Monetary Policy Framework and Growth in India

The main objectives of the monetary policy are price stability, providing adequate credit to productive sectors and financial stability. India has always emphasized on price stability and growth with in broad content of controlling the inflation. Monetary and credit policy operate through five interrelated factors; (i) the availability of credit, (ii) the volume of money, (iii) the cost of borrowing, (iv) the prices of capital assets and (v) the general liquidity of the economy.

One of the fundamental tasks of monetary authorities in the growth context remains the creation of conditions for the effective mobilisation of the supply of actual and potential savings through the promotion of financial intermediaries and the creation of a spectrum of financial assets on the one hand and on the other the effective investment of these resources through the adaptation of the credit structure to sub-serve the needs of development.

Monetary policy assumed importance since the early seventies, when strong inflationary pressures began building up in the economy. In December 1982, a committee under the chairmanship of Sukhamoy Chakravarty was appointed to undertake a review of the working of the monetary system. The committee made a detailed study about monetary management and made path breaking recommendations. There were further many committees and working groups constituted to study the functioning of the financial sector and to recommend changes. The prominent among them were Narasimham Committee I and II, Tarapore Committee on Capital Account Convertibility, the Verma Committee on Restructuring of Weak Banks and the Advisory Group on Transparency in Monetary and Financial Policies. The committees have changed the way monetary policy functions.

Objectives of Monetary Policy in India:

The changing economic priorities and views have led to changes in monetary policy. Hence, the focus is on demarking the objectives of monetary policy, this has gained further significance in the context of the increasing stress on autonomy of the central bank. Thus, the main objectives or goals of monetary policy are:

1. Price Stability

2. Economic Growth

3. Full Employment and

4. Maintenance of Balance of Payments Equilibrium.

The relative emphasis on any one of the objectives is governed by the prevailing circumstances.

1) Price Stability: This has been a dominant objective of monetary policy. Fluctuations in the prices bring uncertainty and instability to the economy. Rising and falling prices are both not desirable because they bring unnecessary loss to some and undue advantage to others. Therefore, in this context monetary policy has assumed paramount importance.

To achieve this, investment finance has to be regulated through appropriate variations in the rate of interest in the capital market. Rate of interest is a vital link that connects the volume of money and investment in a given economy. A Policy of price stability keeps the value of money stable, eliminates cyclical fluctuations, brings economic stability, helps in reducing inequalities of income and wealth, secures social justice and promotes economic welfare.

However, there are certain difficulties in pursuing a policy of stable price level. The problem is deciding the type of price level to be stabilized. There is no specific criterion with regard to the choice of a price level. Innovations may reduce the cost of production but a policy of stable prices may bring larger profits to producers at the cost of consumers and wage earners.

Again, in an open economy which imports raw materials and other intermediate products at high prices, the cost of production of domestic goods will be high. Thus, a policy of stable prices will reduce profits and retard further investment. Under these circumstances, a policy of stable prices is not only inequitable but also conflicts with economic growth.

Therefore, price stability means stability of some appropriate price index in the sense that we can detect no definite upward trend in the index after making proper allowance for the upward bias inherent in all price index. Price stability can be maintained by following a counter-cyclical monetary policy, that is easy monetary policy during a recession and a dear monetary policy during a boom. In a nutshell, both inflation and deflation need to be regulated appropriately by the central bank.

2)  Economic Growth: This objective of monetary policy has acquired considerable significance in recent years. Economic growth is defined as the process whereby the real per capita income of the country increases over a long period of time. Monetary policy can lead to economic growth, by having a control on the interest rate which is inversely related to investment.

By following an easy credit policy and lowering interest rates, the level of investment can be raised which promotes economic growth. Monetary policy also contributes towards growth by helping in maintaining the stability of income and prices. By moderating economic fluctuations and avoiding depression, monetary policy helps in achieving the growth objective. Because fluctuations in the rates of inflation have an adverse impact on growth and monetary policy also helps in controlling hyperinflation.

