CII Economy Matters, August-September 2014

ECONOMY MATTERS 2

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FOREWORD

AUGUST - SEPTEMBER 2014

Cairns (Australia) hosted the Group of Twenty (G20) Finance Ministers and Central Bank Gov-ernors Meeting on the weekend of 20 and 21 September 2014 and reportedly made progress on policy initiatives to target 2 per cent additional global growth and make the world econ-omy larger by US$2 trillion over four years. Propping up investment was critical to boosting demand and lifting growth, the Group pointed out. However, G20 officials expressed con-cerns that prevailing low interest rates could lead to a potential increase in financial-market risk. The Group vowed to continue to implement their fiscal strategies flexibly to take into account near-term economic conditions, so as to support economic growth and job creation, while putting debt as a share of GDP on a sustainable path.

On the domestic front, the incoming economic data is pointing towards the sentiment that domestic economic activity appears to be reviving. GDP figures for 1QFY15 rose to 9-quarter high supported by higher domestic demand. Further, the Index of Industrial Production (IIP) has shown signs of recovery in the first four months of the current fiscal though the latest data print for July 2014 has been disappointing. Encouragingly, inflation, which has been a cause of worry for the last several years, has moderated. Both WPI and CPI inflation declined for the period of April-August, 2014, with WPI dropping more sharply than CPI. The recent drop in inflation just ahead of the Reserve Bank’s scheduled policy meet on September 30th, 2014 has raised expectations of a rate cut.

As per CII’s latest study titled ‘Investment Requirements in India: 2014-15 to 2018-19’, CII ex-pects infrastructure investment to go up from around Rs 24 lakh crore (USD 500 billion) in XI plan period to Rs. 64.3 lakh crore (USD 1071 billion) during 2014/15- 2018/19 period. The figure is comparable to the Planning Commission’s estimate of around USD 1.0 trillion during the 12th plan period. Investment in infrastructure is estimated to average 7.7 per cent of GDP over the next five years, up from 7.2 per cent recorded during the XI plan period. The CII study suggests that around 40 per cent of the total investment in infrastructure should come from private sector, which is lower than 48 per cent prescribed by the Planning Commission for the 12th plan period. The private sector continues to face multifarious challenges in infrastruc-ture and even PPP has failed to produce desired results, making the task of raising nearly half of investment from private sector, as envisaged in the 12th plan document, quite difficult in the present milieu. In this context, we cover this crucial aspect of financing infrastructure in this month’s ‘Focus of the Month’.

Chandrajit BanerjeeDirector General, CII

3 AUGUST - SEPTEMBER 2014

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EXECUTIVE SUMMARY


Global TrendsCairns (Australia) hosted the Group of Twenty (G20) Fi-nance Ministers and Central Bank Governors Meeting on the weekend of 20 and 21 September 2014 and reportedly made progress on policy initiatives to target 2 per cent addi-tional global growth and make the world economy larger by US$2 trillion over four years. Structural reforms will be im-portant in this regard. The group pointed out that they had developed a set of new concrete measures that will facilitate growth, increase and foster better quality investment, lift employment and participation, enhance trade and promote competition. However, G20 officials expressed concerns that prevailing low interest rates could lead to a potential increase in financial-market risk. Elsewhere, the East or West conundrum has left Ukraine in turmoil. During the course of the unrest, US, followed by EU, Canada, Norway, Switzer-land, Australia and Japan, began to sanction Russia, which has reciprocated with sanctions of its own. The political un-rest has caused turbulence in financial markets, particularly Russian and European stock markets.

Domestic TrendsThe incoming economic data is pointing towards the senti-ment that domestic economic activity appears to be reviv-ing. GDP figures for 1QFY15 rose to 9-quarter high of 5.7 per cent supported by higher domestic demand. Further, the Index of Industrial Production (IIP) in first four months of the current fiscal registered a growth of 3.3 per cent, com-pared to contraction of 0.1 per cent in the same period last year. However, inflation has been a cause of worry for the last several years, forcing a tight monetary policy even as economic growth has continued to remain abysmally low. Encouragingly, WPI inflation for the period of April-August, 2014, moderated to 5.3 per cent as compared to 5.5 per cent in the same period last year. Retail inflation as measured by CPI too eased to 8.0 per cent in April-August 2014 from 9.5 per cent in the same period last year. On the external front, cumulative value of exports for the first five months of the current fiscal (Apr-Aug) were valued at US$134.8 bil-lion as against US$125.6 billion a year ago, registering a y-o-y growth of 7.3 per cent. Imports during the same period stood lower at US$190.9 billion from US$196.2 billion in com-parable time period, thus registering a degrowth to the tune of 2.7 per cent.

Taxation: GST in India- Its Current State of PlayEight long years have passed after the announcement about the introduction of the Goods and Services Act (GST) in In-dia. The delay has made the sceptics and cynics to lose hope. But Arun Jaitley, the Union Finance Minister in his first Budg-

et Speech has promised to introduce GST at the earliest. GST is a broad based tax levied at multiple stages of production and distribution of goods and services, with taxes on inputs credited against taxes on output. It is a destination based consumption tax. Implementation of GST will help in build-ing up an integrated national market, cut down the corrup-tion, and further reduce the cost of doing business. It will also boost up investments and contribute in increase of GDP. Given its multiple benefits, now is the time for all the stake holders to join their hands and work together in usher-ing in the GST. Once the structure of GST is finalised, a pe-riod of two years should be good enough for completing the preparations with respect to both tax men and tax payers.

Sector in Focus: Food Processing The Food processing sector is the key link between Agricul-ture and Manufacturing. In a developing economy like India, it contributes as much as 9 to 10 per cent of agriculture and manufacturing GDP. The growth of food processing sector would need to be a significant component of the second green revolution, considering its possible role in achieving increased agricultural production by ensuring better remu-neration for farmers. The food processing sector makes it possible by not only ensuring better market access to farm-ers but also by reducing high level of wastages. A developed food processing industry will reduce wastages, ensure value addition, generate additional employment opportunities as well as export earnings and thus lead to better socio-eco-nomic condition of millions of farm families. Given its signifi-cant contribution to the national economy, we cover the key trends, challenges faced and government policies to stimu-late growth of the sector in this month’s Sector in Focus.

Focus of the Month: Improving In-vestment in InfrastructureAs per CII’s latest report titled “Investment Requirements in India”, infrastructure investments are estimated to stand at Rs 64 lakh crore (US$1.07 trillion) in the next five years at current market price and Rs. 29 lakh crore (US$483 billion) at 2004-05 prices. Total investment in infrastructure was 7.21 per cent of GDP during the XI Plan period. The Planning Com-mission has set a target of raising this to a level of 8.18 per cent of GDP in the XII Plan. With overall investment in the economy doing far below expectations in the XII Plan period so far, achieving the plan investment target in infrastructure is going to be difficult. The report foreassumes that invest-ment in infrastructure will increase gradually from 6.9 per cent of GDP in 2011-12 to 8 per cent by 2018-19. Accordingly, it will average only 7.67 per cent over the next five years. In view of the importance of this topic in the current milieu, we have invited experts in the field of infrastructure to voice their opinions on its various aspects.

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GLOBAL TRENDS

Nearing Growth Goal: G20

Cairns (Australia) hosted the Group of Twenty (G20) Finance Ministers and Central Bank Gover-nors Meeting on the weekend of 20 and 21 Sep-

tember 2014 and reportedly made progress on policy initiatives to target 2 per cent additional global growth and make the world economy larger by US$2 trillion over four years. Structural reforms will be important in this regard. The group pointed out that they had devel-oped a set of new concrete measures that will facilitate growth, increase and foster better quality investment, lift employment and participation, enhance trade and promote competition. However, G20 officials expressed concerns that prevailing low interest rates could lead to a potential increase in financial-market risk. The meet-ing was a precursor to the G20 Leaders’ Summit, which will be held in Brisbane on 15 and 16 November 2014. Delegates reviewed the current global economic situa-tion to discuss policies in preparation for the Leaders Summit. Minister of State (Independent Charge) for Ministry of Commerce & Industry, as well as a Minister

of State for Finance and Corporate Affairs Ms. Nirmala Sitharaman represented India at the meeting.

In its issued Communiqué, the Group pointed out, that investment was critical to boosting demand and lifting growth. They agreed to a Global Infrastructure Initiative to increase quality investment, particularly in infrastruc-ture. The Initiative will seek to implement the multi-year infrastructure agenda, including through developing a knowledge sharing platform, addressing data gaps and developing a consolidated database of infrastruc-ture projects, connected to national databases, to help match potential investors with projects. The Initiative will also include key measures in growth strategies to improve investment climates, which were central to their efforts to attract private sector participation. Fur-ther, the Group said that they were strongly commit-ted to a global response to cross-border tax avoidance and evasion so that the tax system supports growth-enhancing fiscal strategies and economic resilience. They welcomed the significant progress achieved to-wards the completion of our two-year G20/OECD Base Erosion and Profit Shifting (BEPS) Action Plan and were committed to finalising all action items in 2015. The group endorsed the finalised Global Common Report-

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ing Standard for automatic exchange of tax information on a reciprocal basis which will provide a step-change in the ability to tackle and deter cross-border tax evasion. This will be done by beginning to exchange information automatically between each other and with other coun-tries by 2017 or end-2018, subject to the completion of necessary legislative procedures.

The Group vowed to continue to implement their fiscal strategies flexibly to take into account near-term eco-nomic conditions, so as to support economic growth and job creation, while putting debt as a share of GDP

on a sustainable path. They agreed to consider changes in the composition and quality of government expendi-ture and tax to enhance the contribution of their fiscal strategies to growth. On the monetary policy front, it was pointed out, that, easy interest rates regime in ad-vanced economies continue to support the economic recovery, and should address, in a timely manner, defla-tionary pressures where needed, consistent with cen-tral banks’ mandates. The Group was looking to achieve broad-based and robust growth which will facilitate the eventual normalisation of monetary policy in advanced economies.

Brent crude, the international benchmark, fell below US$100 for the first time in 16 months in August 2014. It has dropped more than 15 per cent since June 2014 this year as economies from Europe to Asia show signs of slowing while oil output climbs. West Texas Interme-diate (WTI) is also under pressure. Energy shares have

The Paris-based International Energy Agency (IEA) in its report published in August 2014, cut its projection for demand growth in 2014 because of weaker perfor-mance in China and Europe, forecasting that worldwide consumption will expand by 900,000 barrels a day to

slumped by 3.8 per cent within first two weeks of Sep-tember 2014. The price weakness in the face of geopo-litical issues in the Middle East and Russia is evidence of lackluster overall demand. The crude collapse is sending a rather ominous warning to the world. There is a decel-eration of growth going in overseas as well as in emerg-ing markets, which will continue into 2015.

average 92.6 million. Global demand is expected to increase by 1.3 per cent, to 93.8 million next year. The agency also lowered estimates for the amount of crude that the OPEC will need to produce by 200,000 barrels a day for this year and 300,000 a day in the next.

