INDIAN ECONOMY AT THE EVE OF INDEPENDENCE (1947)

The rise of the Indian economy is one of the most important economic developments of our day. To put it
in context, one needs to start by considering how India gained independence.

The year was 1947, and it was the culmination of a long struggle between the British government and the
Indian independence movement. That movement was led by Gandhi, but his most important lieutenant was
Nehru. The two had very different views on a number of questions, and in particular on economic issues.
Gandhi believed in a very simple life, while Nehru had absorbed the doctrines of British socialism. The
British socialist movement at that time aimed to build up a modern economy as rapidly as possible.

BASIC CHARACTERISTICS OF THE INDIAN ECONOMY AS AN UNDERDEVELOPED

ECONOMY IN 1947 :

1. Low per capita income

2. Occupational pattern ( very high population of Indian economy was engaged in agriculture)

3. Heavy population

4. Prevalence of chronic unemployment and underemployment.

5. Low rate of capital formation.

6. Maldistribution of Wealth/Assets.

7. Poor quality of human capital.

8. Prevalence of low level of technology.

9. Low level of living of the average Indian.

10. Poor economic organization

11. There was a manufacturing sector, but it didn't cover many industries.

12. In some ways India had a fully developed capitalist economy, and it had some of the oldest
capitalist institutions in Asia, such as the Bombay Stock Exchange, founded in 1875. So there was a
modern economy, but it was very thin.

13. There was even a steel industry and a relatively strong textile industry, but these were limited. It
was predominantly a subsistence economy.

At that time the Indian Congress absolutely dominated India, so what the Indian Congress thought went.
There was certainly a widespread agreement on the need to develop, to create an industrial revolution, to
grow rapidly, and to build a modern economy. This would involve moving agricultural workers to the
cities, which it was argued-this was a popular line of thought in the early days of development economics-
wouldn't really cost anything, because the marginal products of those agricultural workers was negligible
anyway. They really weren't contributing in the countryside. In any event, with a little agricultural
modernization, it would be possible to increase output.
It was generally agreed that society should be based on collective action, not capitalist acquisitiveness.
Basically, the view was that the state ought to seize control of the economy and ought not be run by the
capitalist sector. Consequently, for the best part of forty years after independence, growth was slow. But
the "License Raj" developed very quickly. Everything needed permission. If you owned a business that
officially was in the private sector, in order to expand you needed a license. You couldn't get foreign
exchange to import until you had the industrial license to expand. The government effectively controlled
everything through a series of interlocking controls of that type.

Even the banks were nationalized in due course. The banking system was one of the later things to be
nationalized, in the late 1960s and early 1970s, but even then this philosophy prevailed. The system was
dominated as in many developing countries by the idea of import substitution, the idea that you would get
expanding markets for industrial goods essentially by producing at home things that had formerly been
imported. That was because you simply couldn't import most goods.

There was on the other hand continuous macroeconomic discipline. Unlike many developing countries in
Latin America, or in Africa, or even in Southeast Asia (such as Indonesia), India never suffered from
hyperinflation. India never went above about 20 percent a year. Instead, where the macroeconomic
problems showed up was in balance-of-payment pressures. The fact that one required a license to import
just about everything was strangling the economy.

UNEMPLOYMENT IN INDIA
India was a under developed though a developing economy. The nature of unemployment therefore sharply
differs from the one that prevails in industrially advanced countries. Keynes diagnosed unemployment in
advanced countries to be the result of a deficiency of effective demand. It implied that in such economies
machined become idle and demand for labor falls. The process of rationalization which started in India
since 1950 caused displacement of labor. The flexibility of an economy can be judged from the speed with
which it heals frictional unemployment. During the pre reform period India suffered from chronic under
employment or disguised unemployment in the rural sector and there was existence of under
unemployment among the educated classes.

UNEMPLOYMENT AMONG URBAN AND RURAL AREAS

PERIOD RURAL AREAS Column1 Column2 URBAN AREAS Column3 Column4
  MALE FEMALE PERSONS MALE FEMALE PERSONS
1977-78 7.1 9.2 7.7 9.4 14.5 10.3
1983 7.5 9 7.9 9.2 11 9.5
1987-88 4.6 6.7 5.3 8.8 12 9.4
1993-94 5.6 5.6 5.6 6.7 10.5 7.4
1999-2000 7.2 7.3 7.2 7.2 9.8 7.7

VARIOUS SCHEMES TO REDUCE UNEMPLOYMENT AND UNDEREMPLOYMENT

1. Employment Guarantee Scheme of Maharashtra.(1972-73)

2. National rural Employment Program(1980)
 3. Rural Landless Employment Guarantee Program(1983)
4. IRDP, NREP, Rural Poverty and Employment.
5. Jawahar Rozgar Yojana.
6. Indira Awaas Yojana.
7. Employment Assurance Scheme.
8. Million Wells Scheme.

