/99 1999/00 2000/01 2001/02 2002/03 2003/04

Primary Deficit 0.6% 2.3% 2.5% 1.8% 1.1% 1.9% -0.3%

Revenue Deficit 1.1% 2.6% 2.8% 2.1% 1.7% 3.0% 0.9%

Non Power Deficit (1) 1.4% 4.0% 5.1% 4.1% 3.2% 3.1% 2.2%

Budgetary Support to Power (2) 0.9% 0.2% -0.4% -0.1% 0.2% 1.4% 0.2%

Budgetary Fiscal Deficit (1+2) 2.3% 4.1% 4.6% 4.0% 3.5% 4.5% 2.4%

Power Sector Financing Requirement(3) 0.8% 1.2% 1.6% 1.7% 2.0% 1.7% 1.4%

Consolidated Fiscal Deficit (1+3) 2.2% 5.2% 6.7% 5.8% 5.2% 4.8% 3.8%

Source: GoTNs Budget documents and TNEB's accounts.Note: Deficits in 2000/01 and 2001/02 were lower due to accumulation of arrears.

Data for 2002/03 includes clearance of arrears equal to 2% of GSDP.Pension arrears in 1999/00 are included for clearance in 2003/04, 2004/05 and 2005/06, respectively.

in the ratio of salaries to GSDP (from 6.5% in1999/00 to 5.2% in 2002/03). Unfortunately,capital outlay and net lending suffered areduction equaling to 0.4% of GSDP (duelargely to a lack of financing and implementationcapacity). The consolidated fiscal deficit isestimated to have decreased to about 3.8% ofGSDP in 2003/04 based on estimates for TNEBas against the MTFP target of 4.8% of GSDP forthe year.

The financial performance of the Tamil NaduElectricity Board improved during the period2001/02 to 2003/04. TNEB's EBIDTA isestimated to have decreased from negative Rs.1,207 crore in 2001/02 to negative Rs.537 crorein 2002/03. The net loss before subsidy isestimated to have been reduced from Rs. 1,854crore to Rs. 1,253 crore over the same period.The financial performance of the state transportunits (STUs) also improved, with net lossreduced by 98.6% between 1999/00 and2002/03.12 But failure to revise transport faressince December 2001 has meant that themomentum of improvement in financialperformance has been lost. Consequently, theSTUs net loss increased from Rs. 4 crore at theend of 2002/03 to Rs. 32 crore at the end of2003/04(pre-audit).

Guarantees outstanding were 6% of GSDP in2003/04, below the ceiling of 10% of GSDP(un-weighted guarantees) set by the FiscalResponsibility Act (also lower than, for example,Andhra Pradesh at 10%). The Government forthe first time classified guarantees under five riskcategories (from very high risk to nil risk) as perthe guidelines issued by the Reserve Bank ofIndia, and made the information public via the

2003/04 budget. The risk-weighted guarantees(Rs. 3,362 crore) amounted to about 2% ofGSDP in 2003/04.13 A guarantee redemptionfund along the lines recommended by theReserve Bank of India has been established. TheGovernment also intends to institutionalize theprocess of evaluating requests for guarantees.

The GoTN signed up to the Fiscal ReformsFacility of Government of India in 2003. As perthe Memorandum of Understanding, GoTN wasrequired to achieve a Revenue Deficit to RevenueReceipts ratio of 17.4% in 2003/04. GoTNinstead has achieved a major improvement overthe target by achieving a ratio of 6.5%. TheTwelfth Finance Commission (TFC) has fixedTamil Nadu's share in the total divisible pool ofcentral taxes at 5.305% as opposed to theprevailing 5.385%, a marginal decrease. Butstates' share in the centre's divisible tax pool hasbeen increased from 29.5% to 30.5%, keepingthe effective share of Tamil Nadu unchanged at1.6% of central taxes during 2005/06-2009/10.The total devolution of central taxes to TamilNadu over the five year period is estimated by theTFC at Rs. 32,553 crore. The TFC has doneaway with normal central loan assistance for stateplans in favor of market borrowings. Tamil Naduis not affected by this change. The TFC has alsorecommended debt relief to the states in the formof restructuring of all central loans with stategovernments' as of March 31, 2004 outstandingas of March 31st, 2005. The loans will beconsolidated and rescheduled at 7.5% interestrate repayable over twenty years. This has beenmade conditional on states' enacting FiscalResponsibility Legislation, which Tamil Nadugovernment has already enacted making iteligible straightway. As a result, Rs. 6,872 crore of


33

12 The finances of the state transport units have not been incorporated into the consolidated fiscal deficit. The Bank's work onstates' fiscal reform has focused so far on incorporating the finances of the power sector into the consolidated fiscal deficit.

13 The risk weights used are as follows: 100% risk weight assigned to the very high risk category, 75% to the high riskcategory, 50% to the medium risk category, and 25% to the low risk category. The nil risk category used by thegovernment is treated as off-budget borrowing.

outstanding central loans on Tamil Nadugovernment's books will be restructured. Theinterest gain is estimated at Rs. 1,195 crore inTamil Nadu's case over the period 2005/10. TheTFC has also recommended debt write-off linkedto reduction in the revenue deficit of the stategovernment. Under the scheme, a certainproportion of repayment of rescheduled debt willbe written off by Government of India over theperiod 2005/06 to 2009/10. The quantum ofwrite-off is linked to the absolute amount ofreduction in the revenue deficit each year withthe ultimate objective of eliminating the revenuedeficit by 2008/09. Tamil Nadu can benefit tothe extent of Rs. 1,718 crore in debt write-offsunder the scheme. Tamil Nadu also gets Rs.1,214 crore in grants for maintenance of roadsand bridges, Rs. 242 crore for maintenance ofpublic buildings, Rs. 30 crore for forests, Rs. 40crore for Heritage conservation, Rs. 250 crore fordevelopment of urban areas and Rs. 50 crore forsea erosion over 2005/06 to 2009/10.

GoTN's MTFP has been revised along with the2005/06 budget and accelerates the fiscaladjustment path when compared to the firstMTFP. The revised MTFP builds in the TFC'saward conservatively as opposed to the actualaward thereby providing a revenue cushion. Thestate benefits from TFC's debt restructuring anddebt write-offs while it is not affected by theabolition of central lending in support of stateplans. However, to take advantage of the debtwrite-off the state has to stay on track toeliminate the revenue deficit by 2008/09 which isalso the state's revised MTFP target. If theGoTN maintains its current rate of progress, it is

well poised to take full advantage of the TFC'srecommendations. The costs of policy reversals of2003/04 have thus been absorbed in 2005/06but pose an underlying medium term fiscal threatunless effectively addressed.

Medium-Term Adjustment PathConsolidated fiscal deficit. The medium-termadjustment path under the first MTFP(2003/04-2008/09), which was tabled in thestate legislature on February 11, 2004, waspredicated on maintaining an increasing ownrevenue effort progressing from 10.2% of GSDPin 2002/03 to 10.4% in 2008/09-with thestate's own tax revenue improving from 9.3% ofGSDP in 2002/03 to 9.8% in 2008/09-andfurther reorienting expenditure from salaries,pensions, and subsidies to non-wage O&M andcapital investments, while stabilizing theconsolidated fiscal deficit (see Table 2.2) toachieve a targeted real GSDP growth rate of 6%by 2008/09.14

The reversal of some reforms-PDS, bus travelconcessions and electricity tariff after nationalelections in May have resulted in mid yearexpenditure of Rs. 1,000 crore. Additionalexpenditure of Rs. 650 crore was provided for insupplementary budgets increasing expenditure in2004/05 to about Rs. 1,650 crore over thebudgeted estimates (about 5% of projectedexpenditure in 2004/05). But lower expenditureunder salaries and pensions of Rs. 1,500 crore inthe 2004/05(RE) as compared to the budgetestimates and stronger than projected revenuegrowth has meant that the fiscal deficit in2004/05(RE) is projected to be lower at


34

14 The MTFP was drawn up by the Government using 2003/04 (revised estimates) as the base. Subsequently, higher GoIdevolution in March 2004 and savings under salaries and pensions and lower capital outlay resulted in the state exceeding theMTFP projections for 2003/04. With revised estimates for 2004/05 available to government and taking into account theimpact of policy changes, the TNEB's accounts for 2003/04 and 2004/05, the salary cost of 15,500 new hires, the TwelfthFinance Commission's award, revised GSDP growth projections etc. the first MTFP has been updated along with the budgetfor fiscal 2005/06. However, it is useful to look in detail at the first MTFP as this was the state's first effort at fiscal projectionsand formed the basis for budget 2004/05.

Rs. 5,447 crore (3% of GSDP) as compared tothe budgeted Rs. 6,921 crore (3.8% of GSDP).The lower fiscal deficit also builds in highercapital outlay and non wage operations andmaintenance expenditure of Rs. 1,100 crore ascompared to the budget.15 As it stands, theincrease in subsidy expenditure implies littlethreat to achieving the MTFP targets in the nearterm. But an opportunity is being lost of tryingto correct resource misallocation and therebydecreasing underlying fiscal risks on theexpenditure side.

Revenue performance. The ratio of revenue toGSDP was projected to increase from 13.3% in2002/03 to 13.7% by 2007/08 in the firstMTFP. The scope for increase in the tax ratio isconstrained: by the already high tax effort inTamil Nadu; the Constitutional restriction onstate taxes to certain types and activities(particularly the state's inability in taxing thebulk of the fast growing services sector), the

secular decline in Tamil Nadu's share in sharedtaxes devolved by the central government, therelatively slower GSDP growth in Tamil Nadu inrecent times and the perceived political difficultyof substantial increases in user charges.

Expenditure composition. The share of non-wageO&M and capital outlays and net lending toGSDP is projected to rise from 2.9% in 2002/03to 3.6% in 2008/09 in the first MTFP, owinglargely to the projected decline in the share ofsalaries (from 5.2% of GSDP to 4.3%) and foodsubsidies (from 0.8% of GSDP to 0.3%) over thesame period. However, reversal in policy reformspertaining to subsidies (see page no. 19) may makeexpenditure adjustment relatively slow. It is notcertain now whether the GoTN can undertakehigher non-wage O&M and capital outlaywithout raising the fiscal deficit given the fiscalcost of the new policy choices. The decline in theshare of salaries is to come from a combination oftwo factors: the net attrition of 2.8% per year


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Table 2.2: Primary, Revenue, Fiscal and Consolidated Deficits as a Percent of GSDP Projected Under Tamil Nadu’s MTFP (February, 2004)

2002/03 2003/04* 2004/05 2005/06 2006/07 2007/08 2008/09

Primary Deficit 1.9% 1.3% 0.8% 0.3% -0.3% -0.5% -0.9%

Revenue Deficit 3.0% 2.2% 1.9% 1.5% 0.7% 0.4% 0.0%

Non Power Deficit (1) 3.1% 3.8% 3.6% 3.2% 2.6% 2.4% 2.1%

Budgetary Support to Power (2) 1.4% 0.3% 0.1% 0.1% 0.1% 0.1% 0.1%

Budgetary Fiscal Deficit (1+2) 4.5% 4.1% 3.7% 3.3% 2.8% 2.5% 2.1%

Power Sector Financing Requirement(3) 1.7% 1.0% 0.8% 0.6% 0.4% 0.1% 0.0%

Consolidated Fiscal Deficit (1+3) 4.8% 4.8% 4.4% 3.8% 3.0% 2.5% 2.1%

Source: GoTNs MTFP, Budget Speech 2004/05.Note: Data for 2002/03 are actuals, including clearance of arrears equal to 2% of GSDP.

* 2003/04 actuals have improved dramatically over the MTFP target.Deficits for 2003/04, 2004/05, and 2005/06 include clearance of pension arrears from 1999/00.

15 Four broad sets of factors have additionally helped the state meet the challenge of the additional expenditure: (i) salaries andpensions have remained virtually flat in nominal terms in 2002/03 and 2003/04 (ii) the government expects conservativelyto realize Rs. 1,500 crore of savings under salaries and pensions expenditure as compared to the budget in 2004/05, (iii)interest expenditure savings consequent to debt restructuring in 2004/05 and (iv) revenues have been growing well duringthe fiscal year 2004/05 exceeding the Budget projections ( 15% over 2003/04 as opposed to annual 3% in the MTFP).

during the MTFP period (which are explained bythe projected retirement patterns and hiringfreeze) and the slower growth in the cost of livingindexation of wages (i.e., dearness allowances).

Priority development expenditure. The firstMTFP projected an increase in developmentexpenditure (capital outlays and non-wageO&M) in priority infrastructure and socialsectors (roads, rural water supply and sanitation,irrigation, elementary education (ages 6-14),nutrition and health). However, the fiscal costs ofthe policy reversals would shrink the resourcespace originally envisioned in the MTFP to makethe desired expenditure adjustment.

Since about 80% of total expenditure isinflexible in nature (salaries, pensions, interest,subsidies and transfers), reform will have totarget these heads of expenditure if resources areto be found for non-wage O&M and capitaloutlay without expanding the fiscal deficit. Thelong-term economic growth consequences ofpoor expenditure composition can be costly.The ability to increase social expenditure incritical areas such as education, health, watersupply and sanitation, and nutrition may beaffected. To put the Rs. 1,100 crore expenditureon annual power subsidy in perspective: thestate spends about Rs. 1,400 crore only (4% oftotal expenditure) on the entire health sectorand Rs. 750 crore (3% of total expenditure) onwater supply and sanitation. The higher subsidyburden therefore represents a lost opportunityto improve social outcomes.

Pension reform (see page no. 24) has slowedgrowth of pension liabilities-reducing theimplicit pension debt by 7% of GSDP.However, it is not realistic to expect reductionin pension expenditure in the short to mediumterm. This is mainly due to the long-termnature of pension policies, the acquired rights ofexisting employees, the aging civil servicewhich, measured by per hundred population, is

larger than all other Indian states except Punjab,and the need for the Government to contributeto the new defined contribution scheme.

Revised MTFP. The MTFP has been revised toreflect changes in policy, TFC's award, changesin underlying economic growth scenario andbuilds on the 2004/05(RE). The revenuegrowth assumptions are conservative. Forinstance in 2005/06, tax devolution to the statefrom the centre has been budgeted by the centreat Rs. 5,041 crore as compared to Rs. 4,407crore in the first MTFP, a gain of Rs. 634 croreif realized. The GoTN in its 2005/06 budgethas gone along with a more conservativeassumption of Rs. 4,672 crore, thus providingan inbuilt revenue cushion. The buoyancy ofSales tax is assumed at 1.05 from 2006/07onwards; state excise growth at 3.5% perannum, vehicles tax at 8% per annum andstamp duty at 5% per annum. The revisednominal GSDP growth assumptions althoughhigher than the first MTFP is still an annualaverage 10.4 %. The revised MTFP targetsrevenue surplus in 2008/09 as against amarginal revenue deficit in the first MTFP. Thefiscal deficit is to be reduced to 3% of GSDP by2005/06 as against the TFC's requirement ofdoing so by 2008/09. The revised fiscal targetsare shown in Table 2.3.

Fiscal Sustainability and Risks If the fiscal reform and MTFP are broadly ontrack, Tamil Nadu's debt stock is expected tostabilize around 31% of GSDP in 2005/06, alevel below that in many other Indian states.However, due to fiscal cost of recent policyreversals, the debt to GSDP ratio may increasefrom 31% of GSDP in 2004/05 to 32.3% ofGSDP by 2008/09.

Tamil Nadu's long-term fiscal sustainability willdepend critically on two factors: The first is theevolution of key national macroeconomicvariables-real interest rates on government


36

borrowing, inflation rate, and actual devolutionof the center's shared taxes. The second factorconsists of the evolution of two key variables-the state's economic growth and the primarydeficit-that will depend largely on the policiesand reforms of the state government. Thecentral government can still influence these twokey variables through for example: taxdevolution policy, the Pay Commission, andpolicies of a concurrent nature affectingeconomic growth (e.g., labor market reform andbankruptcy procedures). To stabilize the debt-to-GSDP ratio over the long term, thegovernment will need to implement reformmeasures that stimulate economic growth,eliminate primary deficit, or lower the effectiveinterest cost of borrowing-or all.

There are significant risks to fiscal adjustmentacross Indian states; Tamil Nadu is no exception.These risks are: � Political resistance to adjustment.

Correction of the distortions and fiscalexcesses of several decades entails largeshort-term costs. These affect many vestedinterests and are often met with strongresistance. The resistance typicallyintensifies near and during elections. Priorto the national elections in April-May2004, the political leadership had providedstrong support for reform. However, afterthe electoral loss some critical reforms wererolled back.

� A key challenge in fiscal adjustment is theperceived political difficulty of increasinguser charges. This is amply illustrated bythe difficulty of pricing power supplyto agriculture. Providing increasingbudgetary support would derail fiscalrecovery. Financing the deficit througharrears or guaranteed-backed borrowingwould increase the government'scontingent liabilities.

� Unexpected macroeconomic shocks couldthreaten Tamil Nadu's fiscal sustainability.India's large fiscal imbalances could pose athreat to sustained economic growth.Slower growth and high fiscal deficits maytranslate into higher borrowingrequirements but also put pressure oninterest rates on government borrowing.This would negatively affect the ongoingdebt restructuring efforts at the state level,hence the trajectory of debt sustainability.Since interest and real growth rates tend tobe negatively correlated, it is very likelythat if interest rates start rising, economicgrowth will decline, resulting in a rise inthe debt-to-GSDP ratio unless fiscal policyis adjusted. For instance debt dynamicsmodeling indicates, the combination ofrising nominal interest rates (say between11% and 14%) and economic slowdown(to 3%) implies that the government willhave to run surpluses in the range of


37

Table 2.3: Primary, Revenue, Fiscal and Consolidated Deficit as a Percent of GSDPUnder Tamil Nadu’s revised MTFP (March, 2005 )

2003/04* 2004/05(RE) 2005/06(BE) 2006/07 2007/08 2008/09

Primary Deficit 0.3 -0.3 -0.5 -0.2 0.1 0.4

Revenue Deficit -0.9 -0.9 -0.7 -0.6 -0.3 0.0

Fiscal Deficit -2.4 -2.9 -3.0 -2.6 -2.2 -1.9

Consolidated Fiscal Deficit -3.8 -3.9 -4.2 -3.5 -2.7 -2.3

Source: GoTNs MTFP, Budget Speech 2005/06.* Accounts, positive sign indicates surplus.

0.9-1.9% of GSDP in order to avoidincreasing the debt-to-GSDP ratio beyond 35%.16

� A decline in central government revenuetransfer poses another risk. Successivefederal Finance Commissions have reducedthe percentage share of Tamil Nadu in thepool of net shareable central taxes, and thecontribution of the share of central taxes toTamil Nadu's revenue declined from 21%in 1992/93 to 15% in 2002/03. The TFC'saward will be a determinant of the pace offiscal adjustment at the state level. Centraltransfers to states (both as share of revenueand GDP) have fallen over time because ofdecrease in the revenue to GDP ratio of theGoI (Box 2.4). Further tax sharing isnecessary to reduce vertical imbalances

between expenditure responsibilities ofstates and their revenue powers and toaddress the revenue concerns of relativelybetter-off states. For example, the GoI canassign the right to states to tax a larger shareof services and raise the constitutionalceiling on the professional tax. If and whenthe central government reduces or abolishesthe Central Sales Tax, Tamil Nadu, as anexporting state, will lose tax revenue, and itis important that it have other sourcesavailable to it as compensation. Moreover,introduction of VAT (from April 1, 2005)should be on the basis of floor rather thanharmonized rates, so that states like TamilNadu do not lose revenue as a result. Anyshortfall in revenue due to VATintroduction could jeopardize TamilNadu's medium-term fiscal program.


38

16 Details of the model are presented in the report Tamil Nadu: Fiscal Reform and Sustainability, World Bank (2004).

As Figure 2.2 shows, central transfers have fallen over the last two decades largely because GoI revenue hasfallen as a percentage of GDP, and to a lesser extent because there has been a decline in grants to the states asa percentage of central (gross) revenue. In the last few years, stronger revenue growth, and an increased sharegoing to the states have helped reverse the long-term decline in GoI transfers to states. However, transfers areyet to reach the 5% of GDP level last seen in the early nineties.

Box 2.4: Central Transfers to States have fallen

Source: State Fiscal Reforms in India, World Bank (2004).

