## Currency Withdrawal and Exchange and its Economic Impact

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### Context and background
- India recorded a recovery in real GDP growth from 5.6 percent in FY2012/13 to 7.6 percent in FY2015/16.
- Since late 2014, a halving of global oil prices helped boost activity, improve the current account and fiscal positions, and lower inflation.
- Post-November 8, 2016 currency exchange initiative:
  - withdrawal of the legal tender of Rs 500 and Rs 1000 notes (which accounted for 86 percent of the value of currency in circulation);
  - introduction of new Rs 500 and Rs 2000 notes.
- The supply of new banknotes in the first month following the initiative was insufficient, prompting multiple steps by authorities to ease the transition.

### Impact on activity and near-term transmission
- Growth context:
  - Growth has been consumption-led; investment contracted sharply in the first half of FY2016/17.
- Direct effects of the currency exchange initiative:
  - Cash shortages and payment disruptions strained consumption and business activity.
  - Sharp declines in November PMI for both manufacturing and services (large drops in output and new orders).
  - Weighed on operations of the financial system and posed monitoring priorities for financial institutions.
- External demand environment:
  - Growth of import volumes of India’s trading partners decelerated to 2½ percent in 2015 from 4½ percent in the previous year.

### Macroeconomic projections and outlook
- Real GDP growth projection:
  - Slow to 6.6 percent in FY2016/17 (due to temporary disruptions primarily to private consumption).
  - Rebound to 7.2 percent in FY2017/18 as cash shortages ease and tailwinds (favorable monsoon, low oil prices) support recovery.
- Inflation:
  - CPI inflation expected at about 4¾ percent by early 2017 — in line with the RBI inflation target of 5 percent by March 2017.
  - Inflationary pressures likely to reappear in the second half of 2017, partly reflecting government pay reviews and waning effects of the oil price collapse.
- Current account deficit (CAD):
  - Average of 1.4 percent of GDP during FY2013/14–FY2015/16.
  - Expected to be about 1.1 percent of GDP (about US$25 billion) in 2016/17.
  - Expected to widen to about 2 percent of GDP over the medium term as domestic demand strengthens and commodity prices rebound.
- Note: All macroeconomic projections are based on oil-price assumptions contained in the October 2016 World Economic Outlook.

### Financial market and capital flow developments
- Immediate reaction (two weeks after November 8, 2016 announcement):
  - Rupee weakened by 2½ percent against the U.S. dollar.
  - Portfolio capital outflows totaled US$3.5 billion.
  - SENSEX equity index fell by 6 percent.
- Subsequent dynamics:
  - Rupee rebounded by about 1 percent by mid-December.
  - Cumulative portfolio outflows of US$2.2 billion so far during FY2016/17, after inflows of US$6.8 billion prior to November 8.

### Banking sector and credit conditions
- System-wide asset quality:
  - Gross NPA ratio rose from 5.1 percent in September 2015 to 7.6 percent in March 2016.
  - Expected to rise further by an additional one percentage point towards the end of FY2016/17.
- Credit growth and drivers:
  - Aggregate credit growth remains modest; primarily led by private banks (one-quarter of Indian banking system assets) and better performing public sector banks (PSBs).
  - PSB credit growth slowed to 4.0 percent year-on-year as of March 2016 from an average of 11.7 percent in the preceding three years.
- Capital and resolution constraints:
  - Aggregate CET-1 ratio of PSBs was 8.7 percent as of end-FY2015/16, above the 6.125 minimum requirement (including CCB) under India’s implementation schedule.
  - Simulation estimates additional PSB recapitalization needs of about 1.5 to 2.4 percent of FY2018/19 GDP (cumulatively over the next three years) under specified assumptions.
  - Under this simulation, the government share would range between 1 to 1.6 percent of FY2018/19 GDP (cumulatively over the next three years).
  - Estimate includes a cumulative capital injection of 0.5–0.8 percent of FY2018/19 GDP related to ongoing Basel III implementation expected to be finalized by March 2019.
  - Government’s share estimate assumes no dilution of government ownership in PSBs, currently at about 61 percent.
- NPA drivers and corporate sector linkages:
  - NPA slippages accelerated to 7.2 percent in FY2015/16, up from 3.4 percent in FY2014/15.
  - Ratio of stressed assets (restructured assets and NPAs) edged up to 10.8 percent at end-FY2015/16 (from 10 percent a year earlier).
  - PSBs' ROA turned negative in FY2015/16.
  - PSBs’ aggregate provisioning coverage ratio was 39 percent as of end-FY2015/16.
  - Corporate sector accounts for about 40 percent of banks’ credit portfolios.
  - Share of debt held by firms with interest coverage ratio below one declined to 16.6 percent in FY2015/16, from 20.2 percent a year earlier.
  - Debt of highly-levered firms (debt-to-equity ratios above 150 percent) accounts for about a half of overall debt.
  - Corporate FX funding via ECBs continued to account for about 13 percent of total funding at end-March 2016.
  - Corporates’ hedging ratio (excluding natural hedges) increased to about 46.8 percent of borrowings in the first half of FY2015/16, up from 33.8 percent in FY2013/14.

### Policy stance, reforms and medium-term prospects
- Recent policy actions and reforms:
  - Fiscal consolidation at the Union level resumed in FY2016/17; excise duties on petrol and diesel raised; kerosene and fertilizer subsidy reforms pursued.
  - RBI adopted a flexible inflation targeting regime with a formal inflation target band (August 2016) and introduced a statutory Monetary Policy Committee (September 2016).
  - Structural reforms include: Insolvency and Bankruptcy Code (May 2016), formalization of inflation targeting, and constitutional amendment enabling pan-India GST.
- Expected medium-term benefits:
  - GST adoption and continued reforms expected to improve medium-term prospects; staff view that GST could help raise medium-term GDP growth to above 8 percent by creating a single national market and enhancing intra-Indian efficiency.
- Risks to outlook:
  - Near-term adverse impact of cash shortages from the currency exchange initiative.
  - Potential further deterioration of corporate and public bank balance sheets.
  - Setbacks in reform implementation (including GST design and rollout).
- Upside scenarios:
  - Larger-than-expected gains from GST and further structural reforms.
  - A sustained period of continued-low global energy prices.

### Key policy recommendations (staff)
- Strengthen PSB capitalization and governance:
  - Consider larger government capital injections in PSBs and some divestments of banks’ non-core assets to support lending capacity.
  - New recapitalization norms linking support to performance can open way for restructuring, including mergers and acquisitions.
- NPA resolution strategy:
  - Continue stringent supervision, frequent in-depth reporting of NPA portfolios, intensive on-site supervision, and enhanced regulation and guidance.
  - Pursue more robust provisioning.
  - Incentivize use of asset restructuring mechanisms (5:25 Refinance Scheme, Strategic Debt Restructuring (SDR), and S4A).
  - Ensure prompt implementation of the new Bankruptcy Code and introduce out-of-court corporate debt restructuring mechanisms.
  - Develop distressed debt markets and examine market-based rehabilitation mechanisms (corporate restructuring vehicles, asset management companies).
- Financial-market and liquidity measures:
  - Reduce SLR further as general government fiscal deficit continues to contract; current SLR rate: 20.5 percent (down from 25 percent of deposit liabilities in mid-2008).
  - Develop domestic corporate bond market: implement reforms recommended by the Khan Committee; support risk transfer mechanisms including CDS; enhance cross-agency coordination.
- Financial inclusion and digital payments:
  - Continue enhancing financial inclusion via PMJDY, PMMY, gold monetization schemes, and technologies such as Unified Payments Interface.
  - PMJDY: bank accounts opened for 254 million previously unbanked individuals since August 2014.
  - PMMY: close to 1 percent of GDP in loans disbursed under this scheme.
  - UIDAI: as of end-December 2016, enrolled over 1,100 million people.

### Risks to the outlook (staff and authorities)
- Authorities viewed external risks as more important:
  - Weak global growth, potential financial spillovers from accommodative monetary policies and negative interest rates, and an upsurge in protectionism.
- Key domestic risks (Risk Assessment Matrix):
  - Prolonged cash shortages — Likelihood: M; Impact: M. Policy: enhance supply of new banknotes; consider sector-based exemptions for rural and remote areas.
  - Balance sheet risks — Likelihood: M; Impact: H. Policy: strengthen oversight, enhance loss-absorbing buffers, incentivize corporate restructuring and implement insolvency framework.
  - Setbacks in structural reform process — Likelihood: L; Impact: M. Policy: facilitate state-led reforms, enhance revenue raising, address supply bottlenecks.
  - Larger positive impact from GST than currently expected — Likelihood: L; Impact: H. Policy: facilitate further structural reforms and enhance public investment quality.
- External risks:
  - Tighter/volatile global financial conditions — Likelihood: M; Impact: M. Policy: attract FDI, maintain rupee flexibility, provide foreign currency liquidity as needed.
  - Weaker global growth — Likelihood: M; Impact: M. Policy: structural reform to strengthen domestic growth.
  - Increased volatility in global energy prices — Likelihood: M; Impact: M. Policy: improve targeting of transfers; accelerate fuel subsidy reform; provide dollar liquidity to oil marketing companies as required.
  - Rising regional geopolitical tensions — Likelihood: L; Impact: M. Policy: oversight, rupee flexibility, foreign currency liquidity where needed.

### Boxes and specific program summaries (selected highlights)
- Box 1 — Currency Withdrawal and Exchange:
  - Affected notes totalled about Rs 15 trillion (about 86 percent of all cash in circulation).
  - Defunct notes could be deposited in unlimited amounts into bank accounts until end-2016; large deposits (US$ 4000 and above) expected to attract scrutiny.
  - New Rs 500 and 2000 notes distribution proceeded slowly; cash exchanges initially allowed up to Rs 4,500 (US$ 70) but later discontinued.
  - Temporary exemptions were granted for certain public offices, farming sector, payments for public utility services and purchasing key primary products.
  - At end-2015, currency in circulation in India stood at about 12 percent of GDP.
  - Cash accounted for about three quarters of the narrow money base.
  - The average number of transactions made with payments instruments per Indian in 2015 totalled 11 transactions.
  - Staff growth-impact estimates: cash shortages likely to slow FY2016/17 growth by about 1 percentage point and FY2017/18 growth by about 0.5 percentage points (compared to October 2016 IMF WEO forecasts).
  - IMF India Quarterly Projection Model: GDP growth expected to slow to about 6 percent in the second half of FY2016/17, before gradually rebounding in FY2017/18.
- Box 2 — UDAY (DISCOM debt restructuring):
  - At launch in November 2015, DISCOMs had about Rs 3.8 trillion in losses (3 percent of then-GDP) and Rs 4.3 trillion in debt (3.4 percent of GDP).
  - UDAY states take over 75 percent of DISCOMs’ outstanding debt as of September 2015—50 percent in FY2015/16 and 25 percent in 2016/17.
  - As of November 2016, nine states had issued UDAY bonds amounting to Rs 1,585 billion (50 percent of DISCOM debt eligible for the scheme).
- Box 3 — Corporate bond market:
  - Issuance volumes roughly doubled to Rs 5.8 billion in the five years to end-FY2016.
  - Outstanding debt close to 15 percent of GDP at end-FY2016.
  - Domestic debt securities account for only about 20 percent of corporate funding; bank credit and external borrowing jointly accounted for more than 80 percent.
- Box 4 — Financial inclusion:
  - PMJDY: more than 240 million previously unbanked individuals gained access to bank accounts since August 2014; about two-thirds are rural; share of zero balance accounts exceeds 25 percent across majority of states.
  - PMMY: close to 1 percent of GDP in loans disbursed; women-led businesses accounted for about one-half of the total amount lent and about four-fifths of the number of loans.
  - Staff model: increased women’s access to formal finance improves gender equality in entrepreneurship and boosts female labor force participation, employment, consumption and GDP.

### Inflation and monetary policy (selected exact figures)
- CPI inflation declined from an average of 9.8 percent during 2011–13 to an average of 4.9 percent in FY2015/16.
- CPI inflation dropped to 3.6 percent in November 2016, from an average of 5.4 percent in the first half of FY2016/17.
- Core inflation averaged 4.7 percent from April to November.
- Currency exchange initiative widened the output gap to around ¾ of one percent of GDP.
- Inflation expected to remain at about 4¾ percent in March 2017.
- RBI medium-term inflation target band: 4 percent CPI inflation ± 2 percent.
- Interim inflation target of 5 percent by March 2017.
- Real policy interest rate at about 1.25 percent; neutral range about 1.25–1.75 percent.
- Household inflation expectations remain near double digits.

### External sector and trade (selected exact figures)
- Merchandise exports contracted sharply in 2015/16.
- Refined petroleum products made up about one-fifth of the value of goods exports in 2014/15.
- India’s tariff rate (a simple average of MFN tariff rates) per WTO 2016: 13.4 percent for all products, 32.7 percent for agricultural products, and 10.1 percent for non-agricultural products.
- FDI inflows increased from US$31 billion in FY2013/14 to over US$45 billion in FY2015/16.
- External debt remains low at 23 percent of GDP at end-June 2016.
- Authorities estimate sustainable level of the CAD at about 2⅓ percent of GDP; staff projects a medium-term CAD of about 2 percent of GDP.
- International reserves around US$360 billion as of late-December 2016; reserves around US$359 billion in January 2017 (about 8 months of next year’s imports).

### Fiscal framework and expenditure reforms (selected exact figures)
- Budgetary direct plan capital expenditure:
  - Rs 2,35,807 crore in 2014–15 (actuals).
  - Rs 2,74,197 crore in 2015-16 (revised estimates) — y-o-y increase of 16.2 percent.
  - Rs 3,13,322 crore in 2016–17 (budget estimates) — y-o-y increase of 14.2 percent.
- Consolidation and GST:
  - GST constitutional amendment passed; GST Council formed; expected implementation most likely by July 1, 2017 (status as of January 16, 2017).
- Seven‑teenth Pay Commission impact:
  - Overall increase in pay & allowances by 23.55 percent.
  - Total financial impact in FY2016/17 estimated at ₹1,021 billion and additional cost of ₹121 billion in arrears and salary/pension for two months of FY2015/16.

### Data, statistics, and surveillance notes
- India subscribes to SDDS (since December 27, 1996) and is currently in observance, with flexibility options for timeliness of general government operations and labor market data.
- CSO new national accounts base year 2011/12 implemented 2008 SNA.
- Data limitations noted: use of WPI to derive volume estimates for many activities; index of industrial production base year 2004/05; gaps in employment data; state fiscal data lagged.
- Table of key indicators (selected):
  - Nominal GDP (in billions of U.S. dollars): 2,073
  - GDP per capita (U.S. dollars): 1,581
  - Headcount ratio at $1.90 a day (2011): 21.2
  - Total population (in billions): 1.31
  - Real GDP growth projections (market prices) 2016/17: 6.6; 2017/18: 7.2
  - CPI (period average) 2016/17: 4.7 percent
  - Gross reserves (end-period) 2016/17: 404.9 (in billions of U.S. dollars)
  - Current account balance 2015/16: -22.1 (in billions of U.S. dollars)
  - Merchandise exports 2015/16: 266.4 (in billions of U.S. dollars)
  - Merchandise imports 2015/16: 396.4 (in billions of U.S. dollars)

### Immediate near-term actions recommended by staff
- Quickly restore cash in circulation and avoid payment disruptions by enhancing supply of new banknotes.
- Consider extending or expanding targeted temporary exemptions, including on use of old banknotes, particularly for rural and remote areas.
- Remain vigilant about potential further build-up of NPAs and elevated corporate sector vulnerabilities, and ensure prudent support to economic sectors affected by the currency exchange initiative.