POVERTY IN INDIA
NUMBER AND PROPORTION OF POPULATION IN POVERTY IN India
  NUMBERS (IN MILLION)     POVERTY LINE    
198 198
  1970 1983 1988 1970 3 8
BELOW POVERTY LINE            
252. 252.
RURAL 236.8 1 2 53 42.5 41.7
URBAN 50.5 64.7 70.1 45.5 36.4 33.6
311. 322.
TOTAL 287.3 7 3 52.4 42.5 39.6
BELOW ULTRA POVERTY LINE            
128. 123.
RURAL 134.6 1 6 30.1 22.8 20.4
URBAN 28.4 31.5 32.9 25.6 17.7 15.8
159. 156.
TOTAL 163 6 5 29.8 21.8 19.2
733. 813.
TOTAL POPULATION 547.6 2 7 100 100 100

PLANNING AND ECONOMIC DEVELOPMENT

OBJECTIVES AND STRATEGIES OF ECONOMIC PLANNING

1. To increase production to the maximum possible extent so as to achieve higher level of national and
per capita income.
2. To achieve full employment.
3. To reduce inequalities of income and wealth.
4. To set up a socialist society based on equality and justice and absence of exploitation.
INDUSTRIAL POLICY RESOLUTION

1. The manufacture of arms and ammunition, the production and control of atomic energy, and the
ownership and management of railway transport were to be the exclusive monopoly of the central
government.
2. The second category covered coal, iron and steel, aircraft manufacture, ship building, manufacture
of telephone, telegraphs and wireless apparatus Etc.
3. The third category was made up of industries of such basic importance that the central government
would feel it necessary to plan and regulate them.
4. Fourth category comprises the remainder of the industrial field, was left open to private enterprise
individual as well as co-operative.

INDUSTRIAL POLICY RESOLUTION, 1956

1. New classification of industries.

2. Fair and non-discriminatory treatment of the private sector.
3. Encouragement to village and Small scale enterprise.
4. Removing regional disparities
5. The need for the provision of amenities for labor.
6. Attitude towards foreign capital.

INDUSTRIAL POLICY STATEMENT, 1977

1. Development of Small scale sector.

2. Areas for large scale sector.
3. Approach towards large business houses.
4. Expanding role for the public sector.
5. Approach towards foreign collaboration.
6. Approach towards sick units.

INDUSTRIAL POLICY OF 1980

1. Effective operational management of the public sector.

2. Integrating industrial development in the private sector by promoting the concept of economic
federalism.
3. Redefining of small units.
4. Promotion of industries on rural areas.
5. Removal of regional imbalances.
6. Regularization of unauthorized excess capacity installed in the private sector.
7. Automatic expansion.
8. Industrial sickness.
LIBERALISATION OF INDUSTRIAL LICENSING AFTER 1980

1. Liberalization of licensed capacity in the name of economies of scale and modernization.

2. Concept of broad banding was introduced.
3. Raising the asset limit of MRTP companies.
4. Relaxation of industrial licensing.
5. Industrialization of backward areas.

BANKING SYSTEM IN INDIA

The first bank was in India was established in 1786, the General Bank of India and Bank of Hindustan,
which are both dysfunctional now. The oldest bank in existence today in India is the State Bank of India,
which originated in the Bank of Calcutta in June 1806, which almost immediately became the Bank of
Bengal. This was one of the three presidency banks, the other two being the Bank of Bombay and the Bank
of Madras. All the three were established under charters from the British East India Company. For many
years the Presidency banks acted as quasi-central banks, as did their successors. All the three banks merged
in 1921 to form the Imperial Bank of India, which, upon India's independence, became the State Bank of
India.

The banking system has since then seen a lot of changes and gone through various phases.

The major phases being:

 Early phase from 1786 to 1969 of Indian Banks

 Nationalization of Indian Banks and up to 1991 prior to Indian banking sector Reforms.
 New phase of Indian Banking System with the advent of Indian Financial & Banking Sector
Reforms after 1991.

We will talk about the banking sector post independence:

The partition of India in 1947 adversely impacted the economies of Punjab and West Bengal that
paralyzed banking activities for months. India's independence marked the end of a regime of the Laissez-
faire for the Indian banking. During this period the Government of India initiated measures to play an
active role in the economic life of the nation also the Industrial Policy Resolution adopted by the
government in 1948 envisaged a mixed economy. This resulted into greater involvement of the state in
different segments of the economy including banking and finance.

