Report No. 18921-IN India Towards Rural Development & Poverty Reduction (in Two Volumes) Volume 1 Summary June 24, 1999 Rural Development Sector Unit South Asia Region uE Document of the World Bank CURRENCY Rsl US$ Currency Official Unified Market a Prior to June 1966 4.76 June 6, 1966 to mid-December 1971 7.50 Mid-December 1971 to end-June 1972 7.28 1971-72 7.44 1972-73 7.71 1973-74 7.79 1974-75 7.98 1975-76 8.65 1976-77 8.94 1977-78 8.56 1978-79 8.21 1979-80 8.08 1980-81 7.89 1981-82 8.93 1982-83 9.63 1983-84 10.31 1984-85 11.89 1985-86 12.24 1986-87 12.79 1987-88 12.97 1988-89 14.48 1989-90 16.66 1990-91 17.95 1991-92 24.52 1992-93 26.41 30.65 1993-94 31.36 1994-95 31.40 1995-96 33.46 1996-97 35.50 1997-98 37.16 Jan 1998 39.36 Feb 1998 38.91 Mar 1998 39.50 Note: The Indian fiscal year runs from April 1 through March 31. Source: IMF, International Finance Statistics (IFS), line "rf"; Reserve Bank of India. a A dual exchange rate system was created in March 1992, with a free market for about 60 percent of foreign exchange transactions. The exchange rate was reunified at the beginning of March 1993 at the free market rate. Vice President: Mieko Nishimizu Director: Edwin Lim Sector Director: Ridwan Ali Staff Members: Benoit Blarel/Gajanand Pathmanathan INDIA TOWARDS RURAL DEVELOPMENT & POVERTY REDUCTION Volume I: Summary Table of Contents Currency Acknowledgements .....................i Abbreviations and Acronyms ..................... ii Economic Development Data ..................... iv Executive Summary ..................... vii Policy Matrix: Toward a Rural Development & Poverty Reduction Strategy ..........................x VOLUME ONE: SUMMARY Rural Development & Poverty Reduction . ...........................................................1 Agriculture and the Non farm Economy: Linkages ...........................................................1 The 1980s: Farm Output Soars, Poverty Drops .............................................................2 The 1990s: A Less Poverty Alleviating Growth ......4...................... .....................4 Constraints and Challenges for the Future ................................ ............................5 A Multi-Level Rural Development Strategy ................................................ . . 9 Redefining the Role of Government .10 Empowering the Poor .13 Liberalizing the Rural Economy .17 List of Tables Table 1 Income Sources In Rural India, 1994 .2 Table 2 State-Wise Growth in Agricultural GDP & Rural Wages .4 Table 3 India Spends More on Agriculture than Most Asian Economies .5 Table 4 Over-Regulated Agricultural markets & Agro-Industry .8 Table 6 Poverty and Productivity Effects of Additional Government Expenditures in Rural India .12 Table 7 Changes & Deterninants of Rural Poverty by Agricultural Regions .14 List of Boxes Box I Reforms of the Seed Industry Illustrate the Gains from Liberalization .7 Box 2 The Andhra Pradesh Irrigation Sector Reform Program .1 Box 3 Empowering the Poor: Joint Forest Management in Madhya Pradesh .16 List of Figures Figure 1 Rural Poverty Incidence .3 Figure 2 Agricultural Terms of Trade .3 Figure 3 Trends in Functional Composition of Agricultural Expenditures .5 Figure 4 Poorer States Squeeze Capital Expenditures .6 ACKNOWLEDGEMENTS This report was prepared by a team led The report benefited from comments by Benoit Blarel, and composed of Messrs. from its peer reviewers: Peter Hazell (IFPRI), Gajanand Pathmanathan and Luis Constantino. Alex McCalla and Robert Thompson (World It draws from contributions from V.J. Bank), and from comments at the India Poverty Ravishankar, Rajni Khanna and Farah Zahir Consultation Workshop: Professor C.H. (public finance); Lynn Bennett and Jacques Hanumantha Rao (Chairman, Center for Toureille (rural finance); David Marsden (social Economic and Social Studies, Hyderabad), Dr. inclusion); Jessica Mott, Ian Hill and Peter Jipp V.S. Vyas (Policy Research and Action Group, (forestry, and natural resources); Magdalena Jaipur), Dr. N.J. Kurian (Advisor, Planning Manzo, Djamal Mostefai, and Sunil Khosla Commission), and Dr. Sheila Bhalla (J. Nehru (rural power); Alok Bansal and Anil Bhandari University, New Delhi). It also benefited from (rural roads); Tahid Nawaz and Maj-Lis Voss detailed comments from John Williamson (Chief (health); N.K. Jangira and Ward Heneveld Economist, South Asia Region), Roberto Zagha (education), G.V. Abhyankar (rural water supply (Sector Manager, PREM), Ridwan Ali and and sanitation), Ashok Seth (agricultural Michael Baxter (Sector Managers, SASRD), technology). Joelle Chassard, M. Balasubramanian, Meera Chatterjee, James Hanson, Stephen Howes, Background papers for the report were Valerie Kozel, Lars Lund, Keith Oblitas, Jeeva prepared by Ashok Gulati (fertilizer), Garry Perumalpillai-Essex, Kalanidhi Subbarao and Pursell and Anju Gupta (protection coefficients Dina Umali-Deininger. and impact of economy-wide policies on agricultural prices). The report draws heavily The report was edited by Alfred from the large body of literature and research Friendly. Logistical support was provided by conducted on agriculture and rural development Theodosia Karmiris, Lalita Gamat, Grace in India, as well as several World Bank reports. Domingo and Santhakumar. - ii - ABBREVIATIONS & ACRONYMS BPL Below the Poverty Line CDF Cooperative Development Foundation CIG Community interest Group CPR Common Pool Resources DAP Development Action Plan DPAP Drought Prone Area Program DRDA District Rural Development Agency DSM Demand Side Management GATT General Agreement on Tariffs and Trade GDP Gross Domestic Product GOI Government of India GOK Government of Kerala GSDP Gross State Domestic Product EAS Employment Assurance Scheme FCI Food Corporation of India HYV High-Yielding Varieties IAY Indira Awaas Yojana ICAR Indian Council of Agricultural Research ICDS Integrated Child Development Support IFS International Finance Statistics IMT Irrigation Management Transfer IPP Independent Power Plant IRDP Integrated Rural Development Program IREDA Indian Renewable Energy Development Agency JFM Joint Forest Management JRY Jawahar Rozgar Yojana LIS Lift Irrigation Scheme LRMC Long-Run Marginal Cost MFA Multi-Fiber Agreement MOU Memorandum of Understanding MWS Million Wells Scheme MYRADA Mysore Resettlement and Development Agency NABARD National Bank for Agriculture and Rural Development NBFC Non Bank Financial Company NTFP Non timber Forest Products O&M Operation & Maintenance PDS Public Distribution System PRI Panchayati Raj Institution PROBE Public Report on Basic Education RBI Reserve Bank of India RFI Rural Financial Institutions RNFS Rural Non-Farm Sector RRB Regional Rural Bank SC/ST Scheduled Caste/Scheduled Tribe SEB State Electricity Board SHG Self Help Group SID State Irrigation Department SSI Small-Scale Industry - iii - TFP Total Factor Productivity TPDS Targeted Public Distribution System TRIP Trade Related Intellectual Property Rights T&V Training & Visit VFC Village Forest Committee WBREDA West Bengal Rural Energy Development WTCs Women's Thrift Cooperatives WTO World Trade Organization Wl UA Water Users Association - iv - ECONOMIC DEVELOPMENT DATA GNP Per Capita (US$, 1996-97): 380a Gross Domestic Product (1996-97) Annual Growth Rate (% p.a., constant prices) % of 70-71- 75-76- 80-81- 85-86- 92-93 93-94- US$ Bin GDP 75-76 80-81 85-86 91-92 96-97 GDP at Factor Cost 323.7 90.0 3.4 4.2 5.4 5.2 5.3 7.1 GDP at Market Prices 359.7 100.0 3.3 4.2 5.6 5.4 5.3 7.0 Gross Domestic Investment 90.7 25.2 5.3 3.7 5.7 6.6 12.3 11.4 Gross Domestic Saving 78.8 21.9 4.4 2.6 4.6 7.9 9.7 12.5 Current Account Balance -4.4 -1.2 -- -- -- -- -- -- Output, Employment and Productivity (1990-91) Value Added Labor Force b V. A. per Worker US$ Bin. % of Tot Mill. % of Tot. US$ % of Avg. Agriculture 82.5 31.0 186.2 66.8 443 46.4 Industry 78.0 29.3 35.5 12.7 2198 230.2 Services 105.7 39.7 57.2 20.5 1848 193.7 Total/ Average 266.2 100.0 278.9 100.0 954 100.0 Government Finance General Government c Central Government Rs. Bin. % of GDP Rs. BIn. % of GDP 96-97 96-97 90-91-96-97 96-97 96-97 90-91-96-97 Revenue Receipts 2424.1 19.0 19.3 1531.4 12.0 11.5 Revenue Expenditures 2936.8 23.0 23.1 1834.1 14.4 14.9 Revenue Surplus/ Deficit (-) -512.7 -4.0 -3.8 -302.7 -2.4 -3.4 Capital Expenditures d 436.6 3.4 4.4 399.9 3.1 3.7 External Assistance (net) 29.9 0.2 0.6 344.3 2.7 2.3 Money, Credit, and Prices 90-91 91-92 92-93 93-94 94-95 95-96 96-97 (Rs. billion outstanding, end of period) Money and Quasi Money 2658.3 3170.5 3668.3 4344.1 5314.3 6040.1 7001.8 Bank Credit to Government (net) 1401.9 1582.6 1762.4 2039.2 2224.2 2577.8 2888.2 Bank Credit to Commercial Sector 1717.7 1879.9 2201.4 2377.7 2927.2 3446.5 3753.6 (percentage or index numbers) Money and Quasi Money as%ofGDP 49.6 51.4 52.0 53.6 55.2 54.0 54.8 Wholesale Price Index (1981-82 = 100) 182.7 207.8 228.7 247.8 274.7 294.8 314.6 Annual Percentage Changes in: Wholesale Price Index 10.3 13.7 10.1 8.4 10.9 7.3 6.7 Bank Credit to Government (net) 19.7 12.9 11.4 15.7 9.1 15.9 12.0 Bank Credit to Commercial Sector 13.2 9.4 17.1 8.0 23.1 17.7 8.9 a. The per capita GNP estimate is at market prices, using World Bank Atlas methodology. Other conversions to dollars in this table are at the prevailing average exchange rate for the period covered. b. Total Labor Force from 1991 Census. Excludes data for Assam and Jammu & Kashmir. c. Transfers between Centre and States have been netted out. d. All loans and advances to third parties have been netted out. e. As recorded in the government budget. -v - Balance of Payments (US$ Millions) Merchandise Exports (Average 1990-91-1996-97) 1994-95 1995-96 1996-97 USs Mi % ofTot. Exports of Goods & NFS 32,990 39,668 42,379 Tea 386 1.6 Merchandise, fob 26,855 32,311 33,764 Iron Ore 486 2.1 ImportsofGoods&NFS 41,437 51,213 54,271 Chemicals 1,919 8.1 Merchandise, cif 35,904 43,670 48,063 Leather& Leather products 1,457 6.2 of which Crude Petroleum 3,285 3,442 4,797 Textiles 3,000 12.7 of which Petroleum Products 2,396 3,759 5,239 Garments 2,875 12.2 Trade Balance -9,049 -11,359 -14,299 Gems and Jewelry 3,894 16.5 Non Factor Service (net) 602 -186 2,407 Engineering Goods 3,229 13.7 Others 6,363 26.9 Resource Balance -8,447 -11,545 -11,892 Total r 23,610 100.0 Net factor Incomea -3,711 -3,497 -3,584 External Debt, March 31, 1997 Net Transfersb 8,093 8,506 11,071 US$ Mil. Balance on Current Account -4,065 -6,536 -4,405 Public & Publicly Guaranteed 74,406 Private Non-Guaranteed 7,382 Foreign Investment 4,922 4,794 5,834 Total (Including IMF and Short Term) 89,827 Official Grants and Aid 416 345 410 Net Medium & Long Term Capital 2,357 562 -758 Debt Service Ratio for 1996-97 Gross Disbursements 7,533 7,585 6,483 Principal Repayments 5,175 7,023 7,240 % curr receipts Public & Publicly Guaranteed 20.6 Other Capital Flows' 2,410 -2,113 1,582 Private Non-Guaranteed 1.3 Non-Resident Deposits 818 944 3,536 Total (Including IMF and Short Term) 24.5 Net Transactions with IMF -1,174 -1,719 -972 IBRD/ IDA Lending, March 31,1997 (US$ Mil) Overall Balance 6,858 -2,004 6,199 IBRD IDA Change in Net Reserves -5,684 3,723 -5,227 Outstanding and Disbursed 8,768 17,616 Gross Reserves (end of year) 21,160 17,436 22,664 Undisbursed 3,097 4,368 Outstanding incl. Undisb. 11,865 21,984 Rate of Exchange End-Mar 1998a US$ 1.00 Rs. 39.50 -- Not available. a. Figures given cover all investment income (net). Major payments are interest on foreign loans and charges paid to IMF, and major receipts is interest earned on foreign assets. b. Figures given include workers' remittances but exclude official grant assistance which is included within official loans and grants, and non-resident deposits which are shown separately. c. Includes short-term net capital inflow, changes in reserve valuation and other items. d. Excluding gold. e. The exchange rate was reunified at the market rate in March 1993. f. Total exports (commerce); net of crude petroleum exports. - vi - India Social Indicators Latest single year Same regionlincome group 1970-75 1980-85 1990-96 South Low- Asia income POPULATION Total population, mid-year (millions) 613.5 765.1 945.1 1,265.8 3,236.2 Growth rate (% annual average) 2.3 2.1 1.8 1.9 1.8 Urban population (% of population) 21.3 24.3 27.1 26.6 29.1 Total fertility rate (births per woman) 5.6 4.4 3.1 3.4 3.2 POVERTY (% of population) National headcount index .. .. 35.0 Urban headcount index .. .. 30.5 Rural headcount index .. .. 36.7 INCOME GNP per capita (US$) 180 280 380 380 490 Consumer price index (1987=100) 45 85 227 233 275 Food price index (1987=100) .. 83 238 INCOME/CONSUMPTION DISTRIBUTION (% of income or consumption) Lowest quintile 5.9 .. 9.2 Highest quintile 49.4 39.3 SOCIAL INDICATORS Public expenditure Health (% of GDP) .. .. 0.7 0.8 1.5 Education (% of GNP) .. 3.4 3.8 3.0 3.6 Social security and welfare (% of GDP) .. Net primary school enrollment rate (% of age group) Total Male Female Access to safe water f% of population) Total 31 54 81 78 76 Urban 80 80 85 83 80 Rural 18 47 79 74 72 Immunization rate (% under 12 months) Measles .. 1 84 82 80 DPT .. 41 92 83 81 Child malnutrition (% under 5 years) . .. 66 Life expectancy at birth (years) Total 50 52 63 62 63 Male 51 52 62 61 62 Female 49 51 63 63 64 Mortality Infant (per thousand live births) 132 101 72 73 68 Under 5 (per thousand live births) 202 173 85 93 94 Adult (15-59) Male (per 1,000 population) 324 261 229 239 231 Female (per 1,000 population) 353 279 219 230 206 Maternal (per 100,000 live births) .. 