*International Monetary Fund — cr1754 (Chapter: "Currency Withdrawal and Exchange and its Economic Impact" and related excerpts).*

### 1. Currency Withdrawal and Exchange and its Economic Impact _______________________________ 29

### 1. Currency Withdrawal and Exchange and its Economic Impact

### Context and background
- India recorded a recovery in real GDP growth from 5.6 percent in FY2012/13 to 7.6 percent in FY2015/16.
- Since late 2014, a halving of global oil prices helped boost activity, improve the current account and fiscal positions, and lower inflation.
- Post-November 8, 2016 currency exchange initiative: withdrawal of the legal tender of Rs 500 and Rs 1000 notes (which accounted for 86 percent of the value of currency in circulation) and introduction of new Rs 500 and Rs 2000 notes.
- The supply of new banknotes in the first month following the initiative was insufficient, prompting multiple steps by authorities to ease the transition.

### Impact on activity and near-term transmission
- Growth has been consumption-led; investment contracted sharply in the first half of FY2016/17.
- The currency exchange initiative caused cash shortages and payment disruptions that:
  - Strained consumption and business activity.
  - Led to sharp declines in November PMI for both manufacturing and services (large drops in output and new orders).
  - Weighed on operations of the financial system and posed monitoring priorities for financial institutions.
- External demand weakened: growth of import volumes of India’s trading partners decelerated to 2½ percent in 2015 from 4½ percent in the previous year.

### Macroeconomic projections and outlook
- Real GDP growth projection:
  - Slow to 6.6 percent in FY2016/17 (due to temporary disruptions primarily to private consumption).
  - Rebound to 7.2 percent in FY2017/18 as cash shortages ease and tailwinds (favorable monsoon, low oil prices) support recovery.
- CPI inflation:
  - Expected at about 4¾ percent by early 2017 — in line with the RBI inflation target of 5 percent by March 2017.
  - Inflationary pressures likely to reappear in the second half of 2017, partly reflecting government pay reviews and waning effects of the oil price collapse.
- Current account deficit (CAD):
  - Average of 1.4 percent of GDP during FY2013/14–FY2015/16.
  - Expected to be about 1.1 percent of GDP (about US$25 billion) in 2016/17.
  - Expected to widen to about 2 percent of GDP over the medium term as domestic demand strengthens and commodity prices rebound.
- All macroeconomic projections are based on oil-price assumptions contained in the October 2016 World Economic Outlook.

### Financial market and capital flow developments
- In the two weeks after November 8, 2016 announcement:
  - Rupee weakened by 2½ percent against the U.S. dollar.
  - Portfolio capital outflows totaled US$3.5 billion.
  - SENSEX equity index fell by 6 percent.
- Subsequent dynamics:
  - Rupee rebounded by about 1 percent by mid-December.
  - Cumulative portfolio outflows of US$2.2 billion so far during FY2016/17, after inflows of US$6.8 billion prior to November 8.

### Banking sector and credit conditions
- System-wide gross non-performing asset (NPA) ratio:
  - Rose from 5.1 percent in September 2015 to 7.6 percent in March 2016.
  - Expected to rise further by an additional one percentage point towards the end of FY2016/17.
- Aggregate credit growth remains modest; primarily led by private banks (one-quarter of Indian banking system assets) and better performing public sector banks (PSBs).
- Banking system capacity to expand credit constrained by weakened capital, profitability and asset quality of many PSBs.
- Resolution outlook depends on success of the Asset Quality Review (AQR), the new Insolvency and Bankruptcy Code, and asset reconstruction mechanisms.
- Investment recovery expected to be modest and uneven as deleveraging takes place and capacity utilization picks up.

### Policy stance, reforms and medium-term prospects
- Past Fund advice and authorities’ policies broadly aligned: fiscal consolidation at the Union level resumed in FY2016/17; excise duties on petrol and diesel raised; kerosene and fertilizer subsidy reforms pursued.
- RBI adopted a flexible inflation targeting regime with a formal inflation target band (August 2016) and introduced a statutory Monetary Policy Committee (September 2016).
- Structural reforms over the past year include: legislation of a new bankruptcy code, formalization of inflation targeting, and constitutional amendment enabling pan-India GST.
- GST adoption and continued reforms expected to improve medium-term prospects; staff view that GST could help raise medium-term GDP growth to above 8 percent by creating a single national market and enhancing intra-Indian efficiency.
- Risks to the outlook include: near-term adverse impact of cash shortages from the currency exchange initiative, potential further deterioration of corporate and public bank balance sheets, and setbacks in reform implementation (including GST design and rollout).
- Upside scenarios: larger-than-expected gains from GST and further structural reforms, or a sustained period of continued-low global energy prices.

### Authorities’ views
- Authorities considered the near- and medium-term outlook encouraging, citing wide-ranging reforms (Goods and Services Tax Act, Aadhaar Act 2016, Insolvency and Bankruptcy Code 2016, operationalization of NCLT/NCLAT, formalization of Monetary Policy Committee, enhanced FDI liberalization, and infrastructure initiatives).
- Authorities highlighted Direct Benefit Transfer and JAM (Jan Dhan, Aadhaar, Mobile) trinity in supporting inclusive growth and fiscal consolidation.
- Authorities expected currency replacement effects on activity to be transitory (not extending beyond two quarters) and to be outweighed by medium-term benefits from a more efficient payments system and greater formalization.
- Authorities agreed overall GST impact on growth would be positive and that continuation of structural reforms would strengthen medium-term growth.

*International Monetary Fund — Chapter: "Currency Withdrawal and Exchange and its Economic Impact"*

### 14. Risks to the outlook were seen as coming more importantly from abroad. In

### cr1754 - 14. Risks to the outlook were seen as coming more importantly from abroad. In

### Risks to the outlook
- Authorities saw risks coming more importantly from abroad, particularly:
  - Weak global growth.
  - Potential financial spillovers in a world characterized by highly accommodative monetary policies and negative interest rates in many advanced economies.
  - An upsurge in protectionism in advanced economy markets posing risks to India’s exports.
- Authorities judged India to be well prepared to navigate accompanying turbulence.

### A. Strengthening the Financial Sector and Reining in Risks — summary of conditions and trends
- NPA recognition and asset quality
  - NPA slippages accelerated to 7.2 percent in FY2015/16, up from 3.4 percent in FY2014/15.
  - Share of restructured assets in total advances receded to 4.1 percent, from 7.1 percent a year earlier.
  - Ratio of stressed assets (restructured assets and NPAs) edged up to 10.8 percent at end-FY2015/16 (from 10 percent a year earlier).
  - Most AQR-related recognition of NPAs appears to have already materialized.
- Profitability, provisioning and recovery
  - PSBs' ROA turned negative in FY2015/16.
  - PSBs’ aggregate provisioning coverage ratio was 39 percent as of end-FY2015/16.
  - Write-offs accounted for a 1.2 percentage-point offset in NPA slippage rates in FY2015/16; loan recoveries accounted for 0.6 percentage points (down from 0.8 percentage points a year earlier).
- Corporate sector vulnerabilities
  - Share of debt held by firms with interest coverage ratio below one declined to 16.6 percent in FY2015/16, from 20.2 percent a year earlier.
  - Debt of highly-levered firms (debt-to-equity ratios above 150 percent) accounts for about a half of overall debt.
  - High debt-at-risk concentrated in metals and mining, construction and engineering, and transportation and infrastructure; debt-at-risk in metals and mining as high as 36 percent.
  - Corporate sector accounts for about 40 percent of banks’ credit portfolios.
  - Corporate FX funding via ECBs continued to account for about 13 percent of total funding at end-March 2016.
  - Corporates’ hedging ratio (excluding natural hedges) increased to about 46.8 percent of borrowings in the first half of FY2015/16, up from 33.8 percent in FY2013/14.
- Credit growth and intermediation
  - PSB credit growth slowed to 4.0 percent year-on-year as of March 2016 from an average of 11.7 percent in the preceding three years.
  - Government capital injections and shift of demand toward private banks and alternatives (e.g., commercial paper) have supported credit growth.
- PSB capitalization and fiscal impact
  - Aggregate CET-1 ratio of PSBs was 8.7 percent as of end-FY2015/16, above the 6.125 minimum requirement (including CCB) under India’s implementation schedule.
  - Simulation of further balance sheet clean-up and Basel III implementation estimates additional PSB recapitalization needs of about 1.5 to 2.4 percent of FY2018/19 GDP (cumulatively over the next three years) under assumptions: transition of 25 percent of restructured loans to NPAs; 40 percent minimum provisioning coverage ratio; and build-up of an additional 0 to 2 percentage-point capital buffer.
  - Under this simulation, the government share would range between 1 to 1.6 percent of FY2018/19 GDP (cumulatively over the next three years).
  - Estimate includes a cumulative capital injection of 0.5–0.8 percent of FY2018/19 GDP related to ongoing Basel III implementation expected to be finalized by March 2019.
  - Government’s share estimate assumes no dilution of government ownership in PSBs, currently at about 61 percent.
  - All but one bank (a private bank) currently meet Basel III’s minimum CET-1 and Tier-1 capital requirements.
- Recent reforms and mechanisms
  - AQR initiated by RBI in December 2015 to enforce robust asset quality recognition and clean balance sheets by March 2017.
  - Scheme permitting debt-to-equity conversions of unsustainable portions of banks' exposures introduced by RBI in June 2016 (S4A).
  - Insolvency and Bankruptcy Code adopted in May 2016 targets reduction in timing of bad asset resolution from 4.3 years to about 180 days.
  - Regime for foreign ownership of Asset Reconstruction Companies (ARCs) relaxed to permit foreigners to take full stakes in ARCs.
  - UDAY scheme envisages state governments taking on 75 percent of DISCOMs’ debt owed to banks.
  - Eligibility criteria for government recapitalization support to troubled PSBs amended in September 2016 to focus on cost of operations, credit quality and ability to recover assets.

### Key risks to growth and financial stability
- Slow deleveraging and repair of corporate balance sheets and potential further build-up of NPAs can:
  - Dampen provision of credit to the real economy and impair growth.
  - Be exacerbated by shocks affecting corporates’ debt repayment capacity (weaker demand in certain sectors, exchange rate or interest rate shocks).
  - Be worsened by PSBs’ inability to raise adequate capital.
- Limited monetary and fiscal space constrains policymakers’ capacity to counteract additional increase in NPAs.

### Policy recommendations (staff)
- Ensuring Adequate PSB Capitalization
  - Consider larger government capital injections in PSBs and some divestments of banks’ non-core assets to support lending capacity.
  - Note: government’s capital injections in PSBs thus far modest in scale (0.2 percent of projected FY2018/19 GDP cumulatively over the next three years).
  - New recapitalization norms linking support to performance are welcome; can open way for restructuring, including mergers and acquisitions.
- NPA Resolution — a comprehensive strategy including:
  - Continued stringent supervision
    - Persist in robust supervision, including frequent in-depth reporting of NPA portfolios, ongoing monitoring of banks’ capital and profitability, intensive on-site supervision, and enhanced regulation and guidance.
    - Pursue more robust provisioning.
  - Corporate debt resolution
    - Incentivize use of asset restructuring mechanisms (5:25 Refinance Scheme, Strategic Debt Restructuring (SDR), and S4A).
    - Prioritize rehabilitation and restructuring to raise demand for corporate bond issuances.
    - Ensure prompt implementation of the new Bankruptcy Code and introduce out-of-court corporate debt restructuring mechanisms.
  - Distressed debt markets
    - Follow through on steps to develop the market for distressed debt.
    - Examine costs and benefits of market-based mechanisms for rehabilitation of distressed but viable firms, such as corporate restructuring vehicles and asset management companies.
- PSB Governance Reforms
  - Strengthen NPA disclosures; enhance governance (including risk management practices and accountability); consider divestments and mergers as outlined in the Indradhanush plan (August 2015).
- Banks’ Statutory Liquidity Requirement (SLR)
  - As the general government fiscal deficit continues to contract, reduce SLR further to facilitate more private sector lending and aid corporate bond market development.
  - Current SLR rate: 20.5 percent (down from 25 percent of deposit liabilities in mid-2008).
- Developing the domestic corporate debt market
  - Implement reforms recommended by the Khan Committee.
  - Complement with: (i) strengthening corporate balance sheets via rehabilitation/restructuring; (ii) developing risk transfer mechanisms, including the CDS market; and (iii) continued coordination across Government of India, RBI, and SEBI.
- Financial inclusion
  - Continue enhancing financial inclusion via PMJDY, PMMY, gold monetization schemes, and technologies such as Unified Payments Interface.
  - PMJDY: bank accounts opened for 254 million previously unbanked individuals since August 2014.
  - PMMY: close to 1 percent of GDP in loans disbursed under this scheme.
  - UIDAI: as of end-December 2016, enrolled over 1,100 million people.

### Authorities’ views (summarized)
- Recognize corporate balance sheets in some sectors remain strained but noted steps being taken to address vulnerabilities, including:
  - Early signs of improving financial health of listed corporates.
  - Reactivation of stalled infrastructure projects; UDAY contributing to DISCOM balance sheet repair.
  - AQR imposing homogenous loan classification and triggering adequate recognition, allowing shift of focus to NPA resolution.
  - RBI mechanisms allow tailored workouts; resolution process expected to be gradual.
  - New insolvency regime ensures dialogue between debtors and creditors; authorities considering Arbitration Act clauses for out-of-court settlement.
- Commitment to ensuring adequate bank capitalization per prudential requirements, maintaining stringent supervision, and deepening financial inclusion.
  - Estimated capital needs of PSBs: Rs 1.8 trillion through FY2018/19; Rs 0.7 trillion to be infused by Government.
  - Government infused Rs 250 billion in FY2015/16 and is infusing Rs 229 billion in FY2016/17.
  - Banks raised additional AT1 and Tier II capital in the market; remaining needs expected to be covered from alternative sources.
  - Authorities noted interest coverage ratio should be viewed in context of cyclically depressed profits and that provision coverage decline reflected countercyclical provisioning.
  - Authorities noted sensitivity of leverage ratios to sample selection and that system-level leverage of Indian corporates not large, though stressed for certain sectors.