Crude entropy in Energy Scenario

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Saudi Arabia, OPEC’s biggest member, cut production by 330,000 barrels a day to 9.68 million in August 2014, according to the IEA. The nation exported 6.95 million barrels a day in June 2014. While conflicts in Iraq and Libya show no sign of abating, their effect on global oil market balances and prices remains muted amid weak-ening oil demand growth and abundant supply. The US production continues to surge, and OPEC output remains above the group’s official 30 million barrels a day supply target. In US, the domestic crude production has risen to the highest level in 28 years, shrinking oil imports.

Conflict in Iraq, the second-biggest OPEC producer, has largely spared the southern region of the country, home to about three-quarters of its crude output. The nation pumped 3 million barrels a day in July this year. Infra-structure bottlenecks are believed to be more troubling for Iraq’s overall supply growth than the humanitarian disaster in the north. In Libya, production climbed to 656,000 barrels a day, according to the state-run Na-tional Oil Corp. The region is in chaos but production continues to rise. Here too, deteriorating security situ-ation isn’t believed to be able to unsettle prices while blockaded crude export terminals may matter more to the market as a downside risk.

The Euro Zone has been singled out for particular atten-tion, with the IEA saying that the macroeconomic ma-laise experienced across much of Europe has been un-favorable to the global demand. Euro zone economies are getting close to deflation. Falling European prices trigger a deflationary spiral that causes further reduc-tions in economic activity over the entire world.

The US and the EU sanctions against Russia are having little effect on the oil market. Nigeria is an important oil producer, but its constant state of conflict, corruption and theft has left its contribution to the world’s oil sup-ply largely discounted. Conflicts in other countries like Mali and Sudan have little interest for the world and do not interrupt oil flows right now. Only unrest in the Arabic world seems to grab the attention of the market. Saudi Arabia has already crippled Egypt’s voice in Mid-dle Eastern politics through the turmoil created by the Muslim Brotherhood.

For Iran, a lower oil price not only harms its economy, al-ready hit by sanctions but also put pressure on its diplo-matic relations with the West with regards to its nuclear program. With oil prices falling, the immediate econom-ic incentive of getting Iranian barrels smoothly back to the world market is diminished, allowing Western powers more flexibility to drive a harder deal. Islamic State, which has captured a number of oilfields in Syria and Iraq, will be hurt by lower oil prices as it is forced to discount further the black market sales that help fund the militant group. For Saudi Arabia, the world’s largest crude exporter, lower prices may create some short-term budgetary pain, but it is willing to absorb the impact as it does greater damage to regional rivals such as Iran. Saudi Arabia has said for years that it will supply the world with the oil it needs.

The drop in oil prices to their lowest in two years has caught many observers off guard, coming against a backdrop of the worst violence in Iraq this decade, heightened tensions between the West and Russia, and sanctions against Iran. But as rising supplies of North American crude and tepid demand have pushed prices below US$100 a barrel, the move underlies how the shale oil revolution is creating a political and economic advantage for Washington and its Western allies. Russia and Iran are heavily reliant on oil sales and face budget shortages at current price levels, weakening their po-sition when negotiating over Ukrainian sovereignty or the Iranian nuclear deal.

Higher oil production from the United States as well as Canada is providing a buffer against the threat of recip-rocal supply curbs from Russia or further disruptions to supplies from the Middle East. Daily oil production in the United States has risen sharply since the financial crisis. In 2010 the country still imported half of the crude it consumed, but the U.S. Energy Information Adminis-tration forecasts that will fall to little more than 20 per cent next year. Even as the United States has largely maintained its ban on exporting crude, it has left a lot of barrels from West Africa and the Middle East look-ing for new homes. While U.S. energy company profits might take a hit from lower prices, consumers will ben-efit more from spending less at the pump.

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After the “Orange Revolution” in 2004, the lack of economic growth, currency devaluation, and an in-

ability to secure funding from public markets compelled the Ukraine President, Viktor Yanukovych, to establish closer relations with the EU and Russia. In November 2013, he initially considered an Association Agreement with the EU which would provide Ukraine with funds contingent to several reforms but would require sev-erance of economic ties with Russia. He ultimately re-fused to sign it considering it too austere and detrimen-tal to Ukraine, particularly the big budget cuts and a 40 per cent increase in gas bills. However, he signed a trea-ty with Russia instead. While Russia would buy US$15 billion in Ukrainian bonds, and discount gas prices to Ukraine by one-third, the opposition leaders were sus-picious of the true cost to Ukraine for Russian support.

Unrest and violence ensued as an organized political movement known as ‘Euromaidan’ demanded closer ties with the EU and ousting of Yanukovych, even as the Prime Minister, Mykola Azarov, discredited pro-EU poll numbers claiming that Ukraine had never been invited to join EU, but only to sign the Association Agreement. The movement was successful. However, pro-Russia demonstrations, described as ‘Russian Spring’ by the Russian media, began in the Crimean peninsula, a region that has historically been subject to a territorial dispute between Ukraine and the Russia. Russia then annexed Crimea following an internationally criticized disputed

status referendum and military intervention. The coun-ter-offensive by Ukrainian government resulted in the ongoing War in the Donbass region of Ukraine. The newly appointed interim government of Ukraine signed the aforementioned Association Agreement with the EU and committed to adopt reforms in its judiciary and political system, as well as in its financial and economic policies, including a raise in domestic gas-supply price to the global price. The EU Commission entered into a full free-trade agreement with Ukraine in March 2014.

The current situation does not look good for Ukraine. The political uncertainty has raised demand for foreign currency, causing additional reserve losses and increas-ing the risk of disorderly currency movement. Interest rates have risen sharply as the National Bank seeks to tighten its national currency, Hryvnia’s liquidity. The Hryvnia fell to a five-year low against the US dollar in February 2014. In the same month, Standard & Poor’s cut Ukraine’s credit rating to CCC; adding that it risked default without “significantly favorable changes”.

While the world watches the escalating crisis in Ukraine, investors and world leaders are considering how the instability could roil the global economy. The political turmoil is rooted in the country’s strategic economic position. It is an important conduit between Russia and major European markets, as well as a significant export-er of grain. But in the post-Soviet era, it’s a weakened

Ukraine: An Emergency of Explosives

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economy. Now, the government is in need of an eco-nomic rescue - and torn between whether Russia or the Western economies (including EU) is the savior it needs.

During the course of the unrest, US, followed by EU, Canada, Norway, Switzerland, Australia and Japan, be-gan to put sanctions on Russia. EU suspended talks on economic and visa related matters. Japan announced suspension of talks relating to military, space, invest-ment, and visa requirements. The G7 bloc (G8 minus Russia) issued a joint statement condemning Russia and announced cancellation of the 40th G8 summit which was to be held in in June 2014 at Sochi, Russia. NATO condemned Russia’s military escalation in Crimea and the Council of Europe expressed full support for Ukraine. In response to the escalating War in Donbass, the US has extended its transactions ban to Russian en-ergy firms and banks. EU introduced another round of sanctions on all majority government-owned Russian banks and energy and defense industries along with asset freezes. In August 2014, Ukraine introduced sanc-tions against Russia.

Three days after the first sanctions against Russia, in March 2014, the Russian Foreign Ministry published a list of reciprocal sanctions. In August 2014, Russia man-dated an embargo for one year on imports of most ag-ricultural products from US, EU, Norway, Canada and Australia, prior to which food imports from EU, the US and Canada were worth around €11.8 billion, €972 mil-lion and €385 million, respectively. Sanctions relating to the transport manufacturing sector are also being con-sidered.

The political unrest has caused turbulence in financial markets. In the beginning of March 2014, in response to approval of a military intervention in Ukraine by the Duma, the Russian Parliament, European markets which depend on Russian gas supply also fell sharply. The FTSE 100 (UKX) fell by 1.6 per cent and the German DAX was down 3 per cent. The Russian stock market declined by 12.5 per cent, whilst the Russian Ruble hit all-time lows against the US dollar and Euro. The Russian central bank hiked interest rates and intervened in the foreign exchange markets to the tune of US$12 billion to try to stabilize its currency. Prices for wheat and grain rose, with Ukraine being a major exporter of both crops.

Amongst all EU nations, Germany has the most to lose as it is Russia’s largest trade partner in Europe. It is expect-ed to enter a contraction in the second half of the year over its economic standoff with Russia, with its main stock index having already fallen 11 per cent in the first week of August 2014 from its peak in June 2014. While the sanctions have had little direct impact on the Ger-man economy, the stock market has been hammered by investor unease over a potential trade war with Rus-sia. Russian politicians are considering further sanctions of their own, including closing off the country’s airspace to European and American airlines, which would erode US$30,000 from the already paper thin profits made on each flight between Europe and Asia. Shares in the Ger-man airline and the defense contractor have also fallen. Eurozone economic growth is expected to have almost certainly contracted, with the block having reported a weak 0.2 per cent quarter-on-quarter gain in the first three months of the current year.

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Russia supplies about a quarter of Europe’s gas, with just over half of that flowing through Ukraine. The abili-ty for Russia to cut those gas supplies provides potential leverage as Western states threaten to impose econom-ic sanctions over its actions in Ukraine. There is history here too; during disputes in both 2006 and 2009, Rus-sia cut off gas supplies to Ukraine. However, energy ex-perts have talked down the prospect of a repeat. From the viewpoint of Russia, part of its value-proposition is that it’s a reliable supplier. Meanwhile, the US is moving to reduce Ukraine’s dependence on Russian gas.

Ukraine’s instability comes at a difficult time for emerg-ing markets worldwide, which are seeing growth slow

as the Federal Reserve eases its economic stimulus. The situation in Ukraine could lead investors to reas-sess the risks of other emerging markets slowing eco-nomic growth. Troubles in Ukraine will also hurt Russian banks, which have lent heavily to Ukraine. The Russian Ruble is down about 10 per cent since the start of 2014. Ukraine offers economic growth at Europe’s doorsteps. A predictable and rule-based Ukraine will expand Eu-ropean market by an extra 45 million consumers with rich resources and great human capital, London-based Chatham House reported. This is particularly true of the energy market, where gas transit and export of electric-ity from Ukraine is of strategic importance for EU.