460 437 World Development Indicators 1998 CD-ROM, World Bank. Executive Summary India scored great success in paring the widespread adoption of scale-neutral, down the incidence of rural poverty from 55 high-yielding technology, agricultural percent in the early 70s to less than 35 growth spread to the lagging rain-fed percent by the late 80s. However, in the 90s regions and highly populated eastern states the fundamentals of rural growth and in the 1980s, becoming more broad-based poverty reduction are fading away: neither and labor-intensive during the decade than public investments in technology, rural and ever before. On-farm productivity and the social infrastructure, nor prices are favorable demand for rural labor on and off the farm to a dynamic growth in agriculture and the both rose, pushing-up real wages as rural non-farm economy that can simultaneously labor markets tightened and real food prices reduce poverty. declined. Farmers prospered, and the poor Significant policy and public benefited as rural poverty underwent an expenditure reforms are needed to restore unprecedented decline. the sources of rural development and Unlike its two predecessors, the poverty reduction, both at the central and current decade has been a period of state governments levels. The old formula slackening momentum. While there is not that combined heavily subsidized much difference in aggregate agricultural technological change and declining food growth rates between the 80s and 90s, there prices to produce both rapid farm and non- is no strong evidence that the incidence of farm rural growth, and to reduce the rural poverty has declined in the 90s. incidence of rural poverty worked well for Explanation lies with an agricultural growth India in the 1970s and 1980s. In this decade, that is less well distributed across regions: it the formula's ingredients have become both is declining in star performing states less reliable and less accessible. India's (Punjab, Haryana and to a lesser extent West fiscal crisis, for example, is sharply reducing Bengal), and deteriorating in eastern states government's ability to underwrite and Uttar Pradesh where rural poverty is simultaneously both subsidies -many of concentrated. Explanation also lies in the them wasteful- and much needed observed decline in the pace of investments in infrastructure, rural services, technological change in agriculture, human development. Globalization of the reflecting in part rapid growth in agricultural Indian economy, without matching domestic employment. Unless this trend is reversed liberalization of agriculture and non-farm and the non-farm economy expands faster, economy, is hurting the agricultural growth future agricultural growth will eventually potential as well as rural employment fall, rural wages will rise marginally, if at opportunities on and off-the-farm. In current all, and rural growth will do less to alleviate changed circumstances and with a view to rural poverty. Already, all-India (real) rural new, long-term opportunities and wages that rose at 4.8 percent per annum in challenges, India stands in need of a broadly the 1980s have slowed dramatically to 2.4% reformed rural development strategy, one between 1990/91 and 1997/98, falling or that can restore strong growth in agriculture stagnating in seven major states between and the non-farm economy as a reliable 1990/91 and 1993/94. Finally, explanation force for alleviating rural poverty. lies in part with rapid increases in the price The 1980s witnessed a broad-based, of basic -food staples (rice, wheat), labor-intensive and poverty alleviating rural preventing (real) rural wages from rising. growth. Characterized by a remarkable Behind this pattern of less poverty performance in non-foodgrains led by alleviating rural growth lie two important oilseeds, dairy and poultry products and by changes in India's broader economy. First is - viii- the fiscal crisis that is sharply reducing the them more cost-effective instruments of ability of central and state governments to rural growth, India needs to deepen the on- underwrite rapid technological change for going changes in social, legal and agriculture and development of the non-farm administrative practices in order to focus on economy through high levels of spending on the problems of the poor and combat the technology, rural infrastructure, support non-economic aspects of poverty. services and human development. Second is Improving the land market, access to forest the over-regulation of agriculture, forestry and common resources, higher-quality and products, agro-industry, and more generally more extensive literacy and health programs, the non-farm economy, that benefits neither and more tightly targeted safety nets are all farmers nor the poor. The re-alignment of needed to buttress rural development agricultural prices raises food prices, hurting programs. Fourth, the over-regulated rural the poor in the short run. At the same time, economy is at odds with an increasingly inefficiencies in agricultural markets and liberalized Indian economy. Out-of-date agro-industry becoming exposed to external policies (e.g., small-scale industry competition are passed on to farmers by way reservation, barriers to entry, state control of of lower farmgate prices and market cooperatives, rural finance, labor rigidities) opportunities that, combined with and government interventions on inadequate rural financial policies and agricultural markets (rice, wheat, sugar) institutions, discourage private investments deny agriculture and the non-farm economy at a time when public investments are (including the agro-industry) the flexibility falling. These inefficiencies further depress they need to adjust to rapidly evolving rural employment opportunities, both on and conditions brought about by globalization, off the farm by hurting the competitiveness greater (foreign and domestic) competition, of agriculture and agro-industry, and by changing consumer demands, and rising lowering agricultural incomes and demand rural wages. for non-farm goods and services. The report lays out a framework for Four main challenges face the Indian rural growth and poverty reduction. It rural economy. First, India spends more for focuses on restoring the sources of rural development than most other productivity growth in Indian agriculture developing economies, yet the composition and non-farm economy, and ensuring the of its public spending is not conducive to benefits of growth flow to the rural poor. faster, labor-intensive rural growth and The report advocates an ambitious program poverty reduction, most notably in those combining policy and institutional reforms states where poverty is concentrated. with a socially inclusive process of Subsidies in power, irrigation and fertilizer decentralization that aims at: crowd out capital formation, and lead to the 1. improving the quality of public mis-exploitation of scarce water and land spending in rural areas; resources. Second, though India is making progress in re-defining government's role 2. emipowerlng the poor; and and substituting participatory, demand- including the rural financial system. driven means of delivering infrastructure, technology and support services in rural Practically, the proposed three-pronged areas from its traditional bureaucratic, top- strategy for rural development and poverty down and centralized approach, progress is reduction would involve: far from complete and highly variable and Cutting spending on input subsidies on uneven across states. Third, the access by irrigation, rural power and urea fertilizer the poor to basic public services, assets and ichga en, few while iling safety nets is inadequate. In addition to re- which benefit few while imposing orienting policies and practices to make icreasng serious distortions in agriculture and use of natural resources; - 1X - * Spurring re-investment in more effective agricultural markets and agro-industry in and equitable infrastructure services in order to offer farmers better farmgate prices rural areas, notably roads, power, and market opportunities, while protecting irrigation, and telecommunications, and consumers and the poor from high and in rural towns and market centers; unstable food prices. Second, the reform * Supporting the provision of more agenda would require careful sequencing. effective and equitable rural services, With regard to subsidy rationalization for especially in health and education, example, priority should go to the reforms of technology generation and canal irrigation and power sectors, followed dissemination, and natural resource by the elimination of the fertilizer subsidy. management; Not only will this generate significant public * Empowering the poor and socially- savings, but also do away with the large excluded, improving their access to land inefficiencies that today compel farmers to and common resources, health and make do with highly rationed, unreliable education, safety nets and control over power and canal irrigation services; this will the institutions that deliver services and also begin to combat the environmental infrastructure in rural areas; degradation that comes from encouraging * Reanimating the rural financial system, intensive and inefficient water use where making it an efficient market-oriented water is scarce because of canal water and intermediary supporting private rural power price distortions. Third, using investments and mobilizing the savings fiscal transfer as incentive mechanisms, the that will spur the growth of the rural central government has a key role to play in economy; and encouraging state governments to reform * Adjusting agricultural price and forest their agricultural policies, spending patterns, marketing policies, and de-regulating and public administration. Fourth, with the agro-industry and rural non-farm decentralization already given a framework economy to encourage growth and in the 73rd Constitutional Amendment, state private investment in agriculture and the governments can stimulate private-sector non farm economy, while safeguarding competition and establish incentives strong national and household food security enough to encourage financial discipline, objectives. and put higher-quality, more equitable rural services and infrastructure and natural The proposed reform program is resource management on a participatory and ambitious and would require eight to ten demand-driven footing at the local level. years to be completed. Its pay-offs in terms Among those incentives are transparent and of faster, labor-intensive and sustainable non-discretionary fiscal transfers tied to rural growth and poverty reduction will be performance indicators that reward local large and commensurate with the political outcomes in resource mobilization and cost commitment needed for its implementation. recovery, improved governance, To succeed, a reformed strategy for responsiveness to local demands, social- rural development and poverty reduction inclusion, poverty reduction, natural would require a few but key ingredients. resource management, and provision of First, the reform agenda would require close public goods by local governments and coordination between central and state administration. governments. For example, the phased elimination of the power and irrigation subsidies by state governments would need to be complemented with central government measures to improve and tightly target safety nets, and to de-regulate INDIA - Towards a Rural Poverty and Development Strategy Reforms Policy Institutional Institutional Institutional Institutional Central Govemment State Government Local Govemments (PRIs) Community Empowerment A. Improve Quality Public Spending Phase-out Subsidies: Irrigation & Power Irrigation & Power Address Interstate water rights Establish: (a) Regulatory Decentralized, participatory water Establish Water User Association to Power tariffs and power sector Fiscal transfer mechanisms to Authority; (b) Water Basin management (groundwater, canal) achieve participatory water refomms encourage state reforms, and Authority; (c) Water Resource management (canal irrigation, Raise water charges to achieve cost inter-state cooperation Board groundwater) recovery (O&M) Introduce water rights Expenditure prioritization Improve water legislation Fertilizer Eliminate Retention Price Scheme Beneficiary identification Beneficiary Committee (fertilizer Reform fertilizer prices, import (fertilizer stamp program) stamp program) tariffs & policies Pilot targeted stamp program _ Invest, Improve Quality Service Delivery: Line department accountable, Community Interest Groups (CIG), Ag Technology Intellectual Property Rights Private/Public Partnership Line agencies to: (a) support responsive to PRIs CIGs including socially excluded, to (a) (R&D, dissemination) Phase-out subsidies (seeds, Fiscal transfer mechanisms to participatory, demand-driven Strengthen institutional capacity strengthen local govemance, (b) seedlings, inputs) encourage state reforms (untied, approach; (b) focus on land, water Build local governance through improve access to technology services matching grants) management (a) social mobilization, (b) by the socially excluded (targeting beneficiary choice, (c) social audit through co-financing incentives) PRI management of selected Rural Infrastructure O&M policy Fiscal transfer mechanisms to Define O&M responsibility infrastructure Market Committees (road, power, Power sector reform encourage state reforms (untied, Prioritize expenditure (O&M, market, rural towns) Allow private sector delivery matching grants) rehabilitation, upgrading) Rural Water Supply Cost recovery (O&M), capital cost Fiscal transfer mechanisms to Restructure State water agency Right to levy and set user charge Water user committees, &Sanitation