*International Monetary Fund — India: Chapter on Risks to the Outlook and Financial Sector Policy Issues*

### 26. After some pick-up earlier in the year, CPI inflation has moderated in recent months.

### 26. After some pick-up earlier in the year, CPI inflation has moderated in recent months.

### Inflation developments
- CPI inflation declined from an average of 9.8 percent during 2011–13 to an average of 4.9 percent in FY2015/16, driven by the collapse in global commodity prices, a range of supply-side measures, and a relatively tight monetary stance.
- Inflation dropped to 3.6 percent in November 2016, from an average of 5.4 percent in the first half of FY2016/17, largely due to a fall in the prices of vegetables.
- Core inflation averaged 4.7 percent from April to November (underlying inflation momentum remained steady).
- Given the disinflation shock from the currency exchange initiative, widening the output gap to around ¾ of one percent of GDP, inflation is expected to remain at about 4¾ percent in March 2017.
- In the medium term, inflation is expected to remain within the RBI’s medium-term inflation target band (4 percent CPI inflation ± 2 percent).
- Risks noted: food supply constraints, sticky household inflation expectations, and demand pressures from the implementation of the decennial pay increase in the public sector (along with expected similar adjustments to follow for state government employees) — inflation likely to remain in the upper half of the target band and susceptible to volatile price movements.
- Household inflation expectations remain near double digits and propagate rapidly from food inflation into non-food inflation.

### Monetary policy stance and transmission
- Following policy rate cuts in 2015–16, monetary conditions remain consistent with coming near the RBI’s interim inflation target of 5 percent by March 2017.
- Real policy interest rate at about 1.25 percent, which is at the lower end of the mission’s estimated neutral range of about 1.25–1.75 percent given current external conditions; monetary policy stance assessed to be broadly neutral.
- Any inflationary effects of the GST when implemented are expected to be small and transitory—monetary policy response should be geared toward containing potential second-round effects if needed.
- Given medium-term upside risks to food and CPI inflation, authorities should stand ready to raise the policy rate if inflationary pressures gather pace.
- Measures to improve transmission taken by RBI include adjusting the liquidity management framework, guidelines to ensure consistency in banks’ calculation of lending rates, and more frequent revisions of administered rates on small savings schemes.
- Increase in banking system liquidity as a result of the currency exchange initiative can reduce banks’ funding costs and lead to a decline in bank lending rates.
- Terminating the adaptive nature of Indian household inflation expectations will likely require a prolonged period of low inflation, underpinned by a continued anti-inflationary monetary policy stance.

### Inflation targeting framework and credibility
- Amendments to the RBI Act and formation of the Monetary Policy Committee (September 2016) completed the statutory underpinning of flexible inflation targeting.
- Headline CPI inflation target of 4 percent with a symmetrical band of 2 percent retained as the official inflation target for the next five years (August 2016).
- Consensus Surveys show five-year ahead inflation expectations have come down by about ¾ of one percentage point since 2014, but remain above the midpoint of the inflation target band (4 percent CPI inflation).
- Staff views: achieving the target on a sustained basis requires structural reforms to ramp up food supply commensurate with strong consumption demand, improved food grain buffer stock management, increased investment in storage and distribution infrastructure for perishable produce, continued fiscal consolidation, and reducing impediments to monetary transmission (including reductions in still-high SLR rates).

### Fiscal and supply-side reforms linked to inflation outcomes
- Supply-side reforms, particularly in agriculture, continued fiscal consolidation, and relieving impediments to monetary transmission are prerequisites for low inflation in the medium term.
- Staff sees scope to improve food grain buffer stock management, and for increasing investment in storage and distribution infrastructure for perishable produce.
- Continued fiscal consolidation to narrow public sector demand for credit remains paramount for the success of the new monetary framework.
- Reducing the SLR over time to a level in line with the liquidity coverage ratio (LCR), increasing competition in the banking sector, and further progress on financial inclusion would improve monetary transmission.

### Key statistics and projections (preserved exactly)
- 9.8 percent (average CPI inflation during 2011–13)
- 4.9 percent (average CPI inflation in FY2015/16)
- 3.6 percent (CPI inflation in November 2016)
- 5.4 percent (average CPI inflation in the first half of FY2016/17)
- 4.7 percent (core inflation average from April to November)
- ¾ of one percent of GDP (widening of the output gap from the currency exchange initiative)
- 4¾ percent (expected inflation in March 2017)
- RBI medium-term inflation target band: 4 percent CPI inflation ± 2 percent
- Interim inflation target of 5 percent by March 2017
- Real policy interest rate at about 1.25 percent
- Neutral range of about 1.25–1.75 percent
- Household inflation expectations remain near double digits

*Source: IMF staff report text (cr1754).*

### 40. Boosting exports remains a key challenge. Despite a sharp contraction in merchandise

### 40. Boosting exports remains a key challenge. Despite a sharp contraction in merchandise

### External sector performance and export dynamics
- Merchandise exports contracted sharply in 2015/16.
- India’s trade balance improved in 2015/16 due to:
  - an increase in the oil trade balance by about 2 percent of GDP, and
  - weak non-oil import growth.
- Causes of the contraction in merchandise exports:
  - collapse in commodity prices (refined petroleum products made up about one-fifth of the value of goods exports in 2014/15),
  - weak global demand, and
  - ongoing appreciation of the rupee real effective exchange rate.
- Despite these headwinds:
  - India’s export performance was comparable to that of emerging market peers,
  - India’s share in world merchandise exports has remained relatively stable,
  - India’s exports are geographically diversified.
- Staff estimate implication:
  - Using staff’s average estimated income elasticity of exports of 1.5, in the absence of further measures to enhance competitiveness, India’s merchandise export growth will likely remain below 10 percent per annum.

### Policy measures to support export growth and trade
- Priority measures identified:
  - further trade liberalization,
  - continued progress on supply-side reforms,
  - steps to reduce barriers to trade and facilitate a focus on higher value-added products.
- Concern noted:
  - India’s high import tariffs could weigh on trade expansion by affecting the quality and availability of inputs and potentially undermine productivity growth.
  - WTO 2016 World Tariff Profile figures cited: India’s tariff rate (a simple average of MFN tariff rates) is 13.4 percent for all products, 32.7 percent for agricultural products, and 10.1 percent for non-agricultural products.

### External financing, FDI, and external debt
- External financing requirements declined with shrinking current account imbalances.
- Importance of attracting stable, non-debt creating capital flows, particularly FDI, emphasized.
- Recent liberalizations and outcomes:
  - liberalizing caps on FDI inflows in most sectors helped FDI inflows increase from US$31 billion in FY2013/14 to over US$45 billion in FY2015/16,
  - FDI inflows far exceeded the FY2015/16 CAD of US$22 billion.
- Other measures:
  - restrictions on foreign borrowing by firms were relaxed in 2015,
  - limits for foreign portfolio investors’ (FPI) purchases of government bonds were increased in 2016.
- External debt position:
  - India’s external debt remains low at 23 percent of GDP at end-June 2016.
  - net external borrowing by Indian corporates was minimal in 2014/15 and 2015/16.
- Caution:
  - Further liberalization of external commercial borrowings (ECBs) should proceed cautiously and be carefully monitored by the RBI, given continuing corporate vulnerabilities.

### Exchange rate policy and shock absorption
- Recommendation if global financial market volatility surges:
  - continue to rely on exchange rate flexibility as the main shock absorber.
  - exchange rate flexibility could be accompanied by judicious FX intervention, either through spot and forward markets, or via liquidity provision through swaps, to minimize disruptive movements divorced from fundamentals.

### Authorities’ views on external position and exports
- Authorities broadly comfortable with current level of reserves; direction of reserves would depend on developments in capital flows.
- They expected the current account deficit to remain relatively subdued and below its sustainable level, which they estimated at about 2⅓ percent of GDP.
- Authorities attributed recent export weakness mainly to sluggish external demand.
- Optimism about scope to expand exports given the country’s small global market share; supportive initiatives being implemented in trade facilitation and infrastructure, including development of coastal employment zones.
- Authorities’ stance on trade policy:
  - underscored commitment to an open trade regime,
  - noted that once agricultural products are excluded, India’s tariffs were broadly comparable to those of other emerging market peers,
  - expressed concern about rising non-tariff barriers in export markets,
  - stated the country had refrained from increasing import restrictions except for anti-dumping measures.

### Structural policies to boost growth and employment (priorities and measures)
- Overall assessment:
  - India has made considerable progress on pace and composition of reforms and retained reform momentum in recent years.
  - In 2016, India advanced fiscal, monetary and financial, trade and factor market reforms.
- Labor market reforms (priority):
  - Greater labor market flexibility and product market competition essential to create jobs and raise growth.
  - Specific measures:
    - reforms to the Industrial Disputes Act (IDA) of 1947 (which requires firms employing 100 or more workers to obtain government permission for layoffs, retrenchments, and closures),
    - reforms to restrictive clauses under the Factories Act of 1948,
    - reducing the numbers of labor laws (currently numbering around 250 at central and state level).
  - Intended outcomes: increase employment of women, broaden manufacturing base, raise formal sector employment, enhance impact of other structural reforms.
- Land reforms:
  - Streamline and expedite land acquisition and simplify procedures at center and state levels to facilitate infrastructure development.
- Power reforms:
  - Build on the UDAY scheme for state power distribution companies; switch focus to implementing measures to improve operational efficiency of state power distribution companies, including reducing transmission losses and raising power tariffs when needed.
  - Energy price reforms should consider regulatory policies for reducing fossil fuel use to aid achievement of India’s climate change commitments.
- Gender-focused reforms:
  - Improve infrastructure (wider sanitation coverage, easier access to roads and drinking water) to lower females’ home care burden and raise female labor force participation.
  - Amend and strengthen implementation of gender-specific labor laws and invest in gender-targeted skills training programs to increase female employment in better quality formal jobs.
  - Strengthen implementation and awareness of females’ land inheritance rights and financial literacy programs.
- Strengthening the business climate:
  - Continue efforts to improve India’s ranking on the World Bank’s Doing Business indicators, particularly resolving insolvency and enforcing contracts.
  - Support for state-based doing business indicators to encourage cross-state competition in attracting domestic and foreign investment.

### Agricultural sector reforms and food policy
- Agriculture’s role and recent initiatives:
  - agriculture contributes around 15 percent of India’s GDP and provides employment for about half of the Indian labor force.
  - recent initiatives include:
    - assured irrigation initiative under the Pradhan Mantri Krishi Sinchayee Yojana launched in July 2015,
    - comprehensive crop insurance scheme Pradhan Mantri Fasal Bima Yojana launched in February 2016,
    - common electronic trading platform for National Agriculture Market (e-NAM) launched in April 2016 (aims to integrate 585 wholesale markets across India by March, 2018).
  - These arrangements are expected to reduce production risk and improve competitiveness of agricultural markets.
- Further priority measures to address long-term bottlenecks and food inflation pressures:
  - Food procurement reforms:
    - revamp government procurement processes and the public distribution system (PDS) for food,
    - limit minimum support price (MSP) interventions to correcting market failures,
    - implement recommendations of the Shanta Kumar High Level Committee (HLC) on restructuring the role of the Food Corporation of India (FCI), including outsourcing procurement and stocking operations to states and agencies, better price support for pulses and oilseeds, introducing cash transfers, and setting up vigilance committees to check leakages in the PDS.
  - Reforms to the Essential Commodities Act (ECA) and state-level Agricultural Produce Marketing Committee (APMC) Act:
    - liberalize markets by giving farmers more flexibility in distribution and marketing of their produce, raise competitiveness, efficiency and transparency in state agriculture markets.
  - Subsidized water and other agricultural inputs:
    - current subsidies (free or cheap water, electricity and fertilizers) have harmed ground-water levels, soil fertility and production efficiency,
    - recommend administering input subsidies through direct cash transfers rather than underpricing inputs, and direct support toward small-scale farmers (in accordance with Kumar HLC recommendations).

### Authorities’ views on reforms and service delivery
- Authorities highlighted progress in facilitating investments in road, power and coal sectors and commitment to strengthening public service delivery and business environment.
- Noted gains in targeted delivery through Direct Benefit Transfer to flagship welfare schemes and subsidy programs.
- Emphasized shift toward evaluation and monitoring of outcomes rather than inputs and processes.
- At state level, publication and ranking of policy outcomes is generating reform momentum through cross-state competition.
- Labor market reforms being pursued at state level; objective to expand reforms to a critical mass of manufacturing states.
- In agriculture, pilot programs underway to rationalize fertilizer subsidies and efforts to integrate agricultural markets across the country.

### Other issues: statistics and data
- Macroeconomic statistics broadly adequate for surveillance but improvements needed:
  - priority to developing price indices suitable for deriving volume estimates for key economic activities in the national accounts and updating the index of industrial production,
  - step up efforts to back-cast the revised national accounts,
  - improve timely reporting and dissemination of fiscal performance of the states.
- Recommendation: authorities should use impending establishment of SARTTAC to obtain technical assistance to enhance quality of national accounts statistics.

### Staff appraisal and near-term risks
- Recent performance:
  - Indian economy recorded strong growth aided by terms of trade gains, implementation of key structural reforms, and reduced external vulnerabilities.
  - halving of global oil prices, sound macroeconomic management, and efforts to tackle supply-side bottlenecks supported recovery and stability.
- Near-term outlook and risks:
  - FY2017/18 economic growth expected to rebound from temporary slowdown caused by the currency exchange initiative which is adversely affecting private consumption.
  - investment recovery expected to remain modest and uneven across sectors as deleveraging continues and industrial capacity utilization picks up.
  - balance of risks tilted to downside. Key downside risks:
    - the currency exchange initiative (may have larger-than-anticipated near-term negative impact via weaker private consumption),
    - renewed global market volatility,
    - uncertainty in design and implementation of the GST,
    - continued weak corporate and public bank balance sheets.
  - Prominent upside risks:
    - lower-for-longer energy prices,
    - enhanced investor confidence accompanying structural reforms.
- Immediate action recommended:
  - quickly restore cash in circulation and avoid payment disruptions by enhancing supply of new banknotes,
  - consider extending or expanding targeted temporary exemptions, including on use of old banknotes, particularly for rural and remote areas.
  - remain vigilant given potential further build-up of NPAs and elevated corporate sector vulnerabilities, and ensure prudent support to economic sectors affected by the currency exchange initiative.

*INTERNATIONAL MONETARY FUND staff report (India)*

### 53. Despite a strong policy push for balance sheet clean up, elevated corporate sector

### 53. Despite a strong policy push for balance sheet clean up, elevated corporate sector

### Banking sector vulnerabilities and asset quality
- Despite India’s financial system being generally sound, elevated corporate sector vulnerabilities continue to pose risks to the soundness of public banks.
- Recommendations for the RBI:
  - Continue to ensure full recognition of non-performing assets on banks’ balance sheets.
  - Increase provisioning requirements as needed.
- Structural and policy measures that will help bridge gaps in resolution of bank asset quality distress and enhance financial stability:
  - Successful implementation of the AQR process.
  - Implementation of the new bankruptcy code.
  - Additional debt recovery mechanisms.
- Further reforms to enhance the financial system’s ability to contribute to growth:
  - Augmenting capital buffers in public banks.
  - Strengthening the NPA resolution regime and public sector bank governance reform.
  - Further measures to develop corporate debt markets.
- Financial inclusion:
  - India’s strong efforts in enhancing financial inclusion should continue to be facilitated by new technologies and greater use of electronic payment technologies.