Figure 2.2 : Trends in GoI revenues and Transfers to States

External shocks are a major source of risk tofiscal adjustment. Tamil Nadu's agriculture isvulnerable to periodic droughts due to itsdependency on rainfall. More frequent than inthe recent past, three annual droughts includingthe unprecedented century's worst statewidedrought in 2002, led to an annual average of -3.9% growth during 1999/00-2002/03compared with an annual average of 4.5% in

the previous nine years. The droughts havegreatly contributed to the slowdown ineconomic growth as well as the financialdeterioration of the power sector in 2001 andthe slower recovery in 2002, notwithstandingtariff adjustments. Drought(s) during themedium-term adjustment period couldseriously affect economic growth (and hence taxcollection) and the TNEB.


39

43

Fiscal reform must be complemented with astrong program to improve investment climatefor accelerating economic growth and meetingthe poverty reduction objective. The slowdownin economic growth in Tamil Nadu since the late1990s and the structural impediments to fastereconomic growth would affect the pace ofpoverty reduction. The debt dynamics analysisunderscores the importance of acceleratingeconomic growth to achieve fiscal correction andsustainability. Faster economic growth positivelyinfluences not only debt sustainability but alsoemployment and income generation, facilitatinga larger distribution of reform gains.

Economic growth is a key driver for sustaining andaccelerating the pace of poverty reduction and theattainment of MDGs. Accelerating economicgrowth is the foundation stone of anti-povertypolicies worldwide. A dynamic economy, growingstrongly, is a powerful force for creating new andbetter employment opportunities for poor people,enabling empowerment, and reducingvulnerability. Most of the reduction in poverty inthe recent period in India has been a result of theincrease in average consumption driven by

economic growth (Deaton and Dreze, 2002). InIndia, policies that foster overall economic growthhas the greatest potential for reducing povertyfurther (Ferro, Stern, et. al, 2003).

Cross-country evidence has demonstrated astrong link between investment climate andgrowth. There could be considerable growthgains from improvement in investment climatein Tamil Nadu. Investment climate influences theexpected returns and flow of foreign anddomestic investment to a country or a location.In addition to macroeconomic policy, politicalstability and national policy towards foreigntrade and investment, investment climatecomprises of two critical factors: efficacy andtransparency of regulatory framework for factormarkets (labor, capital and land), for taxationpolicy and administration as well as for startingor exiting a business; and quality and quantity ofavailable physical and financial infrastructure.Findings from the investment climate surveys inTamil Nadu suggest that cumbersome andexcessive regulation and infrastructurebottlenecks are major or serious constraints togrowth.17 Accelerating economic growth will

IImmpprroovviinngg IInnvveessttmmeenntt CClliimmaattee ffoorr

MMaannuuffaaccttuurriinngg aanndd SSeerrvviicceess

17 41% of respondents in a World Bank/CII survey identified infrastructure as a severe bottleneck to improving theinvestment climate as compared to say 25% in Gujarat. 47% felt power was a severe bottleneck, 43% felt transport wasa bottleneck (second highest after Karnataka's 50%). Senior management in the survey reported spending 13% of theirtime dealing with regulations as opposed to say Haryana 10%.Tamil Nadu's manufacturing establishments reported anaverage of 11 official inspections a year as compared to 5 in Maharashtra and 6 in Karnataka. 14% of respondents(second highest after Gujarat's 21%) in Tamil Nadu felt constrained by overstaffing. 42% respondents reportedcorruption as a growth bottleneck better than Karnataka's 65% but worse than Andhra Pradesh's 10%. Source: India Investment Climate Assessment, World Bank November 2004.

require sound policy, institutions andinfrastructure development to support privatesector development.

Priority reforms concern labor market flexibility,a more responsive urban land supply system,more efficient tax policy and administration,streamlining regulations over entry, exit andoperation, power sector reform and scaling upPPP for sustainable infrastructure development.Several important issues are exclusively or largelywithin the purview of the central government:labor reforms, the introduction of VAT, exitpolicy and bankruptcy procedures, and keyinfrastructure such as national highways,international air markets, major ports and railssystems. Within the federal framework, TamilNadu can explore reform opportunities.

Removing Regulatory BurdensThe regulatory framework is broadly understoodto include the following three areas: factormarket regulations, i.e., regulations of labor,capital, and land markets; tax and customsadministration; and regulations of entry, exit andoperation through regulation requirements andbankruptcy laws. Tamil Nadu has made reformefforts to improve the regulatory environment forthe private sector such as the entry regulation forlarger investment projects and regulation andstreamlining regulations over compliance withlabor regulations, but the regulatoryenvironment generally continues to be complex.Many of the issues such as labor regulations,indirect tax, exit and bankruptcy procedures arelargely within the purview of the centralgovernment.

Labor market rigidity. Labor market restrictionon hiring and retrenching workers is one of thegreatest challenges of doing business in India,according to the Global Competitiveness Report-India ranks 73rd of 75 countries. Rigid laborregulations have prevented Tamil Nadu fromunleashing its full potential in labor productivity.

Tamil Nadu is known for its good industrialrelations and its highly educated, hard workingand a disciplined labor force.

There are three main issues with laborlegislations. The national Contract Labor Act1970 restricts the hiring of contract labor. Anyfirm employing more than 100 employees mustseek official permission for retrenchment orclosure based on the national Industrial DisputesAct of 1947. The regulatory maze is complex,leading to high compliance cost and rent-seeking.There are 23 Union Acts and seven State Actsand Rules which are enforced by the LaborDepartment in Tamil Nadu. For each of thesesubjects there are different enactments by thecenter as well as implementing rules by the state.Many regulations are excessive and outdated(e.g., no overlapping of shifts, capping ofovertime, official permission required forworking on Sunday or holidays, specifiednumber of food cafeterias, and over 60 types ofminimum wages).

Rigid labor regulations deter greater employmentgeneration. Stringent labor institutions tend tobenefit a narrow segment of the populationcomprising the organized and unionized labor,intermediaries in the labor market, and corruptofficials, at the expense of a much larger segmentof the labor force comprising the unemployed,those employed in the unorganized sector, and/oragricultural laborers who are seeking jobs in theorganized industrial sector.

Labor regulations are largely within the purviewof the central government. Nonetheless, withinthe federal framework, Tamil Nadu can exploreways to rationalize and consolidate implementingrules concerning the legal framework governinglabor and statutory compliance requirements tocreate elbow room for contractual laborrelationship and for easing threshold forretrenchment. The experience of Maharashtraand Andhra Pradesh in attempting a more


44

flexible interpretation of the central regulationsmay be of relevance to Tamil Nadu.

Constraints in finance. The issues of access toand cost of finance are at the purview of thecentral government, thus affecting all states.The key obstacles are high interest costs,collateral requirements, and burdensomepaperwork. Recent downward trend in interestrates has been a factor responsible for revival ofindustrial growth. India's Small and MediumEnterprises (SME) sector still faces a relativelyhigh cost of capital, owing to market and policygovernment failures. There is an adverseselection in the credit appraisal process forSMEs, and interest rate premium for the highertransactions costs in dealing with smallborrowers, the lack of sufficient creditinformation on these firms, their frequentinability to provide collateral, problems incollecting collateral (typically land/property)from small borrowers due to the lack of updatedland/property records and the uncertaintysurrounding land ownership, resulting in highercosts of default and contract enforcement.

Urban land market constraints. Urban landmarkets play a critical role in urbaninfrastructure. They provide the physical spacefor industrial, commercial and residentialdevelopment as well as providing rights of waysfor critical infrastructure systems such as roads,transit, water and sanitation and power

networks. Significant and growing demand forurban land requires an efficient land deliverysystem, effective land zoning and a regulatoryprocess for infrastructure and housingdevelopment review and permission. Rapidurbanization and demographic growth-from 19million urban population to 27 million in the1990s in Tamil Nadu-generate significantdemands for urban land (Table 3.1). In order forcities to grow, either agricultural land at theperiphery or vacant and underutilized land inurban areas must be developed.

The initial assessment found the followingsystemic weaknesses in urban land market inTamil Nadu: Master plan designations in theabsence of complementary incentives andmeasures make the supply of land fordevelopment inefficient; land acquisition andproject development is complex, time consumingand expensive; obtaining permission and licensefor building construction industry is complexand time consuming; floor space Indices (FSI)are overly restrictive; over-designed subdivisionregulations' exacerbate the effects of low FSI; rentcontrol, though not enforced for all buildings,also limits supply by discouraging owners fromredeveloping properties to more intensive uses;taxes on land transfers are high comparing withinternational practices; and considerable landacross cities held by government agencies isimmobilized. These systemic weaknesses have ledto more expensive facilities and housing than

Improving Investment Climate for Manufacturing and Services

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Table 3.1 : Projected urban population and employment growth in three cities

Annual Annual Projected Annual ProjectedProjected Annual Urban Land Industrial Land

Population Employment Requirements RequirementsMetropolitan Area growth growth (hectares) (hectares)

Chennai (1991-2011) 180,000 24,400 1,900 250

Coimbatore (1991-2001) 46,000 17,600 600 160

Tirupur (2001-2021) 16,800 17,000 420 200

Note: Data from the master plans of the three cities.

necessary, promoting urban sprawl, and led to1.3% lost GDP per year for India.

Urban land issues are within the purview of thestate government. It is important to rationalizeregulations on urban land zoning anddevelopment controls, and project approval andland acquisition processes, and develop a moreeffective planning and management system tofacilitate infrastructure development. As a first stepto prepare for reforms, the Government of TamilNadu is undertaking a comprehensive urban landaudit in Chennai, in collaboration with the privatesector and an academic institution and planned toextend the audit to secondary cities.

Constraints in the sales tax system. While theTamil Nadu sales tax system generally isbuoyant and the state has one of the highestown tax effort, it has a number of features whichhave a negative impact on the investmentclimate and long-term growth. The existingsales tax regime, the main source of TamilNadu's own revenues, is inefficient withmultiple rates, non-standard classification ofgoods, and concentration of taxation on certainsectors. It has a relatively high tax burden oninputs, with the effective tax rate on inputs at6.7% and taxation on inputs accounting for32% of the total collection. Figure 3.1 depictseffective tax rates in 2002/03 for selectcommodities. The complex structure induceshigh compliance costs, while the frequent ad-

hoc changes in the tax regime generateuncertainty for businesses.

The tax on entry of goods into local areas,combined with the still restrictive trade policy ofthe central government, impact negatively ontrade and investment. The tax is cascading oninput imports, and the concession rate andoffsetting are limited and nontransparent. Thelevy of entry tax on certain inputs currently notproduced in the state also leads to higher cost ofproduction and may thereby divert investmentfrom Tamil Nadu to other states. High stamp dutyon conveyance of immovable property-higherthan that in many other countries, combined withan unreliable property valuation system, result inhigh transaction costs, "lock in" effect of lessefficient real estate transactions, under reporting oftransactions, and administrative and judicialdisputes. Recently, as part of tax reform in TamilNadu, the effective stamp duty has been reducedto a uniform 8%, down from 12-13%.

The tax administration imposes high compliancecosts by, for example, lack of self-assessment in thesales taxation for large businesses and of electronicfiling, cumbersome registration procedures, andtime-consuming dispute resolution, which allencourage undesirable frequent contacts betweenbusinessmen and tax officials. Compliancemanagement in Tamil Nadu continues to beenforcement-oriented, without enough focus ontaxpayer service and information.


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Figure 3.1 : Effective Tax rates on Selected Commodities

Source: GOTN's Commercial Tax Department.

Many of the tax policy problems, commonacross states, may be resolved with theintroduction of the VAT system (set for April 1,2005). Given the federal structure, the state'srole in designing tax policy and administration islimited but there is considerable room forreforms to reduce the impact of taxing inputsand complexity of tax policy and administrationand reduce transaction costs.

Regulation of entry and exit. Easy entry of newproducers and exit of inefficient producers are apowerful force in driving industry-wideproductivity growth. New producers bringinnovation, risk taking, and dynamism into asector, forcing existing producers to continue toinnovate and improve productivity or exit.

Tamil Nadu has made progress in simplifyingregulations over business entry. The sequentialand protracted approval process involvingmultiple government departments/agencies hasbeen replaced by a streamlined and coordinatedone for large investment projects. However, 19percent of business managers still identify licenseand permits as a major constraint. Thestreamlined process for large investment projectsneeds to be extended to all small and medium-sized projects. The process of getting a planningpermission, construction and building licensingfor the construction industry is time consuming,procedurally complex, lacks clarity of rules andcoordination between concerned departments.Moreover, large projects throughout the stateneed to be sent to Chennai for review. Theapproval process can take up to two to three years.

An important entry deterrent has been the Small-Scale Industry Reservation (SSIR) policy by thecentral government. This policy discourageseconomies of scale and greater efficiencies-byinhibiting small firms from investing beyond thestipulated limits, expanding their operations inthe domestic market, and then moving intoexports. Although some of the important items

have been de-reserved (e.g., garments, toys andleather products), SSIR has had significantnegative impact over decades on thecompetitiveness of Indian industries.

Despite the remaining influence of the SSIR,Tamil Nadu can further streamline entryregulations in two areas: streamlining regulationsconcerning construction and real estateindustries and extending the simplified entryregulation covering large investment projects tosmaller projects in every level of investment.

Exit and bankruptcy procedures, both at thepurview of the central government, remainoutdated and ineffective, leading to inefficienciesand making industrial restructuring almostimpossible. The Amendments to the CompaniesAct (2002) should improve the bankruptcyframework. The effectiveness of the amendmentwill depend on the repealing of the SickIndustries Companies Act and the pace of labormarket reform.

Resolving Infrastructure BottlenecksInfrastructure is more developed in Tamil Naduthan in many Indian states but compares poorlywith other emerging economies. Close to 40%of surveyed managers and about 50% ofexporters in Tamil Nadu view infrastructure as amajor impediment to investments and growth.The infrastructure constraints are across-the-board including power, transport, ports andwater. Substantial investment requirements alsoarise from rapid urbanization in Tamil Nadu.Box 3.1 reflects the World Bank's owninteraction with entrepreneurs in Tirupur,India's leading hosiery exporting centre.

Power has become a top infrastructure constraintdespite the relative efficiency of the state powerutility and having the second largest power marketin India. High power tariff to industries and poorquantity and quality of power supply reduce thecompetitiveness of Tamil Nadu's industries. The


47

financial stress of the TNEB, arising largely fromcross subsidy to agriculture (and now the domesticconsumer segment also), has increasinglyconstrained its investment ability to improve thequality of power supply. Captive generation sets inoperation as a share of total electricity sold in TamilNadu has reached 15%, with a statewide averagecaptive plant load factor of 25%. The capital cost ofcaptive generation sets constitutes about 11% oftotal fixed assets for small businesses. Like manyother states, Tamil Nadu will need to find a politicalsolution to the metering of agriculture pump setsand reduction of cross-subsidy to improve thecompetitiveness of industry and services.

On transport, India has no access-controlledexpressways linking the major economiccenters, while for example China has builtsubstantial expressway capacity (over 27,000

kilometers) since the mid-1990s. Poor ridingquality and congestion result in truck and busspeeds on Indian highways that average 30-40kilometers an hour, about half the expectedaverage. Demand for road transport has beenincreasing rapidly in Tamil Nadu with vehicleregistrations growing by about 14% annuallyduring the 1990s. However, road networksupply and quality have not kept pace with thegrowing demand, leading to serious networkdeficiencies in terms of slow response togrowing demand, inadequate road capacity andmaintenance, severe road congestion and highrate of accidents.

Tamil Nadu has initiated measures to improvethe transport network. The East Coast Highwayundertaken by Tamil Nadu Road DevelopmentCompany, a joint venture between GoTN and


48

The Tirupur Export Knitwear Industrial Complex (TEKIC) is one of the major industrial estates or clustersin Tirupur. Tirupur has a population of about 420,000, but exports US$1 billion in knitwear, accounting forabout 18% of total Indian knitwear exports in 2000/01.

TEKIC has 189 laid out sheds situated in and around 100 acres of land and 148 industrial units with smalland medium investment in operation. Most firms in the complex export to US and Europe markets. In thelast three years, member firms have exported about Rs.1750 crore of knitwear (close to US$400 million). Thecomplex employs about 10,000 workers. A World Bank team met with a dozen representatives of businessesin the complex in May 2003. The following infrastructure constraints were highlighted by the representatives:

� Power cuts and fluctuation make it difficult to use precision machinery and equipment which are essentialfor export products;

� Road congestions around the complex, in Tirupur and to the ports.

Adding to these are the rigid labor regulations which make it difficult to efficiently adjust workforce to meetseasonal variations in business demand, while such variations are typical in garment exports.

TEKIC faces huge competitive pressure with the phasing out of quota-based export system under the Multi-Fiber Agreement. Infrastructure investments are thus urgently needed to make it possible for TEKIC toprepare for competition.

The urgently required infrastructure requirements according to the entrepreneurs are:

� Setting up a power plant to provide reliable quality power supply.

� Strengthening and widening the existing road and providing storm water drain; developing a new roadconnecting Vijayapuram in Tirupur (Kangayam road) and Periyapalayam in Tirupur (Uttukkuli Road);building a high-level bridge across river Noyyal to interconnect the above roads.

Box 3.1: Infrastructure Bottlenecks Facing TEKIC in Tirupur

Source: Tamil Nadu: Improving Investment Climate, World Bank (2004).

Infrastructure Leasing & Financial Services, is anexcellent example of public private partnershipsfor rehabilitation and maintenance of roads, andcould be applied more widely to upgrade theroad network. The provision of state equity andother financial support such as "viability gapfunding" are also methods of leveraging publicfunds, which GoTN is considering. A clearregulatory framework for support of publicprivate partnerships needs to be put in placewhich would define the role of the governmentand the private sector, lay out the risk sharingprinciples and also regulate the tariff regime forprivate roads. An important priority is to pressforward with fiscal reform to create fiscal spacefor investment in the infrastructure sector.

There are complex administrative barriers, hightransaction costs and delays relating to shipping,trucking, and customs administration of exportsand imports at major ports. The entire cargotransport chain from inland to a European port isestimated to cost 15% higher, and many days ofdelay, than the reform scenario.

On water supply, unreliability and shortage area major weakness in Tamil Nadu's physicalinfrastructure. The problem, however, is notlimited to Tamil Nadu alone. Across Indiaabout 54% of businesses rely on own wells. Theproblem in Tamil Nadu is more acute becauseof the absolute scarcity of water resources in thestate. Renewable freshwater resources arescarce, owing to high variability of rainfall andresulting low river flows and periodic drought.Ground water has been overly exploited. Manyof the most important aquifers of the state havebeen tapped at an unsustainable rate.Businesses report an average of 11 days permonth of interruption in water supply from thepublic line, against the all-India average of 4days per month and only about half day permonth in Malaysia. The economic cost of rawwater is high, but water user charges are wellbelow cost recovery. Industrial consumers pay

substantially higher tariff to cross subsidizedomestic users.

Public and private partnership in infrastructurefinance and development. Fiscal distress in TamilNadu (as well as in many other Indian states) is amajor constraint on the public financing of badlyneeded infrastructure investment andmaintenance. Planned capital outlays and netlending covering all sectors is about US$750million in 2004/05, or 1.9% of GSDP. This isalready much higher than the US$300 million in1997/98 (1.2% of GSDP) before the start of thefiscal crisis. Assuming the success of the fiscaladjustment, capital outlays per year are estimatedto increase gradually to only about US$1.2billion, or about 2.1% of GSDP in 2007/08.This would, however, satisfy only a fraction ofinvestment demands.

Another constraint is the limited local municipalgovernment revenues from user charges, underassessment of property taxes, and drying up ofinstitutional financing backed by stateguarantees. Table 3.2 presents an assessment ofurban investment resource needs estimated bythe Second State Finance Commission. For TamilNadu public and private partnerships ininfrastructure financing and development aretherefore not only a fiscal necessity but alsowithin the broader reform context in India ofcreating sustainable financial structures whichlink liberalizing domestic capital markets withurban infrastructure financing needs.

