China's GDP growth for 2013 came in at 7.7%, the lowest in 14 years but above the government's target of 7.5%. While China's economy showed signs of stabilizing in the last quarter, policymakers will need to adopt measures to sustain higher growth trajectories. The World Bank forecasts global GDP growth to accelerate from 2.4% in 2013 to 3.2% in 2014, led by a recovery in high-income economies. India is projected to see the strongest growth among major developing economies, with its rate rising from 4.8% in 2013 to 7.1% in 2016, reducing the growth differential with China.

1. ECONOMY MATTERS
Volume 19
January 2014
Rev
e
No. 01
nue
Expe
ndit
ure
Fiscal Situation
Cover Story
Inside This Issue
China GDP Slows Down
Review of IIP, Inflation & Trade data
Interview with Mr Akhilesh Ranjan,
Ministry of Finance
Interview with Mr R Seshasayee,
Past President, CII
Corporate Performance for 3QFY14
Special Feature: Policy Trade-offs
by Dr Probab Sen

3. FOREWORD
The world's second largest economy, China is slowly recovering, though the pace of
recovery has been rather lackadaisical. GDP for 2013 came in at 7.7 per cent- the lowest
print in 14 years. In 2013, China tried to maintain strong growth while rebalancing its
economy, by moving away from an investment-led growth model to one driven by
domestic consumption. Firm recovery in China is very critical for the global economic
prospects. The policy makers in China would need to adopt unconventional policy
measures to stabilise GDP on higher growth trajectory in 2014, which the country has
seen in the last many years. The rebalancing of economic growth in favor of domestic
consumption will be crucial in order to achieve this.
On the domestic front, the IIP numbers for the month of November 2013 were
disappointing and reaffirmed our belief that signs of turn-around are sporadic and at
best nascent. On a positive note, WPI inflation moderated to 5-month low in December
2013, driven by deceleration in food prices. RBI meanwhile, chose to hike interest rates
again in its third quarter monetary policy review held on 28th January 2014. CII is
disappointed with RBI's move as it is important for monetary policy to support growth
at this crucial juncture especially when WPI inflation has shown signs of moderation.
Low interest rates are the precursor for any meaningful recovery in both investment
and consumption demand.
Fiscal deficit has already widened to 95 per cent of the budgeted levels in the first nine
months of the fiscal, thus raising red flags in the economy. Sluggish revenue growth due
to weak GDP growth has been the main driver behind the widening deficit.
Unfortunately, the options available in front of the government are clearly limited,
given the fact that general elections are due soon. Any compression in plan expenditure
in order to meet the fiscal target can be detrimental to growth. Consequently, CII has
been advocating several unconventional sources of revenue for the government like
utilizing the cash-pile of PSUs, monetising the surplus land lying with them, clearing up
the funds held up in disputes and litigations etc time and again in its various dialogues
with the government.
Chandrajit Banerjee
Director-General, CII
1
JANUARY 2014

4. CONTENT
Inside This Issue
Executive Summary .................................................03
Global Trends
04
Fiscal Situation
Cover Story
China GDP Slows Down to 14-year Low but
Crosses Official Target
Domestic Trends
08
With the fiscal deficit having
reached 95 per cent of the
budgeted estimates for the entire
year in the first nine (AprilDecember) months already, the
Finance Minister’s call of not
breaching the red-line of fiscal
target of 4.8 per cent this year
looks increasingly difficult. In the
Special Article, we provide an
analysis of the fiscal situation so
far and its impact on the overall
growth prospects.
GDP, IIP, Inflation, Trade, Balance of
Payments, Monetary Policy
Taxation
Interview with Mr. Akhilesh Ranjan, MoF
16
BEPS Action Plan on TP
Mr Ameya Kunte ,Taxsutra.com
Corporate Performance
20
Profitability Improves Sharply for Services, while
for Manufacturing Remains Subdued in Q3
Sector in Focus
23
Manufacturing
Special Article
30
Fiscal Situation
Reining in the Fiscal Deficit
Mr R Seshasayee , Past President, CII
Subsidy Bill
Bidisha Ganguly, Principal Economist, CII
Special Feature
36
The Tradeoffs for Policy Makers
Dr. Pronab Sen, Chairman, NSC
Economy Monitor ................................................... 38
ECONOMY MATTERS
2

5. EXECUTIVE SUMMARY
two quarters is encouraging, especially, since it comes
at the back of a lackluster showing in the preceding
several quarters.
Global Trends
China's economy, the world's second-largest, has
shown signs of stabilising, as 2013's growth rate
matched that for 2012. Gross domestic product (GDP)
grew at an annual rate of 7.7 per cent in the October-toDecember period, down from 7.8 per cent in the
previous quarter. With this, the full year GDP growth
came in at 7.7 per cent, higher than the government's
target rate of 7.5 per cent for the year. Coming to the
global economies, the latest forecasts for the world
economy released by the World Bank recently
suggests that after several years of extreme
weakness, high-income economies appear to be finally
turning the corner, contributing to a projected
acceleration in global growth from 2.4 per cent in 2013
to 3.2 per cent this year.
Sector in Focus: Manufacturing
Manufacturing sector has played a robust role in driving
the GDP growth in the 2005-11 period, when it was
growing at around 9 per cent CAGR. However, since
then, industry has posted an overall slump, with
manufacturing GDP growth at around 3 per cent in 201112 and at around 1 per cent in 2012-13. This is in sharp
contrast to the over 10 per cent average annual growth
that the sector needs in order to reach its aspiration of
25 per cent share in national GDP by 2022, as envisaged
by the National Manufacturing Policy. However,
multiple opportunities exist even in this environment;
new avenues are still opening up. The depreciation of
the currency in 2013 has lent optimism to Indian
manufacturers as regards exports. A good monsoon
has raised hopes of strong rural demand. Overall,
industry is more confident of achieving a higher growth
going forward as compared to previous years.
Domestic Trends
Industrial sector output contracted for the second
consecutive month in November 2013, despite a
supportive base effect. Industrial output declined to
2.1 per cent in November 2013, worsening from the -1.6
per cent print seen in the previous month. In a positive
sign, WPI based inflation moderated to 5-month low of
6.2 per cent in December 2013 as compared to 7.5 per
cent in the previous month on the back of cooling of
primary food inflation and subdued manufacturing
inflation. However, in an unanticipated move, Reserve
Bank of India (RBI) in its third quarter monetary policy
review held on 28th January 2014 chose to hike the repo
rate by 25 bps to 8.00 per cent, citing stickiness in core
CPI.
Special Article
With the fiscal deficit having reached 95 per cent of the
budgeted estimates for the entire year in the first nine
(April-December 2913) months already, the Finance
Minister's firm call of not breaching the red-line of fiscal
target of 4.8 per cent this year looks increasingly
difficult. A challenging domestic and external
economic environment has kept the revenue growth
low, while expenditures have so far not shown any
signs of abatement. Given that the general elections
are due soon, the options available to the government
to restrict the fiscal deficit within the budgeted levels of
4.8 per cent are clearly limited. The urgent task,
therefore, is to prune expenditure while trying to boost
government revenues, especially tax revenues. The axe
is bound to fall on plan expenditure and that in turn will
have a negative impact on the growth momentum.
Under this scenario, it is best for the government to opt
for getting revenue from unconventional sources. CII
has suggested several innovative measures to prop up
the government's revenue stream.
Corporate Performance
The analysis of the results of the firms in India, which
have declared their results so far for the third quarter
(Q3) of current financial year, suggests an
improvement in their financial result at the aggregate
level. It may recalled that the firms had recorded an
improvement in their sales growth in the second
quarter as well after disappointing previous few
quarters as per the RBI analysis of 2,708 listed nongovernment non-financial (NGNF) companies. This
improvement in corporate performance for the last
3
JANUARY 2014

6. GLOBAL TRENDS
China GDP Slows Down to 14-year Low but
Crosses Official Target
was the lowest GDP print in 14 years. Consumer price
inflation rose by 2.6 per cent in 2013, with the maximum
increase coming from food articles.
In 2013, China tried to maintain strong growth while
rebalancing its economy, by moving away from an
investment-led growth model to one driven by domestic
consumption. Firm recovery in China is very critical for
the global economic prospects. The policy makers in
China would need to adopt unconventional policy
measures to stabilise GDP on higher growth trajectory in
2014, which the country has seen in the last many years.
The rebalancing of economic growth in favor of
domestic consumption will be crucial in order to achieve
this.
C
hina's economy, the world's second-largest, has
shown signs of stabilising, as 2013's growth rate
matched that for 2012. Gross domestic product (GDP)
grew at an annual rate of 7.7 per cent in the October-toDecember period, down from 7.8 per cent in the
previous quarter. With this, the full year GDP growth
came in at 7.7 per cent, higher than the government's
target rate of 7.5 per cent for the year. To be sure, this
Moderate GDP Growth in 2013
y-o-y%
8.2
8.1
8
7.9
7.8
7.8
7.7
7.7
7.6
7.6
7.5
7.4
7.4
7.2
7
1Q12
2Q12
3Q12
4Q12
Source: National Bureau of Statistics
ECONOMY MATTERS
4
1Q13
2Q13
3Q13
4Q13