### Monetary policy, inflation, and fiscal support
- Monetary policy credibility:
  - Formalization of the flexible inflation targeting regime and formation of the Monetary Policy Committee provide institutional foundation for strong credibility.
  - The current monetary policy setting is consistent with inflation remaining within the RBI’s medium-term inflation target band.
  - However, inflation is likely to remain in the upper half of the target band over the medium-term, mainly due to food supply constraints and sticky household inflation expectations.
- Policy recommendations:
  - Monetary policy should continue to be supported by fiscal consolidation and agricultural reform measures to boost food supplies.
- Fiscal strategy and recommendations:
  - Authorities should press ahead with the longer-term objective of substantially reducing fiscal deficits and the public debt burden.
  - With delays in reaching medium-term deficit targets, public debt ratio is likely to remain high and fiscal policy space limited.
  - Fiscal consolidation pillars should include:
    - Implementation of a robust GST, given its growth enhancing effects.
    - Further subsidy reforms and better targeting via direct benefit transfers.
  - To prevent pro-cyclicality and safeguard quality of fiscal adjustment:
    - Strengthen fiscal responsibility and medium-term expenditure and budget frameworks for both the Union government and the states.
    - In the revised fiscal responsibility framework, consider anchoring the deficit path by a medium-term public debt target, complemented by a nominal expenditure growth rule.
  - Fiscal consolidation will enable a gradual phasing-out of financial repression, which will help price stability and lower the cost of credit for the private sector.

### External sector and trade
- External position:
  - India’s external position remains broadly consistent with fundamentals and the level of international reserves is assessed to be adequate.
  - Continued vigilance is needed given potential external shocks and global financial market volatility.
- Policy recommendations:
  - Maintain exchange rate flexibility as the main shock absorber, accompanied by judicious foreign exchange intervention given increased reserve buffers.
  - Reduce trade barriers and support trade liberalization as the external environment remains weak.
  - Continue efforts to revamp the business climate to attract greater FDI and ensure the success of the “Make in India” initiative.

### Structural reforms and growth
- Priority reforms:
  - Labor market reforms to enhance impact of product market reforms, increase formal sector employment and increase employment of women.
  - Improvements in infrastructure, including wider sanitation coverage, to raise female labor force participation and potential growth.
  - Improve business climate and leverage cross-state regulatory and economic competition to raise foreign and domestic investment.
  - Address structural bottlenecks and enhance market efficiency in the agricultural sector to raise food availability and consumption, enhance returns to farmers, and dampen food inflation pressures.
- Consultation timing:
  - Recommendation that the next Article IV consultation take place on the standard 12-month cycle.

### Box 1 — Currency Withdrawal and Exchange and its Economic Impact (summary)
- Policy action:
  - Government withdrew legal tender status of existing Rs 500 and 1000 notes effective November 9, 2016.
  - Affected notes totalled about Rs 15 trillion (about 86 percent of all cash in circulation).
  - Defunct notes could be deposited in unlimited amounts into bank accounts until end-2016; large deposits (US$ 4000 and above) expected to attract scrutiny.
  - New Rs 500 and 2000 notes were announced but distribution proceeded slowly; cash exchanges initially allowed up to Rs 4,500 (US$ 70) but later discontinued.
  - Caps imposed on cash withdrawals by individuals and corporations; check and electronic payments remained unaffected.
  - Temporary exemptions were granted to ease cash crunch for certain public offices, the farming sector, payments for public utility services and purchasing key primary products.
- Payment system context and metrics:
  - At end-2015, currency in circulation in India stood at about 12 percent of GDP.
  - Cash accounted for about three quarters of the narrow money base.
  - The average number of transactions made with payments instruments per Indian in 2015 totalled 11 transactions.
- Growth impact estimates:
  - Staff analysis suggests cash shortages are likely to slow FY2016/17 growth by about 1 percentage point and FY2017/18 growth by about 0.5 percentage points (compared to October 2016 IMF WEO forecasts).
  - Based on the IMF India Quarterly Projection Model, GDP growth is expected to slow to about 6 percent in the second half of FY2016/17, before gradually rebounding in the course of FY2017/18.

### Box 2 — Ujwal Discom Assurance Yojana (UDAY): Debt Restructuring for Power Distribution Companies (summary)
- Background:
  - Electricity distribution primarily through inefficient and financially troubled state-owned DISCOMs.
  - DISCOMs’ operational losses driven by (i) aggregate technical and commercial (AT&C) losses and (ii) electricity tariffs low relative to procurement cost.
  - India’s T&D losses, at almost 20 percent of generation, are among the highest levels in the world.
- Pre-UDAY metrics:
  - At launch in November 2015, DISCOMs had together accumulated about Rs 3.8 trillion in losses (3 percent of then-GDP) and Rs 4.3 trillion in debt (3.4 percent of GDP) with interest rates as high as 15 percent.
  - Financial losses concentrated in several states, with losses of the worst seven states accounting for almost 90 percent of total losses.
- UDAY scheme mechanics:
  - States joining UDAY take over 75 percent of their DISCOMs’ outstanding debt as of September 2015—50 percent in FY2015/16 and 25 percent in 2016/17—funded by issuing state bonds in the market or directly to the banks originally holding the DISCOM debt.
  - UDAY bonds would not count towards states’ FRBMA prescribed borrowing limits of 3 percent of GSDP.
  - Remaining 25 percent of outstanding DISCOM debt: holding banks convert the debt to loans with lower interest rate, not more than the bank’s base rate plus 10 basis points.
  - Future DISCOM losses would be gradually taken over and funded by states and would count towards state deficit limits.
- Implementation status and next steps:
  - As of November 2016, nine states had issued UDAY bonds amounting to Rs 1,585 billion (or 50 percent of DISCOM debt eligible for the scheme).
  - Six additional states and one Union territory signaled intention to join; in total the 15 states and Union territory account for almost 60 percent of outstanding DISCOM debt.
  - Focus should now turn to stronger reforms to improve operational efficiency, decrease cost of purchasing power, enable quarterly increases in electricity tariffs, increase billing efficiency and decrease commercial losses.

### Box 3 — Developing India’s Corporate Bond Market (summary)
- Market status and metrics:
  - Corporate bond market expanded rapidly but remains a limited source of funding; firms rely predominantly on bank credit.
  - Issuance volumes roughly doubled to Rs 5.8 billion in the five years to end-FY2016.
  - Outstanding debt reached close to 15 percent of GDP at end-FY2016.
  - Domestic debt securities account for only about 20 percent of corporate funding.
  - Bank credit and external borrowing jointly accounted for more than 80 percent of funding at end-FY2016.
- Structural impediments:
  - Dominance of issuances by financial sector entities.
  - Prevalence of private placements.
  - Very limited market liquidity.
  - Restrictions on institutional-investor allocations to non-investment-grade bonds.
  - High dependence on external funding exposes corporates to potential debt repayment difficulties.
- Reform plan measures announced August 2016 (Working Group chaired by Deputy Governor Khan):
  - Emphasis on inter-agency coordination.
  - Development of missing markets, including the corporate repo market.
  - Support for extension of partial credit enhancements (PCEs) via increase in aggregate bank cap (to 50 percent).
  - Enhancement of market liquidity via sanctioning of corporate bond reissuance under the same ISIN.
  - Steps towards ensuring uniform valuations and rationalization of stamp duties across states.
- Implementation actions and remaining constraints:
  - Regulators (RBI and SEBI) moved to boost incentives for market funding, expand participation, and introduce an Electronic Dealing Platform in the corporate repo market.
  - The National Stock Exchange introduced a trade repository for primary- and secondary-market activities.
  - Remaining constraints include:
    - High leverage, particularly among large corporates, likely to dampen issuance in the short term.
    - Limited domestic investor base; domestic insurance companies and pension funds play a very limited role.
    - Need for better risk transfer mechanisms, including a dormant CDS market.
    - Requirement for effective cross-agency coordination among Government of India, RBI, SEBI, FIMMDA, IRDA, and PFRDA.

*Source: IMF Staff Report excerpt (cr1754).*

### Box 4. Financial Inclusion in India: Recent Initiatives and Policy Priorities

### Box 4. Financial Inclusion in India: Recent Initiatives and Policy Priorities

### Challenges: access and usage
- Bank penetration stood at 35 percent in 2011.
- In 2014:
  - account dormancy rate exceeded 40 percent;
  - only 11 percent of those who had a bank account made deposits;
  - only 8 percent took out loans (World Bank, 2014).
- Informal finance plays an important role for small-scale and informal business, including in agriculture, and has often entailed predatory lending practices.
- Womens’ access to finance has been low, limiting womens’ entrepreneurship and empowerment.

### Recent initiatives and outcomes
- Pradhan Mantri Jan Dhan Yojana (PMJDY), launched in August 2014:
  - more than 240 million previously unbanked individuals have gained access to bank accounts since launch;
  - about two-thirds of these new account holders are rural Indians;
  - the share of zero balance accounts exceeds 25 percent across the majority of Indian states.
- Pradhan Mantri MUDRA Yojana (PMMY), launched in January 2016:
  - aims to enable access to formal finance for micro, small and medium-sized business by providing collateral-free loans;
  - close to one percent of GDP in loans have been disbursed under this scheme;
  - over one-third of loans have been extended to new entrepreneurs.
  - Women-led businesses accounted for about one-half of the total amount lent under the scheme, and about four-fifths of the number of loans, reflecting the scheme’s support to new business undertakings led by women.

### Staff analysis: macroeconomic and gender effects
- Using a two-sector general equilibrium model incorporating formal and informal sources of finance, staff estimates show:
  - policies that an increase in womens’ access to formal finance improves gender equality in entrepreneurship;
  - improved gender equality in entrepreneurship boosts female labor force participation and employment;
  - these changes lead to higher consumption and GDP (see Selected Issues Chapter IX).

### Policy priorities and recommendations
- Continue focusing on the supply of finance while prioritizing demand-side constraints:
  - Strengthen financial literacy programs.
  - Hold workshops aimed at building the trust of rural communities with the banking system.
  - Conduct surveys to understand the costs and barriers to usage of formal financial services.
- Promote technology-driven initiatives to lower transaction costs:
  - know-your-customer (KYC) innovations;
  - mobile banking and digitalization;
  - greater usage of direct benefit transfer schemes.
- Measure the success of interventions by:
  - extent of reduction in informal employment;
  - rise in formal entrepreneurship;
  - extent of mobility of firms to medium and large sizes.

*Prepared by Purva Khera.*

### 9.1 percent), is an associated scheme, with the aim of providing financial independence and

### cr1754 - 9.1 percent), is an associated scheme, with the aim of providing financial independence and

### Beti Bachao Beti Padhao and gender-related policies
- The Sukanya Samriddhi Yojana (as described) is an associated scheme, with the aim of providing financial independence and insurance to girls when they turn 18 years of age.
- Increasing engagement at the state level, deepening community participation, and long-term growth-supporting policies will help the success of the Beti Bachao Beti Padhao scheme.
- Cross-state disparity in implementation and target realization of Union government-led programs undermines scheme objectives.
- With more autonomy in states’ spending owing to higher tax devolution, combined with a cut in Union Budget allocation for these programs, there is a need to strengthen coordination and participation across states to more equally prioritize spending on schemes with intended impact on the wellbeing of the girl child.
- A more holistic policy approach oriented towards higher growth, job creation, and financial inclusion is expected to lead to better sex ratios in the long run.
- Reorienting public expenditure towards broadening the social safety net will reduce the dependence of the old on their children and help equalize preferences for girls and boys.
- Reference note: As per the implementation of the Fourteenth Finance Commission report, tax devolution from the center to the states increased from 32 percent to 42 percent.

### Growth and activity (key findings)
- The Indian economy has grown strongly, supported mainly by private consumption.
- Demand composition highlights:
  - Private consumption is the main driver of growth (figures shown in Demand Components of GDP).
  - Real investment has contracted even as new projects have been announced.
- Export performance has been weak, driven primarily by commodities (particularly processed fuels).
- Electricity production has shown steady growth due to gradual reduction in supply-side bottlenecks.
- Charts and time-series evidence presented for GDP Growth (percent, yoy), Demand Components, Exports (yoy percent change), Production: Mining & Electricity (Percent change, yoy), and Gross Fixed Capital Formation (yoy percent change).

### External vulnerabilities (key findings)
- India’s external position remains sustainable; the current account deficit has remained small with a sharp decline in the merchandise trade deficit that resulted from sustained low commodity-import prices.
- Financing of the deficit has shifted to FDI while portfolio inflows have moderated and turned to outflows in late 2016.
- Foreign exchange exposures of corporates are limited and international reserves are adequate.
- Time-series indicators presented include:
  - Current Account Balance (In percent of GDP)
  - Imports: Principal Commodities (Coal, Gold, Oil in millions of US$)
  - Financial Account composition (Bank capital incl. NRI loans, FII, FDI in percent of GDP)
  - FII Flows (Equity and Debt, in billions of USD)
  - Non-Financial Corporate Debt, 2015Q4 (In percent of GDP)
  - Estimated Reserve Adequacy (Official reserves as a percent of IMF country-specific metric)

### Financial markets (key findings)
- Financial markets were generally buoyant in 2016.
- Indian rupee remained relatively stable over the past two years, unlike some other emerging market currencies.
- Following a period of strong inflows, foreign portfolio investment outflows were recorded in late 2016.
- The stock market recovered momentum in 2016 while bond yields declined across the term structure.
- Spreads on the proxy CDS for the Indian sovereign remained low.
- India's real and nominal effective exchange rates have been relatively stable since early 2015.
- Indicators shown: Exchange Rate indices, Debt and Equity Inflows (cumulative), Stock Market Indices (SENSEX), Bond Yields (3-month, 3-year, 10-year), Credit Default Swap spreads, NEER and REER (Index, 2010=100).

### Monetary developments
- Inflation has declined markedly, but upside risks remain.
- CPI inflation has been stable following a sharp decline in late 2014; household inflation expectations remain elevated with some gradual softening.
- Vegetables and pulses have been key drivers of food inflation volatility.
- The policy repo rate has been cut by a cumulative 175 basis points since early 2015.
- Bank liquidity has been in surplus in the past few months; international reserve buffers have been rebuilt since late-2013.
- Time-series and level indicators include CPI (Combined and Core), Household Inflation Expectations (Current and 1 Year Ahead), CPI Food Inflation contributions (Cereals, Milk, Vegetables, Pulses, Others), Interest Rates (Interbank call money, MSF rate, Reverse repo, Repo), Daily Liquidity Operations (in billions of Rupees), and Exchange Rate and Intervention (Spot USD purchases, Change in USD Forward Position, Rs/US$ inverted).

### Fiscal developments and vulnerabilities
- Fiscal consolidation has resumed, but medium-term challenges remain.
- General government deficit has been slowly declining while still high.
- A small negative fiscal impulse has enabled consolidation over past few years.
- Current spending has fallen but remains above the pre-crisis average; central government budget targets higher capital outlays.
- Indirect tax measures continue to drive revenue growth; energy subsidies have fallen significantly, while food and fertilizer subsidies remain high.
- Fiscal vulnerability indicators:
  - India’s public debt is relatively large compared with other major emerging markets, as is the general government fiscal deficit.
  - Debt roll-over risks are mitigated by long average maturity of Indian debt and favorable automatic debt dynamics.
  - Currency risks affecting public debt are minimal and exposure to non-resident investors is limited.
- Specific numeric indicators and charts shown include government debt (general government gross public debt, 2015, In percent of GDP), government fiscal balance (2015), average government debt maturity (years), projected interest-growth differential (2015-20), government debt in foreign currency (percent of total), and government debt held by non-residents (percent of total).