sharing encourage state reforms (untied, Untied, performance-based Functionally responsible including socially excluded, to (a) Allow private sector matching grants) transfers to PRIs (co-financing Strengthen institutional capacity strengthen local govemance, (b) matrix to reflect national or state Build local govemance through improve access to sanitation services priorities) (a) social mobilization, (b) & safe water by socially excluded Functional transfer to PRls beneficiary choice, (c) social audit (targeting through co-financing Functionally responsible incentives) Support Services & Privatization, cost recovery Fiscal transfer mechanisms to Line agencies to: (a) support Right to levy and set user charge Watershed committees, CIG, Self- Productive Assets: (O&M), capital cost sharing encourage state reforms (untied, participatory, demand-driven Strengthen institutional capacity Help Groups, including socially (animal health, matching grants) approach; (b) focus on public Build local govemance through excluded, to (a) strengthen local watershed, land goods (a) social mobilization, (b) govemance, (b) improve access to reclamation...) Untied, performance-based beneficiary choice, (c) social audit productive assets and public services transfers to PRIs (co-financing by the socially excluded (targeting matrix to reflect national or state through co-financing incentives) priorities) - xi - Reforms Policy Institutional Institutional Institutional Institutional Central Government State Government Local Governments (PRls) Community Empowerment B. Empower the Poor Access to Land Assets De-regulate tenancy Fiscal transfers to encourage Land registration Assignment of land tax Community Interest Groups Land Promote women's rights state policy and institutional Reduce transaction costs, improve Improve public access to, (watershed, shepherd, tenants) reforns (untied, matching land administration transparency land administration including socially excluded grants) Forestry (JFM), Review marketing policies (TFP, Fisca tr nsfers to encourage iassets transferred to Forest Functional responsibility shared Forest Committee (poor, socially Common land NTFP) to raise value of assets Fscatplic tandfrst inscoutioale Committees under JFM with Forest Committees and excluded) transferred to Forest Committees state polrcy and msttucionag Line agencies to support Forest Department reforns (ntied mathing participatory, demand-driven grants) approach Human Development Rationalize health spending Fiscal transfers to encourage Line agencies to support Functionally responsible for Primary Education Committee, Education towards communicable diseases, state policy and institutional decentralized management management of school, health and including socially excluded Health basic health information refomns (untied, matching (school, health and nutrition nutrition centers campaigns; education spending grants) centers) Nutrition towards primary education Anti-Poverty Programs Food Subsidy (TPDS) Phase-out Above Poverty Line Target poor areas with formula- 100% fiscal transfer to PRls for Beneficiary identification Beneficiary committees (poor, Public Works (JRY (TPDS); Pilot food stamp based transfer (tied grants); co- public works tied to Below Functionally responsible socially excluded) EAS, IAY) Self-target public works by relying finance targeted labor costs Poverty Line labor on public Build local governance through Oversight PDS on market wage Improve monitoring & works (a) social mobilization, (b) Rationalize funding APP evaluation Improve monitoring & evaluation beneficiary choice, (c) social audit C. Liberalize Rural Economy Rice & Wheat Adjust GOI market interventions De-regulate agro-industry, Eliminate controls on private Sugar (price band rule, eliminate levy, small-scale industry and trade and agro-industry Oilseeds open market sales and domestic trade Reform State Cooperative Act Cotton & Textile procurement) Reform FCI Dairy Eliminate SSI reservation Improve price and market Futures Markets Relax labor regulations information system Agro-industry Liberalize extemal trade Rural Financial Liberalize rural financial policies Implement performance-based Reform State Cooperative Act Self-Help savings and credit Groups (e.g., interest rates, selective credit institutional reform program controls) Adjust NABARD role Strengthen supervision and Adjust IRDP to support regulations intermediary organizations for social mobilization and linkage of SHGs to formal RFIs RURAL DEVELOPMENT & POVERTY REDUCTION 1. Raising agricultural growth to the 9th Plan target of 4.5 percent per year would enable India to significantly increase rural incomes and reduce poverty. Significant policy and public expenditure reforms are needed to achieve that goal, both at the central and state governments levels. The formula that combined heavily subsidized technological change and declining food prices to produce both rapid farm and non-farm rural growth and to reduce the incidence of rural poverty worked well for India in the 1970s and the 1980s. In this decade, the formula's ingredients have become both less reliable and less accessible, and the incidence of rural poverty appears to have stagnated. India's fiscal crisis, for example, has sharply reduced government's ability to underwrite simultaneously both subsidies - many of them wasteful - and investments in infrastructure, rural services, human development which support the dissemination of much- needed new agricultural technology and the development of the rural non-farm economy. Globalization of the Indian economy without matching domestic liberalization of agriculture and the non-farm economy is hurting the agricultural growth potential as well as rural employment opportunities on and off-the-farm. In current changed circumstances and with a view to new, long-term opportunities and challenges, India stands in need of a broadly reformed rural development strategy, one that can restore strong growth in agriculture and the non-farm economy as a reliable force for alleviating rural poverty. 2. An ambitious program combining policy and institutional reforms with a socially inclusive process of decentralization can improve the quality of public spending in rural areas, empower the poor, liberalize the rural economy, including the rural financial system. Sequenced, inter-locking policy and institutional reforms should: * Cut spending on input subsidies on irrigation, rural power and urea fertilizer, which benefit few while imposing increasingly serious distortions in agriculture and the exploitation of natural resources; * Spur reinvestment in more effective and equitable infrastructure in rural areas; * Support the provision of more effective and equitable rural services, especially in health and education, technology generation and dissemination, and natural resource management; * Empower the poor and socially-excluded, improving their access to assets, health, education, safety nets and control over the institutions that deliver services in rural areas; * Reanimate the rural financial system, making it an efficient market-oriented intermediary supporting private investments and mobilizing the savings that will spur the growth of the rural economy; and * Adjust agricultural price policies and those influencing the rural non-farm economy to encourage growth and private investment in agriculture and the non farm economy, while safeguarding national and household food security objectives. Agriculture and the Non Farm Economy: Linkages 3. The reality that makes these reforms urgent is both demographic and economic. With 77 percent of India's population living in rural areas and agriculture accounting for 27 percent of aggregate GDP, the rural sector provides employment to an estimated 243 million people (1993) or about 70 percent of the labor force. Whether it grows, stagnates or shrinks, the rural sector and its employment opportunities are critical to sustained poverty reduction, food security at the national and household level and the size of the market for industry and services. As the main source of employment for 75 percent of the rural working population, agriculture provides about 65 to 70 percent of rural income (Table 1). Rapid agricultural growth is therefore central to sustained poverty reduction in rural areas. Yet, agriculture cannot be expected to achieve it alone. - 2 - Achieving full employment and higher incomes for rural workers critically depends on the performance of the rural non-farm sector (RNFS). The RNFS plays an increasingly important role in reducing rural poverty either directly by providing employment, or indirectly by raising agricultural wages. Three basic ingredients determine the capacity of the RNFS to grow and contribute to rural poverty reduction. First, as concluded by the Study Group on the RNFS, "the greatest stimulant for the growth of the non-agricultural economy in rural areas is dynamic agricultural sector growth" because of the multiple and strong (production and consumption) linkages that tie both sectors together. Second, adequate physical and social (education and health) infrastructure in rural areas, including in rural towns and market centers where non-farm activities typically concentrate as the RNFS develops, is also critical to its improved performance. Finally, to grow faster, the RNFS needs the flexibility and capacity to adjust to the rapidly evolving conditions brought about by globalization of the Indian economy, increased competition from goods produced in urban centers or abroad, changing demands from rural consumers, and rising rural wages. Today, however, those policies and public spending patterns that hamper growth prospects in agriculture also frustrate the development potential of the RNFS by reducing its capacity to adjust and modernize, and by cutting into Government of India's (GOI) ability to invest in physical and social infrastructure. The lesson is that agricultural growth and the policies and investments that encourage it are central to a rural development strategy that aims at alleviating poverty; accordingly, this report focuses on agriculture and the policies that influence its performance, including that of the non-farm economy. Table 1: Income Sources in Rural India, 1994 (%) Ag wage Non-Ag Non-Ag Non-Ag Per caQta Inlcome Agriculture Labor Casual wage Self-empl. Regular empl. Other Bottom 20% 38 27 16 12 4 2 2nd Inc. Quintile 38 21 15 17 7 2 3'P Inc. Quintile 45 14 10 16 12 3 4th Inc. Quintile 50 7 7 14 18 3 Top 20% 64 2 2 8 21 3 Source: Lanjouw and Shariff. 1999 The 1980s: Farm Output Soars, Poverty Drops 4. During the 1980's broad-based agricultural growth met that test. Accelerating from two percent in the 1970s to three percent and outpacing the rate of population growth for the first time since independence, it also lowered the incidence of rural poverty. Characterized by a remarkable performance in non-foodgrains led by oilseeds, dairy and poultry products and by the widespread adoption of scale-neutral, high-yielding technology, growth spread to the lagging rain-fed regions and highly populated eastern states in the 1980s, becoming more broad-based and labor-intensive during the decade than ever before. On-farm productivity and the demand for rural labor on and off the farm both rose, pushing-up real wages as rural labor markets tightened and real food prices declined. Farmers prospered, and the poor benefited as rural poverty underwent an unprecedented decline (Figure 1). 5. The twin factors behind this impressive performance have vanished. First, since 1994/95, the closed external trade regime that encouraged import substitution and diversification into non- foodgrains is giving way to a more open trade regime, and agricultural terms of trade are deteriorating (Figure 2). Import controls that maintained the domestic prices of importables (oilseeds, sugar, rubber, dairy) well above world price levels have been either removed or significantly relaxed, prompting a major re-alignment of prices within agriculture in the 90s that - 3 - caused prices of basic food (rice, wheat) to rise and that of importables to stagnate. The absence of domestic de-regulation, however, constrains Indian agriculture and agro-industry from capturing new market opportunities and facing external competition brought about by the globalization of the Indian economy. Second, the massive public spending in technology and rural infrastructure (roads, markets, electrification, canal irrigation, water supply, research and extension services, credit, education and health facilities, and subsidies for fertilizer, power and irrigation), that resulted in rapid technological change for almost all crops and simultaneously encouraged the development of the RNFS has become fiscally unsustainable. Figure 1: Rural Poverty Incidence Head Count Index (1973/74 - 1993/94) 60 _- 55 - i-- Rural 50 __ -- Urban $ 45 __ __ _ - X 40 _ ___ __ 35 _ 30 - 25 m In t- 00 c X C1 ~~ ~~~ ~~~ 00 ~ o 00 oc Note: The larger data points indicate the larger quinquennial NSS surveys, and smaller ones the smaller annual surveys Source Doff 1999 Figure 2: Agricultural Terms of Trade 1970/71 - 1997/98 95o0 - 90.0 0.flJ _ _: _ _ _ _, _,,.,, 95.0 ->fl- -t ''A 0 o- i lS2N : U g :f 9 LO N , Cc. - . a)7 Source: CommissionforAgriultural Cost and Prices. CD ' -;.;f fFf~~~) 0 03 CD a) q' a)f: ' Soure: Co'mm;' ''ff-iss ?ion-S\ s for; Arclural Cs t s an Pries -4 - The 1990s: A Less Poverty Alleviating Rural Growth 6. Unlike its two predecessors, the current decade has been a period of slackening momentum: rural growth has become less poverty alleviating and future growth prospects look dim. Obliged to observe tight fiscal constraints, GOI can no longer be generous in its outlays for rural and social infrastructure, subsidies and technology dissemination, putting in question the sustainability of a faster, broad-based rural (farm and non-farm) growth capable of reducing poverty. Until 1993/94, the latest year for which official data are available, rural poverty indicators are stagnating: as noted by S.D. Tendulkar (1998), "the rural poverty situation deteriorated sharply in 1992 and reached approximately their pre-reform level by 1993/94"; there is no strong evidence that the incidence of rural poverty has declined since 1993/94 (Figure 1). Explanation for this less poverty alleviating growth lies in part with an agricultural growth that is much less well distributed across regions: it is actually declining in star performing states (Punjab, Haryana and to a lesser extent West Bengal), and deteriorating in eastern states and Uttar Pradesh where rural poverty is concentrated (Table 2). 