Tamil Nadu has been at the forefront ofexperimenting with public-private partnerships ininfrastructure financing and development(Box1.1). These reforms have shown that privatesector participation under appropriate regulatoryarrangements would help not only address theproblem of low capital outlay owing to fiscalconstraints but also highlight the benefits ofincreased efficiency in infrastructure financing,delivery, and management. For example, in the


49

East-Coast Highway (100km) project, theGoTN's contribution of Rs.10 crore leveraged aninvestment of Rs.51 crore from the private sector.It will also save the Government more than Rs.100crore through savings on future maintenanceexpenses and ensure sustained O&M spending forthe entire 30-year concession period.

Experiences with implementation haveunderscored the importance of the following keyfactors for a successful public-private partnershippilot: providing selective credit enhancement toUrban Local Bodies and developing financingmechanisms with targeted use of stategovernment contribution and guarantees andlink municipal financing with domestic capitalmarkets; leveraging private equity and debtfinancing to multiples of initial publicinvestment; user fees based on improved servicedelivery and cost recovery with cross subsidiesbetween consumer categories; building inconsideration of operations and maintenancespending when planning a project; and proactivesupport from the government in inter-departmental co-ordination, close monitoringand trouble shooting; and transparency inbidding and contracting. In addition, asupportive political environment, regulatorycertainty (for user charge regimes, concessions

and contracting out, and dispute resolutions),operational restructuring to improve thefunctioning of public institutions, and initialequity participation are important in reassuringprivate promoters and attracting co-financingfrom financial institutions. The thrust of reformsshould be on sustaining and enhancing projectcash flows, rather than relying on governmentsubsidies and guarantees.

With industry and service sectors accounting forover 83% of GSDP, Tamil Nadu is among themore rapidly urbanizing states in India, which iscausing growing pressure on urban land andinfrastructure. With public/private collaboration,the Government has initiated a comprehensiveassessment of urban land markets and projectionsof future land supply requirements in Chennai,the state capital. Such projections will facilitatethe development of an efficient, cost-effective,and financially sustainable urban land deliverysystem to meet the growing needs for urbaninfrastructure. The land market audit is plannedto be extended to selected cities and towns.

The Government has plans to issue anInfrastructure Policy Paper and establish anInfrastructure Development Board withmembership of the private sector to implement


50

Table 3.2: Sectoral Investment Requirement 2002-2007

TownLocal Body Corporations Municipalities Panchayats Total %

Water Supply 506.2 673.4 1409.4 2589.0 31.9

Sanitation 409.3 391.3 41.7 842.3 10.4

Solid waste mgmt. 116.0 33.8 20.5 170.2 2.1

Storm water drains 747.9 1101.6 684.5 2534.0 31.2

Roads 310.8 204.4 406.5 921.7 11.3

Lighting 43.2 43.6 125.3 212.1 2.6

Others 341.7 231.0 282.9 855.6 10.5

TOTAL 2475.1 2679.0 2970.8 8124.9 100.0

Source: State Finance Commission Report II, 2002.

(Rs. crores)

the gradual scale up of public-privatepartnerships. Given the intrinsic link betweenurban land markets and infrastructuredevelopment, and based on internationalexperience, pilot projects in urban areas can beinitiated to focus on using land value capture tomobilize public finance, structuringpartnerships with the private sector in financeand development, using value capture tofinance housing projects for the poor, andintegrating sustainable environmentmanagement with urban land management andinfrastructure development.

Special economic zones. Special economic zones(SEZs) have been envisioned in India as a scaled-up version of the export processing zones (EPZs)to overcome the constraints of poorinfrastructure and high regulatory burdens.GoTN has recently unveiled its own specialeconomic zones policy providing broadguidelines with specifics being worked out.International experience of EPZs and SEZs ismixed, which can provide lessons for the designof a policy and regulatory framework for SEZs.Unless SEZs can significantly overcome keyconstraints facing the private sector, SEZs willsimply be a physical scaling up of EPZs whileexperience of EPZs in India is mixed. State-widebroader regulatory reforms and infrastructureimprovements continue to be important.

Institutionalizing Public and PrivateSector DialogueDevelopment and implementation of a reformagenda that addresses complex regulatory andinfrastructure issues will require aninstitutionalized dialogue between theGovernment, the private sector, and civilsociety for setting priorities and findingsolutions. The recent establishment of anAdvisory Industrial Council, to act as a thinktank for the government, is an important stepforward. The Council and its ConsultativeWorking Groups can serve as an apparatus toformalize the dialogue between theGovernment and the private sector.

Tamil Nadu may draw valuable lessons from thetype of Councils which has been key in thedevelopment of international competitiveness inAsia, particularly in South Korea, Taiwan(China), Singapore, and some other countries.Key factors contributing to the success of theseinstitutions include political support, a clearly-defined decision-making authority in theCouncil, an accountable implementationmechanism, broad-based private sectorparticipation that is not perceive as representingspecial interest groups, and a public informationand education campaign to build a sharedconsensus that can transcend any changes at thepolitical level.


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55

While agricultural sector growth rates in TamilNadu were among the highest in India during the1980s and early 1990s, deceleration in growthsince the mid-1990s is of increasing concern topolicymakers. During the 1980s agriculturalGSDP grew at 3.4 percent, exceeding the all-India agricultural growth of 2.9 percent.Adequate rainfall contributed to even highergrowth in the early 1990s: between 1989/90 and1994/95 agriculture grew by 7.2 percent in TamilNadu, compared with 3.1 percent in all of India.But between 1994/95 and 1999/2000 agriculturein Tamil Nadu suffered from severe consecutivedroughts and grew only 1.3 percent a year,compared with 2.9 percent for all of India. As aresult, the state's agricultural growth rate duringthe 1990s was only 2.9 percent a year, comparedwith 3.2 percent for all of India. Regressionanalysis showed that a one percent increase inrainfall relative to the mean is associated with a0.3 percent increase in real agricultural GSDPrelative to the trend agricultural GSDP.

Faster growth in agriculture is central to ruraldevelopment and poverty reduction in TamilNadu. Although agriculture accounts for only14% of Tamil Nadu's GSDP and nonfarmincome accounts for about 50% of ruralhousehold income, farm income accounts forabout half of household income for 35 millionpeople (56 percent of the state's population) wholive in rural areas. Reinvigorating agriculturegrowth remains critical since a vibrant agriculturesector encourages industrial growth and farm

income accounts for 78% of the income of thepoorest 20 percent of the rural population (withestimates ranging from 7.4 million people (20.6percent of the rural population) to 11.4 million(31.8 percent of the rural population). Given theimportance of agriculture in the incomes of thepoor in Tamil Nadu, growth in labor-intensiveagriculture could further reduce rural povertythrough higher yields to small producers, higherreal wages to agricultural laborers, and increasedincome and employment opportunities withforward and backward links to the rural non-farm sector.

Salient Features of AgricultureThere are three salient features of Tamil Nadu'sagriculture that set the political economy contextfor searching a viable strategy for revitalizingagriculture growth: water scarcity; the largeshares of rice and sugar (both water-intensivecrops) in total irrigated land; and the dominanceof small and marginal farmers in overallagriculture production.

Water scarcity. Tamil Nadu is one of the drieststates in India. Per capita availability of waterresources in Tamil Nadu is only 900 cubic meters ayear, compared with 2,200 cubic meters for all ofIndia. The state's dry season lasts five months(January through May) even in good years, andsevere droughts occur in 3 of 10 years, severelylimiting cultivation of crops between June andSeptember. Irrigation through a combination ofcanals, wells, and tanks increases the reliability and

RReeiinnvviiggoorraattiinngg AAggrriiccuullttuurree GGrroowwtthh

availability of water for farming and is essential forcultivating crops in much of the state. But theseasonality and scarcity of supply limit cultivationto only one crop per plot for most of the state (in1998/99 average cropping intensity was only 1.20in Tamil Nadu, compared with 1.34 for all ofIndia). 96% of surface water for irrigation has beenutilized and ground water resources are depleting.

Today the state relies equally on surface andgroundwater sources for irrigation, though itsreliance on groundwater has been steadilyincreasing. Approximately 30 percent of the netirrigated area is watered by canals and 21 percentby tanks, while 49 percent is fed by wells. Theremaining area is irrigated by other sources suchas streams and springs. Rain-fed agriculture,employing approximately 25 percent of farmers,accounts for 46 percent of the net sown area of5.5 million hectares.

The agricultural sector faces increasingcompetition for water from industry and domesticusers and intensifying interstate competition forsurface water resources. In many parts of the state,the rate of extraction of groundwater has exceededrecharge rates, contributing to falling water tables.Of a total of 1.8 million wells in the state,approximately 10 percent are now defunct. Thedepth of bore wells in hard rock area has increasedto as much as 600ft to 1000ft. Today, use of dugwells as a source of irrigation is only possible incanal and tank command areas; only bore wellsremain operational in hard rock areas (mainly inthe western part of the state). Water quality is alsoa growing concern. Effluents discharged fromindustries and heavy use of pesticides andfertilizers have had a major impact on surfacewater quality, soils, and groundwater.

Rice and sugar. Rice and sugar, both water-intensivecrops, account for nearly 40% of gross cropped area

and almost 70% of irrigated area in Tamil Nadu.Rice dominates agricultural production, accountingfor about a third of total gross cropped area andnearly 60% of irrigated area in Tamil Nadu (over90% of paddy is irrigated). Pulses (18% of totalcropped area), millet (11%), and groundnuts(10%) require less water than rice or sugar cane, andmillet and pulses are grown almost exclusively onnon-irrigated land. About 5% of total cropped areais devoted to sugar cane, all of it irrigated(accounting for almost 10% of irrigated land).Cotton occupies about 3% of cropped area, andabout a third of the cotton crop is irrigated.

The livestock and fisheries subsectors are alsoimportant in Tamil Nadu. The state rankssecond among Indian states in egg productionand ninth in milk production.18 In 2001/02Tamil Nadu accounted for approximately 6percent of national milk production and 11.9percent of egg production. The state is alsorelatively well endowed with fisheries,accounting for 13.2 percent of total marine fishproduction and 4 percent of in-land fishproduction in India. In all, crop agriculture,livestock, and animal husbandry account for92.2 percent of total value added in agricultureand allied activities, with fishing accounting for4.5 percent and forestry for 3.3 percent.

Dominance of small and marginal farmers. Theaverage size of individually-held farms is only 0.91hectares, with over half the farms smaller than 0.5hectares. Nearly three-quarters of farms are smallerthan 1 hectare, accounting for only 30.2 percenttotal cultivable land. In comparison, the averagefarm size in India is 1.41 hectares, with 62 percentof farmers holding less than 1 hectare.

Efficient Water Resource Management Efficient water resource management is a keypriority for not only agriculture but also the


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18 Ranks are computed based on average production in Indian states between 1999 and 2001.

entire state economy. It requires complexregulatory and institutional changes beyond themedium term. There are three main issuesconcerning the management of water resources:fragmentation and lack of strategic coordination;distorted pricing of water; and decline in thequantity and quality of public investment inirrigation structure.

Institutions for water resource management.Institutional weaknesses have underminedproper management and development of waterresources in the state. As is common in manyIndian states, inadequate priority to and fundingfor operations and maintenance led to rapiddeterioration of surface irrigation. There was alsominimal involvement of farmers in theoperations and maintenance of irrigationsystems. Management of water resources isfragmented and lacks strategic coordinationacross key institutions. But recent efforts havebeen made to address many of the issues plaguingthe water sector.

Important legislation has been enacted to requirerainwater-harvesting structure in all publicbuildings to recharge the groundwater andarresting seawater intrusion; a massive andsuccessful public campaign has been underway.The Government is also moving away fromfragmented management of water resourcestoward a holistic river-basin framework, with theparticipation of all stakeholders. The River-BasinManagement Council in two out of 17 riverbasins has been established, a first in India. Abasin perspective helps minimize negativeimpacts on downstream human and ecologicaluses. A groundwater policy is being prepared.The state has drafted a Water Policy, initiatedsteps for irrigation management transfer, andpassed a Groundwater Regulation andManagement Act, one of the first states in Indiato do so. The State Legislative Assembly passedthe Tamil Nadu Farmers Management ofIrrigation Systems Bill (FMIS) in May 2000.

There are three priorities for more efficientinstitutional management of water resources. Thefirst is the need to develop a state-wide waterresources management strategy which examinescompeting uses for water and a strategicframework for inter-sectoral allocation of scarcewater resources. The second is the need tointroduce specific, legally enforceable waterentitlements to various users in a river basin and oraquifer framework. The third is the need to clarifyand develop rules and a framework for interplayamong various agencies and institutions on themanagement of water resources policy, i.e., theRiver-Basin Management Council, farmers' wateruser associations, local governments, and WaterResources Organization under the Public WorksDepartment. Irrigation management transfer is atan early stage in Tamil Nadu and water userassociations are not yet fully functional, thoughthe FMIS Act mandates the transfer of irrigationmanagement to farmers. Further, the separation ofa regulatory function and service deliveryfunction, currently held by the Public WorksDepartment, would be required.

Pricing of water and electricity. Under thecurrent system of economic incentives (prices,subsidies, taxes), the cost of water for farmersand other water users does not reflect the scarcityvalue (opportunity cost) of water. ThroughoutIndia, farmers using surface water for irrigationfrom canals or tanks are implicitly subsidizedbecause water charges fall short of operationsand maintenance expenditures. Between 1990and 2002 farmers using groundwater forirrigation in Tamil Nadu also benefited from freeagricultural power supply. Subsidizing irrigationwater means that the environmental costs ofwater use are not being internalized, reducingincentives for water conservation, encouragingthe cultivation of water-intensive crops, andcontributing to environmental degradation. Theirrigation and agricultural power subsidies havecontributed to the state's large fiscal deficit.These subsidies also have a high opportunity

Reinvigorating Agriculture Growth

57

cost in terms of other social and economicexpenditures foregone.

In 2003, the Government of Tamil Naduannounced increases in irrigation water charges.Previously, water charges were levied by theGovernment of Tamil Nadu at a base rate (whichvaried according to crop, season, and soil quality)plus an additional charge equivalent to six times thebase rate. This additional charge was transferred tothe local panchayats. Beginning in July 2003, anadditional water charge of Rs.150 per hectare wasimposed, de-linked from any additional cess. Withthis change, farmers were to pay the original chargeplus the Rs.150 per hectare. In addition, the FMISAct empowered water user associations to chargeusers between Rs.250 and Rs.500 per hectare. Thisfee could be retained by the associations foroperation and maintenance of the systems turnedover to them. These provisions for irrigation watercharges allowed full cost recovery of requiredoperations and maintenance expenditures. Theextent to which farmers were actually beingcharged the proposed water rates is unclear.

The agricultural power tariff introduced inMarch 2003 included a flat rate for unmeteredconnections of Rs.250 per horsepower a year andRs.0.20 per kilowatt-hour for meteredconnections. Along with the reintroduction ofthe agricultural power tariff, the governmentannounced an income support scheme forsmallholders and marginal farmers. Under theincome support scheme, the Government ofTamil Nadu provided smallholders and marginalfarmers a transfer of up to Rs. 1,250 a year. Thiswas a significant step toward creating a moredirect and transparent system of subsidies tofarmers and other target groups and ensuring theseparation of commercial operation of the powerutility from the need for subsidy. However, in arecent development power supply to agricultureis now free again and the direct subsidy schemeto farmers has been replaced by non-transparentbudgetary support to the TNEB.

In any case the flat rate charge of Rs.250 a year fora five horsepower pump set would have had only asmall effect on net returns to land andmanagement, reducing them by only 4.9 to 6.5percent. Costs of crop cultivation using wellirrigation would have risen by only Rs.625 perhectare (annual charge pro-rated for one season) toRs. 1,250 per hectare (for sugar cane grown overeleven months). However, such increases were alsoagainst the background of repeat droughts startingin 1999 which have reduced significantlyagriculture growth and income (see page no. 10).

Increases in electricity charges would have littleeffect on overall rice production and market pricesbut a major effect on sugar cane production. Sinceonly about 10 percent of rice area cultivated isirrigated with well water (about 200 thousandhectares), changes in electricity pricing would haveonly marginal effects on production. And since riceis also supplied by net public distribution(averaging 1.2 million tons a year from 1997/98 to2001/02, 18 percent of net production) and privatemarket trade from neighboring states (estimated at1.0-1.3 million tons in the drought year 2002/03),the effect of lower rice production from wellirrigated areas on market prices of rice would likelybe small. Impact on sugar cane production wouldbe much higher however, as essentially all sugarcane is irrigated in part with well water.

If electricity charges are raised to the estimatedmarginal economic price of electricity toagriculture of Rs.3.1 per kilowatt-hour, irrigationcosts would rise to about Rs. 4,600 per hectarefor paddy and sugar cane, reducing returns toland and management by 35.9 percent for paddyand by 23.8 percent for sugar cane. Likewise,total returns to land, labor, and capital (valueadded) fall sharply for paddy and sugar caneirrigated by wells when the cost of electricity forpumping is included.

It has been well recognized in India that thepower subsidy is regressive, and farmers most at


58

risk from drought are those without a pump set.But the reality is that nearly three-quarters offarms are smaller than 1 hectare, which may notbe all poor, but they are not too far fromsubsistence living. Unless an integrated servicepackage is provided to farmers, reducing powercross-subsidy is politically difficult. As a way tomove forward, Tamil Nadu may carry out a smallscale experiment of providing a community offarmers with the best facilities they need andassuring them of a minimum of their presentincome levels and asking them to pay for powerand then examine whether their incomes levelsincrease or decrease in this experiment.

Challenges of Agriculture DiversificationEven with efficient management of water resources,diversification into higher value, less water-intensive products, such as fruits, vegetables, spices,and livestock products, may be one of the mostpromising sources of future agricultural growth,simply because of the aggregate scarcity. TamilNadu's agro-climatic conditions are well suited fordiversified agriculture. Rapidly increasing incomesand changing patterns of food demand also providestrong impetus for diversification. Increasedagricultural diversification and private investmentsin processing for many of the higher valueagricultural commodities are likely to generate newrural non farm employment opportunities andcontribute to higher rural incomes.

Notwithstanding its importance, there aredaunting challenges in diversifying agriculture.Simply raising water and electricity tariffs has notonly met political resistance but also would notprovide sufficient incentives for farmers to movetoward less water intensive crops. Currently inaddition to having price incentives to grow riceand sugar, farmers engaging in rice and sugarproduction also have an extension systemsupporting them and a government procurementsystem to protect them against crop failuresassociated with droughts, market risks, andinfrastructure constraints which reduce farm gate

prices. Pure market pricing solution andderegulation will not work in a complex contextof political economy and institutions.

Broader policy and institutional reforms arerequired to form a coherent package. Therequired reforms are: decentralizing atraditionally top-down centralized extensionsystem which cannot respond to market signalsfor more diversified agriculture; facilitatingefficient markets; developing a rural creditmarket, and developing an insurance and safetynet program to cushion against the risk ofdiversification particularly for small and marginalfarmers who rely mainly on agriculturesubsistence income; and a delivery package toimprove farmer income associated with gradualadjustment of input pricing.

Decentralizing the extension system. Theagricultural extension system in Tamil Nadu, likethe rest of the country, is still organized around amodified Training and Visit approach andcontinues to focus on major food-grains. There islittle coordination among line departments(agricultural, animal husbandry, fisheries) in theirextension approach. The highly centralizedextension system cannot meet the needs ofdiversified crops and products. A wide range ofproduct types would require a decentralized andflexible extension system that can respond tomarket signals.

The extension system is slowly changing,however, and the promotion of public-privatepartnerships in extension is encouraging andoffers potential for both cost-savings and greaterefficiency. The Government of Tamil Nadu alsoplans to link agricultural, horticultural, andagricultural engineering extension systems andunits to improve the extension capacity forhorticultural development. Related to extension,an assessment of the state's comparative advantagein producing higher value crops for the domesticand export markets would also help in setting


59

future research and development priorities. Re-orienting agricultural research to make it morefarmer-responsive would likewise improve theoutput of a system that has enjoyed much successin rice technology development in the past.

Facilitating efficient markets. Well functioningagricultural markets are also important forsuccessful agricultural diversification. Unlikemost Indian states, where wholesale marketing isrestricted to regulated markets, Tamil Nadupermits traders to transact sales outside ofregulated markets. Private markets account forabout 90 percent of the statewide trade in majorcrops. Regulated markets, in which licensedtraders bid for farmer produce through a tendersystem, account for only 10 percent.

