Measuring National Income

We need information on how much spending, income and output is being created
in an economy over a period of time. National income data gives us this
information as we see in this chapter.
Measuring national income
To measure how much output, spending and income has been generated in a given
time period we use national income accounts. These accounts measure three
things:
1. Output: i.e. the total value of the output of goods and services produced in the
UK.
2. Spending: i.e. the total amount of expenditure taking place in the economy.
3. Incomes: i.e. the total income generated through production of goods and
services.
What is National Income?
National income measures the money value of the flow of output of goods and
services produced within an economy over a period of time. Measuring the level
and rate of growth of national income (Y) is important to economists when they
are considering:
The rate of economic growth
Changes over time to the average living standards of the population
Changes over time to the distribution of income between different groups within
the population (i.e. measuring the scale of income and wealth inequalities within
society)

Consumer spending accounts for over two thirds of total spending. Consumer
spending has been strong in recent years, a reflection of rising living standards and
low unemployment, but this may now be coming to an end because of the
mountain of household debt
Gross Domestic Product
Gross Domestic Product (GDP) measures the value of output produced within the
domestic boundaries of the UK over a given time period. An important point is that
our GDP includes the output of foreign owned businesses that are located in the
UK following foreign direct investment in the UK economy. The output of motor
vehicles produced at the giant Nissan car plant on Tyne and Wear and by the many foreign
owned restaurants and banks all contribute to the UK’s GDP.
There are three ways of calculating GDP - all of which should sum to the same
amount since the following identity must hold true:
National Output = National Expenditure (Aggregate Demand) = National Income
Firstly we consider total spending on goods and services produced within the
economy:
Nissan at Sunderland – Celebrating 20 years of production
The Nissan plant at Washington, Tyne and Wear is celebrating its 20th anniversary in July
2006, the first car having rolled off the line on July 8th, 1986. In that first year of
production 470 staff had a production target of 24,000 Bluebirds. Twenty years on,
more than 4,200 employees produce around 310,000 Micras, C+Cs, NOTEs,
Almeras and Primeras each year. That car has been followed by 4.3 million others
thanks to a total investment of £2.3 billion. Production is set to rise from 310,000
per year last year to 400,000 in 2007 with the introduction of a new small 4x4, and
Sunderland has been rated as Europe's most productive car factory for the last eight
years.
Sources: Reuters News, Sunderland Echo, July 2006
(i) The Expenditure Method of calculating GDP (aggregate demand)
This is the sum of spending on UK produced goods and services measured at
current market prices. The full equation for GDP using this approach is GDP = C +
I + G + (X-M) where
C: Household spending
I: Capital Investment spending
G: Government spending
X: Exports of Goods and Services
M: Imports of Goods and Services
The Income Method of calculating GDP (the Sum of Factor Incomes)
Here GDP is the sum of the incomes earned through the production of goods and
services. The main factor incomes are as follows:
Income from people employment and in self-employment
+
Profits of private sector companies
+
Rent income from land
=
Gross Domestic product (by factor income)
It is important to recognise that only those incomes that are actually generated
through the production of output of goods and services are included in the
calculation of GDP by the income approach.
We exclude from the accounts the following items:
Transfer payments e.g. the state pension paid to retired people; income support
paid to families on low incomes; the Jobseekers’ Allowance given to the
unemployed and other forms of welfare assistance including child benefit and
housing benefit.
Private transfers of money from one individual to another.
Income that is not registered with the Inland Revenue or Customs and Excise.
Every year, billions of pounds worth of economic activity is not declared to the tax
authorities. This is known as the shadow economy where goods and services are
exchanged but the value of these transactions is hidden from the authorities and
therefore does not show up in the official statistics!). It is impossible to be precise
about the size of the shadow economy but some economists believe that between 8
– 15 per cent of national output and spending goes unrecorded by the official
figures.
Output Method of calculating GDP – using the concept of value added
This measure of GDP adds together the value of output produced by each of the
productive sectors in the economy using the concept of value added.
Value added is the increase in the value of a product at each successive stage of the
production process. We use this approach to avoid the problems of double-
counting the value of intermediate inputs.
The table below shows indices of value added from various sectors of the economy
in recent years. We can see from the data that manufacturing industry has seen
barely any growth at all over the period from 2001-2004 whereas distribution,
hotels and catering together with business services and finance have been sectors
enjoying strong increases in the volume of output. These figures illustrate a process
of structural change, with a continued decline in manufacturing output and jobs
relative to the rest of the economy. By far the largest share of total national output
(GDP) comes from our service industries.
Index of Gross Value Added by selected industry for the UK
Mining Manufacturin Constructio Distribution Business
and g n , hotels, and services
quarrying catering; and
, inc oil repairs finance
 & gas
extraction
2001 weights in total 28 172 57 159 249
GDP
(out of 1000)
2001 100 100 100 100 100
2002 100 97 104 105 102
2003 94 97 109 108 106
2004 87 98 113 113 111
We can see from the following chart how there have been divergences in the
growth achieved by the manufacturing and the service sectors of the British
economy. Indeed by the middle of 2006, the index of manufacturing output was
below the level achieved at the start of 2000.
In contrast the service industries have enjoyed strong growth, leading to a
continued process of structural change in the economy – away from traditional
heavy industries towards service businesses.

GDP and GNP (Gross National Product)

Gross National Product (GNP) measures the final value of output or expenditure
by UK owned factors of production whether they are located in the UK or
overseas.
In contrast, Gross Domestic Product (GDP) is concerned only with the factor
incomes generated within the geographical boundaries of the country. So, for
example, the value of the output produced by Toyota and Deutsche Telecom in the
UK counts towards our GDP but some of the profits made by overseas companies
with production plants here in the UK are sent back to their country of origin –
adding to their GNP.
GNP = GDP + Net property income from abroad (NPIA)
NPIA is the net balance of interest, profits and dividends (IPD) coming into the
UK from our assets owned overseas matched against the flow of profits and other
income from foreign owned assets located within the UK. In recent years there has
been an increasing flow of direct investment into and out of the UK. Many foreign
firms have set up production plants here whilst UK firms have expanded their
operations overseas and become multinational organisations.
The figure for net property income for the UK is strongly positive meaning that our
GNP is substantially above the figure for GDP in a normal year. For other
countries who have been net recipients of overseas investment (a good example is
Ireland) their GDP is higher than their GNP.
Measuring Real National Income
When we want to measure growth in the economy we have to adjust for the effects
of inflation.
Real GDP measures the volume of output produced within the economy. An
increase in real output means that AD has risen faster than the rate of inflation and
therefore the economy is experiencing positive growth.
Income per capita
Income per capita is a basic way of measuring the average standard of living for
the inhabitants of a country. The table below is taken from the latest edition of the
OECD World Factbook and measures income per head in a common currency for
the year 2005, the data is adjusted for the effects of variations in living costs
between countries.
GDP per capita $s GDP per capita $s
Luxembourg 57 704 EU (established 15 countries)28 741
United States 39 732 Germany 28 605
Norway 38 765 Italy 27 699
Ireland 35 767 Spain 25 582
Switzerland 33 678 Korea 20 907
United Kingdom 31 436 Czech Republic 18 467
Canada 31 395 Hungary 15 946
Australia 31 231 Slovak Republic 14 309
Sweden 30 361 Poland 12 647
Japan 29 664 Mexico 10 059
France 29 554 Turkey 7 687

Source: OECD World Economic Factbook, 2006 edition

By international standards, the UK is a high-income country although we are not in
the very top of the league tables for per capita incomes. We do have an income per
head that is about ten per cent higher than the average for the 15 established EU
countries. But we are some distance behind countries such as the United States
(where productivity is much higher). And Ireland’s super-charged growth over the
last twenty years means that she has now overtaken us in terms of income-based
measures of standards of living.

2003 FAMILY INCOME AND EXPENDITURE SURVEY

Final Results
Percent
Philippines 2003 2000 Increase
(Decrease)
Total Income
2,417,678,863 2,187,250,217 10.5
(In P1,000)
Total Expenditure
2,023,353,939 1,791,132,882 13.0
(In P1,000)
Total Saving
394,324,924 396,117,335 (0.5)
(In P1,000)
Average Income 148,616 145,121 2.4
Average Expenditure 124,377 118,839 4.7
Average Saving 24,239 26,282 (7.8)
Gini Ratio 0.4678 0.4822 (3.0)
Number of Families
16,268 15,072 7.9
(In 1,000)
Source National Statistics Office, 2003 Family Income
and Expenditure Survey (Final Results)

Increase in total family income and expenditure seen in 2003

 • Total family income in 2003 was estimated at P2.4 trillion increasing
by 10.5 percent over the P2.2 trillion in 2000.
• Total family expenditure reached P2.0 trillion, which was higher by
13.0 percent over the P1.8 trillion in 2000.
• Adjusting for inflation, total family income in 2003 was worth P2.1
trillion in 2000. Thus, in real terms, total family income decreased by
2.9 percent compared to that in 2000.
• Likewise, total family expenditure in 2003 was valued at P1.78 trillion
in 2000 prices. This real value of the total family expenditure
decreased by 0.7 percent compared to that in 2000.
• Among regions, NCR got the biggest share of 26.6 percent (P642
billion) of the total income while Caraga and ARMM posted the least
with 1.6 percent (P38 billion) each.
• Similarly, NCR had the biggest share of the total family expenditures
spent (P528 billion or 26.1%). ARMM likewise showed the least
expenditure with 1.5 percent (P30 billion).

Annual average income and expenditure showed upward trend

• Average income was estimated at P148,616 in 2003 yielding an

increase of 2.4 percent compared to the 2000 level of P145,121. This
translates to an annual growth of 0.8 percentage point.
• Average expenditure increased from P118,839 in 2000 to P124,377
in 2003 posting a growth rate of 4.7 percent over the three-year
period, or an annual growth of 1.5 percentage points.
• The P148,616 average income in 2003 becomes P130,594 in 2000
prices when the effect of inflation was removed. Similarly, the
P124,377 spent in 2003 was worth only P109,294 in 2000 prices.
• The inflation-adjusted estimates showed a decrease of 10.0 percent
in average income and an 8.0 percent decline in average
expenditure.

Rising annual average income observed in regions

• Most of the regions exhibited increases in average income between

2000 and 2003 at current prices, except for NCR, MIMAROPA and
Northern Mindanao which reported decreases.
• NCR (P274,529), CALABARZON (P185,661), Central Luzon
(P158,075) and CAR (P157,045) were the top four regions in terms of
average income, posting estimates higher than the national average.
 • ARMM registered the lowest average income among regions with
P84,439. This was higher by 6.7 percent compared to its 2000
average income of P79,110.

Annual average saving declined in 2003

• Average saving was measured in 2003 at P24,239 down by 7.8

percent from P26,282 in 2000. In real terms, this 2003 average
saving was equivalent to P21,300 in 2000 prices.
• Despite the decline in average saving, families in all regions on the
average, earned more than they spent. NCR recorded the biggest
average saving of P48,593 while Caraga got the least with P10,960.