7. Explanation also lies in the observed decline in the pace of technological change in agriculture (measured by growth in Total Factor Productivity or TFP), with latest estimates even suggesting a negative TFP growth between 1990 and 1994 - the result of rapid growth in agricultural employment. Unless this trend is reversed and non-farm economy expands faster, future agricultural growth will eventually fall, rural wages will rise marginally, if at all, and rural growth will do less to alleviate rural poverty. Already, all-India rural wages that shot up to an 4.8 percent annual rate (in real terms) in the 1980s have slowed dramatically to a 2.4 percent annual increase between 1990/91 and 1997/98; rural wages were actually falling or stagnating in seven major states between 1990/91 and 1993/94 (Table 2). 8. Public funds shrink; food prices rise and aggregate price incentives stagnate. Behind this pattern of less Table 2: State-Wise Growth in Agricultural GDP, poverty alleviating rural growth & Rural Wages '- 1990-1996 (% per annum) lie two important changes in Agricultural Rural Wages India's broader economy. First GDP growth (real terms) is the fiscal squeeze that has 1981-91 1992-96 1980-89 1990-94 sharply reduced the ability of North central and state governments to Punjab 4.7 3.1 3.6 2.3 sustain high levels of spending Haryana 4.2 3.2 3.2 1.4 on technology, rural Uttar Pradesh 2.7 2.4 6.6 -1.3 inf te, uport rvi East infrastructure, support services Bihar 3.1 -1.7 4.7 -2.1 and human development that Orissa 2.2 0.4 5.8 3.9 historically boosted productivity West Bengal 6.1 5.8 5.3 0.8 growth in agriculture and the Centerdeeomnoftennar Madhya Pradesh 1.8 4.5 6.2 15.8 development of the non-farm Rajasthan 3.5 3.7 5.1 -8.1 economy. Second is the over- West regulation of agriculture and Gujarat -0.7 2.9 3.0 -1.2 agro-industry, and more Maharashtra 3.5 4.4 8.6 1.7 generally the non-fanm economy South Andhra Pradesh 1.7 3.0 6.4 -4.0 that benefits neither farmers nor Karnataka 2.5 4.7 5.3 -6.7 the poor. The re-alignment of Kerala 2.1 5.3 3.5 3.3 agricultural prices raises food Tamil Nadu 3.3 4.1 8.3 8.3 prices, hurting the poor in the All India 2.9 3.1 4.8 1.1 short run. At the same time, Source: Government Spending, Growth and Poverty: An Analysis inefficiencies in agricultural of Inter-Linkages in Rural India, IFPRI, 1998. markets and agro-industry becoming exposed to external competition are passed on to farmers by way of lower farngate prices and market opportunities, discouraging private investments at a time when public investments are squeezed. These inefficiencies further depress rural employment opportunities, both on and off the farm. Constraints and ChallengEes for the Future 9. While Indian agriculture has the potential to grow at a sustained level of 4.5 percent per annum, the report suggests that structural problems prevent the sector from even sustaining its historical 3-percent annual growth and successfully reducing poverty at the same time. The quality of public spending is the first of those problems. Compared to other Asian economies, India's central and state governments appear to be getting poor results for outlays on agriculture and rural development equivalent to about 6 percent of GDP or 25 percent of agricultural GDP (Table 3, Figure 3). 10. The composition of public spending for rural development is not appropriate and is inefficient. First, subsidies in power, irrigation and fertilizer increasingly dominate public spending on rural development and crowd out public capital formation and non-wage expenditures in physical and social infrastructure known to encourage private investments, productivity growth, the non-farm economy and poverty reduction (Figure 3). The fall in capital formation in physical and social infrastructure is more pronounced in those states where rural poverty is concentrated (Figure 4). Input subsidies for power and irrigation are also harmful to agricultural growth in the short run by compelling farmers to make do with highly rationed, unreliable power and canal irrigation services. In addition, combined with inadequate management policies, these subsidies so threaten the sound water and land management needed to Table 3: India Spends More on Agriculture than Most Asian Economies (Public spending on agriculture as a % of Ag GDP) India China Indonesia Pakistan S. Korea Thailand Malaysia Average 1990-93 12.8 6.4 7.7 3.4 19.2 17.5 9.4 Memo Item: Ag. Growth Rate (1990-96; % 2.46 6.50 2.80 3.70 1.73 2.82 2.75 year) Source: Government Spending on Asian Agriculture: Trends and Production Consequences. S. Fan & P.G. Parde, 1997. Figure 3: Trends in Functional Composition of Agricultural Expenditures 25 20 0 15 -10 0 86/7 87/8 88/9 89M0 90/1 91/2 92/3 93/4 94/5 9516 96/7 g Capital Growth Enhancing Exp. a Other Growth Enhancing O Safety Nets M Subsidies Source: World Bank - 6 - support intensification that agricultural scientists and economists are increasingly concerned about the sustainability of the rice-wheat cropping systems in the Indo-Gangetic plains and India's capacity to satisfy future food demand. Figure 4 Poorer States Squeeze Capital Expencitures .... percent GSDP . Orissa Madhya Pradesh Bihar 0.0 1 - _ t_ vS4 states Average co O ar Pradesh 0) 0 ') - ~~~~0) Years 2 11. Improving the Quality of Services in Rural Areas. India is making progress in re- defining government's support role to the sector and substituting or experimenting with participatory, demand-driven means of providing infrastructure, technology and support services for the traditional bureaucratic, top-down and centralized approach. These developments are highly variable and uneven across states and services. There has been marked progress -- and benefits -- in liberalizing the seed industry (Box 1); but, additional steps are needed in the trade regime, seed regulatory framework, testing and release procedures to expand further access by farmers to a wider range of improved seeds. By contrast, progress is less forthcoming in livestock breeding and curative services where state government staff continues to dominate, crowding-out private sector and undermining competition. The landscape of technology dissemination services is undergoing major changes with the rapid entry of the private sector in input distribution, and the emergence of alternative service providers (private, cooperative, NGOs) in selected areas or agricultural activities. State governments, however, are not taking these developments sufficiently into account in adjusting their mode of technology dissemination services. The federal government is also encouraging participatory, demand-driven, cost-sharing approaches in the delivery of selected services such as rural water supply & sanitation, watershed programs. Progress among states remains uneven or slow, in part, because of the limited fiscal incentives the central government offers them in reforming their sectoral policies and institutions. 12. As a result, government delivery of public services often remains a centralized, inefficient top-down process that is not responsive to rural needs. Funding priorities that emphasize physical and financial targets and spending norms, domination by largely non- accountable government departments and the absence of arrangements to share costs and decision-making with local governments or beneficiaries promote distortion in investment decisions and undermine cost-effectiveness. It also discourages the knowledgeable participation of the local communities, including the poor, the socially excluded and other interest groups. Kept at arm's length in the selection, design and execution of rural development programs, the local institutions that are expected to take over operation and maintenance responsibilities have - 7 - little sense of ownership. Much remains to be done to systematically and sustainably improve the effectiveness of government programs in the countryside and, importantly, to promote private sector involvement in rural areas. 13. Focusing on the poor. Related to the quality of public spending is its inclusiveness. In addition to reorienting policies and practices to make them more cost-effective instruments of rural growth, the report suggests that on-going changes in social, legal and administrative practices should be deepened to focus on the problems of the poor and combat the non-economic aspects of poverty. Improving the land market, better access to forest and other common resources, higher-quality and more extensive literacy and health programs and more tightly targeted safety nets are all needed to buttress rural development programs in general and to build on the dynamism of economically viable, family farms for sustained poverty reduction. 14. Many of the landless households that make-up about half of the 320 million rural poor and the marginal land owners who, together, account for 90 percent of all households leasing land are penalized by imperfections in land markets. They arise from legislative restrictions on land leasing, high transaction costs in land sale-purchase markets that fall disproportionately on the poor and social customs that exclude women from exercising effective, independent land rights. This is particularly notable in some of the former Zamindari states of North and Eastern India, discouraging more efficient and poverty-alleviating land utilization patterns. 15. A range of formal and informal policies tend to reduce access by the poor and socially excluded groups to common resources (land, forestry) on which they depend for their economic survival. It has been estimated that poor households, derive 23 per cent of household income from common lands, compared to just I to 3 percent for non-poor households. The 1988 National Forest Policy envisioned joint forest management and benefit sharing as important sources of rural income generation and poverty reduction among the poorest of the poor. The promising experience with implementation among the early-adopting states, indicates that the poor would benefit significantly from a more widespread adoption of the National Forest Policy which capitalizes on best practices, and the careful re-assessment of existing forest product marketing policies that may artificially devalue the resources transferred to forest communities.. 16. There are limits, however, to what can be usefully achieved through land re-allocation in the Indian context. Steady increases in demand for rural labor would contribute more (or at least as much) to equity gains. In the Indian countryside, where growing numbers are net consumers rather than net producers of food, wages are at least as likely as crop earnings to keep or lift - forRefof the Seed Iadstry :lushtrt theCGalns trom Uberalization Recent stdies of the Indian seed industry and proJJect experiece confim that fairmers are benefiting from the opening-up of the industry initiated by (Ot in lfte 80i and A-pelerated sikm 1991. The tripling of private research expendituresimproved compettion and competitivenss offheldian seed insy, and a positive impact of prvate sector-ed varietalimprovemet irn fiuer yiaids are maring the opeing of seed policies and regulations and increased commercialization f state seed emporations. Furher libemlizaion in the seed industry would lead to more private researh -and benefits.to farers-. Iports and exports of comnercial seeds remains ig reict-for a r crops An ineffective,quaranine system together with non- transparent gerrnplasm- collection. polity nrin imrt of germplsm -and the strong, obseed complemcenlarities between foren and domestic research. An inadequate intellectual property rights (IPR) iframework father liittis prive sector involvement beyond hybrids, leaving the bulk of seed requirements for major fdcrops such as rice and wheat outside tie purview of the priv*a sector. Te same research, however, cnfirms the strong complenrenritiebeteen public and private setr research. Source C-E. Ptay, . uRmaswn T. Kell, ,1998 D. Gisselquist&S. Kala, 199 WoAdB kCRSeed DeveiopMent Project - 8 - families out of poverty. For the poor, the size and stability of earnings from whatever source, however, are intimately related to the health and literacy levels of workers, and to the efficacy of safety net programs. However, as elaborated in the recent World Bank report on Poverty in India, public spending is not contributing effectively either to developing human capital or to maintaining reliable safety net programs. 