### Corporate and banking sectors
- Corporate-sector vulnerabilities have persisted and have led to a further increase in banks’ stressed loans (NPAs and restructured loans), particularly for public sector banks (PSBs).
- Indian banks’ capital positions were slightly stronger in 2015 but are weak relative to other EMs.
- Credit to the corporate sector, especially to industry, has grown at a far slower pace than to other sectors.
- PSBs' loan-to-deposit ratio has contracted; corporate leverage has edged down with the exception of the mining sector.
- Financial indicators and charts presented: Corporate Debt Repayment Capacity (Interest coverage ratio, Return on equity), Banks' Nonperforming and Restructured Assets (Gross NPA ratio, Restructured loan ratio by bank type), Capital Adequacy Ratios (Tier 1 and Tier 2), Growth of Bank Credit by sector, Banks' Loan to Deposit Ratio, Corporate Leverage Ratios.

### Gender inequality: health, education, economic, and political
- India has made considerable progress in gender equality in education and in women’s health.
- India fares poorly on gender-parity in labor force participation; female labor force participation is considerably lower than peers.
- Wage gaps are wide and quality of female employment remains low, with women mostly employed in informal agricultural sector jobs.
- India lags behind in women’s participation in political decision-making.
- Specific indicators displayed:
  - Primary school enrollment rates (female and male, percent)
  - Maternal mortality ratio (per 100,000 live births)
  - Female Labor Force Participation Rate, 2014 (percent) across countries
  - Gender Gap in Wages (male-to-female ratio)
  - Sectoral composition of female employment (percent)
  - Women representation in politics, 2015 (percent)

### Poverty, consumption, and per capita income
- Poverty levels in India have declined significantly but remain high compared to peers.
- Decline in poverty was broad-based across Indian states; North and Northeast states have relatively higher poverty.
- Income and consumption per capita have risen although there is ample room for catch-up with peers.
- Indicators and charts include:
  - India: Poverty Headcount Ratio at National Poverty Line (Tendulkar Method) for 1993, 2004, 2010 (Percent of population)
  - Poverty Headcount Ratio at $1.90 a day (2011 PPP) compared across countries
  - State-level poverty rates in 2010 (percent)
  - Per Capita Consumption and GDP in 2010 (Current US$) by state and country comparisons

### Business environment and competitiveness
- Recent reform measures have improved India’s competitiveness (licensing process, investor protection, new insolvency scheme).
- India's key advantages include large market size and sound macroeconomic management.
- Further reforms needed in tax, labor, and product market regulations.
- Indian labor markets appear less efficient due to rigid regulations and large informal employment.
- Regulatory quality shows room for improvement to support growth.
- Charts and indicators:
  - Global Competitiveness Ranking: BRICS (2007-08 vs 2016-17)
  - Doing Business indicators evolution (2008 vs 2017)
  - India's Scores in Global Competitiveness Index 2016-17
  - Most Problematic Factors for Doing Business (weighted ranking scores)
  - Labor Market Efficiency Ranking and Young Dependency Ratio: BRICS
  - Regulatory Quality (Percentile rank)

### Agricultural sector
- Improving productivity and reducing distortions are foremost challenges.
- Close to half the Indian population is vegetarian; cereals contribute the largest share to protein intake; expenditure on food remains high in household consumption.
- Share of agricultural employment remains high though declining; a large proportion of rural households still earn livelihoods from agricultural activities.
- To ensure food security and contain volatility, MSPs and procurement of cereals have risen; improving productivity remains key challenge.
- Indicators presented include vegetarianism and protein intake breakdown, share of food in rural household expenditure, share of employment in agriculture (millions and percent), agricultural households as percent of rural households, food grains stock in central pool (mln. tonnes, 12mma), WPI and MSP changes, and agriculture productivity (yield; hg/ha) across countries.

### Key tables and selected quantitative indicators (selected highlights)
- Millennium Development Goals table (1990–2015) summarizing progress on poverty, education, gender equality, child mortality, maternal health, diseases, environmental sustainability, and ICT access.
- Selected Social and Economic Indicators, 2012/13–2017/18:
  - Nominal GDP (in billions of U.S. dollars): 2,073
  - GDP per capita (U.S. dollars): 1,581
  - Headcount ratio at $1.90 a day (2011): 21.2
  - Undernourished (2015): 15.2
  - Total population (in billions): 1.31; Urban population percent: 33; Life expectancy at birth: 68.0
  - Growth projections: Real GDP (at market prices) for 2016/17: 6.6; 2017/18: 7.2 (table shows series 2012/13–2017/18)
  - CPI (period average) 2016/17: 4.7 percent
  - Gross reserves (end-period) 2016/17: 404.9 (in billions of U.S. dollars)
- Balance of Payments (2012/13–2017/18) key figures:
  - Current account balance 2015/16: -22.1 (in billions of U.S. dollars)
  - Merchandise exports 2015/16: 266.4 (in billions of U.S. dollars)
  - Merchandise imports 2015/16: 396.4 (in billions of U.S. dollars)
  - GDP in USD 2015/16: 2,073.0 (in billions of U.S. dollars)
- Reserve Money and Monetary Survey (selected levels and percent changes shown for 2012/13–2015/16).
- Central Government and General Government operations (revenues, taxes, expenditure, deficits) provided in percent of GDP for 2012/13–2017/18 projections (tables 5 and 6).
- Macroeconomic framework projections to 2021/22 include Real GDP growth path and general government debt trajectory (Table 7).
- Indicators of external vulnerability (Table 8) and Financial Soundness Indicators (Table 9) provide detailed numeric metrics for external and banking sector resilience.
- High-frequency economic activity indicators (Table 10) summarize % y-o-y changes across consumption, investment, external sector, industry, services, and financial flows.

*International Monetary Fund. Content extracted from the supplied PDF chapter/section.*

### Annex I. Key Policy Actions 2016–17

### Annex I. Key Policy Actions 2016–17

### Monetary Policy
- March 3, 2016 — Marginal Cost of Funds based Lending Rate (MCLR): RBI notified guidelines for MCLR effective April 1, 2016. MCLR replaces ‘base rate’ and is based on marginal cost of funds (= 92 percent x marginal cost of borrowings + 8 percent x return on net worth). Banks required to review and publish MCLR monthly.
- April 5, 2016 — Policy actions:
  - (i) Reduced repo rate by 25 bps to 6.50 percent from 6.75 percent;
  - (ii) Narrowed the policy rate corridor from +/-100 bps to +/- 50 bps by reducing the marginal standing facility (MSF) rate by 75 bps and increasing the reverse repo rate by 25 bps; reverse repo rate adjusted to 6.0 per cent, and MSF rate to 7.0 percent;
  - (iii) Progressively lower the average ex ante liquidity deficit in the system from one percent of net demand and time liabilities (NDTL) to a position closer to neutrality; supply of durable liquidity to be smoothened over the year through open market operation (OMOs);
  - (iv) Reduced the minimum daily maintenance of cash reserve ratio (CRR) from 95 percent of the requirement to 90 percent, while keeping the CRR unchanged at 4.0 percent of NDTL.
- May 14, 2016 — Flexible Inflation Targeting & Monetary Policy Committee (MPC): Government amended RBI Act, 1934 to include flexible inflation targeting (FIT) and notified failure-to-achieve conditions: (a) average inflation remains more than the upper tolerance level of the inflation target notified for any three consecutive quarters; or (b) average inflation remains less than the lower tolerance level of the inflation target notified for any three consecutive quarters, requiring RBI to explain factors and spell out policy action.
  - Amendment provides for a six-member MPC: three RBI members (including Governor, ex-officio chairperson; Deputy Governor in charge of monetary policy; and one executive director) and three outside experts appointed by the government for 4 years and not eligible for re-appointment. Each member has one vote; Governor has casting vote in case of a tie.
- August 5, 2016 — Inflation target: Government notified CPI headline inflation target band for five-year period ending March 31, 2021 to be 4 +/- 2 percent.
- September 30, 2016 — MPC formation: Government notified formation of six-member MPC including Dr. Urjit Patel (Governor RBI, Chairperson), Mr. R. Gandhi (Deputy Governor, RBI), Dr. Michael Patra (Executive Director, RBI), Dr. Chetan Ghate (Professor, ISI), Dr. Pami Dua (Director, DSE) and Dr. Ravindra H. Dholakia (Professor, IIM) with effect from September 30, 2016.
- October 4, 2016 — Policy rate: MPC in its first review reduced policy repo rate by 25 bps to 6.25 percent from 6.5 percent.
- November 25, 2016 — Oil Bonds: RBI allowed oil bonds issued by the government to qualify as eligible securities for repos, reverse repos and MSF; non-statutory liquidity requirement (SLR) status of these bonds continues.
- November 26, 2016 — Cash reserve ratio (CRR): RBI asked banks to maintain an incremental CRR of 100 percent on the increase in NDTL between September 16, 2016 and November 11, 2016, effective from November 26, 2016 (temporary measure related to withdrawal of old ₹500 and ₹1000 notes).

### Financial Sector
- February 28, 2016 — Banks Board Bureau (BBB): Government set up autonomous BBB to improve governance of public sector banks (PSBs), responsible for selection of heads of PSBs and financial institutions, and to help develop strategies and capital raising plans.
- March 17, 2016 — Framework for Revival and Rehabilitation of MSMEs: RBI changed framework for MSME stressed assets up to loan size of ₹250 million, requiring banks to form special committees at district/regional level and categorize stressed assets under Special Mention Account (SMA-0, SMA-1, SMA-2).
- March 17, 2016 — Currency Futures Market: RBI permitted stand-alone primary dealers (PDs) to deal in currency futures contracts on recognized exchanges subject to prudential criteria.
- March 29, 2016 — Investment by Foreign Portfolio Investors (FPI) in Government Securities: RBI raised limits for FPI investment in central government securities by ₹105 billion from April 4, 2016 and by ₹100 billion from July 5, 2016; SDL by ₹35 billion each from April 4, 2016 and July 5, 2016.
- March 30, 2016 — External Commercial Borrowing (ECB): RBI allowed infrastructure companies, NBFC-IFCs, NBFC-AFCs, Holding Companies and Core Investment Companies (CICs) to raise ECB with minimum average maturity of 5 years, subject to 100 percent hedging; exploration, mining and refinery sectors deemed infrastructure.
- May 11, 2016 — Insolvency and Bankruptcy Code, 2016: Parliament passed the Code providing a 180-day time-bound insolvency resolution process for companies, partnerships and individuals.
- May 26, 2016 — Strategic Debt Restructuring Mechanism for NBFCs: RBI issued guidelines asking NBFCs to implement debt-restructuring package under Joint Lender's Forum and multiple banking arrangements in 90 days, at par with commercial banks.
- June 13, 2016 — NPA resolution: RBI notified Scheme for Sustainable Structuring of Stressed Assets (S4A) for large stressed accounts (> ₹5 billion), bifurcating debt into Part A (sustainable portion not less than 50% of total debt) and Part B (unsustainable portion). Part B classified as NPA with enhanced provisioning; Part A treated as ‘Standard’ upon implementation. Part B could be upgraded after one year of satisfactory performance of Part A. Resolution plan to be prepared by credible professional agencies and reviewed by an Overseeing Committee set up by IBA in consultation with RBI.
- June 15, 2016 — Bank consolidation: Government gave in-principle approval to merger of five associate banks of SBI and Bharatiya Mahila Bank with SBI.
- June 23, 2016 — OTC currency options market: RBI permitted resident exporters and importers to write standalone plain vanilla European call and put option contracts against contracted exposure (covered call and covered put).
- July 28, 2016 — Retail Participation Secondary Government Securities Market: RBI allowed retail demat account holders to trade in government securities.
- August 1, 2016 — On Tap Bank Licensing: RBI issued guidelines for “on tap” licensing of private sector universal banks. Minimum paid-up capital requirement: ₹5 billion; foreign investment limit pegged at 74 percent.
- August 25, 2016 — Corporate bond market measures:
  - (i) Raised aggregate exposure limit for all banks toward partial credit enhancement (PCE) of a given bond issue size to 50 percent from 20 percent;
  - (ii) Masala bonds by banks: allowed banks to issue Perpetual Debt Instruments (PDI) qualifying as Additional Tier 1 capital and Tier 2 capital instruments by way of rupee-denominated (Masala) bonds overseas; permitted long term Masala bonds for infrastructure and affordable housing (notified November 3, 2016);
  - (iii) Enhancing Credit Supply for Large Borrowers through Market Mechanism: new guidelines limiting fresh lending to large borrowers beyond specified Aggregate Sanctioned Credit Limit (ASCL) effective FY 2017/18; Normally permitted lending limit (NPLL) set at 50 percent of incremental funds raised over ASCL would be treated as risky and invite higher risk weights and provisioning;
  - (iv) Allow FPIs to trade directly in corporate bonds without involving brokers;
  - (v) Amend RBI Act to accept corporate bonds under Liquidity Adjustment Facility (LAF) of RBI;
  - (vi) Permit corporates to lend through the repo market, without tenor or counterparty restrictions;
  - (vii) Permitted brokers registered with SEBI and authorized as market makers in corporate bond market to undertake repo/reverse repo contracts in corporate debt securities.
- September 1, 2016 — Debt recovery: Government passed Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Bill, 2016 amending SARFAESI Act, 2002; Recovery of Debts due to Banks and Financial Institutions Act, 1993; Indian Stamp Act, 1899; and Depositories Act, 1996. Key features include empowering District Magistrate to assist banks, allowing secured creditors to take over collateral within 30 days, empowering RBI to audit/regulate ARCs, and exempting stamp duty on transfers to ARCs.
- September 1, 2016 — Sale of Stressed Assets: RBI allowed banks to sell stressed assets to other banks, NBFCs or financial institutions with necessary capital and expertise (previously restricted to SCs/RCs).
- September 29, 2016 — SEBI permitted commodity exchanges to introduce trading in options, subject to approval.
- September 28, 2016 — Resolution corporation: Government released report and draft Bill to create a Resolution Corporation to resolve insolvency of financial firms; board to include representatives of RBI, SEBI, IRDA, and central government. Corporation to categorize firm risk as low, moderate, material, imminent or critical; resolution for critical firms to be completed within two years with option to extend by one year.
- September 30, 2016 — Investment by FPIs in Government Securities: limits raised in two tranches: ₹100 billion each in central government securities and ₹35 billion each in SDLs from October 3, 2016 and January 2, 2017, respectively.
- October 20, 2016 — FPIs participation in government securities: RBI allowed FPIs to trade government securities in the secondary market through primary members of NDS-OM including the Web-module.
- October 28, 2016 — Money market futures: RBI introduced Interest Rate Futures based on any rupee-denominated money market interest rate or money market instrument on SEBI authorized stock exchanges; RBI had already permitted futures based on the 91-day Treasury Bill.
- November 17, 2016 — FPI investment in corporate bonds: RBI permitted FPI investment in unlisted corporate debt securities and securitized debt instruments within prescribed investment limits, currently at ₹350 billion.