Further, if recent policy reforms removingrestrictions on purchase, movement, stocking andsales of paddy and 13 other crops by the privatesector are consistently implemented at the locallevel, they can be expected to improve marketingefficiency, reducing the margin between producerand consumer/export prices.19 Reductions inmarketing costs are also necessary in order forproduction increases to lead to higher agriculturalincomes, particularly for perishable high-valueproducts (e.g., fruits, vegetables, animalproducts). Private investments in processing andmarketing horticultural and export crops haveenjoyed some success (for example, turmericexports from Erode). Contract farming involvingbusiness agreements for the purchase of outputsand often the provision of inputs and extensionadvice is increasing, particularly for sugarcane,cotton, and horticultural crops.

Inadequate transport network including majorports is a major constraint to well-functioning

agriculture markets as it impedes the efficienttransportation of agriculture products fromfarm gates to consumers, increasingtransportation and delay costs. These areparticularly important constraints for high-value agriculture products such as cut flowers,vegetables, fruits, and fishery products.

Developing safety nets. Whether agriculturaldiversification reduces rural poverty in TamilNadu will depend on the extent to which smalland marginal farmers, who dominate TamilNadu's agriculture (see page no. 56), adopt newtechnologies and have access to markets, themagnitude of employment and real wage rategains, and the size of linkage effects with ruralnon-agriculture. Furthermore, periodic droughtsbring about volatility in production and income,dramatically increasing vulnerability for smalland marginal farmers, who rely on subsistenceliving and have less non-farm income and assetsto mitigate the impact of volatility. Theimplications of an agricultural diversificationstrategy involving higher risk crops and capital-intensive technologies (drip irrigation) must beassessed. This assessment should review crop anddrought insurance instruments, and the potentialfor innovations in these instruments to enablerural farmers, particularly poor farmers, to bettermanage risks.

Increasing employment and earnings in the dryseason is especially important for the rural poor.Increased availability of water and greaterefficiency of water use in the dry season (forexample, through the widespread adoption of dripirrigation) could enable cultivation of crops year-round, providing employment in agriculturalproduction and processing. Dissemination of newproduction technology and establishing markets


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19 In May 2003, following the February 2002 central Government order removing licensing restrictions on rice and 13other crops, the state Government withdrew its licensing system for these crops. Restrictions on purchase, movement,stocking, and sales of these commodities have been removed, though some provision remains for Governmentintervention in the case of high market prices for goods distributed through the public distribution system.

for dry season crops remains an importantunresolved issue, however. Contract farming (Box4.1) may help overcome these problems, ifcompetition between firms helps farmers maintaintheir share of the value of the final product sales.

Improving Public Expenditure. Althoughpublic expenditure on agriculture in TamilNadu is relatively high among Indian states, thecomposition of expenditure is a problem.Expenditure on agriculture, allied activities,and irrigation as a share of agricultural GSDP ishigher in Tamil Nadu than in most majoragricultural states in India. Between 1998 and

2000, public expenditure on agricultureequaled 11 percent of total agricultural GSDPin Tamil Nadu, compared with 7.8 percent inall of India.20 Public agricultural capitalexpenditure in the state is relatively low as ashare of agricultural GSDP compared with theall-India average, while the opposite is true ofrevenue (i.e., current) expenditure. This is asituation for concern since capital investment isimportant for future growth. Furthermore, alarge share of revenue expenditure is incurredon staff salary, and food and irrigation subsidy,leaving operating expenses under funded. Grossfixed capital formation in agriculture increased


61

Contract farming involves a business agreement between a farmer and a firm in which the firm providesinputs, extension services, processing and a ready market in return for a guaranteed source of supply of theoutput product. Such arrangement between sugar mills and cane farmers has long been practiced in TamilNadu and other parts of India. For other products, however, restrictions on private sector trade motivated bya general mistrust of traders, along with the structural characteristics of output markets (including the inabilityto differentiate products by quality or brand) have greatly limited the scope of contract farming.

Rice: Beginning in a limited way in 2002/03, EID Parry sold approximately 60 tons of improved seedsfor super fine quality 'Ponni' rice (enough for about 800 hectares) and provided extension servicesto sugar cane farmers who sold sugar cane to the firm's sugar mill in Cuddalore, but were alsowilling to grow rice. With the improved rice technology, paddy yields were approximately 25percent higher than normal yields of 3.75 tons/hectare. Moreover, because of drought, marketprices were about 20 percent higher than the previous year. EID Parry later purchased the output.In the absence of an explicit sales contract, though, the firm risked not being able to purchasesupply for its rice mills. The entrance of large private firms into rice markets has only been possiblewith the removal of stocking limits (in May 2003), and other restrictions on movements of paddyand rice.

Cotton: Cotton contract farming started in about 1200 hectares in the 2002-03 season. The farmers havethe option to sell cotton to the contractor or to any other buyer under the market prices prevailingduring harvest period. For the services provided by the contractor, a nominal charge will be leviedon the farmer on a unit area basis.

Gherkin: Gherkin cultivation and processing started in India in the early' 90s and at present is spread over7,900 hectares in the three southern states of Karnataka, Tamil Nadu and Andhra Pradesh. Thereare about twelve companies operating in the state and each company has agricultural extensionteam of 5-25 who identify farmers and then enter into a buyback contract with them.

Poultry: Contract farming for poultry is also practiced in Tamil Nadu. For broilers, firms supply chicks,feed, medicines and technical guidance to the farmers. The firms then buy the birds when they areeight weeks old at a predetermined price.

Box 4.1: Contract farming in Tamil Nadu

20 Agricultural public expenditure as a share of expenditure on Economic Services and Agricultural GSDP are averages ofdata from 1998/99-2000/01.

by 15 percent during the 1990s, due primarilyto private capital formation, which accountedfor 88 percent of gross fixed capital formationin agriculture.

There remain, however, important roles for thepublic sector in promoting agro-food system andagro-enterprise development. In addition topolicies that establish "rules of the game" andaddress market failures, public investments in theroad network to strengthen connectivity cancontribute to reduced costs of marketing.Reorienting public expenditure from consumptionto growth-enhancing areas in key public goodssuch as rural roads, markets and agriculturalresearch and extension will facilitate productivityimprovements and diversification of agriculture tohigher value products. Tightening competition for

limited fiscal resources heightens the urgency ofappropriate public expenditure reallocation.Institutional reforms within governmentdepartments to ensure improved quality of deliveryof rural-related public goods and services is alsoimportant (see Section II on fiscal reform and V onpublic administration reform).

Greater attention is also needed for modernizingirrigation infrastructure and scaling up theadoption of water-saving irrigation technologies.While the use of sprinkler and drip technologyhas been promoted in the state, their high capitalcost constrains widespread adoption bysmallholders and marginal farmers. Moreaffordable technology or a suitable system oftargeted subsidies should be developed toincrease the use of sprinkler and drip systems.


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While the main objective of fiscal consolidationand reform is to correct aggregate expenditureimbalance to create the fiscal space for priorityspending in infrastructure and social sectors, it iscritical that the expenditure allocated to thepriority sectors and areas be spent efficiently. Tothis end, the strengthening of public expendituremanagement and financial accountability wouldneed to be supported by public administrationreform to enhance service delivery.

Tamil Nadu has traditionally had capable publicadministration. It has moved from a near-average to a high-performing state as indicatedby the HDI, which is measured by longevity,education, and command over resources. TamilNadu's HDI, though ranked seventh place in1981 rose to the third highest among 29 Indianstates in 2001. Tamil Nadu has also done well indelivering key services: A recent surveyconducted by the Public Affairs Center revealsthat the state has the country's best publicdistribution and school education systems, andthe second best public drinking water and roadtransport services after Gujarat. This, of course,is not a uniform picture: health services, forexample, are ranked fifth.21 Yet,notwithstanding this impressive record, TamilNadu faces several critical challenges that needto be addressed to preserve and extend the gainsmade so far.

To further improve public administration andenhance service delivery, the reform agendawould need to focus on the following areas whichcut across sectors: (i) administrative reform toimprove the efficiency of the government byrationalizing and restructuring governmentfunctions, simplifying decision-makingprocesses, and improving the stability of stafftenure; (ii) improving services with a large publicinterface through a combination of measures,including agency reform and e-governance; (iii)transparency and anti-corruption by overhaulingthe public procurement system, ensuring thepublic's right to information, and strengtheningthe anti-corruption enforcement machinery.

Rationalizing the Role of GovernmentThe civil service in Tamil Nadu has proliferated inthe last twenty years: Tamil Nadu today possessesthe highest ratio of civil servants per hundredpopulation in India of any major state afterPunjab. While restructuring the government hasbecome imperative because of the fiscal crisis, afundamental issue is to rationalize the role andfunctions of the government in an increasinglymarket-driven economy.

To rationalize and restructure the civil service andimprove its productivity, the Governmentconstituted a Staff and Expenditure ReformsCommission (SERC) in December 2001 to

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EEnnhhaanncciinngg SSeerrvviiccee DDeelliivveerryy

21 Public Affairs Center, a well-known NGO in India, "Study of India's Public Services: Benchmarks for the NewMillennium", April 2002.

systemically review and realign the roles andresponsibilities of each of the 140 departments andidentify redundant departments/functions/posts,including areas where the government should exitand let the private sector take over (Box 2.2). Theexercise was carried out with the benefit ofextensive consultation within the government,including with staff associations and unions, as wellas consultation with the public.

The SERC reports have identified about 85,000surplus posts, and 113,000 vacant posts madefeasible by hiring freeze. The surplus posts aretargeted mainly at lower-level administrative postsand at those government functions no longerrequired in an increasingly market-orientedeconomy. The rationale for eliminating theseposts is three-fold: (a) they are overstaffed in termsof existing work norms; (b) they are overstaffed interms of the work that can be done by newtechnology; and (3) these tasks can be outsourced.There are no cuts in teachers, doctors and nurses,and police in front line service delivery.

The reduction in the core civil service size (posts)by 2007/08 (from 2002/03) can be achieved byabolishing 85,000 posts using 2002/03 as thebase year. The abolishing of the surplus posts willenable a more efficient allocation of staff acrossdepartments within the targeted ceiling. TheGovernment has commenced theimplementation of the SERC's recommendationsby issuing orders to abolish 40,500 vacantsurplus posts; an additional 10,000-15,000 postswhich are currently live, are to be abolished in2004/05. Downsizing has been difficult toaccomplish in India, and Tamil Nadu couldprove to be no exception, notwithstanding solidgains to date. Moreover, the recent decision ofretaining the services of 15,500 temporaryworkers hired last year is not an encouraging signof government commitment.

The Government has also issued an orderallowing for the "progressive" outsourcing of all

Group D categories (e.g., sweepers, securitypersonnel), with the exception of officeassistants, provided that new contractors givepreference to existing employees on thenominal muster roll (NMR) or receiving dailyor consolidated wages. The Government alsoplans to take actions on the SERC'srecommendations to further streamline publicadministration.

Streamlining Decision MakingLike many Indian states, the process of decisionmaking is cumbersome and involves a largevolume of paper work and multiple and oftenduplicating layers.

To simplify the decision-making process, theSERC also reviewed the functioning of theSecretariat, focusing on three issues: (i) improvingefficiency through delegation to heads ofdepartments, level-jumping, the introduction ofthe single-file system, and computerized filemonitoring; (ii) greater flexibility for redeployingstaff; and (iii) tightening up on discipline bytracking attendance. The Government issued anorder in March 2002 permitting level-jumping-which reduces the number of layers throughwhich a file passes to no more than three-for avariety of subjects including, among others,transfers, granting of annual pay increments, leavematters, and disciplinary cases. Another order inNovember 2002 allows departments to introducethe single-file system, which permits heads ofdepartments to send an entire file directly to theSecretariat for approval on various subjects. Acomprehensive e-governance strategy is beingformulated to increase transparency, improveefficiency, and speed up decision making.

Improving the Stability of Staff TenureTamil Nadu is not immune to the nationalphenomenon of frequent staff transfers, whichundermines service delivery by disruptingmanagerial continuity and generates corruptionby creating a market in posts.


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Responding to the problem of pre-maturetransfers, the Government introduced a systemof formal counseling for transfers in both theHealth and Education Departments. The newsystem is aimed at reducing discretion in theprocess by holding annual, open consultationto allocate postings in the presence ofapplicants based on transparent and publicly-known criteria. The Government has plans tointroduce computerized counseling in healthand education. The Government has alsorecently issued a Government Order (GO)covering the entire civil service. The GOspecified transferring authorities, establishednorms for three- to seven-year tenure, limitedtransfers to 20% of cadre strength and to theseason only, and announced the creation of apublic transfer database on the internet to tracktransfers over time. The creation andimplementation of a public transfer databaseon the Internet to track transfers will provide a basis for formulating additional measures toimprove the transfer process. Recentannouncements of transfers (after nationalelections) however raises questions about theimplementation of the GO.

Improving Critical Services with aLarge Public InterfaceWhile Tamil Nadu has done well in servicedelivery in some key areas relative to the rest of

the country, there is still room forimprovement. A number of reforms areongoing; these include improving theRegistration Department by introducing acomputerized guidance value calculationsoftware package for use in its sub-registries,and promoting the development of kiosks invillages to improve rural service delivery andempower rural citizens (Box 5.1). Rural landrecords have also been fully computerized.Urban municipalities have computerized manyservices, including the issuance of birth anddeath certificates, trade licenses and thecollection of property taxes and water charges.Metrowater, Chennai's public water utility, is amodel of how to deliver services in a citizen-friendly manner.

Over the next few years, in addition to policy andinstitutional reforms in critical sectors such aswater supply and sanitation, education andhealth to enhance service delivery, theGovernment plans to focus on improving 10critical services with a large public interface,including regional transport services, commercialtax, stamps and registration for propertytransfers, district administration, and localbodies. It plans to accomplish this through acombination of measures such as e-governance,process reengineering, citizens' charters, andpartnerships with the private sector.

Improving Public Administration and Enhancing Service Delivery

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RASI delivers a variety of services to rural villages using wireless technology connected to the state's fiber opticnetwork and the Internet Service Provider. It is based on public-private partnerships involving the IndianInstitute of Technology Madras, N-Logue, a private company, the Center for Entrepreneurial Developmentin Madurai, and the GoTN. In villages located in Melur Taluq and Madurai districts, the kiosks were locatedin a prominent spot in the village. Villagers can send application forms on line to government offices forvarious certificates, which are collected by the operator and delivered to the applicants by hand. A web-camerainstalled at the kiosks allows people suffering from eye defects to send photos of their eye to Madurai's EyeHospital for an initial analysis; this has been extended to photographing diseased crops for analysis at the localagricultural university. When several cases of malaria broke out in a nearby village, health officials received ane-mail and arrived the following day. Critical information is online, such as crop prices, canal irrigationtimings, guideline values, and eligibility criteria for schemes. RASI also offers business applications, such aslinking villagers to buyers and sellers of farm equipment or providing them access to life insurance offeredthrough the website of the Life Insurance Corporation of India.

Box 5.1: Rural Access to Services through the Internet (RASI) in Tamil Nadu

Procurement ReformTamil Nadu was the first Indian state tointroduce legislation, in October 1998, toimprove transparency in public procurementand to regulate tendering and contractingprocedures of government departments,statutory bodies, public sector enterprises andother local bodies. The Act has become a modelfor other states wishing to reform publicprocurement (e.g., Karnataka, Andhra Pradesh,and Punjab). The detailed rules and tenderingprocedures under the Act took two years tofinalize and the Act and the Rules came intoeffect only in October 2000.

The pace of procurement reform has beenaccelerated, focusing on the implementation ofthe Act. It has completed a three-yearcomprehensive procurement reform actionplan, based mainly on a study carried out by theWorld Bank for the Government.22 Adedicated central "Procurement Procedure Cell"was created in the Department of Finance inOctober 2002 to supervise the implementationof the agreed reforms and to serve as a centralpolicy and oversight unit for publicprocurement in the state. Consultants havebeen selected for some high-priority items inthe action plan, e.g., revision of Finance,Accounts, Public Works codes and Manuals,and preparation of a set of Standard Tender andContracts documents.

The implementation of the procurement reformaction plan is expected to be completed over threeyears (2004/05-2007/08). This will include:setting up a complaint/challenge/appealmechanism; finalizing and issuing five sets ofStandard Bidding Documents; finalizing the

revision of Finance, Accounts, and Public Workscodes; improving works procurement procedures;introducing code of ethics for officials and thebusiness community and tightening enforcement;evaluation of reservation and exemptions with aview to provide a level-playing field; enlarging thescope of rules to cover consultant selectionprocedures; and issuing guidelines and directiveson procedural improvements.

Right to InformationTamil Nadu passed the country's first Right toInformation (RTI) Act in 1997; the Act itself,however, was flawed. Exemptions are numerousand broad enough to make virtually allgovernment information off limits to the publicif interpreted literally. While most RTI Acts inIndia, and globally, provide for automatic andpro-active release of certain categories ofinformation on a suo-motu or routine basis,there is no such provision in the Tamil Nadu law.It also lays down no penalties for non-complianceand fails to establish an independent channel forappeals. The law falls below GoI's standards setin the Freedom of Information Act (2002), aswell as the standards of state laws in Delhi,Karnataka, and Maharashtra.

The Government announced in the 2003/04Tamil Nadu Governor's Address the need torevise the Right to Information legislation. TheGovernment is currently preparing a new draftlaw that will provide for minimal exceptions, anindependent appeals process, penalties for non-compliance, and more automatic disclosure ofinformation by departments. The GoTN hopesto submit this bill to the state legislature soon, forthe purpose of providing a sound basis forimplementation over the next three years.


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22 In November 2000, the World Bank carried out a Country Procurement Assessment Review (CPAR) for India, andselected Tamil Nadu as the first state to review, particularly to assess the effect of the Transparency Act. The report madea number of recommendations to further improve the efficiency, transparency and accountability of public procurementprocedures and to minimize opportunities for corruption, as also to introduce modern concepts and technology in theprocurement system.

Enforcing Anti-CorruptionIn addition to ongoing systemic reforms toprevent corruption (e.g., procurement reform,business deregulation, e-governance, and fiscaltransparency), enforcement efforts needstrengthening. The Vigilance Commission andits investigating agency, the Department ofVigilance and Anti-Corruption (DVAC)function as government agencies. Quite unlikeneighboring Karnataka's independent LokAyukta who has the authority to investigate bothcorruption cases and grievances arising out ofmaladministration involving civil servants andMinisters and exercises supervisory authorityover the police wing of the Lok Ayukta. Theperformance of the DVAC has been mixed, withhigh conviction rates drawn from a very smallnumber of registered cases, mostly easy-to-proveones for whom traps were set. Only 1% ofpetitions filed with the DVAC between 1993/94and 2002/03 resulted in prosecution in any givenyear. Neither the Vigilance Commission nor theDVAC possessed a public website to disseminateperformance information.

Building on various, ongoing governance reforminitiatives, a Government Order was issued inFebruary 2004 to establish a high-poweredGovernance Reform Commission to: (i) preparean action plan with monitoring indicators forimproving 10 critical services with a large publicinterface; (ii) suggest the structure and modalityfor an independent institutional mechanism tooversee public grievance management and handlecorruption complaints in service delivery; and(iii) recommend measures to strengthen thegovernment's capacity to implement a broaderprogram of governance reform includingmodalities for encouraging well-informed publicdebate and building broad-based consensus onpriority issues. The Governance ReformCommission is, however, yet to beginfunctioning. Meanwhile, the government hasannounced the constitution of 'Service DeliveryImprovement and Grievance RedressalCommittees' at the levels of district, departmentand secretariat departments while a state-leveljoint council headed by the Chief Secretarywould be reconstituted.

Improving Public Administration and Enhancing Service Delivery

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Notwithstanding good progress in reducingpoverty and improving human developmentindicators in Tamil Nadu, poverty remainshigh, with 12-17 million out of 62 millionpeople still below the poverty line. There arealso emerging human development challenges(see page nos. 7 to 9). While broad-basedeconomic growth is necessary for povertyreduction, programs targeted at the poor,disadvantaged and vulnerable are equallyimportant to ensure that growth is morebroadly shared and that the poor will beprotected against the potential impact of forexample the reduction of subsidies.