Low income families drawn towards more dissavings

• The income decile distribution showed increasing income shares of

families from the first to the ninth decile. Only families belonging to
the high-income group, such as those in the tenth decile, registered a
1.6 percentage points decrease in their income share.
• Although the tenth decile?s share decreased, still its income was
about 21 times the income of the bottom 10 percent.
• Relatively, average expenditure of families from the first to the ninth
decile increased between 2000 and 2003 but those in the tenth decile
declined by 2.0 percentage points.
• Dissaving was observed in the first three deciles. The positive income
trend was not enough to cover the expenditure of low-income families
in the first three deciles as seen in their average dissaving (income
net of expenditure) of P2,121 for the first decile, P1,202 for the
second decile and P44 for the third decile.

Less unequal income distribution in 2003

• The 2003 Gini coefficient was recorded at 0.4678 down by 3.0

percent from 0.4822 in 2000. A lower gini coefficient indicates a
movement towards a more equal or less unequal income distribution
among families.
• Eight of the regions registered decreases in the Gini coefficient
indicating a shift towards lesser family income disparity. NCR showed
the biggest decrease from 0.4451 in 2000 to 0.4088 in 2003.
Spending pattern of Filipino families moved towards lesser food
consumption expenditure

• The share of family expenditure on food items continued to slide

indicating a change in the spending pattern of Filipino families
towards less spending on food. In 2003, the share of food
expenditure to total expenditure was 42.8 percent, about 0.8
percentage point lower than the 2000 proportion of 43.6 percent.
• The proportion of expenditure on food consumed at home went down
from 38.6 percent in 2000 to 37.5 percent in 2003. On the other hand,
higher spending on food consumed outside the home was observed
as the proportion went up from 5.0 percent in 2000 to 5.3 percent in
2003 suggesting a change in the Filipino family lifestyle of regularly
eating outside the home and possibly be linked to the growth of fast
food chains.
• Families spent more on transportation and communication as these
expenditures were monitored to move up from 6.8 percent in 2000 to
7.4 percent in 2003.
• Increases in expenditure share were also noted in fuel, light and
water, personal care and effects, clothing, footwear & other wear,
medical care, durable furniture & equipment and miscellaneous
expenditures such as those for special family occasions and gifts &
contributions.
• Meanwhile, the share of expenditure on housing decreased by

TECHNICAL NOTES:

• The 2003 Family Income and Expenditure Survey (FIES) is a

nationwide survey of households undertaken every three years by the
National Statistics Office (NSO). It is the main source of data on
family income and expenditure which include, among others, levels of
consumption by item of expenditures as well as sources of income in
 cash and in kind. The results of FIES provide information on the
levels of living and disparities in income of Filipino families, as well as
their spending patterns.
• The sampling design of the 2003 FIES uses the 2003 Master Sample
for Household Surveys. In this design, the country?s 17
administrative regions were defined based on Executive Orders 36
and 131.
• For comparability of results, the 2000 FIES data in this release were
generated using the new regional grouping. However, 2000 FIES
estimates for Isabela City cannot be generated separately from
Basilan as this city was not a domain in the sampling design used for
the 2000 FIES. As such, Isabela City remained to be part of the
whole Basilan province under Region IX in 2000. In 2003, however,
based on Executive Order 36, Isabela City, being a separate domain
was grouped under Region IX while the rest of the province of
Basilan (excluding Isabela City) is grouped under ARMM.
• In 2000, Marawi City was a separate domain under Region XII. In
2003, with the use of the new master sample, Marawi City became
part of ARMM together with the rest of Lanao del Sur.
• To be able to compare the 2003 FIES estimates with the 2000 FIES
results in real terms, the effects of inflation have to be removed. For
comparative purposes, the Consumer Price Index (CPI) is used to
deflate the 2003 FIES estimates. The country?s CPI for 2003 is
estimated at 113.8.

Gross domestic product and gross national

income, 2000-2003 (First Release)
National accounts 22.9.2004
1. Gross domestic product and gross national income,
2000-2003

2000 2001 2002 2003

Current prices
Mio SIT
1 Output, basic prices 8715 9670 10749 11559
52 84 796 991
8 4
2 Intermediate consumption 5036 5532 61496 65800
13 39 77 41
8 4
3 Value added, basic prices (1 3679 4138 46001 49799
minus 2) 39 45 19 50
0 0
4 Net taxes on products 5729 6233 71437 76721
24 64 5 8
5 Gross domestic product (3 4252 4761 53144 57471
plus 4) 31 81 94 68
5 5
Plus: primary incomes from the 9673 1108 10883 12109
rest of the world 5 94 9 5
Less: primary incomes to the 9072 1015 14326 16224
rest of the world 7 61 5 7
6 Gross national income 4258 4771 52800 57060
32 14 67 16
3 8
Constant 2000 prices
Gross Domestic Product 4252 4366 45114 46253
31 22 14 02
5 1
Of which: total domestic 4403 4443 45461 47587
consumption 14 91 15 84
1 2
Growth rates (%)
Gross domestic product 3,9 2,7 3,3 2,5
• COMMENT

According to the first annual estimate, GDP 2003 at current

prices amounted to SIT 5 747 168 mio or 8.1% more than in
2002. In nominal terms the first annual GDP figure is 0.4%
higher than it was by quarterly estimation. At constant 2000
prices GDP 2003 amounted to SIT 4 625 302 mio or in
volume terms 2.5% more than in 2002 (SIT 4 511 414 mio).
Annual real growth 2003 rate was 0.2 percentage points
higher than by quarterly estimate (2.3%) and was the
lowest since 1992. GDP 2002 growth rate was reduced by
0.1 percentage point: now 2.3%, before 2.4%.

Gross national income (GNI) 2003 amounted to SIT 5 706

016 mio and was the same as GDP 8.1% higher than a year
ago. At the same growth rate GNI value relatively to GDP
has not changed: 99.4% in 2002 and 99.3% in 2003.

At the current exchange rate, GDP 2003 amounted to EUR

24 592 mio or EUR 12 319 per capita, which is 4.6% more
than in 2002. In USD GDP 2003 amounted to 27 749 mio
and 13 900 per capita, which is 25.4% more than a year
ago.

By activities, gross value added at basic prices declined the

most in agriculture, hunting and forestry (by 0.5 percentage
points to 2.3% of GDP) and thus due to dry year reached so
far the lowest level in GDP. At constant 2000 prices, gross
value added in agriculture in volume terms reduced by
15.4%, which is the main reason of low real growth rate of
the economy in 2003. Total gross value added at basic
prices increased in volume terms by 2.5%, the same as GDP
and without agriculture, hunting and forestry by 3.1%.

In the structure of primary incomes of GDP 2003 the share

of compensation of employees and taxes on products has
not changed in comparison with 2002. The share of
subsidies increased by 0.3 percentage points, other taxes on
 production by 0.2 percentage points and particularly gross
operating surplus by 0.7 percentage points. Rather
substantial increase of the share of net operating surplus in
2003 (by 1.4 percentage points to 10.3% of GDP) was due
to further deindexation of the value of fixed assets and thus
lower valuation of consumption of fixed capital in
corporations. The share of gross mixed income of
households further declined at the same amount as gross
value added of agriculture, hunting and forestry (by 0.5
percentage point to 7.5% of GDP).

After three years the total domestic consumption relatively

to GDP for the first time increased to GDP level at current
prices (in 2002 98.5% of GDP). In volume terms the total
domestic consumption increased by 4.7% (final consumption
by 2.7%, gross capital formation by 10.5%, of which gross
fixed capital formation by 6.3%). Exports of goods and
services in volume terms increased by 3.2% (a year ago by
6.7%), imports by 6.8% (a year ago by 4.9%). Therefore,
the external trade balance contribution to GDP growth was
after three years for the first time negative, at -2.2
percentage points.

Interim poverty strategy

I. INTRODUCTION
1.1 The primary development goal for Kenya is to achieve a broad-based,
sustainable improvement in the standards of welfare of all Kenyans. This will
require a concerted effort to tackle the intolerably high incidence of poverty that
now afflicts about half our population. While Government has a particular
responsibility for spearheading action and creating a positive framework, the
private sector, non-governmental and community based organisations all have a
vital role to play in meeting the challenge of poverty reduction. Kenya must
mobilise all available resources and use them efficiently and effectively in the fight
against poverty.

1.2 Our most precious resource is the people and their potential to work for the
collective betterment of our nation. Poverty wastes this resource and its potential.
Poverty has numerous manifestations including low and unreliable income, poor
health, low levels of education and literacy, insecurity and uncertain access to
justice, disempowerment, and isolation from the mainstream of socio-economic
development. It is, therefore, necessary to devise multi-dimensional policies and
interventions that will provide a permanent solution. The poor must be provided
with the means to help themselves through income earning opportunities, ready
access to means of production, the provision of affordable, basic services and the
protection of the law. This will not be achieved through temporary relief
programmes but only through a deliberate and long term policy to increase equity
of opportunity and to ensure that all members of our society can participate fully in
the socio-economic development of Kenya.

1.3 A fundamental prerequisite for poverty reduction is economic growth that

considerably outpaces population growth. Over the past few years Kenya's
economy has declined in per capita terms. As a result, the standard of living for the
vast majority of the population has suffered and the level of poverty has risen
alarmingly. Therefore, the Governments immediate priority is to restore and
sustain rapid economic growth in order to generate the wealth and economic
expansion necessary to reduce the incidence of poverty. Over the next three years,
the foundations for a broad, sustained attack on poverty and the creation of a more
equitable society must be strengthened. At the same time, Government, working
together with civil society and development partners, will take a number of
targeted short term measures to directly address some critical causes and
manifestations of poverty.

1.4 Kenya's Interim Poverty Reduction Strategy (IPRSP) has five basic
components and policy objectives:

• to facilitate sustained and rapid economic growth;

• to improve governance and security;
• to increase the ability of the poor to raise their incomes;
• to improve the quality of life of the poor; and
• to improve equity and participation.

The Strategy outlined in this paper will be used by Government as a national

planning framework upon which detailed sectoral priorities, programmes and
allocations will be developed within hard budget constraints determined by
projections of economic performance. It will also outline the policies, reforms and
programmes that the Government will instigate over the coming three years to
realise the objectives described above. It is the first phase of implementing the
National Poverty Eradication Plan (NPEP).

POVERTY

2.1 The poor constitute slightly more than half the population of Kenya1. Women
constitute the majority of the poor and also the absolute majority of Kenyans.
Three-quarters of the poor live in rural areas. The bulk of them are located within
the highly populated belt stretching South to South-East from Lake Victoria to the
Coast which straddles the rail and road corridors.

2.2 Preliminary results of the 1997 Welfare Monitoring Survey (WMS),

summarised in Table 1 of Annex 2, show that the incidence of rural food poverty
was 51%, while overall poverty reached 53% of the rural population. In urban
areas, food poverty afflicted 38% and overall poverty 49% of the population. The
overall national incidence of poverty stood at 52%. According to available
estimates, over the past 25 years food poverty has increased more than absolute
poverty. The number of poor increased from 3.7 million in 1972-3 to 11.5 million
in 1994. Thereafter, numbers increased to 12.5 million in 1997 and is now
estimated to have reached some 15 million.