The major steps taken to regulate banking in India included:

 1949 : Enactment of Banking Regulation Act.

 1955 : Nationalization of State Bank of India.
 1959 : Nationalization of SBI subsidiaries.
 1961 : Insurance cover extended to deposits.
  1969 : Nationalization of 14 major banks.
 1971 : Creation of credit guarantee corporation.
 1975 : Creation of regional rural banks.
 1980 : Nationalization of seven banks with deposits over 200 crore.

The phase observed in the Indian Banking System after Independence as mentioned above are described as below:

 The Reserve Bank of India, India's central banking authority, was nationalized on January 1, 1949. Also in
1949, the Banking Regulation Act was enacted which empowered the Reserve Bank of India (RBI) "to
regulate, control, and inspect the banks in India." The Banking Regulation Act also provided that no new
bank or branch of an existing bank could be opened without a license from the RBI, and no two banks could
have common directors

 In 1955, it nationalized Imperial Bank of India with extensive banking facilities on a large scale
especially in rural and semi-urban areas. It formed State Bank of India to act as the principal agent
of RBI and to handle banking transactions of the Union and State Governments all over the country.
 Seven banks forming subsidiary of the State Bank of India were nationalized in the year 1960 and
on 19th July, 1969, the major process of nationalization was carried out. It was the effort of the then
Prime Minister of India, Mrs. Indira Gandhi, that the 14 major commercial banks in the country
were nationalized.
 Second phase of nationalization Indian Banking Sector Reform was carried out in 1980 with seven
more banks. This step brought 80% of the banking segment in India under Government ownership.
 After the nationalisation of banks, the branches of the public sector bank India rose to
approximately 800% in deposits and advances took a huge jump by 11,000%.Banking in the
sunshine of Government ownership gave the public implicit faith and immense confidence about
the sustainability of these institutions.

ECONOMIC GROWTH OF INDIA (1980 – 1990)

After independence in 1947, India’s development pattern was characterized by strong centralized planning.
Government ownership of basic and key industries, excessive regulation and control of private enterprise,
trade protectionism through tariff and non tariff barriers and a cautious and selective approach towards
foreign capital. It was a quota, permit and license regime. This so called inward looking, import
substitution strategy of economic development began to be widely questioned with the beginning of 1980s.
Policy makers started realizing the drawbacks of this strategy which inhibited competitiveness and
efficiency and produced a much lower rate of growth than expected.

The growth improved in the 1980s. From FY 1980 to Fy 1989, the economy grew at an annual rate 5.5%,
or3.3% on a per capita basis. Industry grew at an annual rate of 6.6% and agriculture at a rate of 3.6%.
 FIRST SEVEN FIVE YEAR PLANS (BEFORE THE REFORMS)
(1950-1990)
FIRST PLAN- At the time of the first five year plan (1951-1956) India was faced with three problems-
influxes of refugees, severe food shortage and mounting inflation. India had also to correct the
disequilibrium in the economy caused by the Second World War and the partition of the company.
Accordingly the first plan emphasized as its immediate objectives, the rehabilitation of refugees, rapid
agriculture development so as to achieve food self sufficiency in the shortest possible time and control of
inflation. Simultaneously the First plan attempted a process of all round balanced development which could
ensure a rising national income and a steady improvement in the living standards of the people over a
period of time.

SECOND PLAN- From (1956- 61) was conceived in an atmosphere of economic stability. Agriculture
targets fixed in the first plan had been achieved. Price level had registered a fall and, consequently, it was
felt that the Indian economy had reached a stage where agriculture can be assigned a lower priority and a
forward thrust made in the development of the heavy and basic industries of the economy. The basic
philosophy of the second plan was therefore, to give a big push to the economy so that it enters the take-
off stage.

THIRD PLAN- The goal was the establishment of a self reliant and self generating economy. It gave top
priority to agriculture. But it also laid adequate emphasis on the development of basic industries, which
were vitally necessary for rapid economic development of the country.
FOURTH PLAN- It aimed at an average 5.5% growth in the national income and the provision of national
minimum for the weaker sections of the society- the later come to be known as the objectives of
“GROWTH WITH JUSTICE” and “GARIBI HATAO”.

FIFTH PLAN- It was prepared and launched by Dr. D P dhar proposed to achieve the two main objectives
i.e. removal of poverty and attainment of self reliance, through promotion of higher rate of growth, better
distribution of income and a very significant step up in the domestic rate of saving.

SIXTH PLAN- It was introduced by congress and brought the Nehru model of growth by aiming at a
direct attack on the problem of poverty by creating conditions of an expanding economy.

SEVENTH PLAN- It sought to emphasize policies and programs which would accelerate the growth in
food grains production increase employment opportunities and raise productivity.