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DOMESTIC TRENDS

A Welcome Shift in DiscourseIn its first 100 days, the new government has spoken with intent, perspective and a sense of purpose

A hundred days is a short time for a government, but when it assumes charge it is expected to present a

strong indication of its policy intent in this period. Since the Indian economy has been growing at sub-5 per cent for two years, rapid progress on reforms was critical.

Prime Minister Narendra Modi and his government have delivered on all counts. The government has affirmed policy direction, initiated action on multiple fronts, and enabled the economy to shift track to a faster growth trajectory within this short time. Investor spirits are surging and a new investment cycle is now underway.

Economic growth and investment rejuvenation are on top of the priority list. The Finance Minister in his Budg-et speech sought to alleviate the concerns of investors

by assuring them of a stable and predictable tax regime, and stressed the imperative of adhering to a tight fiscal deficit target.

The Budget additionally lowered the investment allow-ance to Rs 25 crore and set up a Rs 10,000 crore fund for start-ups. The Finance Minister has also driven the agen-da for GST through several meetings of the empowered State finance ministers group to resolve pending issues.

Top Billing

Infrastructure is high on the agenda. Modi has travelled to different States to flag off infrastructure projects and has strongly voiced the Government’s commitment to building new facilities. Industrial corridors integrated with smart cities are on the anvil. The smart city concept can be revolutionary for a rapidly urbanising nation such as India. Power, roads and highways, ports and airports would be taken up and the public-private partnership model would be revisited through 3P India, an institu-tion to come up soon. The Government has facilitated rapid movement of ongoing projects and addressed hurdles in mining and environmental clearances.

The Railways has received high attention. Raising pas-

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senger fares was a long-awaited move, while in the long-term, the vision is for a high-speed rail network across the country. For the first time, FDI too has been permitted in various areas of railway infrastructure.

The Prime Minister issued a strong invitation to ‘Make in India’ and drive the manufacturing sector to a new level in his Independence Day address. Although the sector is expected to be the engine for new employment crea-tion, it has experienced near-stagnant growth for the last three years. The Budget announced steps such as correcting the inverted duty structure, continuing ex-cise duty rebates, and redefining MSME. Raising FDI lim-its in defence and insurance would encourage overseas investors to connect with Indian manufacturing.

Also, agriculture has been prioritised with the inten-tion to infuse productivity and technology into farming. Farmer producer organisations and farmers’ markets are being encouraged so that the Agricultural Produce Market Committee Act operates in the right spirit. Lo-gistics have been addressed in the Budget with incen-tives for warehousing and storage. A price stabilisation fund was announced as well, apart from new agricultur-al research facilities. This would contribute to address-ing food inflation through supply side measures.

There are strong indications that economic recovery has started taking roots. The new GDP numbers released by CSO on 29th August, 2014 showed that the economy dur-ing Q1FY15 registered a strong performance at 5.7 per cent as compared to 4.6 per cent in the previous quarter. Improvement in the growth was on the card, given that the business sentiments in the economy had improved

In Response Mode

The Government itself is sought to be reformed by more efficient, responsive and effective administration at all levels, including ministries, departments, states and regulatory bodies. E-governance, use of IT and re-ducing face-time for more transparent administration has been stressed.

Finally, the Government has brought issues such as fe-male foeticide, sanitation and violence against women on the front-burner. The Swachch Bharat programme for total sanitation is inspirational and corporates have quickly responded to the call for building toilets in schools.

A new multi-skill mission is proposed to enable our workforce to be globally competitive. Financial inclu-sion is being accelerated through the Jan Dhan Yojana which offers incentives such as insurance cover.

Most of all, industry is enthused by the shift in discourse. The idea is to build a facilitative investment climate, im-prove ease of doing business, and encourage industry to seize opportunities. The Confederation of Indian In-dustry expects that with renewed investor confidence, GDP could expand at 5.5-6.0 per cent this year, and en-ter the 7-8 per cent trajectory in two years.

significantly, post the formation of new government at the centre. CII Business Confidence Index, released in June 2014, had jumped up to 53.7 for April- June 2014 quarter from 49.9 in the previous quarter. What, how-ever surprised, many was the quantum of the improve-ment, which far exceeded the average expectations.

This article appeared in Hindu Business Line dated 27th August 2014. The online version can be accessed from the follow-ing link: http://www.thehindubusinessline.com/opinion/a-welcome-shift-in-discourse/article6357265.ece

Improved GDP Numbers for 1QFY15 Provide a Ray of Hope

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What is also encouraging is to note that the growth is broad-based, covering the major sectors. Agricultural sector grew by impressive 3.8 per cent. However, given the fact that monsoons are deficient this year, some slowdown in farm sector growth on account of the kharif crop is expected in Q2 and Q3. Industrial growth posted a strong recovery (4.2 per cent) in line with the strength in IIP witnessed over the first quarter. Manu-facturing registered 3.5 per cent after two consecutive quarters of negative growth. Further contribution came from construction sub-sector, which recorded a strong growth of 4.8 per cent, the highest since March 2012. The significant improvement in production of cement,

as seen in core industry data, appears to have led the growth in construction activities. GDP heavy-weight, services sector, also improved growth to 6.8 per cent from 6.4 per cent in Q4FY14, led by ‘Community, Social and Personal Services’. Despite an adverse base, growth in ‘Community, Social and Personal Services’ clocked a growth of 9.1 per cent, led by government spending.

Other components within services, namely ‘Trade, ho-tels, Transport and communication’ and ‘Financing, In-surance, Real estate and Business’ both saw decelera-tion in growth in the first quarter.

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At market prices, however, GDP grew at 5.8 per cent in Q1FY15, lower than 6.1 in Q4FY14. Further, the pri-vate consumption demand grew by merely 5.6 per cent against the earlier quarter’s figure of 8.2 per cent, indi-cating the need for monetary policy intervention. Gov-ernment consumption, which rose by 8.8 per cent as compared to a contraction of 0.4 per cent in the previ-ous quarter, can be seen to boost demand. The demand has also received support from boost in exports earn-ing, growing by 11.5 per cent, compared to 10.5 per cent in the previous quarter. Growth in investments surged to a 2 year high of 7.0 per cent in Q1FY15 as against a

mild contraction of 0.1 per cent in FY14. While a favoura-ble base was helpful, the sharp growth in capital goods output (IIP data) by 13.9 per cent in Q1FY15 from a con-traction of 11.0 per cent in Q4FY14, underlines the recov-ery in investments. Further, the recent turnaround seen in core sector growth led by higher output in leading indicators of coal, cement and electricity, should have had a positive impact on overall investment sentiment. However, given that these are early days of economic recovery, policy efforts would have to be sustained to provide momentum to investment activities.

Outlook Sharp rise in GDP growth to 5.7 per cent in the 1QFY15, after remaining in sub-5 per cent range for the last 2 years, is noteworthy and reinforces faith in India’s growth story. Going forward, improvement in business sentiment, pro-ject clearances, lower inflation and continued government commitment towards reforms is likely to lead to strong recovery in industry and services. We expect GDP growth to come in a range of 5.5-6.0 per cent in the current fiscal.

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Industrial output growth moderated sharply to 0.5 per cent in July 2014, after growing at a modest pace in first quarter of the current fiscal, partly attributable to a high base of last year. Consumer goods sector out-put continued to contract for the second consecutive month. However, in some positive news, the sequential momentum as indicated by the movement in the sea-sonally-adjusted month-on-month series showed that industrial output growth increased in July 2014 (from

Mirroring the moderation in IIP growth in July 2014, the output of eight core industries, having a combined weight of 37.90 per cent in the IIP, eased to 2.7 per cent in July 2014, from healthy rate of 7.3 per cent recorded in June 2014. The output has shown an increase of 4.1 per cent for April-July 2014. Coal production increased

-1.2 per cent in June 2014 to 0.4 per cent in July 2014). For April-July 2014 as a whole, the average IIP growth stands at a respectable 3.3 per cent as compared to de-cline to the tune of 0.1 per cent in the same period last year. This clearly shows that the nascent signs of a re-vival in manufacturing growth are very much evident on the horizon, despite some weakening visible in the last couple of months.

by 6.2 per cent, while the electricity generation and ce-ment output increased sharply to 11.2 and 16.5 per cent respectively in July 2014. However, the production of natural gas, fertilizer, refinery products declined sharply by 9.0, 4.2 and 5.5 per cent respectively in July 2014.

Industrial Output Decelerates Sharply in July 2014

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On the sectoral front, output of the manufacturing sec-tor, which constitutes over 75 per cent of the index, de-clined to 1.0 per cent in July 2014 as compared to 2.5 per cent in the previous month, partly due to a high base of last year. In terms of industries, twelve (12) out of the twenty two (22) industry groups (as per 2-digit NIC-2004) in the manufacturing sector have shown positive growth during the month of July 2014 as compared to the corresponding month of the previous year. The in-dustry group ‘Other transport equipment’ showed the highest positive growth of 17.1 per cent, followed by 12.3 per cent in ‘Basic metals’ and 11.8 per cent in ‘Other non-metallic mineral products’ in July 2014. On the other hand, the industry group ‘Radio, TV and communication equipment & apparatus’ showed the highest negative growth of (-) 58.3 per cent, followed by (-) 26.0 per cent in ‘Office, accounting & computing machinery’ and (-) 17.4 per cent in ‘Furniture; manufacturing n.e.c.’. Mining sector, which had turned the corner in the last couple of months, continued to post healthy growth rate, albeit moderating to 2.1 per cent in July 2014 as compared to 4.5 per cent growth in the previous month. In line with the core sector data, electricity sector output growth grew at a brisk pace of 11.7 per cent in the reporting

month as compared to a healthy 15.7 per cent in the previous month.

Amongst the use-based sectors, capital goods output contracted by 3.8 per cent in July 2014 as compared to healthy rate of 23.3 per cent in the previous month. Despite, the blip in the month of July 2014, the perfor-mance of the volatile sector this year has been good as it has grown at an average rate of 8.5 per cent as compared to an anemic 1.4 per cent in the same period last year. Intermediate goods, which registered steady growth for most part of last fiscal, continued its good performance in July 2014 too, growing by 2.6 per cent. Basic goods growth eased to single-digit of 7.6 per cent in July 2014 from 10.0 per cent in the previous month. Consumer goods sector growth collapsed to -7.4 per cent, pulled down by poor showing in its durables sub-component. Consumer durables growth declined by a sharp 20.9 per cent, while non-durables growth stood at 2.9 per cent during the month. With the improve-ment in the coverage of monsoons, consumer non-durables sector growth has shown an uptick during the reporting month.