### Fiscal Policy
- February 29, 2016 — Strategic disinvestment: Government asked NITI Aayog to prepare list of CPSEs for strategic disinvestment (sale of equity up to 50 percent or above with transfer of management control). NITI Aayog submitted list of loss-making CPSEs grouped into those to be closed and those for divestment. Government approved many recommendations; on October 27, 2016 announced closures and strategic sales.
- March 18, 2016 — Interest rates on various Small Savings Schemes (SSS): Government moved to reset interest rates quarterly (based on government security yields of previous three months) instead of annual basis.
- April 6, 2016 — State fiscal deficit target: Central government accepted Fourteenth Finance Commission recommendation of fiscal deficit threshold limit of 3 percent of GSDP for states, with year-to-year flexibility for additional fiscal deficit of maximum of 0.5 percent for states meeting favorable debt-to-GSDP and interest payments-to-revenue receipts ratios in previous two years.
- May 10, 2016 — Double taxation avoidance treaty: India and Mauritius signed Protocol amending Convention for Avoidance of Double Taxation and Prevention of Fiscal Evasion; existing investments grandfathered and would not be subject to capital gains taxation in India.
- May 17, 2016 — FRBM review committee: Government constituted five-member committee to review FRBM roadmap and recommend on possibility of a ‘fiscal deficit range’ and alignment with credit cycle.
- July 1, 2016 — Subsidy on kerosene: Government allowed state-owned oil companies to raise kerosene price by 25 paise a liter each month; government to bear entire fuel subsidy burden beginning FY2016/17.
- July 6, 2016 — Committee to examine feasibility of new commencement date for financial years constituted.
- July 15, 2016 — Public Financial Management System (PFMS) implemented for processing payments, tracking, monitoring, accounting, reconciliation and reporting for all central sector schemes.
- July 26, 2016 — Seventh Pay Commission: Government notified implementation of award with overall increase in pay & allowances by 23.55 percent. Total financial impact in FY2016/17 estimated at ₹1,021 billion and an additional cost of ₹121 billion in arrears and of salary and pension for two months of FY2015/16.
- August 8, 2016 — Goods and Services Tax (GST) Bill, 2014: Parliament passed constitutional amendment GST Bill 2014; ratified by more than half of the states and received Presidential assent on September 8, 2016.
- September 12, 2016 — GST council: Government notified formation of GST council and its secretariat under Constitutional amendment Act 2016; Finance Minister is ex-officio chairman. Council to recommend model GST Laws, exempted goods and services list, and GST rates.
- September 21, 2016 — Merger of railway budget with central government budget approved; expected net savings ₹50 billion to the railways.
- September 21, 2016 — Merger of Plan and Non-Plan classification in Budget and Accounts from FY2017/18 approved.
- September 21, 2016 — Advancement of Budget presentation by one month to help legislative and planning processes.
- September 28, 2016 — New Indirect Tax Network: Government approved ‘Project SAKSHAM’ for CBEC systems integration to facilitate GST roll-out and single window customs interface.
- September 30, 2016 — Voluntary disclosure of income: Income Declaration Scheme (IDS) 2016 closed on September 30, 2016 after four-month window; total disclosures of Rs 652.5bn (or 0.4 percent of GDP), potentially earning tax revenue of Rs 294bn (0.2 percent of GDP).
- November 29, 2016 — Tax amnesty scheme (Lok Sabha passed Income Tax Amendment Bill) proposing “Taxation and Investment Regime for Pradhan Mantri Garib Kalyan Yojana, 2016’ (PMGKY). Proposed levy of 50 percent (30 percent tax + 10 percent penalties + 33 percent Pradhan Mantri Garib Kalyan Cess on 30 percent tax amount) on voluntarily undisclosed income deposited into bank accounts following currency initiative; levy of 85 percent for those who did not disclose but were caught.

### Structural Policy
- January 27, 2016 — Public Private Partnership (PPP): Government approved hybrid annuity model for highway projects under which government finances 40 percent of project cost as construction support to private developers through annuity payments; balance financed by private developer.
- March 25, 2016 — Aadhaar Act, 2016: Parliament passed the Act legalizing UIDAI and Aadhaar numbers for targeted delivery of subsidies, benefits and services.
- May 2, 2016 — Mines and Minerals Amendment Bill, 2016 passed to allow transfer of mining leases granted through auction or non-auction to eligible parties.
- May 12, 2016 — Ease of doing business: RBI delegated power to Authorized Dealers Category-I Banks to grant approvals for establishment of branch, liaison, and project offices by foreign entities in sectors with 100 percent FDI allowed.
- May 25, 2016 — National Capital Goods Policy, 2016 announced focusing on: (i) long term, stable and rationalized tax and duty structure; (ii) 'Start-up Center for capital goods sector’; (iii) at least five incubation centers in PPP mode; (iv) allow ECB under automatic route.
- August 3, 2016 — Toll Operate Transfer (TOT): Government authorized NHAI to monetize certain publicly-funded National Highway projects generating sustained revenue for two years through TOT model; revenue to finance future development and O&M.
- August 31, 2016 — Expediting arbitration in construction sector: Government directed PSUs and departments to expedite arbitration cases under Arbitration and Reconciliation (Amendment Bill), 2015 Act.
- November 8, 2016 — Demonetization: Government notified withdrawal of legal tender status of existing ₹500 and ₹1000 notes with effect from November 9, 2016; replaced with new ₹500 and ₹2000 notes to unearth unaccounted wealth, eliminate counterfeit currency, bring more activity into formal sector and spur digitization.
- November 25, 2016 — Roadmap for rapid adoption of digital payments: High-level panel chaired by Chief Minister of Andhra Pradesh to prepare blueprint for transition to less-cash economy in next 12 months; Committee of Officers led by NITI Aayog to enable 100 percent conversion of Government–citizen transactions to digital platform.
- December 31, 2016 — Prime Minister announced measures to support informal sector affected by demonetization:
  - Small enterprises: Raise credit limit to 25 percent of turnover from 20 percent; working capital loans to 30 percent of turnover from 20 percent for enterprises that transact digitally; enhance limits for underwriting on loans up to Rs 20 million from Rs 10 million.
  - Farmers: Write-off interest for 60 days for loans taken from cooperative banks; issue 30 million RuPay debit cards; give additional loans of Rs 2,000 million through cooperative banks.
  - Housing: Interest rate subvention on loans for low-income housing: 4 percent on loans up to Rs 0.9 million; and 3 percent for loans up to Rs 1.2 million (urban areas) and for loans up to Rs 0.2 million (rural areas).

### FDI
- March 23, 2016 — FDI limit for insurance and pension sectors raised from 26 percent to 49 percent under automatic route.
- March 29, 2016 — 100 percent FDI through automatic route permitted in marketplace model of e-commerce retailing.
- April 21, 2016 — Government allowed FDI into Real Estate Investment Trusts, Infrastructure Investment Trusts, and Alternative Investment Funds registered under and regulated by SEBI.
- May 18, 2016 — FDI up to 100 percent under automatic route allowed for credit information companies (CICs).
- June 20, 2016 — More flexibility in FDI policy including:
  - (i) 100 percent FDI under government approval route for trading in food products manufactured or produced in India;
  - (ii) termination of 'state-of-art' technology condition for FDI in defence up to 100 percent under approval route;
  - (iii) 100 percent FDI in teleports, DTH, cable networks, mobile TV under automatic route;
  - (iv) up to 74 percent FDI under automatic route in brownfield pharmaceuticals, up to 100 percent under approval route;
  - (v) 100 percent FDI under automatic route in brownfield airport projects;
  - (vi) raised FDI limit to 100 percent in Scheduled Air Transport Service/Domestic Scheduled Passenger Airline and regional Air Transport Service, up to 49 percent under automatic route and up to 100 percent through government approval route;
  - (vii) FDI limit for private security agencies raised to 74 percent, up to 49 percent under automatic route and up to 100 percent under government approval route.
- August 31, 2016 — Grant of Permanent Residency Status (PRS) to Foreign Investors approved: PRS permits multiple entry for 10 years, extendable by another 10 years. Investment requirements: minimum of ₹100 million within 18 months or ₹250 million within 36 months, resulting in employment of at least 20 resident Indians every financial year.
- October 20, 2016 — Foreign investment in Other Financial Services: Government permitted 100 percent foreign investment under automatic route in ‘Other Financial Services’ regulated by financial sector regulators.

### Agriculture Sector
- January 27, 2016 — Crop insurance scheme: Pradhan Mantri Fasal Bima Yojana introduced. Premium payable by farmers:
  - Kharif crops: 2 percent of sum insured (SI);
  - Rabi crops: 1.5 percent of SI;
  - Commercial/horticultural crops: 5 percent of SI.
  - Balance of premium to be borne equally by the states and center.
- April 14, 2016 — National Agriculture Market (NAM) launched as pan-India electronic trading portal. At inauguration 21 wholesale markets in eight states integrated; scheme plans to integrate 585 wholesale markets by March 2018.
- May 26, 2016 — Krishi Kalyan cess (KKC): Government imposed 0.5 percent KKC on most services to support agriculture sector.
- June 1, 2016 — Buffer stock for pulses approved up to 2 million tonnes through domestic procurement and imports of 1 million tonnes each. MSP for pulses raised by 7-9 percent and bonus of ₹425 per quintal for Kharif pulses for Arhar (Tur), Urad and Moong popular varieties.
- June 16, 2016 — Export duty on sugar: Government imposed export duty of 20 percent on raw sugar, white or refined sugar.
- June 22, 2016 — Reforms in textile and apparel sector including:
  - (a) Permitted fixed term employment to address seasonal labor demand with terms and conditions at par with permanent workers;
  - (b) Raised government’s contribution by 3.67 percent to 12 percent toward Employers Provident Fund (EPF) Scheme for newly-recruited employees for 3 years;
  - (c) Made employee contributions to EPF optional for those earning less than Rs 15,000 per month;
  - (d) Enlarged coverage for duty drawback to refund the state levies.

### Factor Market Reforms
- August 10, 2016 — Maternity benefit: Maternity Benefit (Amendment) Bill, 2016 introduced to increase maternity leave from 12 weeks to 26 weeks for two surviving children and 12 weeks for more than two children; 12 weeks for 'Commissioning mother' and 'Adopting mother'; facility to 'work from home'; mandatory crèche in establishments having 50 or more employees; applicable to all establishments employing 10 or more persons.
- Handbook for women farmers issued: ‘Farm Women Friendly Hand Book’ containing special provisions and package of assistance under various missions/schemes.
- September 9, 2016 — Railways: Indian Railways introduced experimental surge (dynamic) pricing model for passenger fares in a few premium trains; base fares increase by 10% with every 10% of tickets sold.

### Environment and Climate Action
- October 2, 2016 — Ratification of the Paris Climate Change Agreement: India (about 4.5 percent of global greenhouse gas emissions) became the 62nd country to ratify; these countries together account for 52 percent of global emissions. India committed that at least 40 percent of its electricity will be generated from non-fossil-based sources by 2030.

### State Reforms
- April 8, 2016 — Titling law: Rajasthan passed law providing statutory backing to land records to guarantee land and property ownership.
- Night shifts for women: State governments of Maharashtra, Tamil Nadu, Karnataka, Andhra Pradesh and Sikkim allowed women to work night-shifts in factories by amending Factory Act, 1948; factories required to ensure adequate safety and security within premises and during transit.

*Prepared by Sudip Mohapatra.*

### Annex II. India: Risk Assessment Matrix

### Annex II. India: Risk Assessment Matrix

### Domestic Risks
- Prolonged cash shortages  
  - Likelihood: M  
  - Impact: M: Given the large role of cash in everyday transactions in the Indian economy, prolonged cash shortages accompanying the currency exchange initiative can weigh on economic activity, fiscal revenues, and could cause a further rise in corporate vulnerabilities and weaken bank asset quality.  
  - Policies to Minimize Impact: Continue to enhance the supply of new banknotes, and if needed consider further sector-based exemptions, including on use of old banknotes, particularly for rural and remote areas.

- Balance sheet risks  
  - Likelihood: M  
  - Impact: H: Failure to promptly address bank asset quality distress through asset resolution and repair of corporate balance sheets could lead to further bank and corporate balance sheet deterioration, undermining capital positions of public sector banks, reducing lending in the medium term and adversely affecting the investment recovery.  
  - Policies to Minimize Impact: Strengthen oversight of financial and corporate risks. Enhance loss-absorbing buffers in public sector banks. Policies to incentivize corporate restructuring and implementation of new insolvency framework.

- Setbacks in structural reform process  
  - Likelihood: L  
  - Impact: M: Difficulty in GST implementation and passing key bills (Labor Market and Land Acquisition) and slow progress on reforming factor and product markets, including agriculture, could weigh on investment and growth, stoke inflation, and weaken investor sentiment.  
  - Policies to Minimize Impact: Facilitate state-led reform initiatives. Enhance revenue raising efforts; continue to address long-standing supply bottlenecks through non-legislative measures; and strengthen the business climate.

- Larger positive impact from GST than currently expected  
  - Likelihood: L  
  - Impact: H: Higher growth will help rebuild fiscal space, facilitate balance sheet repair and investment recovery, enhance external competiveness and price stability.  
  - Policies to Minimize Impact: Facilitate further structural reforms, particularly to labor markets. Enhance quality and scope of public investment. As fiscal deficit decline, consider faster phasing out of financial repression.

### External Risks
- Tighter or more volatile global financial conditions  
  - Likelihood: M  
  - Impact: M: While external vulnerabilities have declined considerably, the impact from risk re-pricing or a surge in global financial market volatility could be very disruptive, particularly against the backdrop of recent large capital inflows, maturing FCNR deposits, sluggish exports, and weak corporate balance sheets.  
  - Policies to Minimize Impact: Enhance the environment for attracting stable non-debt creating capital flows, particularly FDI. Rupee flexibility and monetary policy tightening. Given adequate level of international reserves, provide foreign currency liquidity to prevent disorderly movements in the exchange rate.

- Weaker-than expected global growth  
  - Likelihood: M  
  - Impact: M: Deterioration of economic outlook in key advanced and emerging market countries would cloud the sustainability of the recovery in India, both for exports and investment.  
  - Policies to Minimize Impact: Structural reform will raise returns to investment, strengthen domestic sources of growth, and support export competitiveness.

- Increased volatility of global energy prices  
  - Likelihood: M  
  - Impact: M: Significant effects on the current account deficit, inflation. While volatility in energy prices can have an adverse impact, persistently-low energy prices are beneficial for India given its net energy importer status.  
  - Policies to Minimize Impact: Improve targeting of transfers to shelter the most vulnerable; accelerate reform of remaining fuel subsidies; smooth volatility of domestic fuel prices through fiscal measures; provide dollar liquidity to oil marketing companies as required, to address disruptive exchange rate volatility.

- Rising regional geopolitical tensions  
  - Likelihood: L  
  - Impact: M: Financial market pressure, reduced capital inflows, and general tightening of financial conditions.  
  - Policies to Minimize Impact: Strengthen oversight of financial and corporate risks. Rupee flexibility. Given adequate level of international reserves, provide foreign currency liquidity to prevent disorderly movements in the exchange rate.

### Legend and Notes
- "L"=Low; "M"=Medium; "H"=High.  
- This matrix shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline. The Risk Assessment Matrix reflects staff views on the source of risks and overall level of concern as of the time of discussions with authorities.

