The World Bank Group on 20 June 2016 released the mid-year edition of India Development Update 2016: Financing Double-Digit Growth. The report finds that India’s economy expanded at a faster pace in FY 2016.
It says that the economy was lifted to a higher growth path by demand from urban households and public investments, despite the fact that other key growth engines had stalled.
Highlights of the Update
• It reviews the current challenges in India’s financial sector and analyzes some of the impacts of the recommendations of the 14th Finance Commission on Indian states.
• Agriculture, rural household consumption, private investments, and exports have not performed to potential.
• The oil bonanza most directly benefited the government, which for the first time in five years exceeded its revenue collection targets and used the resources to contain the fiscal deficit.
• Capital spending by the central government was ramped up.
• Urban households were the main drivers of growth in FY 2016.
• The manufacturing and services sectors, which expanded 7.4 and 8.9 percent, respectively, also created urban jobs.
• Inflation abated primarily because of lower food prices.
• Lower inflation raised real incomes and allowed RBI to cut interest rates, which favored the financially-connected urban households.
• To remain on this growth path and sustain growth at 7.6 percent into FY17, the challenge for the Indian economy is to activate the stalled engines that are agricultural growth, rural demand and trade.
• The dissipation of the large boost from historically low oil prices in the past year will make this a challenging task, but prospects of a normal monsoon will help, the Update suggests.
• It expects India’s economic growth to be at 7.6 percent in 2016-2017, followed by a modest acceleration to 7.7 percent in 2017-2018 and 7.8 percent in 2018-2019.
• In less than three decades, India’s financial sector has evolved from an essentially state-controlled system toward one with greater participation of private banks and generally more competition.
• Banks currently have capital levels in excess of regulatory requirements, regulations have been strengthened, and overall credit growth in real terms has been resilient.
• On the other hand, concerns have arisen about growing non-performing assets (NPAs) and declining credit growth, particularly in public sector banks (PSBs).
• States are now responsible for 57 percent of the spending, which accounts for 16 percent of GDP. Of this, nearly 74 percent of the funds are untied, allowing more flexibility to states.
• Tax devolution increased everywhere, even for states that saw a reduction in their inter-state share, such as Bihar and Rajasthan.
• Overall, transfer of grants to states increased by 0.7 percent of GDP in FY16 compared to the budget estimate of a net increase of 0.5 percent.
• Health and education expenditures increased in almost every state in FY16.
• Combined health and education expenditures increased in 13 of the 14 states for which data was available.
• Uttar Pradesh spent over one-third of its additional resources on health and education. Rajasthan and Kerala stood out by spending the equivalent of over 70 percent of additional resources on health, education and infrastructure.
Two Key Reform Fronts for the Financial Sector
The Update suggests two key reform fronts for the financial sector. These are:
• First, accelerate the ongoing structural transformation of the sector toward one that is more market-oriented and competitive, for example relaxing government mandates on banks.
• Second, address the NPA challenge, both by its branches and its roots.