Outlook The muted performance of the industrial sector, with IIP expanding at the slowest pace in three months, on the back of the negative growth of the manufacturing sector indicates that full fledged industrial recovery could still be some distance away. However, anecdotal evidence suggests some pick-up in new orders. A sustained recovery would be indicated by an improvement in off-take of commercial credit by industry. The government has under-taken significant reforms and is receptive to industry concerns and the industry sentiments are strong. This, we believe will foster higher industrial output growth, going forward.

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WPI based inflation slowed down to a 58-month low of 3.7 per cent in August 2014 from 5.2 per cent in the previ-ous month, at a time when retail inflation (as measured by CPI) too decelerated. The fall in WPI inflation was at-tributable to all round moderation in all its sub sectors. In line with the moderation in headline, core inflation too eased to a 7 month low of to 3.5 per cent from 3.6 per cent in July 2014 supported largely by lower prices of imported commodities. Retail inflation too eased to 7.8 per cent in August 2014 from 7.96 per cent in the previous month. This was attributable to a sharp drop in core CPI to 6.9 per cent, lowest level in the current

Primary inflation moderated sharply to 3.9 per cent in August 2014 - its lowest reading since January 2012. Pri-mary food inflation too eased to 5.2 per cent from 8.4 per cent in the previous month. Amongst primary food prices, the data showed that vegetable prices including onions dropped nearly 45 per cent during the month. In contrast, primary non-food inflation increased to 4.2 per cent from 3.3 per cent in the month before. Fuel inflation decelerated sharply to 4.5 per cent in August 2014 as compared to 7.4 per cent in the previous month, benefitting from a favourable base effect. Fuel prices came off sharply tracking a fall in global Brent crude prices, which is now trading at a two-year low. Petrol

series. Apart from a favourable base effect, the fall in sequential momentum to nearly half compared to prior month, supported the easing in core inflation. Fuel CPI slipped to another record low of 4.2 per cent, on the back of recent reduction in LPG cylinder prices. Not-withstanding the fall in core and fuel CPI, food inflation remained elevated at 9.2 per cent during the month. With this, there seems to be clear visibility towards at-tainment of 8 per cent CPI target by January 2015. From monetary policy perspective, lower core WPI inflation amid recent moderation in retail inflation is likely to pro-vide some near term comfort to RBI.

prices were cut thrice in August 2014, helping bring down petrol inflation to -0.2 per cent in August against 5.9 per cent in July.

Manufacturing inflation eased to 3.5 per cent in August 2014 as compared to 3.7 per cent in the previous month. Encouragingly, non-food manufacturing or core infla-tion, which is widely regarded as the proxy for demand-side pressures in the economy, moderated to 3.5 per cent during the month as compared to 3.6 per cent in July 2014. In the coming months, we expect core WPI to hover around 3.0-3.5 per cent, RBI’s comfort level for this inflation measure. Manufacturing food inflation too showed a deceleration during the month.

Inflation Trajectory on Downward Momentum

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Cumulative value of exports for the first five months of the current fiscal (Apr-Aug) were valued at US$134.8 bil-lion as against US$125.6 billion a year ago, registering a y-o-y growth of 7.3 per cent. Imports during the same period stood lower at US$190.9 billion from US$196.2 billion in comparable time period, thus registering a de-growth to the tune of 2.7 per cent. Amongst imports, oil imports during April-August 2014 were valued at US$67.9 billion, which was 1.7 per cent higher than the oil imports of US$66.7 billion. In contrast, non-oil im-ports in the comparable time period were valued 4.9 per cent lower than the comparable levels seen in last fiscal. As exports growth accelerated compared to a de-cline in imports, merchandise trade deficit narrowed to US$56.1 billion in the period from April-August 2014 as compared to US$70.6 billion in same period last year.

Given the benign trade balances, first quarter (Q1FY15 henceforth) current account deficit (CAD) remained comfortable at 1.7 per cent of the GDP as against 4.8

per cent of GDP in Q1FY14. Sequentially, CAD widened to US$7.8 billion in Q1FY15 as against US$1.3 billion in Q4FY14. However, the lower CAD (as compared to last year) was primarily on account of a contraction in the trade deficit contributed by both a rise in exports and a decline in imports.

On BoP basis, merchandise exports grew by 10.6 per cent in Q1FY15 to US$81.7 billion as against US$73.9 bil-lion in Q1FY14. Improving growth prospects in devel-oped economies and stability in Indian Rupee bodes well for exports sector performance going forward. Meanwhile, on BoP basis, imports contracted by 6.5 per cent to US$116.4 billion in Q1FY15 as against US$124.4 billion in Q1FY14. Non-gold imports recorded a modest rise of 1.3 per cent in Q1FY15 as against (-) 0.6 per cent in corresponding quarter of last year. The sharp con-traction in imports reflects the steep decline (-57.2 per cent YoY) in gold imports. As a result, the merchandise trade deficit (BoP basis) contracted by about 31.4 per

Outlook The sharp drop in wholesale inflation comes just ahead of the Reserve Bank’s scheduled policy meet on September 30 and raises expectations of a rate cut. However, inertia in CPI inflation might be of some cause of worry to the Central Bank, as it is still hovering around the Reserve Bank’s inflation target of 8 per cent by January 2015.

External Sector Gathers Steam

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cent to US$ 34.6 billion in Q1 of 2014-15 from US$50.5 bil-lion in the corresponding quarter a year ago. Revival in the domestic economy is likely to boost future imports

Strong capital inflows under portfolio and FDI route supported the capital account surplus of US$19.8 billion in Q1FY15. While, net portfolio inflows remained strong at US$12.4 billion in Q1FY15 (vs. outflow of US$0.2 bil-lion in Q1FY14), net FDI inflow was substantially higher at US$8.2 billion (US$6.5 billion in Q1FY15). Additionally, loans (net) availed by deposit taking corporations (com-mercial banks) witnessed an outflow of US$2.6 billion

growth. Net services receipts improved marginally in Q1 of 2014-15 on account of higher exports of services.

in Q1FY15 owing to higher repayments of overseas bor-rowings and a build-up of their overseas foreign cur-rency assets.

In sum, lower CAD and stronger capital flows resulted in net accretion of US$11.2 billion to India’s foreign ex-change reserves during Q1FY15, compared to a draw-down of US$0.3 billion in the same period last year.

OutlookGoing ahead, with the Fed tapering nearing its end, there are risks of FII withdrawals from emerging economies including India. It is therefore important for India to attract long-term capital flows to reduce its vulnerability to external shocks. The government has already taken steps in this direction by liberalising FDI limits in defence and railways infrastructure. It is also making efforts to facilitate and fast track FDI investments in Indian infrastructure from countries like Japan.

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Summary

The paper brings to attention important concerns regarding the current status of India’s merchandise exports, provides perspective in light of the ongoing global happenings. It goes on to deliver useful and plau-sible policy suggestions, general as well as sector-spe-cific. While the export figures last year were definitely encouraging, they fell short of the target numbers. A quick comparison with the growth figures in China over the last two decades shows that while both India and China started off with nearly same export growth rates, the latter has surpassed us by enormous margins. At present the export rate (merchandise) stands at 1.7 per cent and a respectable figure of 4 per cent in the next five years is achievable given the right kind of policy de-cisions. Most important of these decisions encompass altering export basket, improving infrastructure and modifying existing Foreign Trade Agreements apart from specific policies for different sectors. The paper further provides recommendations for boosting ex-ports potential all major sectors including agriculture, mining, capital goods, manufacturing, electronics, gems and jewelry, textiles and leather.

The July 2014 update of IMF‘s World Economic Outlook has lowered both the global growth and trade volume projections for 2014 by 0.3 percent to 3.4 percent and to 4.0 percent respectively. India‘s exports during 2013-14 stood at US$312.6 billion against a target of US$325 bil-lion, though they grew by 4.1 percent as compared to a contraction of 1.8 percent during the previous year. This coupled with plunge in imports led the trade defi-cit to fall by 27.8 percent. Export growth has picked up during the first quarter of 2014-15 to 8.6 percent while import growth fell by 3.8 percent; further trade deficit fell by 24.4 percent mainly due to the fall in gold and silver imports.

Policy Issues

Between 1990 and 2013, India‘s share in world exports (merchandise) increased from 0.5 percent to 1.7 per-cent while China‘s share increased from 1.8 percent to 11.8 percent. The aim should be to increase our share to at least 4 percent in the next five years. For this the CAGR of exports should be around 30 percent, which is plausible; from 2003-04 to 2007-08, this figure was above 20 percent with 29 and 31 percent growth in two years.

In the top 100 imports of the world, except for dia-monds (21.0 percent) and jewellery (11.2 percent), In-dia has three other items with only around 6-7 percent share. Most items in top 100 include the three Es— elec-tronic, electrical, and engineering items and textiles. A resounding shift from hitherto supply-based exports to demand-based diversification with perceptible shift to the three Es is essential.

Export infrastructure, particularly transportation and ports-related infrastructure, requires immediate at-tention. Poor road conditions and port connectivity, congestions and vessel berthing delays, poor cargo handling techniques and frequent EDI server down are major issues. The Multi-modal Transportation of Goods Act 1993 needs revisions to ease existing restrictions on transportation and documentation. Higher exchange rate for freight payments and additional charges by shipping companies require a check. So do the gang system in ports and arm-twisting by unions.

Some Foreign Trade Agreements have led to an in-verted duty structure-like situation, with import duty on finished goods being lower than that on raw materi-als imported. Some such cases include textile imports from India by Bangladesh. Other apprehensions include anomalies in guidelines of Nepal Banks and Indo-Nepal treaty, exports to Nepal and Bhutan under rupee pay-

India’s Merchandise Exports: Some Important Issues and Policy Suggestions

Paper Review

Dr. H. A. C. Prasad, Dr. R. Sathish, Salam Shyamsunder Singh August 2014 Department of Economic Affairs, Ministry of Finance, Government of India

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ment for export incentives and tariff rate quota on foot-wear imports by Japan. Additionally, there are some non-FTA countries where Indian exporters face discrim-ination like duty by China on cashew and oilseeds im-ports exclusively on India. Further, we need to gear up to new threats like Trans-Pacific Partnership and Trans-Atlantic Trade and Investment Partnership between EU and US, which are likely to produce restrictions for Indi-an exporters. There is also need for new FTAs with Chile (automobiles), South Africa (leather) and EU (textiles, coir, leather).

India has been successful in getting concerns addressed in WTO negotiations at Bali and blocking trade facilita-tion agreement in recent WTO meeting at Geneva. This comes a long way forward from Agreement on Agricul-ture and Information Technology Agreement-1, which affected us adversely.