7. GLOBAL TRENDS
In 2013, Chinese policymakers took various steps to
open up new avenues of growth. China announced
dramatic new social and economic policies
contemplating much greater reliance on market forces
than it has in the past and inviting private-sector
participation and foreign competition in industries,
previously controlled by the central government. It also
relaxed its one-child policy, opening the country and its
people to vast new opportunities.
In 2013, the total value added of the industrial
enterprises above designated size was up by 9.7 per
cent at comparable prices. Specifically, the year-on-year
growth of the first quarter was 9.5 per cent, 9.1 per cent
for the second quarter, 10.1 per cent for the third
quarter and 10.0 per cent for the fourth quarter. Coming
to the demand-side, investment in fixed assets
(excluding rural households), a measure of government
spending on infrastructure, grew by 19.6 per cent in
2013. Retail sales, a key indicator of consumer spending,
gained 13.6 per cent on year-on-year basis in December
2013 and rose 13.1 per cent in 2013.
Additionally, in order to boost trade, a free trade zone
was launched in Shanghai recently. However,
challenges are galore for the economy as it steps into
2014. One of the several concerns for the economy
currently is the growth of shadow banking - lending by
non-banking companies - in the country. Shadow
banking makes credit less transparent and poses a
major risk to China's economic growth. China is thought
to be drafting rules calling for greater supervision and
monitoring of the shadow banks. Banks have been told
to publish data on 12 key indicators, including offbalance-sheet assets, to enhance their transparency.
The total value of imports and exports in 2013 came at
US$4,160.3 billion, which translates into an annual
increase of 7.6 per cent. Out of this, the total value of
exports stood at US$2,210.0 billion, up by 7.9 per cent on
y-o-y basis; while the total value of imports was at US$
1,950.3 billion, registering a y-o-y increase of 7.3 per cent
in 2013. Consequently, the trade balance stood at
US$259.75 billion for 2013.
World Bank Upbeat about 2014 Global Growth
The latest forecasts for the world economy released by
the World Bank recently suggest that after several years
of extreme weakness, high-income economies appear
to be finally turning the corner, contributing to a
projected acceleration in global growth from 2.4 per
cent in 2013 to 3.2 per cent this year, 3.4 per cent in 2015,
and 3.5 per cent in 2016, as the drag on growth from
fiscal consolidation and policy uncertainty eases and
private sector recoveries gain firmer footing. Highincome countries growth is projected to strengthen
from only 1.3 per cent in 2013 to 2.2 per cent this year and
2.4 per cent in each of 2015 and 2016. This strengthening
of output among high-income countries marks a
significant shift from recent years when developing
countries alone pulled the global economy forward.
United States ticked up in response to expectations of
the gradual withdrawal of quantitative easing. Other
major headwinds included declining commodity prices
for commodity exporters. Overall, growth in developing
countries is projected to pick up modestly from 4.8 per
cent in 2013 to 5.3 per cent this year, 5.5 per cent in 2015,
and 5.7 per cent in 2016. However, it is pertinent to note
that the developing-country GDP growth will be about
2.2 percentage points weaker than it was during the precrisis boom period. The developing countries will not
cover the entire lost ground because growth in those
years was unsustainably high, partly because of the
global credit bubble.
As per the report, India will see the strongest economic
recovery among the major developing economies
between 2013 and 2016. Its rate of expansion will go up
by 2.3 percentage points, from 4.8 per cent in 2013 to 7.1
per cent in 2016. Interestingly, World Bank projections
suggest that the gap between economic growth rates
of India and China could narrow sharply by 2016. Chinese
economic growth will remain at current levels while
Indian growth will accelerate. There will be only a 0.4
percentage point gap in 2016 compared with the 3.1
percentage points gap in 2014.
The latest edition of the Global Economic Prospects
report published by the multilateral lender further adds
that the activity and sentiment in developing countries
have turned up since mid-2013, bolstered by
strengthening high-income demand and a policyinduced rebound in China. These positive developments
were partly offset by tighter financial conditions and
reduced capital flows as long-term interest rates in the
5
JANUARY 2014

8. GLOBAL TRENDS
World Bank's GDP Growth Forecast (y-o-y %)
8.0
7.7
6.5
6.2
3.2
3.0
2.8
2.8
1.1
0.9
Jun'13
Jan'14
Jun'13
World
Jan'14
Jun'13
US
Jan'14
Jun'13
Euro Area
Jan'14
Jun'13
China
Jan'14
India
Source: Global Economic Prospects, January 2014- World Bank
US Unemployment Rate Falls to 6.7 Per cent
The unemployment rate in US declined from 7.0 per cent
to 6.7 per cent in December 2013, the lowest since
October 2008, as more people dropped out of the labor
force. The labor force participation rate, which gauges
the proportion of the working-age population in the
labor force, slipped to 62.8 percent, down 0.8 percent
from a year ago, and the lowest since February 1978.
However, the U.S. economy added only 74K jobs in
December, the smallest increase since January 2011. The
unseasonably severe winter weather last month
probably played a part in the disappointing December
jobs number. November was revised to 241,000 from
203,000, while October's gain was unchanged at
200,000. Of the 74K jobs created in December, 55K were
in retail, above its average of 32K in 2013. Health care
was down 6K, a huge drop from its 2013 average of
adding 17K jobs. Manufacturing added 9K jobs and
construction jobs were down by 16K
US Unemployment Rate Falls Sharply
Thousand of Jobs
332
350
8
300
238
250
199
200
148
176
241
175
172
200
7
142
150
89
100
74
6
Source: US Bureau of Labour Statistics
6
Dec/13
Nov/13
Oct/13
Sep/13
Unemployment Rate (RHS)
US NFP
ECONOMY MATTERS
Aug/13
Jul/13
Jun/13
May/13
Apr/13
Mar/13
Feb/13
Jan/13
50

9. GLOBAL TRENDS
Other Global Developments During the Month
The US
v Federal Reserve in its meeting held on January 29th, 2014, reduced its asset purchase program further
from US$75 billion/month in the month of January to US$ 65 billion month in February. Fed would trim its
purchases of long-term Treasury bonds to US$35 billion/month (from US$40 billion) and mortgage-backed
securities (MBS) to US$30 billion/month (from US$35 billion). This was Ben Bernanke's last policy meeting as
the Fed Chairman. Jenet Yellen takes over as new Fed Chairperson from the next policy.
The Consumer price Index (CPI) in the UK grew 2.0 per cent on y-o-y basis in December 2013, falling to its target
v
level for the first time since November 2009. The inflation has eased dramatically in the last quarter of 2013,
averaging 2.1 per cent, in Q4, sharply lower from 2.7 per cent in September 2013. The largest negative
contribution came from 'food and non-alcoholic beverages', wherein inflation eased from 2.8 per cent in
November to 1.9 per cent last month, marking its lowest level since February 2010. On the other hand, the
contribution of 'transport' items - especially petrol and diesel - increased in December 2013.
U.K. unemployment fell to 7.1 per cent in the three months through November from 7.4 per cent in the quarter
v
through October 2013. The data will add pressure on BOE Governor Mark Carney to reassess his guidance policy,
under which the Monetary Policy Committee has said it will consider raising interest rates once joblessness has
fallen to 7 per cent.
In an
v update to its World Economic Outlook report, IMF predicted the global economy would grow 3.7 per cent
this year, 0.1 percentage point higher than its October 2013 projection. It said it sees growth of 3.9 per cent in
2015. IMF highlighted the basic reason behind the stronger global recovery as the brakes to recovery being
progressively being loosened. As per the Fund, United States is likely to be one of the bright spots, after a
budget deal in Congress reduced some of the government spending cuts that had weighed on domestic
demand.
7
JANUARY 2014

10. DOMESTIC TRENDS
GDP, IIP, Inflation, Trade, Balance of
Payments, Monetary Policy
underpinned by robust performance by exports sector.
Industry growth picked up to 2.4 per cent in Q2FY14 from
a mere 0.2 per cent in the previous quarter. The revival in
industry was led by an improvement in the construction
and utilities sector. Manufacturing growth remained
weak at 1.0 per cent, albeit it moved into the positive
territory from the previous quarter. On the aggregate
demand-side, though high interest rates in the economy
continue to impact private final consumption
expenditure growth, a vibrant rural economy helped to
negate some of the ill-effect, thus pushing its growth to
2.2 per cent from 1.6 per cent in the previous quarter.
Growth in gross fixed capital formation or investment
moved into the positive territory in second quarter,
clocking a growth of 2.6 per cent as compared to decline
to the tune of 1.2 per cent in the previous quarter.
G
DP data released on 29th November, 2013 showed
that growth increased to 4.8 per cent in the
second quarter of the current fiscal (Q2FY14 henceforth)
as compared to 4.4 per cent in the quarter before, mainly
led by healthy performance by the agriculture sector
and mild upturn in industry. With this the first-half
growth stands at 4.6 per cent as compared to 5.3 per
cent in the same period last year. From the demand-side,
GDP picked up to its highest value since March 2012,
Real GDP increases in 2QFY14
GDP at factor cost GDP at market prices
5.6
4.8
4.7
4.8
4.4
4.1
3.0
2.4
3QFY13
4QFY13
1QFY14
Source: CSO
ECONOMY MATTERS
8
2QFY14

11. DOMESTIC TRENDS
The CSO released the revised estimates for 2011-12 and
2012-2013 and final estimates for 2010-11. According to
the revised estimates, the economy had grown by 4.5
per cent in 2012-13, compared with the earlier estimate
of 5 per cent. Similarly, the growth for 2010-11 was
revised downwards to 8.9 per cent from 9.3 per cent
earlier. However, GDP growth in 2011-12 has been revised
upwards to 6.7 per cent from 6.2 per cent. The major
concern emerging from these estimates is the
downward revision of growth in 2012-13, which is the
lowest in a decade. Even more worryingly, the low
growth continues to persist in the current year as well.
CII has been for long highlighting that the heightened
downside risks to growth will become more entrenched
unless bold measures are taken by the policymakers.
Even though GDP growth picked up in the 2QFY14, it
continues to remain the below 5 per cent growth for the
fourth consecutive quarter. We expect growth to pick
up from the 4.6 per cent clocked in the first-half in the
second-half of the current year and consequently expect
GDP to come in a range of 5.3-5.8 per cent in the current
fiscal. The RBI would need to take the lead and should
start the monetary easing cycle at the earliest in order to
ensure that growth picks up in the second-half. GDP for
the third quarter is due to be released on 28th February,
2014.
Outlook
The second quarter GDP data has raised hopes that growth has bottomed out. However, although the worst may be
over for the economy, a recovery will not be substantive. The overall growth this fiscal year would remain below 5
per cent. The positive signals from the second quarter data included higher-than-anticipated farm output growth
and robust exports growth. Going forward, real risk to GDP growth will come from stalling consumption and
investment demand which are holding up economic recovery. The prospect of fiscal squeeze by the government, by
restraining capital expenditure, may also impact growth.
The Bad News on the Industrial Growth Front Continues
Industrial sector output contracted for the second
consecutive month in November 2013, despite a
supportive base effect. Industrial output declined to 2.1
per cent in November 2013, worsening from the -1.6 per
cent print seen in the previous month. The decline in IIP
during the month was underpinned by contraction in its
sub-sectors such as manufacturing and consumer
goods. The sequential momentum declined too as the
seasonally-adjusted month-on-month series moved into
the negative territory in during the month. On a
cumulative basis, for the first eight months of the fiscal,
industrial output has now contracted by 0.2 per cent.
Dismal performance by industrial output growth was
preceded by muted performance of the eight crucial
sectors of the economy in November 2013, which
expanded by mere 1.7 per cent. The eight core industries-coal, crude oil, natural gas, refinery products, fertilisers,
steel, cement and electricity--have a combined weight of
37.9 per cent in IIP. The November core sector data
revealed dismal performance in the natural gas, fertiliser
and petroleum refinery sectors. Natural gas output fell
11.3 per cent on year-on-year basis during the month.
IIP Contracts for Second Consecutive Month
y-o-y%
SA m-o-m%
10
5
0
-0.1
-2.1
9
Nov/13
Sep/13
Jul/13
May/13
Mar/13
Jan/13
Nov/12
Sep/12
Source: CSO
Jul/12
-5
JANUARY 2014