INDIAN ECONOMY FROM 1991 – 1999 (POST

ECONOMIC REFORMS ERA)
India was a latecomer to economic reforms, embarking on the process in earnest only in 1991, in the wake of an
exceptionally severe balance of payments crisis.

The collapse of the Soviet Union, which was India’s major trading partner and the first Gulf War, which caused a
spike in oil prices, caused a major balance of payments crisis for India, which found itself facing the prospect of
defaulting on its loans. India asked for a $1.8 billion bailout loan from IMF, which in return demanded reforms.

In response, Prime Minister Narasimha Rao along with his finance minister Dr. Manmohan Singh initiated the
economic liberalization of 1991. The reforms did away with the Licence Raj (investment, industrial and import
licensing) and ended many public monopolies, allowing automatic approval of foreign direct investment in many
sectors.

India’s economic performance in the post-reforms period has many positive features;

1. The average growth rate in the ten year period from 1991 to 1999 was around 6%, as shown in
Table, which puts India among the fastest growing developing countries in the 1990s.
 Total GDP Growth
9 7.8
8 7.3 7.3
7 6.5
5.9 6.1
6 5.1 4.8 Total GDP Growth
5
4
3
2 1.3
1
0
1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-991999-2000

In sharp contrast, growth in the 1990s was accompanied by remarkable external stability despite the east
Asian crisis. Poverty also declined significantly in the post-reform period, and at a faster rate than in the
1980s. However, the ten-year average growth performance hides the fact that while the economy grew at
an impressive 6.7 percent in the first five years after the reforms, it slowed down to 5.4 percent in the next
five years. India remained among the fastest growing developing countries in the second sub-period
because other developing countries also slowed down after the east Asian crisis, but the annual growth of
5.4 percent was much below the target of 7.5 percent which the government had set for the period.

2. Fiscal profligacy was seen to have caused the balance of payments crisis in 1991 and a reduction in the
fiscal deficit was therefore an urgent priority at the start of the reforms. The combined fiscal deficit of the
central and state governments was successfully reduced from 9.4 percent of GDP in 1990-91 to 7 percent in
both 1991-92 and 1992-93 and the balance of payments crisis was over by 1993.

As shown in Table, public savings deteriorated steadily from +1.7 percent of GDP in 1996-97 to –1.7
percent in 2000-01. This was reflected in a comparable deterioration in the fiscal deficit taking it to 9.6
percent of GDP in 2000-01. Not only is this among the highest in the developing world, it is particularly
worrisome because India’s public debt to GDP ratio is also very high at around 80%. Since the total
financial savings of households amount to only 11 percent of GDP, the fiscal deficit effectively preempts
about 90 percent of household financial savings for the government. What is worse, the rising fiscal deficit
in the second half of the 1990s was not financing higher levels of public investment, which was more or
less constant in this period.
3. Import licensing was abolished relatively early for capital goods and intermediates which became freely
importable in 1993, simultaneously with the switch to a flexible exchange rate regime.

Removing quantitative restrictions on imports of capital goods and intermediates was relatively easy,
because the number of domestic producers was small and Indian industry welcomed the move as making it
more competitive. It was much more difficult in the case of final consumer goods because the number of
domestic producers affected was very large (partly because much of the consumer goods industry had been
reserved for small scale production).

Progress in reducing tariff protection, the second element in the trade strategy, has been even slower and
not always steady. The weighted average import duty rate declined from the very high level of 72.5 percent
in 1991-92 to 24.6 percent in 1996-97. However, the average tariff rate then increased by more than 10
percentage points in the next four years.

Liberalizing foreign direct investment was another important part of India’s reforms, driven
by the belief that this would increase the total volume of investment in the economy, improve production
technology, and increase access to world markets.

These reforms have created a very different competitive environment for India’s industry than existed in
1991, which has led to significant changes. Indian companies have upgraded their technology and
expanded to more efficient scales of production. They have also restructured through mergers and
acquisitions and refocused their activities to concentrate on areas of competence. New dynamic firms have
displaced older and less dynamic ones: of the top 100 companies ranked by market capitalization in 1991,
about half are no longer in this group. Foreign investment inflows increased from virtually nothing in 1991
to about 0.5 percent of GDP.

These policy changes were expected to generate faster industrial growth and greater penetration of world
markets in industrial products, but performance in this respect has been disappointing. As shown in Table
1, industrial growth increased sharply in the first five years after the reforms, but then slowed to an annual
rate of 4.5 percent in the next five years. Export performance has improved, but modestly.
The share of exports of goods in GDP increased from 5.7 percent in 1990-91 to 9.7 percent, but this reflects
in part an exchange rate depreciation. India’s share in world exports, which had declined steadily since
1960, increased slightly from around 0.5 percent in 1990-91 to 0.6 percent in 1999-2000, but much of the
increase in world market share is due to agricultural exports. India’s manufactured exports had a 0.5
percent share in world markets for those items in 1990 and this rose to only 0.55 percent by 1999.