17. Costly regulation of the rural economy. Inadequate rural infrastructure, including in rural towns, seriously impedes the smooth development of India's commodity markets and agro- industry, and more generally the rural non-farm economy. This limits the ability of Indian farmers and agro-industrialists to respond to fast rising demand, often export-led. Large inefficiencies are observed in the marketing and processing of rice, wheat, sugarcane, oilseeds, cotton (including textiles) and dairy products. Markets and agro-industry, and the small-scale industry which pervades the rural economy, remain over-regulated (Table 4). Large direct government interventions in the rice, wheat and sugar markets crowd out efficient private-sector (including independent cooperatives) activities in marketing and processing. In agriculture, these pervasive inefficiencies cause marketing and processing margins to be needlessly large and reduce its competitiveness. The evidence of the last few years shows that, in the absence of domestic reforms to trim margins and improve marketing and processing efficiency, the export or import liberalization course that India pursues to meet its WTO commitments or combat food price inflation penalizes farmers by depressing farmgate prices below parity levels (e.g., oilseeds, sugar). By the same token, it also reduces non-farm employment opportunities by lowering agricultural incomes and the demand for non-farm goods and services, and by reducing the capacity of the agro-industry to compete effectively. As argued by the Abid Hussain Committee (1997), the small-scale industry (SSI) reservation is a case in point, but there are other policies (barriers to entry, labor rigidities, export incentive schemes) that do not place rural-based industries on a level-playing field with either external competitors or domestic urban-based industries. As many as 54 percent of the items reserved for exclusive SSI production fall under a free trade regime. Barred from modernizing and competing effectively, imports of rural industries reserved for exclusive production by the small-scale sector increase, and rural job opportunities are being missed. For example, exposed to free edible oil imports, the SSI reservation policy Table 4: Over-Regulated Agricultural Markets & Agro-Industry Rice Wheat Sugar O=iseeds Cotton Dairy & Textile Central Government: FCI/TPDS (pan seasonal & territorial price) /VV/ V'i // / Dual Market V/I VVV i/i Forced Procurement (levy) V15 / i/V Essential Commodities Act VVV /V// 5V/ /V (V1/5) Selective Credit Controls (RBI) ("/""/') (V/"') '/ (V/) (Vv'5) Size Reservation (SSI) VI15 V51' Barriers to Entry (.1// ) isv Administered Prices (sugarcane, ginning) "/b" (vii) Ban forward & futures markets VV" Vi 4' ( //) (1'/) Health safety legislation & enforcement 5 5 V State Governments: Movement controls VV / 5 5,15 Storage controls "v iv.%/ V' V/ Regulated markets management V V i/ /5V Control on Cooperatives V 55 Non-unitary & multi-point taxation V'/ I' Source: World Bank Note: The number of "5l" indicates the intensity of the inefficiencies imposed by the corresponding policy or regulation. (/) means either lifted or recently repealed. -9 - (among others) prevents the small-scale, fragmented, under-utilized Indian oilseed processing industry from competing effectively with large, highly efficient foreign firms. Many of the reserved products are also star export items, often produced in rural areas. With few constraints to export growth, highly labor-intensive industries such as garments, hosiery, silk textiles would have done even better, and may be missing large employment opportunities under the planned dismantling of the Multi-Fibers Agreement. 18. The rural financial system is another example of policy and regulation that hinders the development of the rural economy. Driven in past decades primarily by the desire to finance agricultural investment as part of a wider effort to assure food security through low-cost inputs, rural financial policies succeeded in establishing an impressive rural financial infrastructure. Under changing conditions, however, the multiplicity of government-promoted public sources of credit such as cooperatives, nationalized commercial banks, regional rural banks (RRBs), the National Bank for Agriculture and Rural Development (NABARD) and new, state-level agricultural finance companies, not only leaves little room for private-sector growth but also perpetuates inefficient lending patterns that reward capital-intensive investments instead of labor- intensive technologies and firms. Similarly, the manifold macro- and micro-level regulations on rural financial institutions (RFIs) create high transaction costs for borrowers and lenders, undermines a commercial banking and repayment culture, and appears to steer credit away from would-be non-farm borrowers whose unmet demand is large and into more formal, large-scale activities where capital substitutes for labor. In addition, RFIs are experiencing significant loan- recovery problems. Available data suggests that only about 60 percent of loans are repaid on time, if at all. A Multi-Level Rural Development Strategy 19. The point of reforming rural development strategy is to put in place a framework for faster growth that will roll back poverty. The strategy, therefore, needs to focus both on restoring the sources of productivity growth in Indian agriculture and the non-farm economy, and on ensuring that the benefits of growth flow to the rural poor. To achieve these related goals, an ambitious program of policy and institutional reforms is recommended which has to be accompanied by measures of decentralization that remove structural policy and institutional deficiencies and permit decision-making at the grass roots to shape public investments and service provision. 20. Reviving productivity growth will require the rural sector to be able to respond to the changing patterns of increasing domestic demand for new and diverse commodities such as livestock (and foodgrain), horticultural products, processed food items and agro-industrial products. Capturing these demand-led growth opportunities in a more open and competitive trade regime, while at the same time facing greater competition for land and water resources, will require improved management of land and water resources, the spread of technology to areas where yield gaps are important and the development of new technology to counter stabilizing yields in others. Policies that now give little or no priority to such concerns must now be changed to encourage the requisite shifts. 21. The report suggests that domestic markets should become more efficient at moving goods from surplus to deficit regions, providing appropriate arbitrage signals and encouraging farmers to specialize in those commodities where they enjoy a natural comparative advantage. A third essential for boosting rural productivity is the modernization of India's agro-industrial complex and more generally the RNFS. The policy framework and public interventions must facilitate technological change and modernization so that the RNFS can contend effectively with competitors (domestic and foreign), offer high and stable prices to farmers, and expand non-farm employment opportunities. - 10- 22. To achieve rapid rural growth that also alleviates poverty, new policy instruments and approaches are required to reconcile farmers' interests in higher food prices with the needs of the rural poor for earnings and public support that can lift them out of destitution. Public expenditures that have the effect of cutting into the sources of growth in (farm and non-farm) employment opportunities and higher rural wages serve the interests of neither farmers nor the poor, and it is with improvements in the quality of those expenditures that reform should begin. A comprehensive rural development strategy must also empower the poor, and liberalize the rural economy, including the rural financial system. Redefining the role of Government 23. Eliminating input subsidies. Improving the quality of increasingly scarce public resources is a key aspect of the proposed strategy. Two lines of attack should be followed in reforming public expenditures. First, rural development spending should be put on a rational footing, phasing-out input subsidies and re-investing savings in growth-enhancing and poverty reducing measures. Second, the delivery of public services in rural areas should be improved so that intended beneficiaries become active participants, and the private sector gains a widening role in providing a range of services from agricultural technology, to infrastructure and credit on and off the farm. 24. With regard to subsidy rationalization, priority should go to the staged elimination of irrigation and power subsidies, followed by those for fertilizer. Not only will this allow significant savings but also begin to combat the environmental degradation that comes from encouraging intensive and inefficient water use where water is scarce or from chemical pollution where fertilizer is improperly applied because of price distortions. The savings from ending subsidies can be productively applied to agricultural productivity growth-enhancing that, historically, also encouraged the development of the RNFS. To be economically and politically sustainable, however, subsidy reduction needs to be -sequenced and combined with selective investments, policy and institutional measures that boost farm productivity, protect the poor, raise farmgate prices and enable farmers to adjust their cropping patterns. 25. Phasing-out the fiscally more significant irrigation and power subsidies before those for fertilizer would generate greater savings that state governments could redirect to assuring reliable canal water and power supplies that would have an immediate and positive impact on agricultural growth. In contrast, eliminating the fertilizer subsidy, without compensatory investments in long gestating growth-enhancing expenditures, would have negative consequences on agricultural output, food prices and income distribution. 26. Canal irrigation. The analysis suggests that to achieve cost recovery and improve water management, spending priority for canal irrigation should go to low-cost, deferred maintenance work that restore reliable service before shifting to modernization and expansion investments. As demonstrated by Andhra Pradesh, concurrent institutional changes that promote participatory, decentralized irrigation management considerably strengthen and facilitate the technical, economic and political viability of irrigation reforms (Box 2). Recognizing the need for regional variation, international and Indian experiences indicate that a few, common principles should guide irrigation sector reform. Among them are (a) establishing independent, state-level water tariff regulatory commissions to regulate and monitor the performance of water authorities and water user associations (WUAs) and set and review water charges; (b) transforming State Irrigation Departments into functionally specialized, managerially and financially autonomous water authorities on a scheme or a river basin basis to manage water development and distribution to multi-sectoral end-users (e.g., agriculture, industry, urban, environmental), and the operation and maintenance of irrigation systems (canal and drainage major structures and above); (c) establishing similarly independent WUAs with the legal authority and responsibility to manage - Il - O&M of minors/distributories and water within the group, and collect water charges from their members; (d) introducing volumetric pricing and raising water charges to be collected from WUAs and fully cover O&M costs; and (e) introducing a system of enforceable water entitlements or water rights among multi-sectoral end-users and organizing mechanisms for dispute resolution and for adjusting or exchanging water rights among states and sectors 27. Rural power. As with the phasing-out of irrigation subsidies, a sound strategy for eliminating the power subsidy to agriculture must be twinned with medium-term measures to improve the quality of electricity services and decentralized groundwater management. The subsidy cannot be eliminated overnight: both farmers and the power industry need time to adjust. In the short run, power pricing reforms would involve metering and shifting to consumption- based tariffs with regular adjustments to reflect inflation, improvements in power supply and end- use efficiency, as well as financial requirements from power utilities to meet demand and improve the quality and efficiency of their services. Power policy reforms, as initiated in Andhra Pradesh, Orissa and Haryana, would be central to closing the accountability gap in the power sector, and to creating strong incentives for capturing large efficiency gains in the delivery and end-use of power services in rural areas. Early evidence indicates that overall efficiency gains in the order of 50 percent of the cost of power required to meet current (groundwater) requirements are possible, and would considerably reduce the additional cost burden to farmers of the power subsidy phase-out. 28. Fertilizer. The anticipated surge in productivity flowing from improved canal irrigation and power supply and from renewed investments in rural infrastructure and technology would make it possible to phase-out fertilizer subsidies without depressing agricultural output and driving food prices higher. In the short run, streamlining the subsidy while it remains in place can generate efficiency gains in both agricultural and fertilizer production. The gains would come from improving the balance in the way chemical nutrients are applied; raising urea prices would diminish its use while explicit subsidies for potassium and phosphatic would act as incentives for a better mix of fertilizer application. BrpZ:TheAnhr Prdeh rriatonSeetor iUeforx Prga Faced ith decl g irrigain reue under-un ing andineget of maintnanc and lac of ftirmer involuement, An radesh initiatbred since 1997 a major seprogram. The rfms cntreed on intiaioA mnget ts T) tie -W UA supp by policy, prici g public ependiturannsitutionarefs. Act'Ion fa-t iUd: . Poicy isanc -a ptolic dcunet Ia t reform . . . : . Commankunityoutreah: a continuous .and-interactiv process including worhops with NGOs and p dati p and rural rlilies;. * Teipplig water- cage9done in -7 and now-fo11owed y a campaign0 to raise collection. A water Chags eie.w Committee....... ha als bee - :tabl--shed; * legslation: isance of the Farmes Magement of Irrigation System 997) esshing the lega bsis and modalties forl .