Export credit as a proportion of net bank credit has de-clined from 9.8 percent in March 2000 to 3.7 percent in March 2013, even as Canada, Germany, Italy, Japan, US and China aggressively finance exports. Further, levy-ing of taxes breaching initial promises have affected investor‘s confidence in SEZs. More tax related issues include early implementation of GST, clarification on TDS on Foreign Agents Commission and service tax on remittances.

Greater trade facilitation by reducing delays and costs on account of procedural and documentation factors, besides infrastructure bottlenecks presents major chal-lenge. A World Bank and International Finance Corpora-tion publication, ‘Doing Business 2014’, places India at 134th position in the ease of doing business. Singapore is at 1st place and China at 96th. In trading across bor-ders, India ranks 132. India needs 9 export and 20 import documents with time to export being 16 days. Cost of exports and imports per container is over twice as com-pared to China and Singapore. Inter-ministerial delays and policy overlaps is also a concern.

State-wise exports show domination of only two states, Gujarat followed by Maharashtra. Tamil Nadu and Kar-nataka are a distant third and fourth. A performance based scheme ‘Assistance to States for Developing Ex-port Infrastructure and Allied Activities’, is expected to encourage state exports.

Sector Specific Issues

The issues in agriculture sector include absence of or-ganized market and uniform rules and levies across states. Mining needs special focus due to high linkage effects. In the medium to long-term we have to devise policies to use Iron ore domestically, however, in the short term there is need to abolish export duty on low grade Iron ore as it cannot be economically used do-mestically.

Lower taxes on finished goods as compared to raw materials is discouraging domestic value addition es-pecially in aluminum, capital goods, cement, chemicals, paper, steel, textiles and tires. Further, the issue of defi-nition of MSME in terms of capital Investment needs re-dressal as technological upgradation will take company out of MSME limits depriving it of other benefits. For electronics and IT hardware manufacturing, levies on components makes trading more viable than manufac-turing. Further, the activity of electronic manufacturing has been arbitrarily declared as mere assembly thereby denying local manufacturers the credit of being genu-ine.

Major concerns in textiles include customs duty reduc-tion for synthetic garments machinery and fabrics, al-lowing increased overtime and FTAs with EU and Cana-da. Procedural ambiguities and delays plague the gems & jewellery sector. Also, there is no policy to control the premium charges of banks/nominated agencies for gold import. The issues in leather sector include revising the FTA with EU, Canada, Australia and Russia, restoring im-port of second hand machinery as many factories are closing down in Europe and focusing on exports of la-dies and children‘s footwear.

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GST in India – Its Current State of Play


Eight long years have passed after the announce-ment about the introduction of the Goods and Services Act (GST) in India. The delay has made

the sceptics and cynics to loose hope. But Arun Jaitley, the Union Finance Minister has silenced all Doubting Thomases when he said in his first Budget Speech that the debate “whether to introduce Goods and Services Tax (GST) must now come to an end. I do hope we are able to find a solution in the course of this year and ap-prove the legislative scheme which enables the intro-duction of GST.....˝. This statement has spurred all the stakeholders to resume their preparations for ushering in the GST.

GST is a broad based tax levied at multiple stages of production and distribution of goods and services, with

taxes on inputs credited against taxes on output. It is a destination based consumption tax. GST has various models – different in different countries, depending upon the politico-economic situation of a country. For India, the policy makers have opted for the ‘Dual GST’ model. They felt that this model would take care of the federal character of the Indian Constitution and the concern for retaining the fiscal autonomy of the States. In the ‘Dual GST’ model, there will be two streams of GST running concurrently. The Centre will administer the Central GST (CGST), and the individual States would administer their respective State GST (SGST). In respect of inter-state movement of goods and services, the In-tegrated GST (IGST) model would take care of the share of State GST (SGST); the SGST would accrue to the desti-nation state, since GST is a destination based tax.

The ‘Dual GST’ would be a joint-venture between Centre and the States, and therefore, there has to be consen-sus between them. But, consensus continues to elude. The major dispute is with respect to the Constitution Amendment Bill to be passed by the Parliament for em-powering both the Centre and the States to levy GST concurrently. The bill was tabled before the Parliament in 2011, which referred it to the Parliamentary Standing committee on Finance. In its report submitted in July

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2013, the Committee endorsed the Dual GST model, and allayed the fears of the States about loss of fiscal auton-omy. While agreeing broadly with the Bill, the Report recommended certain changes. After accepting most of the recommendations, the Centre had drafted a revised bill and sent to the States for their endorsement, but the States expressed strong differences with Centre on certain issues, and consequently the revised bill could not be presented before the expiry of the Parliament in May 2014, and the Bill died its natural death. Now, a fresh bill will have to be presented after reconciling the differences between Centre and the States. The differ-ences are on following issues:

(i). Goods to be kept outside the ambit of GST

Petroleum and petroleum products and alcohol are ma-jor inputs for other industries. If these are kept outside GST, there would be cascading effect of taxing the tax-es for other sectors and the cost of production would increase. But having failed to convince the States, the Centre had at one point agreed to the exclusion of these items from GST, to start with. The Centre, how-ever, urged the States not to insist on their exclusion to be embodied in the Constitution itself, so that in fu-ture these items could be brought within the GST, with-out going through the arduous route of Constitution amendment. The States however have not relented.

(ii). Taxes to be kept outside the GST

Some agricultural States have demanded to keep ‘Pur-chase Tax’ on purchase of farm produce in bulk out of the ambit of GST, because under GST regime, this major source of revenue for them would accrue to the des-tination consuming states. Some States have also de-manded that Entry Tax including Octroi should not be subsumed in GST. The Centre feels that charging Octroi or Entry Tax for interstate movement separately would cause interruption of free flow of goods inside the country, and would defeat the purpose of making India a common market.

(iii). Compensation to the States for loss of revenue

The Centre had promised that the States would be compensated for any revenue loss on account of intro-

duction of GST. The States have demanded that these promises regarding compensation should be enshrined in the constitution. The Centre has not agreed stating that the existing institution of Finance Commission could take care of this concern. In order to instil trust in the minds of the States, the Centre is working on an-other legal framework that will provide a mechanism for compensation to the States in case of revenue loss.

Thus, the major challenge now would be to bridge the trust deficit between Centre and the States, and to get a consensus evolved on the Constitution Amendment Bill. After the empowerment by the Constitution to levy and collect GST, the Centre has to get the Central GST Act enacted by the Parliament. Similarly the State GST Act will have to passed by respective State Assemblies. These will have to be drafted on the basis of a Model GST Law so as to avoid any further dispute between Centre and the States, and also to have uniform legisla-tion for CGST and SGST.

The next major challenge would be with respect to the IT infrastructure. The administering of GST would nec-essarily have to be technology based. The Goods and Services Tax network (GSTN), a Special Purpose Vehicle (SPV) has been set up in 2012. The GSTN would operate a common GST portal which would provide a common PAN-based Registration, Returns and Payment facilities for all stakeholders. The tax payers and tax men would be connected through this common portal. In order to make the GST Net fully operational, it would be impera-tive that the IT ability of different States are brought on par. At present, the States are at different levels of IT ability.

The other challenge would be the restructuring of the current tax administrations, both at the Centre and the States so as to make it GST specific. It would be neces-sary to ensure that the administrative structures as well as the laws and procedures with respect to both CGST and SGST are harmonious.

Besides, a good number of technical issues will need to be finalized jointly by Centre and the States. Some such issues are with respect to finalization of common threshold for CGST and SGST, common list of exemp-tions, common rules, procedures for registration, re-

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turns, payments, and refunds etc. There is also an ur-gent need for a quick finalization of the ‘Place of goods and Services Rules’ which is essential to determine the ‘Place of Supply’ in the context of the interstate move-ment of goods and services. Further, IGST being the keystone in the GST structure, the chosen IGST model for taxing the interstate transactions would need to be put in place on priority.

The apprehension of the States regarding loss of fiscal autonomy has been allayed by allowing the States to keep a band of rates to be varied with a fixed ceiling rate and a floor rate. The loss of revenue by manufactur-ing States because of the State GST getting accrued to the destination States can be taken care of by a suitable mechanism for compensation.

The challenges are no doubt daunting. But, with strong political will and commensurate bureaucratic efficiency, these challenges can be met effectively. Positive state-ments from the Union Finance Minister and leaders of

different political parties have already rekindled the hope. It has been realised by the people of India that subsuming of different indirect taxes, both at Central and State level, will do away with the multiple points of collection for multiple taxes. This, added with the fact that the GST administration will be completely technol-ogy based, will drastically reduce the points of physical contact between Tax Payers and Taxmen. This will in turn cut down the corruption, and further reduce the cost of doing business. Besides, a broad tax base for the GST would reduce the rate of duty, and thus bring down the price. Above all, in light of the factors discussed above, introduction of GST will surely help in building up an integrated national market. It will also boost up investments and contribute in increase of GDP. Now is the time for all the stake holders to join their hands and work together in ushering in the GST. Once the struc-ture of GST is finalised, a period of two years should be good enough for completing the preparations with re-spect to both tax men and tax payers.

[Mr. Sumit Dutt Majumdar is also the author of a book titled “GST in India – its travails, tribulations and chal-lenges ahead”]

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Food Processing Industry

The changing preferences of the upward mobile middle class families from the urban areas have given prominence to food processing sector and

also fuelled the growth in the last few years to make the industry the fifth largest in India in terms of produc-tion and export growth. Indian food processing indus-try was between US$121 billion to US$130 billion (various sources) and accounts for 30 per cent to 35 per cent of the total food market.

Food processing industry includes the following sub-sectors:

1. Dairy – milk, milk powder, ice cream, butter, cheese and ghee

2. Fruits & Vegetables –Slices, Pulps, Juices, Concen-trates, Beverages, Potato wafers/ chips etc

3. Grains & Cereals – Flour, Bakery products, Corn flakes, Starch, Glucose, Malted foods, Vermicelli, Beer and malt extracts

4. Fisheries – Frozen and canned foods mainly in fresh form

5. Meat & Poultry – Frozen and packed foods mainly in fresh form

6. Consumer goods, which includes snack food, bis-cuits, ready-to-eat foods, alcoholic and non-alcohol-ic beverages

The following section reviews the food processing sec-tor based largely on the Report “Indian Food & Beverage Sector” prepared by the Confederation of Indian Indus-try (CII) and Grant Thornton. The report, which was re-leased in August 2014 explores and assesses the growth drivers and challenges for the sector.

