India - International University of Japan prime minister, Atal Behari Vajpayee, has called for...

Country Report December 2003

India

December 2003

The Economist Intelligence Unit15 Regent St, London SW1Y 4LRUnited Kingdom

India at a glance: 2004-05

OVERVIEWPolitics in 2004 will be dominated by the general election, due by October. Itcould be held earlier if the Bharatiya Janata Party (BJP, the lynchpin of theruling National Democratic Alliance) performs well in state elections inDecember 2003 in four key states. The outcome of the general election willlargely depend on the ability of the BJP and the main opposition party,Congress, to form alliances with smaller regional parties. Any attempt by theBJP to mobilise its Hindu-nationalist support base could harm its relationshipwith its allies. Relations with Pakistan are improving slowly. The privatisationprocess is likely to slow in the run-up to the election. The economy is growingstrongly, underpinned by a recovery in the agricultural sector, and GDP (atfactor cost) is forecast to grow by 6.2% in fiscal year 2003/04 (April-March).Inflation is forecast to pick up in 2004-05, with industrial sector bottlenecksconstituting the main source of price pressure. The current account will recordrising surpluses in 2004-05, underpinned by growing services exports.

Key changes from last month

Political outlook• The decision to call an early election in Andhra Pradesh may make the

central government more likely to bring forward the date of the generalelection and hold it at the same time as the Andhra Pradesh stateassembly poll.

Economic policy outlook• As the general election approaches, a cut in the benchmark bank rate or

repurchase rate, which would anger savers, will become less likely. Recentsigns of a pick-up in inflation will be another factor limiting the ability of theReserve Bank of India (the central bank) to reduce rates in the short term.

Economic forecast• Continued strong industrial demand and a rebound in the agricultural

sector have led the Economist Intelligence Unit to revise up its forecast forGDP growth (at factor cost) in 2003/04 to 6.2%.

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India 1

Country Report December 2003 www.eiu.com © The Economist Intelligence Unit Limited 2003

Contents

3 Summary

4 Political structure

5 Economic structure5 Annual indicators6 Quarterly indicators

7 Outlook for 2004-057 Political outlook8 Economic policy outlook9 Economic forecast

12 The political scene

18 Economic policy

22 The domestic economy22 Economic trends24 Agriculture25 Manufacturing25 Infrastructure31 Financial and other services

33 Foreign trade and payments

List of tables9 International assumptions summary

11 Forecast summary

23 Components of GDP

24 Summer crop production

26 Proposed pipelines

29 Cellular telephone subscribers

31 Tourist arrivals

32 Information technology companies

34 Trade, reserves and the exchange rate, 2003

34 Current and capital accounts

35 Foreign institutional investors’ transactions in equities, 2003

List of figures

12 Gross domestic product12 Consumer price inflation24 Inflation indices25 Industrial indicators

India 3


Summary December 2003

Politics in 2004 will be dominated by the general election, due by October. Itcould be held earlier if the Bharatiya Janata Party (BJP, the lynchpin of theruling National Democratic Alliance) performs well in five state elections inDecember. The outcome of the election will depend on the ability of the BJPand the main opposition party, Congress, to form alliances with smallerregional parties. Relations with Pakistan are improving slowly. The economy isgrowing strongly, underpinned by a recovery in the agricultural sector, and GDP(at factor cost) is forecast to grow at 6.2% in 2003/04 (April-March). Inflation isforecast to pick up in 2004-05, with industrial sector bottlenecks constituting themain source of price pressure. The current account will record rising surplusesin 2004-05, underpinned by growing services exports.

State assembly election campaigns are in full swing. Congress has suffered anumber of setbacks. The Uttar Pradesh state government has fallen. TheAyodhya issue continues to bubble away. The judicial process in Gujarat hasbeen slow. Civil service reform has been proposed. India has cemented itsrelationship with Israel. The chief minister of Andhra Pradesh, ChandrababuNaidu, has survived an attack. The peace process with Pakistan has continuedslowly. Overflight rights and a Kashmir bus service have remained contentious.

Foreign portfolio investment from Mauritius has been challenged. Investmentby overseas corporate bodies (those bodies that are at least 60%-owned by non-resident Indians, or NRIs) has been banned. Measures to deter NRI investmenthave been introduced. Southern states have amended their alcohol policies.The electricity bill was passed in August; it will give direction to power-sectorreforms in the states. Foreign investment in the print media has grown.

The economy has grown strongly. Lower interest rates have helped the states’finances. A new tax tribunal is to be established. Northern states have ignored acentral government ruling. The introduction of product patents remains con-troversial. Moves to improve the gas and oil pipeline network are under way.The privatisation of two oil companies has stalled. Mobile phone demand isbooming. A new telecommunications licensing scheme has been proposed. Ano-frills airline, Deccan Airways, has been launched. Foreign interest isreturning to the stockmarket. The tourism sector has staged a recovery. A newpension system is being introduced.

The trade deficit has widened. The Reserve Bank of India (RBI, the central bank)has tried to stem capital inflows. Industrial growth has raised demand forimports. The prime minister, Atal Behari Vajpayee, has called for increased tradewith ASEAN. India plans to sign ten free-trade agreements. Shrimp exportshave been threatened by anti-dumping measures.

Editors: Gareth Price (editor); Kilbinder Dosanjh (consulting editor)Editorial closing date: November 20th 2003

All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] report: Full schedule on www.eiu.com/schedule

Outlook for 2004-05

The political scene

Economic policy

The domestic economy

Foreign trade and payments

4 India


Political structure

Republic of India

Federal republic, with 29 states and six union territories

President, currently Abdul Kalam, indirectly elected in 2002 for a five-year term bymembers of the central and state assemblies

The prime minister presides over a Council of Ministers chosen from elected members ofparliament

Bicameral. The Rajya Sabha, or upper house, has 245 members (233 elected by weightedvotes of the elected members of parliament and the legislative assemblies of states andunion territories, and 12 appointed by the president). The Lok Sabha, or lower house, has545 members, 543 elected from single-member constituencies (79 seats are reserved forscheduled castes and 40 for scheduled tribes) and two representatives of Anglo-Indiansappointed by the president

Unicameral or bicameral, with elected members; state governors are appointed by thepresident

Based on the 1950 constitution and English common law

The National Democratic Alliance (NDA), a coalition led by the Bharatiya Janata Party(BJP), won a clear majority in the September-October 1999 election and installed AtalBehari Vajpayee as prime minister. The NDA continues to rule, despite minor changes inits composition

The next Lok Sabha election is due by October 2004

Bharatiya Janata Party (BJP); Indian National Congress (Congress); Communist Party ofIndia (Marxist) (CPI-M); Telegu Desam Party (TDP); Samajwadi Party; Shiv Sena; BahujanSamaj Party (BSP); Dravida Munnetra Kazhagam (DMK); Janata Dal; Samata; All-IndiaAnna DMK (AIADMK); Biju Janata Dal (BJD); Trinamool Congress (TC); NationalistCongress Party (NCP); Rashtriya Janata Dal (RJD); Rashtriya Lok Dal (RLD); ShiromaniAkali Dal (SAD)

Prime minister, planning, statistics & atomic energy Atal Behari Vajpayee (BJP)Deputy prime minister, home affairs & personnel Lal Krishna Advani (BJP)Agriculture Rajnath Singh (BJP)Chemicals & fertiliser Sukh Dev Singh Dhindsa (SAD)Commerce & industry, law & justice Arun Jaitley (BJP)Communications & information technology & disinvestment Arun Shourie (BJP)Defence George Fernandes (Samata)External affairs Yashwant Sinha (BJP)Finance Jaswant Singh (BJP)Heavy industry & public enterprises Subodh Mohite (Shiv Sena)Human resources development, science & technology Murli Manohar Joshi (BJP)Petroleum & natural gas Ram Naik (BJP)Power Anant Gangaram Geete (Shiv Sena)Railways Nitish Kumar (Samata)

Yaga Venugopal Reddy

Official name

Form of state

Head of state

The executive

National legislature

State legislatures

Legal system

National government

National election

Main political organisations

Key cabinet ministers

Central bank governor

India 5


Economic structure

Annual indicators1999 a 2000 a 2001a 2002 b 2003 b

GDP at market prices Rs bnc 19,369.3 20,589.6 22,960.5 24,320.5 26,794.1GDP US$ bn 444.4 450.7 481.4 502.4 578.6

Real GDP growth (%) 7.1 3.9 5.5 4.8 6.4Consumer price inflation (av; %) 4.7 4.0 3.8 4.3 a 4.0Population (m) 997.9 1,014.0 1,030.0b 1,045.8 1,061.6

Exports of goods fob (US$ m) 36,877.0 45,636.0 45,399.0 52,743.0 a 55,417.6Imports of goods fob (US$ m) -45,556.0 -60,268.0 -58,231.0 -65,160.0 a -71,637.8

Current-account balance (US$ m) -3,227.0 -2,639.0 1,761.0 4,656.0 a 481.1Foreign-exchange reserves excl gold (US$ m) 32,667.0 37,902.0 45,871.0 67,666.0 a 93,017.2Total external debt (US$ bn) 98.3 99.1 97.3 98.0 101.8

Debt-service ratio, paid (%) 15.8 14.3 11.7 12.6 14.4Exchange rate (av) Rs:US$ 43.06 44.94 47.19 48.61 a 46.52

a Actual. b Economist Intelligence Unit estimates. c Fiscal years beginning April 1st of year indicated.

Origins of gross domestic product 2002a % of total Components of gross domestic product 2001a % of totalAgriculture 23.6 Private consumption 65.0Industry 26.2 Government consumption 12.8

Mining 2.2 Fixed investment 21.7Electricity, gas & water supply 2.5 Stockbuilding 0.8

Manufacturing 15.4 Exports of goods & services 13.3Services 50.2 Imports of goods & services 13.9

Principal exports 2002ab US$ bn Principal imports 2002ab US$ bnGems & jewellery 8.8 Petroleum & petroleum products 17.7

Engineering goods (incl iron & steel) 8.4 Capital goods 7.7Textiles 5.8 Precious & semi-precious stones 6.1Readymade garments 5.4 Electronic goods 5.4

Chemicals 5.0 Chemicals & related products 4.7

Main destinations of exports 2002 % of total Main origins of imports 2002 % of totalUS 22.9 US 8.0UK 5.2 Belgium 7.5

UAE 5.2 China 5.2Hong Kong 4.6 Singapore 5.2

Germany 4.3 UK 5.2

a Fiscal years beginning April 1st of the year indicated. b Ministry of Finance, Economic Survey 2000-01.

