India: Economic Overview

1. FIN 680D/ FIN 360AMAR 680V/ MAR 356E/ INB 670C India: Economic Overview P.V. Viswanath

2. Economic History: 1950-1990 • Post-independence India had a mixed economy, i.e. including both private and public sectors. The reasons for a strong public sector were: • Greate inequality in income distribution – doubts as to the viability of free markets • Free trade would probably have led to exploitation by stronger foreign countries • Exports were seen as a drain of resources from the country.

3. Post-independence economy • Foreign Investment was seen as foreign domination. • The quickest path to economic development was seen to be rapid industrialization, which would probably not happen without government intervention • Capital goods and heavy industry were seen as particularly needed. • Planning was needed to ensure industrial growth and the concomitant agricultural and service growth, as well as employment growth

4. Objectives • The broad objectives were: • Rapid growth in production with a view to achieving a higher level of national and per-capita income. • Full employment • Reduction of inequalities in income and wealth • Socialistic pattern of society with a democratic framework, based on equality and justice and absence of exploitation.

5. Policy Measures for Industrial Development • Trade and Regulatory Regimes designed to shield industrial producers from competition • High tariffs • Industrial licensing of production and investment • Monopoly and Restrictive Trade Practices (MRTP) Act • Foreign Exchange Regulation Act (FERA) • Export Restrictions

6. Industrial Policy • Directed allocation of subsidized credit through the commercial and developmental banking system • Administered interest rates and financial institutions required to lend for specific purposes at the administered rates. • Fixed, overvalued exchange rates; this ensured cheap imports for the government.

7. Industrial & Agricultural Policy • Price control for many products • Rigid labor laws that made it difficult to lay off workers. • Direct public investment in industrial activities. • Management of the agricultural sector to ensure reasonable supplies of food grains, edible oils, sugar and cotton to the domestic market.

8. Agricultural Policy • Procurement prices were fixed, which , in times of surplus, worked as a minimum support price. • At times of deficit, the government mandatorily procured a part of the grain at the procurement price and distributed it to poorer people through ration shops. • Fertilizer, irrigation, power and credit were subsidised for the agricultural sector.

9. Agricultural and Fiscal Policy • The need to mop up excess production led to trade restrictions. • Quantitative restrictions on exports and imports, through licensing • Canalization – the use of a single parastatal for imports and exports; the use of minimum export prices. • High income tax rates

10. Social Policies • Higher education was emphasized (IITs and IIMs) • Growth-oriented strategy as a means of mitigating poverty and unemployment. • However, structural inequalities in land ownership, availability of water, access to credit etc. led to growth without income and employment growth for poorer people.

11. Social Policies • Land reform (at least in some states) • Alleviation of poverty through special programs and policies, such as asset creation programs, employment generation programs, minimum needs programs. • Intervention programs to solve the problems of malnutrition and hunger.

12. Did the policies work? Industry • Industry grew 6% p.a. between 1951 and 1989 • There was little competition; hence there was little R&D. • The capital-input ratio went up considerably; total factor productivity dropped. Capacity utilization fell. • Deeply entrenched interest groups.

13. Agricultural Progress • Between 1950 and 1980, food grain production increased by 2.8% p.a., due primarily to productivity gains and multiple cropping. • But, investment growth slowed. • R&D suffered, development of irrigation lagged behind plan targets. • There was a substantial rise in subsidies for food and fertilizer and for credit, water and electricity. • India became self-reliant, but at great cost.

14. Social Progress • From 1970-88, the proportion of population below poverty dropped from 46.17% to 37.76% in urban areas and from 58.75% to 48.69% in rural areas. • Average life expectancy improved from 32.1 in 1950-51 to 58.7 in 1990-91. The death rate dropped from 27.4 to 12.5 during the same period. • Literacy was 52.2% in 1990-91 compared to 18.33% in 1950-51. • But compared to other developing countries, this was not good.

15. The 1991 crisis and the change • A massive rise in the government deficit spilled over to the current account deficit because it was financed by external debt. • External shocks, such as increased oil prices, decreased access to concessionary loans from abroad • Structural rigidities in the Indian economy made Indian products non-competitive, globally.

16. The solution • A twofold solution: • Make the economic structure more competitive • Contain the government deficit • Effects: • Structural Change and • Fiscal stabilization.

17. Initial Reforms • Trade policy reforms have done away with most quantitative restrictions and reduced tariff levels • Industrial policy has removed barriers to entry and limits on growth in the size of firms • Regimes for foreign investment and foreign technology have been liberalized considerably • Domestic tax structure has been rationalized. • The financial sector is being deregulated.