Overview of the Food Processing Sector

Food processing is an important segment in terms of contribution to GDP, and share in the agriculture and manufacturing sectors. The industry’s GDP as a share of agriculture GDP is 12 per cent and that of manufacturing GDP is 10 per cent in FY13, which has increased from 10 per cent and 9 per cent, respectively in FY09.

Food processing industry has been performing better

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than agriculture and manufacturing. FY13 growth was lower at 3 per cent due to lower growth in agriculture and manufacturing; however the industry has per-formed marginally better than both those sectors.

Higher growth of food processing industry over agricul-ture since FY11 indicates that the level of processing has been increasing over the years. Earlier food processing was limited to food preservation, packaging and trans-portation, whereas the industry has evolved and wid-ened its scope with emerging new trends in consumer preferences and the advancement in technologies adapted to meet those preferences.

These new developments include establishment of cold storage facilities, food parks, packaging centres, irra-diation centers and modernised abattoir to offer new products like ready to eat foods, beverages, processed fruits & vegetables, processed marine and meat prod-ucts, etc.

Extent of Processing in the Industry

The level of processing has been the key driver for growth in the industry. While the current data does not

Export Potential of the Industry

With the growth in the industry driven by the domes-tic demand, the industry has also geared up for tap-

clearly indicate the extent of processing, a look at the composition of the industry indicates the trend. The un-organised sector accounted for 40 per cent to 45 per cent of India’s food processing industry in FY12.

The key trends in the industry are:

• While share of processing in dairy is high at around 35 per cent only 15 per cent of the processing is done by organised players. This is after white revo-lution/ Operation Flood till early 1990s, which saw emergence of cooperative societies. Private sector players started investing post liberalisation in 1992-93.

• Only 2 per cent of fruits and vegetables are pro-cessed as against 65 per cent in US, 78 per cent in Philippines and 23 per cent in China.

• Rice mills account for the largest share of process-ing units in the organised sector.

• The sizeable presence of small scale industries points to the sector’s role in employment genera-tion.

ping the export potential. The share of food process-ing exports in total exports was around 12 per cent in the last few years. This was on the back of significant growth experienced in the sector. Exports of the sector during the period from FY10 to FY14 is set out below:

ECONOMY MATTERS 28

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Value Chain of the Industry

The supply chain of the industry involves five stages of inputs, production, procurement, processing and retail-ing. Food processing industry is a key step in the value chain and it is broadly categorised into two segments:

• Primary processing, which includes basic steps of processing like cleaning, grading, sorting, packing

etc to make the products fit for human consump-tion. Finished products in this case include packed milk, fruits & vegetables, milled rice, flour, pulses, spices and salt largely unbranded.

• Value-added processed food (secondary/ tertiary processing), which includes dairy products (ghee, cheese and butter), bakery products, processed fruits & vegetables, juices, jams, pickles, confec-

This growth was primarily driven from -

• Location advantage as India is geographically close to some of the top export destinations.

• Increased participation of private sector due to in-vestments in the recent past.

• Improvements in product and packaging quality .

The key trends in food exports are:

• US is the top destination for India’s exports of pro-cessed food, followed by Vietnam, Iran, Saudi Ara-bia and UAE.

• Rice is the key food product exported by India, fol-lowed by meat preparations, gaur, gum, wheat and other cereals.

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tionery, chocolates and alcoholic beverages. These products undergo higher level of processing to convert into new or modified products. This is esti-mated to account for the balance 38 per cent of the total processed food and mostly falls in the organ-ised sector.

Regulations, Policies and Risks

Food processing sector is estimated to generate em-ployment for 48 million (13 million directly and 35 million indirectly). In addition, food processing industry is seen as to have the potential to provide alternate employ-ment opportunities to rural youth, who are currently dependent on agriculture or moving to urban areas for employment. Sine a large section of the population is dependent on agriculture and allied sectors, the income enhancement of such a large section of population is possible only through adding value in the food chain.

Government of India has accorded high prior-ity status to food industry with an objective to re-duce inefficiencies resulting in wastages/ losses by setting up infrastructure (expect cold storage facili-ties) and generate huge employment in this sector.

Government Initiatives for Food Industry

• Entities in infrastructure development are given a deduction of 100 per cent for the first 5 years & 30 per cent for the next 5 years for the calculation of taxable income.

• Customs duty on all imported capital goods and raw materials & other inputs is exempted, in addi-tion to excise duty & sales tax on domestic inputs, for all export oriented units.

• There is a provision for duty-free import replenish-ment of inputs, subject to basic input-output norms for approximately 600 export categories.

• Encouragement to private sector – 100 per cent ex-port-oriented units are allowed to sell up to 50 per cent of their produce in the domestic market. Ex-port earnings are exempted from corporate taxes.

• Tax incentives and Sops - Import duty scrapped on capital goods and raw materials for 100 per cent export-oriented units. 100 per cent tax exemption for 5 years followed by 25 per cent in subsequent years.

• Tax exemption for the next 5 years for new agro-processing industries. Full excise duty exemption for goods that are used in installation of cold stor-age facilities.

• Relaxed FDI norms – 100 per cent FDI under auto-matic route (except for alcohol, beer, and sectors reserved for small scale industries). Repatriation of capital and profits permitted.

• Focus on infrastructure - Assigned priority sector for bank credit. 60 Agri Export Zones (AEZ) have been set up across the country. According to Vision 2015, formulated by MoFPI, the government plans to establish 30 mega food parks in public-private partnership mode across the country; out of these 10 have already been approved in the first phase. Government has also announced setting up of 15 Mega Food Parks in its FY12 Budget, as part of the third phase of Mega Food Park Scheme.

• Incentives for development of storage facilities- Investment-linked tax incentive of 100 per cent de-duction of capital expenditure for setting up and operating cold chain facilities (for specified prod-ucts), and for setting up and operating warehous-ing facilities (for storage of agricultural produce).

• Focus on R&D and modernisation - The govern-ment launched initiatives such as the Setting Up/Upgradation of Quality Control/Food Testing Labo-ratory, R&D and Promotional Activity Scheme and the Technology Upgradation/Setting Up/Moderni-sation/Expansion of Food Processing Industries Scheme.

Challenges in the Sector

Food processing industry is key for the overall develop-ment of the economy as it is a critical linkage between the agriculture sector, which is yet to achieve the target yields, and the emerging Indian consumer, whose as-

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pirations and commitments are driving a fundamental shift in his lifestyle preferences, including food habits.

Historically, food processing industry has witnessed low margins due to the investments which need to be made in processing facilities, volatility in material prices due to scarcity of resources and uncertainty in consumer preferences.

Hence, it has been facing lack of funds as banks are re-luctant to extend loan to the industry as this is perceived to be high risk, high gestation period and low returns.

Various industry studies indicate that the top challenges faced by the industry are as follows:

• Ambiguity in the regulations as there is no compre-hensive national level policy on food processing

sector and also as there are inconsistencies in the centre and state policies

• Shortage of skilled manpower is a concern as it is a labour intensive operations

• Supply chain is not geared up for the scale of the sector

• Rising food prices would have an impact on the de-mand for the sector

• Lack of product development and innovation

These challenges are still relevant in the current stage of the food processing industry. While there is scope for growth in the industry, there will be re-strictions due to these challenges.

ConclusionGiven its significance to the national economy, CII accords top priority to growth and development of Food Pro-cessing sector in the economy. As a part of the ‘inclusive growth’ agenda of CII, it is anticipated that the optimum development of food processing sector will contribute significantly in tackling several developmental concerns, such as, disguised unemployment in agriculture, rural poverty, food security, improved nutrition of food, reduc-tion in food wastage etc. The CII National Committee on Food Processing is a high-powered industry forum, which works towards the overall vision of positioning India as a Food Factory to the world. The Committee works in close partnership with Ministry of Food Processing Industries, State Missions on Food Processing, Food Safety Stand-ards Authority of India as well as other stakeholders in this regard.

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Improving Investment in Infrastructure


As per CII’s latest report titled “Investment Re-quirements in India: 2014-15 to 2018-19”, infra-structure investments are estimated to stand at

Rs 64 lakh crore (US$1.07 trillion) in the next five years at current market price and Rs. 29 lakh crore (US$483 billion) at 2004-05 prices. Total investment in infrastruc-ture was 7.21 per cent of GDP during the XI Plan period. The Planning Commission has set a target of raising this to a level of 8.18 per cent of GDP in the XII Plan. With overall investment in the economy doing far below ex-pectations in the XII Plan period so far, achieving the plan investment target in infrastructure is going to be difficult. The report foreassumes that investment in in-

frastructure will increase gradually from 6.9 per cent of GDP in 2011-12 to 8 per cent by 2018-19. Accordingly, it will average only 7.67 per cent over the next five years.

The report further highlights that, in terms of sources of infrastructure investments, share of private sector has gone up from X Plan to XI Plan. XII Plan has further set an ambitious target of 48 per cent of infrastruc-ture investments to be accounted for by the private sector. However, this appears to be a very optimist target in the present scenario, when economic slow-down and policy paralysis in the last 2-3 years has hit the business sentiment hard. Therefore, in the next 5 years, CII expects this share of private sector to be 40 per cent and that of public sector to be 60 per cent.

In view of the importance of this topic in the current milieu, we have invited experts in the field of infra-structure to voice their opinions on its various aspects.

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The reality that states, left to themselves, had neither the political will, bureaucratic energy nor the financial resources to cater to India’s expected need for power was realised as early as 1975 by the Union government.

In order to ensure that the country did not merely de-pend on the uncertain addition of state-owned generat-ing stations, NTPC Ltd (formerly known as the National Thermal Power Corporation Ltd), a central public sector undertaking under the ministry of power, was set up in 1975. It is today the largest power company in India with a generating capacity of 42,964 Mw. The Nuclear Power Corporation of India Ltd, a central government-owned corporation, was set up in 1987 with the objec-tive of undertaking the design, construction, operation and maintenance of atomic power stations. NHPC Ltd (formerly the National Hydroelectric Power Corpora-tion) was incorporated in 1975 with the objective to plan, promote and organise the integrated and efficient development of hydropower. PowerGrid (the Power Grid Corporation of India) was incorporated in 1989 and charged with planning, executing, owning, operating and maintaining high-voltage inter-state power trans-mission systems. Similar needs to push for financing of the power sector led to the creation of the Rural Elec-trification Corporation in 1969, and the Power Finance Corporation in 1986.

The concept of a national power distribution company (NPDC) that builds and owns networks and distributes power is, therefore, well within the realms of possibil-

ity. To suggest that it encroaches on the constitutional right of states to be left alone in the power sector is de-molished by the spate of central involvement and cen-tral schemes over the years.