6 India


Quarterly indicators2001 2002 20034 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr

Government finance (Rs bn)Revenue 569.29 781.55 361.55 685.49 645.24 990.89 381.14 979.73Expenditure 886.81 1,253.52 757.15 867.35 930.47 1,574.67 767.22 1,403.79Balance -317.52 -471.97 -395.60 -181.86 -285.23 -583.78 -386.08 -424.06OutputGDP at constant 1993/94 prices (Rs bn)a 3,437.4 3,426.8 3,109.7 2,983.5 3,516.9 3,593.1 3,288.4 n/aGDP at constant 1993/94 prices (% change, year

on year) 6.3 6.3 5.3 5.2 2.3 4.9 5.7 n/aIndustrial production index (1993/94=100) 168.8 177.1 167.5 171.9 178.5 188.7 177.1 182.2

PricesConsumer prices (1982=100) 469.7 467 472.3 483.3 486.7 484.7 494.7 499.7Consumer prices (% change, year on year) 4.8 5.1 4.5 4.0 3.6 3.8 4.7 3.4

Wholesale prices (1993/94=100)General index 162.0 161.1 163.7 166.9 167.4 170.2 173.6 174.2Fuel 229.5 228.6 231.9 238.4 240.1 247.8 248.2 250.6Manufactured goods 144.3 144.2 145.6 148.1 148.5 150.5 153.8 155.3Financial indicatorsExchange rate Rs:US$ (av) 47.98 48.59 48.96 48.60 48.29 47.77 47.06 46.01Exchange rate Rs:US$ (end-period) 48.18 48.80 48.87 48.38 48.03 47.55 46.47 45.85Bank rate (end-period; %) 6.50 6.50 6.50 6.50 6.25 6.25 6.00 n/aLending rate (av; %) 12.00 12.00 12.00 12.00 11.67 11.50 11.50 n/aM1 (end-period; Rs bn) 3,846.0 4,017.3 4,204.5 4,206.8 4,324.9 4,524.5 4,755.2 n/aM1 (% change, year on year) 10.0 11.5 11.3 13.1 12.5 12.6 13.1 n/aM2 (end-period; Rs bn) 13,368 13,821 14,911 15,345 15,609 15,958 16,689 n/aM2 (% change, year on year) 14.3 14.4 17.0 17.4 16.8 15.5 11.9 n/aBSE Sensex (end-period; 1978/79=100) 3,262 3,469 3,245 2,991 3,377 3,049 3,607 4,453BSE Sensex (% change, year on year) -17.9 -3.7 -6.1 6.4 3.5 -12.1 11.2 48.9Sectoral trendsCrude oil production (m barrels/day) 0.75 0.74 0.75 0.76 0.76 0.76 0.73 0.75Production index (1993/94=100)Manufacturing 173.9 184.1 173.1 178.0 184.5 196.8 183.4 190.2Mining 137.2 141.1 131.4 134.2 143.6 149.1 138.7 138.1Electricity 160.6 163.1 160.6 163.5 167.8 165.5 167.3 166.0Foreign trade (Rs bn)Exports fob 493 579 580 637 601 659 596 697Imports cif -596 -604 -668 -720 -755 -767 -803 n/aTrade balance -104 -25 -88 -83 -154 -108 -206 n/aBalance of payments (US$ m)b

Merchandise trade balance fob-fob -2,886 -2,281 -2,752 -2,661 -4,350 -3,147 -5,854 n/aServices balance 1,446 1,704 894 1,541 2,655 1,675 1,583 n/aIncome balance -1,004 -872 -1,318 -967 -1,379 -1,271 -1,118 n/aNet transfer payments 3,090 3,373 3,586 3,684 3,989 3,958 4,185 n/aCurrent-account balance 646 1,924 410 1,597 915 1,215 -1,204 n/aForeign reserves excl gold (end-period) 45,871 51,671 55,363 60,319 67,666 72,566 79,519 n/a

a At factor cost. b Reserve Bank of India.

Sources: Centre for Monitoring Indian Economy, Monthly Review of the Indian Economy; IMF, International Financial Statistics; International Energy Agency, Monthly Oil Market Report;

Financial Times; Reserve Bank of India.

India 7


Outlook for 2004-05

Political outlook

The political environment is heating up in the run-up to four key state electionsto be held on December 1st this year. The outcome of the elections—in Delhi,Rajasthan, Madhya Pradesh and Chhattisgarh—will be crucial in deciding thetiming of the general election, due by October 2004 (an election also took placein Mizoram on November 20th; the vote will be counted on December 2nd). Ifthe Bharatiya Janata Party (BJP) performs well in the state elections it maychoose to bring forward the general election—possibly to March, when it couldbe held at the same time as another state poll, in Andhra Pradesh. The deputyprime minister, Lal Krishna Advani, is thought to be keen to hold the electionearly to capitalise on the feel-good factor associated with this year’s goodmonsoon rainfall and strong economic growth. The BJP appears unlikely to winin Delhi, but if it performs well elsewhere an early election is possible.However, the Economist Intelligence Unit’s current assumption is that theelection will not take place until later in 2004.

The BJP-led government will be keen to present the general election as apersonality contest between the prime minister, Atal Behari Vajpayee, and theleader of the main opposition Congress party, Sonia Gandhi, but it will also tryto mobilise its core Hindu-nationalist support base. This will involve a difficultbalancing act. Hindu extremist groups are campaigning for the right to build atemple on the site of a demolished mosque at Ayodhya—an issue that is almostguaranteed to inflame communal passions. Moreover, the smaller parties in theruling coalition, the National Democratic Alliance (NDA), oppose moves toallow the temple to be built. Although Mr Vajpayee has a reputation as amoderate, many around him—probably including Mr Advani—will be keen tofight the election on a hardline Hindu-nationalist platform.

The response of Congress will be crucial. If Congress campaigns on a secularplatform it could become a more attractive ally than the BJP for smaller parties.However, Congress is less willing than the BJP to offer any concessions topotential allies, and so the nature of coalition politics may favour the BJP,which has successfully managed a disparate coalition since 1999. The BJP’ssuccess has been largely based on its ability to offer sops to many of theconstituent parties, but has also stemmed from Mr Vajpayee himself, who isrespected across the political spectrum. It is doubtful whether the NDA wouldsurvive were he to be replaced by the hawkish Mr Advani.

The greater the likelihood of a Congress victory, the more vociferous will be theBJP’s criticism of Mrs Gandhi’s Italian origins. Congress, by contrast, will try tofight the election on issues, one of which will be corruption. We do not expecteither the BJP or Congress to secure an outright majority. Pre-election coalition-building and post-election horse-trading will determine the make-up of thenext government. Provided that the coalition is relatively stable, the politicalsituation will calm down after the election. However, if neither the BJP nor

Domestic politics

8 India


Congress wins enough seats to dominate a post-election coalition, a furtherperiod of instability may result, and another election will loom large.

Despite the increasing frequency of offers of confidence-building measures byboth India and Pakistan, many of the proposals appear to be intended more toappease other countries than each other, and the relationship between the twois expected to improve only slowly, if at all. On October 22nd India proposed anumber of measures to accelerate the normalisation of relations with Pakistan.However, only the uncontentious issues, such as sporting links, will befollowed through in the short term. Pakistan wants a wide-ranging dialoguefocussed on Kashmir, and views India’s offers as an attempt to divert attentionfrom the key dispute.

The latest proposals are an attempt to restore the momentum behind the thawin bilateral relations since Mr Vajpayee launched a major peace effort in Aprilthis year. However, they include elements of political calculation. If progress ismade, the BJP could benefit from a “peace” dividend; if it fails, BJP supporterswould be energised in an election year. A resolution of the dispute overKashmir is unlikely in the near future, as neither government is strong enoughto offer major concessions.

Economic policy outlook

Strong economic growth and large capital inflows have raised the possibilitythat the economy may overheat, although we do not consider this to be amajor risk at the moment. As at November 17th, the Bombay Stock Exchangehad risen by 46% for the year, driven largely by foreign institutional investors.Foreign-exchange reserves have continued to grow. Money-market interest ratesare falling, the rate of wholesale price inflation has been increasing and thelarge fiscal deficit has boosted spending. As India’s foreign-exchange reserveshave risen, the currency has continued to appreciate. Factors weighing againstoverheating include relatively high prime lending rates and India’s persistentinfrastructural bottlenecks.

We forecast that India’s consolidated central government deficit will narrowslightly to 5.6% of GDP in fiscal year 2003/04 (April-March) and will fallgradually to 4.9% in 2005/06. The government’s fiscal deficit target for 2003/04is 5.4% of GDP, although this appears increasingly likely to be overshot. Thegovernment has been trying to improve tax collection, and has eased itsexpenditure by paying back more expensive debt and replacing it with cheaperborrowing. But the temptation to overspend in the run-up to the election willput the deficit under pressure.

Although the government’s fiscal position is broadly under control, currenttrends have been clouded by several anomalies. Total tax revenue fell in thefirst quarter of 2003/04, reflecting unusually large tax refunds awarded at thestart of the fiscal year. In the next three months, tax revenue rose by 5.3% yearon year. Direct tax collection through end-September, excluding refunds, wasrunning about 12% ahead of that in the previous year, driven in part by highercorporate tax revenue. The weakness in total tax revenue was, however, more

International relations

Policy trends

Fiscal policy

India 9


than offset by loan recoveries as states paid back loans from the centralgovernment. As a result, the central government’s total receipts rose by 30%year on year in April-September. But with total expenditure already runningnearly 10% ahead of the previous year’s levels, and election-related spendingpressures mounting, the full-year deficit will improve only modestly on the2002/03 level of 5.9% of GDP.

The other key determinant of the fiscal deficit is the privatisation process. Thesale of the government’s stakes in Hindustan Petroleum and Bharat Petroleum,which could realise US$1.5bn-2bn, has stalled following a Supreme Court orderthat parliament must vote on the sale. The government may ask for a review ofthe order, but progress is likely to be limited before the general election, and ithas been reported that the government expects to receive only aroundRs30bn (US$645m) from its privatisation programme, compared with the initialtarget of Rs132bn.

On November 3rd, in its mid-term review of monetary policy, the Reserve Bankof India (RBI, the central bank) left interest rates unchanged, defying marketexpectations of a cut. The rise in inflation in September and October, andcontinued economic expansion, mitigated against a rate cut. The key issue forthe RBI was and remains the prime lending rate charged by commercial banks,which has been stuck at 10.5-11.5% since May, despite ample liquidity.Persuading the banks to lower the rates they charge will remain a higherpriority than reducing the repurchase rate (which was cut by 50 basis points to4.5% in August) or the benchmark bank rate (currently at 6%), not least becausea cut in these rates would harm savers and would be unpopular in an electionyear. Although a reduction in one of these rates remains possible in 2004, theRBI will strive to find more effective means of encouraging lending.

Economic forecast

International assumptions summary(% unless otherwise indicated)

2002 2003 2004 2005GDP growthWorld 2.9 3.4 4.1 4.1US 2.4 3.0 4.0 3.3EU 1.0 0.6 1.9 2.2Exchange ratesUS$ effective (1990=100) 127.7 113.0 106.7 110.4¥:US$ 125.3 115.7 109.8 114.8US$:€ 0.94 1.13 1.23 1.19Financial indicatorsUS$ 3-month commercial paper rate 1.70 1.08 1.38 3.56¥ 2-month private bill rate 0.10 0.05 0.10 0.10

Commodity pricesOil (Brent; US$/b) 25.0 27.6 19.6 18.9Gold (US$/troy oz) 310.3 357.8 350.0 320.0Food, feedstuffs & beverages (% change in US$ terms) 12.7 5.5 3.2 11.1Industrial raw materials (% change in US$ terms) 2.2 9.0 3.1 4.4

Note. Regional GDP growth rates weighted using purchasing power parity exchange rates.

Monetary policy

International assumptions

10 India


We estimate that world GDP will grow by 3.3% (at purchasing power parityexchange rates) in 2003—a modest improvement on 2002. Growth in the US isforecast to rise to 3.9% in 2004 and to 4.1% in 2005, underpinning world GDPgrowth and increasing demand for India’s information technology (IT)-relatedand back-office services exports. A decline of nearly 30% in average oil prices(dated Brent Blend) will also benefit India’s external accounts, as India importsalmost all of its oil.