2.3 The geographic distribution of poverty is illustrated in Table 3 of Annex 2.

According to the WMS 1994 and the Participatory Poverty Assessment (PPA)
1996, the prevalence of overall poverty in 1994 was highest in North Eastern
Province (58% of population), Eastern (57%), and Coast (55%) while the lowest
were Nyanza (42%) and Central (32%). However, by 1997 indications are that not
only had poverty increased rapidly but that its distribution had changed with
Nyanza (63%) recording the highest level followed by Coast (62%) although
Central still recorded the lowest incidence (31%).

2.4 Major characteristics of the poor include landlessness and lack of education.
The poor are clustered in certain socio-economic categories that include small
farmers, pastoralists in ASAL areas, agricultural labourers, casual labourers,
unskilled and semi-skilled workers, female-headed households, the physically
handicapped, HIV/AIDS orphans and street children. The poor have larger families
(6.4 members compared to 4.6 for non-poor) while in general rural households are
larger than urban. Geographically, North Eastern and Coast Provinces have the
largest poor households. Nationally, poor
women have a higher total fertility rate (rural 7.0 and urban 4.8) than non-poor
women (rural 6.7 and urban 4.1). Studies in Kenya show that fertility rates decline
with education while the use of family planning is higher among the non-poor.

2.5 According to evidence on health status, the prevalence and incidence of

sickness are similar for both the poor and non-poor. However, the response to
sickness is markedly different. An overwhelming majority of the poor cannot
afford private health care (76% rural and 81% urban) and rely on public health
facilities. However, 20% of the urban poor and 8% rural poor found even public
health charges unaffordable. Furthermore, 58% urban and 56% rural poor reported
that they do not seek public health care because of the unavailability of drugs. A
further indicator of disparity is that only 37% of poor mothers gave birth in
hospital compared to 58% of the non-poor mothers.

2.6 Empirical evidence shows that 13% of the urban poor have never attended
school at all while the comparative rural figure is 29%. Of the poor, only 12% of
those in rural areas have reached secondary education while for the urban poor the
figure rises to 28%. Dropout rates have risen, as have disparities in access, due to
geographic location, gender and income. The main reason for not attending school
is the high cost of education. Children are also required to help at home, while for
girls socio-cultural factors and early marriage are significant factors.

2.7 Regardless of poverty, over 50% of Kenya's households do not have access to
safe drinking water, although the proportion is higher for the poor. In urban areas,
large populations living in informal settlements within the towns and cities have no
access to safe water. In rural areas there are large disparities between geographic
areas where in North Eastern and Eastern Provinces less than 30% of the poor have
access to safe water compared to some 60% in Western Province.

2.8 Certain occupations, such as subsistence farmers (46% poor) and pastoralists
(60% poor), have a higher than average incidence of poverty. Subsistence farmers
account for over 50% of the total poor in Kenya. While the poor cultivate, on
average, more land and have more livestock than the non-poor, the non-poor earn
more than two and one half times the income from cash crops and more than one
and one half times the income from livestock sales. This pattern can be partly
attributed by differences in the fertility of land and the affordability of inputs to
improve productivity. For livestock, cultural factors and the lack of high-grade
stock and poor access to markets could account for low sales among the poor.
2.9 Studies in Kenya indicate that women are more vulnerable to poverty than
men. For instance, 69% of the active female population work as subsistence
farmers compared to 43% of men. Given that subsistence farmers are among the
very poor, this relative dependence of women upon subsistence farming explains
the extreme vulnerability of women. These problems are most severe in arid and
semi-arid areas where women spend a great portion of their time searching for
water and fuel. The release of women's productive potential is pivotal to breaking
the cycle of poverty so that they can share fully in the benefits of development and
in the products of their own labour. In the urban areas, the proportion of poor
female-headed households was higher than male-headed households in 1997. Both
rural and urban women in 1997 were severely affected by poverty. This means that
women are affected more by development process and the area of residence plays a
major role in poverty status of women. However, poverty is still pre-dominant in
the rural areas for both men and women, meaning targeting needs to be intensified
in the rural areas.

2.10 Inequitable access to the means of production (land and capital), the
distribution of wealth, reduced access to economic goods and services and
remunerative employment are all causes of poverty. Poverty adversely affects
participation in social and political processes and denies life choices while the poor
are particularly vulnerable to natural disasters. In terms of income distribution,
Kenya ranks highly as inequitable. Estimates indicate that a high proportion of
wealth is concentrated in a very small proportion of the total population. This
income concentration is the highest amongst the 22 poorest countries and is
exceeded only by Guatemala (per capita income US$1340), South Africa
(US$3,160) and Brazil (US$3,640).

2.11 The indicators demonstrate the depth and breadth of poverty in Kenya today
and the magnitude of the challenge. The fight against poverty, ignorance and
disease has been a major goal of Government since independence. However, it is
evident that efforts to-date have been inadequate and the growth of poverty has not
been reversed. In response, Government is mounting a new effort which will
incorporate wider consultation and broader participation of various stakeholders.
This is designed as an ongoing long term poverty strategy for policy and
programme development

RAISING INCOME OPPORTUNITIES OF THE POOR

5.1 The goal to raise GDP growth to 5% per annum by the end of this strategy
period and thereafter to a sustained level of 6-7% per annum will result in
significant increases in national wealth. However, national growth will not
necessarily be spread evenly across all sectors of the economy and between all
members of society. Historically, the service sector has grown at much higher
rates than either manufacturing or agriculture while rural agricultural
smallholders have, in general, not benefited to the extent of those employed in
urban enterprises. The poor in all circumstances will be ill-placed to take
advantage of economic growth unless deliberate interventions are put in place
to increase their opportunities and access to the resources, skills and services
required for them to rise out of the poverty trap.

5.2 With 80% of the population and the majority of the poor living in rural
areas and reliant upon small-holder agriculture and livestock production,
often at subsistence levels, it is evident that poverty reduction calls for higher
agricultural growth rates. But with increasing population pressure on the
land, it is equally important to expand non-farm employment in the rural
areas. For the poor in urban centres, increased access to employment and self-
employment in both the formal and informal sectors will be vital. As female-
headed households constitute a significant proportion of the poor, any
intervention must be gender-sensitive. All these will require very substantial
improvements in infrastructure services and a conducive legal and regulatory
environment.

Immediate Priorities

5.3 Detailed policies to increase the ability of the poor to raise

their incomes are contained in the sector chapters, specifically
Agriculture and Rural Development, Trade Tourism and Industry
and Physical Infrastructure. Briefly, the following are considered
the most immediate priorities for Government action:

• Dismantling intrusive, restrictive and outmoded laws and

regulations in all the productive sectors while maintaining
adequate protection for workers, society and the environment;
• Creating an effective agricultural advisory service that
provides practical, cost-effective extension to the smallholder;
• Establishing an effective and efficient private marketing
system for agricultural produce that enables producers to
maximise their returns;
• The promotion of rural non-farm employment;
• The rehabilitation and subsequent adequate maintenance of
all physical infrastructure, particularly feeder roads, ports, etc.;
• Implementing widespread labour-intensive roads schemes;
• Overcoming the existing shortfall in electricity supply and
reduce its cost

IMPROVING THE QUALITY OF LIFE

6.1 The Government will focus resources on improving the

provision of and access to basic social services that are most
needed by the poor. They are education, particularly primary
education, health, and water supply. In all of these activities,
Government will seek a closer working relationship with
development NGOs, religious organisations, and other private
providers to increase the range and quality of provision.

Immediate Priorities

6.2 Detailed policies to improve the quality of life are contained in

the sector chapters, specifically, Human Resource Development
and Physical Infrastructure. The following are considered the
most immediate priorities in this area for Government action:

• Increasing primary school enrolment and completion;

• Enabling more poor children to attend secondary school;
• Providing all public primary healthcare facilities with an
appropriate and adequate supply of drugs;
• Making essential primary health care drugs and treatment
affordable to the poor;
• Increasing the provision of portable water in poor areas and
working with all communities to enable them to assume
responsibility for managing and maintaining water supplies;
• Prepare enabling legislation for the privatisation of urban
water supplies
•

Development of Water Supplies in rural, urban and peri-

urban areas: Current Government policy is to withdraw from
direct involvement in the implementation and management of
water schemes and instead, hand them over to communities,
local authorities and other service providers. This will be achieved
by developing a rehabilitation program with the stakeholders to
enhance ownership, and facilitate choice of technologies that are
appropriate for management by communities and the other
service providers. Handing over also requires clearly defined
mechanisms to guide the process, and a functional legal and
institutional framework. To complement efforts to increase access
to the poor, the Government has committed itself to promote
self-help initiatives which have been in existence in the country
for a long time and have had significant impact. With proper
training, self-help water supplies are potentially quick winners in
poverty reduction.

8.22 The Government recognises that there is inadequate

capacity among service providers to take over the management
of schemes on a large scale. The Strategy has, therefore,
identified the need for a comprehensive capacity building
programme which will require funding. There will in addition, be
need to carefully plan the redeployment/retraining of Government
personnel currently running the schemes through a
comprehensive public sector reform programme. The initiative is
being coordinated under the Office of the President.

8.23 Government policy for urban water utilities is to involve the

private sector in financing and management. Although
investments in urban utilities have been substantial, the poor
have received little attention in planning and access remains very
low. The Strategy proposes a sharp focus on peri-urban areas by
developing models for distribution and management of WSS
services and expansion of infrastructure.

Water Resources Management

The incidence of violation of water rights, conflicts, and pollution
have dramatically increased. In addition to arbitration and legal
mechanisms, avenues for resolution to ensure fair play will be
created. The Government proposes to develop a community
based catchment management strategy to ensure adequate
quality and quantity of water to the poor. However, for the
strategies to have meaningful impact, the financing and
disbursement arrangements need to be more efficient than they
currently are. This implies that there is urgent need to examine
the disbursing organs with a view to urgently restructure them to
make them more responsive to the implementation requirements.

HUMAN RESOURCE DEVELOPMENT SECTOR

9.1 To improve the quality of life, the Government will focus

resources on improving the provision of and access to basic social
services, particularly education and health, that are most needed
by the poor. In all of these, Government will seek a closer
working relationship with development partners, NGOs, religious
organisations, and other private providers to increase the range
and quality of provision.

9.2 Education: After the high enrolments of the two post

independence decades, there has been a reversal at all levels of
education characterized by non-enrolment, high level of drop-
outs/low completion rates particularly among girls, and poor
transition rates from one level of education to the other. This is
attributed to the high cost of education worsened by the burden
of cost sharing which has had a negative impact on access, equity
and quality of education. The Government's highest priority will
be to improve access to basic education and will start pursuing
the target of Universal Primary Education (UPE) by lowering costs
borne by parents.

9.3 To improve access to basic education, the Government in

collaboration with NGOs and other development partners will
supplement communities' efforts to increase the provision of
textbooks and other learning and teaching materials at primary
school level. At the secondary school level, more day schools will
be encouraged by providing science equipment and other support
materials. Textbooks will be standardized and remain relatively
unchanged so that they can be utilized for longer length of time.

