INDIAN ECONOMIC DEVELOPMENT - II

Transcription

1 EurekaWow INDIAN ECONOMIC DEVELOPMENT - II Authors: Akshita Gupta Kalyani Chaudhury Harshit Maloo Naman Chaudhary Pranav Gupta Sagar Wadhwa Varsha Varghese As per the Delhi University syllabus, 3 rd Semester for B.A. Economics (H).

2 EurekaWoW EurekaWow First Edition: September 2013

3 EurekaWoW SYLLABUS Paper 19: INDIAN ECONOMIC DEVELOPMENT SINCE II Course Description This course examines sector-specific polices and their impact in shaping trends in key economic indicators in India. It highlights major policy debates and evaluates the Indian empirical evidence. Course Outline 1. Macroeconomic Policies and Their Impact Fiscal Policy; trade and investment policy; financial and monetary policies; labour regulation. 2. Policies and Performance in Agriculture Growth; productivity; agrarian structure and technology; capital formation; trade; pricing and procurement. 3. Policies and Performance in Industry Growth; productivity; diversification; small-scale industries; public sector; competition policy; foreign investment. 4. Trends and Performance in Services Readings: 1. Shankar Acharya, 2010, Macroeconomic Performance and Policies , in Shankar Acharya and Rakesh Mohan, editors, India s Economy: Performances and Challenges: Development and Participation, Oxford University Press. 2. Rakesh Mohan, 2010, India s Financial Sector and Monetary Policy Reforms, in Shankar Acharya and Rakesh Mohan, editors, India s Economy: Performances and Challenges: Development and Participation, Oxford University Press. 3. R. Nagraj, 2013, India s Dream Run, , EPW May K Kanagasabapathy, Vishakha G Tilak, and R Krishnaswamy, 2013, A Rethink on India s Foreign Trade Policy, EPW August 3 5. A. Ahsan, C. Pages and T. Roy, 2008, Legislation, Enforcement and Adjudication in Indian Labour Markets: Origins, Consequences and the Way

4 EurekaWoW Forward, in D. Mazumdar and S. Sarkar, editors, Globalization, Labour Markets and Inequality in India, Routledge. 6. Pulapre Balakrishnan, Ramesh Golait and Pankaj Kumar, 2008, Agricultural Growth in India Since 1991, RBI DEAP Study no Mahendra Dev, 2012, Agricultural Development, in NOC 8. Chandrasekhar Rao and Mahendra Dev, 2010, Agricultural Price Policy, Farm Profitability and Food Security, EPW June R. Nagaraj, 2012, Industrial Growth, in NOC. 10. Pulin Nayak, 2012, Privatization, in NOC 11. Aditya Bhattacharjea, 2010, Of Omissions and Commissions: India s Competition Laws, Economic and Political Weekly, 28 August, sections 1 and 3 only 12. Kunal Sen, 2010, Trade, Foreign Direct Investment and Industrial Transformation in India, ïn Premachandra Athukorala, editor, The Rise of Asia, Routledge. 13. Dipak Mazumdar and Sandeep Sarkar, 2009, The Employment Problem in India and the Phenomenon of the Missing Middle, Indian Journal of Labour Economics. 14. Rupa Chanda, 2012, Services Led Growth, in NOC.

5 UNIT 1 Macroeconomic Policies and Their Impact References: 1. Shankar Acharya, 2010, Macroeconomic Performance and Policies , in Shankar Acharya and Rakesh Mohan, editors, India s Economy: Performances and Challenges: Development and Participation, Oxford University Press. 2. Rakesh Mohan, 2010, India s Financial Sector and Monetary Policy Reforms, in Shankar Acharya and Rakesh Mohan, editors, India s Economy: Performances and Challenges: Development and Participation, Oxford University Press. 3. R. Nagraj, 2013, India s Dream Run, , EPW May K Kanagasabapathy, Vishakha G Tilak, and R Krishnaswamy, 2013, A Rethink on India s Foreign Trade Policy, EPW August 3 5. A. Ahsan, C. Pages and T. Roy, 2008, Legislation, Enforcement and Adjudication in Indian Labour Markets: Origins, Consequences and the Way Forward, in D. Mazumdar and S. Sarkar, editors, Globalization, Labour Markets and Inequality in India, Routledge.

6 Chapter 1 Shankar Acharya Flow of topics: [Period of study: ] Review of macroeconomic developments Growth Inflation External Balance Current a/c balance Capital a/c balance Domestic Balance: Deficits, Savings & Investment Macroeconomic performance: an overview Major Challenges for macroeconomic policy Fiscal Consolidation At Centre At State Foreign Capital Surge Key issues for the future Restoring fiscal balance Convertibility & exchange rate management Role of the Reserve Bank Coping with international uncertainty