*Source: cr1754 - Annex II. India: Risk Assessment Matrix*

### 4. There is no evidence of a systematic projection bias in the baseline assumptions

### 4. There is no evidence of a systematic projection bias in the baseline assumptions

### Forecast track record and projection realism
- India’s forecast track record ranks in excess of 90 (for real GDP growth) and 77 (for primary balance) among surveillance countries.
- The boom-bust analysis is not triggered because India had a negative output gap in 2015/16.
- Figure titles in the source: "India Public DSA—Risk Assessment", "India Public DSA—Realism of Baseline Assumptions", and "India Public DSA—Baseline Scenario" support assessment of realism.

### Projected fiscal adjustment
- Projected fiscal adjustment: an improvement of around three-quarters of one percentage point in cyclically-adjusted primary balance/GDP over the medium term.
- This magnitude of adjustment is modest and comparable to other countries: a three-year adjustment in cyclically-adjusted primary balance is at the 44th percentile among all surveillance countries with market access.

### Contingent liabilities shock (customized)
- The contingent liabilities shock is customized to reflect:
  - (i) the central government bearing the full cost of PSBs’ recapitalization in a severe stress scenario (about 3 percent of GDP), and
  - (ii) state governments assuming 75 percent of the remaining debt of the electricity distribution companies that may become eligible for restructuring (about 1 percent of GDP).

### Public DSA—Baseline and key projection figures (selected, as presented)
- Sovereign spreads (10Y LT (bp)): 401 (as shown in the Baseline figure).
- 10Y CDS (bp): 163 (as shown in the Baseline figure).
- Real GDP growth (in percent), projections row: 7.8, 7.2, 7.6, 6.6, 7.2, 7.7, 7.8, 7.9, 8.1 (as presented across years).
- Inflation (GDP deflator, in percent), projections row: 6.6, 3.3, 1.1, 3.9, 4.3, 4.3, 4.5, 4.3, 4.2.
- Nominal GDP growth (in percent), projections row: 14.9, 10.8, 8.7, 11.2, 11.8, 12.3, 12.7, 12.6, 12.6, 12.7.
- Effective interest rate (in percent) projection: 7.6–7.8 (values across years shown as 7.6, 7.7, 7.8, 7.8, 7.8, 7.6, 7.6, 7.6, 7.6).
- Change in gross public sector debt (cumulative, percent of GDP): -1.7, 0.4, 1.5, -0.2, -0.9, -1.8, -2.0, -2.0, -2.1, -8.9 (across years).
- Primary deficit (in percent of GDP), projection series: 3.1, 2.8, 2.3, 2.1, 2.0, 1.7, 1.5, 1.4, 1.2, 9.9 (cumulative).
- Primary (noninterest) revenue and grants (in percent of GDP), projection series: 19.3, 19.4, 20.9, 21.2, 21.1, 21.3, 21.5, 21.6, 21.8, 128.5 (cumulative).
- Primary (noninterest) expenditure (in percent of GDP), projection series: 22.4, 22.2, 23.2, 23.2, 23.3, 23.0, 23.0, 23.0, 23.0, 138.5 (cumulative).
- Automatic debt dynamics contribution (percent of GDP, cumulative): -4.7, -1.9, -0.6, -1.9, -2.5, -2.9, -3.0, -2.9, -2.8, -15.9.
- Of which: real interest rate (percent): 0.4, 2.5, 4.2, 2.3, 1.9, 1.8, 1.7, 1.7, 1.7, 11.2.
- Of which: real GDP growth (percent): -5.1, -4.4, -4.8, -4.2, -4.5, -4.7, -4.6, -4.6, -4.5, -27.1.
- Contingent liabilities (percent of GDP) projection shown as 0.0 across years in the Baseline table.
- Residual, including asset changes (percent of GDP, cumulative): 0.2, -0.3, 0.0, -0.5, -0.2, -0.2, -0.2, -0.2, -0.2, -1.5.

### Alternative scenarios and stress tests (high-level)
- Alternative scenarios presented include Historical Scenario and Constant Primary Balance Scenario with their underlying assumptions:
  - Baseline Real GDP growth (selected years): 6.6, 7.2, 7.7, 7.8, 7.9, 8.1.
  - Historical Scenario Real GDP growth (selected years): 6.6, 7.5, 7.5, 7.5, 7.5, 7.5.
  - Constant Primary Balance Scenario Primary Balance: -2.1 across projection years.
- Stress tests shown: Primary Balance Shock; Real GDP Growth Shock; Real Interest Rate Shock; Real Exchange Rate Shock; Combined Shock; Contingent Liability Shock.
- Example stress-test outcomes (selected):
  - Under Contingent Liability Shock, projected Primary balance in 2017 is -7.3 (percent of GDP) in the table for that shock.
  - Effective interest rate under certain stress tests increases (examples: 7.8, 8.2, 8.6, 8.8, 9.1, 9.3 across years in the Contingent Liability Shock table).

### External sector assessment (Annex IV) — main findings
- Staff assesses India’s external position in FY2015/16 was broadly consistent with medium-term fundamentals and desirable policy settings.
- Current account (CA) deficit narrowed to 1.1 percent of GDP in FY2015/16 and is projected to remain at about 1.1 percent of GDP in FY2016/17.
- The EBA CA regression estimates a norm of -4.2 percent of GDP for India in FY2015/16; staff judges a smaller CA deficit of about 2¼ percent of GDP is a more appropriate norm given vulnerabilities.
- The estimated underlying CA in FY2015/16 is -1.75 percent of GDP (CA adjusted for temporary factors).
- Staff assesses the CA gap to be about ½ percent of GDP, or in a range of -½ to +1½ percent of GDP.
- EBA Index REER and Level REER regressions estimate an overvaluation of about 8 and 13 percent for the 2015 average REER, respectively; staff’s CA-gap–implied REER suggests an undervaluation of 2½ percent for FY2015/16 average REER. Overall REER gap assessed in a range of -5 to +10 percent (moderately overvalued).
- Financial-account composition: dominated by portfolio equity and FDI; FDI flows as share of GDP have been increasing since 2014/15.
- Portfolio flows were moderately negative in 2015/16 after large net portfolio flows in 2014/15.
- India’s net international investment position (NIIP) stable at around 17½ percent of GDP in recent years and projected to increase slightly over the medium term.
- External debt at 23 percent of GDP as at end-June 2016; share of long-term external debt in total debt is over 80 percent.
- With a CAD of about 2 percent of GDP projected for the medium term and higher GDP growth, the NIIP-to-GDP ratio is expected to remain broadly stable.

### Reserve adequacy and external buffers
- International reserves around US$360 billion as of late-December 2016.
- RBI purchases: about US$11 billion in spot and forward markets from April to September 2016.
- Net outstanding forward FX purchases of the RBI stood at about US$5 billion as at end-September 2016; net forward position at end-September 2016 was negative US$38 million (negligible).
- Other lines of defense:
  - Contingent Reserve Arrangement (CRA) among BRICS with US$100 billion committed resources.
  - SAARC Swap Arrangement overall amount US$2 billion (maximum available broadly based on two months of import cover subject to a maximum of US$400 million per country).
  - RBI bilateral swap lines: Central Bank of Sri Lanka US$700 million; Royal Monetary Authority of Bhutan US$100 million.

*Source: IMF staff (as presented in the provided content).*

### Annex V. Expenditure Reforms

### Annex V. Expenditure Reforms

### Overview
- Emphasis: Efficiency and effectiveness of expenditure are highlighted as a more powerful determinant of growth than merely the quantum of expenditure or debt sustainability trade-offs.
- Recent progress: Over the last two years, the Government of India implemented systemic reforms across scheme architecture, budgeting, appraisal, capital expenditure, public financial management, beneficiary transfers, and outcome evaluation.

### Rationalization of Schemes
- Objective: Reduce fragmentation of cost centres, capture economies of scale, and improve focus on outcomes.
- Key changes:
  - Centrally Sponsored Schemes reduced from 66 to 30.
  - Central Sector Schemes reduced from 1059 to 230.
- Process: Consolidation undertaken in consultation with Central Implementing Ministries and Sub-group of Chief Ministers constituted by the NITI Aayog.

### Cost Center Approach and Plan/Non‑Plan Distinction
- Reform: Removal of the plan non-plan distinction at the end of the Twelfth Five-Year Plan (2016–17 is the last year).
- Outcome: Adoption of a cohesive cost centre approach with a clear revenue-capital distinction and issuance of guidance notes to stakeholders.

### Appraisal and Approval Protocols
- Delegation of financial powers: Three-fold increase in delegation of financial powers in August, 2014.
- Simplification: In August, 2016 a complex web of serial circulars and annexures was replaced by a single master circular.
  - Master circular length: five pages.
  - Number of annexures: five.
- Intended effect: Simplified appraisal and approval protocols aligned with the cost centre approach to enhance growth impact via more efficient project/scheme formulation and approval.

### Quality of Expenditure and Capital Expenditure (Cap‑Ex)
- Fiscal multipliers cited:
  - Infrastructure investment multipliers: 1.5 to 2.0.
  - Revenue expenditure and transfers multipliers: 0.90 to 1.00.
- Budgetary support to growth defined as: direct plan capital expenditure + grants-in-aid for capital expenditure to central agencies and State Governments.
- Recent trajectory of these capital expenditures:
  - Rs 2,35,807 crore in 2014–15 (actuals).
  - Rs 2,74,197 crore in 2015-16 (revised estimates) — y-o-y increase of 16.2 percent in 2015-16 over 2014–15.
  - Rs 3,13,322 crore in 2016–17 (budget estimates) — y-o-y increase of 14.2 percent in 2016-17 over 2015–16.
- Additional investment from public enterprises and autonomous bodies:
  - 12.9 percent fall in 2014–15.
  - 40.4 percent increase in 2015-16.
  - Likely further increase by 23.8 percent in 2016-17.

### Public Financial Management System (PFMS)
- Scope extension: From plan scheme monitoring to the entire universe of schemes, projects, and establishment expenditures on the non-plan side.
- Revenue-side integration: Linked with operational tax portals; addition of a non-tax revenue portal to capture all non-tax revenues.
- Cash management reform: All implementing agencies of Central Sector Schemes directed to register and adopt the Expenditure-Advance-Transfer (EAT) Modules of the PFMS by March, 2017.
- States: Encouraged to design integrated financial management information systems and link to the Central Public Financial System to improve execution efficiency for State and Centrally Sponsored Schemes.

### Direct Benefit Transfer (DBT) and Aadhaar Integration
- DBT Gateway: Established through the National Payment Corporation of India (NPCI).
  - 74 central entitlement schemes/sub-schemes have moved to the DBT platform.
- Aadhaar developments:
  - Aadhaar Law enacted in March, 2016 enabling biometric linkage of entitlements and subsidies to intended beneficiaries.
  - Since September 2010, over 1084 million Aadhaar numbers have been generated, covering more than 90 percent of the adult (over 18 years) population.
- State mechanisms: A State DBT mechanism set up through NPCI; State Governments increasingly using DBT to improve targeting of entitlement and subsidy schemes.

### Outcome‑Evaluation Framework
- Requirement: All schemes and projects to have a medium-term expenditure and outcome framework formulated with Implementing Ministries and the NITI Aayog.
- Parliamentary oversight: Framework to be presented to Parliament through a consolidated Outcome Budget each year.
- Temporal clarity: Each Scheme will have a start and a sunset date coterminous with the Finance Commission cycle to provide Central and State Governments clarity over resource flows.
- Evaluation: Third party evaluation formally incorporated into the appraisal and approval framework to ensure periodic feedback and enhanced focus on outcomes.

*Contributed by Dr Arunish Chawla, Joint Secretary, Department of Expenditure, Ministry of Finance.*

### 1.      General: Data provision is broadly adequate for surveillance. However, weaknesses remain

### 1. General: Data provision is broadly adequate for surveillance. However, weaknesses remain

### Overview of data provision and SDDS observance
- India produces a vast quantity of data covering most sectors of the economy.
- India subscribed to the Special Data Dissemination Standards (SDDS) on December 27, 1996 and started posting its metadata on the Dissemination Standards Bulletin Board on October 30, 1997.
- India is currently in observance of the SDDS, although it uses flexibility options for:
  - timeliness of data on general government operations, and
  - periodicity and timeliness of labor market data.
- The data module of the Report on Observance of Standards and Codes (ROSC, IMF Country Report No. 04/96) was published in April 2004 and assessed India’s dissemination practices against SDDS and six datasets using the Data Quality Assessment Framework (DQAF).

### National accounts and employment statistics — findings and limitations
- In January 2015 the Central Statistical Office (CSO) released a new series of national accounts with base year 2011/12 that:
  - implemented 2008 SNA,
  - reflected a review of source data and compilation methods.
- Due to weaknesses in estimating taxes less subsidies on products in constant prices, and because supply-side data remain of better quality than expenditure-side data:
  - Gross Value Added is preferred as a proxy for measuring economic growth.
- For current price estimates, data sources provide adequate coverage and methodology is broadly consistent with international standards and best practices.
- Specific shortcomings:
  - A sales-tax-based extrapolation of trade turnover value from the base year does not provide an accurate gauge of growth of economy-wide value added from trade.
  - Constant price estimates of GDP deviate from conceptual requirements of the national accounts in part because the Wholesale Price Index (WPI) is used to derive volume estimates for many economic activities.
    - The WPI includes some product taxes whereas GDP by activity does not include product taxes, so WPI can be influenced by changes in tax rates.
    - WPI weights include imports but WPI prices are collected only on domestic goods.
  - Large revisions to historical series, the relatively short time span of the revised series, and major discrepancies between GDP by activity and GDP by expenditure complicate analysis.
  - The current index of industrial production (base year 2004/05) has limited usefulness for compiling national accounts statistics as its weights are over ten years old and thus its use may lead to some bias in estimates.
  - Long-standing deficiencies in employment data: they only cover the formal sector (a small segment of the labor market) and are available only with a substantial lag.

### Price statistics — coverage and recent changes
- A revised all-India Consumer Price Index (CPI) with new weights was released in early 2011 covering combined rural and urban India, with 2009/10 as a base year; separate urban and rural CPI series are also published.
- CPIs are published with a lag of about one month.
- In early 2015, the CPI weights were updated using 2011/12 expenditure data and the CPI series was revised from January 2015.
- Since January 2006 the Labour Bureau has published a CPI for industrial workers with a 2001 base year.
- Four CPIs remain, each based on the consumption basket of a narrow category of consumers (industrial workers, urban and non-manual employees, agricultural laborers, and rural laborers); except for the industrial workers’ CPI, these indices are based on weights that are over ten years old.
- The WPI has a 2004/05 base year and is subject to frequent and large upward revisions.
  - A new WPI series using 2011/12 base year was likely to be released in early 2017.
  - Authorities have been encouraged to develop a Producer Price Index to replace the WPI.
- RBI developments:
  - New RBI residential property price indexes have helped surveillance though geographic coverage remains limited; commercial real estate price data are not available.
  - RBI started producing a series covering rural wage data; economy-wide wage data are scant.