9.4 Bursaries will be provided for school children from poor

households to cover user charges. Bursaries will also be
expanded with improved targeting and special emphasis on girls.
At the tertiary level, loans and scholarships will be provided for
outstanding students from poor households targeted to specific
degree programs in high demand by the economy.
9.5 Further, curriculum will be reviewed and rationalized to
ensure quality and relevance. Specifically, taught and examinable
subjects will be reduced at both primary and secondary school
levels. In addition, optional subjects at the secondary schools will
be reduced. This will result in reduction of the number of
textbooks and range of equipment required. At the same time,
equitable distribution of teachers will be carried out.

9.6 Other policy measures will include improvement in

management and utilization of resources. Some of the strategies
will include decentralization of teacher and school management to
the district/school levels supported by capacity building and more
autonomy of district/school boards, parents and teachers
associations and school committees. Besides, pupil teacher ratios
will be revised upwards at both primary and secondary school
levels in order to allow more efficient utilization of teachers.
Some of the measures will include multi-grading and double shifts
teaching and subsidising the poor households on examinations
fees.

9.7 In order to provide educational opportunities for children with

special needs and those who are currently out of school,
increased resources targeted to AIDS orphans, child workers,
nomadic groups, rural poor and slum dwellers will be provided. To
supplement this, curriculum will be developed to facilitate
transition from non-formal to formal programs. At the tertiary
level, the focus will be to shift towards rationalized degree
programs which provide skills required for a modern economy.
Means testing and targeting of the higher education loans scheme
will be improved and affirmative action put in place to increase
the number of women receiving assistance.

9.8 Health: This Interim Poverty Reduction Strategy Paper

(IPRSP) for the Health Sub-Sector represents a major milestone
by linking the objectives contained in the Kenya Health Policy
Framework Paper (1994) and the National Health Sector Strategic
Plan (1999-2004) to the MTEF, budget allocation.

9.9 As reflected on the attached implementation matrix linking

four core sub-sector objectives to planned strategies/activities to
be implemented and monitored with given outcome indicators
over the next three years, there is a definite commitment to
enhance equity, quality, accessibility and affordability of basic
health resources to the poor both geographically and technically.
There is also commitment and budgetary allocation to implement
high-priority activities within the essential package of health
services with particular emphasis on women and children under 5
and to decentralise control over financial resources for non-wage
recurrent items, and to improve accountability and transparency.
To improve access to the poor, charges for treatment of certain
diseases will be dropped while the waiver system will be enforced
for the very poor.
9.10 The most striking feature of the three year implementation
plan is the proposed real shifts of financial, human and other
resources away from curative services to
preventive/promotive/rural health services sub-votes. The aim is
to translate stated health policy objectives to tangible and
targeted activities supported through the MTEF process to
redirect health resources to those areas that provide maximum
benefits to the majority of the vulnerable groups who form a big
proportion of our society in line with the Poverty Reduction
Strategy adopted by the Government.

9.11 The proposed strategy, focus and budget allocation will help
to stimulate a reversal of the adverse factors that have stifled
economic growth and help the economy to start on a sustainable
growth path and achieve increased per capita incomes.

9.12 Control of HIV/AIDS is central to an effective poverty

reduction strategy. The Government has declared AIDS a National
Disaster. Consistent with this, the MOH proposes to implement
HIV/AIDS control activities to achieve the objectives of
preventing transmission of HIV among the population with a
focus on the vulnerable groups.

9.13 Population: The Government will continue its efforts to

reduce the high rate of population growth from the current 2.4 to
2 percent in the medium term. This will be done through
expanding family planning services and improving information
and education.

9.14 Labour and Employment: In order to emphasize the

promotion of a productive and freely chosen employment as a
priority and fundamental base for national economic and social
policy, there will be a shift towards jobs creation and
improvement in the productivity of labour . This will call for
improvement in the provision of skills and knowledge for the
workforce, the stimulation of economic growth, and the
maximization of the utilization of labour and human resources in
income generating opportunities. Basic rights of all segments of
society to work irrespective of sex, age and geographic location
will be respected.

9.15 Housing and Shelter are important for improving the quality
of life and housing construction itself boosts economic growth and
job creation. The current housing situation in both rural and
urban areas is deplorable, with most housing facilities failing to
meet minimum standards of durability, sanitation and habitable
space. Demand, particularly in urban areas, outstrips supply.
Measures to improve housing and shelter will include: promotion
of lower cost housing (technology, materials, best practices),
mobilizing lower cost housing finance and development of
enabling business conditions for private sector to construct
affordable housing.
9.16 Social security: The objective will be to create safety nets
for the aged, retrenched, unemployed, disabled and displaced
persons and victims of other calamities. The National Social
Security Fund (NSSF), which caters only for those employed, is
inadequate while traditional systems are disappearing due to the
break-down of the extended family system, migration, economic
hardships and poverty. Government will continue current efforts
to restructure and reform the NSSF and take measures to cater
for the poor and vulnerable groups with new and innovative
approaches for dealing with social safety nets. This will include
finding ways to strengthen the traditional safety nets; targeting
HIV/AIDS infected and affected persons; cooperating with civil
society and NGOs which are more experienced in this area;
strengthening the Retirement Benefits Authority and National
Hospital Insurance Fund; and facilitating development of more
private sector pension schemes and other long-term savings
instruments.

AGRICULTURE AND RURAL DEVELOPMENT SECTOR

10.1 Agriculture is the lifeline of 80% of Kenya's poor who live in

rural areas, including farmers, workers and unemployed. 70% of
Kenya's employment is in agriculture, consequently creating jobs
and increasing income in that sector is vitally important and, if
achieved, will have an important direct effect on poverty.
Furthermore, agricultural growth can catalyse growth in other
sectors, with an estimated growth multiplier of 1.64, compared to
1.23 in non agriculture, it is likely to have a strong indirect effect.
Restoring high and sustainable agricultural growth is therefore
critical for alleviating poverty.

10.2 Agricultural growth has been well below potential in recent

years due to a number of constraints. Those which result partly
from an accumulation of poor past policies and which will take
time to remedy include; (i) non availability of quality seeds and
inappropriate production technologies especially for small holder
farming, (ii) lack of access to credit, by the majority of small
holder farmers, particularly women, (iii) high cost of farm inputs,
(iv) poor and inadequate rural infrastructure, especially feeder
roads, power supply and market facilities. Other constraints,
which Government intends to make relatively rapid efforts to
ameliorate include (v) inconsistencies in policy/poor institutional
and legal framework, (vi) inadequate research, inefficient
extension delivery systems as well as inadequate extension
services and support, (vii) poor sequencing of the liberalisation
process, (viii) lack of effective co-ordination of investment
activities among the key stakeholders in agriculture. Lastly, there
are constraints which are almost entirely exogenous, including
(ix) insecurity in high potential areas and cattle rustling in some
ASAL areas, (x) unfavourable weather conditions and high
dependence on rain fed production, and (xi) population pressure
on the natural resource base. As a result, many indicators of rural
livelihood have been worsening, indicating an increase in rural
poverty.

10.3 The Agriculture sub-sector needs to grow at about 4-6%

per annum if it is to contribute to national growth and increasing
rural wealth. For this to happen in a way that effectively supports
poverty reduction over most of the sector, a number of important
elements need to be in place and actions to facilitate them need
to be taken. These include: (i) building an effective and efficient
participatory extension and technology delivery service; (ii)
undertaking affirmative action in agriculture by facilitating
participation of women; (iii) establishing efficient rural finance
and credit supply system for smallholders and rural primary
agroprocessors; (iv) ensuring policies, institutional and legal
frameworks are investor friendly; (v) implementing sound land
use, water and environmental policies; (vi) facilitating long term
investments in farm improvement; (vii) protecting water
catchment areas by developing forest plantations; and (viii)
improving the governance of the co-operative sector by
empowering farmers. To address specific problems of ASAL areas
livestock marketing needs to be improved and small scale
irrigation investments undertaken in poverty stricken areas.
10.4 The role of Government in encouraging growth in the rural
sector would be redirected towards fulfilling those functions which
are truly public goods. In particular it would strive to provide
better research/extension linkages and which are seen as the
main way of supporting effective increases of smallholder maize
and traditional crop production which is undertaken mainly by the
rural poor. It would also set policies to create an enabling
environment which encourages investment and trade, thereby
leading to job creation, which would also be of direct benefit to
the poor

STATE INCOME

The advance estimates of State Domestic Product for the year 2003-
3.1.0 2004 indicate that during the year the Gross State Domestic Product (GSDP)
of Assam is expected to grow by 6.0 per cent at constant (1993-94) prices and
by 10.2 per cent at current prices. At national level the growth of GDP during
2003-2004 is expected to be 8.1 per cent at constant (1993-94) prices and 11.9
per cent at current prices as revealed from the advance estimates released by
the Central Statistical Organisation. As per the advance estimates the per
capita NSDP (i.e. Per Capita Income) of Assam is likely to attain the level of
Rs.6403 at constant (1993-94) prices and Rs.12593 at current prices during
2003-2004 while at national level the per capita income is estimated at
Rs.11684 at constant (1993-94) prices and Rs.20860 at current prices during
the same period.

3.1.1 The quick estimates of the Gross State Domestic Product (GSDP) of
Assam for 2002-2003 shows that the growth of GSDP at constant (1993-94)
prices has increased by 3.94 per cent during the year as against increase of
3.23 per cent in 2001-2002 (Provisional Estimates). At current prices the
same has increased by 7.79 per cent in 2002-2003 (Q) as against 4.44 per cent
increase in 2001-2002 (P). The Primary Sector registered a negative growth
of (-) 1.6 per cent during 2002-2003 (Q) over the previous year in real terms
while the Construction Sector in the State registered a positive growth of 16.7
 per cent, which resulted a growth of 9.7 per cent in Secondary Sector during
the aforesaid period. The Tertiary Sector registered a positive growth of 6.6
per cent during the year. The quick estimates of GSDP of Assam in 2002-
2003 (Q) at constant (1993-94) prices has been estimated at Rs.19121.44
crore as against Rs.18397.33 crore in 2001-2002 (P). At current prices, GSDP
in 2002-2003 (Q) is estimated at Rs.35431.42 crore as against Rs.32872.31
crore in 2001-2002 (P).

According to the Quick Estimates released by the Central Statistical

Organization (CSO), the Gross Domestic Product (GDP) at National level at
constant (1993-94) prices has grown by 4.0 per cent during 2002-2003. As
per the said estimates the Agriculture and allied sector has declined by 4.0 per
cent, mainly due to the draught conditions prevailed in the country during the
aforesaid period while the Secondary and Tertiary Sectors has shown a
growth of 6.2 per cent and 7.1 per cent respectively.

The Net State Domestic Product (NSDP) of Assam in real terms i.e.
3.1.2 at 1993-94 prices has been estimated at Rs.16784.61 crore in 2002-2003 (Q)
as against Rs.16155.32 crore in 2001-2002 (P) and Rs. 15670.90 crore in
2000-2001. Thus, the NSDP registered a growth of 3.90 percent in 2002-2003
over 2001-2002 as against a growth of 3.09 per cent witnessed in 2001-2002
over 2000-2001. At current prices the same was Rs.31720.80 crore in 2002-
2003 (Q) as against Rs.29419.22 crore in 2001-2002 (P) and Rs.28262.14
crore in 2000-2001. The growth rate at current prices in 2002-2003 was 7.82
per cent in comparison to 4.09 per cent growth witnessed in 2001-2002 (P).
The annual compound growth rate of NSDP during the period from 1993-94
to 2002-2003 has been worked out at 10.25 per cent at current prices and 2.29
per cent at constant (1993-94) prices.