7 1 REVIEW OF MACRO DEVELOPMENTS SINCE GROWTH Economic growth is usually seen as the primary indicator of macroeconomic health. India has done well in this regard, especially in the period 2003/4-2007/8 as shown by GDP growth rate 8.8% pa. The best performance before this period was in 1992/3-1996/7, when GDP grew at 6.6% pa, following initial burst of 1991 economic reforms. Growth faltered in the period 1997/8-2001/2 and worsened further in the 2003 agricultural slowdown. Reasons: Effects of east Asian financial crisis Initial uncertainties of coalition govt Fiscal deficit deteriorated due to large public payments after 5 th pay commission But since 2003 we have seen an extraordinary boom. Reasons: Sustained investment boom Productivity-enhancing effects of reforms Acceleration of services output (communications, business services, IT and finance) Buoyant international economic environment Contribution of Services Sector: Rapid growth in this sector is reflected in its contribution to overall economic growth since 1991 Expenditure composition of growth: Surge in investment expenditure in and Govt consumption & surge in and private consumption fall later a & b had opposite behaviour

8 Summary of growth performance: Time Period Growth record Growth rate p.a. 1992/3-1996/7 Good performance 6.6% 1997/8-2001/2 (9 th Five yr Slowdown 5.5% plan) 2002/3 Fall in agricultural 3.8% output 2003/4 Turnaround 8.5% 2005/6-2007/8 Boom 9% 1.2 INFLATION Inflation can be seen as the most important indicator of macroeconomic performance after growth. But india does not have a nation-wide Consumer Price Index (CPI). Price indices in India: CPI (industrial workers) : most commonly cited WPI: indicator of headline inflation, but limited to commodities only WPI (manufactured products): proxy for core inflation GDP deflator: best indicator for inflation over the years Inflation trends: Inflation has been in comfort zone (< 5%) since 1998/9. Going by WPI or 5-yr averages of any index, inflation has been subdued since 1996/7 GDP deflator average just above 4% over decade Inflation was not a significant macro policy problem until early 2008 due to: Low world inflation until 2008

9 Indian foreign trade policies became more liberal Anticipatory monetary policies backed by declining fiscal deficits Downward revision of inflationary expectations in line with actual outcomes 1.3 EXTERNAL BALANCE (a) CURRENT ACCOUNT BALANCE: Poor health of the Current account in 1990, when rise of CAD to 3% of GDP preceded the 1991 BOP crisis. But throughout , India s external balance position has been comfortable: Relative health of CAD has been concurrent with a rise in merchandise trade to GDP ratio (from 23% in 2000 to 35% in 2007) Growth of service exports (IT software) has been strong throughout the period Current transfers (remittances from abroad) were buoyant, remaining above 3% of GDP Trends in CAD [ ] Time period Current a/c Current a/c Evidence record balance (average) 2001/2 2003/4 Surplus 1.43 Net Invisibles to GDP ratio: 6.2% in /4 2007/8 Deficit Merchandise Trade Deficit to GDP ratio: 7.7% (b) CAPITAL ACCOUNT BALANCE 2002/3-2007/8: unexpected surge in Net foreign capital inflows from 10.8 to 108 billion dollars Since current account was close to balance during this period, the bulk of net inflows swelled our forex reserves

10 Capital surge and reserves buildup posed challenges for country s macroeconomic policies 1.4 DOMESTIC BALANCE: DEFICITS, SAVINGS AND INVESTMENTS Deficits, savings and investment are intermediate target variables crucial for macro policies and outcomes (a) FISCAL DEFICIT: not very good record for india, which has been running large deficits for over 30 yrs Before 1991 Mid 90 s After 2002 Over 9% of GDP Efforts by govt brought deficit down to 6.5% Consolidation reversed due to large public pay increases, low revenue buoyancy Fiscal consolidation resumed; deficit down to 5% Periods of declining fiscal deficits are associated with acceleration in economic growth ( and ), while periods of high deficit correlate with slowdown in economic growth ( ). This is not surprising, as large deficits pre-empt loanable funds, foster high interest rates and crowd out productive investment. (b) SAVINGS AND INVESTMENT: 2002/3-2007/8: this period saw a huge transformation in aggregate savings & investment. Level of savings & investment: Investment rate: steady at 24% of GDP till early 2000 s and then rose steeply to 36% in 2006 Savings rate: saw an equal spurt from 23.6% to 34.8% of GDP in the period India had very little recourse to net foreign savings throughout this period

11 Composition of savings: Households: largest single component of domestic savings with share rising as a ratio of GDP Private corporate sector: contribution to savings doubled from 3.6% to 7.8% over the period to 2006/7 Public sector: biggest contributor to savings explosion after 2001; went from -1.9% to 3.2% over the period to 2006/7. Most of this improvement occurred in govt administration 1.5 MACROECONOMIC PERFORMANCE: AN OVERVIEW [ ] [ ] [8 th FYP] [9 TH FYP] [10 TH FYP +2007] Best average outcome with respect to all macroeconomic indicators, when compared to any other 5-yr period since /4-2007/8 performance record: Growth 8.8% Inflation (GDP deflator) 4.5% Current a/c deficit 0.4% of GDP Combined fiscal deficit 6.7% of GDP Gross domestic investment 33.6% of GDP