18. Second-generation reforms • Privatization of public sector undertakings • Very slow, but steady. BHEL • Exit policy for labor • Reforms of the agricultural sector • Reforms of the state government

19. Real Net National Product

20. Growth in Industrial Production Atul Kohli, “Politics of Economic Growth in India, 1980-2005,” Economic and Political Weekly, April 2006, pp. 1251-1259 and 1361-1370

21. Changes post-1991 • Disparity in growth across states • Move towards service sector • Lack of industrial growth • Income inequalities • High poverty in the rural sector – farmer suicides • Continued casteism, gender inequality, communal unrest

22. Special Topics • Microfinance • Economic Discrimination in Employment • Capital Account Convertibility • Shareholder Dispersion

23. Microfinance • Lack of rural development was thought to be due to lack of production assets and credit. • The government introduced easy credit programs through Regional Rural Banks. • These banks improved access to credit of better-off farmers, but failed to reach the vast numbers of landless people, micro-entrepreneurs, agricultural labourers and illiterate women. • Cheap credit skewed development to richer farmers.

24. Microfinance • Early Rural Credit programs failed because: • procedures of rural banks were unduly complicated and costly • the sole emphasis on production loans was ill-guided • the poor were able to save, but had no opportunity of depositing their savings • transaction costs were prohibitive • financial products were unsuitable

25. Microfinance in India • National Bank for Agriculture and Rural Development (NABARD) concluded from a study that: • Microfinance programs have to be savings-led, not credit-driven. • The poor have to have a say in their design. • The NABARD program with the help of the RBI based itself on the work of self-help groups (SHGs).

26. SHGs • SHGs are successful because they are self-directed, • largely homogeneous in terms of caste and activity, • build a common fund from very small regular savings and interest income • lend to their members for periods of 1-3 months at an interest rate of 2-3% per month.

27. SHG Banking • The NABARD program piggy-backs on the work of established SHGs by providing them refinance. • This program works because India already has in place a network of rural banks. • By March 2005 SHG banking reached 1.6 million savings-based groups with 24 million members, covering over 120 million people from the lowest strata of the rural population. • The program is in the hands of local agencies, driven by local SHG ownership.

28. Microfinance • Why does it work? • Incentives • Group Monitoring

29. Economic Discrimination • Two theories of employee discrimination: • Statistical Discrimination – desired characteristics are more prevalent in the sought-after group. Hence employees belonging to this group are preferred. • A recent study concluded that SC/ST graduates of the 2006 IIM-Ahmedabad batch got jobs with lower pay offers. • The study found that after adjusting for weaker academic performance, there was no discrimination.

30. Economic Discrimination • Preference-Based Discrimination (Becker) • If employers prefer to associate with employees of a certain background, then that characteristic will be priced – employees of the favored group will be preferred even if there is no difference on efficiency grounds. • This may be changed by advertising, marketing and misconceived associations between group affiliation and economic performance.

31. Benefits of Capital Account Convertibility • to stimulate economic growth through higher investment by minimizing the cost of both equity and debt capital; • to improve the efficiency of the financial sector through greater competition, thereby minimizing intermediation costs and • to provide opportunities for diversification of investments by residents.

32. Capital Account Convertibility • CAC based on the theory that capital will flow from high capital-endowment countries to low capital-endowment countries, from low-return-to-capital countries to high-return-to-capital countries. • But CAC often led to movement of capital from developing countries to developed countries. • One reason is information asymmetry problems in developing countries combined with contract enforcement difficulties. • Capital flows can be volatile.

33. Capital Account Convertibility • Currently in India, the rupee is fully convertible for current account transactions. • Capital account transactions are transactions that alter the assets or liabilities outside India of an Indian or inside India of a non-Indian, i.e. that convert local financial assets into foreign financial assets – for such transactions, convertibility is limited.

34. Capital Account Convertibility • State governments are not allowed to directly access any form of external borrowing • Banks are not allowed to borrow abroad; however, Indian companies are allowed ECBs (external company borrowings). • Foreigners are allowed to invest in India only in certain sectors and subject to certain limits.

35. Capital Account Convertibility: Examples • In insurance, they are not allowed to operate directly, but they can have a joint venture with up to a 26% equity interest. • Foreign investment is not permitted in the retail sector with certain restrictions. • 100% FDI is permitted for wholesale cash and carry trading and trading for exports • 51% FDI permitted for Single Brand product retailing

36. Shareholder Dispersion: Why? • Helps stock market liquidity • Which, in turn, helps market efficiency and • Information aggregation • Prevents control of government by corporate sector, leading to subversion of political system. • From the firm’s point of view, IPOs directed to shareholders at large, rather than Financial Institutions will keep the cost of capital lower; this will ensure economic efficiency.

37. Shareholder Dispersion: Why not? • Agency costs • Leads to divergence between managerial goals and shareholder goals • Reduced investment in monitoring of managers • Inefficient investment • Need strong market for corporate control and well-regulated securities market to offset this. • Empirically, dispersed share-ownership is a characteristic of developed economies.

38. Shareholding Patterns in India • As of end Mar 2007, promoters held 54.94% of total shares, individuals held 13.78% and institutional holdings accounted for 14.64% -- these holdings were spread over all industries. • However, only 6.5% of household savings are invested in securities markets – including government securities, mutual funds and others. • As of end 2005, India’s market cap was 68.6% of GDP, compared to 112.9% for high-income countries.

39. Shareholding Patterns in India • However, the ratio of the number for India to that of high-income countries has risen from 0.236 in 1990 to 0.6076 in 2005.