Tamil Nadu has a plethora of poverty-reduction programs. One of the mostimportant ones is the public distributionsystem for food security. Another well-knownprogram is the Noon Meal Scheme to provideincentives, particularly to the poor children forschool enrollment. It will be important tostrengthen monitoring and evaluations oftargeted poverty-reduction interventions inorder to inform better ways to improvetargeting and rationalization across programs.

Effective poverty targeting needs to start withthe identification of the poor and understandingthe nature of poverty (both income and non-income) and identifying the key determinants ofpoverty. From available data - mainly NSSO,National Council of Applied EconomicResearch and National Family Health Survey

(NFHS) -some important lessons regarding therelationship between poverty in Tamil Nadu andgeography, asset ownership, occupation,demographics, health and education, andagriculture could be drawn.

These messages yield a number of broadimplications regarding targeted poverty-reducing programs. In terms of targeting, thereappears to be a case for paying special attentionto the rural areas in the Coastal North and theSouth, and possibly to the urban areas in theCoastal North. Scheduled Castes and ScheduledTribes (SC/STs) also appear to face particularbarriers to upward mobility, and the datasuggests that these stem at least in part fromthree sources: access to land, education, andregular non-farm employment. Indeed thesethree barriers, although especially acute forSC/STs, tend to be characteristic of the poormore broadly. Addressing them will therefore bea vital part of any poverty alleviation strategypursued by the state.

There are a great many questions regardingpoverty in Tamil Nadu that are difficult toanswer for lack of data. The list of questionswhich remain unanswered is extremely long,but a couple of examples may serve to illustratethe consequences of data limitations facingpoverty analysis.

First, since National Sample Survey (NSS) dataare only representative at the NSSO regional

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aanndd EEvvaalluuaattiioonn

level, constructing more disaggregated regionalpoverty measures has not been possible. Fromthe point of view of policymakers, and inparticular against a background ofdecentralization, there is a real interest inknowing more about the geography of povertyat the level of 29 districts or the 384 blocks. Fora state as large as Tamil Nadu with a populationof 62 million, data disaggregated at the fourregional levels cannot provide detailedgeographic profile of the poor-i.e., where thepoor are. Methods have been developed inrecent years to combine survey with census dataso as to produce detailed geographic profiles ofpoverty, but such methods have not yet beenimplemented in India. Such information isthus unlikely to become available in the short run.

Similarly, although we can glean some insightsfrom NFHS data, we cannot paint a very detailedpicture of urban poverty. This is clearlyunsatisfactory since urban poverty promises to bea growing challenge with the rapid urbanizationof the state.

Second, although data such as the NFHS doprovide us a rich picture of women's quality oflife, it has little data regarding income orconsumption. This makes it difficult to mapthese indicators into an understanding ofpoverty. Given that the Tamil Nadu governmenthas been laying increasing emphasis on assistingwomen, it would no doubt be useful tosystematically identify the challenges facing poorwomen. Although constraints on employmentand earnings appear to be an important deterrentto upward mobility amongst women, as well asother disadvantaged demographic groups,especially SC/STs, we are not in the position toelaborate on the nature of these constraints,particularly in urban areas.

Developing a comprehensive poverty reductionstrategy will involve more investment in poverty

monitoring. This is obviously a grandundertaking, but the recent Below Poverty Line(BPL) survey is an important step in thisdirection. It asks a number of importantquestions regarding household characteristics,including income, asset ownership, and a fewoccupational and demographic characteristics.Since it is a census, the BPL is amenable to theaddition of modules, which could be used toacquire data representative at least at the districtlevel. Such an undertaking would beconsiderably facilitated by virtue of the fact thatmuch of the necessary survey infrastructure isalready in place. The BPL therefore offers avaluable opportunity to fill gaps in ourknowledge regarding the nature anddeterminants of poverty in Tamil Nadu. Muchremains to be learnt, however, about the qualityand reliability of the BPL data that are currentlybeing collected.

The BPL type of surveys can also besupplemented by sectoral MIS data. Variousgovernment departments in Tamil Nadu such asSocial Welfare, Education, Health, and RuralDevelopment collect and maintain useful datasuch as nutrition, infant mortality, primaryschool enrollment and dropout rates, maternalmortality. One deficiency is that these data fromvarious departments are not integrated. With theambitious e-governance project initiated tomodernize the information system of the stategovernment, a useful and important step can betaken to establish a central poverty and humandevelopment monitoring unit under thePlanning Department to integrate monitoring(currently done by each of the concerneddepartments) for synergy and a commondatabase that will facilitate systematicevaluations and policy feedback on poverty-reduction interventions.

The capacity to monitor the progress of povertyand human development and link that with overall policy and poverty-reduction


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interventions remains critical. There is also scopefor aligning the various programs listed in theTenth Plan to improve coordination andtargeting: many programs are not coordinated,with multiple, overlapping and sometimesdifferent objectives. The government has plansto conduct evaluations of key programs. The

Noon Meal Scheme may be a good program tobegin the exercise. A comprehensive and well-coordinated monitoring and evaluation systemwill be essential to streamline the variousprojects currently envisaged and furtherstrengthen the government's efforts in povertyreduction.

Strengthening Poverty Monitoring and Evaluation

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Tamil Nadu faces the longer-term challenge ofreform for accelerating economic growth andreducing poverty. Repeated droughts andgrowing waters shortages have heightened theimportance of structural transformation. Suchtransformation will reduce the vulnerability ofthe economy to periodic drought, and free upscarce water resources to higher value-additionactivities in the industrial and service sectors. Thefaster growth of these two sectors would helpabsorb agriculture surplus labor and reducecurrently high unemployment rate of the state.

Reform priorities for the structuraltransformation to accelerate economic growthand reducing poverty are the following: � Fiscal reform remains an immediate

development challenge for Tamil Nadu, andIndia. Fiscal stabilization, correctingaggregate imbalances, and improving thecomposition of expenditure is critical forcreating the fiscal space for priority spendingin infrastructure and social sectors.

� Fiscal reform must be accompanied bystrengthened public expendituremanagement and public administration toimprove the effectiveness of publicspending and service delivery.

� Fiscal adjustment alone without acomplementary focus on the investmentclimate and economic growth isinsufficient. Faster economic growth

positively influences not only debtsustainability but also employment andincome generation, facilitating largerdistribution of reform gains.

� Even assuming the success of fiscaladjustment in accordance with the MTFP,public investments in infrastructure andbasic services are likely to remain a fractionof investment needs. Thus, public-privatepartnerships in infrastructure financing anddevelopment under an appropriate policyand regulatory framework are essential.

It needs to be understood that many importantpolicies are not within the purview of the stategovernment. Policies of the central governmentaffect fiscal sustainability and growth in states.These central policies include the share of thestate in central tax devolution, the introductionof VAT, a macroeconomic framework that mayaffect interest rates on state debt, regulatorypolicies on private sector activities such as labormarket regulations, business exit and bankruptcyprocedures, and infrastructure policies anddevelopment affecting major ports, air markets,inter-state highways etc.

Agenda for fiscal reform. Putting Tamil Nadu'sfiscal reform in the Indian context, fiscalconsolidation remains the most seriousmacroeconomic challenge facing India, with thegeneral government deficit estimated at close to10% of GDP and the debt/GDP ratio at 81% in

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2003/04. Almost half of the consolidated fiscaldeficit is made up of states' deficit. States' fiscalreform has shown to be difficult, its progressuneven across states and several states haveexperienced varying degrees of policy reversals.Reforming civil service salaries, pensions, subsidiesimproving tax administration and reforming thepower sector remain politically challenging. Statereforms will be accelerated by the linking of centralfiscal resource transfers to states with their fiscalperformance. In this regard, strengthening of theinitiatives already undertaken by GoI, such as theFiscal Reforms Facility, will be important. Aschematic list of necessary reforms in the broadarea of fiscal and public expenditure managementis presented at Annex 2.

MTFP will need to reflect the vision of the statein consonance with the state's FiscalResponsibility Act. To operationalize thedevelopment vision, policy formulation andbudgeting need to be better integrated byensuring that fiscal constraints are realisticallyidentified and appropriately incorporated intoeach of these processes. As recognized by theGoTN, the fiscal crisis offers an opportunity toaddress systemic institutional weaknesses andminimize the recurrence of fiscal crisis. Recentpolicy actions undermine the reform frameworkand question government commitment.Institutional reform includes upstream budgetformulation to downstream execution andaccounting and audit (some of which will nodoubt depend on consensus at the national level).

Tamil Nadu, (and India) will need to find apolitically viable solution to power sector reformto resolve the twin problems of shortage and poorquality of power supply, as a viable power sectoris critical for achieving fiscal stabilization,accelerating economic growth, and ensuringsustainability of ground water resources whichare depleting at an accelerated rate. Althoughpower theft and corruption are a lesser issue inTamil Nadu reducing cross subsidy is critical to

the financial viability of the power sector. To getthe reform levers aligned so vested interests arenot alienated and, most importantly, that poorpeople receive their rightful delivery of socialservices, is the challenge.

Equally challenging is expenditure reform whichreduces and/or redistributes benefits. First, usercharges have to keep step to improve servicedelivery. Second, there is limited scope for TamilNadu to increase its own tax revenues under theexisting taxation powers conferred on states.Third, the increased infrastructure and socialspending using newly created fiscal space (if fiscalreforms are successful) can only be gradual, andeven in the long term cannot be increased rapidlyif economic growth is not accelerated and if taxpowers are limited. Fourth, it will take time forinfrastructure and social spending to translateinto tangible benefits.

The reform program of the government made agood beginning and its impact is positive in the fiscal turnout upto 2003/04. However, recent policy choices of reversing critical reformsalready undertaken will impede expenditurerestructuring efforts and jeopardize the gainsmade thus far. This poses a threat to fiscalconsolidation besides affecting the credibility ofthe MTFP and fiscal and budgetary discipline.Particularly in the power sector, the governmentseems to have painted itself into a corner, and itis hard to see how in the current environmentany plan for financial recovery can be workedout. If, as seems likely given what has justhappened, there are no further tariff increasesbefore the next state election, expected in2006/07, power sector losses could, in that year,exceed what it projected in the reformist businessplan by as much as Rs 2,000 crore or more than1% of GSDP. In such a scenario, theconsolidated deficit will be back at or above pre-reform levels, and productive spending will becrowded out by power subsidies. Tamil Nadu hasno choice but to return to the path of fiscal


80

consolidation. Otherwise the success of thereform program initiated by the Governmentlooks uncertain with every possibility of the statereverting to the fiscal distress highlighted inGoTN's 2001 White Paper.

Investment Climate: The reform agenda dealswith not only regulatory policies and practicesconcerning all factor markets (labor, land, andcapital), but also regulation of entry/exit and taxpolicy and administration. Further, removingsubstantial infrastructure bottlenecks-power,road network, water supply, etc.-top the reformagenda. The wide scope of issues is notsurprising, given that internationalcompetitiveness involves all critical chains ofinvestment, production and marketing. Theagenda will thus require an institutionalizeddialogue between the Government and theprivate sector for setting priorities and findingsolutions. The private sector must be a soundingboard and source of information in formulatingpolicy for the business environment.

Priority reforms comprise of the following areas:labor market flexibility; a more responsive urbanland supply system; a more efficient tax policyand administration; continuing reform of entryand operation; power sector reform; and scalingup PPP for sustainable infrastructuredevelopment. Many of the issues concerninginvestment climate are exclusively or largelywithin the purview of the central government.This report confines itself to options for thereform agendas which are partially or mainlywithin the purview of the state government.These are presented at Annex 3. It must berecognized that there is a balance betweencomprehensive reform and strategic selectivity.Therefore, the proposed agenda serves as a menuof options from which a strategic yetprogrammatic reform agenda could beformulated based on the Government's owninternal consultation, opportunities andconstraints. Many of the proposed reforms

involve complex institutional reform that willtake efforts beyond the medium term.

Agriculture. Traditional sources of agriculturalgrowth in Tamil Nadu face major constraints.Seasonal water shortages, increasing landdegradation, continually shrinking farm sizes andrising costs of agricultural labor represent seriousconstraints that need to be overcome if futuregrowth in agriculture is to be realized. Given theexisting constraints, diversification into lesswater-intensive higher-value products, includingfruits, vegetables, spices, and livestock products,is one of the most promising avenues forincreasing agricultural growth. Tamil Nadu'sagro-climatic conditions are well suited todiversified agriculture. Furthermore, rapidlyincreasing incomes and changing food demandpatterns provide strong impetus fordiversification. Increased agriculturaldiversification and private investments inprocessing for many of the higher valuedagricultural commodities are likely to generatenew rural non-farm employment opportunitiesand contribute to higher rural incomes. Contractfarming and other private sector initiativesshould be encouraged, though the impact ofthese business arrangements on farmer incomesshould be evaluated, as well.

Overcoming the constraints faced by theagricultural sector in Tamil Nadu, and acceleratinggrowth in agricultural production and the rate ofrural poverty reduction, will require appropriatepolicies and investments in four priority areas:improving the efficiency of water use; increasingthe effectiveness of public expenditures andagricultural extension; spurring the developmentof agricultural markets; and maximizing the realincome growth of the rural poor.

More specifically, there are several options thatTamil Nadu could consider to manage its scarcewater resources. These include: scaling up thepilot river-basin framework for managing water

Reform Challenges and Risks

81

resources holistically, allowing interagencycoordination and public-private partnerships;introducing specific legally enforceable waterentitlements to various users in a river basin andor aquifer framework; changes in electricity,water and crop prices to change the financialincentives for irrigation and crop choice;improved management practices and irrigationtechnologies (such as drip and sprinklerirrigation) and new investments in canals andwater storage (coupled with improved operationand maintenance).

Tamil Nadu is the only state in India without aseparate department of irrigation: administrationof irrigation in the state is part of theDepartment of Public Works. Two new agenciesare needed: a regulatory agency to allocate theshare of water resources to agriculture, industryand other uses, and an irrigation departmentfocusing on irrigation delivery systems.

Re-introduction of agriculture power tariff (bothflat rate on pump sets and metered) became ahighly contentious issue in Tamil Nadu duringnational elections and were reversed.International experience with income supportprograms also provides several important lessonsfor providing clear incentives and containingfiscal costs, including the need for targeting topoorer farmers (e.g., paying more per hectare asfarm size increases, with a ceiling on the numbersof hectares eligible for payment), an effectivedelivery system for the transfer payments, and alimit on the number of years for which producerswill be eligible for payments.

Gradual step towards marginal cost pricing ofelectricity, (perhaps combined withcompensation to farmers in the form of incometransfers or a more reliable electricity supply),would help rationalize water use in Tamil Nadu.Metering of farmers is critical to link agriculturaltariffs to consumption levels. Metering will alsoenable power subsidy to be better targeted. If

farmers costs and incomes varied according to theamount of electricity (and water) used with wellirrigation, farmers would have an incentive toshift some land from water-intensive crops (riceand sugar cane) towards less water-intensivecrops (including cotton, maize and vegetables).Greater attention to marketing infrastructure,strengthening the research and extension systemto meet the needs of diversified agriculture, thedevelopment of tools for farmers to bettermanage risks, and improving irrigation pump setefficiency may create an environment withinwhich higher power charges would be morepalatable for farmers.

It is important to sequence the raising of waterand electricity tariffs as part of broader packageof coherent policy and institutional reforms.These reforms are: decentralizing a traditionallytop-down centralized extension system;facilitating efficient agricultural markets;developing a rural credit market, and developingan insurance and safety net program to cushionagainst the risk of diversification particularly forsmall and marginal farmers who rely mainly onagriculture subsistence income; and a deliverypackage to improve farmer income associatedwith gradual adjustment of input pricing.

Greater attention is also need for scaling-up theadoption of water saving irrigation technologiesand modernizing irrigation infrastructure.Improving the productivity of rainfed agriculturewill require new investments and increasedemphasis on community participation withsound technical inputs to improve the success ofwatershed programs. A basin perspective shouldbe adopted in implementation of all watershedprograms to ensure that these initiatives do nothave negative impacts on downstream humanand ecological uses.

Rationalizing public expenditures and shiftingexpenditures from subsidies to investments inkey public goods such as rural roads, markets and


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agricultural research and extension will facilitateproductivity improvements and diversification ofagriculture to higher value products.

Poverty Monitoring and Evaluation. Thereappears to be a case for paying special attentionto the rural areas in the Coastal North and theSouth, and possibly to the urban areas in theCoastal North. Scheduled Castes and ScheduledTribes (SC/STs) also appear to face particularbarriers to upward mobility, and the data suggestthat these stem at least in part from three sources:access to land, education, and regular non-farmemployment. Indeed these three barriers,although especially acute for SC/STs, tend to becharacteristic of the poor more broadly.Addressing them will therefore be a vital part ofany poverty alleviation strategy pursued by thestate. Given that the Tamil Nadu government hasbeen laying increasing emphasis on assistingwomen, it would no doubt be useful tosystematically identify the challenges facing poorwomen. Constraints on employment andearnings appear to be an important deterrent toupward mobility amongst women, as well asother disadvantaged demographic groups,especially SC/STs.

Developing a comprehensive poverty reductionstrategy will involve more investment in povertymonitoring. This is obviously a grandundertaking, but the recent BPL survey is animportant step in this direction. It asks a numberof important questions regarding householdcharacteristics, including income, assetownership, and a few occupational anddemographic characteristics. Since it is a census,the BPL is amenable to the addition of modules,which could be used to acquire datarepresentative at least at the district level.

The GoTN expends considerable thought andeffort in undertaking, the formulation of goals andidentification of targets for its anti povertyprograms. However, different programs are not

always coordinated, with multiple, overlapping andsometimes conflicting objectives. Encouragingly,however, many schemes appear to be, or have thepotential to be, broadly focused on issues whichdata suggest are important to the poor. More needsto be done regarding the design andimplementation of poverty alleviation schemes.

Monitoring and evaluation (M&E) requiresstrengthening. This is not a problem particular toTamil Nadu: it is common to all of the states inIndia, as it is to most of the developing world.Monitoring of extant anti-poverty policies andsocial services more generally is, however,important if one is to gauge whetherimplementation is proceeding according to planand achieving its stated objectives. This is acontinuous process, instrumental in identifyingproblems to be addressed. Impact evaluationinvolves isolating the effects of a particular policy — assessing its effect on welfare and livingstandards. The GoTN is an ideal agent forengaging in M&E, given its voluble commitmentto combating poverty, openness to receivingfeedback, and rich human capital resources.Impact evaluations are most appropriate toprograms which are innovative, replicable,involve substantial resource allocations, and havewell-defined interventions. It is also obviouslythe case that impact evaluations are bestconducted on policies which are viewed asimportant to social welfare.

Service Delivery and Public Administration: Thefollowing measures are suggested for improvingthe efficiency of Government administration: (a)Implementation of the SERC recommendationsacross departments and the Secretariat over athree year time-period, resulting in theelimination of surplus posts; (b) Introduction ofa computerized file-monitoring system to reducedelays in file movement, in conjunction withlevel-jumping, the single-file system, and greaterdelegation of powers; (c) The Government hasalready issued a Government Order on transfers

Reform Challenges and Risks

83

covering the entire civil service. The creation andimplementation of a public transfer database onthe Internet to track transfers will provide a basisfor formulating additional measures to improvethe transfer process including computerizedcounseling in health and education and adoptinglegislation to limit transfers; and (d) Creating ahuman resource database for civil servants' tofacilitate better employee tracking, forecasting,and career planning.

Reducing Corruption: (a) Creation of anindependent institutional mechanism to focus oncorruption and grievance redressal in servicedelivery, and greater transparency in thefunctioning of DVAC (e.g., tabling of reportswithin three months of their submission,creation of a public website with data oncomplaint numbers/types, pendency rates, andoutcomes over time); (b) Adoption of a newTamil Nadu Right to Information (RTI) Act,with minimum exceptions, strong suo-motudisclosure provisions, and independent appealsprocess; and (c) Implementation of furtherprocurement reforms.

Strengthening Service Delivery: (a) Revision ofcitizen charters' for agencies with large publicinterface on a priority basis (e.g. districthospitals) and use of surveys to provide feedback;

(b) Continuation of service deliveryimprovements in key agencies (e.g., Registration,Transport, Revenue, and Public DistributionSystem); and (c) Expansion of E-Governance bypromoting single-point delivery of services,beginning with Chennai, and the spread of ruralinformation kiosks.