Moreover, tight monetary policy affects small firms more in comparison to large firms, and higher interest rates have greater impact on small investments in comparison to large industrial investment. So, monetary policy needs to be formulated in the way that it may encourage investment and simultaneously control inflation in order to enhance growth and put a control on economic fluctuations.

3) Full Employment: Full-Employment is the ultimate objective of monetary policy. According to Keynes, “full employment means the absence of involuntary unemployment”. That is full employment is a situation in which everybody who is willing to work and able to work gets work and achieves this, Keynes advocated increase in effective demand.

4) Balance of Payments Equilibrium: This objective of monetary policy has emerged since the 1950s. The emergence of this objective is due to the phenomenal growth in global trade as against the growth of international liquidity. A deficit in the balance of payments is said to retard the attainment of other objectives as it reflects excessive money supply in the economy.

As a result, people exchange their excess money holdings for foreign goods and securities. Under a system of fixed exchange rates, the central bank will have to sell foreign exchange reserves and buy the domestic currency for eliminating excess supply of domestic currency. This is how equilibrium will be restored in the balance of payments.

If the money supply is below the existing demand for money at the given exchange rate, there will be a surplus in the balance of payments. Consequently, people acquire the domestic currency by selling goods and securities to foreigners. They will also seek to acquire additional money balances by restricting their expenditure relatively to their income. The central bank, on its part, will buy excess foreign currency in exchange for domestic currency in order to eliminate the shortage of domestic currency.

Targets and Indicators of Monetary Policy: The choice of targets and indicators of monetary policy are based on the objectives of monetary policy. There are three targets of monetary policy; money supply, availability of credit and interest rates.

The central bank cannot directly control output prices; hence it selects the growth rate of money supply as an intermediate target. The availability of credit, and interest rates are the other two target variables of monetary policy. They are often referred to as the “money market conditions”.

The monetary authority can influence the short-term interest rates. It can change credit conditions and affect economic activity by rationing of credit or other means. The central bank influences economic activity by following an easy or expansionary monetary policy through reducing short-term interest rates and a tight or contractionary monetary policy through rising short-term interest rates.

Money supply and interest rate are intermediate targets of monetary policy. They are also the competing targets, as the central bank faces a trade off as it can aim either at increasing the money supply or maintaining a level of interest rate. By targeting money interest rate, it would be neglecting money supply. The general consensus of economists and policy makers is towards money supply as it is measurable, while there are a variety of interest rates.

Instruments of Monetary Policy in India: Monetary policy transmission involves two stages. In the first stage, monetary policy changes are transmitted through the money market to other markets, i.e., the bond market and the bank loan market.

The second stage involves the propagation of monetary policy impulses from the financial market to the real economy – by influencing spending decisions of individuals and firms. Within the financial system, money market is central to monetary operations conducted by the central bank.There are several direct and indirect instruments that are used in the implementation of monetary policy.

Cash Reserve Ratio (CRR): The share of net demand and time liabilities deposits that banks must maintain as cash balance with the Reserve Bank of India. It is used to regulate the money supply, level of inflation and liquidity in the country. The higher the CRR, the lower is the liquidity with the banks and vice-versa.

Statutory Liquidity Ratio (SLR): The share of net demand and time liabilities deposits that banks must maintain in safe and liquid assets, such as, government securities, cash and gold. Changes in SLR often influence the availability of resources in the banking system for lending to the private sector.

Refinance Facilities: The sector-specific refinance facilities aim at achieving sector specific objectives through provision of liquidity at a cost linked to the policy repo rate. The Reserve Bank has, however, been progressively deemphasizing sector specific policies as they interfere with the transmission mechanism.

Liquidity Adjustment Facility (LAF): This consists of overnight and term repo/reverse repo auctions. The RBI has progressively increased the proportion of liquidity injected in the LAF through term-repos.