12. DOMESTIC TRENDS
On the use based front, the consistently volatile capital
goods segment continued to remain in the positive
territory, albeit growing at a lower rate as compared to
October 2013. The sector's growth moderated to 0.3 per
cent in November 2013 from 2.4 per cent in the previous
month. Consumer goods remain a drag on overall IP
growth primarily led by the continuing weakness in the
durables goods sector. During the reporting month,
consumer goods output declined for the second
consecutive month to 8.7 per cent in November 2013 as
compared to -4.9 per cent in the previous month. It's
pertinent to note here that output of consumer
durables, one of the sub-sectors of consumer goods,
has now remained in red since the starting of the current
fiscal. Such a poor performance by the sector is a
matter of concern as it is widely regarded as a proxy for
consumption growth. Non-durables on the other hand
remained in the positive territory, albeit showing a
flattish growth in November 2013 as compared to
October 2013. Going ahead we expect recovery in this
component as good agricultural GDP this year will
support rural demand, which will prop up non-durables
even if urban demand remains weak.
On the sectoral front, manufacturing sector output,
which constitutes over 75 per cent of the index, declined
by 3.5 per cent in November as against a contraction of
0.8 per cent a year ago. This is the fifth negative data
print of manufacturing output so far in this fiscal and has
elevated the upside risks to growth. In terms of
industries, ten (10) out of the twenty two (22) industry
groups (as per 2-digit NIC-2004) in the manufacturing
sector showed negative growth during the month of
November 2013 as compared to the corresponding
month of the previous year of manufacturing sector. The
industry group 'Radio, TV and communication
equipment & apparatus' showed the highest negative
growth of (-) 42.2 per cent, followed by (-) 27.5 per cent
in 'Office, accounting & computing machinery' and (-)
19.5 per cent in 'Furniture; manufacturing'. Mining
sector output which has declined by 2.2 per cent in the
year till date so far, moved into the positive territory,
growing by 1.0 per cent in November 2013 as compared
to contraction of 3.2 per cent in the previous month.
Barring a few intermittent months, electricity sector
growth has remained on a strong footing this fiscal,
growing at an average 5.4 per cent in April-November
2013.
Sectoral Growth (y-o-y, %)
Apr-Nov
Weight
Nov-12
Sept-13
Oct-13
Nov-13
FY13
FY14
1000.0
-1.0
2.0
-1.6
-2.1
0.9
-0.2
Manufacturing
755.3
-0.8
0.6
-1.8
-3.5
0.9
-0.6
Mining
141.6
-5.5
3.3
-3.2
1.0
-1.6
-2.2
Electricity
103.2
2.4
12.9
1.3
6.3
4.4
5.4
Basic
456.8
1.1
5.3
-1.4
0.7
2.8
0.7
Capital
88.3
-8.5
-6.7
2.4
0.3
-11.3
-0.1
Intermediates
156.9
-1.4
4.2
2.2
3.3
1.8
2.7
Consumer Goods
298.1
-0.3
0.7
-4.9
-8.7
3.6
-2.6
84.6
1.1
-10.8
-12.1
-21.5
5.2
-12.6
213.5
-1.5
11.6
2.2
2.5
2.3
6.3
General
Use-Based
-Durables
-Non durables
Source : CSO
Outlook
The two consecutive negative data prints of industrial production is a worrying trend. It clearly conveys the
message that much more needs to be done to revive investment. The government should ensure that projects
getting cleared by the Cabinet Committee on Investment (CCI) are implemented on the ground. Government
policies should be complemented with a shift towards an accommodative policy announcement by the RBI in its
forthcoming monetary policy to revive investment and propel demand.
ECONOMY MATTERS
10

13. DOMESTIC TRENDS
Inflation Moderates as Food Prices Cool-Off
on-month series slipped into the negative territory
during the reporting month. To be sure, consumer
prices based inflation (CPI) too slowed down, moving
into single digits after a gap of two months. For the
month of December 2013, it came at 9.87 per cent as
compared to 11.2 per cent in the previous month. The
moderation in food inflation in the month of December
2013 was expected due to seasonal factors and off-load
of fresh vegetable supply in the market.
WPI based inflation moderated to 5-month low of 6.2
per cent in December 2013 as compared to 7.5 per cent in
the previous month on the back of cooling of primary
food inflation and subdued manufacturing inflation.
Amongst the primary food prices, vegetable prices
which have been the main driver behind pushing overall
WPI higher in the last few months, moderated to 57.3
per cent in December 2013 from record high of 95 per
cent seen in the previous month. The momentum
indicator indicated by the seasonally-adjusted month-
Both WPI & CPI Inflation Moderate
12
10.3
10
9.9
8
7.5
6
6.2
4
WPI y-o-y%
Dec/13
Oct/13
Aug/13
Jun/13
Apr/13
Feb/13
Dec/12
Oct/12
Aug/12
Jun/12
Apr/12
2
CPI (Combined) y-o-y%
Source: Office of Economic Advisor
Primary inflation decelerated to 5-month low of 10.8 per
cent in December 2013 from 15.9 per cent in the previous
month and average of 14.5 per cent seen in the last 4months. This was mainly attributable to the sharp
slowing down of food inflation to 13.1 per cent as
compared to almost 20 per cent a month ago. Amongst
primary food inflation, vegetable prices declined by
nearly 30 per cent on month-on-month basis in
December 2013 led by massive decline in items such as
onions and tomatoes. Encouragingly, the prices of
products other than vegetables also witnessed healthy
decline during the reporting month. Non-food inflation
too moderated to 6.0 per cent as against 7.6 per cent in
the previous month. Inflation in minerals to decelerated
sharply to 2.1 per cent from 6.1 per cent in the previous
month.
Fuel inflation remained stable at 11.0 per cent in
December 2013 as compared to the reading in the
previous month. Though on month-on-month basis, it
did show a 0.8 per cent increase, driven by rise in prices
LPG, electricity and high speed diesel. High-speed diesel
inflation rose to 17.0 per cent during the month as
compared to 15.7 per cent in the previous month. Going
forward, we expect fuel inflation to moderate due to
stabilisation witnessed in global crude prices and the
recent strengthening of the Rupee.
Manufacturing inflation remained subdued and broadly
unchanged at 2.6 per cent in December 2013, led by
across the board correction in prices. Non-food
manufacturing or core inflation which is widely
regarded as the proxy for demand-side pressures in the
economy too remained stable at 2.8 per cent during the
11
JANUARY 2014

14. DOMESTIC TRENDS
month as compared to 2.7 per cent in November 2013.
The stability in the core inflation since the last two
quarters is an indication of weak pricing power of the
corporate. In the coming months, we expect core WPI to
remain at sub 3 per cent, RBI's comfort level for this
inflation measure. Mirroring the sharp deceleration in
primary food inflation, manufactured food products
inflation also slowed down to 1.8 per cent in December
2013 from 2.5 per cent in the previous month.
Sectoral Components of Inflation
April-Dec
Weight
Dec-12
Oct-13
Nov-13
Dec-13
FY13
FY14
General
100.0
7.3
7.2
7.5
6.2
7.6
6.2
Primary
20.1
10.6
14.6
15.9
10.8
9.8
10.9
- Food
14.3
11.2
18.3
19.9
13.1
9.6
14.1
- Non-Food
4.3
13.6
7.1
7.6
6.0
10.4
5.8
- Minerals
1.5
5.6
4.6
6.1
2.1
10.7
0.8
14.9
10.2
10.5
11.1
11.0
10.7
10.2
- Petrol
1.1
3.4
5.3
4.4
5.4
7.4
2.3
- High Speed Diesel
4.7
14.6
14.6
15.7
17.0
8.7
20.5
65.0
5.0
2.8
2.6
2.6
5.7
2.8
- Food
10.0
8.7
2.3
2.5
1.8
8.1
3.9
- Non-food
55.0
4.3
2.9
2.7
2.8
5.2
2.6
Fuel
Manufacturing
Source: Office of Economic Advisor
Outlook
December month's inflation data print both at retail and wholesale level has been reassuring and conforms to RBI's
expectation of a notable correction on account of decline in vegetable prices. Stability in core inflation is an
indicator of weak demand conditions. Moreover, the lagged effects of effective monetary tightening since
September 2013 would also exert an opposite force on inflation in the coming months. Consequently, we expect the
RBI to cut rates in its forthcoming monetary policy review, in order to provide a fillip to falling growth.
Inflation Control Finds Priority with RBI
Reserve Bank of India (RBI) in its third quarter monetary
policy review held on 28th January 2014 chose to hike the
repo rate by 25 bps to 8.00 per cent. Citing concerns
regarding the stickiness in core CPI and upward bias in
core WPI inflation, the Central Bank made it aptly clear
that only by bringing down inflation to a low and stable
level that monetary policy can contribute to reviving
consumption and investment in a sustainable way. The
Central Bank also implicitly appears to have accepted Dr.
Urijit Patel Committee's recommendations to
strengthen the monetary policy framework and hence,
ECONOMY MATTERS
the hike is also in consonance with upside risks towards
achievement of the 12-month target of 8 per cent for
headline CPI inflation, the new nominal anchor.
In its policy review, RBI mentioned that the GDP growth
is expected to firm up from sub 5 per cent in the current
fiscal to 5-6 per cent in next fiscal with support from
exports, pick up in investment and expected decline in
inflation levels. CPI inflation was expected to decline to
close to 9 per cent by March-2014 and continue to fall in
FY2015, though upside risks remain to the central
forecast of 8 per cent
12

15. DOMESTIC TRENDS
RBI Hikes Repo Rate (%)
10.00
9.00
8.00
8.00
7.00
7.00
6.00
5.00
4.00
4.00
Repo rate
Reverse repo rate
Jan-14
Aug-13
Mar-13
Oct-12
May-12
Dec-11
Jul-11
Feb-11
Sep-10
Apr-10
Nov-09
Jun-09
Jan-09
Aug-08
Mar-08
Oct-07
3.00
CRR
Source: RBI
CII is surprised by the RBI's decision to increase the repo
rate, when all indicators were suggesting maintaining a
'status-quo'. While the overwhelming concern of the
monetary authorities is to keep inflation under check, it
is also expected that the RBI should have taken
cognisance of the faltering investment and
consumption demand which is preventing the economy
from realising its growth potential. India has entered a
cycle where higher interest rates are leading to subdued
demand conditions resulting in lower growth and
investment. This in turn is aggravating the supply
bottlenecks and adding to inflationary pressure,
thereby inducing the RBI to hold on to higher interest
rates. This circularity can be broken only by a change in
the monetary policy stance sooner than later. And this is
an opportune time to accord precedence to growth
over inflation especially as prices are trending
downwards and inflationary expectations are not
unduly high in view of a robust performance by the
agriculture sector.
Exports Growth Weakens for the Second Consecutive Month
The pace of expansion of exports slackened for the
second consecutive month in December 2013. Exports
growth moderated to 3.5 per cent in December 2013 as
compared to 5.9 per cent in the previous month. The
slowdown was attributable primarily to decline in the
shipments of petroleum products during the month.
Exports of petroleum products fell 16 per cent to US$4.8
billion in December 2013. That was mainly due to an
unexpected maintenance shutdown by energy giant
Reliance Industries, India's biggest exporter of
petroleum products and second-biggest company by
market value. Exports had been growing at a doubledigit rate until October but lost momentum in the last
two months, signalling that the worst might not be all
over as yet for the Indian economy. Cumulative value of
exports for the first nine months of the current fiscal
(Apr-Dec) were valued at US$230.3 billion as against
US$217.4 billion a year ago, thus registering a year-onyear growth of 5.9 per cent.
Imports during December 2013 were valued at US$36.5
billion, posting a decline to the tune of 15.3 per cent over
the same month last year, as weak domestic demand
and restrictions on gold imports lowered non-oil
imports by nearly 23 per cent on year-on-year basis.
India imports almost all of the gold it consumes. The
yellow metal is the country's second-biggest import
after oil and was an important reason for driving the
country's current account gap to a record high last year,
pushing the rupee sharply lower. Oil imports rose
slightly by 1.0 per cent reversing the fall seen last month.
Going forward, consumption goods import may pick up
as household consumption improves. A revival in
household demand would be supported by higher farm
incomes due to a good monsoon.
13
JANUARY 2014