The one area which has shown robust growth through the 1990s with a strong export orientation is software
development and various new types of services enabled by information technology like medical
transcription, backup accounting, and customer related services. Export earnings in this area have grown
from $100 million in 1990-91 to over $6 billion in 2000-01 and are expected to continue to grow at 20 to
30 percent per year. India’s success in this area is one of the most visible achievements of trade policy
reforms which allow access to imports and technology at exceptionally low rates of duty, and also of the
fact that exports in this area depend primarily on telecommunications infrastructure, which has improved
considerably in the post-reforms period.

The share of India’s agricultural exports in world exports of the same commodities increased from 1.1
percent in 1990 to 1.9 percent in 1999, whereas it had declined in the ten years before the reforms.
But while agriculture has benefited from trade policy changes, it has suffered in other respects, most
notably from the decline in public investment in areas critical for agricultural growth, such as irrigation and
drainage, soil conservation and water management systems, and rural roads.
In 1998, a tax was imposed on gasoline (later extended to diesel) , the proceeds of which are earmarked for
the development of the national highways, state roads and rural roads.

Financial Sector Reform

India’s reform program included wide-ranging reforms in the banking system and the capital markets
relatively early in the process with reforms in insurance introduced at a later stage.
Banking sector reforms included: (a) measures for liberalization, like dismantling the complex system of
interest rate controls, eliminating prior approval of the Reserve Bank of India for large loans, and reducing
the statutory requirements to invest in government securities; (b) measures designed to increase financial
soundness, like introducing capital adequacy requirements and other prudential norms for banks and
strengthening banking supervision; (c) measures for increasing competition like more liberal licensing of
private banks and freer expansion by foreign banks. These steps have produced some positive outcomes.
There has been a sharp reduction in the share of non-performing assets in the portfolio and more than 90
percent of the banks now meet the new capital adequacy standards. However, these figures may overstate
the improvement because domestic standards for classifying assets as non-performing are less stringent
than international standards.

Reforms in the stock market were accelerated by a stock market scam in 1992 that revealed serious
weaknesses in the regulatory mechanism. Reforms implemented include establishment of a statutory
regulator; promulgation of rules and regulations governing various types of participants in the capital
market and also activities like insider trading and takeover bids; introduction of electronic trading to
improve transparency in establishing prices; and dematerialization of shares to eliminate the need for
physical movement and storage of paper securities. Effective regulation of stock markets requires the
development of institutional expertise, which necessarily requires time, but a good start has been made.
Privatization
The principal motivation was to mobilize revenue for the budget, though there was some expectation that
private shareholders would increase the commercial orientation of public sector enterprises. This policy
had very limited success. Disinvestment receipts were consistently below budget expectations and the
average realization in the first five years was less than 0.25 percent of GDP compared with an average of
1.7 percent in seventeen countries reported in a recent study. There was clearly limited appetite for
purchasing shares in public sector companies in which government remained in control of management.

In 1998, the government announced its willingness to reduce its shareholding to 26 percent and to transfer
management control to private stakeholders purchasing a substantial stake in all central public sector
enterprises except in strategic areas.i The first such privatization occurred in 1999, when 74 percent of the
equity of Modern Foods India Ltd. (a public sector bread-making company with 2000 employees), was
sold with full management control to Hindustan Lever, an Indian subsidiary of the Anglo-Dutch
multinational Unilever.

Social Sector Development in Health and Education

India’s social indicators at the start of the reforms in 1991 lagged behind the levels achieved in southeast
Asia 20 years earlier, when those countries started to grow rapidly (Dreze and Sen, 1995). For example,
India’s adult literacy rate in 1991 was 52 percent, compared with 57 percent in Indonesia and 79 percent in
Thailand in 1971. The gap in social development needed to be closed, not only to improve the welfare of
the poor and increase their income earning capacity, but also to create the preconditions for rapid economic
growth. While the logic of economic reforms required a withdrawal of the state from areas in which the
private sector could do the job just as well, if not better, it also required an expansion of public sector
support for social sector development.

The literacy rate increased from 52 percent in 1991 to 65 percent in 2001, a faster increase in the 1990s
than in the previous decade, and the increase has been particularly high in the some of the low literacy
states such as Bihar, Madhya Pradesh, Uttar Pradesh and Rajasthan.