3.1.3 The Per Capita Net State Domestic Product (NSDP) i.e., the Per
Capita Income of Assam at constant price (1993-94) has been worked out at
Rs.6220 in 2002-2003 (Q) as against Rs.6059 in 2001-2002 (P) and Rs.5943
in 2000-2001. At current prices the same was Rs.11755 in 2002-2003 (Q) as
against Rs.11034 in 2001-2002 (P) and Rs.10718 in 2000-2001. Thus, the Per
 Capita Income at constant prices (1993-94) showed an increase of 2.66 per
cent in 2002-2003 (Q) over 2001-2002 (P) as against the increase of 1.95 per
cent in 2001-2002 over 2000-2001. At current prices the same recorded an
increase of 6.53 per cent in 2002-2003 (Q) over 2001-2002 (P) as against 2.95
per cent increase in 2001-2002 (P) over 2000-2001.

This shows the Per Capita Income of Assam and India during the
period from 1980-81 to 2002-2003.

It would be evident from Table-3.2 that in respect of Per Capita

Income, Assam continued to lag behind the Per Capita Income at National
level in every year under reference in the table. Another noticeable feature in
this regard is that the gap between the Per Capita Income of Assam and India
is widening in every subsequent years. During 2002-2003 (Q) the Per Capita
Income of Assam stood at Rs.11755 at current prices and Rs.6220 at constant
(1993-94) prices and during the same period the Per Capita Income for the
country as a whole was Rs.18912 at current prices and Rs.10964 at constant
(1993-94) prices. As per Quick Estimate the Per Capita Income of Assam
showing an increase of 6.53 per cent at current prices and 2.7 per cent at
constant (1993-94) prices during 2002-2003 over that of previous year. The
movement of GSDP and NSDP of Assam at Factor Cost by Industry of origin
along with Per Capita Income at current and constant prices may be seen from
the Tables at Appendix.

An analysis of the Sectoral contribution by broad groups reveals that

3.1.4 during 2002-2003 (Q) the contribution of Primary, Secondary and Tertiary
Sectors to the total Net State Domestic Product of the State at current prices
stands at 38.72 per cent, 16.16 per cent and 45.12 per cent respectively.
During the same year, the contribution of Primary, Secondary and Tertiary
Sectors at constant (1993-94) prices have been found to be 38.69 per cent,
15.26 per cent and 46.05 per cent respectively. While in 2001-2002 (P), the
contribution were 41.00 per cent for Primary Sector, 14.99 per cent for
Secondary Sector and 44.01 per cent for Tertiary Sector at current prices and
41.06 per cent, 14.21 per cent and 44.73 per cent respectively at constant
prices.

The share of the entire Sectors to the total NSDP of the State during
2002-2003 (Q)
 The Sectoral composition of the State’s economy has undergone
considerable changes during 1992-93 to 2002-2003 as revealed from the
movements of the SDP of the State. During this period, the share of Primary
Sector has declined from 51.45 per cent to 38.72 per cent. On the other hand,
the share of Secondary Sector has increased from 12.84 per cent to 16.16 per
cent and Tertiary Sector has also increased from 35.71 per cent to 45.12
percent over the same period. The increasing share of Secondary and Tertiary
Sectors is due to faster rate of development in these two Sectors in
comparison to the development in the Primary Sector.

The contribution of Agricultural Sector to the total NSDP of the State

is found to be dwindling over the years. During 2002-2003 (Q), 2001-2002
(P) and 2000-2001 the share of this Sector were 30.34 per cent, 31.69 per cent
and 34.45 per cent respectively at current prices and 29.60 per cent, 31.43
percent and 32.46 per cent respectively at constant (1993-94) prices.

Review of Developments

Consumption, savings and investment

the increasing trend in gross domestic savings as a proportion of GDP observed

since 2001-02 continued, according to the new series of national accounts, with
the savings ratio rising from 26.5 per cent in 2002-03 to 28.9 per cent in 2003-04
and further to 29.1 per cent in 2004-05 (Table 1.3). In 2004-05, the rise in the
savings rate was contributed by two of its three components: namely public and
corporate savings. The third component, namely household savings, grew at 5.9
per cent – slower than the GDP growth rate – and made a negative contribution
by coming down as a proportion of GDP.

The trend in public savings had reversed from negative (1998-99 to 2002-03) to
positive in 2003-04. With progress in the implementation of FRBMA, this virtuous
trend consolidated further with an increase in public sector savings from 1.0 per
cent of GDP in 2003-04 to 2.2 per cent of GDP in 2004-05. The positive saving of
Rs. 69,390 crore in 2004-05 (QE) was composed of lower dissavings of public
authorities and higher savings from non-departmental enterprises.

Savings by the private corporate sector – reflecting the high retained earnings
from their higher profits – grew rapidly (24.9 per cent) to increase its share in
GDP from 4.4 per cent in 2003-04 to 4.8 per cent in 2004-05 (QE). There has
been a continuing upward momentum in the savings of the private corporate
sector for three years; as a proportion of GDP, it increased steadily from 3.6 per
cent in 2001-02 to 4.8 per cent of GDP in 2004-05 (QE). The increase of 0.2
percentage points in gross domestic savings rate between 2003-04 and 2004-05
was considerably lower than the 2.4 percentage point rise in the previous year
because of a decline in household savings, in both financial as well as physical
assets, relative to GDP.

Private final consumption expenditure (PFCE), at current prices as a proportion of

GDP, after declining from 64.6 per cent in 1999-2000 to 62.9 per cent in 2002-03,
fell further to 62.4 per cent in 2003-04 and 60.6 per cent in 2004-05. Among the
various components of PFCE, the share of food, beverages and tobacco in total
expenditure came down from 46.8 per cent in 2000-01 to 40.6 per cent in 2004-
05. The other major item of importance, namely, transport and communication, as
a proportion of PFCE, rose from 14.3 per cent in 2000-01 to 18.2 per cent in
2004-05.

While consumption expenditure, when measured as a proportion of GDP, exhibited

a declining trend both in public and private consumption categories, such
expenditure continued to dominate the demand side of national income. As a
proportion of GDP at current prices, Government final consumption expenditure
(GFCE) declined from 12.9 per cent in 1999-2000 to 11.2 per cent in 2003-04.
The proportion is estimated to have grown marginally to 11.3 per cent in 2004-05.

In line with the rise in the rate of gross domestic savings in 2002-03 and 2003-04,
there was an increase in the rate of GDCF or investment ( Table 1.3). However,
the increase in GDCF was less than the increase in savings, leading to a current
account surplus in BOP, as a proportion of GDP, of 1.2 per cent and 1.6 per cent,
respectively. In 2004-05, reflecting the pick up in investment in the economy,
GDCF increased by 2.9 percentage points of GDP, surpassing the 0.2 percentage
point increase in the ratio of gross domestic savings to GDP. A current account
deficit in BOP of 0.8 per cent of GDP largely bridged the savings-investment gap.

Gross domestic investment grew from 27.2 per cent in 2003-04 to 30.1 per cent
in 2004-05 (Table 1.3), mainly on account of private investment growing at 19.7
per cent. In the revised series data, a new item “valuables” covering expenditure
on acquisition of precious metals and stones as a store of value has been included
as a component, separate from public and private, of GDCF on the basis of 1993
System of National Accounts of United Nations.

GDCF at constant prices (base: 1999-2000) as a proportion of GDP (Table 1.4) is

consistently lower than the corresponding proportion at current prices (Table 1.3).
But, irrespective of the choice of constant or current prices as the weights, the
direction of change from year to year remains unaltered. The lower values of the
change in GDCF as a proportion of GDP at constant prices, particularly in more
recent years, may reflect the higher prices of capital goods relative to the general
 price level, with growing technological sophistication of the production processes
in the economy in general and manufacturing in particular.

At constant 1999-2000 prices, the composition of GDCF for 2003-04 and 2004-05
reveals a faster growth in the public component than in the private. Furthermore,
there is a faster growth in inventories and valuables in the latest two years, with
gross fixed capital formation (GFCF) growing at a lower rate than gross domestic
capital formation. This may partly reflect a process of adjustment to the rapid
decline in the change in stocks as a proportion of GDP from 2.0 per cent in 1999-
2000 to a low of 0.5 per cent in 2001-02 and the progressive liberalization of gold
and silver imports.

In terms of contribution to growth of GDP at current market prices, from the

demand side, there was a change in the pattern of PFCE providing the lead (Figure
1.2 and Table 1.5). PFCE contributed as much as 54.5 per cent of the growth in
GDP at current market prices between 2000-01 and 2003-04. The percentage
point contribution of private final consumption expenditure was as much as 7.4
out of the overall growth of 12.7 per cent in GDP in 2003-04. In the same year,
the corresponding contribution of investment was 5.4. In an encouraging
development, the percentage point contribution of investment at 6.8 out of 13.1
per cent growth in GDP in 2004-05 exceeded the corresponding contribution of
private final consumption expenditure at 6.1 for the first time in recent years.
Reflecting the higher growth of imports relative to exports, the negative
contribution of external balance increased in 2004-05.

Poverty Statistics

Explanatory Notes on the 2003 Poverty Estimates

E. Growth rate of average per capita income (at current

prices) versus the growth rate of the poverty threshold
provides an alternative way to analyze trends in poverty
incidence

• Another way of validating changes in poverty incidence

would be to compare the growth rate from 2000 to 2003 of
the nominal average per capita income as against that of the
poverty threshold.
• At the national level, the average per capita income
increased faster than the poverty threshold (Table 5),
indicating that on the average, the increase in per capita
income was more than sufficient to match the increase in
the cost of basic food and non-food requirements. Moreover,
the average per capita income of the three lowest income
 groups, where the country’s poor belongs, rose at a higher
rate than the poverty threshold as shown in Appendix Table
D . This means that poor families were able to cope better
despite the increase in the cost of basic necessities, thereby
improving their living conditions. Thus, the 2.7 percentage
point reduction in national poverty incidence from 2000 to
2003 is plausible.