In view of a rebound in the agricultural sector and continued industrialexpansion, we have raised our forecast for GDP growth (at factor cost) in2003/04 to 6.2%. This is based on an agricultural sector contraction of 3.2% (inreal terms) in 2002/03. The RBI forecasts GDP growth of 6.5-7% in 2003/04, butthis is only likely to be achievable if last year’s contraction in agriculture turnsout to have been greater (a revision of the data is likely). We currently forecastthat the agricultural sector—a major determinant of private consumption andthe sector on which around two-thirds of India’s population depends—willgrow by 4.5% in 2003/04.

The main sources of growth, however, will be the industrial and servicessectors. The index of industrial production grew by 6.2% in the first five monthsof 2003/04, and we forecast that the industrial sector will grow by 6% in the fullyear. The government’s index of manufacturing production has also risen bymore than 6% year on year in recent months. Manufacturing should remainstrong as rising agricultural incomes support higher rates of private consump-tion, and government spending on transport infrastructure will underpin stronggrowth in the construction sector. Private consumption also appears robust:sales of cars and multi-utility vehicles rose by 28% year on year in April-September, and the number of new mobile phone subscribers rose by 166%.

In 2004/05 we expect slower agricultural growth of 2.5%. Following thehistorical pattern of alternating stronger and weaker harvests, we expect thesector to pick up slightly in 2005/06 and to grow by 4.3%. The main engine ofgrowth in 2004/05 and 2005/06 will continue to be the services sector,propelled by the shift of back-office functions from Western countries to India.

Year-on-year wholesale price inflation averaged 5% in the first three weeks ofOctober, the highest rates recorded since July. The recent rises are largely a resultof higher prices for foodstuffs, and should cease after crops—buoyed by strongmonsoon rains—are harvested in November. The main source of price pressurein 2004-05 is likely to be bottlenecks in the industrial sector. Consumer priceinflation, which is reported with a lag, follows a similar trend to that ofwholesale price inflation. Continued rupee appreciation will reduce importcosts and also restrain price rises. The consumer price index remainedstationary in September compared with August, as a result of which we havelowered our estimate for average consumer price inflation in 2003 to 4%.Inflation is forecast to rise by an average of 4.7% next year and 6.3% in 2005 onthe back of higher prices for manufactured goods and slight rupee depreciation.

Economic growth

Inflation

India 11


Despite efforts by the RBI to discourage capital inflows, the rupee hascontinued to appreciate. Year-on-year appreciation has been greater than 5%since June, driven by strong foreign portfolio investment. Net foreign equityinflows in 2003 amounted to US$5.2bn as at October 22nd, compared withUS$763m for 2002 as a whole. These inflows have contributed to continuedgrowth in total reserves, which reached US$93bn on November 7th. We nowexpect an average exchange rate of Rs46.5:US$1 in 2003. The rupee should begindepreciating slowly in the second quarter of 2004 as the US dollar strengthensand government efforts to restrain the currency become more aggressive. Weexpect the currency to average Rs45.1:US$1 in 2004 (the annual appreciationbeing a result of the base effect) and Rs46.5:US$1 in 2005. However, given thatIndia’s inflation rate is relatively high, this will still imply a real exchange-rateappreciation of around 5.8% in 2004 and 0.4% in 2005.

We estimate that India will record a current-account surplus of 0.1% of GDP in2003. The surplus is forecast to increase to 0.4% in 2004 and 0.8% in 2005, ascurrency depreciation leads to a slowdown in import growth and servicesexports continue to grow strongly. Nevertheless, after six consecutive quartersof surpluses India recorded a current-account deficit of US$1.2bn in the secondquarter of 2003, driven by surging imports.

In the April-September period exports grew by 16% year on year. However,imports expanded by 21%, driven by rising investment and robust privateconsumption. Both trends partly reflect base-year effects, but could also signaldifficulties associated with the strengthening currency. We expect India torecord a trade deficit of more than US$16bn in 2003. Given that oil prices areforecast to fall and that the currency is expected to begin depreciating from thesecond quarter of 2004, import growth should slow in 2004. We expect theservices account to record rising surpluses in 2004-05, owing to strong growthin the IT sector and in IT-enabled services. The greatest risk to the forecastrelates to current transfer receipts. In the first half of 2003 transfers rose by 20%year on year, but these inflows remain vulnerable to an upsurge in the use ofunderground channels for the transfer of money.

Forecast summary(% unless otherwise indicated)

2002a 2003 b 2004c 2005c

Real GDP growth 4.8b 6.4 6.9 7.3

Industrial production growth 4.9 6.6 7.1 7.3Unemployment rate (av) 9.3b 8.9 8.6 8.4

Consumer price inflation (av) 4.3 4.0 4.7 6.3Consumer price inflation (year-end) 3.2 5.0 5.5 6.7

Short-term interbank rate 11.9 11.5 11.5 11.8Government balance (% of GDP) -5.9b -5.6 -5.3 -4.9Exports of goods fob (US$ bn) 52.7 55.4 61.3 67.1

Imports of goods fob (US$ bn) -65.2 -71.6 -76.1 -82.9Current-account balance (US$ bn) 4.7 0.5 2.8 6.0

Current-account balance (% of GDP) 0.9b 0.1 0.4 0.8

Exchange rates

External sector

12 India


Forecast summary(% unless otherwise indicated)

Total foreign debt (year-end; US$ bn) 98.0b 101.8 105.9 104.5Exchange rate Rs:US$ (av) 48.61 46.52 45.14 46.50

Exchange rate Rs:¥100 (av) 38.78 40.20 41.13 40.52Exchange rate Rs:€ (av) 45.93 52.66 55.52 55.10Exchange rate Rs:SDR (av) 62.97 65.19 66.06 66.61

a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.

The political scene

A state assembly election took place in Mizoram on November 20th, andfurther state elections will take place in Delhi, Rajasthan, Madhya Pradesh andChhattisgarh on December 1st. The results of the polls will provide a keyindicator of the outcome of the general election, which will be held by October2004. As a result, the state elections are being keenly fought by both theBharatiya Janata Party (BJP, the lynchpin of the ruling National DemocraticAlliance or NDA) and the main opposition Congress party.

The Central Bureau of Investigation (CBI) has charged Ajit Jogi, the chiefminister of Chhattisgarh, with having forged a letter from the InformationBureau, another investigation agency. On April 1st Mr Jogi had sent a copy ofthe letter to the prime minister, Atal Behari Vajpayee. The letter alleged that MrJogi had moved assets abroad; he said that the charge was false, and asked thatthe CBI should investigate it. The following day he released the letter to thepress. The CBI contends that Mr Jogi fabricated the letter, presumably to pre-empt discovery of the funds. The Election Commission (EC) also took him totask for breaching election rules by distributing bags bearing his picture toschoolchildren. Mr Jogi said that the distribution had started before the rulescame into force. James Michael Lyngdoh, the Chief Election Commissioner,accused the bureaucrats of Chhattisgarh of being even more partisan that thosein Gujarat (see below). Meanwhile, on November 18th the BJP’s likely candidatefor chief minister of Chhattisgarh resigned after being filmed accepting moneyfrom an unnamed Australian mining company.

State assembly electioncampaigns are in full swing

Controversy dogs Congressand the BJP in Chhattisgarh

India 13


The chief minister of Madhya Pradesh and Congress leader in that state,Digvijay Singh, also faces difficulties, particularly over infrastructural problemssuch as poor roads and a chronic power shortage. Early in 2003 Mr Singh hadtried to divert attention from developmental issues by asking the centralgovernment to pass a law banning cow slaughter. However, Mr Singh’sattempts to fight the BJP on its own turf quickly fizzled out. The centralgovernment responded by drafting its own bill to ban cow slaughter, but theissue lost momentum in August when smaller parties in the NDA refused tosupport the bill.

Congress lost two by-elections in September. In January, Sushilkumar Shindehad replaced Vilas Deshpande as chief minister of Maharashtra, and hisparliamentary seat became vacant. In the September election, his seat was lostto the BJP. In Kerala, Congress lost a seat to the Left Front, which was openlysupported by K Karunakaran, a senior Congress leader who has been smartingat the choice of his rival, A K Antony, as chief minister. Despite his opendisloyalty, Congress took no action against him because it did not want to makewaves just before the state elections.

The EC is applying the strict disclosure rules set out by the Supreme Court inMay 2002 in the forthcoming elections. The rules have discomfited politicians,and in October last year the central government passed an amendment to theRepresentation of the People Act that nullified the Supreme Court direction.The Supreme Court declared the amendment ultra vires in March this year, andrestored the direction, which requires candidates to disclose the following:

• offences punishable with imprisonment of which any candidate has beenaccused or convicted, and details of convictions;

• movable and immovable assets of the candidate, their spouse anddependants;

• monies owed as taxes and for loans from banks and financial institutions;and

• school and university education.

In October the CBI filed a first information report in the Taj Heritage Corridorcase against the former chief minister of Uttar Pradesh, Mayawati, the stateenvironment minister, Nasimuddin Siddique, and six bureaucrats. The caserelated to the construction of a shopping mall close to the Taj Mahal. The lawforbids construction within 300m of an archaeological monument. InNovember the CBI froze 84 bank accounts belonging to Mayawati and herrelatives containing Rs11m (US$240,000), and seems likely to file a case allegingthat her assets are disproportionate to her income.

Mayawati had resigned as chief minister of Uttar Pradesh in August. Althoughher party, the Bahujan Samaj Party (BSP), held just 111 seats in the 403-seat statelegislature, she had managed 15 months earlier to form a coalition governmentwith the BJP, which held 87 seats. The state-level leaders of the BJP wereincreasingly unhappy with her autocratic ways, but felt obliged to cohabit with

Congress’s hold on power inMadhya Pradesh looks weak

A shopping mall causes thedownfall of a chief minister

The Election Commission iscracking down on politicians

14 India


her in the expectation that the BSP would support the BJP in the comingelections. In August Mayawati withdrew her support for the centralgovernment, claiming that 40 BJP members of the state assembly planned todefect to join the Samajwadi Party (SP).

Mulayam Singh, the leader of the SP, subsequently asked the governor of UttarPradesh, Vishnu Kant Shastri, to allow him to be called to form a government,and on September 8th he won a vote of confidence, with 244 votes out of 401.His supporters included: 37 members of the BSP, who joined the SP (had lessthan one-third of the party’s members of the legislative assembly split, theywould have been disqualified); the main opposition party, Congress, whichsupported him without joining his government; the Rashtriya Lok Dal, whoseleader, Ajit Singh, had resigned as the federal minister of agriculture in May;and the Rashtriya Krishak Party, led by Kalyan Singh, who had been a BJP chiefminister in the early 1990s but was subsequently expelled. In OctoberMulayam Singh formed a cabinet of 95 ministers, which included most of theBSP renegades.

The BJP had counted on the support of the BSP and its lower-caste vote bank,in the state elections as well as the general election. The BJP now appears to betrying to mend fences with Mulayam Singh. Soon after he formed hisgovernment, Mr Singh faced a test. The campaign to build a temple on the sitein Ayodhya of the Babri Masjid mosque, demolished in 1992, is spearheaded bya Hindu extremist organisation linked to the BJP, the Vishwa Hindu Parishad(VHP). The VHP announced that it would organise a mass congregation at thesite on October 17th. In 1997 Mr Singh had faced a similar threat, and had usedthe police to break up the mob by force, invoking the ire of the BJP. This time,however, instead of making his task more difficult, the central government sentover 10,000 paramilitaries to help maintain order. The troops sealed offAyodhya and arrested 35,000 volunteers before they got there. Senior leaders ofthe VHP were also arrested. All were released on the evening of October 17th,and the campaign fizzled out. In an attempt to win over Hindu nationalists,Mr Singh is now planning to spruce up Mathura, the claimed birthplace of aHindu deity, Krishna, and to develop it as a major place of pilgrimage as acounterpoint to Ayodhya, which is claimed to be the birthplace of Rama.