### Government finance statistics — coverage, timeliness, and comparability
- The Ministry of Finance (MoF) compiles and disseminates Government Finance Statistics (GFS). India does not report fiscal data to STA.
- India disseminates:
  - the budgetary central government cash flow statement within one month after the reference month, and
  - stock of liabilities within one quarter after the reference quarter.
- With agreement of the authorities, STA uses these data to compile a monthly cash flow statement for publication in the International Financial Statistics, following the GFSM 2001/2014 summary presentation, with some missing breakdowns, particularly for expenditure.
- State-level fiscal performance data are available only at annual frequency and with a considerable lag.
- Data on functional and economic classification of expenditures are available with considerable lag.
- Presentation issues that reduce analytical usefulness:
  - Classification of government expenditure between developmental/nondevelopmental and plan/nonplan obscures the economic nature and impact of fiscal actions.
- Reporting history:
  - MoF reports central government data (on a cash basis) for publication in the Government Finance Statistics Yearbook (GFSY); the latest reported data correspond to 2013.
  - Two years after the reference year, MoF reports general government (Central and State) data to STA in the GFSM 1986 format; staff rework to GFSM 2001 presentation for inclusion in GFSY (latest reported data correspond to 2008).
- Data on general government operations are not internationally comparable as they exclude operations of extra-budgetary funds, local governments, and social security funds.
- Under SDDS, India disseminates annual general government data within 3 quarters after the reference year, using the timeliness flexibility option.
- India meets the SDDS specifications for central government debt and operations.

### Monetary and financial statistics — dissemination and conceptual alignment
- The RBI web site and the RBI Bulletin publish a wide array of monetary and financial statistics, including:
  - reserve money and its components, RBI’s survey, monetary survey, liquidity aggregates (outstanding amounts), interest rates, exchange rates, foreign reserves, and results of government securities auctions.
- In 2011, the RBI started publishing a weighted average lending interest rate and other lending rates at annual frequency.
- Frequency and quality of data dissemination have improved substantially in recent years.
- Concepts and definitions used by the RBI are in broad conformity with the Monetary and Financial Statistics Manual (MFSM), with deviations:
  - Resident sector data do not provide sufficient information on sectoral distribution of domestic credit:
    - Present sectorization subdivides resident nonbank sector data by (i) central government; (ii) state government; and (iii) the commercial sector (including other financial corporations, public and other nonfinancial corporations, and other resident sectors).
  - Commercial banks add accrued interest to credit and deposit positions on a quarterly basis only (instead of the prescribed monthly basis).
- The RBI reports monetary data for IFS with long delays and in non-standard format:
  - As of December 12, 2016, the latest monetary statistics published in IFS refer to April 2016.
  - Data reported to IFS cover depository corporations only; other financial corporations (insurance corporations, pension funds, investment funds, etc.) are not covered in IFS.
- Financial Soundness Indicators (FSIs):
  - All 12 core and 11 encouraged FSIs for deposit takers are reported on a quarterly basis.
  - FSIs for other financial corporations, nonfinancial corporations, and households are not reported.

### External sector statistics — alignment, valuation, and coverage issues
- Balance of payments concepts and definitions are broadly in line with BPM6.
- Trade data suffer valuation, timing, and coverage problems:
  - Imports of goods in balance of payments are registered in c.i.f. prices while BPM6 requires f.o.b. pricing.
  - Trade in goods prices, volumes, and composition data are not regularly available on a timely basis.
- External debt statistics:
  - Available on a quarterly basis with a one quarter lag.
  - Estimates of short-term external debt are presented on an original maturity basis.
  - Short-term maturity attribution on a residual maturity basis is available only annually (and excludes residual maturity of medium- and long-term nonresident Indian accounts).
- International Investment Position (IIP) statistics:
  - Cover sectors prescribed in BPM6 and are disseminated within three months of the reference period for quarterly data.
  - Note: The IIP as published by the RBI values equity liabilities at acquisition cost, while the Fund uses market prices, resulting in substantial differences.
- Coverage limitations:
  - Coverage of direct investment positions data is hampered by the absence of appropriate legal or institutional authority.
- Reserves and liquidity templates:
  - India disseminates monthly the Data Template on International Reserves and Foreign Currency Liquidity as prescribed under SDDS.
  - More up-to-date information on certain variables (total foreign reserve assets, foreign currency assets, gold, and SDRs) are available on a weekly basis and disseminated as part of a weekly statistical supplement on the RBI web site.

### Table of Common Indicators Required for Surveillance (as of December 13, 2016) — selected latest observations and frequencies
- Exchange Rates: Date of latest observation 12/07/16; Frequency D (Daily); Date received 12/07/16.
- International reserve assets and reserve liabilities of the monetary authorities: Date of latest observation 11/25/16; Date received 12/02/16; Frequency WWW (Weekly).
- Reserve/base money: Date of latest observation 11/25/16; Date received 12/02/16; Frequency WWW.
- Broad money: Date of latest observation 11/11/16; Date received 12/02/16; Frequency BWWW.
- Central bank balance sheet: Date of latest observation Nov. 2016; Date received 12/04/16; Frequency MMM.
- Consolidated balance sheet of the banking system: Date of latest observation Sept. 2016; Date received 11/11/16; Frequency MMM.
- Interest rates: Date of latest observation 12/07/16; Date received 12/07/16; Frequency DDD.
- Consumer price index: Date of latest observation Oct. 2016; Date received 11/15/16; Frequency MMM.
- Revenue, expenditure, balance and composition of financing - General Government: Date of latest observation 2014/15; Date received 08/29/16; Frequency AAA.
- Revenue, expenditure, balance and composition of financing - Central Government: Date of latest observation Oct. 2016; Date received 11/30/16; Frequency MMM.
- Stocks of central government and central government-guaranteed debt: Date of latest observation Oct. 2016; Date received 11/30/16; Frequency MMM.
- External current account balance: Date of latest observation June 2016; Date received 09/21/16; Frequency QQQ.
- Exports and imports of goods and services: Date of latest observation Oct. 2016; Date received 11/15/16; Frequency MMM.
- GDP/GNP: Date of latest observation Sept. 2016; Date received 11/30/16; Frequency QQQ.
- Gross external debt: Date of latest observation June 2016; Date received 10/02/16; Frequency QQQ.
- International Investment Position: Date of latest observation June 2016; Date received 09/30/16; Frequency QQQ.

### Additional near-term developments noted in staff statements (January 2017)
- CSO advance estimate of real GDP growth for FY2016/17 (April-March) at 7.1 percent, down from 7.6 percent in FY2015/16; this advance estimate captures data through October and does not include the impact of the currency exchange initiative that commenced on November 8, 2016.
- RBI currency replacement data as of December 19, 2016:
  - currency notes worth about 38 percent (Rs 5.93 billion) of the value of the demonetized currency notes have been reissued;
  - over 80 percent of the old currency notes (Rs 12.44 billion) have been deposited into bank accounts.
- RBI policy changes effective January 16, 2017:
  - ATM daily withdrawal limits increased from Rs 4,500 to Rs 10,000;
  - weekly withdrawal limit for current accounts increased from Rs 50,000 to Rs 100,000.
- High-frequency indicators after the currency exchange initiative:
  - index of industrial production rose by 5.7 percent in November 2016 but driven mainly by volatile components and orders-to-inventory ratio contracted;
  - PMIs in December: services PMI at 46.3; manufacturing PMI at 48.6;
  - bank credit growth decelerated to 5.1 percent at end-December (a decadal low);
  - CPI inflation softened to 3.4 percent (year-over-year) in December from 3.6 percent in the previous month.
- International reserves and capital flows (early 2017 data):
  - international reserves declined by US$ 1.1 billion thus far in 2017, standing at US$ 359 billion as of January 6, 2017;
  - reserves represent about 8 months of next year’s imports of goods and services;
  - net portfolio investment outflows amounted to about US$ 900 million so far in January 2017;
  - foreign direct investment inflows amounted to US$ 27 billion during the first eight months of FY2016/17;
  - RBI net spot sale of foreign currency amounted to US$ 3 billion in October and November 2016, with outstanding net forward and futures purchases of foreign currency standing at US$ 1.9 billion at end-November;
  - the Indian rupee remained near its end-December 2016 levels, at about 68 rupees to the U.S. dollar.
- GST timeline and status as of January 16, 2017:
  - GST Council reached consensus on sharing of administrative powers between central and state governments in assessing taxpayers;
  - detailed rate schedules and draft legislation still to be finalized and approved by Parliament and state Assemblies before GST implementation, most likely by July 1, 2017.

*IMF staff report chapter: "1. General: Data provision is broadly adequate for surveillance. However, weaknesses remain" (from the IMF country report content provided).*

### 5.      We want to emphasize the commitment of our authorities on medium-term fiscal

### 5.      We want to emphasize the commitment of our authorities on medium-term fiscal

### Fiscal consolidation and GST
- Authorities emphasize commitment to medium-term fiscal consolidation.
- A conducive environment for improvement in state public finances has been created through suitable incentives/costs for states to renew fiscal efforts towards consolidation.
- The passage of the Goods and Services Tax (GST) Bill 2016 marks a new era in co-operative fiscal federalism.
- The GST system is most likely to be implemented at the earliest in July this year, as the GST council has finally reached consensus on rate slabs and jurisdictional issues.
- Expected effects of GST:
  - Widen and stabilize the indirect tax base by reducing overall tax burden.
  - Eliminate cascading caused by a multitude of existing levies.
  - Remove duty exemptions and encourage tax compliance.
  - Reduce tax administration costs and improve the public finances.
- Debt assessment:
  - India’s public debt is sustainable because of the authorities’ commitments for fiscal consolidation and the projected interest versus growth trajectory going forward.

### Financial Sector — governance and asset quality
- Indradhanush initiative (announced by the government in 2015):
  - Aims to improve functioning of public sector banks by strengthening Board and management appointments.
  - Decentralize more decisions to the professional board.
  - Find ways to incentivize management to improve loan evaluation, monitoring and repayment.
- Measures to curtail deterioration in asset quality:
  - Schemes for identification, restructuring and resolution of stressed and NPLs for revitalizing distressed assets, optimal structuring of credit facilities, change the ownership/management for reviving bad credits, deep restructuring of stressed assets and facilitating speedy exit from unviable accounts.
  - Reserve Bank initiated an asset quality review (AQR) in December 2015; banks were directed to ensure proper recognition of asset quality and create adequate provisions for all restructured loans.
  - Tighter scrutiny led to an increase in the stressed assets ratio to 12.3 per cent by September 2016 from 11.5 per cent in March 2016.
- Current banking sector risks and resilience:
  - Risks remain elevated owing to the deterioration in asset quality, significantly so with respect to large borrowers, low profitability and liquidity.
  - Stress tests reveal that adverse macroeconomic shocks would lead to increase in GNPA ratios of the scheduled commercial banks with larger adverse impact on public sector banks.
  - Despite this, capital adequacy at the system level and bank group levels is above the regulatory minimum, and has improved since March 2015.
- Resolution and regulatory measures:
  - Scheme for Sustainable Structuring of Stressed assets (S4A) in November 2016: financial restructuring by carving out sustainable and unsustainable parts of debt with conversion of the latter into equity.
  - Flexible restructuring of new project loans permitted in all sectors including for the existing long term project loans.
  - Enactment of the Bankruptcy Code 2016 will enable recovery through judicial process in reasonable time.
  - Regulatory and supervisory measures include guidelines on large exposures, Net Stable Funding Ratios and rationalization of ownership limits in private sector banks.
- Market transparency and consumer protection:
  - Macro-prudential and regulatory measures: tightening of insider trading norms and improving policies and procedures of credit rating agencies in respect of securities market.
  - Monitoring of foreign direct investment and transfer of shares in the insurance sector.
  - Measures to empower customers with wider product choices and mechanisms for grievance redressal.

### Corporate indebtedness
- High leverage and consequent interest burdens hamper viability of companies and could affect aggregate investment behavior.
- Staff assessment:
  - Mixed: acknowledges situation is improving, but at a relatively slow pace.
  - Even with improvement, debt indicators remain uncomfortably high.
- Authorities' view:
  - Conclusion is highly sensitive to sample selection.
  - Analysis by the Reserve Bank of India using a different sample indicates significantly more improvement in the indicators.
  - The problem may not be as acute as the Staff Report assesses it to be.

### External Sector
- Current account deficit (CAD):
  - India has been able to contain its CAD in past two years to 1.3 per cent and 1.1 per cent of GDP in 2014-15 and 2015-16 respectively.
  - CAD is expected to be contained around at one per cent for this year as a whole.
- Trade and barriers:
  - Exports have returned to positive growth after a long decline.
  - Authorities observe India faces high non-tariff barriers for exports, even as the MFN applied tariff rates on non-agricultural exports are held at reasonably low level in relation to peer countries.
- Capital account and reserves:
  - During April-November 2016 net FDI inflows were US $ 25.7 billion, higher than US $ 23.7 billion in the same period last year.
  - Foreign exchange reserves stood at US $ 359 billion in January 2017, covering around eight months of imports.

### Structural Reforms — overview
- Authorities note comprehensive listing of reforms in the Staff Report; focus here on two initiatives: the Currency Policy Initiative and the Gender Initiative.

#### The Currency Policy Initiative
- Context:
  - Decision to withdraw high-denomination currency notes from circulation on November 8, 2016 is placed within broader structural reforms aimed at enhancing transparency of activity and tax compliance.
  - GST implementation is one pillar; other measures include a voluntary disclosure of income scheme and tracking of high-value transactions through taxpayer ID numbers; reforming the real estate registration process is being discussed.
- Motivations for the initiative:
  - Prevalence of cash transactions contributed to widespread tax evasion and building up of cash hoards.
  - Continuing validity of old and less secure currency notes increased the threat from counterfeit notes.
  - Significant increase in capacity and efficiency of the payments infrastructure, contributing to emergence of cash-alternative modes of payment.
- Effects and assessment:
  - Initiative has caused disruptions, but these are viewed as transitory.
  - Payments and settlement system has accommodated massive increases in the use of cash-alternatives without any sign of fragility.
  - Very large shift of even low-value transactions to these alternatives is a significant success of the initiative.
- Broader policy point:
  - Fund advice is to carry out structural reforms when macroeconomic conditions are hospitable to minimize disruptions.
  - Current macroeconomic situation in India described as: relatively rapid growth, relatively low inflation, fiscal consolidation on track and a relatively low CAD — providing the right environment to launch initiatives of this kind.

#### The Gender Initiative
- Authorities welcome the Fund’s piloting of analysis of gender issues as part of the Article IV process in India.
- Expectation that analysis will contribute to policy debate and identification of effective policy measures for gender equity.
- Policy approach:
  - Life-cycle approach recognizing the right interventions at every stage of life determine success.
  - Complements childhood interventions (Celebrate Girl Child, Educate Girl Child) with initiatives on skilling, livelihood and financial access.
- Specific measures:
  - A new National Policy on Women is being formulated to promote gender equality and to support women’s aspirations.
  - A national fund established to provide micro-credit at affordable cost to poor women to support income generation activities.
  - An electronic platform provided for self-employed women to enable them to get the right value for their products/services by linking them to the markets directly.
  - Steps being taken to facilitate and expand employment opportunities for female workers.

*IMF staff report response and authorities’ comments excerpt.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2017/cr1754.pdf_