Topic : Economic Structure Balance of Payment Page 1 of 6 COVERAGE ECONOMIC STRUCTURE, ECONOMIC POLICY 1991 AND BALANCE OF PAYMENT Paper VI Business Environment MBA (Evening) 3 rd Year ÿ ÿ ÿ Economic Structuring: - Composition of national output by sector - Occupational structure of labour New Economic Policy a.k.a. Restructuring the Economy - Liberalisation - Privatisation - Globalisation - Expected benefits Impact of restructuring: - Stabilization process using Monitory & Fiscal Policies - and impact on Balance of Payment trade deficit / Current Account / Capital Account / Official reserves account MAI N REFERENCES Indian Economy Problems of development and planning Silver Jubilee (1999) Edition By A.N. Agarwal. Publisher Wishwa Publisher Topic Area Chapter 1. Workforce and occupational structure 9 2. National Income by industrial origin 12 3. Privatization of Public Sector 30 4. New Industrial Policy 34 5. Balance of Payment : Problems and Policies 46 6. Rupee : Exchange rate and convertibility 50 7. Foreign Capital 51 8. 9 th Five year plan (additional w.r.t to New Industrial Policy) 57 OTHER BOOKS FOR REFERENCE Indian Economy By Mishra & Puri Indian Economy By Dutt & Sundaram Any good book on Balance of Payment NOTE: 1. Students are advised that this handout is meant as a guide and as a short introduction to the main topic. It should not be confused with course material. 2. Students should treat the handout as indicative outline as to how to approach the topic under consideration. They are expected to build up their answers taking into consideration the reference material given above and in the course along with class notes, newspaper & magazines etc. Answers by the students should reflect an understanding of the theory and it s implications in the current economic scenario incorporating recent changes, if any.
Topic : Economic Structure Balance of Payment Page 2 of 6 ECONOMI C STRUCTURE Definition: Economic structure of an economy is the composition of various economic activities of the country in which the workforce of the economy participates. The economic structure of any economy can be broadly divided into three broad sectors : Primary Sector: Consists of all primary economic activities like agriculture, forestry, mining etc. Secondary Sector: Consists of manufacturing, construction, electricity etc. Tertiary Sector: Consists of transport, trade, services and other related industries. The various sectors contribute to the national income of the country and to the occupational pattern of the population or the workforce. According to Simon Kutnetz " Share of agricultural sector in the national income declines in the course of the economic development... while that of the secondary and tertiary sector increases" Changes in Sectoral composition in I ndia: The share of the primary sector, as a percentage of Gross Domestic Product (GDP) fell from 58.3% in 1950-51 to 36.2% in 1988-89. The most noticeable change took place in the mining sector. The contribution of the Mining sector grew from 0.6% in 1950-51 to 12% in 1988-89. The share of the secondary sector remained more or less stable. The share of organised manufacturing sector grew from 6.3% of the GDP to 12.2% in 1989-90. But this growth was negated by the fact that the unorganised manufacturing sector declined from 9% in 1950-51 to about 5% in 1989-90. The tertiary sector has shown a steady growth since independence. It's share has grown from 1.9% of the GDP to 4.6% in 1988-89. Major contributors to this growth were the transport and communication sectors. Services industries whose contribution was negligible in the pre liberalisation period have shown a marked growth in the post liberalisation. Did structural change take place in I ndia? According to established theories - the tertiary sector and the secondary sector are the dominant sectors in a developed country. Seeing the changes that have taken place in the three sectors since independence one can be led to believe that sectoral changes in India has taken place following the well established norms of economic growth and development. However a deeper look in the occupational distribution of the work force reflects a completely different picture. The theory of structural change is implicitly linked with the assumption that the changes in the sectoral importance of the sectors are also reflected in the occupational distribution of the work force of the country. However that has not been the case in India. The percentage of people employed in the agricultural sector has remained more or less the same since independence. The percentage of people employed in the agricultural sector has never fallen below 65%. This implies that the gains from the structural changes have been negated due to almost negligible change in the work force distribution. Various factors combined to negate the gains of the structural changes. Rapid growth of population after independence coupled with inadequate manpower planning by successive governments can be identified as the two major factors for the lack of development. After independence stress was laid on industrialisation leading to a increase in employment in the industrial sector with the hope that employment generation in industry would lead to a fall in the proportion of labour force engaged in agriculture. But since the population growth was rapid and the rate of industrial growth fell short of expectation - the desired transfer of population from agriculture to industry did not take place. To make matter worse little attention was given to manpower planning. The government policies failed to create adequate jobs outside the agricultural sector resulting in widespread unemployment. In Sum: Even though the share of sectors has changed; the levels of employment in the various sectors have remained the same negating any growth effects of the change in sectoral composition.