Public Expenditure on Social Sector and Rural Development (% of GDP)

IMPACT OF THE ECONOMIC REFORMS
The impact of ten years of gradualist economic reforms in India on the policy environment presents a
mixed picture. The industrial and trade policy reforms have gone far, though they need to be supplemented
by labor market reforms which are a critical missing link. The logic of liberalization also needs to be
extended to agriculture, where numerous restrictions remain in place. Reforms aimed at encouraging
private investment in infrastructure have worked in some areas but not in others. The complexity of the
problems in this area was underestimated, especially in the power sector. This has now been recognized
and policies are being reshaped accordingly. Progress has been made in several areas of financial sector
reforms, though some of the critical issues relating to government ownership of the banks remain to be
addressed. However, the outcome in the fiscal area shows a worse situation at the end of ten years than at
the start.

Critics often blame the delays in implementation and failure to act in certain areas to the choice of
gradualism as a strategy. However, gradualism implies a clear definition of the goal and a deliberate choice
of extending the time taken to reach it, in order to ease the pain of transition. This is not what happened in
all areas. The goals were often indicated only as a broad direction, with the precise end point and the pace
of transition left unstated to minimize opposition—and possibly also to allow room to retreat if necessary.
This reduced politically divisive controversy, and enabled a consensus of sorts to evolve, but it also meant
that the consensus at each point represented a compromise, with many interested groups joining only
because they believed that reforms would not go “too far”. The result was a process of change that was not
so much gradualist as fitful and opportunistic. Progress was made as and when politically feasible, but
since the end point was not always clearly indicated, many participants were unclear about how much
change would have to be accepted, and this may have led to less adjustment than was otherwise feasible.

The impact of these reforms may be gauged from the fact that total foreign investment (including foreign
direct investment, portfolio investment, and investment raised on international capital markets) in India
grew from a minuscule US$132 million in 1991–92 to $5.3 billion in 1995–96. Cities like Gurgaon,
Bangalore, Hyderabad, Pune and Ahmedabad have risen in prominence and economic importance, became
centres of rising industries and destination for foreign investment and firms. As of March 1998, deposits of
the banking system stood at Rs6,013.48 billion and net bank credit at Rs3,218.13 billion.
 INDIAN ECONOMY FROM 2000 – 2010
INDIA’S GDP GROWTH (BILLION $)
INDIA’S TRADE PERFORMANCE
Over six year period 2002-03-07-2008, the average annual growth in :

Exports – 25%
Imports – 31%
Trade – 28%

However total trade grew only by 10% in 08-09 due to global slowdown.
HOW THE OTHER FACTORS PERFORMED DURING 2000-2010 (A SNAPSHOT)
 FISCAL POLICY
A Brief Introduction: The Arms & Ammunition of the Central Government
Fiscal policy is based on the theories of British economist John Maynard Keynes. Also known as
Keynesian economics, this theory basically states that governments can influence macroeconomic
productivity levels by increasing or decreasing tax levels and public spending. This influence, curbs
inflation thereby increasing employment and maintains a healthy value of money.

It basically means by which a government adjusts its levels of spending in order to monitor and influence a
nation's economy. It is the sister strategy to monetary policy, with which a central bank influences a
nation's money supply. These two policies are used in various combinations in an effort to direct a
country's economic goals. It refers to the union government's use of its annual budget to affect the level of
economic activity, resource allocation and income distribution.

The two main instruments of fiscal policy are

 Government spending
 Taxation

Fiscal Policy “The Indian context”

Government Expenditure
It is considered to be one of the most important cause of present fiscal problems. In India, the expenditure
of the government has been very large. The rise in it has indeed been rapid resulting in widening of the gap
between the revenues and expenditure.