16. DOMESTIC TRENDS
External Sector Performance (y-o-y %)
20
10
3.5
0
-10
-15.3
Exports
Dec/13
Oct/13
Aug/13
Jun/13
Apr/13
Feb/13
Dec/12
Oct/12
Aug/12
Jun/12
Apr/12
-20
Imports
Source: Ministry of Commerce
As the pace of decline of imports waned, without a
commensurate rise in exports growth, trade deficit in
December 2013 widened slightly to US$10.1 billion from
US$9.2 billion in November 2013. On a cumulative basis,
trade deficit came in at US$110.0 billion in AprilDecember FY14, lower than a deficit of US$146.8 billion
during the same period in FY13.
Outlook
The economic conditions in the U.S. and the Euro Zone are not very favorable for exports and we hope the Indian
government will help the exporters by providing help by way of including more products and countries for Focus
Product Scheme and Focus market Scheme, where we have a comparative advantage. Also we need to relook at the
duty drawback rates. These measures, if announced at the earliest will give the necessary push to the industry which
can then benefit the industry and help them reach the export target.
Current Account Deficit Improves Sharply in 2QFY14
The latest data released for the second-quarter of 201314 on December 3rd, 2013 shows that the current account
deficit (CAD) narrowed sharply to 1.2 per cent of GDP
from 4.9 per cent in the previous quarter. Narrowing of
CAD was primarily on account of lower trade deficit on
the back of sharp compression in gold imports and
encouraging growth in exports. Merchandise trade
deficit narrowed to US$33.3 billion in Q2 (7.9 per cent of
GDP) due to the turnaround in export growth and
decline in imports. In value terms CAD was recorded at a
16 quarter low of US$5.2 billion as compared to US$21.8
ECONOMY MATTERS
billion in Q1FY14. On the capital account, foreign
investment witnessed marginal inflows of US$0.3 billion
as FDI net inflows (i.e. US$6.9billion) in Q2 were negated
by portfolio outflows (US$6.6 billion). While the outflow
on portfolio account was anticipated, sharp decline in
banking capital inflows and other capital outflows
worth US$6.9 billion led to a drawdown of US$10.3
billion on forex reserves. Correspondingly, BoP
witnessed a deficit of US$10.4 billion in Q2 as against a
deficit of US$0.3 billion in Q1.
14

17. DOMESTIC TRENDS
Current Account Deficit Narrows Sharply in 2QFY14
35
8
6.7
30
5.4
6
25
4.9
32.6
3.6
20
4
15
21.8
12.6
18.1
1.2
10
2
5
5.2
0
0
2QFY13
3QFY13
3QFY13
1QFY14
2QFY14
CAD (as a % of GDP) RHS
CAD (US$ billion)
Source: RBI
Outlook
Continued improvement in export performance and expected traction in invisibles inflows are expected to support
a lower reading on the current account deficit. The reduction in imports would further help ease pressure on CAD.
Consequently, CAD during the current fiscal is expected to come down to 2.6 per cent, as predicted by the
government. On the capital account, improving domestic growth outlook amid receding concerns on CAD are likely
to partially counterbalance the concerns on taper and as such may improve the outlook on equity flows going
forward.
Know Your Facts: Banking Stability Index*
The quality of assets in the Indian banking system has emerged as a cause of concern for the central bank in recent
times. The asset quality has suffered due to a rise in the non-performing loans. It is also worrying for policymakers
that a large portion of distressed assets in the banking system is concentrated in just a few sectors such as
infrastructure, aviation, mining and textile. Concentration of bad assets in a handful of sectors increases the risk for
the banking system as default in one sector can put significant pressure on the balance sheet of several banks.
Further, since the banking and the financial system is highly interconnected, the failure of one bank, or some banks,
is likely to affect the stability of other banks. This interdependence is measured by the Banking Stability Index. The
Reserve Bank of India (RBI) defines Banking Stability Index (BSI) as "the expected number of banks that could
become distressed given that at least one bank has become distressed". The Financial Stability Report (FSR),
released by RBI on the 30 December 2013, highlighted that the BSI has gone up since August 2013. This means that
more banks are expected to become distressed if one bank in the system is distressed.
*Adapted from Mint dated January 02, 2014
15
JANUARY 2014

18. TAXATION
Govt.'s View Point on Some Critical
International Taxation Issues
Guest Interview
Q2: What is the current status of renewed dialogues
with US Competent Authorities? Are you expecting any
major cases to be closed?
Ans 2: Renewed dialogue with the US is progressing
along planned lines. There may be a meeting very soon
and we sincerely hope that at least a few cases will be
resolved by end-March.
Mr Akhilesh Ranjan
Joint Secretary (FT&TR-I)
Department of Revenue, Ministry of Finance
Government of India
Q 3: The APA process has been very smooth so far. Are
you expecting APA closure in the coming weeks? Any
changes to be made in the APA process in coming
months after first year learnings?
Q1: The response to Transfer pricing safe harbour
filings has not been encouraging. What would be the
main reasons for the same and anything more that
Government is contemplating to make safe harbour
more acceptable?
Ans 3: We are happy to note the public response to the
APA process. We are certainly hoping that agreements
will be reached in a few cases perhaps in February itself
but the procedural aspects are likely to take some time
and so the actual APAs may not start rolling out before
March. Government is examining the issue of the
possibility of bilateral APAs even where the relevant
DTAA does not have Article 9(2) in it.
Ans 1: Response has also not been discouraging. We
gather that it was more of taxpayers not being sure how
everyone else was responding to the rules! Also, there
are probably some definitional issues that are creating
uncertainties and we would shortly be going into them
for the purposes of further clarifying Government
intent.
ECONOMY MATTERS
Q 4: Is India looking at "Cyprus" like situation with more
treaty partners to enforce effective exchange of
information?
16

19. TAXATION
Ans 4: Efforts are being made to resolve issues in this
regard with some countries. We hope there will be no
further occasion to take strong unilateral steps.
What are the important "asks" put forward by India ?
Ans 6: India is engaging quite closely with other G20
member countries in the BEPS process. We are involved
in almost all of the different action points. India is also
part of the BEPS Bureau Plus which is coordinating and
guiding the work being done in all areas. We would
request Indian industry, particularly through the CII, to
carefully examine the BEPS discussion papers that have
now started coming out for public consultation and
forward to us their valued comments. The first paper on
Transfer Pricing Documentation is already out.
Q 5: There has been reorganisation in FT&TR. How will
these changes affect delivery of services to taxpayers?
Ans 5: The work distribution in FT&TR had become quite
uneven. It is hoped that the redistribution will enable
faster and more focused work in important areas.
Q 6: Has the Indian Government provided its comments
and feedback as part of the BEP's consultative process?
ECONOMY MATTERS
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17
JANUARY 2014

20. TAXATION
BEPS Action Plan on Transfer Pricing Changing Rules of the Game?
intangibles and TP documentation are some of the
significant action points, which are especially relevant in
the current Indian context.
Why TP in focus under BEPS?
Tax treaties determine allocation of taxing rights
between countries. Transfer pricing on the other hand
determines quantum of allocation profits (and
therefore the tax base) between countries arising out of
transactions associated entities. OECD has found "arm's
length" as solution to deal with transfer pricing. The
arm's length principle is founded on the basis that profit
allocation will follow "functions, assets and risks (FAR)".
India too has adopted arm's length approach for its
Transfer pricing law and it is a subject matter of great
debate between taxpayers and Revenue authorities in
last 5 years.
Mr Ameya Kunte
Executive Editor and Co-Founder
Taxsutra.com
BEPS in Brief
OECD's ambitious Base Erosion and Profit Shifting
project essentially arises out of concerns on double
"non-taxation". BEPS behaviour arises because under
existing international tax and treaty rules, MNCs are able
to artificially separate allocation of their taxable profits
from jurisdictions in which these profits arise. This has
caused severe strain on Governments' resources in last
few years as well as is harming individual tax payers. The
G20 finance ministers called on the OECD to develop an
action plan to address BEPS issues in a co-ordinated and
comprehensive manner. OECD in July 2013, released a 15
points action plan addressing various issues arising out
of BEPS behaviours.
However, OECD now believes that arm's length creates
an incentive to shift functions/assets/risks to jurisdiction
where their returns are taxed more favourably. Out of
the three, risk and ownership of assets (especially
intangibles) is easier to shift to low tax jurisdictions.
Thus, shifting of income using contractual
arrangements has resulted in base erosion and profiting
shifting behaviour. Also, the TP rules on risk and asset
attribution within Group are applied on an entity-byentity basis. Thus, it was perceived that current TP
Guidelines are putting too much emphasis on legal
structures rather than on the underlying reality of
economically integrated group. This resulted in BEPS.
OECD has also acknowledged that media attention on
transfer pricing especially intangibles has been one of
the major reasons for its focus under BEPS.
The approach in BEPS Action Plan involves coherence of
taxation, realigning taxation with substance and
bringing more transparency. The significance of BEPS
project suggests change in the approach by OECD, from
"Bottom Up" to "Top Down". OECD states that it is
developing international policy to tackle BEPS with
commitment first at highest political level within OECD
and G20 Countries. The G20 Leaders endorsed BEPS
Action Plan during their meeting in September 2013 at
the Saint Petersburg Summit. It is relevant note that all
non-OECD G20 countries (Argentina, Brazil, China, India,
Indonesia, Russia, Saudi Arabia and South Africa) are
participating in BPES project on an equal footing with
OECD countries.
BEPS Action Plan for TP
Out of the 15 action points under BEPS, four specifically
deal with transfer pricing. OECD states that the current
transfer pricing system leads to serious BEPS concerns,
but replacing arm's length principle is not the solution.
The thrust of the OECD is now on assuring that transfer
pricing outcomes are in line with "value" creation. In
Addressing taxation issues from digital economy,
preventing treaty abuse, transfer pricing (TP) aspects of
ECONOMY MATTERS
18