Electoral politics and capacity constraints maylead to reform uncertainty and politicalsensitivity to many reforms. What is critical isthe political commitment to reform, as well asthe sequencing and prioritization of reforms,and careful managing of trade-offs in reformgains, costs, and risks. To do so, it is importantto build a broadly-shared consensus throughpublic debate and to carefully design aminimum set of policies and programs tocompensate for the impact of reform, so as tomaintain a critical mass of support for reformsto proceed. GoTN's capacity to manage acomplex and growing reform agenda requiresstrengthening. Substantial capacity buildingand broad-based knowledge partnerships canhelp address the management of reforms inpriority areas such as water resourcesmanagement, agriculture diversification, publicexpenditure management, and public-privatepartnerships in infrastructure financing anddevelopment.


84

85

� Move to a functional structure. Movingfrom a territorial to a functional structurein the commercial tax administration isprobably the single most important reforminitiative the Tamil Nadu government cantake to reform tax administration. Thereorganization would have to be carried outat the headquarters and territorial levels. Itwould create the necessary organizationalbasis for separating and strengthening the

key tax administration functions ofregistration, audit, collection, and taxpayerservices. Figure A1.1 outlines a typicalfunctional tax administration structure.

In order to mitigate risks and develop aclearer understanding of the operation of a

functional tax administration, thereorganization could be implemented instages and begin with a pilot site. Theestablishment of a new large taxpayer unitin the Commercial Tax Department wouldoffer an ideal venue for such a pilot.

� Create a special structure for largetaxpayers: A small number of large traderscontribute the bulk of sales tax collection

in Tamil Nadu.23 To address thecompliance risks and the special serviceneeds of this group of taxpayers, thegovernment should set up a special largetaxpayer unit responsible for theadministration of the largest 200-500traders in the country, and staffed with

AA FFuunnccttiioonnaall RReeoorrggaanniizzaattiioonn SScchheemmee

ffoorr tthhee CCoommmmeerrcciiaall TTaaxx DDeeppaarrttmmeenntt

Figure A1.1: Tax Administration Structure

23 Currently, the largest 400 taxpayers-representing 0.37% of assessments-account for 75% of total sales tax collections.

Annex 1

senior and experienced tax officials. Such aunit would also considerably facilitate theintroduction of a VAT. As discussed above,the unit should be organized alongfunctional lines.

� Streamline the territorial structure of taxadministration: Following the successfulpiloting of the functional structure in thelarge taxpayer unit, the reorganizationneeds at the territorial level should beaddressed. The current 323 assessmentcircles should be abolished and taxadministration tasks transferred to the 40district offices. Circle offices would,however, be maintained and transformedinto service posts where appropriate.

� Strengthen the human resources of theCommercial Tax Department: Aprofessional and specialized taxadministration requires an appropriatelevel of highly qualified staff. Thisrequires increasing the percentage ofsenior staff at officer level in theadministration.

� Strengthen the enforcement function: Atotal of 4,646 inspections of dealers wereconducted in fiscal year 2001/2002. Theseinspections resulted in the assessment ofadditional taxes and penalties amountingto Rs.211.86 crore, which accounts foronly 3% of total sales tax collections.Enforcement productivity is thusextremely low. To enable the departmentto counteract tax evasion more effectivelyrequires strengthening risk analysis for caseselection; moving from a routine deskinspection to a targeted field inspectionsystem; introducing an enforcementmanagement system with clear plans andregular review of performance ofenforcement units; and training ofprofessional staff.

� Establish a vigilance unit: TheCommercial Tax Department has an auditwing responsible for internal audit of itsoperations. The audit wing focusesprimarily on reviewing the correctness ofthe assessment work, but does not assumeresponsibility for ensuring integrity andcounteracting corruption in the taxadministration. To investigate taxpayerallegations against tax officials and detectcorrupt practices and officials in thedepartment, a special vigilance unit shouldbe established.

� The current commercial tax system has twounusual features that complicatecompliance by the business community:First, the current sales tax system is notbased on self-assessment. Temporary self-assessment is possible only for a smallgroup of small taxpayers with a turnover ofless than Rs.10 crore and-in the case of thesales tax-only if the taxpayer declares a10% increase in the taxable turnover overthe preceding year. Modern taxadministrations, however, have moved to auniversal self-assessment scheme for salestax/VAT and have, when the scheme isintroduced in phases, started not withsmall taxpayers, but with the small groupof large taxpayers, for which self-assessment is more feasible and important.A review of the self-assessment approachchosen and the development of a roadmapfor moving to universal self-assessment willtherefore be required. Second, effortsshould be made to facilitate theregistration process for sales taxpayers and,in future, for VAT taxpayers. The process iscomparatively long-almost one month-while many tax administrations manage toregister taxpayers within 72 hours from themoment of filing the application. TheGovernment is, understandably, concernedabout the risk of registering non-existent


86

or fly-by-night firms, and efforts to reducethese risks are perfectly justified.Nevertheless options should be consideredto make the registration process moretaxpayer-friendly, without neglecting theneed to mitigate risk. The options shouldalso include reviewing the requirement tore-register businesses periodically andcharging annual registration fees.

� Tamil Nadu faces substantial problems indetermining the taxable value of realproperty and enforcing payment of stampduties for property transfers: Valuation forstamp tax purposes is based on a guidelinevalue, which is determined by a ValueFixation Committee. Guideline values arefrequently subject to disputes and are notupheld in court. Taxable transactions areeither not reported to the RegistrationDepartment, or the registration is delayed.Frequent use of fake stamps causes additionalrevenue losses, so that the actual tax revenuescollected by the Registration Department arefar below the revenue potential.

� Problems in collecting stamp duties,especially on real estate transfers, cannot beaddressed exclusively from a taxadministration angle: They are part of abroader problem of keeping up-to-daterecords on property ownership and sales. A

well-functioning cadastre system is necessaryfor eliminating the possibility of unrecordedproperty transfers. A revision of cadastralrecords therefore needs to be launched.Tamil Nadu can benefit in this respect fromthe experience of some states that haveembarked on this exercise already; inparticular the experience of Uttar Pradeshand Karnataka with using satellitetechnology for this purpose could berelevant. On the tax side, the interest andpenalty system for delayed applications forregistering property transfers needs to bereviewed. Efforts to set more reliableproperty values need to be pursued, inparticular by establishing a CentralValuation Committee, following therecommendation of the EmpoweredCommittee of State Finance Ministers andthe positive experience with the operation ofsuch committees in other states. Furthercomputerization of the valuation process,taking into account experience in AndhraPradesh, and especially in Maharashtra,could facilitate property valuation. Valuationfor stamp duty purposes and for assessmentof the urban land tax could be harmonized.The overall result of the reform processshould not only be an increase in stamp dutycollections, but a quicker processing ofregistration requests, which would support amore dynamic real estate market.

Annex 1: A Functional Reorganization Scheme for the Commercial Tax Department

87

89

Budget and Policy FormulationStrengthening policy formulation� Establish an apex Policy Reform

Committee linked to a network of policy research institutes/universities to upgrade quality of policy proposals.

� Establish an annual forum withstakeholders to report on developmentprogress and to invite comments onproposed policy initiatives.

Strengthening budget formulation � As a priority, develop capacity to

undertake multi-year revenue forecastingin Department of Finance.

� Formalize the functioning of a standingExpenditure Review Committee as part ofthe annual process of reviewing budgetsubmissions to eliminate unproductiveprograms and improve efficiency ofexisting programs.

� Ensure budget preparation processencompass expenditures due to all "newpolicy, provision of a new facility, or anysubstantial alteration in character or extentof an existing facility."

� Eliminate policies or schemes thatviolate established budgetary review andvetting process.

� Initiate time-bound implementation ofexpenditure rationalization recommendationsof the Staff and Expenditure ReformCommission.

� Establish a working group to (a) developrecommendations on rationalization andaccessibility of budget documentation and(b) update the budget manual.

� Initiate Zero-Base Review of Schemes andprograms; close those with doubtfulbenefits and merge others, which aresimilar in nature post review.

� Adjust budget schedule to ensure that theAppropriation Act is passed by thebeginning of the fiscal year.

Strengthening budget execution � Initiate and complete a full review of

budget execution procedures (cashmanagement, release of cash or letters ofcredit and payment, control processes,predictability and scope for departmentalvirement) to identify factors thatcontribute to under-spending, arrears, end-of-year spike in spending, etc. Implementrecommendations from such review.

� Introduce quarterly circulars providingdepartments with information onanticipated cash disbursement/letter ofcredit limits for next quarter.

BBuuddggeett aanndd FFiinnaanncciiaall

MMaannaaggeemmeenntt RReeffoorrmmss

Annex 2

� Delegate greater financial powers toallow managers more discretion inmanaging inputs. Provide departmentswith greater authority over discreteblocks of budget appropriation andincreasing the unit of parliamentaryappropriation.

Improving fiscal accounting� Adopt a clear and internationally standard

definition of the fiscal deficit to bereported in the fiscal accounts.

� Initiate improvements to accountingsystem within the current system.� Prepare and publish regular reports on

fiscal and revenue deficit.� Monitor and report payment

obligations, arrears and guaranteesissued.

� Discourage and limit transfer ofresources from consolidated fund ofthe state to the public account.

� Improve timeliness and compre-hensiveness of reconciliation ofaccounts across treasury, departmentand accountant general.

� Develop and implement a medium termstrategy for networked computerization offinancial transactions and records andadoption of department-based financialmanagement.

� Improve and strengthen the internal audit function.

Improving accountability to Legislature� Ensure more complete and prompt

departmental responses to auditparagraphs.

� Avoid delays in obtaining ex postlegislative authorization of expenditure inexcess of appropriation.

Taxation Policy and AdministrationTamil Nadu's own tax revenue effort is amongstthe highest in Indian states. Nonetheless, there isconsiderable room for improving the efficiency,equity and administration of the tax system toincrease revenue yield and investment friendliness.

Tax policy� Continue preparation for the introduction

of the VAT; and prepare appropriate legalacts to levy tax on goods and services thatshould cover taxes such as the SpecialAdditional Sales Tax and some type ofpresumptive taxation applicable to smalldealers not covered by the VAT.

� Consider to switch State Excise from thecurrent specific excise to ad valorem leviedon the Maximum Retail Price of alcoholicbeverages.

� Streamline duties on dutiable instruments(especially financial instruments), movingsome to ad valorem. Minor duties may beeither abolished or increased to justify thecollection costs.

� Consider raising non-transport vehiclelifetime taxes to 8% in line with some other states. Revamp fees for permits,registration, licenses, fitness certificates on motor vehicles, increasing revenuepotential from road tolls, and raise the"green tax." In addition, part of the roaduser charges can always be incorporatedinto the fuel/diesel price through increasedsales and/or excise taxes.

� Abolish Entry Tax on motor vehicles andgoods upon introduction of VAT.

Tax AdministrationShort term� Prepare a five-year tax administration

reform strategy.


90

� Streamline reporting and accountabilityarrangements for revenue collection.

� Establish a Central Valuation Committeefor fixing guideline values.

� Establish a vigilance unit in theCommercial Tax Department (CTD).

� Issue a uniform taxpayer identificationnumber and revise taxpayer registrationprocess.

� Create a pilot Large Taxpayer Unit (LTU) inthe CTD, structured along functional lines.

Medium-term� Prepare an annual audit plan and training

for auditors.

� Prepare a HR audit and training plan.

� Introduce self-assessment for large taxpayers.

� Start roll-out of LTU concept.

Long-term� Full roll-out of LTU concept: move to a

functional tax administration organization.

� Abolish assessment circles and transformcircle offices into service points whereappropriate.

� Transfer responsibility for collecting othertaxes to CTD.

Expenditure ReformPension reform Year 1� Produce assessment of transition costs of

moving from pay-as-you-go financing tofunding. The government will have to payhalf of the overall contribution asemployer. This has fiscal implications that

depend on the chosen contribution rateand, more importantly, on how manycurrent civil servants are allowed /encouraged to move to the new scheme.The 'transition cost' must be in line withfiscal realities.

� Determination and announcement ofparameters of the new defined contributionscheme. A series of parameters remain to be determined before the scheme can be started. Key among these is thecontribution rate, the retirement age, thepayout options and the treatment of theGPF account. These may be influenced byGoI's recent announcements in these areas.

� Determination and announcement of rulesregarding the choice between the existingdefined benefit (DB) scheme and the newdefined contribution (DC) scheme forthose already participating in the former.The conditions of this option must bedesigned in line with fiscal plans.

� Implementation of new informationsystems required to track individualaccounts for members of the definedcontribution scheme on a regular basis forgovernment offices in Chennai.

Year 2� Dissemination of information regarding

the pension system options available tocivil servants. Civil servants faced with achoice as to whether to stay in the currentDB scheme or move to the new DCscheme should be provided with adequateinformation. (This assumes that there is achoice rather than a mandate).

� Implementation of information system fortracking individual accounts in the definedcontribution scheme to at least 90 percentof eligible government employees.

Annex 2: Budget and Financial Management Reforms

91

� Development of plan to link new schemeto the infrastructure created under thePension Fund Regulatory andDevelopment Authority.

� Adopt revalued lifetime average earnings toplan for the target replacement rate whendesigning the provisions of the definedcontribution scheme.

� Index pensions automatically to priceincreases instead of ad hoc wage indexationevery 10 years through Pay Commissions.

Salary control� Continue staff rationalization as per the

Staff Expenditure and ReformCommission's recommendations.

� Link wage indexation decisions to capacityto pay.

Subsidy reduction� Improve targeting of the poor in the PDS

by incorporating income/asset criteria andgradually raise public distribution systemprice of rice to BPL issue price of theGovernment of India.

� Evolve guidelines to manage growth ingrants-in-aid of salary expenditure tohigher educational institutions and privateaided schools.

� Audit subsidies and phase out subsidies ofdoubtful benefit.

Improving capital outlay and non-wageO&M � Reallocate expenditure towards non-wage

O&M expenditure in critical sectors andcapital outlay.

� Leverage capital outlay to scale up publicprivate partnerships.

� Progressively reduce budgetary support toPublic Sector Enterprises and cooperativesthrough different means such as loans,grants, waivers, non-recovery and Ways &Means support.

Reform of Public Sector EnterprisesState Transport Units � Continue containment of salary and

pension growth.

� Continue to reduce operational loss.

� Improve staff/bus ratio.

� Implement phased program of privatizingselect routes and services, subject to legalcase in the court being ruled in favor of thegovernment.

Other public sector units and cooperatives� Formulate a time line for restructuring and

divestment and transparent guidelines fordivestment.

� Formulate a strategy and action plan forsales of assets and divestment.

� Carry out environment audit for units tobe closed / sold.

� Conduct training and counseling programfor retrenched workers.

Power sector reform� Formulate and implement a comprehensive

reform program addressing the need forsector restructuring for transition to afinancially viable power sector -inaccordance with the requirements ofIndia's new Electricity Act 2003 (Act) aswell as specific needs of the state.

� Increase cost recovery from domesticpower consumers.


92

Annex 2: Budget and Financial Management Reforms

93

� Limit TNEB's borrowing requirement.

� Combine metered power supply toagriculture with a package deal toimprove agricultural services deliverycombined with marginal cost recoverylevel power tariff, efficient pump sets, lesswater intensive crops, and direct subsidyto the poor.

� Address high power purchase costs andintroduction of competition in the powersector.

� The open access provisions in the Act, ifcarefully implemented, can result insubstantial private investments ingeneration with reasonable costs.

� Improved cost recovery from rural areasto be planned to balance increase in costswith improved service delivery, so as to

prepare for the reduction in cross-subsidy.

Management of Debt andContingent Liabilities� Eliminate off-budget borrowings.

� Continue debt swaps and seek extension ofswap scheme to other costly borrowings.

� Eliminate the existing system of incentivesfor mobilizing small savings.

� Abide by the limit on risk weightedguarantee limits under FRA.

� Establish a set of formal rules to governeligibility of PSUs, cooperatives and statutoryboards for government guarantee. The rulescould take into account financial statements,record of profitability, performance on pastguarantees, priorities of government, etc.

95

Labor market flexibilityWithin the constraint of national legislation, thestate government can explore ways to rationalizethe legal framework governing labor andstatutory compliance requirements to createelbow room for contractual labor relationshipand for easing threshold for retrenchment. Morespecifically, the following can be considered.

Short term1. Carry a complete review of the entire

spectrum of Labor Laws governing TamilNadu and the machinery needed toimplement these laws.

2. Bring in flexibility to Factory Act onworking hours, overlapping of shifts, workdays, working on holidays either throughState Amendments of the Act or throughexemption under section 65.

3. Bring in State Amendments to the ContractLabor (Regulation and Abolition) Act 1970.Through the amendment, redefine whatconstitutes a "core" activity and reclassifymany activities to the "non-core" list, allowhiring of contract labor in activities, likesanitation works, security services, canteenand catering services, health services, courierservices, gardening and maintenanceservices, transport services, and otheractivities of intermittent nature even if theyconstitute core activities (e.g. hiring contractlabor in production line to meet unexpected

export orders). Furthermore, the decisionshould be left with the firms to decide whatis core and non core.

4. Amend the notifications under the Shopsand Establishment Act to removeinflexibility regarding working hours andalso dismissal of employees.

5. Review licensing procedures in all the laborrelated laws to remove unnecessaryprocedures, simplify and ensure compliance.

6. Remove inflexibilities introduced in thepast by the state related to the IndustrialDisputes Act. Initiate State Amendmentsto amend Chapter VB like Maharastragovernment and perhaps follow theexample of the Andhra Pradeshgovernment, which is the process ofinitiating amendment to Chapter VB toraise the number to 1000.

Medium term1. Amend Section 16 of the Trade Union Act,

1926, which contemplates constitution of aseparate fund for political purposes.Empower the Registrar of Trade Unions toadjudicate upon a dispute as to which of theoffice bearers are validly elected and limitthe number of unions in any establishment.

2. Initiate State Amendments to the IndustrialDisputes Act 1947 and Shops and

RReeffoorrmmss ttoo iimmpprroovvee tthhee

IInnvveessttmmeenntt CClliimmaattee

Annex 3

Establishment Act to allow terminationunder reasonable grounds, differentiationbetween the termination of temporary andpermanent employee, introduction ofprobation period and confirmation period,removal of compulsory regularization of aperson who works for more than 2 yearsand to provide for court awardedcompensation instead of reinstatement andpermitting compulsory retirement underthe Industrial Disputes Act.

3. The Presiding Officers of the Labor Courtsto be given Special Training or to havetrained personnel for the resolution of thedisputes.

4. Evaluate the need for Minimum WagesAct (1948) and Rules (1950). Extendexemption if necessary.

Longer term1. Consolidate the 27 Central and 7 State Laws

into Industrial Relations and labor matters.Like most other developing countries, stepsneed to be taken to consolidate laborregulations to 5 main legislation to govern,first the relationship between employer andemployee (Employment Act), second togovern quasi judicial body that arbitratesbetween employer and employee (IndustrialDisputes Act), third to govern the activitiesof employees in unions (Trade Unions Act),fourth to govern welfare and compensation(Workman Compensation Act) and fifth togovern safety and security at work(Occupational Safety Act).

2. Carry out institutional reengineering tomake the regulation of labor effective andcost efficient.

3. Consider establishing an independent bodylike Labor Regulatory Authority to dealwith retrenchment and closure of factories.

Urban land market reformThe focus should be on rationalizing regulationson zoning and development controls, projectapproval and land acquisition processes, anddeveloping a more effective planning andmanagement system to facilitate infrastructuredevelopment.

1. Initiate a land market assessment in theChennai metro area and select towns toidentify an inventory of publicly owned land.

2. Complete a through review of real estateand land development regulations(regulatory audit).

3. Identify needed reforms.

4. Prepare report on the results of theassessments.

5. Hold series of meetings with governmentand private sector stakeholders on theresults.

6. Follow up support to assist governmentand private sector to implement reforms.

7. Monitor implementation of reforms andassess and evaluate their effects.

Streamlining regulations of entryand operation

1. Work with private sector representatives inthe construction and real estate business toreview problems in entry regulations.

2. Develop an action plan to ease entryregulations.

3. Identify clearance delays if any.

4. Complete the ongoing exercise of reformsto consolidate 53 returns/registers into onecommon form.


96

5. Extend the simplified entry approvalsystem for large investment projects(Rs.250 million) to cover small andmedium projects as well.