Term Repos: The term repos are introduced by the RBI since October 2013. They are of different tenors (such as 7/14/28 days). They are used to inject liquidity over a period that is longer than overnight. The aim of term repo is to help develop inter-bank money market, which in turn, can set market-based benchmarks for pricing of loans and deposits, and through that improve transmission of monetary policy.

Marginal Standing Facility (MSF): A facility under which scheduled commercial banks can borrow additional amount of overnight money from the Reserve Bank by dipping into their SLR portfolio up to a limit (currently two percent of their net demand and time liabilities deposits ) at a penal rate of interest (currently 100 basis points above the repo rate). This provides a safety valve against unanticipated liquidity shocks to the banking system. MSF rate and reverse repo rate determine the corridor for the daily movement in short-term money market interest rates.

Open Market Operations (OMOs): These include both, outright purchase or sale of government securities (for injection /absorption of liquidity).

Bank Rate: It is the rate at which the RBI is ready to buy or rediscount bills of exchange or other commercial papers of commercial banks. This rate has been aligned to the MSF rate and, therefore, changes automatically as and when the MSF rate changes alongside policy repo rate changes.

Market Stabilization Scheme (MSS): The instrument for monetary management was introduced in 2004. Surplus liquidity of a more enduring nature arising from large capital inflows is absorbed through sale of short-dated government securities and treasury bills. The mobilized cash is held in a separate government account with the RBI. The instrument thus has features of both SLR and CRR. The Reserve Bank of India seeks to influence monetary conditions through management of Liquidity by operating in varied instruments. Since 1991, the market environment has been deregulated and liberalized where in the interest rates are largely determined by the market forces.

Process of Monetary Policy Formulation in India:

The process of monetary policy formulation in India had largely been internal with only the end product of actions being made public. The process has overtime become more consultative, participative and articulate with external orientation. The process has now been re-engineered to focus on technical analysis, coordination, horizontal management and more market orientation. The process entails a wide range of inputs involving the internal staff, market participants, academics, financial market experts and Reserve Bank’s Board.

Evolution of Monetary Policy in India:

1935 to 1949: Initial Phase:

Reserve Bank came into being in the backdrop of the great depression facing the world economy. Until independence, the focus was on maintaining the sterling parity by regulating liquidity through open market operations (OMOs), with additional monetary tools of bank rate and cash reserve ratio (CRR). In other words, exchange rate was the nominal anchor for monetary policy. In view of the agrarian nature of the economy, inflation often emerged as a concern due to frequent supply side shocks. While the price control measures and rationing of essential commodities was undertaken by the Government, the Reserve Bank also used selective credit control and moral suasion to restrain banks from extending credit for speculative purposes.

1949 to 1969: Monetary Policy in sync with the Five-Year Plans:

India’s independence in 1947 was a turning point in the economic history of the country.The broad objective was to ensure a socialistic pattern of society through economic growth with a focus on self-reliance. Accordingly, the government also assumed entrepreneurial role to develop the industrial sector by establishing public sector undertakings.

As planned expenditure was accorded pivotal role in the process of development, there was emphasis on credit allocation to productive sectors. The role of monetary policy, therefore, during this phase of planned economic development revolved around the requirements of five-year plans.

The policy instruments used in regulating the credit availability were bank rate, reserve requirements and open market operations (OMOs). With the enactment of the Banking Regulation Act in 1949, statutory liquidity ratio (SLR) requirement prescribed for banks emerged as a secured source for government borrowings and also served as an additional instrument of monetary and liquidity management. Inflation remained moderate in the post-independence period but emerged as a concern during 1964-68.