21. TAXATION
order to achieve this objective, OECD has initiated 3
specific actions, first dealing with intangibles (Action No
8), risk & capital (Action No 9) and high risk transactions
that rarely occur between third parties (Action No 10).
The fourth aspect deals with re-examining TP
documentation (Action No 13).
documentation rules, requiring MNEs to provide all
relevant Governments, with needed information on
their global allocation of the income, economic activity
and taxes paid among countries according to a common
template. For me personally, more than defining
specific rules of profit allocation, transparency of
information could be a 'game changer'. This will
certainly provide a "big picture" & held identify value
creation to the revenue authorities. OECD's outcome is
expected to be in the form of recommendations
regarding the design of domestic rules and it has set an
aggressive deadline of September 2014.
Action 9 states that OECD will develop special measures
to ensure that inappropriate returns will not accrue to an
entity, solely because it has contractually assumed risks
or has provided capital. Action 10 pertains to providing
circumstances for re-characterisation of high risk
transactions, application of profit split in global value
chains and provide protection against common types of
base eroding payments, such as management fees and
head office expenses.
What does it mean for India?
As a member of G20, India too has endorsed BEPS Action
Plan. Indian revenue has welcomed BEPS initiative and is
also participating in various working groups set-up
under BEPS. Specifically in the area of Transfer pricing,
India has stated that OECD or United Nations work on
transfer pricing has ignored developing countries'
perspective. India has also specifically expressed its
reservations to UN Transfer Pricing Manual (2012 ) on
areas such as risk allocation, location savings,
intangibles (these issues are also part of BEPS).
Specifically for risk, India has stated that it is unfair to
give undue importance to risk in determination of arm's
length price. India believes the risk is a by?product of
performance of functions and ownership, exploitation
or use of assets. India has also taken aggressive stand on
compensation of market based intangibles. Many
believe that acceptance of these issues by OECD,
vindicates India's stand, particularly with respect to
"source" (or market based) based taxation principles.
Action Plan on Intangibles
OECD proposes to develop special rules to prevent BEPS
by moving intangibles within MNC Group members. This
entails identifying and defining intangibles, ensuring
profit allocation in line with (rather than divorced from)
value creation, solutions for hard-to-value intangibles
and cost contribution arrangements (covered under
Action 8).
Even before BEPS, OECD had already started work on TP
aspects of intangibles since 2010 and has issued two
discussion drafts, followed by two public consultations
(last one was held in Paris in November 2013). In the
second discussion draft on intangibles, OECD has
proposed that no separate adjustment for "location
savings" is warranted where reliable local comparables
are available. Another significant proposal includes
eligibility of full returns to legal owner of intangibles,
only when he performs all important functions related
to development, enhancement, maintenance &
protection. The deadline for Phase 1 of this action step is
September 2014 wherein OECD is expected to suggest
changes to the Transfer Pricing Guidelines and possibly
to the Model Tax Convention.
OECD's Pascal Saint-Amans during January 2014 update
has said that they are on track on 'ambitious' BEPS
timelines. The next 24 months & BEPS "success" will
shape the future of international taxation and also
hopefully would address Indian revenue's concerns.
Businesses too need to factor 'moral tax' issues on one
hand and balancing compliance costs and business
certainty on the other. It is therefore imperative that all
the stakeholders including from India, actively
participate in BEPS process & proactively get ready to
face this "directional" change in international taxation.
Action Plan on TP Documentation
Improving transparency for tax administration is one of
the focus areas under BEPS Action Plan. OECD is
proposing under Action 13 re-examination of TP
(Views are personal)
19
JANUARY 2014

22. CORPORATE PERFORMANCE
Profitability Improves Sharply for Services, while
for Manufacturing Remains Subdued in Q3
Our analysis of the firms in this section factors in the
financial performance during the third quarter of 201314 using a balanced panel of 300 manufacturing
companies (excluding oil & gas) and 148 services firms
extracted from the Ace Equity database.
T
Growth in net sales, on an aggregate basis, rose to 15.1
per cent in the third quarter of 2013-14, as compared to
11.1 per cent in the same quarter of the previous fiscal.
This can possibly be attributable to the signs of
bottoming of the domestic economy along with the
recovery in the global economies. While the net sales
growth in services sector recorded a higher jump to 18.6
per cent in the third quarter of the current fiscal, as
compared to a growth of 15.2 per cent in the comparable
quarter last year, the growth in net sales in the
manufacturing sector was relatively subdued at 13.5 per
cent as compared to 9.4 per cent in the comparable
quarter of 2012-13.
he analysis of the results of the firms in India, which
have declared their results so far for the third
quarter (Q3) of current financial year, suggests an
improvement in their financial result at the aggregate
level. It may recalled that the firms had recorded an
improvement in their sales growth in the second quarter
as well after disappointing previous few quarters as per
the RBI analysis of 2,708 listed non-government nonfinancial (NGNF) companies. This improvement in
corporate performance for the last two quarters is
encouraging, especially, since it comes at the back of a
lackluster showing in the preceding several quarters.
From the analysis of the results declared so far,
profitability too has shown an uptick, despite an
increase in the overall expenditure costs.
ECONOMY MATTERS
20

23. CORPORATE PERFORMANCE
Growth in Net Sales (y-o-y%)
15.1
Aggregate
Q3FY14
11.1
Q3FY13
18.6
Services
15.2
13.5
Manufacturing
9.4
Source: Ace Equity database & CII calculations
The expenditure costs of the firms, on an aggregate
basis, witnessed an increase by 14.5 per cent in the
reporting quarter, as compared to 9.9 per cent in the
comparable time period last year. The increase in
growth of expenditure costs was driven largely by an
increase in the growth of raw materials cost , which
stood at 13.1 per cent over 6.1 per cent in the same period
last year. Growth in wages & salaries cost also showed
an uptick. Amongst the broad categories, it is notable to
point out that manufacturing firms showed the highest
increase in interest costs in the third quarter at the rate
of 36.3 per cent as compared to 20 per cent in the same
period last year. For services sector, raw material costs
registered the highest increase to the tune of 38.2 per
cent in the reporting quarter as compared to 8.7 per cent
in the comparable period last year.
Growth in Expenditure on an Aggregate Basis (y-o-y%)
19.7
19.9
18.3
16.0
13.1
6.1
Q3FY13
Q3FY14
Raw Materials
Q3FY14
Q3FY13
Wages & Salaries
Q3FY13
Q3FY14
Interest cost
Source: Ace Equity database & CII calculations
On an aggregate basis, growth in Profit after Tax (PAT)
increased to 20.8 per cent in the third quarter as
compared to 15.0 per cent growth in the same quarter of
last year. This was driven by a sharp rise in PAT growth of
services sector to 34.3 per cent as compared to single-
digit growth in the same quarter of the previous fiscal.
However, across the manufacturing sector firms, PAT
growth moderated to 10.4 per cent as compared to a
growth of 24.5 per cent in the third quarter of previous
year. Manufacturing sector has contracted by 0.1 per
21
JANUARY 2014

24. CORPORATE PERFORMANCE
cent in the first-half of the fiscal so far and hence reflects
in the poor performance of the PAT growth of the
sector. Further, growth in operating profits (profits
earned from a firm's core business operations excluding
investments and the effects of depreciation, interest
and taxes) on an aggregate basis too saw an increase to
19.6 per cent in the October-December, 2013 quarter as
compared to a growth 14.0 per cent in the third quarter
of last year.
Growth in PAT (y-o-y%)
20.8
Aggregate
Services
Manufacturing
Growth in PBDIT (y-o-y%)
Aggregate
15.0
34.3
4.7
FY14Q3
Services
FY13Q3
10.4
Manufacturing
24.5
19.6
14.0
26.9
11.5
FY14Q3
FY13Q3
12.8
16.5
Source: Ace Equity database & CII calculations
will remain to be watched, given the fragile nature of the
same. The political uncertainty before the next General
Elections due in April 2014 along with high interest rates
prevailing in the economy currently could also play
spoilsport in the scheme of things.
The corporate performance of the firms at aggregate
level has been encouraging for the last two quarters.
However, manufacturing firms have displayed a
subdued performance so far in contrast to the sharp
improvement in service sector firms' performance.
Going forward, how far, this recovery will be sustained
ECONOMY MATTERS
22

25. SECTOR IN FOCUS
Manufacturing
in recent years, the manufacturing sector growth
slumped to around 3 per cent in 2011-12 and mere 1 per
cent in 2012-13. This is in sharp contrast to 10-12 per cent
average annual growth that the sector needs to clock in
order to reach the aspirational 25 per cent share in
national GDP by 2022, as envisaged by the National
Manufacturing Policy (NMP). At 15 per cent currently,
the share of manufacturing sector in India's GDP
indicates significant potential, compared to
corresponding figures of over 30 per cent share in China
and 25-30 per cent share in many other emerging
economies.
M
anufacturing sector has played a robust role in
driving the GDP growth in the 2005-11 period,
when the Indian economy registered an impressive
average growth of around 9 per cent per annum.
However, in the milieu of global and domestic slowdown
Manufacturing Value Added as % of GDP in Select Economies (2012)
32
China*
24
Indonesia
Philisppines
21
Japan
19
18
Sri Lanka
14
India
13
Brazil
Source: World Bank Note: * Data is for 2010
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JANUARY 2014

26. SECTOR IN FOCUS
The monthly IIP figures for manufacturing sector
reflects the consistent downward trend in the last
several quarters. In the current financial year, it has
stayed sluggish so far (April- Nov). A sub-sectoral look at
the manufacturing GDP shows modest growth in just a
few sectors, only to be offset by contraction in others.
However, three sub-sectors - textiles/apparels,
chemicals, and coke/refined petroleum products - have
maintained a robust growth over the past two years.
The sustained slowdown and lack of desired policy
initiatives to counter it have derailed the growth
momentum of the sector in the last few years. In the
subsequent sections, we discuss, the drivers for
manufacturing growth along with the challenges faced
by the sector at present.
Manufacturing Growth (y-o-y %)
20
15
14.5
10
5
0
-5
-3.5
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
Jul-12
Apr-12
Jan-12
Oct-11
Jul-11
Apr-11
Jan-11
Oct-10
Jul-10
Apr-10
-10
Source: CSO
consecutive months of decline, Indian exports posted
double-digit growth in the next four months, growing at
an average 12.6 per cent. The growth was driven
primarily by textiles, chemicals and petroleum exports.
For instance, textile exports have maintained a strong
growth trajectory in the current financial year. While a
depreciated Rupee has helped, resurgence in demand
from key developed markets has also been instrumental
in driving exports growth for textiles. The recent
increase in the rate of interest subvention from 2 per
cent to 3 per cent is expected to further boost exports
across several sectors, including textiles.
Drivers of Manufacturing Growth
Notwithstanding the continuing slowdown in domestic
and global economies, ample scope exists for the
manufacturing sector to return to high growth
trajectory at the earliest. The sharp depreciation of the
currency coupled with pick in growth revival of global
economies in recent months has lent optimism to Indian
manufacturing exporters. Some sectors like textiles and
petrochemicals are already doing well. International
markets are seen as essential components of Indian
companies' business aspirations. The speedy clearances
of some mega projects by the Cabinet Committee on
Investments (CCI) in recent months lends further
support to early revival of the sector. A good monsoon
has raised hopes of strong demand for the sector from
rural India. Overall, industry is more confident of
achieving a higher growth going forward as compared
to previous years. In this section, we touch upon some
of the main opportunities to be tapped by the
manufacturing sector.
Rural Growth: This year, India has experienced one of
the best monsoon seasons in recent history, with the
southwest monsoon rainfall averaging at 106 per cent of
normal. As observed in the past, favourable monsoons
have a positive impact on agricultural as well as overall
GDP growth in the same and the subsequent year.
Hence, favourable monsoon this year is expected to
spur rural demand. This is already evident in the robust
growth of several industries in last few months, driven
primarily by rural demand. For example, domestic
tractor sales of Mahindra & Mahindra grew by 37 per
cent in September 2013 over previous year. Similarly,
Export Growth: Manufacturing companies have
increased focus on exports, in comparison to previous
year. After modest growth in April 2013 followed by two
ECONOMY MATTERS
24