- * Creation of WUA aross tie State: 10,292 WUAs elected in June 1997 covering al major, medum. and minorsfa irrgton semes (4.9 milo ha 17 D o ommittes rie in November 1997; * Traiing: m aining ofWUAs iigion datem staff and NGOs; * Soint 'wakthroagb of all systems , by, WUAs and ira drnt to only idt oations improement nee4s: * Lauhing the operio iit oi; t r :det :dn May-June, 1998 canal closure period. About Rs. 1,600 million (USS 38 milliOperations improvement works were irmpleented 7% of which by WUAs and Distri-urory Crn mittees, and 30% by the rrigaion deparmen on the main canal and drains.- Source WorldBank- -12- 29. Further, as recommended by the High Powered Fertilizer Pricing Policy Review Committee (1998), the abolition of fertilizer allocations under the Essential Commodities Act and elimination of the Retention Price Scheme (RPS) would also spur efficiency gains in fertilizer production and distribution. Going further, the Report recommends that an import tariff should take the place of the RPS, and a one-time compensation or capital subsidy to fertilizer units having made erroneous technological (feedstock) choices based on earlier distorted oil- and fertilizer-policy regimes would be a more efficient and fiscally cheaper solution than incurring the risk of unlimited liabilities based on the long-run marginal cost of fertilizers and feedstock price differential. 30. Investing in more and better services. As a vital contribution to its overall rural development strategy, state governments would need to re-invest in a wide range of public goods and services that support rural (farm and non-farm) growth and poverty reduction (Table 6): technology dissemination, rural infrastructure, power supplies, natural resource (land, water, forest) management, watershed development, but also human development (health, education) . At the same time, money alone will not be sufficient and India needs to deepen its on-going efforts at elevating the quality of a wide range of rural services by promoting a more participatory and demand-driven approach to the delivery of public goods and services. The central government has a critical role to play in encouraging states to experiment, and in rewarding them to scale-up and adjust their sectoral policies and institutions. Indian experiences point toward re- orienting the role of government as the means to this end, one that focuses on public goods and market failures. Relevant reforms would strengthen the private sector as the commercial provider of many services and inputs while Government would strengthen participatory, demand-driven mechanisms for the delivery of public goods. 31. Any strategic commitment to spur rural growth and reduce rural poverty requires a shift away from top-down, centralized management into bottom-up, demand-driven and participatory mechanisms for the provision of rural infrastructure and support services. Decentralization experiences in many states such as Kerala and Andhra Pradesh as well as numerous successful pilot or individual programs (technology dissemination, rural water supply; watershed programs, joint forest management) are demonstrating the benefits of such a strategic shift. 32. Natural resource management. Natural resource management is fraught with externalities and provides many international, national and local public goods. Natural resources are therefore a high priority for government intervention. Unfortunately government intervention in natural resources is often misguided in India: too much public effort goes into delivering Table 6: Poverty and Productivity Effects of Additional Government Expenditures in Rural India Government Elasticities Marginal Impact Expenditures: Rural Agriculture Rural Agriculture Poverty Productivity Poverty Productivity Growth Growth (TFP) (TFP) Ag. Technology - 0.065 (2) 0.296 (1) - 0.48 (2) 6.98 (1) Irrigation - 0.007 (5) 0.034 (4) - 0.04 (6) 0.56 (3) Road - 0.066 (1) 0.072 (2) - 0.87 (1) 3.03 (2) Education - 0.054 (3) 0.045 (3) - 0.17 (3) 0.43 (4) Power - 0.002 (6) 0.0007 (5) - 0.015 (8) 0.02 (5) Soil, Water Conservation - 0.0004 (7) 0 (6) - 0.035 (7) 0 (6) Safety Net Programs -0.019 (4) - 0.15 (7) Health -0.0007 (8) - 0.02 (4) Note: Numbers in parentheses are ranks Source: Government Spending, Growth and Poverty: An Analysis of Interlinkages in Rural India, IFPRI, 1998 - 13 - services that should be left to communities and the private sector; instead insufficient attention goes into creating a policy and institutional framework conducive to sustainable resource management that benefits the rural poor. Natural resources have the potential to play three critical roles in the Indian economy: (a) as a safety net for the rural poor who use a disproportionate share of natural resources in both production and consumption (e.g., fuelwood, non-timber forest products, range management, fish, lakes and ponds); (b) as natural capital for the rural sector in helping sustaining productivity of the farm sector (e.g., surface and groundwater, watersheds, soil and water conservation); and (3) as outputs which can play an important role in resource intensive rural economies (e.g. timber, fish, non-timber products) to contribute to rural growth. These potentials are not being realized. The poor's access to the natural resource safety net is under threat, because control over natural resources has been appropriated by government or local elites. The quality of the natural resource base is declining because of power and irrigation subsidies, excessive use of urea. And the value and quantity of outputs from natural resource sectors can be depressed by government ownership of downstream production and marketing activities. The strategy for natural resources should be to refocus government on the management of externalities and policies regarding provision of public goods, the definition and enforcement of property rights, the facilitation in the resolution of conflicts, and the empowerment of the poor in their access to natural resources of importance to them, rescinding its role on downstream production and marketing where the private sector, including community interest groups, could be brought in much more efficiently. Empowering the poor 33. For poor rural Indian households to share the benefits of more rapid growth, a comprehensive development strategy must ensure not only that growth takes labor-intensive forms, but that the access of the poor to land and other assets widens significantly and that the quality of the health and education programs that serve them rises steadily. The fundamental refortns needed in health and education services have been identified in companion World Bank reports. In addition, one broad, systemic set of reforms has the potential to achieve successful progress in all areas - purposeful decentralization that gives the poor and the excluded the power to assert their demands for public services and to put their concepts of effective programs into practice. 34. Regionally differentiated strategy. Reflecting the wide variety of India's agro-climatic regions, actions to make rural growth labor-intensive and lift agricultural productivity should be tailored to the different settings. Agricultural potential varies greatly between irrigated, high and low potential rain-fed regions. Rural poverty also shows considerable regional variation, being more prevalent and concentrated in rain-fed than in irrigated regions (Table 7). Since the marginal returns from investments in technology, infrastructure and additional irrigation run higher in rain-fed than irrigated regions, the report suggests that a sensible poverty reduction strategy would invest more where the growth and poverty reduction payoffs are higher. In the high rainfall areas of eastern India, the high employment elasticities of agricultural growth will make agricultural growth especially labor-intensive, provide significant employment opportunities to the large number of landless and marginal farmers, and raise agricultural wages. Policy and institutional measures that support renewed land-improving investments in irrigation, drainage and flood control, rural infrastructure and technology dissemination that benefit many are likely to be important for further productivity growth. Improving access to land by landless and marginal farmers would also help achieve a more poverty-alleviating growth. - 14 - Table 7: Changes and Determinants of Rural Poverty by Agricultural 35. In the low-potential Regions In India (1972, 1987, and 1993) dryland areas, participatory Irrigated Rainfed Areas and demand-driven Areas Total High Low programs in technology Potential Potential development and % of Poor in rural 1972 45 54 51 57 dissemination, watershed, population 1987 41 47 44 49 joint forestry and common 1993 37 140 33 45 ln aaeet n Number of poor 1972 66 95 41 55 land management, and (millions) 1987 75 103 44 59 income generation that 1993 73 96 37 59 empower the poor will be Estimated Poverty particularly important to Function: meet the area-specific Ag. Production -0.095 -0.635* -0.287* Wage -0.127* -0.157* 0.052 requirements of these less Terms of Trade 0.180 0.175* 0.181* favorable and risk-prone *: statistically significant at 5% level. R= 0.757 regions, and the need to Source: P. Hazell, S. Fan (1998): Balancing Regional Development Priorities to Achieve manage sustainably the Sustainable and Equitable Agricultural Growth; IFPRI, Washington D.C. fragile natural resource base through greater decentralization and improved property rights over common resources. In the high productivity irrigated regions, because labor absorption of agriculture is low, investments in human development and rural infrastructure that empower the poor would do more to reduce poverty. Such investments are particularly critical for developing the non-farm economy and improving access to employment opportunities by the poor and disadvantaged groups. 36. Safety-Net Programs. India's diverse, over-lapping and often ineffective programs to shield the poor against insecurity are ripe for consolidation and could be turned into an effective permanent safety net that insures the poor against risk, and responds flexibly to their needs. This matters to both protecting the poor from a crisis, and to longer-term prospects of escaping poverty in risky environments, particularly for the poor and socially excluded, since this spills into their investment decisions, including education. Indian experience (and elsewhere) suggests a unified JRY-style public works program under direct Panchayati Raj Institutions (PRIs) administration, provided it is targeted effectively and tightly to the genuinely needy, can be one option for an effective permanent safety net. It would need to be combined with targeted transfers to reach those who cannot work, or should not be drawn out of school. 37. Effective targeting need not be exclusive targeting. Indeed, to maintain political support, some level of spillover to the non-poor is unavoidable. In public works programs, however, setting the wage rate for unskilled manual labor at levels no higher than prevailing market wages and making willingness to work the only criterion for eligibility can insure that the poor take the jobs being created, minimize work disincentive and adverse selection under rationing when the wage is set too high. Activating such schemes where the incidence of poverty is high through geographical targeting, and encouraging the poor to select the projects (infrastructure or asset to be created) would also add to targeted impact. 38. As recommended by the Hashim Committee (1997), one essential first option is to consolidate the current regime of multiple public-works schemes (JRY, EAS, IAY, MWS), each with resources tied to specific assets, different guidelines, implementation agencies, reporting requirements and poverty criteria, into a system that transfers untied resources from central and state governments to local governments (PRIs) for their implementation. Additional steps are worth considering. Going further, a consolidated public-works program could make willingness to work at a wage no higher than the prevailing market wage for unskilled labor the only test of eligibility. As a further option to encourage local governments to use such targeted, labor- - 15 - intensive works programs in place of cumbersome and easily flouted labor content guidelines, the new scheme could simply offer to co-finance 100 percent of the (targeted) labor component of any qualifying public works. The non-wage component of the public works would be financed out of the own resources of local implementing agencies, either mobilized locally or from (block or matching) grants devolved to them under a decentralization framework. 