Table 5
Poverty Incidence, NOMINAL Average Per Capita Income,
and Poverty Threshold by Region, 2000 and 2003

• For NCR, although the cost of basic necessities went up

faster than the overall per capita income, poverty incidence
decreased nonetheless since the increase in the average per
capita income of families in the lowest income group, where
all of the poor in the metropolis belongs, was more than
sufficient to match the rising cost of basic necessities in the
region. This contributed to the reduction in Metro Manila’s
poverty incidence. In fact, the decrease in the region’s
overall per capita income can actually be attributed to those
 in the highest income group, which could not have affected
the estimate of poverty incidence.
• Similarly, for Region VIII, while the cost of basic
requirements grew faster than the overall per capita income,
poverty incidence dropped nonetheless since the rise in the
average per capita income of families in the lower income
groups, particularly those in the fourth lowest income group,
were more than enough to cover the increasing cost of basic
requirements in the region.
• For Regions IV-B, IX, and X, poverty incidence worsened
(although only by a negligible rate in the case of Region X,
that is, by 0.02 percent) since the increase in the overall per
capita income was not sufficient to cope with the rising cost
of basic necessities. In fact, the average per capita income
of families went down from 2000 to 2003 for the third,
fourth and fifth lowest income groups in Region IV-B, and
for the three lowest income groups in Region IX.
• For Region XI, while the overall per capita income increased
faster than the cost of basic commodities, poverty incidence
increased nonetheless due to the insufficient growth in the
average per capita income of the third lowest income group.
That is, improvements in the income of most families in the
said income group were not enough to cope with the rising
cost of basic necessities in the region. In fact, the increase
in the overall per capita income of the region was
contributed mainly by the upper income groups.
• A similar trend was observed in Caraga. Despite the faster
growth in the overall per capita income as against the cost
of basic commodities, poverty incidence increased just the
same since the expansion in the average per capita income
of families in the fifth income group was not enough to deal
with the faster rising cost of basic necessities. A closer
examination of the distribution revealed that it was mainly
the upper income groups that contributed to the increase in
the overall per capita income of the region.
• For the rest of the regions, that is, Regions I, II, III,
Calabarzon (IV-A), V, VI, VII, XII, CAR and ARMM, poverty
incidence improved as the overall per capita income grew at
 a sufficient rate to cope with the escalating cost of basic
necessities in these regions. Moreover, per capita income of
families in the lower income groups grew more rapidly than
the cost of basic necessities helping them cope better