During the first 30 years of independence, between 1950 and 1980, the fiscal deficits of both the central
and the state governments were not excessive. This was a period of revenue surplus in general.
There was a significant deterioration in the fiscal situation in the 1980s, accompanied by large and
automatic monetization of government deficits. The process involved issue of ad-hoc Treasury bills at rates
initially on par with 91- day Treasury Bills. Since July 1974, the ad-hoc Treasury bills were offered at off-
market discount rate of 4.6 percent which was less than half of the prevailing market rates. There were two
immediate consequences. One, when large government deficits were monetized, there was excess liquidity
in the system, which prompted the monetary authorities to increase the cash reserve ratio (CRR) for banks
at regular intervals with a view to mop up the excess liquidity. Two, to facilitate the central government to
borrow comfortably, the monetary authority, which is also the debt manager for the government,
periodically increased the statutory liquidity ratio (SLR) to be maintained by banks. This process went on
to an extent that CRR and SLR, together, pre-empted more than 50% of the resources of the banking sector
in order to primarily finance the budget deficits of the governments. Further, the deposit and lending rates
of banks were administered. This situation impacted the health of the banking system.
 TAXATION IN INDIA
Tax systems the world over have undergone significant changes during the last twenty years as many countries
across the ideological spectrum and with varying levels of development have undertaken reforms. The wave of tax
reforms that began in the mid-1980s and accelerated in the 1990s was motivated by a number of factors. In many
developing countries, pressing fiscal imbalance was the driving force.
The trends in tax ratios of direct and indirect taxes follow different paths. The tax ratio for direct taxes remained
virtually stagnant throughout the forty-year period from 1950 to 1990 at a little over 2 percent of GDP. Thereafter,
coinciding with the reforms marked by significant reduction in the tax rates and simplifications of the tax structure,
direct taxes increased sharply to over 4 percent of GDP in 2003–04 and were expected to be about 4.5 percent in
2004–05. In contrast, much of the increase in the tax ratio during the first forty years of planned development in
India came from indirect taxes, which more than tripled, from 4 percent of GDP in 1950–51 to 13.5 percent in
1991–92. Since then, however, revenue from indirect taxes has fallen back to around 11 percent of GDP. The
decline in the total tax ratio observed since 1987–88 has occurred mainly at the central level, since center accounts
for about 60 percent of the total. Notably, tax ratios of both central and state governments increased sharply
between 1950–51 and 1985–86. Thereafter, the tax ratio at the state level was virtually stagnant at about 5.5
percent until 2001–02, when it increased modestly. In contrast, the central tax ratio increased to its peak in 1987–
88, and remained at that level until the fiscal crisis of 1991–92, when it declined sharply until 2001–02; by 2004–05,
it had nearly recovered its pre-1991 level. Within the central level, the share of direct taxes has shown a steady
increase from less than 20 percent in 1990–91 to more than 43 percent in 2004–05. Following is the table which
shows the relevance of the above.
Analysis of Central Taxes
Interestingly, the comprehensive tax reform at the central level was the direct consequence of economic crisis. As
Bird stated after observing tax reforms in many countries, “fiscal crisis has been proven to be the mother of tax
reform

Analysis of the Trends and Economic Impact of the Tax System

In this section, the observed trends in different central and state taxes are explained in greater detail and the possible
efficiency and equity implications of different taxes are analyzed. Specifically, the analysis seeks to answer a number of
questions. Has tax compliance improved over the years in response to reductions in marginal tax rates? What other factors
influence revenue productivity of the tax system? What are the efficiency and equity implications of the tax system?

Personal Income Tax

The increase in revenue productivity of the personal income tax is attributed to the improvement in tax
compliance arising from the sharp reduction in marginal tax rates in 1991–92 and 1996–97. This is also the
period when the growth of GDP itself had decelerated. The apparent stimulus of declining marginal tax
rates is reflected in the negative correlation between effective tax rates and the ratio of income tax
collections to GDP, akin to a Laffer curve. While it is clearly difficult to attribute the increase in revenue
productivity solely or even mainly to reduction in marginal tax rates, draw a tentative but important
conclusion capturing improvement in overall performance of the tax system.
Corporate Income Tax

Of the four major taxes considered, the revenue from the corporate income tax grew at the fastest rate
during the 1990s, tripling as a percentage of GDP, from 0.9% in 1990–91 to 2.7 % in 2003–04, despite
significant reduction in the rates. The main reforms eliminated the distinction between closely held and
widely held companies, reduced the marginal tax rate to align it with the top marginal tax rate of personal
income tax, and rationalized tax preferences, namely, investment and depreciation allowances, to a
considerable extent. In addition, the introduction of the minimum alternative tax has also contributed to
revenues.