Scaling up private sector involvementin infrastructure service deliveryThe government has announced plans toestablish an Infrastructure Development Boardand an infrastructure fund of Rs.200 crore in the2003 Industrial Policy. A InfrastructureDevelopment Enabling legislation is beingprepared. All of them aim to scale up public andprivate partnership in the development ofinfrastructure. In going forward, key issues thegovernment may consider are:

1. Reduce dependence on national and statebudgets by promoting access of UrbanLocal Bodies, utilities and governmentagencies to adequate and sustainablesources of infrastructure finance.

2. Strengthen creditworthiness of local bodiesand state utilities for accessing privatecapital by providing selective creditenhancement where required to enablethem to set a track record for futureborrowings.

3. Develop financing mechanisms withtargeted use of state governmentcontribution and guarantees and link

municipal financing with domestic capitalmarkets.

4. Choose and select projects which best fitstate/local priorities for economicdevelopment and have sound economic value.

In order to mobilize financing in a robust PPPframework, the following essentials would needfocus:

1. Develop an appropriate and comprehensiveregulatory environment which establishesrules of the game for PPP and Private Sectorparticipation; determining service ownership,developing legal framework for concessions,contract enforcement, bankruptcy and lenderremedies.

2. Bring about financial discipline andenhance revenues through, depoliticisingtariffs/user charges, implementing overallcost recovery and creating dependableinfrastructure revenue streams.

3. Link state transfers to performancebenchmarking for ULBs and utilities.

4. Build and enhance capacity in local bodiesfor project design and structuring, projectevaluation, contracting and implementation,financial planning, budgeting, and strategicplanning.

Annex 3: Reforms to improve the Investment Climate

97

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10.0

5.

0 7.

1 15

.4

15.3

12

.4

8.0

7.8

Pow

er S

ubsi

dy

1.8

4.3

3.6

4.0

5.1

3.5

3.8

3.6

3.3

2.5

0.9

3.2

22.1

0.

0 0.

0H

ydel

Sw

ing

Subs

idy

0.0

2.5

1.3

Oth

ers

1.4

2.1

2.5

2.5

2.3

3.1

3.2

3.4

5.6

4.0

5.1

3.5

2.8

6.5

7.3

Tran

sfer

s 9.

0 11

.2

13.8

13

.8

12.8

14

.0

18.5

23

.8

24.7

26

.1

26.1

22

.2

36.5

47

.1

39.3

o/w

Com

pens

atio

n to

1.

1 2.

0 2.

9 1.

3 1.

3 2.

1 3.

1 7.

9 10

.2

10.2

9.

7 7.

2 15

.6

14.8

14

.3Lo

cal b

odie

s C

apit

al O

utla

y 2.

3 3.

6 4.

0 6.

3 4.

8 5.

9 9.

4 12

.1

16.3

20

.1

24.6

24

.1

20.5

21

.8

33.3

Net

Len

ding

3.

5 2.

2 2.

8 1.

2 6.

7 3.

5 4.

2 0.

0 1.

9 3.

4 0.

9 2.

2 2.

6 4.

4 2.

5

TN

Prim

ary

Surp

lus (

+)/ d

efic

it (-)

-6.4

-7

.7

-10.

9 -4

.3

-3.5

1.

2 -8

.6

-5.8

-2

7.8

-31.

6 -2

5.0

-16.

5 -2

8.6

5.4

-16.

9In

tere

st P

aym

ents

4.

8 5.

9 7.

3 10

.0

11.5

13

.8

15.9

17

.6

21.2

27

.1

30.9

35

.1

41.1

47

.0

52.3

Go

TN

Rev

enue

-5

.4

-7.9

-1

1.3

-6.8

-3

.5

-3.2

-1

0.9

-11.

3 -3

0.8

-35.

2 -3

0.3

-25.

3 -4

6.5

-15.

4 -3

3.4

Surp

lus

(+)/

Def

icit

(-)

Go

TN

Fis

cal

-11.

2 -1

3.7

-18.

2 -1

4.3

-15.

0 -1

2.6

-24.

5 -2

3.4

-49.

0 -5

8.7

-55.

8 -5

1.6

-69.

7 -4

1.5

-69.

2Su

rplu

s (+

)/D

efic

it(-

)

FFiiss

ccaall

DDaattaa

AAnnnneexx

1.1

(a):

Fis

cal S

umm

ary

99


100

MA

RC

H

1990

/91

1991

/92

1992

/93

1993

/94

1994

/95

1995

/96

1996

/97

1997

/98

1998

/99

1999

/00

2000

/01

2001

/02

2002

/03

2003

/04*

20

04/0

5B

EM

emo

Item

sP

OW

ER

SE

CT

OR

Rev

enue

(Exc

l. Po

wer

Sub

sidy)

(1)

14.5

16

.8

21.2

26

.3

35.1

41

.3

44.9

53

.1

56.8

64

.8

75.8

82

.2

94.6

11

6.1

123.

0C

ash

Ope

rati

ng E

xpen

ditu

re

15.4

15

.0

19.6

25

.0

29.9

36

.0

40.0

47

.6

54.9

67

.6

76.6

94

.3

100.

0 10

9.7

112.

5(e

xcl.

Dep

reci

atio

n) (

2)

Ear

ning

bef

ore

Int,

Dep

rn,

-0.9

1.

8 1.

6 1.

4 5.

1 5.

3 4.

9 5.

5 2.

0 -2

.9

-0.9

-1

2.1

-5.4

6.

3 10

.5Ta

x &

App

ropr

n (E

BID

TA

)(3)

= (1

)-(2

)In

tere

st (

4)

2.3

1.7

2.7

3.0

3.4

3.8

4.2

4.7

4.9

5.8

6.4

6.5

7.2

8.0

8.9

Taxa

tion

(5)

0.

0 0.

0 0.

0 0.

0 0.

0 0.

0 0.

0 0.

0 0.

0 0.

0 0.

0 0.

0 0.

0 0.

0 0.

0N

et L

oss/

Prof

it (

excl

. Dep

rn)

-3.2

0.

1 -1

.1

-1.6

1.

7 1.

5 0.

6 0.

9 -2

.9

-8.7

-7

.3

-18.

5 -1

2.5

-1.7

1.

6be

fore

Sub

sidy

(-/

+) (

6)

Cap

ital

Out

lay

(7)

6.2

6.6

3.7

11.3

9.

9 12

.2

10.3

9.

4 11

.4

12.0

16

.7

11.3

13

.9

14.8

16

.0O

vera

ll Fi

nanc

ing

Req

uire

men

t 9.

4 6.

4 4.

9 12

.9

8.2

10.7

9.

7 8.

5 14

.3

20.7

24

.0

29.8

26

.4

16.5

14

.4be

fore

Sub

sidy

(+/

-) (

8)

CO

NSO

LID

ATED

AC

CO

UN

TS

Rev

enue

s 64

.8

76.3

89

.3

104.

4 12

4.4

144.

3 16

1.2

185.

9 19

6.4

223.

5 25

3.9

264.

5 29

7.8

347.

9 36

6.1

Tota

l Exp

endi

ture

s 81

.4

90.8

10

7.5

126.

2 13

8.4

162.

4 18

9.7

208.

5 25

7.6

308.

3 33

5.8

342.

5 37

2.3

402.

3 44

9.9

Rev

enue

Exp

endi

ture

71

.7

79.8

98

.1

108.

9 12

1.0

142.

4 16

7.7

192.

8 22

6.8

264.

8 29

0.6

305.

1 33

4.8

365.

0 39

8.0

Cap

ital O

utlay

and

Net

Len

ding

9.

7 11

.0

9.4

17.4

17

.3

20.0

22

.0

15.7

30

.8

43.5

45

.2

37.3

37

.6

37.3

51

.9C

onso

lidat

ed R

even

ue

-6.8

-3

.5

-8.8

-4

.4

3.4

1.8

-6.4

-6

.8

-30.

4 -4

1.4

-36.

7 -4

0.6

-36.

9 -1

7.1

-31.

8Su

rplu

s (+

) /

Def

icit

(-)

Con

solid

ated

Sur

plus

(+)

/

-16.

5 -1

4.5

-18.

2 -2

1.8

-14.

0 -1

8.2

-28.

5 -2

2.5

-61.

2 -8

4.9

-81.

9 -7

7.9

-74.

5 -5

4.0

-83.

7D

efic

it (

-) (

9)=

(1)-

(8)+

(11)

Gro

ss B

orro

win

g R

equi

rem

ent

-18.

7 -1

6.9

-21.

1 -2

4.9

-16.

6 -2

1.0

-32.

0 -2

6.8

-66.

9 -9

1.5

-89.

8 -8

9.4

-97.

9 -9

0.2

-115

.1G

oTN

Fis

cal D

efic

it (

10)

-11.

2 -1

3.7

-18.

2 -1

4.3

-15.

0 -1

2.6

-24.

5 -2

3.4

-49.

0 -5

8.7

-55.

8 -5

1.6

-69.

7 -4

1.5

-69.

2o/

w G

ross

Bud

geta

ry

4.1

5.6

4.8

5.4

9.2

5.2

5.7

9.3

2.1

-5.5

-2

.1

3.5

21.6

3.

6 -0

.1Su

ppor

t to

Pow

er (

11)

Pow

er S

ubsi

dy

1.8

4.3

3.6

4.0

5.1

3.5

3.8

3.6

3.3

2.5

0.9

3.2

22.1

0.

0 0.

0C

apita

l Out

lay &

Net

Len

ding

2.4

1.3

1.2

1.4

4.1

1.6

1.9

5.7

-1.2

-8

.0

-3.0

0.

3 -0

.5

3.6

-0.1

Non

- Po

wer

Defi

cits (

12) =

(10)

+ (1

1)

-7.1

-8

.1

-13.

3 -8

.9

-5.8

-7

.4

-18.

8 -1

4.1

-46.

9 -6

4.2

-57.

9 -4

8.1

-48.

0 -3

7.9

-69.

3D

ebt

Stoc

k of

GoT

N

57.3

67

.8

80.0

95

.1

114.

2 12

8.5

145.

5 16

8.4

204.

8 25

9.7

313.

3 35

6.7

433.

0 47

4.5

555.

3G

uara

ntee

s 26

.2

29.3

17

.4

34.0

39

.3

48.0

50

.2

53.3

51

.6

72.1

96

.2

87.9

91

.9

108.

2 90

.0G

oTN

Deb

t an

d G

uara

ntee

s 83

.5

97.1

97

.3

129.

0 15

3.4

176.

4 19

5.7

221.

6 25

6.4

331.

9 40

9.6

444.

6 52

4.9

582.

7 64

5.3

* Po

wer

Sec

tor

Num

bers

for

200

3/04

are

for

ecas

ts f

rom

the

bus

ines

s pl

an. I

n 20

03/0

4 th

e ac

tual

con

solid

ated

fis

cal a

nd r

even

ue d

efic

it a

re h

ighe

r by

Rs.

10

bn a

ccor

ding

to

the

Gov

ernm

ent.

Sinc

e de

tails

are

not

avai

labl

e th

is h

as n

ot b

een

inco

rpor

ated

into

thi

s ta

ble.

The

act

ual c

onso

lidat

ed f

isca

l def

icit

in 2

003/

04 is

3.8

% o

f G

SDP.

1.1

(a):

Fis

cal S

umm

ary

(con

tinu

ed)

Fiscal Data Annex

101

MA

RC

H

1990

/91

1991

/92

1992

/93

1993

/94

1994

/95

1995

/96

1996

/97

1997

/98

1998

/99

1999

/00

2000

/01

2001

/02

2002

/03

2003

/04*

20

04/0

5B

E

(As a

Per

cent

of G

SDP)

STAT

E G

OV

ER

NM

EN

TR

even

ue

16.1

%

16.3

%

16.0

%

13.7

%

13.2

%

13.3

%

13.2

%

13.0

%

11.9

%

12.7

%

12.8

%

12.5

%

13.3

%

13.7

%

13.7

%St

ate'

s O

wn

Rev

enue

s 11

.0%

11

.1%

10

.8%

9.

3%

9.4%

10

.0%

9.

7%

9.3%

9.

0%

9.5%

9.

7%

9.6%

10

.3%

10

.4%

10

.6%

Tax

10.0

%

10.1

%

9.7%

8.

4%

8.5%

9.

1%

8.9%

8.

4%

8.1%

8.

6%

8.7%

8.

8%

9.3%

9.

4%

9.7%

Non

- Tax

1.

1%

1.0%

1.

1%

0.9%

0.

9%

0.9%

0.

8%

1.0%

0.

9%

0.9%

1.

0%

0.8%

1.

0%

1.1%

0.

9%C

entr

al T

axes

5.

0%

5.2%

5.

2%

4.5%

3.

8%

3.3%

3.

5%

3.6%

2.

9%

3.2%

3.

1%

2.9%

3.

0%

3.3%

3.

0%Sh

ared

Tax

es

3.2%

3.

2%

3.3%

2.

7%

2.5%

2.

3%

2.4%

2.

6%

2.0%

2.

1%

2.0%

1.

9%

2.0%

2.

1%

2.1%

Gra

nts

1.8%

2.

0%

1.9%

1.

8%

1.3%

1.

0%

1.0%

1.

0%

0.9%

1.

1%

1.1%

0.

9%

1.0%

1.

2%

1.0%

Non

- In

tere

st E

xpen

ditu

res

18.1

%

18.4

%

18.5

%

14.5

%

13.7

%

13.2

%

14.1

%

13.5

%

14.3

%

15.2

%

14.6

%

13.6

%

15.2

%

13.4

%

14.6

%Sa

lari

es (

incl

GIA

for

edu

cati

on)

7.5%

7.

0%

6.7%

5.

6%

5.3%

5.

3%

5.4%

5.

4%

6.3%

6.

5%

5.8%

5.

6%

5.2%

4.

7%

5.3%

Pens

ions

& R

etir

emen

t B

enef

its

1.1%

1.

2%

1.3%

1.

0%

0.9%

1.

0%

1.2%

1.

2%

1.4%

2.

2%

2.1%

2.

1%

2.2%

1.

9%

2.6%

o/w

Pen

sion

s 1.

1%

1.2%

1.

1%

0.9%

0.

8%

0.9%

1.

0%

1.1%

1.

2%

2.1%

1.

9%

1.6%

1.

7%

1.6%

1.

9%N

on-

Wag

e O

& M

2.

9%

2.9%

2.

7%

2.2%

2.

1%

1.9%

1.

9%

1.8%

1.

6%

1.4%

1.

3%

1.1%

1.

4%

1.5%

1.

6%O

ther

Rev

enue

Exp

endi

ture

s 0.

0%

0.0%

0.

0%

0.0%

0.

0%

0.0%

0.

0%

0.0%

0.

0%

0.0%

0.

0%

0.0%

0.

0%

0.0%

0.

0%Su

bsid

ies

and

Tran

sfer

s 4.

7%

5.8%

6.

3%

4.3%

3.

7%

3.7%

4.

1%

4.0%

3.

4%

3.2%

3.

5%

3.0%

4.

9%

3.8%

3.

2%Su

bsid

ies

1.8%

2.

7%

3.1%

1.

9%

1.9%

1.

9%

2.0%

1.

7%

1.3%

1.

1%

1.6%

1.

5%

2.5%

1.

1%

1.0%

Food

Sub

sidy

0.

8%

1.0%

1.

6%

0.7%

0.

7%

1.0%

1.

1%

1.0%

0.

4%

0.6%

1.

1%

1.0%

0.

8%

0.5%

0.

4%Po

wer

Sub

sidy

0.

6%

1.1%

0.

8%

0.7%

0.

7%

0.5%

0.

4%

0.3%

0.

3%

0.2%

0.

1%

0.2%

1.

4%

0.0%

0.

0%H

ydel

Sw

ing

Subs

idy

0.0%

0.

0%

0.0%

0.

0%

0.0%

0.

0%

0.0%

0.

0%

0.0%

0.

0%

0.0%

0.

0%

0.0%

0.

1%

0.1%

Oth

ers

0.4%

0.

6%

0.6%

0.

4%

0.3%

0.

4%

0.4%

0.

3%

0.5%

0.

3%

0.4%

0.

2%

0.2%

0.

4%

0.4%

Tran

sfer

s 2.

9%

3.0%

3.

2%

2.4%

1.

9%

1.8%

2.

1%

2.3%

2.

1%

2.1%

1.

9%

1.5%

2.

4%

2.8%

2.

2%o/

w C

ompe

nsati

on to

Loc

al bo

dies

0.3%

0.

5%

0.7%

0.

2%

0.2%

0.

3%

0.3%

0.

8%

0.9%

0.

8%

0.7%

0.

5%

1.0%

0.

9%

0.8%

Cap

ital

Out

lay

0.7%

1.

0%

0.9%

1.

1%

0.7%

0.

8%

1.0%

1.

2%

1.4%

1.

6%

1.7%

1.

6%

1.3%

1.

3%

1.9%

Net

Len

ding

1.

1%

0.6%

0.

7%

0.2%

1.

0%

0.5%

0.

5%

0.0%

0.

2%

0.3%

0.

1%

0.1%

0.

2%

0.3%

0.

1%

TN

Prim

ary

Surp

lus (

+)/ d

efic

it (-

)-2

.0%

-2

.1%

-2

.5%

-0

.7%

-0

.5%

0.

2%

-1.0

%

-0.6

%

-2.3

%

-2.5

%

-1.8

%

-1.1

%

-1.9

%

0.3%

-0

.9%

Inte

rest

Pay

men

ts

1.5%

1.

6%

1.7%

1.

7%

1.7%

1.

8%

1.8%

1.

7%

1.8%

2.

1%

2.2%

2.

4%

2.7%

2.

8%

2.9%

Go

TN

Rev

enue

Sur

plus

(+)/D

efici

t(-)

-1.7

%

-2.1

%

-2.6

%

-1.2

%

-0.5

%

-0.4

%

-1.2

%

-1.1

%

-2.6

%

-2.8

%

-2.1

%

-1.7

%

-3.0

%

-0.9

%

-1.9

%

Go

TN

Fisc

al S

urpl

us (+

)/D

efic

it(-)

-3.6

%

-3.7

%

-4.2

%

-2.5

%

-2.2

%

-1.6

%

-2.7

%

-2.3

%

-4.1

%

-4.6

%

-4.0

%

-3.5

%

-4.5

%

-2.4

%

-3.9

%

GSD

P (

Rs.

bill

ion)

313.

4 36

9.6

430.

1 57

4.8

687.

5 78

4.9

894.

9 10

35.5

11

82.8

12

65.0

14

11.5

14

85.9

15

37.3

17

05.3

17

93.1

1.1

(b):

Fis

cal S

umm

ary

(% G

SDP

)


102

MA

RC

H

1990

/91

1991

/92

1992

/93

1993

/94

1994

/95

1995

/96

1996

/97

1997

/98

1998

/99

1999

/00

2000

/01

2001

/02

2002

/03

2003

/04*

200

4/05

Mem

o It

ems

PO

WE

R S

EC

TO

RR

even

ue (

Exc

l. Po

wer

Sub

sidy

) (1

) 4.

6%

4.5%

4.

9%

4.6%

5.

1%

5.3%

5.

0%

5.1%

4.

8%

5.1%

5.

4%

5.5%

6.

2%

6.8%

6.

9%C

ash

Ope

rati

ng E

xpen

ditu

re

4.9%

4.

0%

4.6%

4.

3%

4.4%

4.

6%

4.5%

4.

6%

4.6%

5.

3%

5.4%

6.

3%

6.5%

6.

4%

6.3%

(exc

l. D

epre

ciat

ion)

(2)

E

arni

ng b

efor

e In

t, D

eprn

, -0

.3%

0.

5%

0.4%

0.

2%

0.7%

0.

7%

0.5%

0.

5%

0.2%

-0

.2%

-0

.1%

-0

.8%

-0

.3%

0.

4%

0.6%

Tax

& A

ppro

prn

(EB

IDT

A)

(1)-

(2)

Inte

rest

(4)

0.

7%

0.5%

0.

6%

0.5%

0.

5%

0.5%

0.

5%

0.4%

0.

4%

0.5%

0.

5%

0.4%

0.

5%

0.5%

0.