39. The food subsidization program also needs to be rationalized. The current TPDS scheme, as often as not, delivers its benefits to the non-poor. Further strengthening the targeting mechanisms of the TPDS to below the poverty line (BPL) households would be one important way of improving performance; initial evidence from eastern UP and Bihar, suggests that community involvement has the potential to improve the targeting of TPDS to BPL households. The same initial evidence, however, also suggests that incentives for diversion of the subsidized rice and wheat to the open market remain strong, if not stronger. A new strategy calls therefore for experimenting with alternative food transfer mechanisms such as food stamps that have the potential to minimize incentives for diversion, reduce the costs of transferring the food subsidy to the poor, and reduce the crowding-out of private sector participation from direct government interventions in the rice and wheat markets. As the Food Corporation of India shrinks TPDS coverage for non-BPL households and crowds-in the private sector by establishing a credible (rice and wheat) price stabilization regime, the subsidy cost savings could be distributed to PRIs in the form of food stamps or vouchers or as conditional cash grants, with poor recipients - identified by PRIs and targeted groups - enabled to exchange the vouchers for food. Equally practical, food vouchers could be made part of JRY, ICDS and nutrition programs. Not only would these innovations improve targeting without incurring additional costs, they would also complement and support the needed rice and wheat policy reforms addressed below. 40. Access to land assets and common resources. Natural resource products account for a large share of the household consumption and production in poor communities (e.g., firewood and non-timber forest products, construction materials, drinking water, fish and medicinal plants, soil nutrients for subsistence cropping, water for irrigation). Because natural resources are so critical to the consumption and production activities of poor rural households they can be one of the most important safety net available to them. Natural resource rents captured by the rural poor can help them initiate a process of capital accumulation that can help pull them out of poverty. Trading in natural resources products is for many rural people their main contact with and mechanism for integration in the market economy. Reducing the costs of collecting natural resource products, like water or firewood, will increase the availability of rural households for investing in institutional or social capital or getting educated or treated for diseases. Community based natural resource management is a strategy that is largely "self-targeting" in reducing rural poverty. And improving the accessibility, quantity and quality of natural resources for the rural poor is also a growth-enhancing strategy and can itself be an important trigger of stronger social organizations and more effective local institutions. Historically the rural poor have been increasingly excluded from access to the natural resources safety net, in the process of accumulation of assets by powerful elites trying to maximize their wealth. This process needs to be reversed and India has already taken important steps in this direction, for example through the 1988 National Forest Policy that increases the share of forest rents for the rural poor (Box 3). Much more needs to be done, however, and the poor's ownership of or access to forests, fish and common rangelands needs to be increased, enforced and secured, reversing the historical trend of exclusion of the rural poor to the benefits of these assets. 41. Listening to the poor. For reforms in access to land, common resources, health care and education and safety-net programs to make the maximum impact on rural poverty, India's poor and socially excluded populations must have a more decisive influence on the design and implementation of programs meant to assist them. The principle is equally valid for efforts to - 16 - improve their access to technology, support and infrastructure services in rural areas. In putting the principle into actual practice, government needs to play an important role by helping to strengthen the organization of the poor and socially excluded, and ensuring that appropriate media provide the flow of information needed for sound decisions. 42. India's many experiences with promising initiatives aimed at empowering the poor, while differing according to cultural, and socio-economic factors in various states, typically involve women, tribal groups and schedule castes who share either homogenous socio-economic characteristics or common material interests. To be self-reinforcing, programs of empowerment that strengthen local organizations or community groups must also be accompanied by genuine efforts to widen access to assets such as land, common resources (Box 3) and education, and incentives and capacity for local governments and public administration to include the disadvantaged in decision making and to respond and be accountable to them. 43. Potential for a socially inclusive decentralization. The reports suggests that the essential ingredient of reforms that has the potential to transfer fiscal, political and administrative responsibility to local governments to enable them, in turn, to act on the wishes of community interest groups, is decentralization. Decentralization, already given a framework in the 73rd Constitutional Amendment, can stimulate private-sector competition and establish incentives - 17 - strong enough to encourage financial discipline and sustainability, and put higher-quality, more equitable rural services and infrastructure on a participatory and demand-driven footing. Among those incentives are transparent and non-discretionary fiscal transfers tied to performance indicators that reward local outcomes in resource mobilization and cost recovery, improved governance, responsiveness to local demands, social-inclusion, poverty reduction, and provision of non-local public goods by local governments and administration. 44. At a higher level of political authority, appropriate fiscal transfer mechanisms from central and state treasuries may help ensure that public works and services financed under rural development programs are more effectively delivered because they are selected, designed and implemented in a participatory and socially-inclusive fashion at the local level. Practically, this means that the central government could use its fiscal transfer mechanisms (under the planning commission transfers or centrally-sponsored schemes) to encourage state governments to reform their sectoral policies and administration (e.g., rural water and sanitation, roads, veterinary services, forest management and marketing, technology dissemination, watershed programs) and devolve more responsibilities and resources to local governments. 45. Political commitment, in any case, is imperative. Without it, appropriate types of decentralization will neither emerge nor mature. And the commitment to empower local communities and make them socially inclusive must be expressed in access to untied funds and grants of authority to decide their use. More needs to be known, however, about the performance of local governments and administration on social inclusiveness and poverty reduction. In order to better inform policy recommendations on decentralization, more and urgent research and monitoring is needed to examine very different decentralization practices across Indian states, identify those mechanisms and relationships between local government, local administration and community members or groups which can mitigate the capture of benefits by local elites and promote participation and social inclusion, and how these may vary across states and regions. Urgent research and monitoring of on-going experiences is also needed to identify and publicize the very different approaches to achieve improved quality of delivery across the range of infrastructure and support services (e.g., roads, water supply and sanitation, extension, watershed, education, etc.), and how they may vary across regions. To accommodate the need for diverse approaches to decentralization, asymmetrical policies -- treating units differently -- that reward local performance may be required to achieve similar and acceptable outcomes. Liberalizing the rural economy 46. Domestic de-regulation. Liberalization of agricultural markets, agro-industry and more generally non-farm economy is another essential part of the proposed strategy that will speed growth and consequently, reduce rural poverty. In addition to improving agricultural terms of trade and encouraging regional specialization, market liberalization would compensate farmers for the higher fertilizer prices, power tariffs and irrigation charges that will emerge from the subsidy phase-out, and facilitate adjustments in their cropping patterns. An added benefit is more effective protection for the poor and for consumers from shortages driven either by high food prices or depressed agricultural production 47. Analysis of agricultural commodity markets and agro-industry indicates that domestic deregulation promises large returns by overcoming gross inefficiencies in marketing and processing, notably in highly labor-intensive industries such as cotton based textiles. This would represent a "win-win" strategy for both agricultural producers and consumers, including the poor, and provide a real boost to the non-farm economy. More efficient and competitive agricultural markets and agro-industries can deliver better prices and greater market opportunities to farners without raising prices to consumers. They can also expand employment opportunities in the non- - 18 - farm economy by raising farm incomes and demand for rural goods and services, and by enabling the rural industry to modernize, compete better, and expand its domestic and export markets. Domestic deregulation is also needed to lower dairy-industry barriers to private sector entry. Combined with the managerial, financial and commercial control of most dairy cooperatives by government, lack of competition results in large marketing and processing inefficiencies that hurt dairy producers - most of them landless and women -- and impede the healthy development of an industry with undeniable comparative advantage. In the case of timber and non-timber forest products, numerous market regulations and policies that may prevent forest communities, often the poorest among the poor, from sharing fully the benefits of joint forest management or from obtaining higher prices need careful re-assessment. Alone, domestic deregulation can bring large rewards. Complemented by external trade liberalization, those dividends would expand further. Detailed recommendations for selected industries (e.g., rice, wheat, sugar, oilseeds, cotton and textile, dairy), summarized in this report, can also be found in companion World Bank reports. 48. Foodgrains. The Ninth Five Year Plan 1997-2002 indicates a welcome readiness to move toward greater market competition, to minimize controls, to streamline the Public Distribution System and to use external trade more extensively in managing grain surpluses and shortages. In the long term, liberalized trade, reflecting the flow of accurate, timely information, can ensure India's food security more effectively and less expensively than the prevailing regime. But building that new structure requires adopting many specific reforms, a process that will be neither uncomplicated nor unopposed. For those reasons alone and for the benefits new policies and practices will bring, reform should begin immediately. 49. Striking a new balance between government intervention and private competition is the central purpose of marketing reform. The principal changes required must come from adjusting the price stabilization and public distribution programs. Specifically, priority reforms would involve: * Promoting private sector efficiency and investments through: =. FCI open market sales at market prices; => Adoption of FCI "price band" rules stabilizing rice and wheat prices by relying on strategic buffer stocks and market-based interventions to maintain price levels that encourage efficient private-sector participation; => Phasing out the rice levy in the short tern. - Concurrently restructuring FCI operations, including subcontracting activities to private sector, improving management incentives for efficiency and operating under hard budget constraints. Plans to decentralize FCI functions to state agencies should be reevaluated. * Continued targeting of TPDS by: => Proceeding to phase-out the universal portion of the TPDS, shifting to open market sales; z> Pilot-testing food-stamp or voucher programs linked with other targeted safety-net, public works programs. 50. Oilseeds. The oilseed industry faces a choice between modernizing for international competition in which it can have significant advantages or perpetuating a fragmented structure whose inefficiencies are largely borne by growers who receive lower than international prices at one end of the production chain and consumers who pay higher than international prices at the other. Firms in the oilseed complex and its regulators recognize the problems and are weighing various options for change. Among them, the idea of removing the ban on oilseed imports appeals to processors ready to invest in modern, large-scale facilities in port cities, gaining efficiency that small-scale crushers in rural areas could not emulate. Another approach, favored by farmers, would raise tariffs on the import of edible oils, thereby strengthening the growers' position (and prices) in the domestic market --at the expense of consumers. -19 - 51. A different strategy, one that would pay for itself, would focus on the domestic trade regime and on the central problem of the crushers' high margins and risks and the consequent costs to both growers and consumers. Its objective would be to stimulate the industry to perform better at home and compete more strongly abroad by freeing it from a host of unnecessary restraints and strengthening government's ability to promote quality and consumer health and safety. 