1969 to 1985: Credit Planning

Nationalisation of major banks in 1969 marked another phase in the evolution of monetary policy. The main objective of nationalisation of banks was to ensure credit availability to a wider range of people and activities. As banks got power to expand credit, the Reserve Bank faced the challenge of maintaining a balance between financing economic growth and ensuring price stability in the wake of the sharp rise in money supply emanating from credit expansion. Besides, Indo-Pak war in 1971, drought in 1973, global oil price shocks in 1973 and 1979, and collapse of the Bretton-woods system in 1973 also had inflationary consequences.

Therefore, concerns of high inflation caused by deficit financing during 1960s gathered momentum during the 1970s. Incidentally, the high inflation in the domestic economy coincided with stagflation – high inflation and slow growth – in advanced economies.

As banks were flushed with deposits under the impact of deficit financing, they did not need to approach RBI for funds. This undermined the efficacy of Bank Rate as a monetary policy instrument. Similarly, due to underdeveloped government securities market, OMOs had limited scope to be used as monetary policy instrument.

In the case of India, money market prior to the 1980s was characterised by paucity of instruments and lack of depth. Owing to limited participation, money market liquidity was highly skewed, characterised by a few dominant lenders and a large number of chronic borrowers. During this phase, the average growth rate hovered around 4.0 per cent, while wholesale price index (WPI) based inflation was around 8.8 per cent.

1985 to 1998: Monetary Targeting

In the 1980s, fiscal dominance accentuated as reflected in automatic monetisation of budget deficit through ad hoc treasury bills and progressive increase in SLR by 1985. Concomitantly, inflationary impact of deficit financing warranted tightening of monetary policy – both the CRR and Bank Rate were raised significantly.

The experience of monetary policy in dealing with the objectives of containing inflation and promoting growth eventually led to adoption of monetary targeting as a formal monetary policy framework in 1985 on the recommendations of the Chakravarty Committee.

The targeted growth in money supply was based on expected real GDP growth and a tolerable level of inflation. This approach was flexible as it allowed for feedback effects. CRR was used as the primary instrument for monetary control.

Nonetheless, due to continued fiscal dominance, both SLR and CRR reached their peak levels by 1990.The resultant balance of payments crisis triggered large scale structural reforms, financial sector liberalization and opening up of the economy to achieve sustainable growth with price stability. Concurrently, there was a shift from fixed exchange rate regime to a market determined exchange rate system in 1993.

At the same time, there was a notable shift towards market-based financing for both the government and the private sector. In fact, automatic monetisation through ad hoc treasury bills was abolished in 1997 and replaced with a system of ways and means advances (WMAs).

During this period, average domestic growth rate was 5.6 per cent and average WPI-based inflation was 8.1 per cent.

1998 to 2015: Multiple Indicators Approach

Reserve Bank of India adopted multiple indicators approach in April 1998. Under this approach, besides monetary aggregates, a host of forward-looking indicators such as credit, output, inflation, trade, capital flows, exchange rate, returns in different markets and fiscal performance constituted the basis of information set used for monetary policy formulation.

Reforms since 1990s gradually facilitated the price discovery in financial markets and interest rate emerged as a signalling mechanism. This paved way for introduction of the Liquidity Adjustment Facility (LAF) in 2000-01 as a tool for both liquidity management and also a signalling device for interest rates in the overnight money market.

The enactment of the Fiscal Responsibility and Budget Management (FRBM) Act in 2003, by introducing fiscal discipline, provided flexibility to monetary policy. Increased market orientation of the domestic economy and deregulation of interest rates introduced since the early 1990s also enabled a shift from direct to indirect instruments of monetary policy. Accordingly, short-term interest rates became instruments to signal monetary policy stance of RBI.

In order to stabilise short-term interest rates, the Reserve Bank placed greater emphasis on the integration of money market with other market segments. An assessment of macroeconomic outcomes suggests that the multiple indicator approach served fairly well from 1998-99 to 2008-09. During this period, average domestic growth rate improved to 6.4 per cent and WPI based inflation moderated to 5.4 per cent.