In September a senior BJP leader, Murli Manohar Joshi, the minister of humanresource development, offered Mr Vajpayee a letter of resignation. A courttrying the case relating to the destruction of the Babri Masjid had decided tocharge him and six others, although the deputy prime minister, Lal KrishnaAdvani, was not charged. Mr Vajpayee returned the resignation letter toMr Joshi, and asked him to file an appeal, which he did. In November the UttarPradesh government sought to revise the charge sheet it had filed, and statedthat it wanted to withdraw the charges of conspiracy against the BJP leaderspresent during the demolition.

During the anti-Muslim riots in Gujarat in March 2002, 14 people were burnt todeath in the Best Bakery in Baroda. In the subsequent police case 37 of the 43witnesses turned hostile, and the special fast-track court acquitted the 21

The pace of justice in Gujaratis slow

Splits in the parties enableMulayam Singh to take power

The Ayodhya issue continuesto bubble away

India 15


accused in June 2003, blaming a poorly handled investigation by the police. Inearly August the National Human Rights Commission (NHRC) asked theSupreme Court for a retrial, and for four other cases to be transferred to otherstates. Soon after that, the Gujarat government filed an appeal in the GujaratHigh Court against the Best Bakery verdict.

In its counter-affidavit to the Supreme Court, the Gujarat government said thatthe NHRC had been carried away by a media campaign casting aspersions ongovernment functionaries, and said that no witnesses had complained ofthreats during the trial. The Supreme Court, however, said that it had noremaining faith in the government, whose prime responsibility was to protectthe people and punish the guilty. Chastened, the Gujarat government promisedto amend its appeal and to provide protection for witnesses. The SupremeCourt asked the Gujarat High Court to begin hearing the Best Bakery appeal onDecember 1st, and to dispose of it quickly.

A Maoist guerrilla group, the People’s War, detonated a mine under the carof the chief minister of Andhra Pradesh, Chandrababu Naidu, on September30th. Mr Naidu suffered minor injuries and two members of the legislativeassembly who were with him were severely injured. The People’s War said thatthe attack had been prompted by Mr Naidu’s subservience to internationalfinancial institutions. The People’s War (previously known as the People’s WarGroup) was founded in 1976 and is thought to have about 4,000 cadres. In thepast year-and-a-half it has attacked several major industrial plants, and threeyears ago it killed Madhava Reddy, a former home minister.

Mr Naidu returned to work within a week. After completing his visit to thetemple he held a series of meetings to discuss whether his party, the TeluguDesam Party (TDP), should capitalise on the sympathy generated for him byholding an early election, and on November 14th the TDP voted unanimouslyto do so. (The state election is due by October 2004). Mr Naidu asked the EC tohold the election in February, but the EC said that March was the earliest that itcould be held. The BJP would have liked Mr Naidu to hold the state election atthe same time as the general election: this would have allowed the BJP to offersupport for his candidates in the state assembly in return for Mr Naidu’ssupport of BJP candidates in the general election. But Mr Naidu may now gainBJP support without having to make such an explicit offer in return.

The police in many states have used the Prevention of Terrorism Act, passed inearly 2002, with enthusiasm. Numerous people, including minors, have beenjailed for offences with scarcely any connection to terrorism, and state-levelreview committees have been largely ineffective. At the end of October thecabinet passed an ordinance empowering both central- and state-level reviewcommittees to decide whether there is a case to answer in any given instance,and making their decisions binding on state governments.

In December 2002 Mr Vajpayee set up a committee on civil service reform,chaired by Surinder Nath, an ex-chairman of the Union Public ServiceCommission (UPSC). The committee examined three central services—theIndian Administrative Service (IAS), the Indian Police Service and the Indian

Civil service reform isproposed

The anti-terrorism bill is toneddown

The chief minister of AndhraPradesh survives an attack

16 India


Foreign Service, and recommended that the present system of annualconfidential reports for staff should be replaced by open, computerisedappraisals on a scale of one to ten. To make bureaucrats more flexible, itproposed that civil service functions should be divided into 11 domains, ofwhich every civil servant would be assigned to at least three. Civil servantsshould be medically examined once every two years, and a standingcommittee under the cabinet secretary should weed out the inept and mentallyunfit. An eminent persons’ group should judge the integrity and professionalcapability of staff. An empanelment commission to be chaired by the chairmanof the UPSC should choose candidates for administrative posts; a minister mustchoose from the panel.

Business and military links between India and Israel are growing, and India hasnow replaced Turkey as the largest buyer of Israeli military equipment. Indiaplaced orders for Israeli drone aircraft—Searcher and Heron—in August 2001.The purchase of the Phalcon airborne early-warning system has been given USconsent, which Israel considers important because of the US aid it receives. TheUS was originally wary of the deal, as such a purchase could have destabilisedfurther the already tense relations between India and Pakistan. India is alsointerested in the Israeli-manufactured Patriot and Arrow missiles. The Israeliprime minister, Ariel Sharon, visited India in September, together with thedeputy prime minister, Yosef Lapid, and a 100-strong delegation that includedbusiness leaders. Israel and India signed six agreements relating to theenvironment, health, education, cultural exchanges, visa waivers for officialsand steps to combat drug trafficking.

After 21 years of prevarication, in September India signed a contract with a UK-based defence and aircraft manufacturing group, BAE Systems, to buy 64 Hawkadvanced trainer jets for the Indian Air Force, at a cost of Rs124.6bn (US$2.7bn).Under the deal, 42 of the planes will be manufactured in India and theremainder will be delivered in flying condition. BAE will also train the pilots.The UK Royal Air Force recently placed an order for a more advanced versionof the Hawks, and that order is thought to have prompted India’s decision.

Sri Lanka’s prime minister, Ranil Wickremesinghe, gave a speech in Chennai inSeptember, in which he called for the economic integration of Sri Lankaand South India and the construction of a bridge across the Palk Straits.Mr Wickremesinghe visited Delhi in October, and initiated talks on a defenceco-operation agreement. An agreement on economic co-operation is to besigned by next March. Mr Wickremesinghe appears keen to bolster Sri Lanka’srelationship with India in order to keep the Tamil Tigers in check.

In April Mr Vajpayee offered a “hand of friendship” to Pakistan. Both sides thenmade some tentative peace offerings. A bus service between Lahore and NewDelhi was resumed, and there was a relaxation of the visa regime by both sidesfor journalists, parliamentarians and business people. However, followingcontinued violence in Kashmir, both countries soon began to trade accusatorystatements. In his speech to the UN General Assembly in September, the dayafter Pakistan’s president, General Pervez Musharraf, had given his own speech,

India cements its relationshipwith Israel

Sri Lanka’s prime ministercalls for greater ties with India

The peace process withPakistan continues—slowly

India 17


Mr Vajpayee reiterated the Indian position that India would negotiate withPakistan on Kashmir only if Pakistan prevented terrorists from crossing intoIndia. But on October 15th Kanwal Sibal, the Indian foreign secretary, contactedthe Pakistani ambassador with a proposal for confidence-building measures.Within hours the proposal had been publicised on Indian television. Pakistan’sMinistry of Foreign Affairs welcomed the Indian offer, but said that India hadonce again “sidetracked the main issue of a composite peace dialogue soughtby Pakistan”.

India’s offer is wide-ranging, and includes the following points.

• India is ready to resume and extend air and rail links;

• it wants to increase the frequency of the bus service between Lahore andNew Delhi, and to start another service between Srinagar in Indian-heldKashmir and Muzaffarabad in Pakistani-held Kashmir;

• it is ready to resume sporting links with Pakistan;

• it seeks to liberalise the visa regime and enable senior citizens (aged 65 andabove) to cross the border on foot (and not only by rail or bus);

• it is ready to establish a hotline between the two countries’ coast guards;

• it says that both sides should stop arresting fishermen in certain sea areas;

• it has offered to provide free medical treatment to 20 Pakistani children;

• it does not object to a reciprocal increase in the number of staff at the twoHigh Commissions and the issuing of visas in other cities; and

• it is thinking of running a ferry service between Mumbai and Karachi.

A week later the process was repeated in Islamabad: Pakistan’s foreign secretary,Khursid Kasuri, conveyed the Pakistani response orally, and publicised it in atelevised press conference soon after. Although both the proposal and theresponse are chess moves rather than genuine goodwill gestures, they will leadto modest progress in the near future: diplomatic staff will go back to theconsulates outside the capital and start issuing visas, and in March the Indiancricket team will visit Pakistan for the first time in 14 years. One of the mainbones of contention was the Srinagar-Muzaffarabad bus link. Pakistan wantsthe UN to staff the checkpoints and issue travel documents, and is concernedthat anything short of this could be used by India as a means to legitimise theexisting line of control.

Another important dispute relates to overflights. Previous rounds of talks onrestoring air links and overflights have failed to produce results. India says thatthe restoration of rail links is conditional on a restoration of overflight rightsand air links. But Pakistan wants to bind India to a bilateral agreement pre-venting it from banning overflights—a step it has taken on at least threeoccasions in the past. India refuses to concede on this issue. The Pakistanis havedug their heels in because they believe India’s need is greater than Pakistan’s:there are many more potential Indian commercial overflights of Pakistaniterritory than vice versa.

Overflights and a Kashmir busservice remain contentious

18 India


Separately, India’s foreign minister, Yashwant Sinha, has confirmed thatMr Vajpayee will attend the South Asian Association for Regional Cooperation(SAARC) conference that is to be held in Islamabad on January 4th-6th,although direct bilateral talks are unlikely at that time.

In April The Hindu, the leading English-language newspaper in South India,reported that members of the Tamil Nadu state ruling party, the All-India AnnaDravida Munnetra Kazhagam (AIADMK), had refused to let oppositionmembers speak in the state assembly. Incensed with the reporting of itsproceedings, the speaker of the Tamil Nadu assembly, K Kalimuthu, ordered sixjournalists from the paper to be jailed. Policemen barged into the newspaper’soffice and the journalists’ homes, but managed to arrest only one. In the midstof widespread protests by journalists and support from leaders of otherpolitical parties, the Supreme Court gave the journalists protection from arrest.

Economic policy

India signed a double-taxation avoidance agreement with Mauritius in 1983. In1992, when India opened its stockmarkets to foreign portfolio investment byforeign institutional investors (FIIs), those that were registered as residents withthe Mauritian financial authorities were given tax exemption. Mauritius set upa Mauritius Offshore Business Activities Authority (MOBAA) to regulate thesystem. During the 1990s around 80% of foreign portfolio investment camethrough Mauritius. In 1999 a number of income tax officers in Mumbai askedsome of the Mauritius-based FIIs to prove that they were entitled to taxexemption. In April 2000 the Central Bureau of Direct Taxes (CBDT), the apexauthority administering income tax, issued a circular to income tax officers tothe effect that a residence certificate issued by MOBAA would be sufficientproof in judging the entitlement of an FII to tax exemption.

In May 2002 this circular was challenged by a non-governmental organisation(NGO), Azadi Bachao Andolan, and S C Jha, a retired income tax official, in theDelhi High Court, which upheld the challenge. The central government andGlobal Business Institute, a consortium of Mauritius-based companies, filed anappeal in the Supreme Court. To the relief of Mauritius-based FIIs, in Octoberthe Supreme Court overturned the High Court’s decision and upheld theCBDT circular.