12 But 2008 was the end of this golden era: economic growth slowed, inflation soared, deficits widened sharply and investment faltered. Global slowdown, worldwide commodity price shock and fiscal laxity stalled domestic reforms. Therefore, the legacy of the golden period 2003/4-2007/8 is a set of difficult macroeconomic challenges for the country, as outlined in the next section. 2. MAJOR CHALLENGES FOR MACROECONOMIC POLICY 2.1 FISCAL CONSOLIDATION (a) FISCAL CONSOLIDATION (CENTRE) Background (till 2001/2): the deficits of the central and state govts had reached massive levels (9.9% and 7% of GDP respectively). The governments then began to take action in the form of certain policies, as described below: Fiscal Responsibility Budget Management Act (2003): Targeted elimination of centre s revenue deficit by 2008 and reduction of fiscal deficit to 3% of GDP, which was pretty much achieved by 2007/8 A programme to raise tax-gdp ratio through better tax administration: concerted efforts by govt helped to raise the ratio to 9.2% in 2007/8 for which the main source was direct taxes (corporate and personal income taxes) (b) FISCAL CONSOLIDATION (STATE) The big improvements in fiscal consolidation occurred after 2003/4. The 4 major factors at work: The remarkable growth in central tax revenues also benefitted the states

13 States non-tax revenues got a boost due to large transfers of devolution grants from centre, following recommendations of 12 th finance commission (TFC) Adoption of fiscal responsibility laws by nearly all states following TFC recommendations on debt relief Nearly three-fourths of all states reformed their sales taxes to adopt uniform Value Added Taxes in : these measures have come under pressure from mounting subsidies 2.2 FOREIGN CAPITAL SURGE Foreign capital inflows (billion$) This unexpected surge in foreign capital was both a cause and consequence of India's remarkable boom in investment & growth during 2003/4-2007/8. It posed major challenges for management of exchange rate, capital controls, monetary policy and inflation. Impossible Trinity theory says that it is impossible to achieve exchange rate stability, monetary independence and capital market integration (FULL CAPITAL CONTROLS) Monetary Independence Exchange rate stability (PURE FLOAT) (MONETARY UNION)

14 Since 1993, India has followed a Managed float, with active RBI intervention to maintain realistic exchange rate. In , there was a much shorter-lived external capital surge where our policy-makers resorted to sterilised forex intervention and liberalisation of external payments regime. In the recent capital flow surge after 2006/7 also, the government opted for a similar strategy, including: a new market stabilisation scheme (MSS) RBI s short term liquidity management through Liquidity Adjustment Facility (LAF) Occasional increases in CRR Liberalisation of capital outflows to increase international acquisitions by Indian companies Tightening of external commercial borrowings Through this approach, Nominal & Real appreciation of the rupee was contained, but the sterilization operations came along with growing fiscal costs. 3. KEY ISSUES FOR FUTURE 3.1 RESTORING FISCAL BALANCE As we saw, by 2007 fiscal deficit fell to 5.3% of GDP, making good progress in fiscal consolidation since the record deficits of 2001/2. But this progress was exaggerated by resorting to off- budget liabilities to fund growing subsidies. e.g. oil bonds, fertilizer bonds etc. Shankar Acharya says that their impact is similar to expansion of Fiscal deficit. His estimate is that adding the off-budget liabilities, India s combined true fiscal deficit for 2008 would be 10% of GDP. Thus it would be a challenge to restore fiscal balance. Moreover, there are growing expenditure demands of recently launched populist schemes (e.g. NREGA) Thus the main avenues for fiscal consolidation are:

15 Upward adjustment/ decontrol of fuel & food prices Sale of equity in govt enterprises 3.2 CONVERTIBILITY AND EXCHANGE RATE MANAGEMENT Capital account convertibility (CAC) refers to the removal of restrictions on capital account. Many countries have advocated rapid transition to full CAC but there is much debate on this front. India has followed a calibrated approach to CAC, steadily opening up to FDI flows and portfolio equity, while cautiously moving on debt flows. This is also for the purpose of maintaining some discretionary autonomy over the exchange rate. Given the rise in inflation since 2008 and the steep increase in fiscal deficit, Shankar Acharya says that it is not advisable to speed up capital account liberalisation in the future. 3.3 ROLE OF RESERVE BANK Currently, the RBI pursues multiple objectives, some of which are: Low inflation Sustainable economic growth Overall financial stability Regulation of banks Banker to the govt Some have recommended that the RBI follow a single objective of low inflation and let go of its other objectives. Shankar acharya criticises this recommendation through 4 points: The question of who should take up the other responsibilities of RBI It is difficult to see RBI as being able to conduct its monetary policy without consideration of its short-term consequences for growth of economic activity

16 Only the RBI can undertake the responsibility of managed float with partial capital controls No other institute other than RBI can pursue financial stability as a key macroeconomic objective 3.4 COPING WITH INTERNATIONAL UNCERTAINTY Having experienced the sub-prime-based international credit crisis in 2008, Shankar Acharya writes about several challenges for macroeconomic management in India: Short term: As global investors liquidate their assets under stress, large outflows of portfolio capital from indian markets, slowdown in FDI inflows, scarcity of commercial loans from abroad Medium term: As the world economy transmits a deflationary impulse to india, monetary policy needs to be loosened to cushion the negative impact on consumption and investment. Exchange rate policy needs to be flexible with a downward bias.