Topic : Economic Structure Balance of Payment Page 3 of 6 NEW ECONOMIC POLICY 1991 I ntroduction Beginning mid 1997, the Government of India made some radical changes in its policies of trade, foreign investment, exchange rate, industry, fiscal affairs etc. These various elements when put together constitute an economic as well as industrial policy, which marked a big departure form, the old policy. The overall aim of the new policy was to achieve a sort of development which would make industries dynamic in their growth and which rendered social justice. The 3 key words to the NIP of 1991 were LPG i.e. Liberalisation, Privatisation and Globalisation. Liberalisation: The NIP laid a lot of stress on the market forces and a market driven economy. It intended to dismantle the restrictive and regulatory system and allow private entrepreneurs to venture into any industrial sector based on their own commercial decisions with no government judgement. In the absence of Government controls these decisions were in terms of market prices and profits. In other words, allocation of resources among industries with respect to the scale, size of production and the nature of the product would be determined by market prices. The role of the state was confined to selected non-market areas- to ensure a smooth functioning of the market economy. Privatisation: The NIP aimed at strengthening the private sector in a big way. The thrust of the NIP was a market driven economy ; so in line with that objective, the new policy provided for the privatisation of the public sector units (PSUs). The NIP provided for an enlargement in the field of operation of the private sector (and a contraction in the fields of operation of the public sector). A number of activities (17 in number) which so far had been the exclusively in the realm of the public sector were thrown open to private sector. Only 8 industries where security and strategic concerns predominated were reserved for the public sector under the new policy. The Government also, to a certain extent, privatised the ownership of the PSUs. This was done by the sale of a part of the capital of some enterprises. Thus by disinvestment of a part of the capital, the Government made the public sector accountable to the private sector criterion, namely market-related profits. Globalisation: The NIP took great steps towards the integration or the unification of the Indian economy with the world economy. It made the economy outwardly oriented so that its activities were now governed both by the domestic as well as the foreign market. The following steps were taken: 1. The rupee was also made fully convertible on current account of the balance of payments. 2. The custom duties on imports were also reduced with a view to bring them in line with custom duties of other countries. 3. The NIP of 1991 the doors of the Indian economy were thrown open to foreign investment. Foreign investors were allowed to have 51% equity holdings. All this adds up to an open economy with respect to the movements of exchange rate, foreign exchange, imports, exports and foreign direct investment(fdi). Features: 1. Abolition of industrial licensing : In a major move to liberalise the economy the Government Of India abolished all industrial licensing irrespective of the levels of investment,except for certain industries(18 in number) for security and social concerns. In April 1993, the Government exempted three more industries from licensing - leaving only 15 industries in which licensing is compulsory. With this step, almost 80% of the industry have been taken out of the licensing framework. 2. Removal of the MRTP limit : Under the MRTP Act, all firms with assets above a certain limit (Rs. 100 crores since 1985) were classified as MRTP firms. Such firms were permitted to enter selected industries only and this also on case-by-case approval basis. The new Industrial Policy scrapped the threshold limit of assets in respect to MRTP and dominant undertakings. These firms were now at par with other firms for entry or expansion into the delicensed areas. However firms holding more than 25% of the market share were now identified as monopolies
Topic : Economic Structure Balance of Payment Page 4 of 6 and the emphasis had shifted to taking appropriate action against monopolistic and unfair trade practices. 3. Dilution of the role of the Public Sector : The NIP removed various industries from the Reserved List, which were previously the domains of PSUs. Industries, which continue to be reserved for the public sector, are in areas where security and strategic concerns predominate. 4. Disinvestment of Public Holding: Under the NIP, Government actively took part in disinvestment of public holdings. A beginning in this direction was made in 1991-92 itself by divesting part of the equities of 30 selected PSUs (which were placed with mutual funds) and Rs. 3000 crores was raised through these means. 5. Entry of foreign investment and technology : The NIP envisaged a broader role of foreign investment and capital in the industries. The NIP had a specific list of high technology and high investment priority industries where automatic permission would be available for FDI up to 51% foreign equity. The list contained 34 industries. This was a major departure from the earlier policies, which required case-by-case approval of foreign investment normally limited to 40% equity participation. 6. Industrial location policy liberalised : The new industrial policy provides that entrepreneurs willing to set up new industries may choose the location based on their own judgement of availability of resources. Except for industries subject to compulsory licensing entrepreneurs wereallowedtohaveafreehand. 7. Removal of mandatory convertibility clause : A large part of industrial investment in India is financed by loans from banks and financial institutions. These institutions followed a mandatory practice of including a convertibility clause in their lending operations for new projects. This has provided them with the option of converting part of their loans into equity. This option has always been interpreted as a threat to private firms of take-overs from financial institutions. The NIP provided that henceforth financial institutions would not impose this mandatory convertibility clause. 