In early September Bimal Jalan retired as governor of the Reserve Bank of India(RBI, the central bank) after a six-year tenure marked by cautious liberalisation;during his regime, foreign-exchange reserves rose from US$30bn to US$86bn,and the ten-year bond yield fell from 10.9% to 5.3%. Mr Jalan was elevated to theupper house of parliament. He was succeeded by Yaga Venugopal Reddy, whohad been deputy governor before he went to Washington as Indian director ofthe IMF three years ago. Mr Reddy left rates unchanged in his mid-termmonetary policy review in November. At the end of September the RBI paidout US$5.2bn in repayment of Resurgent India Bonds. The bonds were issued in

Mauritius has been a leadingsource of portfolio investment

The press in Tamil Nadu facesa crackdown

Mauritian investment ischallenged, but survives

The governor of the RBI retires

India 19


1998 to non-resident Indians (NRIs) to bolster reserves following the testing ofnuclear weapons and the consequent sanctions imposed on India.

In September the RBI banned foreign inward investment by OverseasCorporate Bodies (OCBs, at least 60% owned by NRIs). The ban includes accessto NRI bank deposits. India first set up schemes to attract deposits fromoverseas Indians in the 1960s, but interest declined in the late 1970s wheninterest rates in other countries rose. In 1982 the government passed a lawallowing OCBs to take advantage of the facilities offered to individual NRIs.Certification by a chartered accountant abroad was sufficient to establish thestatus of an OCB.

In 1993, when foreign portfolio investment was permitted, OCBs were allowedto register with the Securities and Exchange Bureau of India (SEBI). However, in2002 parliament appointed a committee to enquire into a stockmarket scam.The RBI said that of the 664 OCBs, 60% were not found at their postaladdresses, and 60 shared the same address. (In November 2001 the RBI hadbanned OCBs from making portfolio investments.) In September 2003 thegovernment banned all inward investment by OCBs, suspecting that thesefunds included monies being shifted following the crackdown on financialtransfers in Western countries in the aftermath of the September 11th 2001terrorist attacks on the US. In July the RBI had capped interest on one-threeyear NRI deposits at 250 basis points above the London Inter-Bank OfferedRate (LIBOR). The cap was lowered to 100 basis points above LIBOR inSeptember and 25 basis points above LIBOR in October, in another attempt tostem capital inflows.

Duties on alcohol sales are an important source of revenue for stategovernments. Most of the revenue comes from so-called Indian-made foreignliquor (IMFL), principally rum and whisky made from cane juice. In thesouthern states, however, it faces competition from country liquor—toddy(fermented coconut sap) or arrack (distilled toddy). All southern states regulateproduction of country liquor in the interests of revenue, but with mixedsuccess. The taxation of alcohol makes it profitable to evade duties, and evadersoften buy political protection or become politicians themselves. As a result,liquor policies undergo changes both for revenue reasons and because ofshifting political allegiances.

One such change occurred in Tamil Nadu in late October. In fiscal year 2001/02(April-March) the state government abolished auctions for liquor shop licencesand instituted a system under which the potential revenue of each shop wasestimated and licences were given by drawing lots. To curb consumption ofcountry liquor, the number of IMFL shops was increased from 4,700 in 2000/01to 6,000 in 2001/02 and 7,000 in 2002/03. However, there were no takers formany shops—in 2002/03, 1,700 licences were not claimed. In 2003/04 theallocation of licences was passed to district selection committees on whichlocal politicians were represented. As a result, even fewer were allocated. Thestate government refused to believe that villagers did not really want to drinkmore IMFL, and suspected that poor demand for retailing licences was due to a

Foreign investment by OCBs isbanned

Southern states amend theiralcohol policies

Moves to deter NRI investmentare introduced

Tamil Nadu cancels retailliquor licences

20 India


strike by the liquor shop owners. In October it cancelled IMFL retail licencesand handed over the trade to the Tamil Nadu State Marketing Corporation andco-operative societies, in the hope of breaking the lobby of liquor shop owners.

In July Karnataka transferred alcohol wholesaling from Mysore SalesInternational Limited (MSIL) to a new state-owned enterprise, KarnatakaBeverages Corporation. The alcohol industry in Karnataka is an importantsource of finance for politics. Thanks to political support and influence, theindustry evades taxes in a number of ways: excise contractors bid for licencesunder false names, making them untraceable if they default on their licencefees, and, as duty on alcohol sold in other states is lower than it is in Karnataka,some manufacturers claim to sell alcohol in other states while in fact selling itin Karnataka.

A tax reforms commission, appointed by the Karnataka state government in2001 under the chairmanship of a former chief minister, Verapa Moily,estimated that the share of alcohol excise in government revenue, which isbetween 12% and 16% in most states, had fallen in Karnataka from 16% in1993/94 to 14.5% in 1999/2000. In 1993 the government gave a duopoly in arrackdistribution to MSIL and another state-owned company, the Mysore SugarCorporation, but under-reporting of sales and inter-state smuggling continued.In the two-year period 1998/99-1999/2000 excise evasion totalled Rs3.9bn(around US$85m)—three times the excise collected—and Rs6.4bn of sales taxwas evaded.

Following the report of the tax reforms commission, the 2002/03 state budgetreduced excise duty and increased export duty. The budget reduced licence feesfor retailers and gave a monopoly of denatured and rectified spirit, used in theadulteration of country liquor, to government warehouses. It also introducedthird-party inspection of distilleries, breweries and excise warehouses tocurb corruption.

In Kerala the 4,300 toddy shops are mostly owned by Ezhavas, a low caste thatspecialises in toddy tapping, whereas the 150 bars and 300 shops that sell IMFLare mostly owned by Christians. This gives alcohol a caste and politicaldimension in Kerala. The present chief minister of the state, A K Antony,banned arrack in 1996 during an earlier term of office. As a result, revenue fromexcise auctions fell from Rs250m (US$5.4m) to Rs125m a year. Arrack wassmuggled in from Tamil Nadu, and there was much illicit brewing, which led todeaths from contamination. Mr Anthony’s Congress government wassucceeded by a Left Democratic Front (LDF) government dominated by theCommunist Party of India (Marxist), or CPI-M. This passed toddy retailing to co-operatives dominated by the CPI-M. After the defeat of the LDF in 2001, thepresent United Democratic Front (UDF) government returned alcohol retaillicensing to individuals.

In terms of revenue, Andhra Pradesh has been the most successful of the foursouthern states. Andhra Pradesh has 7,314 licensed IMFL shops, together withan unknown number of illegal shops. The ruling Telugu Desam Party came topower in 1995 promising prohibition. In 1997 the chief minister, N T Rama Rao,

Karnataka changes thewholesale trade

Kerala passes alcohol retail toindividuals from co-operatives

Andhra Pradesh has the mostsuccessful policies

India 21


was ousted in by his son-in-law, Chandrababu Naidu, who abandonedprohibition. Mr Naidu came to an understanding with the local liquor industry;he stopped imports from outside the state and encouraged local distilleries toraise prices. This enabled the sales of the monopoly distributor, AndhraPradesh Beverages Corporation, to rise from Rs23bn in 1998/99 to Rs32bn in2002/03.

The Electricity Bill was passed by both houses of parliament in August. Amongits more important provisions are the following.

• State governments must separate generation, transmission and distributionunless the central and the state governments agree otherwise.

• Generation will require no licence; in rural areas, generation, transmissionand distribution are delicensed.

• The transmission companies must give open access to all generators.

• State governments must set up state electricity regulatory commissions(SERCs).

• SERCs will phase in open access to the distribution network.

• There must be load dispatch centres both within and between statescontrolled by the central and state governments.

• Tariffs are to be regulated by SERCs.

• All sales of electricity must be metered after two years (currently, mostelectricity given to farmers is not metered, and Tamil Nadu provides it freeof charge).

• Cross-subsidies are to be abolished, but the period within which they mustbe phased out is not specified. They will be replaced by a surcharge on wheelingcharges (farmers and domestic consumers are currently subsidised).

Some of these reforms had already been implemented in some states. The billestablishes a policy direction towards open markets and competitive pricing.The new distribution companies are writing damages into contracts withgenerating companies in the event of their failure to supply the contractedpower. In turn, some generators—notably National Thermal Power Corporation,National Hydroelectric Power Corporation and Karnataka Power Corporation—are writing damages into contracts with equipment suppliers to cover thepossibility of equipment failure. Bharat Heavy Electricals and other equipmentmanufacturers cannot similarly pass on risk further upstream, and are lookingfor cover against liquidated damages.

In 1992 a Calcutta media house, the Ananda Bazaar Patrika (ABP) Group,applied to the central government for permission to take in a British newspaper,the Financial Times, as a joint-venture partner for its daily newspaper, BusinessStandard. The Congress government, which fell in 1996, took no decision, butthe request faced strong opposition from several newspaper publishers. The BJPgovernment finally rejected the application in 1999, although ABP had already

The electricity bill is passed inAugust

Foreign investment in the printmedia has grown

The bill gives direction tostates’ reforms

22 India


sold its stake in Business Standard. In 2001, however, political support forforeign investment in the media began to rise and in June 2002, the govern-ment allowed foreign investors to buy equity stakes of up to 26% in the printmedia. A similar limit was placed on television channels in March 2003,meaning that foreign television channels had to sell off 74% of their equity toIndian investors. The new rules have recently begun to have repercussionsin the media.

• The Financial Times bought a 13.9% stake in Business Standard for Rs141m inSeptember.

• HT Media, which owns the Hindustan Times, has received US$27.8m fromLondon-based Henderson Global Investors for a 20% stake in a new company,which will start a Mumbai edition of the newspaper early next year.

• New Delhi Television (NDTV) used to provide content to the Star Newschannel. The arrangement was terminated in March, and NDTV started its ownEnglish and Hindi news channels. It needed fresh investment, but wasconstrained by the 26% cap. In August, NDTV sold a 17.8% stake to an Indianbank, ICICI bank. In September it sold a 14.3% stake of the increased capital toStandard Chartered Private Equity, the global private-equity arm of Singapore-based Standard Chartered Bank, for Rs528.8m.

• ABP has bought a 74% stake in Media Content and CommunicationServices, a company that will sell content to Star News, at a cost of Rs740m.

• Bennett Coleman, which led the opposition to foreign investment,proposes to sell its magazines (including Filmfare and Femina) and events(including the Miss India contest) to a new company. The government allows74% foreign ownership of non-news media, and Bennett Coleman is thereforenot restricted to a sale of 26%.

There are many other media groups in dire need of money; so this may be justthe beginning of foreign investment inflows. However, the 26% limit in newsmedia will keep down foreign interest.

The domestic economy

Economic trends

The huge increase in agricultural output this summer will not be reflected inthe national accounts until the October-December quarter of fiscal year2003/04 (April-March). In the April-June quarter, agricultural growth was evenslower than it had been in the same quarter of 2002/03. However, theindustrial sector is growing strongly. Manufacturing showed a sharp rise,underpinned by automotive production and industries relating to construction.Construction, which entered a boom period last year, continued to experiencehigh growth. In addition, trade and tourism have also recorded faster growth.The growth of other services, whose main component is government spending,showed a significant slowdown.

Components of GDP

The economy is growingstrongly

India 23


(% change year on year; fiscal years Apr-Mar unless otherwise indicated)

2001/02 2002/03Apr-Jun

2002Apr-Jun

2003Agriculture 5.7 -3.2 2.7 1.7

Industry 2.9 5.7 4.7 5.8Mining 1.0 5.0 7.7 3.0

Manufacturing 3.4 6.1 3.8 6.3Electricity 4.3 3.9 4.4 4.8

Services 6.2 7.1 6.9 7.6Construction 3.7 7.2 6.3 5.7Trade and hotels 8.7 7.8 6.9 9.6

Finance 4.5 6.1 6.7 7.1Other 5.6 6.8 6.9 4.3

GDP 5.6 4.3 5.3 5.8

Source: Central Statistical Office.