2013-2016: Preconditions Set for Inflation Targeting

In the post-global financial crisis period (i.e., post-2008), however, the credibility of this framework came into question as persistently high inflation and weakening growth began to co-exist. The extant multiple indicators approach was criticised on the ground that a large set of indicators do not provide a clearly defined nominal anchor for monetary policy.

In its Report of 2014, the Committee Expert Committee set up by RBI to revise and strengthen the monetary policy framework reviewed the multiple indicators approach and recommended that inflation should be the nominal anchor for the monetary policy framework in India. Against this backdrop, the Reserve Bank imposed on itself a glide path for bringing down inflation in a sequential manner – from its peak of 11.5 per cent in November 2013 to 8 per cent by January 2015; 6 per cent by January 2016 and 5 per cent by Q4 of 2016-17.

2016 onwards: Flexible Inflation Targeting

Amid this, a Monetary Policy Framework Agreement (MPFA) was signed between the Government of India and the Reserve Bank on February 20, 2015. Subsequently, flexible inflation targeting (FIT) was formally adopted with the amendment of the RBI Act in May 2016. The role of the Reserve Bank in the area of monetary policy has been restated in the amended Act as follows:

“the primary objective of monetary policy is to maintain price stability while keeping in mind the objective of growth”.

Empowered by this mandate, the RBI adopted a flexible inflation targeting (FIT) framework under which primacy is accorded to the objective of price stability, defined numerically, while simultaneously focusing on growth when inflation is under control.

As an outcome, inflation has fallen successively and has averaged below 4 per cent since 2017-18, notwithstanding recent up-tick in inflation driven by food prices , especially the sharp increase in vegetable prices reflecting the adverse impact of unseasonal rains and cyclone.

Challenges in the Current Context

One of the major challenges for central banks is the assessment of the current economic situation. As we all know, the precise estimation of key parameters such as potential output and output gaps on a real time basis is a challenging task, although they are crucial for the conduct of monetary policy.

In recent times, shifting trend growth in several economies, global spill over effects and disconnect between the financial cycles and business cycles in the face of supply shocks broadly explain why monetary policy around the world is in a state of flux. Nonetheless, a view has to be taken on the true nature of the slack in demand and supply-side shocks to inflation for timely use of counter cyclical policies.

Growth in India

Growth of an economy denotes the increase in the capacity of
production of goods and services in a country. It is usually measured as GDP growth rate compared to the previous year adjusted for price rise due to inflation.

Gross Domestic Product: GDP is the monetary value of all goods and services produced in a country in a year.

The above formula is for an understanding about GDP and it is not feasible to calculate GDP of a country using it. The GDP of a country can be arrived at by three methods.

I. Expenditure method:

C – Consumption expenditures by households
I – Gross private investment
G – Government purchases of goods and services
X – Exports
M – Imports

This method is based on the assumption that all goods and services produced in country needs to be sold within country (captured by various expenditure or investments) or outside the country (captured by difference between export and Import).

The GDP value calculated includes the tax imposed by government and sometimes production value decreased due to subsidy of the government. The GDP at factor cost is calculated to nullifies these effects.

And again, in order to measure the growth of the GDP, a base year was select to adjust the values for inflationary price rises. Such adjusted value is called GDP at factor cost at constant price or real GDP

Income method:

NY – National Income (includes employee compensation, corporate profits, proprietor’s income, rental income and net interest).

IBT – Indirect Business Taxes. CCA – Capital Consumption Allowance and Depreciation.

NFP – Net Factor Payment to rest of the world (Payment to the rest of the world – Payment from the rest of the world).

Value Addition Method: The GDP is arrived at by calculating the value addition at each level. The difference between value of the output and value of the intermediate consumed for producing the output.

Measurement of growth in India:
Economic growth in India was measured as change in GDP at factor cost at constant price of base year 2004-05. In 2015, Government of India changed the base year from 2004-05 to 2011-12, and GDP at factor cost at constant price replaced by Gross Value Added (GVA) at basic prices.