27. SECTOR IN FOCUS
FMCG companies like Dabur and ITC have posted strong
growth in sales and profit margins, driven by rural
demand.
The Committee is tasked with monitoring large as well
as critical investment projects facing issues like lack of
capital etc., in order to expedite resolution of any
implementation bottlenecks and ensure timely
completion. The initiative has started yielding results,
having initiated the resolution of bureaucratic hurdles
for nearly 125 stalled projects, accounting for Rs 4 lakh
crore of investments as of December 2013.
Investment Boost: The Cabinet Committee on
Investments, constituted in January 2013, is an
important step by the government towards restoring
confidence in the country's investment environment.
Shocks are Here to Stay
Given the current context of slowing manufacturing growth and its consequent operational stresses, it is critical for
industry to step back and ensure that the sweeping structural trends that it is witnessing are not dismissed as 'short
term blips'. Most likely, these trends will be the driving factors that will determine the operating environment in the
days to come.
Indian manufacturing companies need to take into account the following two key challenges which distinguish
current operating environment from the yesteryears, particularly considering that these are expected to continue
going forward:
I. Increased Volatility: We have entered what seems to be a prolonged period of unprecedented volatility and
rapid change, both globally and in India. Volatility is fundamentally at two levels: firm's performance (for
example, revenues, margins, market positions), and firm's input prices (for example, commodities, interest
rates). Firm performance volatility has been on the increase globally over the last few decades, and continues to
be a strong trend. In India too, the composition of the BSE reflects this volatility. Every four years; about half the
top 30 companies in the BSE are replaced by new firms. Firm input volatility has also risen over the years.
Volatility peaked in the years immediately following the crisis, and seems to be abating mildly in the last two
years. Nevertheless, current volatility across inputs is at a higher level than seen historically. The new era of
volatility will require manu-facturers to be far more nimble and resilient in the way they operate.
II. Currency Shock: The Indian Rupee was largely stable for most part of the 2000s, ranging between 44 and 49 per
USD during 2000-2007. However, the 2008 financial crisis saw a reversal in this trend, triggering a steady
depreciation in the Rupee, reaching about 50-55 per USD by 2012. Additionally in 2013, the Rupee has seen
sharper fluctuations and devaluation compared to most developing economies. The high recent volatility and
depreciation of the Rupee has been driven by a weak do-mestic demand outlook coupled with a widening
current account deficit, and several international concerns related to the U.S.'s 'tapering' and political tensions
in Syria. While RBI's interventions like opening of a swap window to attract NRI funds have been welcomed,
speculations around the imminent tapering by the U.S. and withdrawal of specific moves by the RBI - for
instance, the oil swap window - will continue to test the Rupee in the near term. The Rupee is, therefore,
expected to remain volatile as some of these global and local cues unfold.
The implications of the depreciated and more volatile Rupee for Indian manufacturing companies are three-fold:
1. Exports will become increasingly attractive for sectors that have a high local value-added component, for
example, textiles.
2. For sectors with a high proportion of dollar linked input costs, localization and alternate material development
will be the key to enhance competitive advantage.
3. Contracting philosophies need to change. Wherever possible, firms may need to enter into back-to-back
currency based contracts with suppliers and customers, to shield themselves against the adverse impact of the
fluctuations. If such contracts are not possible, shorter contracting windows and price adjustments, for
example, monthly instead of quarterly contracts, could help minimize exposure and should be explored.
Source: Report on Powering Past Headwinds. Indian Manufacturing: Winning in an Era of Shocks, Swings & Shortages, CII & BCG, November 2013
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JANUARY 2014

28. SECTOR IN FOCUS
also the most vulnerable to the current trends of
sustained volatility and growth slowdown. Overall,
MSME health has declined in the last two to three years.
Credit defaults are the highest for MSMEs amongst all
credit classes, standing at around 5.3 per cent of
advances as of 2012-13. NPA rates have grown by over 1
percentage point in the last two years. This creates a
vicious cycle: on one hand, MSMEs need access to
finance to overcome the slowdown; on the other, banks
/ financial institutions become wary of extending loans
to this sector. This, in turn, creates significant supply
challenges for larger manufacturers. A dipstick survey
of the risk arising due to exposure of a large automotive
manufacturer to MSMEs for supplies revealed that over
30 per cent of its MSME suppliers are exposed to
significant financial or performance risks, largely due to
their inability to handle the current volatility and growth
slowdown.
Challenges Facing the
Manufacturing Sector
The importance of a robust support system to aid strong
manufacturing growth has been emphasized time and
again. However, several fundamental challenges in the
manufacturing support system for India still threaten to
inhibit the country's manufacturing growth. We
highlight two key shortages in this section.
(1) Supply Chain Fragility
Indian manufacturing continues to rely heavily on
Micro, Small and Medium Enterprises (MSMEs). The
MSME sector employs over 100 million people in around
45 million units across the country, contributes 45 per
cent to the manufacturing output, and accounts for 40
per cent of the country's exports. However, MSMEs are
MSME Gross NPA's Rise over the Past Two Years
MSME Gross NPA (%)
100 bps
6
4
5.3
2
4.3
0
FY 2011
FY2013
Source: FIBAC Productivity Survey 2011, 2013
(2) Infrastructure and Regulatory Challenges
The implications of this situation on Indian companies
are two-fold:
Indian infrastructure continues to trail global standards
in terms of both soft (policy action) as well as hard
(physical) infrastructure. For example, power deficits in
India are as high as 25 per cent in states like Jammu and
Kashmir and 21 per cent in even relatively more
industrialized states like Himachal Pradesh.
1. Manufacturers need to be proactive in identifying
areas of fragility in their supply chain - especially
fragility arising out of MSMEs being exposed to
volatility.
2. Supplier capability development activities need to
shift from mere technical support to commercial /
management skills infusion.
ECONOMY MATTERS
The proportion of delayed projects has been on an
upward trend owing to policy bottlenecks. Two global
steel makers recently shelved plans for setting up plants
in India, chiefly due to delays arising out of regulatory
hurdles. Delays in getting regulatory approvals and the
26

29. SECTOR IN FOCUS
larger issue of project delays have also impacted cash
flows for Indian infrastructure companies, leading to
mounting debt burdens for these companies. This is an
inherent structural flaw that needs to be addressed.
years shows that out of leading Indian value creators, 49
per cent had diversified geographically with CAGR of
over 15 per cent for revenues coming from overseas
during 2008 to 2013. Further, companies having greater
than 25 per cent of their revenues from international
business delivered two to four per cent higher TSR per
annum than peer companies having less than 25 per
cent of their revenues from international business.
Implications of this situation on companies are twofold:
1. Companies need to factor in higher costs due to
infrastructure constraints.
In tune with global swings, Indian manufacturers are
also rebalancing their overseas revenue portfolios. As a
result, the share of India's exports to non-U.S., non-EU
companies over the last 10 years has increased from 57
per cent to 70 per cent. This trend is likely to continue as
companies work towards exploring the rise of Africa
and the shifting economic balance towards South East
Asia and Latin America.
2. Companies may need to invest in captive
infrastructure in the short to medium-term,
especially in areas such as power generation.
Looking Forward
One of the key imperatives for Indian manufacturing
enterprises in this era of shocks, swings and shortages is
to build resilient business models. In other words,
business models that will not cave in to the pressures of
volatility/turbulence, will have in built mechanisms for
recovery and will be able to take advantage of the shift
in demand and supply patterns.
Diversification of Manufacturing Centres
Historically, Indian companies have been wary of using a
large labour force within the same plant, for fear of
handling large unions. They have more often than not
gone for a distribut-ed manufacturing setup within the
same region for this precise reason. However, of late,
companies have also consciously started creating a
diversified base from the perspective of de-risking their
supply chain.
Companies typically adopt two approaches to ensure
resilience:
1 Diversification
Companies have adopted different approaches for
diversification. Many companies diversify at their
'front ends' (markets/customers/geographies).
Other successful companies diversify at their 'back
ends' (supply sources/manufacturing centers).
Below we discuss both these levers in detail.
Setting up capacity additions or new units in new
geographies enables or even forces com-panies to focus
on newer markets adjacent to the new unit. This
improves their competitive-ness in the new markets,
gives them a logistical cost advantage and reduces
response time. Several players with lower market share
or penetration in specific geographies, or those with
stagnant growth rates have used this strategy to
diversify and grow.
Diversification of Markets/Customers
Diversifying into export markets is one of the key ways
to gain resilience. It's a well known fact that not all
markets are facing a downturn. Whilst U.S.
manufacturing is reviving and posing a threat, eastern
markets are maturing. The Africa potential is becoming
a reality. Hence, exposure to international markets
helps create resilient business models.
Diversification of Supply Sources
Traditionally, manufacturing companies have focused
on creating leaner supply chains. The key objective has
been to create scale, efficiency and thereby reduce cost
and complexity. However, with the increasing shocks
and swings, companies have started diversifying their
suppliers and prefer not to be dependent on a single
supplier for one type of raw material or component. This
diversification is by way of adding a new supplier or
dispersing input requirements across multiple locations
of the same supplier, thereby creating a natural hedge.
This strategy may or may not improve bargaining power
and has cost implications due to additional complexity;
Historically, geographically diversified companies have
performed better than their peers have. According to
BCG's Value Creators Report, 58 per cent of global value
creating companies (the top one-third as measured in
terms of Total Shareholder Return (TSR) - from 1995 to
2008) had diversified geographically. A similar analysis
of Indian manufacturing companies over the last five
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JANUARY 2014