My colleague and partner P Ramesh (who heads our Group Energy Businesses) and I have been discussing the need for an NPDC for almost a year now.

To start with, the NPDC could be charged with taking over the assets of urban areas falling under the purview of the “Restructured Accelerated Power Development and Reforms Programme” (RAPDRP), as well as being the channelling entity for the central funds for revamp-ing the network in these areas. The RAPDRP scheme envisions reaching a 14 per cent “loss” level after invest-ments and, therefore, what can emerge is an efficient network within five years across almost 1,300 towns that are under the purview of this scheme. With less than 10 per cent of the RAPDRP funds disbursed as of now, the time is right for creating an NPDC. Over time, the entity could also be charged with running the distri-bution network covered under the rural schemes of the Rajiv Gandhi Grameen Vidyutikaran Yojana, with the di-rected subsidy for the needy being routed through this entity in a transparent manner.

In a related development, the government is consider-ing the model in which a power supplier will not man-age the electricity distribution network. In a separate “carriage and contract” model, like the UK, the network

Why India Needs a ‘National Power Distribution Company’

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would be owned by one company, while the suppliers of electricity could be more than one. India has 5,545 ur-ban agglomerations and towns. With the NPDC model in place, the targeted 1,300 towns under the RAPDRP scheme can provide the demonstration effect, setting the example for the rest of the country to emulate.

But why this urgency for a power distribution company at the national level? Here are three pressing reasons:

(i) Fix the leaking bucket of discoms: Distribution is the tail that wags the power dog, and is in the realm of 29 state governments. India’s distribution losses and power sector economics are inter-related, and in the theatre of the absurd. The average cost of supply for all power companies has exceeded the average revenue realised. Not surprisingly, the ac-cumulated losses of financial utilities were esti-mated at Rs 2,00,000 crore at the end of 2011-12, up from Rs 1,23,000 crore at the end of the previous year. The “unintended consequence” in the push for distribution company (discom) profitability is that they are aggressively using load management (power cuts) to control purchases. India just can-not afford to wait any longer for the turnaround of state discoms. Society and the economy are both being held to ransom for what is euphemistically called T&D (“theft & dacoity”) losses. After a Rs 10,000-crore bailout package in 2002, we now have a Rs 2 lakh crore financial restructuring plan for dis-coms. Will that be Rs 10 lakh crore by 2020?

(ii) Stranded capacities and effective alternative to discoms: All stranded capacities, surprisingly, are not because of a lack of gas, coal or evacuation capacity. A substantive portion is because of a lack of off-take by discoms - often referred to as case 1 and case 2 bids. This is an embarrassing waste of ready capacity to deliver power to a power-starved nation that parallely erodes the net worth of pro-

moters and creates stressed assets in the banking sector.

An NPDC would be able to pick up stranded capaci-ties and become an effective market-maker for gen-erators in the face of slothful behaviour by discoms. It would also make for a robust alternative market that could even bring back sparkle to the sector by having sovereign-backed power purchase agree-ments.

(iii) Energy security, price pooling and a national pric-ing benchmark: India clearly requires a price-pool-ing arrangement. First, there is need to diversify our energy basket. If nothing is done, the country is set to become 83 per cent energy-import-dependent by 2040. The diversified basket should embrace nu-clear, hydro, renewable, gas and coal-based power with purpose and focus. Today, discom behaviour is short-sighted and tends to buy from only the cheapest source, which happens to be coal-thermal in the short run. Price pooling can only be achieved at a national level, and national energy-security can-not be left to the self-serving micro decisions of 50+ regional entities.

Second, electricity tariffs cannot be allowed to have great variations from state to state depending on the input-basket, and the vagaries of state regula-tors setting, or not setting appropriate tariffs, and often queering the pitch completely in other ways. The renewable power obligation and its related re-newable electricity certificates trading market have also not taken off. With a combination of input and efficient distribution, an NPDC can create a nation-al price-point for power purchase and retail tariff, which can be the benchmark that other utilities can aspire to emulate.

Clearly, a national power distribution company is an idea whose time has come.

This article appeared in Business Standard dated August 11th, 2014. The online version can be accessed from the fol-lowing link: http://www.business-standard.com/article/opinion/vinayak-chatterjee-why-india-needs-a-national-power-distribution-company-114081101082_1.html

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Distribution continues to be the weakest link in the Indian Power sector with customer not be-ing the centre stage of the delivery process and

the fiscal viability in question. Aggregate Technical and Commercial (AT&C) losses across India continue to be at one of the highest in the world and wastefully tol-erated, despite time and again Delhi and Gujarat have proved that it can easily be corrected.

The commercial losses for discoms in India (after includ-ing subsidies) increased from Rs. 16,666 crore in 2007-08 to Rs. 37,836 crore in 2011-121. According to a report released by the 13th Finance Commission, these finan-cial losses may increase to Rs. 116,089 crore (excluding subsidies) by FY 2016-17, assuming tariffs remain at the 2008 level.2 It is imperative to address the issues that may otherwise jeopardize the growth of an already ail-ing power sector, which in turn continues to be one of the key infrastructural challenges coming in the way of achieving higher rate of GDP growth.

Impact of distribution losses on power value chain

The emphasis of almost all state governments is cur-rently on capacity addition in the generation sector. Capacity addition will not bear fruits unless distribu-tion reforms are taken forward on a war footing. Any increase in generation capacity is more than offset by inefficiencies and wastage at each stage - production,

transmission, distribution and delivery. This is a matter of great concern as the buyers of merchandise have to be solvent and efficient, failing which the fiscal health of all associates in the value chain are impacted and this leads into vicious and unviable circle of uncertainty.

Distribution companies are tiding over the cash short-falls by borrowings from commercial banks and this repeated borrowings with no commensurate increase in efficiency, has seriously undermined the financial health of the sector. Though the previous government had come out with financial restructuring schemes in the recent past, this needs to be viewed only as a short term survival instinct for infusing funds into the ailing distribution sector. Moreover, the financial restructur-ing should be done through due engagement of Elec-tricity Regulatory Commissions and should not be done by the state governments independently. That means money should be made available, as a financial support, to regulators who should then set targets and pursue restructuring to happen only against the achievement of those targets.

Recommended Way Forward

In addition to significant reform-intervention and a combination of tariff increases, going forward, the dis-tribution segment also needs implementation of open access and competition & enforcement of the ‘obliga-tion to service’ and not just use.

Distribution Reforms & Way Forward

1 http://www.adlittle.com/downloads/tx_adlreports/Indian_Power_Disco__s_and_Debt.pdf 2 http://planningcommission.nic.in/reports/genrep/hlpf/ann6.pdf

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The present policy system is governed by the overarch-ing Electricity Act, 2003. The Act replaced the Electricity (Supply) Act, 1948 (which had earlier effectively nation-alized the sector), and introduced a host of reforms like unbundling of State Electricity Boards (SEBs), open ac-cess, competition, development of market mechanisms and independent tariff setting and regulation. It also paved the way for greater private sector participation into a hitherto public sector dominated space.

From the experience of distribution sector reforms, so far, Public Private Partnership (PPP) has helped in the enhancement, effectiveness and discipline in distribu-tion activities. The pace of PPP depends upon the Gov-ernment’s will and private sector appetite for distribu-tion assets. PPP has to be done with an efficient and effective strategy, the main objective being reduction in AT&C losses. Investors seek an anti-theft legislation and its effective enforcement in addition to access for a legal system for a speedy resolution of disputes. Inves-tors also prefer to have a de-risked regulatory regime with clear tariff policy framework from the regulator so that they can understand the extent of independence, philosophy and the overall direction of regulation. This would in turn reduce regulatory risk.

The Electricity Act, 2003 provides for a robust regula-tory framework for distribution licensees to safeguard consumer interests. It also creates a competitive frame-work for the distribution business, offering options to consumers, through the concepts of open access and multiple licensees in the same area of supply. The Act enables competing generating companies and trading licensees, besides the area distribution licensees, to sell electricity to consumers when open access in distribu-tion is introduced by the State Electricity Regulatory Commissions. The concept of open access has been long there but it has not been implemented in a large number of states yet. If implemented holistically, dis-tribution reforms can provide benefits of competition to consumers. This is the thought behind the Mumbai distribution model. However, artificial barrier like Cross Subsidy Surcharges and wheeling charges negatively impact consumer’s right to choose and must be done away with immediately.

PPP also accelerates the implementation of modern technology including Information Technology in utili-ties. This facilitates creation of network information and customer data base which will help in management of load, improvement in quality of Customer Service, detection of theft and tampering, customer informa-tion and prompt and correct billing and collection.

The political environment is an important factor in in-fluencing the investor’s decision. The recent announce-ment by the present government of spending Rs 75,600 crore to supply electricity through separate feeders for agricultural and rural domestic consumption is a pro-gressive initiative aimed at providing round-the-clock power.

Resistance to tariff hikes or reforms in the sector sub-lime the investor’s confidence in the country’s business environment.

Data suggests that the consumption power of Indians has improved significantly, however, the tariffs for elec-tricity are under charged. The tariffs can be accordingly increased such that the system is able to tap into the consumption power to restore sector viability. Tariff growth has not been held back by consumer’s ability to pay but by the inability of the system to tap this paying capacity. Had power tariffs grown in line with house-hold expenses, the Rs 88,000 crore loss at the discoms in the 5 years to FY10 would have turned to a profit of nearly Rs 8,000 crore.

It is time for all stakeholders to come together and plan with a long term focus towards the country’s de-velopment. Privatisation of electricity distribution has brought in significant differences to the sector. It is high time learning and achievements of these experiments are multiplied by adoption in the rest of the country. The criteria for selection of the best suited model should be whether that will enable improvement of the efficien-cies, reduction of losses and bringing in reliability fac-tor much needed. Ultimately, the question one need to answer will be whether you are making the sector customer centric enough to delivery of maximum value to the consumers.

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World over, Public Private Partnership (PPPs) broadly refers to long term contractual part-nerships between the government/ public

and private sector agencies, explicitly aimed at financ-ing, designing, implementing and operating infrastruc-tures services that were traditionally provided by the Public sector. In the case of India, since the early days of economic reforms, infrastructure bottlenecks were of serious concern. Policy makers and leading financial institutions have visualized the need for high quality infrastructure, which is pre requisite to kick start the economic growth in the Country. Specialised Financial Institution like Infrastructure Leasing and Financial Ser-vices (IL&FS) was created to promote Infrastructure on a commercial format using Public Private Partnership.