The fall in interest rates has reduced state governments’ interest payment costs.Until last year states had borrowed at rates above 13%. Last year the centralgovernment authorised states to swap loans up to Rs1trn (US$21.5bn) over thenext three years. In 2002/03 the states repaid Rs137.7bn (US$3bn); Rs27.7bn ofthis was from small savings schemes, and the rest was from market loans (loansfrom banks and state-owned financial institutions). In the first half of 2003/04the states repaid Rs320bn, of which Rs230bn was from market borrowings andRs90bn from small savings schemes. In turn, the central government used thefirst year’s money to repay 10.6% special securities issued to the National SmallSavings Fund (NSSF), to which it owes Rs1.76trn. For lack of better alternatives,NSSF reinvested the money in 7% central government securities. Similarly, theRs320bn received in 2003/04 was used to swap 10.5% for 6% securities.

The cabinet has cleared a proposal to set up a National Tax Tribunal (NTT). Itwill hear appeals from the Income Tax Appellate Tribunal (ITAT) and theCentral Excise and Sales Tax Appellate Tribunal (CESTAT), and will have 25benches. Appeals against its rulings will be heard in the Supreme Court. Thehigh courts have a backlog of 28,000 tax cases, which would take five years toclear at the present rate of 6,000 cases a year; the NTT will expedite disposal ofthe backlog. However, taxpayers are concerned that the benches of the NTT,like the present ITAT and CESTAT, will be filled with retired tax officials whoare inclined to rule in favour of revenue. Taxpayers have more faith in thejudicial system than in tribunals set up by the government.

One such tribunal has drawn the ire of the Supreme Court. The governmentrecently set up a Competition Commission under the chairmanship of DipakChatterjee, who is about to retire as commerce secretary. The Supreme Courtcalled his appointment a direct attempt to encroach upon the judiciary, saying:“At this rate, if these things are allowed to continue, then the day is not far offwhen bureaucrats will replace all judges, including the Supreme Court.” A casecould have been made that industry regulatory commissions requiredchairmen with specialist knowledge, but the government chose not to confrontthe Supreme Court and withdrew Mr Chatterjee’s appointment.

Lower interest rates havehelped the states’ finances

A new tax tribunal is to beestablished

24 India


Agriculture

The Ministry of Agriculture’s first estimates of the summer crop output showoutput close to that of two years ago, and considerably higher than last year’sdisastrous crop. Output of foodgrains is expected to be somewhat lower than in2001 but 20% above that of 2002, and the rice crop estimate is 6% below 2001but 13% above 2002. Coarse grains, generally grown in the drier, non-irrigatedregions, have perform better: their output is expected to be 39% above the 2002level. Oilseeds (apart from soybean) are also dry-region crops; their output in2003 is estimated to be 15% above that of 2001 and 63% above last year’s.Estimates for cotton and sugarcane production have not yet been released.

Last year the northern states ignored the central government’s directive that itsdeclared statutory minimum price would be the price payable by sugar mills,and continued to force sugar mills to pay cane growers state-advised prices(SAPs) above the minimum price set by the central government. Some evenfiled a special leave petition in the Supreme Court questioning the govern-ment’s authority to stop them declaring a higher SAP. But the Supreme Courtsided with the central government, and the states themselves therefore had tocompensate those farmers who had sold cane to private mills.

In response, the central government gave a subsidy to northern states. InSeptember Rajnath Singh, the minister of agriculture, wrote to chief ministers ofnorthern states inviting them to accept the subsidy of Rs6.8bn. This includedRs4.9bn for Uttar Pradesh, Rs322m (US$6.9m) for Uttaranchal, Rs847m forHaryana, Rs310m for Punjab and Rs399m for Bihar. In addition to these grants,the centre also allowed the states to borrow Rs18.9bn to pay to cane farmers. Inreturn, the states had to give up declaring SAPs and withdraw the special leavepetition they had filed in the Supreme Court.

Northern states have ignored acentral government ruling

Four northern states havereceived a sugar subsidy

First estimates suggest anagricultural rebound

India 25


Manufacturing

Under the 1994 Marrakesh Agreement, India is obliged to introduce productpatents for food and chemicals by January 1st 2005 (the current law allows onlyprocess patents in these fields). The present government has amended thePatent Act of 1973 twice; however, as a result of pressure from the local pharma-ceutical industry, it has not introduced the required product patents. But in a2002 amendment the government did create a mailbox for foreign patents thatwill be registered when product patents are introduced. The mailbox hasreceived 5,000 applications. Meanwhile, at the World Trade Organisation(WTO) meeting at Cancún, Mexico, in September 2003, the members decidedto allow compulsory licensing of essential drugs. Compulsory licensing willallow the government to compel the foreign patent holder of an essential drugto license its production to an Indian manufacturer in return for a royalty.

A census held between November 2002 and April 2003 counted 2.35m smallenterprises in India, employing 4.6m workers. Average fixed investment inthese enterprises totalled Rs711,000 (US$15,300); 10.7% were run by women,and they had an average of 2.1 employees each. Of the total, 90% wereindividual proprietorships, 6% were partnerships and 4% were companies. Insectoral terms, 49.8% were in services, 33.6% were in manufacturing and 16.6%were in repairs and maintenance.

Infrastructure

India is poorly provided with pipelines, and three-quarters of oil products aremoved by train or truck. When oil and gas were discovered in the BombayHigh field in the 1980s, the government established the Gas Authority of IndiaLimited (GAIL), which currently runs 4,400 km of pipelines. Its mainstay is thegas pipeline from Hazira on the south coast of Gujarat across Madhya Pradeshand Uttar Pradesh to Delhi. It also runs a pipeline from Kandla in northernGujarat through Rajasthan to Delhi, carrying imported liquefied natural gas(LNG). Petronet, a consortium of government oil and gas companies, has set upa 5m-tonnes/year terminal for imported LNG at Dahef in southern Gujarat;

Moves to improve the pipelinenetwork are under way

The introduction of productpatents remains controversial

A census of small companieshas taken place

26 India


GAIL will lay a pipeline to connect it to the Hazira pipelines. According to RamNaik, the petroleum minister, GAIL will lay 7,000 km of gas pipelines, costingRs180bn, in the next five or six years.

At present almost all pipelines belong to state-owned oil and gas companies;the Indian Oil Corporation (IOC, the major government-owned refining anddistribution company) controls 7,000 km of oil pipelines. This looks set tochange in the next four years: the Ministry of Petroleum and Natural Gas hasgiven approval for an Indian conglomerate, Reliance Industries, to build sixproduct pipelines totalling 5,900 km and costing Rs47.7bn.

Proposed pipelinesLength (km) Cost (Rs bn)

Jamnagar-Patiala 1,580 16.4Jamnagar-Kanpur 2,540 17.8Goa-Hyderabad 660 4.6

Chennai-Bangalore 540 3.3Haldia-Ranchi 375 2.6

Kakinada-Vijayawada 200 1.1

Source: The Hindu.

Reliance has discovered massive gas reserves off the east coast of India, whichit would like to pipe to the major consumption centres on the west coast. Itplans to build two pipelines: a 2,000-km pipeline from Kakinada on the eastcoast to Goa on the west coast, via Bangalore, and a 2,700-km pipeline fromCuttack, north of Kakinada, to the company’s refinery at Jamnagar in Gujarat.Reliance has been negotiating with National Thermal Power Corporation, aswell as with Karnataka Power Corporation (KPCL), which is looking to becomea major gas consumer. Reliance has offered KPCL 10m cu metres per day,sufficient to generate 2,100 mw of electricity, but KPCL has refused to agree tothe benchmarking of the price of the gas to either oil or imported gas. Reliancehas also offered gas to the state governments of Gujarat, Andhra Pradesh andTamil Nadu, but is facing competition from the state-owned Oil and NaturalGas Corporation (ONGC) and a global energy company, Shell.

Until now, Reliance has used the state-owned oil companies as its distributionagents. Almost one-half of Reliance’s annual crude output of 27m tonnes is soldto state-owned companies. It has two contracts for 9m tonnes/year with IOC,and contracts for 2m tonnes/year each with Bharat Petroleum Corporation(BPCL) and Hindustan Petroleum Corporation (HPCL). The present contractsrun until March 2004, but these arrangements are unlikely to continue. IOCwas carrying Reliance products through its Kandla-Bhatinda pipeline, but willin future want to use the pipeline to carry imported crude for its new refineryat Panipat. It is also unlikely to agree to extend a take-or-pay clause in a 7.5m-tonne contract with Reliance. Currently, if IOC does not take the products it hasto pay Reliance Rs700 (US$15) per tonne for the deficit.

Reliance has written to the Ministry of Petroleum and Natural Gas asking forhelp in realising the Rs6bn that it says the state-owned companies owe it.Reliance’s contract with them stipulated that if product prices rose, the

Reliance looks set to expand itspipeline network

Reliance’s gas discovery hassparked its pipeline interest

Reliance’s contract with thegovernment looks set to end

India 27


marketing companies would pay more to Reliance. Although internationalprices rose, the government did not allow prices of kerosene and liquefiedpetroleum gas (LPG) charged by the state-owned companies to rise, and theyare therefore claiming force majeure. In October the ministry decided that one-third of the cost of the subsidy must henceforth be borne by upstreamcompanies and two-thirds by the oil marketing companies.

The government had planned to privatise BPCL and HPCL, and Reliance hadhoped that it would be able to buy one of the two companies in order to gainaccess to its distribution network. However, the proposal was the victim ofstrong underground resistance from Mr Naik. Finally, in September the SupremeCourt ruled that the two corporations had been created by act of parliament in1974, and as such could be privatised only with the approval of parliament. Inview of opposition from the main opposition Congress party as well as fromsome of its allies among the smaller parties, the Bharatiya Janata Party (BJP, themain government party) was not confident of carrying the vote in parliament,and put the privatisation on hold.

ONGC also has a problem: it mainly produces crude, and needs both refiningcapacity and distributional outlets. Last year it bought a 9m tonne refinery inMangalore. Now it is laying a product pipeline from Mangalore to Bangalore.However, the company’s strength is in exploration, drilling and oil extraction,and it would prefer not to get deeply involved in distribution. ONGC has madean agreement with BPCL, under which it will take a stake in BPCL’s futurerefineries and BPCL will take a stake in ONGC’s exploration blocks. GujaratState Petroleum Corporation (GSPC) is laying a 1,200-km gas grid in Gujarat,which will be available to producers and consumers on a common-carrierbasis. Using this infrastructure, which is expected to be in place by the end of2004, GSPC expects to provide cheap energy from offshore gas imports andLNG imports to industries and power producers.

The central and Maharashtra state governments have ten internationalarbitrations pending against them in respect of the Dabhol Power Corporation(DPC), a massive power plant in Maharashtra whose majority shareholder wasa US energy company, Enron. Only one case been settled. On September 9th anarbitration panel chaired by a US district judge ruled that the interests of twoUS companies, GE Capital and Bechtel Enterprise Holdings, each of whichowns 10% of the equity of DPC, “were improperly expropriated by the Indiangovernment”, and awarded US$28.57m to each firm from the Overseas PrivateInvestment Corporation (OPIC, a US agency which provides political riskinsurance). OPIC will in turn claim these sums from the government of India.