GDP = GVA + DITS

Where, DITS stands for Difference between Indirect Taxes and Subsidies.

Gross Value Added (GVA) methods estimate the values from the supply or production side of the economy. GVA method was recommended by the United Nations System of National Accounts in 2008 and has made India’s figures comparable to other countries.

The graph below depicts the GDP growth of India for last two decades.

Since 2011-12, India recorded its lowest quarterly GDP growth in Q4 of 2012-13 (Figure 9). After 13 quarters, the economy achieved its highest quarterly growth of 9.4 per cent in Q1 of 2016-17. Again after 13 quarters, the economy has recorded a low growth of 4.5 per cent in Q2 of 2019-20.

A virtuous cycle of Growth?

The overwhelming evidence across the globe, especially from China and East Asia in recent times, is that high growth rates have only been sustained by a growth model driven by a virtuous cycle of savings, investment and exports catalysed and supported by a favourable demographic phase. As we explain in detail below, investment, especially private investment, is the “key driver” that drives demand, creates capacity, increases labour productivity, introduces new technology, allows creative destruction, and generates jobs.

Traditional view often attempts to solve job creation, demand, exports, and economic growth as separate problems. In contrast, as we show below, these macro-economic phenomena exhibit significant complementarities.

When viewed in this manner, the triggering macro-economic “key driver” that catalyses the economy into a virtuous cycle becomes critical. Investment as the “key driver” that can create a self-sustaining virtuous cycle in India. This investment can be both government investments in infrastructure, as such investment crowds in private investment and private investment in itself.

Increase in the rate of fixed investment accelerates the growth of GDP that in turn induces a higher growth in consumption. Higher growth of consumption improves the investment outlook, which results in still higher growth of fixed investment that further accelerates the growth of GDP, inducing a still higher growth of consumption. This virtuous cycle of higher fixed investment-higher GDP growth-higher consumption growth (Refer Figure) generates economic development in the country.

High Investment and labour – Substitutes or Supplements?

A general apprehension is that high investment rate will substitute labour. This thinking has led to much debate about labour-intensive versus capital-intensive modes of production. However, the Chinese experience illustrates how a country with the highest investment rates also created the most jobs. What matters most is whether or not investment enhances productivity and thereby international competitiveness.

The misconception arises from a view buried in the silo of a specific activity. When examined in the full value chain, capital investment fosters job creation as capital goods production, research and development, and supply chains also generate jobs. International evidence also suggests that capital and labour are complementary when high investment rate drives growth.

Impact of Demography in Growth:

Change in demographics, especially in the age structure of the population, has been shown to have had a significant effect on economic growth throughout Asia between 1960 and 1990 (Bloom and Williamson, 1998). A rise in the share of the working-age population, brought about by a decline in the fertility rate, increases income per capita as output per worker remains unchanged but the number of youth dependents declines.

The rise in the working-age share in Asia created this accounting effect, but it also brought with it behavioural changes. Savings increased as life expectancy increased, and consequently investment increased. In fact, changes in growth of labour force per capita, changes in the savings rate, and changes in the investment rate are three plausible mechanisms by which demographics affects the economic growth.

Savings rate in China and other high-growth East Asian economies was driven significantly by change in its demographics from a predominantly young to an older population.

Household saving rate and the working age proportion of the population move together in China and other high-growth East Asian economies. This makes sense because only people who are earning income can save, and the majority of income for the majority of people will be labour income. But, in addition to this effect of demographic composition, having fewer “mouths to feed” raises the availability of resources that can be saved for the future.

Second, due to the importance of children as a source of retirement income in the Asian/Indian context, the decline in the number of children by the working generation promotes saving as they must rely more on savings for retirement in comparison to previous generations. Finally, saving also increases as a result of a composition effect: a large portion of saving tends to occur between the ages of 40 to 65 as people start to save for retirement.