5%Ta

xati

on (

5)

0.0%

0.

0%

0.0%

0.

0%

0.0%

0.

0%

0.0%

0.

0%

0.0%

0.

0%

0.0%

0.

0%

0.0%

0.

0%

0.0%

Net

Los

s/Pr

ofit

(ex

cl. D

eprn

) -1

.0%

0.

0%

-0.3

%

-0.3

%

0.3%

0.

2%

0.1%

0.

1%

-0.2

%

-0.7

%

-0.5

%

-1.2

%

-0.8

%

-0.1

%

0.1%

befo

re S

ubsi

dy (

-/+)

(6)

Cap

ital

Out

lay

(7)

2.0%

1.

8%

0.9%

2.

0%

1.4%

1.

6%

1.2%

0.

9%

1.0%

0.

9%

1.2%

0.

8%

0.9%

0.

9%

0.9%

Ove

rall

Fina

ncin

g R

equi

rem

ent

3.0%

1.

7%

1.1%

2.

3%

1.2%

1.

4%

1.1%

0.

8%

1.2%

1.

6%

1.7%

2.

0%

1.7%

1.

0%

0.8%

befo

re S

ubsi

dy (

+/-)

(8)

CO

NSO

LID

ATE

D A

CC

OU

NT

S

Rev

enue

s 20

.7%

20

.6%

20

.8%

18

.2%

18

.1%

18

.4%

18

.0%

18

.0%

16

.6%

17

.7%

18

.0%

17

.8%

19

.4%

20

.4%

20

.4%

Tota

l Exp

endi

ture

s 26

.0%

24

.6%

25

.0%

22

.0%

20

.1%

20

.7%

21

.2%

20

.1%

21

.8%

24

.4%

23

.8%

23

.1%

24

.2%

23

.6%

25

.1%

Rev

enue

Exp

endi

ture

22

.9%

21

.6%

22

.8%

18

.9%

17

.6%

18

.1%

18

.7%

18

.6%

19

.2%

20

.9%

20

.6%

20

.5%

21

.8%

21

.4%

22

.2%

Cap

ital O

utla

y an

d N

et L

endi

ng

3.1%

3.

0%

2.2%

3.

0%

2.5%

2.

5%

2.5%

1.

5%

2.6%

3.

4%

3.2%

2.

5%

2.4%

2.

2%

2.9%

Con

solid

ate

Rev

enue

-2

.2%

-0

.9%

-2

.0%

-0

.8%

0.

5%

0.2%

-0

.7%

-0

.7%

-2

.6%

-3

.3%

-2

.6%

-2

.7%

-2

.4%

-1

.0%

-1

.8%

Surp

lus

(+)

/ D

efic

it (

-)C

onso

lidat

ed S

urpl

us (

+)/

-5.3

%

-3.9

%

-4.2

%

-3.8

%

-2.0

%

-2.3

%

-3.2

%

-2.2

%

-5.2

%

-6.7

%

-5.8

%

-5.2

%

-4.8

%

-3.2

%

-4.7

%D

efic

it (

-) (

9) =

(1)

-(8)

+(11

)G

ross

Bor

row

ing

Req

uire

men

t -6

.0%

-4

.6%

-4

.9%

-4

.3%

-2

.4%

-2

.7%

-3

.6%

-2

.6%

-5

.7%

-7

.2%

-6

.4%

-6

.0%

-6

.4%

-5

.3%

-6

.4%

GoT

N F

isca

l Def

icit

(10

) -3

.6%

-3

.7%

-4

.2%

-2

.5%

-2

.2%

-1

.6%

-2

.7%

-2

.3%

-4

.1%

-4

.6%

-4

.0%

-3

.5%

-4

.5%

-2

.4%

-3

.9%

o/w

Gro

ss B

udge

tary

1.

3%

1.5%

1.

1%

0.9%

1.

3%

0.7%

0.

6%

0.9%

0.

2%

-0.4

%

-0.1

%

0.2%

1.

4%

0.2%

0.

0%Su

ppor

t to

Pow

er (

11)

Pow

er S

ubsi

dy

0.6%

1.

1%

0.8%

0.

7%

0.7%

0.

5%

0.4%

0.

3%

0.3%

0.

2%

0.1%

0.

2%

1.4%

0.

0%

0.0%

Cap

ital O

utla

y &

Net

Len

ding

0.

7%

0.4%

0.

3%

0.3%

0.

6%

0.2%

0.

2%

0.6%

-0

.1%

-0

.6%

-0

.2%

0.

0%

0.0%

0.

2%

0.0%

Non

- Po

wer

Def

icits

(12)

= (1

0) +

(11)

-2.3

%

-2.2

%

-3.1

%

-1.5

%

-0.8

%

-0.9

%

-2.1

%

-1.4

%

-4.0

%

-5.1

%

-4.1

%

-3.2

%

-3.1

%

-2.2

%

-3.9

%D

ebt

Stoc

k of

GoT

N

18.3

%

18.4

%

18.6

%

16.5

%

16.6

%

16.4

%

16.3

%

16.3

%

17.3

%

20.5

%

22.2

%

24.0

%

28.2

%

27.8

%

31.0

%G

uara

ntee

s 8.

4%

7.9%

4.

0%

5.9%

5.

7%

6.1%

5.

6%

5.1%

4.

4%

5.7%

6.

8%

5.9%

6.

0%

6.3%

5.

0%G

oTN

Deb

t an

d G

uara

ntee

s 26

.6%

26

.3%

22

.6%

22

.4%

22

.3%

22

.5%

21

.9%

21

.4%

21

.7%

26

.2%

29

.0%

29

.9%

34

.1%

34

.2%

36

.0%

* Po

wer

Sec

tor

Num

bers

for

2003

/04

are

fore

cast

s fr

om t

he b

usin

ess

plan

. In

2003

/04

the

actu

al c

onso

lidat

ed fi

scal

and

rev

enue

def

icit

are

hig

her

by R

s. 1

0 bn

acc

ordi

ng t

o th

e G

over

nmen

t. Si

nce

deta

ils a

reno

t av

aila

ble

this

has

not

bee

n in

corp

orat

ed in

to t

his

tabl

e. T

he a

ctua

l con

solid

ated

fis

cal d

efic

it in

200

3/20

04 is

3.8

% o

f G

SDP.

1.1

(b):

Fis

cal S

umm

ary

(% G

SDP

) (c

onti

nued

)

ProjectionsMARCH 2002/03 2003/04* 2004/05 2005/06 2006/07 2007/08 2008/09

Accounts Accounts

Rupees Billion in current prices

STATE GOVERNMENT

Revenue 204.6 234.1 240.4 266.1 291.0 318.9 349.4

State's Own Revenues 158.2 177.5 185.9 202.8 222.3 244.3 268.4

Tax 143.4 159.4 171.6 187.9 206.1 227.3 250.8

Non- Tax 14.8 18.0 14.3 14.9 16.2 17.0 17.6

Central Taxes 46.3 56.7 54.5 63.3 68.7 74.6 81.1

Shared Taxes 30.5 35.4 37.1 44.1 47.6 51.4 55.5

Grants 15.9 21.2 17.4 19.2 21.1 23.2 25.5

Non- Interest Expenditures 233.1 228.7 255.3 272.5 285.2 306.5 326.3

Salaries (incl GIA for education) 79.8 79.6 91.5 96.1 100.6 104.9 110.3

Pensions & Retirement Benefits 33.4 32.9 45.2 52.1 53.3 58.6 62.9

Non- Wage O & M 21.4 24.8 27.4 29.1 31.0 33.7 37.1

Other Revenue Expenditures 0.2 0.6 0.3 0.3 0.3 0.3 0.6

Subsidies and Transfers 75.1 65.2 57.3 59.4 57.2 59.1 61.3

Subsidies 38.6 18.6 15.9 15.3 14.7 14.2 14.2

Food Subsidy 12.4 8.0 7.7 7.4 7.1 6.8 6.8

Power Subsidy 22.1 0.0 0.0 0.0 0.0 0.0 0.0

Hydel Swing Subsidy 0.0 2.5 1.3 1.3 1.3 1.3 1.3

Others 2.8 6.5 7.0 6.7 6.4 6.1 6.1

Transfers 36.5 47.1 41.4 44.1 42.5 44.9 47.1

o/w Compensation to Local bodies 15.6 14.8 17.2 18.0 19.0 20.7 22.6

Capital Outlay 20.5 21.8 29.5 32.8 39.0 46.5 50.5

Net Lending 2.6 4.4 4.2 2.7 3.8 3.3 3.5

TN Primary Surplus (+)/ deficit (-) -28.6 5.4 -14.9 -6.4 5.8 12.5 23.1

Interest Payments 41.1 47.0 52.7 58.0 64.3 70.7 76.7

Go TN Revenue Surplus (+)/Deficit(-) -46.5 -15.4 -33.9 -29.0 -15.7 -8.5 0.4

Go TN Fiscal Surplus (+)/Deficit(-) -69.7 -41.5 -67.6 -64.4 -58.5 -58.2 -53.6

Memo ItemsPOWER SECTOR

Revenue (Excl. Power Subsidy) (1) 94.6 116.1 123.0 137.3 151.8 179.0 197.0

Cash Operating Expenditure (excl. Depreciation) (2) 100.0 109.7 112.5 124.5 138.1 154.0 170.8

Earning before Int, Deprn, = (1)-(2) -5.4 6.3 10.5 12.8 13.8 25.0 26.1Tax & Approprn (EBIDTA) (3)

Interest (4) 7.2 8.0 8.9 9.2 9.2 9.0 8.8

Taxation (5) 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Net Loss/Profit (excl. Deprn) before Subsidy (-/+) (6) -12.5 -1.7 1.6 3.6 4.6 16.0 17.3

Capital Outlay (7) 13.9 14.8 16.0 15.3 12.3 18.0 18.0

Overall Financing Requirement before Subsidy (+/-) (8) 26.4 16.5 14.4 11.7 7.6 2.0 0.7

Fiscal Data Annex

103

1.2 (a): First Medium Term Fiscal Policy


104


Accounts Accounts

CONSOLIDATED ACCOUNTS

Revenues 297.8 347.9 361.2 401.0 440.3 495.3 543.6

Total Expenditures 372.3 402.3 440.6 474.6 504.0 553.2 596.6

Revenue Expenditure 334.8 365.0 393.5 426.4 451.4 487.8 525.8

Capital Outlay and Net Lending 37.6 37.3 47.1 48.2 52.6 65.4 70.8

Consolidate Revenue Surplus (+) / Deficit (-) -36.9 -17.1 -32.4 -25.4 -11.1 7.5 17.7

Consolidated Surplus (+)/ Deficit (-) (9)= (1)-(8)+(11) -74.5 -54.0 -79.4 -73.5 -63.7 -57.9 -53.0

Gross Borrowing Requirement -97.9 -90.2 -124.9 -93.2 -81.0 -78.7 -75.1

GoTN Fiscal Deficit (10) -69.7 -41.5 -67.6 -64.4 -58.5 -58.2 -53.6

o/w Gross Budgetary Support to Power (11) 21.6 3.6 2.7 2.6 2.5 2.4 1.3

Power Subsidy 22.1 0.0 0.0 0.0 0.0 0.0 0.0

Capital Outlay & Net Lending -0.5 3.6 2.7 2.6 2.5 2.4 1.3

Non - Power Deficits (12) = (10) + (11) -48.0 -37.9 -65.0 -61.9 -56.0 -55.9 -52.3

Debt Stock of GoTN 433.0 474.5 542.3 595.2 648.9 707.1 760.7

Guarantees 91.9 108.2 94.2 99.2 104.2 109.2 114.2

GoTN Debt and Guarantees 524.9 582.7 636.5 694.4 753.1 816.3 874.9

* Power Sector Numbers for 2003/04 are forecasts from the business plan. In 2003/04 the actual consolidated fiscal and revenue deficitare higher by Rs. 10 bn according to the Government. Since details are not available this has not been incorporated into this table.The actual consolidated fiscal deficit in 2003/04 is 3.8% of GSDP.

1.2 (a): First Medium Term Fiscal Policy (continued)

Fiscal Data Annex

105


Accounts Accounts

(As a Percent of GSDP)

STATE GOVERNMENT

Revenue 13.3% 13.7% 13.4% 13.7% 13.7% 13.7% 13.7%

State's Own Revenues 10.3% 10.4% 10.4% 10.4% 10.5% 10.5% 10.6%

Tax 9.3% 9.4% 9.6% 9.7% 9.7% 9.8% 9.9%

Non- Tax 1.0% 1.1% 0.8% 0.8% 0.8% 0.7% 0.7%

Central Taxes 3.0% 3.3% 3.0% 3.3% 3.2% 3.2% 3.2%

Shared Taxes 2.0% 2.1% 2.1% 2.3% 2.2% 2.2% 2.2%

Grants 1.0% 1.2% 1.0% 1.0% 1.0% 1.0% 1.0%

Non- Interest Expenditures 15.2% 13.4% 14.2% 14.0% 13.4% 13.2% 12.8%

Salaries (incl GIA for education) 5.2% 4.7% 5.1% 4.9% 4.7% 4.5% 4.3%

Pensions & Retirement Benefits 2.2% 1.9% 2.5% 2.7% 2.5% 2.5% 2.5%

Non- Wage O & M 1.4% 1.5% 1.5% 1.5% 1.5% 1.5% 1.5%

Other Revenue Expenditures 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Subsidies and Transfers 4.9% 3.8% 3.2% 3.1% 2.7% 2.5% 2.4%

Subsidies 2.5% 1.1% 0.9% 0.8% 0.7% 0.6% 0.6%

Food Subsidy 0.8% 0.5% 0.4% 0.4% 0.3% 0.3% 0.3%

Power Subsidy 1.4% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Hydel Swing Subsidy 0.0% 0.1% 0.1% 0.1% 0.1% 0.1% 0.0%

Others 0.2% 0.4% 0.4% 0.3% 0.3% 0.3% 0.2%

Transfers 2.4% 2.8% 2.3% 2.3% 2.0% 1.9% 1.9%

o/w Compensation to Local bodies 1.0% 0.9% 1.0% 0.9% 0.9% 0.9% 0.9%

Capital Outlay 1.3% 1.3% 1.6% 1.7% 1.8% 2.0% 2.0%

Net Lending 0.2% 0.3% 0.2% 0.1% 0.2% 0.1% 0.1%

TN Primary Surplus (+)/ deficit (-) -1.9% 0.3% -0.8% -0.3% 0.3% 0.5% 0.9%

Interest Payments 2.7% 2.8% 2.9% 3.0% 3.0% 3.0% 3.0%

Go TN Revenue Surplus (+)/Deficit(-) -3.0% -0.9% -1.9% -1.5% -0.7% -0.4% 0.0%

Go TN Fiscal Surplus (+)/Deficit(-) -4.5% -2.4% -3.8% -3.3% -2.8% -2.5% -2.1%

GSDP (Rs. billion) 1537.3 1705.3 1793.1 1945.5 2120.6 2322.1 2542.7

Memo ItemsPOWER SECTOR

Revenue (Excl. Power Subsidy) (1) 6.2% 6.8% 6.9% 7.1% 7.2% 7.7% 7.7%

Cash Operating Expenditure 6.5% 6.4% 6.3% 6.4% 6.5% 6.6% 6.7%(excl. Depreciation) (2)

Earning before Int, Deprn, Tax & -0.3% 0.4% 0.6% 0.7% 0.7% 1.1% 1.0%Approprn (EBIDTA) (1)-(2)

Interest (4) 0.5% 0.5% 0.5% 0.5% 0.4% 0.4% 0.3%

Taxation (5) 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Net Loss/Profit (excl. Deprn) before Subsidy (-/+) (6) -0.8% -0.1% 0.1% 0.2% 0.2% 0.7% 0.7%

Capital Outlay (7) 0.9% 0.9% 0.9% 0.8% 0.6% 0.8% 0.7%

Overall Financing Requirement 1.7% 1.0% 0.8% 0.6% 0.4% 0.1% 0.0%before Subsidy (+/-) (8)

1.2 (b): First Medium Term Fiscal Policy (% GSDP)


106


Accounts Accounts

CONSOLIDATED ACCOUNTS

Revenues 19.4% 20.4% 20.1% 20.6% 20.8% 21.3% 21.4%

Total Expenditures 24.2% 23.6% 24.6% 24.4% 23.8% 23.8% 23.5%

Revenue Expenditure 21.8% 21.4% 21.9% 21.9% 21.3% 21.0% 20.7%

Capital Outlay and Net Lending 2.4% 2.2% 2.6% 2.5% 2.5% 2.8% 2.8%

Consolidate Revenue Surplus (+) / Deficit (-) -2.4% -1.0% -1.8% -1.3% -0.5% 0.3% 0.7%

Consolidated Surplus (+)/ Deficit (-) (9)= (1)-(8)+(11) -4.8% -3.2% -4.4% -3.8% -3.0% -2.5% -2.1%

Gross Borrowing Requirement -6.4% -5.3% -7.0% -4.8% -3.8% -3.4% -3.0%

GoTN Fiscal Deficit (10) -4.5% -2.4% -3.8% -3.3% -2.8% -2.5% -2.1%o/w Gross Budgetary Support to Power (11) 1.4% 0.2% 0.1% 0.1% 0.1% 0.1% 0.1%

Power Subsidy 1.4% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Capital Outlay & Net Lending 0.0% 0.2% 0.1% 0.1% 0.1% 0.1% 0.1%

Non - Power Deficits (12) = (10) + (11) -3.1% -2.2% -3.6% -3.2% -2.6% -2.4% -2.1%

Debt Stock of GoTN 28.2% 27.8% 30.2% 30.6% 30.6% 30.5% 29.9%

Guarantees 6.0% 6.3% 5.3% 5.1% 4.9% 4.7% 4.5%

GoTN Debt and Guarantees 34.1% 34.2% 35.5% 35.7% 35.5% 35.2% 34.4%

* Power Sector Numbers for 2003/04 are forecasts from the business plan. In 2003/04 the actual consolidated fiscal and revenue deficitare higher by Rs. 10 bn according to the Government. Since details are not available this has not been incorporated into this table.The actual consolidated fiscal deficit in 2003/04 is 3.8% of GSDP.

1.2 (b): First Medium Term Fiscal Policy (% GSDP) (Contd...)

Deaton, A., 2003, Regional Poverty Estimates forIndia, mimeo, Research Program inDevelopment Studies, Princeton University.

Deaton, A. and Drèze, J.P., 2002, Poverty andInequality in India: A Re-examination'Economic and Political Weekly.

Deaton, A. and A. Tarozzi (2000) 'Prices andPoverty in India', mimeo, Research Program inDevelopment Studies, Princeton University.

Ferro, Manuela, David Rosenblatt, NicholasStern, 2004, Policies for pro-poor growth. inIndia, in Basu, K. (ed.) India's EmergingEconomy, MIT Press.

Filmer, D. and Pritchett, L. (1999) 'EducationalEnrolment and Attainment in India: HouseholdWealth, Gender, Village and State Effects', Journalof Educational Planning and Administration.

Government of India, Planning Commission,2001, National Human Development Report.

Government of Tamil Nadu, 2004, Budget speech.

Government of Tamil Nadu, 2001, Report ofSecond State Finance Commission.

Government of Tamil Nadu, 2001, White Paperon Tamil Nadu Government's Finances.

National Council for Applied EconomicResearch, 1993/4, Human Development Survey.

Public Affairs Center, 2002, Study of India'sPublic Services: Benchmarks for the NewMillennium.

World Bank, 2000, Country ProcurementAssessment Review.

World Bank, 2004, State Fiscal Reforms in India:Progress and Prospects.

World Bank, 2004, India Investment ClimateAssessment.

World Bank, 2004, Tamil Nadu: AgricultureDevelopment.

World Bank, 2004, Tamil Nadu: Fiscal Reformand Sustainability.

World Bank, 2004, Tamil Nadu: GovernanceChallenges.

World Bank, 2004, Tamil Nadu: ImprovingInvestment Climate.

World Bank, 2004, Tamil Nadu: Poverty Profile.

World Bank and the Confederation of IndianIndustries, 2002, Competitiveness of IndianManufacturing Results from a Firm-LevelSurvey.

World Bank and the Confederation of IndianIndustries, 2003, Second Indian StatesInvestment Climate Survey.

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