Evolution of PPP in the Indian High-way Sector

Since the early nineties road had become the dominant mode of transport with above 50 per cent share in the freight as well as above 70 per cent in the passenger traffic. The stress on the road sector came significantly due to the inabilities of the Indian Railways to cater ad-equately to the needs of the public. The need to involve private sector in the development of highway network became inevitable, the Government of India (GOI) amended the National Highways Act 1956 to levy tolls for the use of services of National Highways. Dr. Rakesh Mohan Committee, estimated around Rs. 63,000 crore was required by 2006 to develop our road network to 4 lane and international standards. Subsequent, Ministry of Surface Transport (MOST) had also estimated in line with the expert committee view, these estimations vali-

dated that budgetary support cannot address the need for building National Highways as per international standards in India. National Highway Authority of India was established by on the basis of National Highways Authority Act enacted in 1988. MOST’s policy paper paved the way for of Build, Operate and Transfer (BOT), bidding, tolling, four laning etc.

The first PPP road in India was built in Madhya Pradesh, a 12 km- long tollway linking Indore to the industrial township of Pithampur financed by IL&FS on a build-own-operate-transfer basis. Even though, there were initial resistances from the users paying users fees, over the period of time due to better quality of road, the us-ers appreciated the road. The new road link reduced the distance between Indore and Pithampur by 10 km and curtailed the travel time by over 45 minutes. The Government of Gujarat (GOG) also initiated the BOT approach, Bharuch Dahej Rob was awarded in 1997, GOG along with IL&FS started the Vadodara Halol and Ahmedabad Mehsana BOT (Toll) road projects in 1999 and 2000 respectively. By mid-2000, Model Concession Agreement (MCA) was formulated for BOT (Toll), BOT (Annuity) and Operations, Maintenance and Tolling (OMT) projects, subsequently Request for Qualification (RFQ) and Request for Proposal (RFP) was also intro-duced in the highway sector. Measures like Viability Gap Funding (VGF) also renewed the interest in the sector, due to rapid economic growth, concessionaire instead of seeking a grant for non-viable road project become willing to pay premium based on his assessment on fi-nancial viability. The introduction of revenue sharing model in lieu of upfront negative grant, the road pro-jects implemented under BOT (Toll) become the peren-

Public Private Partnership in Highways Develop-ment and Management: An Indian Perspective

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nial source of revenue for the Authority. The PPP mode of procurement in a bigger way started with NHDP Phase III. As on March 2013, around 239 PPP road pro-jects were awarded. The economic downturn took the sector for a toss; there were significant variations in the projected traffic growth among the various market par-ticipants, which also paved the way for renegotiation of existing contracts with respective clauses.

Issues in the Current framework

During the early days of PPP, the commitment and seriousness towards the respective project were sig-nificantly higher than today (my observation). For example, in one of our initial NHAI project – Belgaum – Maharashtra Border (North Karnataka Expressway Limited), the seriousness and commitment contributed towards the project by the Authority, Concessionaire and the Independent Engineer paved the way for the smooth completion of the project within the stipulated time as per the respective standards. Probably that’s the reason; the road is still one among the best roads in India. However, I feel today we don’t find that kind dedication among the industry participants; partly due to few concessionaires approach as well few officials approach from the Authority. Strong dedication and commitment is expected from the Authority as well as from the concessionaire to revive the PPP interest in the sector.

The widespread industry complaint is regarding the quality of DPR, it has gone down tremendously in the past 4-5 years. The cost estimates seems to be unreal-istic, it’s easily more than 30 per cent in many cases. In most cases the DPR studies have been conducted much earlier, which didn’t address the current inflationary scenario due to the prevailing economic scenario dur-ing those days. Unfortunately the cost of VG-30 bitu-men has increased significantly in recent years. The case is same with all other materials used in the road construction. This in turn has increased the cost of bitu-minous road as well as the concrete road construction significantly. Due to lower project cost, we developers face lot of issues before financial closure of the project. Bankers are reluctant to accept the realistic project

cost, quite often this amount also add to the develop-ers kitty apart from the 30 per cent equity contribution.

As per the Model Concession Agreement (MCA), the Au-thority should provide 80 per cent of the encumbrance free land; it must be handed over to the Concession-aire on or before appointed date with the balance to be handed over within 90 days of the appointed date. For a smooth functioning of PPP, the process of land acquisition must be completed in the DPR stage itself so that 100 per cent of land, free of encumbrance could be handed over to the Concessionaire prior to the declara-tion of appointed date.

A number of projects have been delayed on account of delays in grant of various environmental consents. For the benefit of PPP road project, all environmental con-sents must be available with Government before launch of RFP. Along with that, tree cutting or tree shifting must be completed by government contractors before appointed date. We anticipate the measures adopted by the current government will address the environ-mental and land acquisition issues.

The Road Ahead

It’s a well-known fact that, availability of quality infra-structure, especially roads, is a pre-requisite to achieve broad based and inclusive growth on a sustained basis in India. In order to attain and sustain 7-9 per cent eco-nomic growth in the coming years, highway sector will have to be a main contributory sector. The recent CII es-timates (Investment Requirements in India: 2014-15 to 2018-19) investment requirements to the tune of Rs 10.5 lakh crore in the Roads and Bridges sector, the study anticipates private sector contribution to the tune of 40 per cent. To address these investment requirements, we should have a PPP framework which incorporates international best practices, embodying and enabling contractual framework for construction of highways in an efficient, economical and competitive environment, keeping the user benefits in mind. Ideally, we shouldn’t permit the lack of road infrastructure to prevent the re-gional, sectorial and socioeconomic broadening of the economy and its benefits affecting inclusive growth in India.

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Indian infrastructure today stands at an inflection point – post the slowdown in the economy, dearth of funds and stalled projects, the new government

seems to have breathed a new life into the sector. The once imagined daunting task of a trillion dollar invest-ment into the country’s creaking infrastructure to get it cracking again may finally see the dawn.

In this context, the infrastructure investment target of US$1 trillion as envisaged in the XIIth Plan will have to be met partly from government sources including budget-ary support, internal generation and borrowings. And balance contribution will have to come from private sector and their ability to execute infrastructure pro-jects and take up new investments under PPP. To put that in perspective – in the next five years the public sources of funds are estimated to amount to ~US$600 billion and private players are estimated to bridge the gap of ~US$400 billion.

What has been thus far…

Challenges on the macro-economic front in the last 3 years have considerably slowed down the impressive economic growth that the Indian economy registered over the last decade. The economy, which grew a rate of around 7.6 per cent between 2001-02 and 2011-12, slid to sub-5 per cent growth by 2013-14 and may well continue for 2014-15. Even though the early signs of recovery have started to emerge, if it is to sustain the private sector will have to explore newer avenues for raising money in its effort to put the economy back on high growth trajectory. How to address this clear and present challenge is the focus of our discussion and a few steps which may help overcoming them.

Availability of finances

It will be tight rope-walk in raising the ~US$600 billion required from public sources as the central and state finances will be stretched, traditional banks will be reel-ing under new Basel III regulations, leaving little head-room to extend support to the private sector (which re-quires no less than ~US$400 billion). So far, banks have been the main providers of infrastructure financing, however, they now face a number of barriers like - con-centration risk such as exposure limits to groups and sectors as well as build-up of asset liability mismatches in the system. So the need of the hour is that the private sector adopts innovative fund-raising practices if they are to sustain in the long run. And this shall be achieved only if government support machinery i.e. reforms and policy making is in sync with the sector requirements.

However, in the coming years – estimated amount of government expenditure of US$600 billion and private sector’s US$400 billion - may need to be relooked - as in the short haul - private sector contribution may suffer a setback as they are not in a position to invest. So may be in this plan period - government may have to increase their commitment - or we may have to scale down our expected infra investment quantum.

How this can be done…

The new government has clearly shown its intent by taking the bull by its horn and initiating some key re-form measures to bring the sector back on track. Some of these key measures and few which still remain in the wish list are presented below –

India - Waking up to Realise the Trillion Dollar Dream

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1). Deepening the bond market

This has always been on the wish list of the infra play-ers in the country. World over the long-term bonds form the major part of infra financing and international bonds can provide access to term financing (can be up to 30 year plus tenor) to an extent not available in the bank market. However, credit enhancement for bonds, high withholding tax, lack of integrated trading and set-tlement system have kept the bond markets from real-izing its true potential.

2). Insurance and pension funds to find way into the infra financing

In principle, investing in infrastructure projects ought to be an attractive prospect for institutional investors. The long life of these assets is a perfect match for the long-term liabilities of a pension fund or insurance com-panies. Infrastructure projects offer reliable cashflow, a hedge against inflation, low volatility and returns that are generally not correlated with other assets. Assum-ing that the current sectoral reforms will produce the desired results, ways and means to channel these funds into the projects will be a key focus area. Infrastructure Debt Funds, Infrastructure Investment Trusts are some of the crucial enablers the government is trying to put in place to channelize the funds.

3). Regulatory changes - favorable

5:25 lending model - and exemption of including infra bonds in SLR/CRR - Approved banks lending to infra-structure for 25 years or more, with periodic refinancing every five-seven years and a considerable tail period. The refinancing can be done by the existing bank, a new set of banks, or even via the bond markets. Loans

that are refinanced or reset in this manner would not be considered as restructured and, hence, would not at-tract the higher provisioning requirements attached to restructured loans. The move will go a long way in de-stressing the fund cash-flow requirements in the initial years of the project.

Further, as per the revised regulations the long-term bonds (with a minimum maturity of 7 years) for financ-ing infrastructure projects and for affordable housing, raised by the banks will be not only exempt from statu-tory liquidity ratio and cash reserve ratio requirements, but advances against these bonds are also exempt from priority-sector lending obligations.

4). Project leasing and Supplier’s credit

In recent years, the rising project costs have been the bone of contention between the borrowers and the lenders. However, the lenders are also partly respon-sible for putting the borrowers in a spot of bother by disallowing them a common project financing pattern followed across the world. Enabling structures for pro-ject leasing as existing in the developed nations need to be explored and implemented. Supplier’s credit is an-other such instrument which remains under-utlised by the Indian infra developers which can significantly bring down the pre-operative costs.

Listed above are some of the many ways by which the government is and can bring the sector back on its feet and running. With the GDP estimates looking upwards, countries world-over keen on making long-term com-mitments in the country, we shall be restricted only by our inability in realizing our true potential. Will the sleeping giant respond to the calling – only time will tell.

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CORPORATE SECTOR INDICATORS


Economy & Finance

CII Economy Matters, August-September 2014