Current Situation Economic growth in India has been broadly on an accelerating path. It is likely to be the fastest growing major economy in the world in the medium-term. The share of manufacturing in India’s
GDP is low relative to the average in low and middle-income countries. It has not increased in any significant measure in the quarter century after economic liberalization began in 1991.

Within manufacturing, growth has often been highest in sectors that are relatively capital intensive, such as automobiles and pharmaceuticals. This stems from India’s inability to capitalize fully on its inherent labour and skill cost advantages to develop large-scale labour intensive manufacturing. Complex land and labour laws have also played a notable part in this outcome. There is a need to increase the pace of generating good quality jobs to cater to the growing workforce, their rising aspirations and to absorb out-migration of labour from agriculture.

The positive news is that high growth rate has been achieved with strong macroeconomic fundamentals including low and stable rates of inflation and a falling fiscal deficit. However, along with macroeconomic stability, the sufficient condition for escalating growth is to continue with the structural reforms that address the binding constraints for a more robust supply-side response.

Way Forward:

1. Raising investment rates to 36 per cent by 2022-23:

To raise the rate of investment (gross fixed capital formation as a share of GDP) from about 29 per cent in 2017-18 to about 36 per cent of GDP by 2022-23, a slew of measures will be required to boost both private and public investment.

India’s tax-GDP ratio of around 17 per cent is half the average of OECD countries (35 per cent) and is low even when compared to other emerging economies like Brazil (34 per cent), South Africa (27 per cent) and China (22 per cent). To enhance public investment, India should aim to increase its tax-GDP ratio to at least 22 per cent of GDP by 2022- 23.

Efforts need to be made to rationalize direct taxes for both corporate tax and personal income tax. Simultaneously, there is a need to ease the tax compliance burden and eliminate direct interface between taxpayers and tax officials using technology.

In 2016-17, the share of government (central and state combined) capital expenditure in total budget expenditure was 16.2 per cent, and government’s contribution to fixed capital formation was close to 4 per cent of GDP. This needs to be increased to at least 7 per cent of GDP by 2022-23 through greater orientation of expenditure towards productive assets, and minimizing the effective revenue deficit.

States could also undertake greater mobilization of own taxes such as property tax, and taking specific steps to improve administration of GST to increase tax collections.

Two areas in which higher public investment will easily be absorbed are housing and infrastructure. Investment in housing, especially in urban areas, will create very large multiplier effects in the economy. Investment in physical infrastructure will address longstanding deficiencies faced by the economy.

Domestic savings can be complemented by attracting foreign investment in bonds and government securities. Regulatory limits can be relaxed for rupee denominated debt.

The government should continue to exit central public sector enterprises (CPSEs) that are not strategic in nature. Inefficient CPSEs surviving on government support distort entire sectors as they operate without any real budget constraints. The government’s exit will attract private investment and contribute to the exchequer, enabling higher public investment.

Private investment needs be encouraged in infrastructure through a renewed public-private partnership (PPP) mechanism on the lines suggested by the Kelkar Committee.

2. Macroeconomic stability through prudent fiscal and monetary policies:

Sustained high growth requires macroeconomic stability, which is being achieved through a combination of prudent fiscal and monetary policies. The government has targeted a gradual lowering of the government debt-to-GDP ratio. It will help reduce the relatively high interest cost burden on the government budget, bring the size of India’s government debt closer to that of other emerging market economies, and improve the availability of credit for the private sector in the financial markets.

But even as lowering of debt and limiting fiscal deficit are important, the government should be flexible in its approach towards settingannual targets based on prevailing economic conditions. This approach is enshrined in the existing Fiscal Responsibility and Budget Management (FRBM) architecture that has built in flexibility in the form of adequately defined “escape and buoyancy” clauses. Targets should take cognizance of the stage of the business cycle and fiscal deficit and borrowing targets should not be set in isolation.