On September 22nd Bechtel and GE filed an international arbitration claim forRs600m each against the Indian government. The same day they approached aNew York court for an injunction against Maharashtra Power DevelopmentCorporation Limited (MPDCL), the Maharashtra government arm that hasinvested in DPC, barring it from approaching an Indian court to seek arestraining order. The New York court gave MPDCL three days to present itself.

The first legal action overEnron has been settled

The privatisation of BPCL andHPCL has stalled

Two state companies arebuilding pipelines

28 India


Four days after GE and Bechtel approached the court in New York, JusticeHemant Gokhale of Mumbai High Court restrained GE and Bechtel frompursuing an arbitration in New York against MPDCL. This order will fend offone attempt by international investors to recover their dues from India. InOctober Bechtel and GE offered to separate their claims in respect of contractdebt and equity if the government agreed to settle the former throughinternational arbitration.

The Indian government financial institutions, which lent large sums to DPC,had filed recovery proceedings in Mumbai High Court, but the court has not yetheld hearings. The delay helps both the central and state governments, whichhave given guarantees to international and domestic investors and lenders andwill face huge liabilities if DPC is liquidated.

Ever since the government cancelled their licence fee arrears and imposed aproportional licence fee on their revenue, private cellular telephone companieshave had a good run. In 2002/03 they added 6.4m subscribers, and surpassedthat number in the first half of 2003/04. However, the companies are livid at afavour that Pramod Mahajan, the telecommunications minister at the time, gaveto landline operators in 2001. Given the expense of laying underground cables,these companies could offer no significant cost or quality advantages over thecellular companies. Mr Mahajan allowed Reliance Infocomm and TataTeleservices, along with Bharat Sanchar Nigam (BSNL), to offer cellulartelephones in wireless local loop (WLL). The understanding was that theywould offer connectivity only within local areas—so-called short-distancecharging areas (SDCAs)—and would hand over calls going out of such areas tolong-distance operators.

Reliance found a way to allow its subscribers to make long distance calls atlocal call rates. It gave subscribers multiple numbers in a number of chargingareas, so that calls within these areas would not incur trunk charges. Reliancealso provided call forwarding facilities so that calls outside these areas couldalso be made at local rates. This led to vehement protests from cellular serviceoperators. In September the Telephone Disputes Special Appellate Tribunal(TDSAT) ruled that WLL services must be limited to the SDCAs, and thatoperators could not employ mobile switching centres which made roamingoutside SDCAs possible. It said that there was a studied silence from thegovernment on action taken or proposed, and asked it to finalise safeguardswithin two months. Reliance had already signed up 3m subscribers to itsmultiple registration and call-forwarding facilities, and the government wasreluctant to force it to cancel them.

In October the Telecom Regulatory Authority of India (TRAI) proposed theunification of fixed-line and mobile licences without any further licence fee,and proposed that third-generation (3G) licences should be distributed withoutcharge. TRAI also proposed that Reliance should pay a penalty of Rs4.85bn, andanother Rs15bn for migration to the new regime. In a well-co-ordinated move,Arun Shourie, the minister for telecommunications, took the proposal to thecabinet, which approved TRAI’s proposal within three days. Cellular licences

Mobile phone demand isbooming

Governments and banks are inno rush to resolve disputes

TRAI proposes a new licensingscheme

India 29


have been granted for circles, broadly equivalent to states, with four licences ineach circle. Some licensees have run short of capital for expansion and wouldlike to sell, whereas others wish to expand. Although mergers and acquisitionshave been allowed, this has not been allowed for operators within an existingcircle. The cabinet has now resolved to allow operators within a circle to merge,providing the number of competitors in a circle does not fall below three.

Despite these moves, cellular operators have remained downbeat. They haveappealed to the Supreme Court against TDSAT’s decision; the appeal is likely tocover the decision to unify fixed and mobile licences. The operators have notsaid what they want. The smaller ones would probably like WLL operations tobe stopped, whereas larger companies may prefer compensation. As thecellular services have expanded, a shortage of spectrum has emerged—partlyowing to the fact that the defence establishment hogs a large proportion ofspectrum. The Ministry of Finance announced in October that it will fund themodernisation of the military’s signalling equipment so that spectrum can bereleased. TRAI will set spectrum fees for new entrants.

After Videsh Sanchar Nigam (VSNL) was privatised in 2001, BSNL channelleda large proportion of its overseas calls through Data Access, which began lifein 1999 as an internet service provider. This expansion has led Data Accessto become ambitious, and the company plans to expand overseas. It hasalready obtained licences in the US, the UK, Sri Lanka and Hong Kong, andis pursuing licences in the Middle East and Latin America. By the end of 2004it expects to bring down the share of revenue it receives in India from 80%to 40%. It is planning a share issue of US$25m next year to finance one-halfof its expansion.

Cellular telephone subscribers(’000; end-Mar unless otherwise indicated)

1997 1998 1999 2000 2001 2002 2003End-Oct

2003Bharti Cellular 0 123 122 189 539 1,351 3,168 4,862

BSNL 17 0 0 0 0 17 2,160 4,381Idea/Batata 79 43 85 86 344 809 1,280 1,976

BPL 0 153 220 341 645 899 1,131 1,335Hutchison Essar 2 0 0 0 0 0 767 1,300Hutchison Max 46 132 100 146 252 424 665 906

Spice 0 40 85 174 361 474 640 776Escotel 63 45 69 135 307 501 587 728

Reliance 0 17 30 69 187 380 541 626Fascel 2 18 49 110 168 299 457 743Aircel 0 17 20 66 194 266 413 595

MTNL 2 0 0 0 18 201 292 322Hutchison Telecom 1 0 0 0 0 0 274 411

RPG 0 26 29 43 69 120 179 204Hexacom 0 9 11 20 48 86 132 193

Total incl others 212 889 1,187 1,884 3,577 6,431 12,688 19,358

Source: Cellular Operators' Association of India.

Mobile phone operatorsremain concerned

A telecoms company isexpanding overseas

30 India


As the finances of Indian Railways have deteriorated under the pressure offeatherbedding and cross-subsidies, the company’s capacity to build new lineshas declined. The only major railway line built since 1947 is the coastal linefrom Mumbai to Goa, connecting via lines going further south to Kerala. Tobuild it, a separate government enterprise, the Konkan Railway Corporation(KRC), was set up. Because of the area it serves and the relatively efficientconstruction of the line, KRC remains profitable. It is also eager to build morelines, and was entrusted two years ago with the task of building a 341-kmrailway line from Jammu to Srinagar and Baramulla. The project, to becompleted by 2007, is likely to cost Rs25bn.

In its most recent budget the Karnataka government reduced the tax onaviation fuel. In August a local no-frills airline, Air Deccan, started operations,with its hub in Bangalore, Karnataka’s capital. Air Deccan has leased six48-seater planes, and charges less than 50% of the larger airlines’ fares—its farefrom Bangalore to Chennai is Rs1,650 (US$35.5), compared with an economyfare of Rs3,400 charged by other airlines. Between Bangalore and HyderabadAir Deccan charges Rs2,270, as against Rs4,900 charged by other carriers.

This begins the third phase of competition in the domestic airline industrysince the opening of the industry to competition in 1993. The first entrant wasJet Airways, which by 1998/99 had taken a 34% market share; the share of thestate-owned domestic carrier, Indian Airlines, had by then fallen to 61%. JetAirways competed not on price but on service and punctuality, and becamepopular with non-government passengers. It looked likely that Jet Airwayswould sweep the board, but Indian Airlines fought back, offering discountedfares to old people and students as well as improving punctuality. The privateairline that responded most successfully was not Jet Airways but Sahara. By2002/03 Indian Airlines’ market share had fallen to 46%. Jet Airways had raisedits share to 41%, while Sahara had almost doubled its share from 7% to 13%.

Deccan Airways is offering far lower fares than existing airlines, and isattempting to develop a new market for flights between hitherto unconnectedor poorly connected cities. It is a risky strategy: many of the towns Deccanserves are relatively close together. However, southern India is currentlyenjoying an economic boom, and the state-run bus and train services are inpoor condition. If Deccan Airways can persuade enough people to fly, it willestablish a model that could spread the flying habit far wider in India anddeprive Indian Airlines of an excuse for not being profitable.

Indian Airlines has performed poorly in two lucrative segments—flightsbetween the four metropolitan areas (metros), and international flights. Theannouncement in Bali, Indonesia, by India’s prime minister, Atal BehariVajpayee, that airlines from Association of South-East Asian Nations (ASEAN)countries would be allowed to fly to 18 tourist destinations in India and flydaily to the metros without any reciprocity, is likely to mean that IndianAirlines and Air India will be deprived of some traffic. The government’sdecision to allow private airlines to fly to Sri Lanka is likely to have a similareffect. Indian Airlines has an ageing fleet and is short of aircraft. Both Indian

A no-frills airline has beenlaunched

A railway to Kashmir is beingconstructed

Deccan Airways couldestablish a new model

India 31


Airlines and Air India had been on the privatisation list, and while they wereto be sold, it made little sense for the government to buy new planes. However,airlines are a source of considerable patronage, and successive aviationministers postponed their privatisation. Now that they are unlikely to beprivatised in the near future, decisions to purchase new aircraft may moveforward. The board of Air India has sanctioned the purchase of 66 aircraft at acost of Rs100bn, although this move still awaits government approval.

Although the government has been uncharacteristically generous to airlinesfrom ASEAN and Sri Lanka, it still protects Air India and Indian Airlines fromWestern competition. As a result, there is a shortage of flights every winterwhen tourist traffic picks up. In October the government announced that itwould open skies to foreign airlines from December to February this year andnext if these airlines can reach agreement with Indian Airlines and Air India.Foreign airlines are prepared to provide more flights, but find makingagreements with the Indian state-owned airlines cumbersome. Lufthansa puton daily flights to Bangalore last winter, but was then forced to reduce theirfrequency; it wants to raise the frequency again to daily flights this year. BritishAirways and Virgin Atlantic have also shown an interest.

Financial and other services

India’s tourism sector slumped after the September 11th 2001 terrorist attackson the US. Arrivals fell by 15% year on year between January and August 2002,and security concerns owing to tensions in the Middle East and between Indiaand Pakistan prevented an improvement after this. However, the slump appearsto be coming to an end. The number of tourist arrivals in recent months hasreturned to pre-September 11th 2001 levels. Arrivals generally fall during the hotsummer months of April-August. The winter tourist season is just beginning,and it is likely to bring a modest rise on the level of arrivals two years ago. Butthe tourism balance is less benign. As a consequence of liberalisation, manymore Indians are travelling abroad. Fares and accommodation charges are oftencheaper in neighbouring tourist destinations. Indians were the largest group oftourists visiting Sri Lanka last year and, unless the civil war breaks out again inthat country, more than 100,000 Indians may visit Sri Lanka in 2003.

Tourist arrivals(’000)

2001 2002 2003Jan 284 228 278Feb 262 241 273

Mar 249 217 220Apr 185 160 168May 151 145 145

Jun 177 135 172July 224 178 218

Aug 199 163 201Jan-Aug 1,729 1,466 1,674

Sources: Securities and Exchange Board of India; National Stock Exchange.

The tourism industry stages arecovery

Western airlines continue toface problems

32 India


After two difficult years, the prospects for information technology (IT) exportshave begun to look up. The top companies have attracted new clients, and theaverage client is paying more. Some companies are offering longer credit toclients, but most of the companies are cash-rich and thus are perfectly capableof doing so.