8. Abolition of phased manufacturing programmes for new projects : To force the pace of indigenisation in manufacturing, phased manufacturing programmes had been in force in a number of engineering and electronic industries. The NIP abolished such programmes in the future as the Government felt that with substantial reforms made in the trade policy and the devaluation of the Rupee, there was no longer any need to enforce local content requirements on a case-by-case basis. Some expected benefits from the NI P: 1. Improved efficiency in the use and allocation of resources: With the removal of controls and restrictions the NIP would promote individual entrepreneurs and this increased competition would help in promoting industry in India. The privatisation of the PSUs and the entry of FDI would also bring about an improvement in efficiency. 2. Increase in the economic growth rate: The growth rate of the economy was also expected to go up sizeably as a result of the implementation of the NIP through an increase in the efficiency of the industries. 3. Increase in employment levels: With higher rate of growth; expansion of employment was also expected. 4. Fall in rate of inflation: The rate of inflation was also predicted to fall due to competition. 5. Improved Foreign Exchange position: The NIP was also expected to improve the Forex reserves of the country by improving the Balance of Payments. [ MAKE A COMPREHENSIVE NOTE ON THE EFFECTIVENESS OF NIP IN THE LAST DECADE ]
Topic : Economic Structure Balance of Payment Page 5 of 6 STABI LI SATI ON PROCESS AND BALANCE OF PAYMENT Balance of Payment : The Balance of payment (BOP) of the country is a summary record of the international economic and financial transaction of the country during a specified period of time. In other words, BOP is merely a way of listing receipts and payments of international transaction of a country. In this sense the BOP is an application of the Double Entry Bookkeeping system and done properly the debits and credits will always balance : hence BOP will always be in equilibrium. Credits Export of Goods Export of Services Unrequited receipts (Gifts, indemnities etc.) Capital Receipts (Borrowings from, capital repayment by, or sale of assets to foreigners) Debits Imports of Goods Import of services Unrequited payments (Gifts, indemnities etc.) Capital Payments (Lending to, capital repayment to, or purchase of assets from foreigners) Balance of Trade: Is the country s visible trade i.e. the exports of goods less the import of goods. Balance of Current Account: The items that are entered into the current account are as follows: Transaction Credit Debit Merchandise Export Import Foreign Travel Earnings Payment Transportation Earnings Payment Insurance Premium Receipts Payments Investment Income Dividends Dividends Sale and purchase of goods and services by the government Receipts Payments Miscellaneous Receipts Payments Equilibrium and Disequilibrium of BOP: A BOP is said to be in equilibrium when the demand for foreign exchange is exactly equal to the supply of foreign exchange. When there is a deficit in the balance of payments the demand for foreign exchange exceeds the supply of foreign exchange. Reasons for Disequilibrium: A. Economic Factors: (1) Development Disequlibrium: It is more common in developing countries. Development disequilibrium arises because developing nations import capital goods on a large scale to carry out various development programs. (2) Capital Disequilibrium: Capital disequilibrium occurs due to cyclical fluctuation in the general business activity. During depression a shrinkage in world trade takes place leading to a disequilibrium in the BOP. (3) Secular Disequlibrium: This type of Disequilibrium is caused by certain secular trends in the economy and persists for a long time. For example in a developed country the disposable income and therefore aggregate demand for consumption products is high. This may lead to heavy imports and cause BOP Disequilibrium. (4) Structural Disequilibrium: Structural changes may also affect the BOP. For example exhaustion (or inadequate production) of productive resource (say petroleum) may lead to Disequilibrium
Topic : Economic Structure Balance of Payment Page 6 of 6 as the government may have to purchase the scarce resource from other countries who have an abundance of it. B. Political Factors: Political stability or instability also plays a large role in maintaining BPO equilibrium. A country with political instability may experience large domestic and foreign capital outflow which may lead to disequilibrium. C. Social Factors: Changes in taste, preference, fashion of the population may lead to large scale imports of the desired commodities leading to BOP problems. BOP Disequilibrium and Stabilisation policies: ( A) Monitory Measures: (1) Contraction of money supply: A fall in money supply leads to a fall in purchasing power and thereby reduction in aggregate demand and consequently leads to a fall in demand of imports. (2) Devaluation: Devaluation means the reduction of the official rate at which the domestic currency is exchanges for foreign currency notably pounds ( ) and Dollars ($). Devaluation makes foreign goods costlier in terms of domestic currency and thereby discourage imports. On the other hand devaluation makes domestic exports cheaper in the foreign market and thereby stimulate exports. (3) Exchange Control: The central bank or the government assumes complete control of the forex reserves and earnings of the country, and limits the amount of forex that can be transacted thereby maintaining the forex reserves. (B) Fiscal Measures: (1) Export Promotion: Reduction in export duties, providing export subsidy, and encouraging the production of exportable goods by various incentives thereby earning forex to balance the BOP Disequilibrium. (2) Import Controls: Increasing import duties, restricting import through import quotas etc. help in controlling imports and consequently help in arresting the outflow of forex. (C) Miscellaneous Measures: Obtaining foreign loans, developing tourism, providing incentives for inward remittances, using Special Drawing Rights (SDR) available with the International Monitory Fund (IMF). [ SHOW HOW THE STABILISATION POLICIES HAVE WORKED IN INDIA IN THE LAST DECADE W.R.T NEW ECONOMI C POLI CY ]