The effective revenue deficit should be brought down as rapidly as possible. Capital expenditure incurred for the health and education sectors, which in effect builds human capital, should be excluded from estimates of revenue expenditure. This will increase government savings.

One of the major institutional reforms of recent years has been to statutely mandate the RBI to maintain “… price stability while keeping in mind the objective of growth”. Inflation needs to be contained within the stated target range of 2 per cent to 6 per cent. Inflation targeting provides a reasonably flexible policy framework which is in line with global best practices and can respond appropriately to supply shocks. Policy should be directed to minimize volatility in the nominal exchange rate.

3. Efficient financial intermediation:

Efficient functioning of the financial markets is crucial to maintain high growth in the economy. There is a need to deepen financial markets with easier availability of capital, greater use of financial markets to channel savings and an improved risk-assessment framework for lending to avoid a situation of large-scale nonperforming assets in the banking sector.

Governance reforms in public sector banks require, apart from the establishment of independent and commercially driven bank boards, performance assessment of executives and increased flexibility in human resources policy.

The Gujarat International Finance and Tech City (GIFT) should be leveraged to push the envelope on financial sector liberalization. It is an opportunity to onshore trading in rupees and other derivatives, which currently happens outside India for regulatory reasons. If GIFT succeeds, liberalization can be extended to the rest of the country.

Enable alternative (to banks) sources of credit for India’s long-term investment needs. The bond market needs deepening through liberalization of regulations and continued fiscal consolidation.

4. Focus on exports and manufacturing:

India needs to remain globally competitive, particularly in the production and exports of manufactured, including processed agricultural, goods.

The following reforms would help in improving the competitiveness:

I.A focused effort on making the logistics sector more efficient is needed.

II.Power tariff structures may be rationalized to ensure global
competitiveness of Indian industries.

III.Import tariffs that seek to promote indigenous industry should come with measures to raise productivity which will provide the ability to compete globally.

Improve connectivity by accelerating the completion of announced infrastructure projects. Enhancing physical connectivity will help reduce delivery times and improve global connectivity and the reach of our exporters.

By 2022-23, we should complete projects that are already underway such as the Delhi-Mumbai Industrial Corridor (DMIC) and Dedicated Freight Corridors.

Work with states to ease labour and land regulations. In particular, we should introduce flexibility in labour provisions across sectors. All state governments should speedily implement fixed term employment (FTE) that has now been extended to cover all sectors.

The government has recently established a dedicated fund of INR 5,000 crore for enhancing “Champion Services Sectors”. Among others, these include IT & ITeS, tourism, medical value travel and audio-visual services. Given the significant role of services exports in maintaining India’s balance of payments, the government should continue to focus on these sectors.

Strengthen the governance and technical capabilities of Export Promotion Councils (EPCs) by subjecting them to a well-defined, performance-based evaluation. Performance evaluations of EPCs could be based on increasing the share of Indian exports in product markets covered by these EPCs. Those EPCs unable to achieve mutually agreed upon targets for increasing market shares could be closed down or re-structured.

Explore closer economic integration within South Asia and the emerging economies of South East Asia particularly Cambodia, Laos, Myanmar and Vietnam, using the existing Bangladesh, Bhutan, India, Nepal (BBIN) and the Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Co-operation (BIMSTEC) frameworks.

Building the physical infrastructure and putting in place measures to facilitate seamless cross-border movement of goods in the North-East region would help accelerate integration and promote exports.

5. Employment generation:

The necessary condition for employment generation is economic growth. Achieving the growth targets by implementing the development strategy can generate sufficient jobs for new entrants into the labour force, as well as those migrating out of agriculture.

A large part of jobs is to be generated in labour-intensive manufacturing sectors, construction and services. In addition, the employability of labour needs to be enhanced by improving health, education and skilling outcomes and a massive expansion of the apprenticeship scheme. The employability and labour reforms are being discussed subsequently in the document.