Developments during 2002-03

Domestic Developments
3. The Central Statistical Organisation (CSO) recently released the latest estimates of
national income for the year 2001-02. According to these estimates, the growth rate of
real GDP in 2001-02 at 5.6 per cent was marginally higher than envisaged earlier, i.e.
5.4 per cent. This was mainly due to an upward revision in growth rates of the
manufacturing, trade, transport and communication sectors. Growth rate of the services
sector was revised upwards from 6.2 per cent to 6.5 per cent and that of industrial
sector from 2.9 per cent to 3.2 per cent. However, the growth rate of agriculture and
allied activities remained steady at 5.7 per cent.
4. For the year 2002-03, the mid-term Review of Monetary and Credit Policy released
on October 29, 2002 had projected the GDP growth in the range of 5.0 to 5.5 per cent
taking into account available data on the performance of the South-West monsoon. The
advance estimates for 2002-03 released by the CSO in January 2003 has placed GDP
growth at 4.4 per cent, which reflects an estimated decline in the output from
agriculture and allied activities by as much as 3.1 per cent. The earlier projection in the
Reserve Bank?s mid-term Review of October 2002 was based on a much lower decline
of 1.5 per cent in agricultural output. The overall growth performance of the industrial
sector, as per CSO advance estimates, at 5.8 per cent is, however, much higher than
that of 3.2 per cent in the previous year. The services sector is estimated to grow by 7.1
per cent as against 6.5 per cent in the earlier year, mainly on account of higher growth
in construction, domestic trade and transport sectors. The CSO has also placed the
growth of financing, real estate and business services sector at 6.5 per cent for 2002-03
as compared with 4.5 per cent in 2001-02.
5. The annual rate of inflation as measured by variations in the wholesale price index
(WPI), on a point-to-point basis, remained below 4.0 per cent up to mid-January 2003
and rose thereafter to 6.2 per cent by end-March 2003 mainly on account of increase in
prices of non-food articles and mineral oils. During 2002-03, the prices of manufactured
products (weight: 63.7 per cent) registered an increase of 4.8 per cent compared with
no increase in prices in the previous year. Prices of primary articles (weight: 22.0 per
cent) showed an increase of 5.9 per cent as against an increase of 3.9 per cent in the
previous year. Similarly, there was a higher increase of 10.8 per cent in "fuel, power,
light and lubricants" group (weight: 14.2 per cent) as against an increase of 3.9 per cent
a year ago. Besides fuel items, the steep increase in prices of oilseeds, sugarcane and
cotton have been major items in the overall price rise in 2002-03. In the WPI basket,
while some items are affected by drought conditions, others have sharply responded to
external supply shocks. The weight of such items, where prices have increased very
sharply, works out to 15.4 per cent. Excluding the price increases due to such items
(mineral oils, oilseeds, edible oils, oil cakes and fibres) from the basket, the inflation rate
works out to 2.7 per cent on a point-to-point basis at the end of March 2003 as
compared with 1.5 per cent last year.
6. The annual rate of inflation in 2002-03 as measured by the increase in WPI, on an
average basis, for the year as a whole was, however, lower than that in the previous
year: 3.3 per cent as against 3.6 per cent a year ago. On an average basis, the annual
change in consumer price index for industrial workers (up to February 2003) was
identical to the previous year at 4.1 per cent.
7. Monetary and credit aggregates for the year 2002-03 reflected the impact of mergers
that took place in the banking industry. During 2002-03, the growth in money supply
(M3) was 15.0 per cent (Rs.2,24,576 crore) as against 14.2 per cent (Rs.1,86,782 crore)
a year ago. However, net of mergers, M3 increased by 12.1 per cent (Rs.1,81,984 crore)
which was well within the projected trajectory. Among the components, growth in
aggregate deposits of scheduled commercial banks (SCBs) at 12.2 per cent net of
mergers (16.1 per cent with mergers), was lower than that of 14.6 per cent in the
previous year. The expansion in currency with the public was lower at 12.5 per cent
(Rs.30,263 crore) as against 15.2 per cent (Rs.31,849 crore) in the previous year.
8. An important feature of monetary developments during 2002-03 was the lower
increase in reserve money despite a sharp increase in foreign exchange assets of RBI.
The increase in reserve money during 2002-03 was 9.2 per cent (Rs.30,960 crore) as
compared with an increase of 11.4 per cent (Rs.34,659 crore) observed in the previous
year. While currency in circulation rose by 12.5 per cent (Rs.31,338 crore) as compared
with an increase of 15.0 per cent (Rs.32,769 crore) in the previous year, bankers?
deposits with RBI declined by 1.0 per cent (Rs.801 crore) as compared with an increase
of 3.3 per cent (Rs.2,670 crore). On the sources side, RBI?s net foreign exchange
assets rose by 35.7 per cent (Rs.94,275 crore) compared with an increase of 33.9 per
cent (Rs.66,794 crore) in the previous year. On the other hand, net domestic assets of
RBI declined on account of a fall in both net RBI credit to government and credit to
banks and commercial sector. Notwithstanding RBI?s subscription to fresh government
dated securities of Rs.36,175 crore, net RBI credit to the Central Government actually
declined by Rs.25,369 crore due to net open market sales of government securities of
Rs.53,780 crore. RBI?s claims on banks and commercial sector also showed a fall of
Rs.6,468 crore as compared with a decline of Rs.9,575 crore in the previous year
reflecting comfortable liquidity conditions.
9. A favourable development during 2002-03 has been a sustained increase in credit
flow to the commercial sector reflecting industrial recovery. During 2002-03, non-food
credit of scheduled commercial banks (SCBs) registered a high growth of 26.2 per cent
(Rs.1,40,144 crore) and, net of mergers, it rose by 17.8 per cent (Rs.95,599 crore), as
against an increase of 13.6 per cent (Rs.64,302 crore) in the previous year. The
incremental non-food credit-deposit ratio during 2002-03 at 79 per cent is the highest
recorded over the last five years. This is indicative of the fact that a substantial part of
lendable resources of banks has been deployed for productive purposes. This is also
borne out by the strong growth of 10.3 per cent in demand deposits in 2002-03, which is
mainly used for working capital requirements. The increase in total flow of funds from
SCBs to the commercial sector during 2002-03, including banks? investments in
bonds/debentures/shares of public sector undertakings and private corporate sector,
commercial paper (CP) etc., was also higher at 24.5 per cent (Rs.1,51,569 crore) as
against 12.7 per cent (Rs.69,483 crore) in the previous year. The total flow of resources
to the commercial sector, including capital issues, global depository receipts (GDRs)
and borrowings from financial institutions was at Rs.1,88,262 crore as compared with
Rs.1,42,082 crore in the previous year.
10. The feedback on industry-wise credit flows received from banks for 2002-03 (April-
February) reveals that, at a disaggregated level, there was significant increase in credit
to iron & steel, other metal & metal products, cotton & jute textiles, electricity, paper &
paper products, fertilisers, drugs & pharmaceuticals, cement, gems & jewellery,
construction, food processing, computer software, power and roads & ports. On the
other hand, decline in credit was observed in coal, all engineering, sugar, tobacco &
tobacco products, telecommunications and petroleum.
11. As a result of subdued procurement due to lower foodgrains production, and higher
off-take of foodgrains, the buffer stock of foodgrains declined from 54.5 million tonnes
on March 1, 2002 to 36.2 million tonnes as on March 1, 2003. Consequently, there was
a decline in food credit of Rs.4,499 crore during 2002-03 as against an increase of
Rs.13,987 crore in the previous year. The large buffer stock with the Government acted
as a deterrent to price increase of food items as also the general price level in the wake
of severe drought conditions witnessed during the year.
12. According to the revised estimates in the Union Budget, the fiscal deficit of the
Central Government for 2002-03 was Rs.1,45,466 crore as against the budget estimate
of Rs.1,35,524 crore. During 2002-03, net market borrowings of the Central
Government at Rs.1,04,118 crore (gross Rs.1,51,126 crore) was higher than the budget
estimate by Rs.8,259 crore but lower than the revised estimate by Rs.8,747 crore. The
state governments? net market borrowings of Rs.13,622 crore for 2002-03 were
supplemented by additional borrowings of Rs.15,442 crore. Although the combined
slippage in the borrowings of the Centre and States was as much as Rs.23,701 crore, it
did not exert undue pressure on interest rates due to decline in the demand for food
credit, reduction in CRR, comfortable liquidity position resulting from the foreign
exchange inflows and judicious debt management by RBI. As such, the weighted
average cost of government borrowings through primary issuances of dated
securities at 7.34 per cent during 2002-03 was lower by 210 basis points than that of
9.44 per cent in the previous year. While unfavourable effects of large fiscal deficits on
the interest rate scenario have not so far been evident, it is necessary, in a medium-
term perspective, to aim at fiscal consolidation and substantially lower fiscal deficits to
facilitate efficient monetary and debt management operations.
13. During 2002-03, the state governments accessed the market for additional
borrowings for an amount of Rs.15,442 crore in two tranches. This amount includes
Rs.10,000 crore for the debt swap scheme mutually agreed between the Central
Government and state governments towards repayment of high cost debt of States to
the Centre. Though repayment of high cost debt is desirable, large borrowings for this
purpose, in addition to high level of approved market borrowings for other purposes, put
pressure on interest rates. The timing of issuance and pricing of the securities also
become difficult, particularly during periods when there is a bunching of borrowing
requirements for various purposes. These difficulties are compounded if there are
periodic defaults by some States or their PSUs in meeting their guarantee obligations. It
is of utmost importance that overall borrowing requirements are kept at a reasonable
level, and that all sovereign obligations, including guarantees, are fully honoured on
time.
14. As emphasised in various policy Statements, overall monetary management
becomes difficult when a large and growing borrowing programme of the Government
puts pressure on the absorptive capacity of the market. The banking system already
holds government securities of about 39 per cent of its net demand and time liabilities
(NDTL) as against the statutory minimum requirement of 25 per cent. In terms of
volume, such holdings above the statutory liquidity ratio (SLR) amounted to Rs.1,95,974
crore in March 2003 which is much higher than the gross borrowings of the
Government. Further, such a scenario exposes banks to substantial interest rate risk
which has adverse implications for sustained financial stability. In addition, the
increasing interest payments have raised concerns about the sustainability of a large
public debt. A reduction in fiscal deficit would release resources for infrastructure and
industrial financing, which in turn would help in realising the long-term potential of the
economy. Fiscal consolidation will also have a favourable effect on inflationary
expectations and hence on the interest rate scenario in the economy.
15. The two-way movement in interest rates during 2002-03, has confirmed that banks
should in their interest take steps to build up investment fluctuation reserves in a
smooth and phased manner for better risk management. It may be recalled that in
January 2002, RBI proposed that banks should build up investment fluctuation
reserve (IFR) to a minimum of 5 per cent of their investment portfolio under the "held for
trading" and "available for sale" categories, by transferring the gains realised on sale of
investments within a period of five years. They were also advised to make adequate
provisions for unforeseen contingencies in their business plans, and to fully take into
account the implications of changes in the monetary and external environment on their
operations. In the light of their own risk assessment, banks are free to build up higher
percentage of IFR up to 10 per cent of their portfolio depending on the size and
composition of their portfolio, with the concurrence of their Boards.
16. The monetary policy stance in recent years has underlined the Reserve Bank?s
commitment to maintain adequate liquidity in the market with a preference for soft
interest rates to the extent the evolving situation warrants. During 2002-03, it was
possible to maintain adequate liquidity on account of sustained inflows of fornment
borrowing. This is evident from the fact that the call money rate declined from 6.97 per
cent in March 2002 to 5.86 per cent by March 2003. The discount rate of prime-rated
CP (61-90 days) showed an even sharper decline by 302 basis points from 9.02 per
cent to 6.00 per cent between March 2002 and March 2003. The cut-off yields on 91-
day and 364-day Treasury Bills declined from 6.13 per cent and 6.16 per cent,
respectively, in March 2002 to 5.89 per cent each by March 2003. An interesting
development during the year has been that the interest rates in money market
instruments converged to a narrow band of 5.5 to 6.0 per cent reflecting easy liquidity
conditions.
17. There was also a distinct downward drift in secondary market yields on
government securities across the maturity spectrum during the year. The yield on
government securities with 1-year residual maturity declined by 60 basis points from
6.10 per cent in March 2002 to 5.50 per cent by March 2003. There was a sharper
decline of 115 basis points in yield on government securities with 10-year residual
maturity from 7.36 per cent in March 2002 to 6.21 per cent by March 2003. The term
structure of interest rates reveals a flattening of the yield curve with long-term interest
rates declining more sharply than the short-term rates. For example, the spread
between the yields on 10-year government securities and 91-day Treasury Bills
narrowed from 123 basis points in March 2002 to 32 basis points by March 2003
reflecting moderation of inflationary expectations.
18. Interestingly, yields on non-government bonds witnessed a sharper reduction
than yields on government securities during 2002-03, and yields on such bonds are now
closer to sovereign bonds than was the case earlier. For example, the spread between
the prime-rated CP (61-90 days) and 91-day Treasury Bills narrowed from 289 basis
points in March 2002 to 11 basis points by March 2003. In the case of longer maturities
also, the risk premium on the private sector bonds has fallen sharply as measured by
the yield spread between highly rated corporate paper and government securities for
residual maturity of 5 years. For example, the spread between AAA-rated corporate
bonds and the yield on government securities narrowed from about 177 basis points in
March 2002 to about 87 basis points by March 2003.
19. It is necessary to impart greater flexibility to the interest rate structure in India
consistent with the underlying macroeconomic conditions. Further progress in this
direction could be made if banks move over to a variable interest rate structure on
longer term deposits as early as possible. Since interest rates could vary in both
directions, depending on the phase of business cycle and inflationary outlook, a variable
interest rate regime on long-term deposits does not necessarily imply lowering of the
average interest rate earned by depositors over a period of time (as compared with a
fixed rate regime, which favours old deposits over new deposits when interest rates are
coming down, and vice versa when rates are moving in the opposite direction). In
addition, banks need to reduce their operating costs over time by improving productivity
and increasing their volume of lending. This should be possible with proper upgradation
of technology in areas which, at present, are contributing to higher costs because of
relatively low productivity.
20. The term deposit rates of public sector banks for maturities up to 1-year moved
down from a range of 4.25-7.50 per cent in March 2002 to 4.00-6.00 per cent by March
2003. The reduction in deposit rates was more pronounced for longer term deposits as
the public sector banks have reduced their deposit rates above 1-year from a range of
7.25-8.75 per cent in March 2002 to 5.25-7.00 per cent by March 2003. While the typical
short-term deposit rate (15-29 days) of the public sector banks declined by 50 basis
points during 2002-03, the rate for longer term deposits (over 3 years) declined by as
much as 200 basis points. As a result, there has been a flattening of the term structure
of deposit rates. The typical interest rate on 3-month and 1-year certificates of deposit
(CDs) also declined from 7.38 per cent and 10.0 per cent in March 2002 to 5.25 per
cent and 5.75 per cent, respectively, by March 2003.
21. In consonance with lower cost of funds, banks have reduced their prime lending
rates (PLRs). The PLRs of public sector banks declined from a range of 10.0-12.5 per
cent in March 2002 to 9.0-12.25 per cent by March 2003. The public sector banks
reduced their PLRs in the range of 25-125 basis points, private sector banks by 50-225
basis points and foreign banks by 15-325 basis points. The number of public sector
banks whose PLR was 11.5 per cent or below, has gone up from 10 to 22 between
March 2002 and March 2003.
22. In the present interest rate environment, it is not reasonable to keep very high
spreads over PLR. In the annual policy Statement of April 2002, RBI had urged banks to
review their spreads over PLR and reduce them wherever they were unreasonably
high. In response, a number of banks have reduced their spreads over PLR. The
number of banks charging maximum spread of less than 4 per cent over PLR increased
from 2 in March 2002 to 15 by March 2003 in the case of public sector banks, from 5 to
12 in the case of private sector banks and from 12 to 14 in the case of foreign banks.
One major public sector bank has reduced the maximum spread over PLR to 2.5 per
cent.
23. In recent years, there has been a persistent downward trend in the interest rate
structure reflecting moderation of inflationary expectations and comfortable liquidity
situation. Changes in policy rates reflected the overall softening of interest rates as the
Bank Rate has been reduced in stages from 8.0 per cent in July 2000 to 6.25 per cent
by October 2002, which is the lowest rate since May 1973. Similarly, the repo rate has
been moderated from 8.0 per cent in March 1999 to 5.0 per cent by March 2003.
Simultaneously, the weighted average call money rate has come down from over 13.06
per cent in August 2000 to 5.86 per cent by March 2003.
24. In the annual policy Statement of 2002, RBI had spelt out its intention of collecting
the maximum and minimum interest rates on credit advanced by banks and place the
same in public domain with a view to enhancing transparency. Accordingly, bank-wise
lending rates have been placed on the RBI website (http://www.rbi.org.in/) for the quarters
ended June, September and December 2002.
25. Liberalisation in the domestic economy combined with the increasing integration of
the domestic markets with the international financial market poses new challenges for
monetary management. It involves constant monitoring of both domestic and
international indicators and fine-tuning of policies in line with the evolving conditions.
Though the overall monetary conditions are at present comfortable in the light of
moderate inflation, easy liquidity and soft interest rate environment, the Reserve Bank
will continue to keep a constant watch on the domestic and external situation to conduct
its monetary management and also to provide more robustness to the country?s
financial architecture.
External Developments
26. According to the latest estimates of the International Monetary Fund (IMF), the
growth rate for the world economy in 2002 was slightly higher than estimated earlier
(3.0 per cent as against 2.8 per cent). For the current year 2003, IMF has projected a
growth rate of 3.2 per cent for the world economy. The growth in volume of world trade
is projected to pick up from 2.9 per cent in 2002 to 4.3 per cent in 2003.
27. The uncertainty regarding the economic outlook, however, remains high due to the
ongoing geopolitical tensions. Its adverse impact on the oil markets could have a
negative impact on economic activity throughout the world, particularly on oil importing
emerging markets.
28. An important lesson emerging from the disturbances in the global financial market
last year has been the role of sound macroeconomic policies and financial sector
reforms in strengthening the resilience of the financial sector to external shocks. In
addition to increasing the effectiveness of the system, efficient regulatory environment
and good disclosure norms constitute the crucial confidence-building measures for the
financial sector. Macroeconomic policies will have to continue to focus on strengthening
the fundamentals of the economy, financial stabilisation and promoting good corporate
governance to aid the long-run welfare gains.
29. Despite adverse external developments, India?s foreign exchange reserves
continued to record healthy growth during 2002-03 on account of improvement in the
current account as well as strong capital and other inflows. India?s foreign exchange
reserves increased by as much as US $ 21.3 billion from US $ 54.1 billion in end-March
2002 to US $ 75.4 billion by end-March 2003. Of these, foreign currency assets rose by
US $ 20.8 billion. This is the highest increase recorded in a single year and has
occurred despite substantial increase in the international oil prices and other
unfavourable developments, like lower international capital flows to developing
countries during the period.
30. It may be noted that major sources of foreign exchange reserves during the
current fiscal year have been: (a) surplus in current account, (b) increase in other capital
and (c) valuation changes in reserves. A recent study by RBI has revealed that, contrary
to popular impression, there is no evidence to show that available arbitrage
opportunities have caused the accretion to foreign exchange reserves. Almost the entire
addition to reserves, in the last few years, has been made without increasing the overall
level of external debt. The cost of accretion to reserves has also not been found to be
very significant, as most of the increase is due to non-debt inflows.
31. In recent years, the annual policy Statements as well as mid-term Reviews have
attempted to bring into sharper focus the main lessons emerging from our experience in
managing the external sector during periods of external and domestic uncertainties. The
recent experience has once again highlighted the need for developing countries to keep
a continuous vigil on market developments, and the importance of building adequate
safety nets that can withstand the effects of unexpected shocks and market
uncertainties. In this context, India?s current exchange rate policy seems to have
stood the test of time. It has focused on the management of volatility without a fixed rate
target and the underlying demand and supply conditions are allowed to determine the
exchange rate movements over a period in an orderly way. Despite several unexpected
adverse developments on the external and domestic front, India?s external situation has
remained strong. The Reserve Bank will continue to follow the approach of
watchfulness, caution and flexibility by closely monitoring the developments in the
financial markets at home and abroad. It will co-ordinate its market operations carefully,
particularly in regard to the forex market with appropriate monetary, regulatory and
other measures as considered necessary from time to time. It is heartening to note that
recent international research on viable exchange rate strategies in emerging markets
has also lent considerable support to the exchange rate policy followed by India.
32. India?s sustained efforts to build an adequate level of foreign exchange reserves in
the last few years have also been fully vindicated by recent developments. As pointed
out in previous policy Statements, the overall approach to the management of India?s
foreign exchange reserves in recent years has reflected the changing composition of
balance of payments, and has endeavoured to reflect the "liquidity risks" associated
with different types of flows and other requirements. The policy for reserve
management is thus judiciously built upon a host of identifiable factors and other
contingencies. Such factors, inter alia, include: the size of the current account deficit;
the size of short-term liabilities (including current repayment obligations on long-term
loans); the possible variability in portfolio investment and other types of capital flows;
the unanticipated pressures on the balance of payments arising out of external shocks;
and movements in the repatriable foreign currency deposits of non-resident Indians
(NRIs). Taking these factors into account, India?s foreign exchange reserves are at
present more than comfortable.
33. The substantial growth in reserves in the recent period has generated a welcome
debate regarding the costs and benefits of holding reserves. In any cost-benefit
analysis of holding reserves, it is essential to keep in view the objectives of holding
reserves, which, inter alia, cover: (a) maintaining confidence in monetary and exchange
rate policies; (b) enhancing the capacity to intervene in forex markets; (c) limiting
external vulnerability so as to absorb shocks during times of crisis; (d) providing
confidence to the markets that external obligations can always be met; and (e) reducing
volatility in foreign exchange markets. Sharp exchange rate movements can be highly
disequilibrating and costly for the economy during periods of uncertainty or adverse
expectations, whether real or imaginary. For developing countries, these economic
costs are likely to be substantially higher than the net financial cost, if any, of holding
reserves. In this context, it is important to note that in India, in the last few years, almost
the whole addition to reserves has been made without increasing the overall level of
external debt. The increase in reserves largely reflects higher remittances, quicker
repatriation of export proceeds and non-debt inflows. Even after taking into account
foreign currency denominated NRI flows (where interest rates are linked to LIBOR), the
financial cost of additional reserve accretion in India in the recent period is quite low,
and is likely to be more than offset by the return on additional reserves.
34. It may also be mentioned that most of the increase in reserves in the recent period
is through net purchases by RBI in the domestic forex market for which an equivalent
amount of domestic currency has been released to the concerned domestic entities,
including public sector units, corporates and individuals. The decision on the use of this
counterpart domestic currency released by RBI (i.e., for investment, deposits or as
liquid assets etc.) is the responsibility of the above mentioned entities and, not that of
RBI, or for that matter, the Government. Needless to add that to the extent that this
counterpart local currency is used by recipient entities for further investment in the
economy, the impact on industrial demand and growth would be favourable.
35. Strong foreign exchange reserves and low interest rates in the domestic markets
have helped the Government to prepay certain foreign currency loans from the Asian
Development Bank (ADB) amounting to US $ 1.36 billion and from the World Bank
amounting to US $ 1.67 billion. These foreign debts were substituted with domestic debt
amounting to Rs.13,000 crore by issuing securities on private placement basis to RBI.
These external loans were repaid on February 24 and 27, 2003. The above transactions
did not have any fiscal or monetary impact as it was a substitution of external sovereign
debt with domestic sovereign debt placed with RBI. Corporate bodies have also taken
advantage of low international interest rates in prepaying a part of their external
commercial borrowings (ECBs). A study by RBI has estimated that during April-
December 2002, corporates have prepaid ECBs amounting to US $ 595 million. The
total prepayment of ECBs during the last three years by corporates amounted to US $
1.1 billion and the saving in the interest burden on account of the prepayment was
about US $ 90 million.
36. The broad principles that have guided India after the Asian crisis of 1997 are:

• Careful monitoring and management of exchange rates without a fixed target or a

pre-announced target or a band. Flexibility in the exchange rate together with
ability to intervene, if and when necessary.
• A policy to build a higher level of foreign exchange reserves which takes into
account not only anticipated current account deficit but also ?liquidity at risk?
arising from unanticipated capital movements.
• A judicious policy for management of the capital account.

37. Considerable flexibility has been given to the corporates over a period to hedge their
forex exposure in the market. It is, however, observed that a noticeable portion of the
corporate foreign currency commitments remain unhedged by the corporates on the
basis of their perceptions of the market and these could impact their overall financial
status in case of unexpected developments. In earlier policy Statements, RBI has urged
banks which have large exposure to such corporates to put in place a system for
monitoring such unhedged external liabilities.
38. A related issue that has been raised recently in the media and through expert
comments by market participants relates to the movement of forward market premia.
The premia have shown considerable downward movement in recent weeks. Thus, as
of April 25, 2003, the 6-month forward premia on US dollar was only 2.1 per cent
(annualised rate) as compared with 5.9 per cent a year ago and 3.4 per cent at the
beginning of January 2003. The sharp downward movement in forward premia has
occurred because, at present, there seems to be a rush to sell dollars in the forward
market by exporters and other entities in anticipation of further appreciation of the rupee
vis-୶is US dollar. In response to this expectation, there is also a rush to "borrow" dollars
(for repayments later) and convert these into rupees now. If the rupee does appreciate,
the borrowers of dollars expect to make a financial gain (as fewer rupees would be
required to repay the "borrowed" dollars). This phenomenon is also reflected in banks
going "short" on dollars during intra-day and inter-day foreign currency trades.
39. While the demand for "borrowing" dollars for repayments later is strong, for the
same reason, the demand by corporates and others for "purchasing" dollars in
exchange for rupees in the spot and forward markets has become weaker. This has
resulted in corporates and other market participants having larger "unhedged"
exposures on their future dollar obligations. It has also led to some postponement of
forward demand for dollars. These two phenomena, i.e. higher incentive to sell or
"borrow" dollars and lower demand for actual purchase of spot or forward dollars have,
inter alia, in combination put pressure on the forward premia.
40. The Reserve Bank has received various suggestions from banks and other market
participants to meet the demand for "borrowed" dollars, arising from expectations of
continued rupee appreciation. It has been suggested that banks should be permitted a
higher level of foreign borrowings (over and above the present limit of 25 per cent of
unimpaired Tier I capital), and/or higher inflows of foreign currency deposits should be
encouraged (by increasing, for example, the ceiling interest rate on FCNR deposits
which is, at present, 0.25 percentage point below LIBOR).
41. While RBI will continue to operate in the spot and forward markets as per its foreign
exchange management policies, RBI is not in favour of increasing the unhedged
borrowings by corporates, and short term forex liabilities of banks in order to meet the
demand for "borrowed" dollars that is arising from expectations regarding future
movements in dollar-rupee exchange rate. To put at rest market speculations about
RBI?s stance in this regard, it is clarified that:

• At present, there is in fact an excess supply of US dollars in both the spot and
forward markets to meet all genuine transactions and investment demand by
corporates, banks and others. There is no shortage of foreign currency
availability in the market.
• One-way expectations of exchange rate or premia may not always be fulfilled.
Present unhedged exposures seem to be on account of expectations on
unconstrained appreciation of rupee. Movements in respect of exchange rates
may not, however, be unidirectional. This can be seen from the movement of the
Euro against the US dollar from 0.9606 to 1.1087 between September 17, 2002
and March 11, 2003, from 1.1087 to 1.0501 between March 11 and March 21,
2003 and from 1.0501 to 1.0997 between March 21 and April 25, 2003. Similar
movements have also been observed in the case of pound sterling/US dollar
rate.
• For these reasons, it is of utmost importance, particularly in relatively thin
developing country markets, that foreign currency exposures by corporates and
others are largely hedged or covered against anticipated foreign currency
earnings. It may be recalled that a part of the problem that many emerging
economies have faced in the past has been due to excessive unhedged foreign
currency exposures in a country during periods when movement in exchange
rate was absent (due to fixed exchange rate policy) or currency was appreciating.
42. The Reserve Bank has been encouraging banks to improve the export credit
delivery system in order to provide timely and adequate credit to the export sector.
Following the survey on exporters? satisfaction conducted with the help of National
Council of Applied Economic Research (NCAER), a small committee was constituted
with officers from RBI, banks and Export Credit Guarantee Corporation of India Ltd. The
Committee has so far visited 10 centres in the country from where large scale exports
are taking place and had discussions with bankers to sensitise the need for bringing
about improvements in the export credit delivery system. Reports received from banks
reveal that the suggestions made by NCAER have been largely complied with. Exports
being an important sector of the economy, banks should continue to pursue customer-
friendly export credit delivery system.
43. The performance of India?s exports during 2002-03 has been encouraging despite
the continued global slowdown. Exports in US dollar terms increased by 16.7 per cent
during 2002-03 (April-February) as against a decline of 0.7 per cent in the
corresponding period of the previous year. Imports showed an increase of 16.3 per cent
as compared with a marginal increase of 0.8 per cent in the corresponding period of the
previous year. While oil imports registered a significant increase of 26.5 per cent on
account of steep increase in the international oil prices as against a decline of 13.0 per
cent in the previous year, non-oil imports showed an increase of 12.5 per cent as
compared with an increase of 7.3 per cent in the corresponding period of the previous
year.
44. At a further disaggregated level, non-oil imports excluding gold and silver increased
by 17.6 per cent during 2002-03 (April-December) as compared with a lower increase of
6.0 per cent in the corresponding period of the previous year reflecting improved
industrial outlook. As a result of higher imports, the trade deficit widened to US $ 7.8
billion during 2002-03 (April-February) from US $ 6.8 billion in the corresponding period
of the previous year despite acceleration in exports. However, higher services exports,
such as software and buoyant inward remittances during 2002-03 (April-December),
resulted in the current account of the balance of payments showing a surplus of US $
2.8 billion as against a deficit of US $ 0.7 billion in the corresponding period of the
previous year. Going by current indications, India would be showing a current account
surplus during 2002-03 for the second year in succession.
45. With a view to liberalising further the movement of cross-border capital flows,
especially in the areas of outward foreign direct investment, inward direct and portfolio
investment, non-resident deposits and external commercial borrowing, RBI inter alia,
announced several important measures relating to current and capital accounts. A list of
measures announced subsequent to the presentation of mid-term Review of October
2002 is given in the Annex.
46. Pursuant to the announcement made in the Budget 2003-04 and moving further
towards liberalisation of capital account, RBI has also implemented the following
measures:

• Prepayment of ECBs under automatic route out of local resources/ market

purchases allowed without any limit.
 • Indian companies with a proven track record permitted to make overseas
investment in a foreign entity engaged in any bonafide business activity, up to
100 per cent of their networth, within the overall ceiling of US $ 100 million, by
way of market purchases.

47. In recent years, the Reserve Bank has been undertaking extensive consultations
with banks, market participants and experts before deciding on major policy issues
relating to the financial sector. In addition to periodic discussions, several Working
Groups were set up to consider proposed new measures that were likely to have wide
impact on the financial sector, especially the banking sector and also for examining
various policy issues. Where necessary, the reports of the Working Groups were also
put on the RBI website for wider dissemination and for inviting comments. The details of
the progress made in respect of certain Working Groups constituted recently are given
in an Annex to