30. SECTOR IN FOCUS
insights than ideating within the organization. Take the
example of a manufacturer of consumer appliances that
was trying to increase share in the North Indian rural
market. Perennial low voltage in the North Indian
villages was causing the company's refrigerators to
malfunction. When this problem was shared with the
supplier of compressor motors, they came up with a
modified motor design that could continuously operate
at lower voltages. This collaboration not only provided
excellent consumer value, but boosted sales in North
India as well.
but it manages the risk of disruptions better. Hence,
such diversification is applied selectively to critical
inputs which have substantially high lead time for
capacity creation in times of crisis.
2
Collaboration
Collaboration with an external entity to tide over
external challenges is a key driver of resilience, not just
within the company, but also beyond. There are a
couple of fundamental reasons why collaboration is an
effective tool to combat external challenges. The first
reason is that there is higher willingness to cooperate
and explore new ideas during a downturn or an external
challenge. Companies are typically more open to new
ideas, including re-considering those that may have
been shelved in the past, when they realize that their
current plans alone will not be sufficient to reach their
goals. The second is that resource allocation
throughout the value-chain is more conducive for
optimal results than that only within the company.
Collaboration to reduce conversion costs due to better
planning process. Collaboration across suppliers can
not only increase customer value, it can also
substantially reduce conversion costs.
Collaboration to reduce raw material and inventory
costs due to better planning and visibility. Collaboration
across the value chain can generate significant
advantage in terms of inventory and raw material costs,
both upstream and downstream. For example, a
manufacturer of consumer appliances successfully
collaborated across three different groups of suppliers
to develop 'composite' printed doors instead of steel
doors for its refrigerators and successfully managed to
combat the inflation in steel prices.
There are two types of collaboration that have proven
effective in the past:
Collaboration within the value chain (with suppliers
or customers).
v
Collaboration with a non-traditional partner (for
instance, often with competitors).
v
Collaboration with Non-traditional Partners
In addition to collaborating with suppliers, companies
are also exploring several innovative non-traditional
collaborations, even with competitors, so as to leverage
their individual strength, manage risks and explore new
avenues of growth at the same time. Some of the nontraditional collaborations that companies are exploring
are as follows:
Collaboration within the Value Chain
Collaboration within the value chain typically occurs
with suppliers and/or customers. While collaboration
within the supply chain is an ongoing process in many
companies, the winners see collaboration not as a oneoff initiative, but as an ongoing program with their core
suppliers. They allocate specific resources in their
procurement department towards supplier
collaboration, devote senior management time, and
ensure that promises about sharing of benefits arising
out of a collaboration program are followed in letter
and spirit.
Collaborating to share supply chain. This type of
collaboration focuses on leveraging economies of scale
by sharing logistics, components and suppliers. For
example, Mars and Nestle combine deliveries to TESCO,
potentially saving over 100,000 kilometres of duplicate
truck journeys every year.
Though collaboration in various forms has been existing
formally across businesses globally for a few decades
now, the current Indian context is forcing companies to
take up col-laboration initiatives more intensively than
ever before. Collaboration today is being seen across
three key dimensions:
Collaboration to explore new markets. In this type of
collaboration, companies come together to share the
risks and rewards of entering new markets. The
objective is to complement each others' strengths while
charting new territory. For instance, Bajaj and Kawasaki
have entered into a global alliance to market and brand
their products jointly across developing countries,
starting with Philippines and Indonesia.
Collaboration to increase customer value through
better design and/or delivery. Often, sharing a
customer challenge with suppliers can provide greater
ECONOMY MATTERS
28

31. SECTOR IN FOCUS
productivity of manufacturing is higher than in
agriculture, facilitating the shift of workers to the sector
will result in better use of resources.
Conclusion
India's strong economic growth since 1990s has
primarily been driven by the services sector,
manufacturing at best has kept pace with the expansion
of overall economy. Share of manufacturing in GDP has
stagnated at around 16 per cent for the last two
decades, greatly limiting the employment creation. This
is undoubtedly a matter of great concern for India with
its huge population size. According to an estimate, 650
million people in the country constituting around 61 per
cent of the population are in the working age group of
15-59 years. It is estimated that an additional about 200
million Indians will enter the job market in next 15 years.
Inclusive growth will be possible only if all workers have
access to opportunities for employment and
entrepreneurship.
To be sure, a lot has changed in the Indian
manufacturing sector. Turbulence has increased
considerably. Product life cycle is shrinking as
customers demand more. Shortages in terms of
infrastructure have started to become a norm in some
of the sectors. Exports have become radically more
attractive for some sectors, marginally more in many
others. Our approach in this era of turbulence needs to
change. Companies need to be more adaptive and build
their strategy and operations around three pillars of
adaptiveness - Resilience, Readiness and
Responsiveness. Resilience to make their businesses
withstand shocks, Readiness to ensure their companies
know how to react to changes, and Responsiveness to
ensure speed. The adaptive companies have already
started powering past the headwinds. Waiting in the
hope that the sector will get back to the days of lesser
turbulence and higher predictability may not be
prudent. The time to change is now.
As the share of agriculture shrinks, it is incumbent on the
manufacturing sector to open up job opportunities for
less skilled workers who cannot be easily absorbed in
the services sector. Secondly, a healthy growth of
manufacturing is critical for creating a large production
and consumption base within the economy. Further, as
(This article is based on the Report Powering Past Headwinds. Indian Manufacturing: Winning in an Era of Shocks, Swings & Shortages,
published by CII & BCG in November 2013)
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32. SPECIAL ARTICLE
Fiscal Situation
a promise of a refund later, in order to boost the muted
tax collections. Second option could be asking the PSU's
to make interim payment of dividends for the year
ending March 31, 2014, this year itself based on the
projections for the entire year's profits. Dividend
payment for a financial year is otherwise usually made in
the first quarter of the following fiscal, after the
declaration of profits. Recently, Coal India announced a
special dividend which will fetch the government
around Rs 18,000 crore. Thirdly, government could also
cut the expenditures of many ministries in order to
constrain fiscal deficit within the target, as it did in the
last fiscal. Whichever of these options the government
resorts to, however, one thing is certain, that it will be a
tough balancing act for the Finance Minister. In this
section, we provide an analysis of the fiscal situation so
far and its impact on the overall growth prospects.
W
ith the fiscal deficit having reached 95 per cent
of the budgeted estimates for the entire year in
the first nine (April-December) months already, the
Finance Minister's clarion call of not breaching the redline of fiscal target of 4.8 per cent this year looks
increasingly difficult. A challenging domestic and
external economic environment has kept the revenue
growth low, while expenditures have so far not shown
any signs of abatement. So what are the options
available in front of the government to stick to its fiscal
deficit target. Well, the first option could be to ask
corporates to cough up higher advance payments, with
ECONOMY MATTERS
30

33. SPECIAL ARTICLE
Reining in the Fiscal Deficit
Guest Interview
Mr R Seshasayee
Past President, CII, Chairman, CII Economic Policy Council and
Vice Chairman, Hinduja Group
Q1: How important, in your opinion, is it to consolidate
our fiscal position?
during April-December 2013, the same pace at which
they were targeted to grow during the entire year.
Ans: Containing the fiscal deficit is extremely important
for India, as it will lead to higher credit rating and lower
cost of borrowings not only for the government but also
for the private sector. The challenge of containing the
fiscal deficit has persisted with successive governments.
The Finance Minister has articulated the problem arising
out of the runaway fiscal deficit commendably. He has
often said that the 'red line' for the fiscal deficit, which
he set at 4.8 per cent of GDP, will not be breached.
However, that may prove to be a daunting task in the
light of the latest fiscal numbers released by the
Controller General of Accounts (CGA), according to
which the fiscal deficit in the first nine months (AprilDecember 2013) of the current fiscal had already
reached 95 per cent of the budgeted estimates for the
full year.
The bright spot happens to be the non-tax revenue,
which has remained relatively robust so far this fiscal at
67.5 per cent of the budgeted target as compared to
52.5 per cent in the comparable period last year. The
robust non tax revenue collection is attributable to
higher PSU dividends and receipts of user charges and
licence fees from telecom companies. In contrast, due
to the dismal PSU disinvestment scenario, non-debt
capital receipts in April-December 2013 have remained
lacklustre at only 20.3 per cent of the target. Proceeds
from disinvestment have only reached Rs 5093 crore so
far as compared to the target of Rs 40,000 crore for the
year. Apart from the expected shortfall in tax revenue
collections, the Union government may not be able to
meet its disinvestment target, which in turn is going to
result in overshooting of the fiscal deficit target for this
year.
Q2: What do you make of the latest fiscal numbers for
the month of December 2013?
Q3: Given that our fiscal deficit has already touched 95
per cent of the year's target in the first nine months,
according to you what options exist in front of the
government in order to adhere to the fiscal target for
the year?
Ans: It appears that the revenue collection has been
sluggish given the growth slump. Net tax revenue stood
at 58.6 per cent of the full year target as compared to
62.8 per cent a year ago. Amongst the various heads of
tax revenue, on a gross basis, excise duty collections
dropped by 6.9 per cent during April-December 2013.
Custom duty and corporate tax collections did grow, but
the growth was weak at 4.3 per cent and 9.6 per cent,
respectively. The growth in services tax collection, too,
appears weak at 19.8 per cent when compared to the
robust 35.8 per cent growth budgeted for the year. It is
only the income tax collections that are showing a
growth trend as scheduled. These grew by 19.8 per cent
Ans: Given that the general elections are due soon, the
options available to the government to restrict the fiscal
deficit within the budgeted levels of 4.8 per cent are
clearly limited. The urgent task, therefore, is to prune
expenditure while trying to boost government
revenues, especially tax revenues. The axe is bound to
fall on plan expenditure and that in turn will have a
negative impact on the growth momentum. Between
October and March last fiscal year, the Centre had
forced massive contraction in expenditure to rein in the
31
JANUARY 2014