The reduction in the quota of US H-1B visas from 165,000 to 65,000 a year isunlikely to inconvenience the industry. Most of the visas went to migratingprogrammers, the demand for whom has fallen considerably. The total numberof H-1B visas issued to technologists fell from 105,700 in 2001 to 27,200 in 2002;Indians received 90,700 in 2001 and 21,000 in 2002. As well as H-1B visas,companies are given L-1 visas to send employees to the US, and additionalvisas are issued to parents and relatives visiting Indians who are living in theUS. As a result, the US consulate in Chennai has become the biggest US visaoffice in the world—in 2002 it issued 180,000 visas.

Information technology companies(2nd quarter)

Revenue perclient (Rs m)

Clients(no.)

Debtordays (av.)

2002 2003 2002 2003 2002 2003Infosys 15.7 20.4 306 346 55 52Wipro 17.3 19.9 240 299 55 62

Satyam 8.1 10.0 267 289 75 83HCL Tech 7.1 6.6 362 385 74 54Mastek 3.8 5.0 72 69 73 85

Polaris 2.9 4.8 102 139 99 101I-Flex 1.9 2.7 357 419 n/a n/a

Source: Business Line.

The central government’s expenditure on pensions rose from Rs153bn in1998/99 to Rs232bn in 2003/03. Forced into action by ballooning liabilities,benefit-based pensions have been ended for new recruits to the civil service,though they will continue for new members of the armed forces. The cabinethas approved the establishment of a Pension Fund Regulatory Authority, whichwill licence pension fund managers. Each will offer three investment funds: agrowth fund (50% invested in equities and 50% split equally betweengovernment and corporate bonds), a balanced fund (20% invested in equitiesand 40% each in corporate and government bonds), and a safe fund (10%invested in equities, 30% in corporate bonds and the remainder in governmentbonds). Changing over to the new schemes is optional for states and the privatesector. Pension funds may invest overseas, subject to regulatory restrictions.Pensions can be cashed at any time after the age of 60, although 40% of thesum must be converted to an annuity.

Prospects for the IT industryare looking up

A new pension system is beingintroduced

India 33


Foreign trade and payments

Although the trade deficit is widening, strong inflows of portfolio investmentinto the stockmarket (see below) have led to an acceleration in the accumu-lation of foreign-exchange reserves. Reserves rose by US$15.6bn in the sixmonths to October and by US$28.1bn in the 12 months to October. In theaftermath of the September 11th 2001 terrorist attacks on the US, Westerncountries tightened controls on the transfer of money via unofficial networks Itis likely that some of these funds found their way to India in the guise of non-resident Indian (NRI) and Overseas Corporate Body (OCB, at least 60% ownedby NRIs) funds. The Reserve Bank of India (RBI, the central bank) has acted inresponse to concerns about such unofficial transfers. In September it bannedOCBs from investing in India, and it has made it unattractive for NRIs to leavedeposits in India. These moves may lead to a slowdown in the accumulation ofreserves in the coming months.

The other, perhaps more potent, cause of reserve accumulation has been theappreciation of the rupee against the US dollar. The rupee has appreciated sincemid-2002, but the RBI did not bring about a commensurate reduction indomestic interest rates, which are much higher than international rates. Thisoffered a tempting arbitrage opportunity. The RBI has tried to plug all potentialloopholes. It has restricted Indian companies from borrowing abroad sinceearlier this year. In October it suspected that foreign currencies were beingconverted into rupees through gold imports, and therefore banned anyoneapart from jewellers from importing gold. However, while interest rate policiesand exchange-rate policies remain mismatched, funds are likely to continue toflow into India. These capital inflows have been boosted by attempts byforeign portfolio investors to take advantage of India’s stockmarket boom.

Trade, reserves and the exchange rate, 2003(US$ bn, unless otherwise indicated)

May Jun Jul Aug Sep OctImports 4.5 4.3 4.7 n/a n/a n/a

Exports -5.6 -5.9 -5.7 n/a n/a n/aTrade balance -1.1 -1.7 -1.0 n/a n/a n/aForeign direct investment 122 168 180 n/a n/a n/a

Foreign portfolio investment 645 794 479 n/a n/a n/aExchange rate (Rs:US$)ab 47.0 46.5 46.2 45.9 45.9 45.3Reservesa 81.3 81.9 84.9 86.3 89.3 92.6

a Last Friday of the month. b RBI reference rate.

Source: Reserve Bank of India.e

As industrial growth has accelerated, so has import growth. Export growth hasslowed, however, possibly owing to currency appreciation. The currentaccount, which posted a surplus for six quarters, went into deficit in thesecond quarter of 2003. According to the Ministry of Commerce, in April-September 2003 exports rose by 9.9% year on year to US$27.4bn. Imports,however, rose by 21.4% to US$34.6bn in the same period. Oil imports rose by

The trade deficit is widening

The RBI is trying to stemcapital inflows

Industrial growth has raiseddemand for imports

34 India


6.3% to US$9.2bn, but non-oil imports rose by 28%. As a result, the tradedeficit widened from US$3.5bn toUS$7.1bn.

Current and capital accounts(US$ bn)

2001/02 2002/03 2002 2003Apr-Mar Apr-Mar Oct-Dec Jan-Mar Apr-Jun

Goods: exports 44.9 53.0 13.0 14.6 13.5Goods: imports 57.6 65.5 17.3 17.3 19.4

Trade balance -12.5 -12.7 -4.3 -2.7 -5.9Services: exports 20.7 25.0 6.9 6.4 5.2Services: imports 16.1 18.8 4.2 5.3 3.6

Services: balance 4.6 6.2 2.7 1.1 1.6Income: inflows 3.4 2.8 0.4 0.6 0.8

Income: outflows 7.0 7.7 1.6 1.6 1.9Income: balance -3.6 -4.9 -1.1 -1.0 -1.1Current transfers: credit 12.6 15.5 4.0 3.8 4.3Current transfers: debit 0.1 0.4 0.0 0.2 0.1Current transfers: balance 12.5 14.9 4.0 3.6 4.2Current-account balance 0.8 3.7 1.2 1.0 -1.2Net direct investment 4.7 3.6 0.5 0.6 0.7

Net portfolio investment 2.0 0.9 0.7 0.6 2.0Official loans 1.1 -2.5 0.1 -2.6 -0.3Commercial loans -1.6 -1.7 -0.3 0.3 1.5

Bank funds 2.8 5.4 3.4 1.0 0.1 Deposits by non-resident Indians 2.8 2.8 0.9 0.4 1.7

Other capital flows incl rupee debt service -0.3 3.0 0.5 0.9 0.2Capital-account balance 10.6 12.6 5.9 1.8 6.1Errors & omissions 0.4 0.6 -1.0 1.4 0.3

Change in international reserves 11.8 17.0 6.1 4.3 5.2

Note. Totals may not sum owing to rounding.

Source: Reserve Bank of India.

A boom followed the opening of the Indian stockmarket to foreign portfolioinvestment in 1992. India attracted sizeable capital inflows until 1997; however,following the Asian financial crisis of 1997, international investors turned awayfrom emerging markets. India has benefited from the recent revival of interestin emerging markets.

Between February and April net inflows of funds from foreign institutionalinvestors (that is, the 500 or so institutions that are registered with theSecurities and Exchange Board of India and are entitled to invest in thestockmarket) into equities were under US$100m a month. But purchasessuddenly mounted in the next two months and reached US$500m a month;the stockmarket index, which had been drifting, began to rise. October was arecord month, with a net inflow of US$1.4bn, and another US$462m came induring the first ten days of November. As a result, the S & P NIFTY, the officialindex of the National Stock Exchange, has risen by 57% since May.

Foreign interest is returning tothe stockmarket

Since June foreign portfolioinvestment has soared

India 35


Foreign institutional investors' transactions in equities, 2003(Rs bn unless otherwise stated)

Purchases Sales Net purchasesNet purchases

(US$m) S&P Niftya

Jan 53 43 9 185 1,042Feb 35 29 4 79 1,068

Mar 34 30 4 86 978Apr 50 46 4 90 934

May 52 40 12 257 1,007Jun 67 42 26 548 1,134Jul 81 57 24 502 1,186

Aug 89 66 22 480 1,357Sep 115 76 39 836 1,417

Oct 152 85 67 1,466 1,555Novb 47 26 21 462 1,576

a At end of month. b To November 10th.

Sources: Securities and Exchange Board of India; National Stock Exchange.

In October the prime minister, Atal Behari Vajpayee, addressed the Associationof South-East Asian Nations (ASEAN) Business and Investment Summit in Bali,Indonesia. He pointed out India’s strengths, including the following.

• A strong economy driven by indigenous skills and enterprise;

• a growing and increasingly accessible market;

• falling import duties, rising ceilings on foreign investment, and a mobiletelephone market growing at the rate of 2m subscriptions a month;

• English-speaking technical and managerial manpower;

• supercomputers and satellites;

• global leadership in technologies of the knowledge economy; and

• a sound and transparent financial system, including the paperless,electronic National Stock Exchange.

Mr Vajpayee said that the current trade level of US$10bn a year betweenASEAN and India should be tripled by 2007. He signed two free-tradeagreements (FTAs), one with ASEAN and another with Thailand. Bothagreements divide commodities into three groups: a small list of goods onwhich tariffs will be brought down by 2004; a group of sensitive goods onwhich tariff reductions will not begin until 2007; and remaining goods onwhich tariffs will come down by 2007. Within ASEAN, the agreementdistinguishes between the major members, which will bring down tariffs asIndia does so, and other countries, which will get more time to reduce tariffs.

Mr Vajpayee also used the visit to give a unilateral concession to ASEANairlines. ASEAN countries can now have daily flights to India’s four metros,Delhi, Mumbai, Kolkata and Chennai, and unrestricted flights to 18 touristdestinations; there is no insistence on reciprocal concessions to Air India andIndian Airlines.

Mr Vajpayee calls for increasedtrade with ASEAN

36 India


India signed FTAs with Nepal and Bhutan in the early 1990s and with Sri Lankain 1998 (the agreement with Sri Lanka came into operation in 2000). Indiasigned its first trade agreement with Bangladesh in 1980, and talks were held inthe Bangladeshi capital, Dhaka, in October this year to convert it into an FTA.A major stumbling block has been Bangladesh’s ban on land transportation ofa number of goods, including textile yarn. A comprehensive economic co-operation agreement with Singapore was signed last year, laying down a “road-map” for a preferential trade agreement or an FTA. Further FTAs are beingplanned with Afghanistan, Myanmar, South Africa and the South Americantrading bloc, Mercosur.

India’s shrimp exports to the US are threatened by anti-dumping action. The USSouthern Shrimp Alliance and the Louisiana Shrimp Alliance have called foranti-dumping duty on Indian shrimps. The Indian Seafood Exporters’Association has raised US$1.5m to fight the case. A duty could be imposedwithin 20 days of the case being filed. It would be refundable if India won thecase, but that could take many months. In July the US imposed an anti-dumping duty of 44-63% on Vietnam’s fish fillet exports for five years. If Indianshrimp exports were to attract a similar duty the US market would in effect beclosed to them, affecting Indian exports worth around Rs5bn a year.

India is itself a prolific imposer of anti-dumping duties. Exceptionally for agovernment body, in October the Designated Authority for Anti-dumping Dutyterminated an investigation into imports of X-ray baggage inspection systemsfrom the EU, saying that the domestic industry had met only a fraction of thedomestic demand and left most of it to be met by imports. It ordered a refundof the provisional duty that had been charged on these imports.

Shrimp exports are threatenedby anti-dumping measures

India plans to sign ten FTAs

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