52. That strategy envisions a series of coordinated reforms that: * Liberalize edible oilseed exports, maintain unhindered imports of edible oil under current tariffs, and install a WTO-consistent set of tariffs, rules and regulations to deal with international price spikes; * De-regulate the oilseed industry by exempting it from the Small-Scale Industry Reservation and the Essential Commodities Act to end multiple, legal controls on movement, storage and processing technology and scale and by eliminating related limits on access to credit; * Legalize access for oilseed products to forward and futures markets; * Improve incentives for quality management and pollution control, including government enforcement capacity. The incentives could set labeling and quality standards that highlight healthier products and raise consumer and producer awareness of them, tighten food safety standards and pollution control, assure better access to seed technology, and recognize intellectual property rights in conformity with Trade Related Intellectual Property (TRIP) under WTO; * Strengthen the market monitoring capacity of government to implement a complex reform process by establishing effective surveillance over trading and marketing in a decentralized, market-oriented economy; * Improve market infrastructure to facilitate the flow of commodities and information both domestically and in external trade. This would involve a freer, wider spread of price information, and the promotion of private investment in market, transport, storage, and port infrastructure. 53. Having made such strong progress toward an oilseed industry capable of supplying domestic needs, providing attractive agricultural employment to rain-fed farmers, and competing in world markets, India now has a promising opportunity to make the most of its successes by adopting further reforms. They should not only pay for themselves but repay some of the costs of the long years of protection and special treatment. 54. Sugar. The sugar industry faces policy challenges similar to that of the oilseed industry. It faces the choice between modernizing for international competition and meeting future demand without raising consumer prices, or preserving an industry that operates at levels of productivity well below potential and compels farmers to receive lower than international prices and consumers to face higher prices. As recommended by the (Mahajan) High Powered Committee on the Sugar Industry (1997), establishing the basis for an efficient sugar industry requires coordinated action over the medium term in four areas: * eliminating barriers to entry while leveling conditions for competition between cooperatives and private sector mills. International experience indicates that to strike a balance sugar mills must be deterred from becoming local monopolies and sugarcane farmers must be able to minimize transportation costs of a highly perishable product. One possible approach would eliminate zoning and help establish workable and enforceable contracts between growers and millers to insure the discipline which mill zoning promotes. A second set of changes would combine a cane-pricing payment formula with a flexible form of zoning such as the one used in many sugar-producing countries that allow zones to become freely tradable assets and base producer prices on average milling costs within homogeneous agro-climatic areas. -20 - * Eliminating the dual market system along with the regulatory controls on the distribution, movement, storage and trading of sugar and sugar by-products; the supply of sugar to the PDS -- if maintained -- would be assured by PDS purchases in the free market or from imports, with any subsidy borne by the budget. * Rationalizing the pricing of sugarcane would be of particular importance if an improved form of zoning is retained and the principle of a cane pricing formula is adopted. Whether zoning is retained or not, quality-related payments based on the sucrose content of cane would need to be introduced to encourage productivity growth at the farm level. * Completing the liberalization of the trade regime by freeing export of molasses, and maintaining import tariffs at zero percent. 55. Implementing this package of reforms would not only stimulate substantial productivity gains, both at the mill and the farm level, but also enable India to continue to meet its domestic demand for sugar at world competitive prices without the need to raise import tariffs, and achieve national food security at the lowest economic and social costs to consumers. Further, productivity enhancing sugar policies would promote a more efficient and environmentally sustainable regional pattern of production by shifting sugar production, at the margin, from tropical to sub- tropical states. 56. Cotton & Textile. Like many of India's large agriculture-based industries, cotton and textiles have been recording impressive growth (3.9 percent in annual output over the last decade) as controls on external and domestic trade have begun to relax. Those advances can continue and even significantly accelerate if the industry's productivity and quality levels rise to make Indian products truly competitive as the phase-out of the Multi-Fiber Agreement (MFA) opens tremendous opportunities for India to enlarge its share of existing markets and capture new ones. 57. A host of policies and regulations relating to firm size, product composition, labor and taxation, combined with inadequate export infrastructure and cumbersome customs procedures, however, now limit the capacity and incentives of textile firms to pursue adjustment and modernization. The necessary efficiency gains require both very large private investments in modernization and extensive government regulatory changes to undo the long-standing bias in favor of small-scale operations. 58. India's 5,000-year-old cotton sector also faces several new challenges, above all to remain competitive with free imports not only in terms of price but also in product quality and consistency. Hampered in that pursuit by the slow pace of investment in higher productivity and quality and by practices at the farm, market and ginning levels, cotton growers must also deal with a textile industry historically oriented toward undemanding domestic customers, and, until recently, an over-regulated domestic trade and ginning sector. Public-sector weaknesses, as in providing extension services and irrigation, and inattention to such inputs as pesticides and seeds further constrain farmers' ability to reduce crop losses and raise yields. If the sector is to remain competitive now that cotton fiber imports have been completely liberalized, efforts to raise productivity, reduce costs and upgrade cotton quality are imperative. 59. Unless they receive higher prices for their crop, India's cotton growers are not likely to invest time, energy and money in improving the quality or widening and bettering the varieties they cultivate. India's textile makers--the farmner's ultimate consumers--sorely need higher grade and more varied raw materials to win buyers in an increasingly open global market for fabric and apparel, and to stave off competition from imports. Export-oriented mills, the textile industry's leaders, have no choice; they must pay more for cotton fiber as it makes it way up the production chain. Textile makers can absorb these higher costs if the Government of India removes or reduces a variety of regulatory and policy obstacles to their efficiency, encourages new -21 - investments to improve their productivity and, back on the farm, extends much needed support to introduce and sustain modem practices. 60. A coordinated, comprehensive deregulation of the cotton and textile industries, combined with carefully targeted interventions and safety nets, would play a critical role in mitigating these social costs: * Liberalize cotton fiber exports to achieve consistency with WTO rules and promote quality cotton production; in the short run, alternative instruments (e.g., export tax, modernization fund) would enable the spinning industry to adjust to the elimination of export quotas for extra-long staple cotton. * Improve cotton quality management by up-dating standards for fiber and kapas, supporting their adoption and systematic application in cotton markets. * Improve cotton marketing efficiency by eliminating the monopoly procurement scheme in Maharashtra, supporting development of forward, futures contracts in cotton fiber. * Liberalize cotton yarn exports to compensate the spinning industry for increased cotton fiber costs and achieve consistency with WtO rules; reductions in excise duties and import tariffs for MMF would further compensate the spinning industry for price increases. * Eliminate or relax non scale-neutral and non market-neutral policies in spinning, weaving/knitting, and garment manufacturing. Examples include the small-scale reservation (knitting, garment making), national labor regulations, differential taxation rates for firms of different size, hank-yam obligation (spinning.) * Improve safety nets for handlooms by substituting the Hank Yarn Obligation imposed upon spinning mills with alternative, targeted programs (e.g., targeted explicit subsidy; technology programs to convert to power looms; skill upgrading programs); for public sector mills, transitional programs to assist retrenched workers would facilitate their privatization or liquidation. 61. Strengthening rural finance. The strategy options suggested require not only changing public-expenditure and marketing policies, but steady progress as well in range and responsiveness of financial services in the countryside. In recent years Indian authorities have implemented several critical policy reforms in the field of rural finance and credit. Far-reaching changes have liberalized interest rates for cooperatives and RRBs to alter the play of incentives within the system. Controls have been relaxed; competition has intensified; NABARD measures have boosted financial discipline and long-term prospects of selected RFIs; and formal institutions have begun pioneering lending to informal and semi-formal institutions linked to NGOs and self-help groups able to provide both savings and lending services to the underserved poor. 62. There is still an unfinished agenda, one that accords policy and institutional issues pride of place. On the policy front, these include lifting the remaining interest rate restrictions; relaxing service area restrictions on RFIs and administrative directives for lending; and ultimately, lifting priority sector lending requirements as reforms in agriculture and the RNFS place these sectors on a competitive basis with the rest of the economy. Other priorities would include the need to strengthen supervision of RFIs and their corporate governance; the reform of state cooperative acts to enable the establishment of member-owned and -managed cooperatives; the need to expand the range of financial services offered to better reflect the needs and capacities of various market segments in rural areas; the need to improve the performance of formal institutions experiencing loan-recovery problems, and to facilitate entry and exit in the rural financial system, in particular for those RFIs which continue to perform poorly in a more liberalized policy environment. NABARD should adjust its priorities to reflect the relative scarcity of longer-term maturities and the changing demands of a more market-driven policy environment. -22 - 63. To reach the bankable poor, linkages need to be promoted between the formal and informal financial sectors. Beyond the policy, regulatory and institutional measures outlined above and designed to strengthen the rural financial system, the best type of public intervention, substituting for the IRDP, would be the support for intermediary organizations carrying out the capacity building and social mobilization needed for effective linkage programs between self- help groups and formal RFIs. Going further, these linkages could be also encouraged by permitting formal RFIs to meet their target group requirements when lending to self-help groups. 64. Experience in India and elsewhere indicates that the banking system -either directly or through intermediaries that reduce transaction costs and risks-is not the appropriate avenue for meeting the needs of a large number of extremely poor people. Similarly, experience around the world suggests no clear solution for sustaining a flow of credit and financial services to such high-risk groups. Reformed policies should, instead, focus on helping them to become bankable poor, widening their access to assets (land), human capital, safety nets and improving the delivery of infrastructure and services in rural areas. Experience in Latin and Central America suggests that small capital grants -with cost sharing arrangements- for productive assets targeted to the non-bankable poor (individual or group-based) can be a cheap, non-distorting and effective way of enabling the poor to accumulate capital.