34. SPECIAL ARTICLE
FY13 fiscal deficit to a creditable 4.9 per cent of the GDP.
A similar policy prescription looks little difficult this year,
since populist measures are expected to rule the roost,
given that elections are due soon. Tax revenues are
directly dependent on GDP growth. There again, with
the economy unlikely to grow much above 5 per cent
during the current year, the outlook for higher tax
collections and hence a lower deficit is by no means
positive.
Liquidity Ratio (SLR) norms, hence they end up in
monetising part of the deficit even though the
automatic monetisation has been done away with.
The effective monetary transmission mechanism of the
Central Bank has been diluted due to the existence of
high fiscal deficit in the economy, as evidenced by the
fact that despite the cumulative 125 bps increase in the
repo rate since March 2012 till April 2013, headline
inflation (wholesale price index, WPI) had refused to
abate and remained persistently high at an average of
7.5 per cent during the said period. To be sure, other
supply-side factors also played a role in stepping up
inflation, but expansionary fiscal policies too played a
pivotal role - a fact which has been acknowledged by the
Reserve Bank of India (RBI) in its various
communications. Thus, inflation at times may become
effectively a fiscal phenomenon, since the fiscal stance
could influence significantly the overall monetary
conditions in the economy. Hence, it's important to
contain the fiscal deficit within sustainable limits every
year, given the perverse consequences of high fiscal
deficit on the efficacy of monetary policy.
Under this scenario, it is best for the government to opt
for getting revenue from unconventional sources. CII
has suggested several innovative measures to prop up
the government's revenue stream. Some of the
measures like utilizing the cash-pile of PSUs, monetising
the surplus land lying with them, clearing up the funds
held up in disputes and litigations are needed to be
pursued aggressively.
Further, as I have discussed earlier too, the
disinvestment target of Rs 40,000 crore will be difficult
to achieve unless in the remaining months of the current
fiscal, government makes a concerted effort to clear the
backlog, especially since it had to postpone large stake
sales like Indian Oil Corporation and Coal India due to
poor market conditions and labour unrest earlier in the
year. Spelling out strict timelines for carrying out
disinvestment in the remaining period of current fiscal
will be helpful.
Q5: There have been talks of economy bottoming out,
but the recent weak IIP data has raised serious doubts
regarding that prognosis. What is CII's stand on the
same?
Ans: There are mixed signals coming out of the economy
at present. While one set of indicators, such as GDP for
the second quarter, exports growth, current account
deficit suggest that the worst might be over for the
economy, there is another group like the monthly
industrial production numbers, non-oil imports which
continue to paint a dismal picture. The latest industrial
output numbers have, in fact, raised the red flags in the
economy once again as the output has now contracted
for two consecutive months. But I must also point out
that the industrial production numbers have been very
volatile, which makes the task of drawing any decisive
inferences from the data difficult. This hypothesis gains
currency particularly in view of the fact that the latest
85th round of CII Business Confidence Index rose sharply
to 54.9 in the third quarter from 45.7 for the JulySeptember 2013 quarter. This has been the swiftest
rebound ever seen in the index. But in the same vein, I
must also add that there is still a case for cautious
optimism, as recovery remains fragile. Hence, we at CII
continue to remain guarded to any signs of distress or
positive signal for the economy in the months to come.
Q4: Fiscal policy is said to be dominant over monetary
policy in India. The efficacy of monetary policy is
reduced under the backdrop of a large fiscal largesse.
What are your views on this pervasive issue?
Ans: It is imperative that both fiscal and monetary policy
complement each other to spur growth in India.
However, under a case of excessive government
borrowings, fiscal policy dominance over the monetary
policy can lead to a situation in which a Central Bank is no
longer able to use its instruments effectively for
achieving the desired objectives. In India, even though
the fiscal policy dominance through the automatic
monetisation of fiscal deficit has been done away with
over the years, the influence of fiscal deficit on the
outcome of the monetary policy has continued to
remain significant given its high level. High fiscal deficit,
even if it's not monetised, can interfere with the
monetary policy objective of price stability through its
impact on aggregate demand and inflationary
expectations. This is particularly true, given the fact that
in India, the banks are captive holders of government
securities due to their adherence to the Statutory
ECONOMY MATTERS
32

35. SPECIAL ARTICLE
Subsidy Bill: Reaching Dangerous Levels
Bidisha Ganguly
Principal Economist, CII
The Indian central government's rising subsidy bill has
been a cause for concern. Despite many attempts to
control the situation, the expenditure on subsidies has
been rising steadily. Although the 2013 Budget has set a
target of reducing the expenditure from 2.6 per cent of
GDP in 2012-13 to 2.0 per cent in 2013-14, it may not be
met. In particular, there is concern that the plan to
reduce the fuel subsidy by allowing higher prices of fuels
such as petrol, diesel and LPG has not yet been
successful in trimming the subsidy bill. This is because
the rupee has depreciated by about 15 per cent against
the dollar during the current year, making it necessary to
raise the rupee price of fuels by higher amounts.
Another practice that needs to be discontinued is
carrying over subsidy payments from one financial year
to the next. This is done in the hope of being able to
control subsidies in the coming year so that actual
payments can be smoothed.
Expenditure on Subsidies (% of GDP)
3.0
1.3
1.3
2.4
2.6
2.0
1.4
2004-05
2007-08
1.4
1.5
2005-06
2.0
2.2
2010-11
2.5
2.2
2009-10
2.3
1.0
0.5
0.0
2013-14BE
2012-13RE
2011-12
2008-09
2004-05
Source: Budget documents
Over the medium-term, there needs to be a debate on
which subsidies can be done away with and which ones
need to continue. Currently, economists favour
continuing with the food subsidy while making it better
targeted and phasing out the fuel and fertiliser
subsidies. Given below is the amount spent on the three
major subsidies - it is apparent that in the last five years
the food and fuel subsidies have increased substantially.
33
JANUARY 2014

36. SPECIAL ARTICLE
Expenditure on Subsidies (Rs crore)
2008-09
2009-10
2010-11
2011-12
2012-13 RE
2013-14 BE
Food
43,751
58,443
63,844
72,823
85,000
90,000
Fertilisers
76,602
61,264
62,301
67,199
65,974
65,972
Fuel
2,852
14,951
38,371
68,484
96,880
65,000
Source: Budget documents
Fuel
petrol, diesel, kerosene and LPG has been inadequate.
Fuel subsidies have become the major component of
government expenditure on subsidies. The level of
under-recovery has ballooned over the last few years on
account of high crude oil prices prevailing in the
international market and depreciation in the Indian
rupee. Recently, the Government had taken several
measures to contain the level of subsidies such as
limiting the number of subsidized LPG cylinders to 9 per
annum per household, deregulation of diesel price for
bulk consumers and small monthly increases in retail
prices. However, the level of under-recoveries continues
to remain high as the increase in domestic prices of
According to the Expert Group Report formed by the
Government under Dr. Kirit Parikh, the actual underrecovery by oil marketing companies in 2013-14 are not
likely to be much lower than last year. As a result, the fuel
subsidy is likely to exceed Rs 65,000 crore budgeted for
2013-14 unless the government makes the upstream oil
companies bear a larger share of the under-recovery or
carries over the subsidy payment to the coming year.
Any new government that comes to power in 2014 will
have to deal with this issue on a priority basis. In fact, the
government may consider a cap on the total
expenditure on fuel subsidies on an annual basis.
Under-Recoveries Reported by OMCs
Rs crore
2012-13
2013-14 (April - December)
Diesel
92,061
47,655
PDS kerosene
29,410
22,373
Domestic LPG
39,558
30,604
Total
161,029
100,632
Source: PPAC website
this year's allocations. It has been reported that faced
with severe financial crunch, the government may roll
over a record 40,000 crore rupees of fertiliser subsidy to
the next financial year starting April.
Fertiliser
The subsidy on fertilisers is also set to increase on
account of a rise in the cost of imported fertilisers due to
the rupee's depreciation against the US dollar. At the
same time, an outstanding amount of Rs 32,000 crore
was carried over from 2012-13, which has to be paid from
Expenditure on Fertilizer Subsidy
(Rs crore)
2010-11
2011-12
2012-13 RE
2013-14 BE
Imported (urea) fertilizers
6,454
13,716
15,398
15,545
Indigenous (urea) fertilizers
15,081
20,208
20,000
21,000
Sale of decontrolled fertilizers
with concession to farmers
40,767
36,089
30,576
29,427
Total
62,301
70,013
65,974
65,972
Source: Budget documents
ECONOMY MATTERS
34

37. SPECIAL ARTICLE
The Finance Ministry has approved a special banking
arrangement for fertilizer companies which will allow
them to raise short-term credit to the extent of Rs 9000
crore from banks in order to tide over the cash crunch in
the industry. The principal will be repaid once the
government makes the subsidy payments. This situation
has made the fertilizer companies in the country
unviable and unable to make any investments.
times in the last ten. Record procurements in recent
years, increasing cost of handling grains and widening
difference between the procurement cost of grains and
the central issue price have been the major factors
leading to the ballooning food subsidy. With the
implementation of the National Food Security Bill, the
subsidy bill could go up further in coming years as the
issue price has now been fixed by the legislation while
procurement price will need to be revised upwards in
order to provide incentive to farmers to increase
production.
Food
The food subsidy has been on a rising trend, having more
than doubled in the last five years and increased five
Expenditure on Food Subsidy (Rs crore)
100,000
90,000
80,000
70,000
60,000
50,000
40,000
30,000
20,000
10,000
02
-0
3
20
03
-0
4
20
04
-0
5
20
05
-0
6
20
06
-0
7
20
07
-0
8
20
08
-0
9
20
09
-1
0
20
10
-11
20
11
-1
2
20
12
-1
3R
E
20
13
-1
4B
E
20
20
01
-0
2
0
Source: Budget documents
currency could have an impact on the amount spent on
subsidies. This would have long-term implications that
are debilitating for the economy. In India, for example,
interest rates have remained high even in a year of
slowing growth due to fiscal excesses. And as the
Finance Ministry has slashed expenditure in order to be
able to meet its deficit target, the economy has found it
difficult to recover.
Conclusion
When governments commit to spend on open-ended
subsidies, there should also be a limit to the amount that
can be spent. This limit could be in terms of percentage
of GDP, as in the case of the fiscal deficit. Otherwise,
unexpected events such as slowdown in economic
growth, increase in oil prices or depreciation in the
35
JANUARY 2014

38. SPECIAL FEATURE
The Tradeoffs for Policy Makers in
India Today
Guest Article
inflation, especially inflation in food products,
arguments have also been made for fiscal correction as a
means of holding back the growth of food demand. In
these circumstances, it may be desirable to understand
some of the underlying features of the Indian economy
which have led us to this pass.
Dr. Pronab Sen
The most underappreciated feature of what has
happened in the Indian economy is the fairly substantial
income redistribution that has occurred over the last
several years. Due to a combination of factors, there has
been a shift in terms of trade in favour of agriculture;
and, within agriculture, in favour of agricultural labour.
Three factors are of particular importance. First the
rapid expansion of alternative work opportunities for
rural labour triggered off by improved rural connectivity
through the Pradhan Mantri Gram Sadak Yojana
(PMGSY) and the spread of rural telephony. Second, the
sharp increases in minimum support price for some
agricultural products since 2004. Third, the role of
Mahatama Gandhi National Rural Employment
Guarantee Scheme (MNREGS) in providing a credible
reservation wage which landless labour could use to
bargain for higher wages. The main consequence of
these redistributions was to shift relative incomes away
from people with high savings propensities to those
Chairman, National Statistical Commission
The combination of high and persistent inflation and low
growth that has characterized the Indian economy over
the past two years has led to considerable anxiety about
the nature of the policy responses that are required.
Although the situation is by no means one of classic
stagflation, the policy conundrum is pretty much the
same. Any effort at taming inflation through the use of
tighter monetary policies raises the risk of a further slow
down in growth; while any effort at boosting growth
runs the risk of a further acceleration in inflation. The
classical prescription of a tight monitoring policy and
expansionary fiscal policy runs aground on the fiscal
stresses that are already being felt by the government.
Moreover, given the structural causes of much of the
ECONOMY MATTERS
36