Long-Term Fiscal Policy Challenges

India’s loose fiscal policy has reduced growth below potential without showing any discernible signs of an
imminent crisis. However, if the fiscal imbalances are not addressed and growth continues to fall short of
potential, the risks of a conventional crisis – fiscal, monetary or external – will increase. According to some
scenarios, in which real interest rates stay relatively high and greater efficiencies in investment are only
partially realized, even fiscal reform that cuts the primary deficit substantially over the next three years will
just succeed in maintaining something like the current deficit-GDP ratio of about 10%, and debt will
continue to accumulate, though less rapidly than in the last few years. This is a minimal objective to aim
for over the next few years. Critical elements of any scenario that does not lead to almost certain crisis
down the road are an increase in the tax-GDP ratio, and a reorientation of public expenditure toward
efficient investment in physical infrastructure and human development, and away from distortionary and
inefficient subsidies.
 INDIA AT A GLANCE : 2011-15
OVERVIEW
Despite its lack of a reliable parliamentary majority, the Indian National Congress-led United Progressive
Alliance coalition government is expected to serve its full second term until 2014. Political stability will
vary from one region of India to another. The violent insurgency waged by Naxalite (Maoist) groups across
large swathes of central and eastern India is becoming the country's most serious security problem.
Economic reform will continue to progress only slowly: the government is likely to restrict its focus to
targeted spending and piecemeal changes, rather than attempting to implement more sweeping structural
reforms. The Economist Intelligence Unit expects the government to meet its budget deficit target of 5.5%
of GDP for fiscal year 2010/11 (April-March). Public spending will continue to rise rapidly in 2011-15.
The Reserve Bank of India (RBI, the central bank) will gradually raise interest rates in the five-year period.
Real GDP (on an expenditure basis) is forecast to expand by 9.1% in 2010/11 and 8.9% in 2011/12,
compared with 7.7% in 2009/10. Growth will average 8.7% a year in 2012/13-2015/16.

Policy trends
The continuance of Congress as the main governing party following the 2009 general election means that
macroeconomic policy in the forecast period will be consistent with the direction pursued in the first five
years of UPA rule. The budget for fiscal year 2010/11 (April-March), which was unveiled in February
2010, contains plans for tax reforms, consolidation of the public finances and a reduction in fiscal stimulus
measures in the medium term. Monetary tightening will continue into early 2011. Priority will continue to
be given to populist measures designed to help the “aam admi” (common man). The concept of "inclusive
growth" will remain central to government policy.
Fiscal policy
The 2010/11 budget includes a strong emphasis on fiscal consolidation. It outlines a schedule of
progressive deficit reduction, according to which the budget shortfall is targeted to narrow to 5.5% of GDP
in 2010/11, 4.8% in 2011/12 and 4.1% of GDP in 2012/13. The improvement in the fiscal position will be
partly a function of faster economic growth. The other main factors contributing to the shrinking of the
deficit until 2012/13 will be the proceeds from the government's divestment of shares in state-owned firms
and auctions of third-generation (3G) telecoms licenses, together with reforms to the fuel-subsidy program.
Moreover, for the first time ever the budget includes an explicit target for a reduction in the ratio of public
debt to GDP. We forecast that the government will achieve its budget deficit target for 2010/11. The
Ministry of Finance has said that the government stands a good chance of beating the target, given the
success of the 3G auction and the strength of tax revenue in the first quarter of 2010/11. Although we
acknowledge that this is possible, we believe it more likely that the government will use any unexpected
fiscal flexibility to fund its myriad welfare schemes. The budget deficit will shrink further in 2011/12, but
at 5.1% of GDP it will miss the government's target by a narrow margin. Public expenditure is expected to
continue to rise rapidly in the remainder of the forecast period, as the government has announced large
increases in spending on health, education and rural infrastructure. However, rapid economic growth will
allow the budget deficit to continue to fall steadily as a percentage of GDP during 2011-15.

Monetary policy
The Reserve Bank of India (RBI, the central bank) has been tightening monetary policy since January 2010
in response to stubbornly high inflation. There were five increases in 2010 in the repurchase (repo) rate (the
interest rate at which the RBI adds funds to the banking system), the most recent of them in early
November; the repo rate now stands at 6.25%. We forecast that the repo rate will rise to 6.5% by the end of
2011. Assuming that the current inflationary surge abates, this will be sufficient to turn real interest rates
positive. However, the  RBI will remain mindful that higher interest rates could undermine the
government's fiscal consolidation plan, encourage volatile capital inflows and exert upward pressure on the
value of the rupee. Monetary policy will return to a more neutral setting in 2012-15.

Economic growth
On the basis of unexpectedly strong national-accounts data for July-September, we have revised up our
forecast for growth in real GDP (on an expenditure basis) to 9.1% (from 8.8% previously) in 2010/11 and
to 8.9% (8.6% previously) in 2011/12. Real GDP growth is then forecast to average 8.7% a year in the
period from 2012/13 to 2015/16. India's strong growth fundamentals--high saving and investment rates,
fast labor force growth and the rapid expansion of the  middle class--will ensure a steady performance, with
little volatility in growth rates from year to year. But despite India's current impressive growth
performance, there are a number of clouds hanging over the economy, including the stubbornly high
inflation rate and the wide (albeit narrowing) budget deficit. It is for these reasons that we do not expect the
government's GDP growth target (on a factor-cost basis) of 10% in 2011/12 to be achieved. Growth will
continue to be constrained by infrastructure bottlenecks, shortages of skilled labour and the difficulties
involved in shifting resources from low-productivity agriculture to higher-productivity manufacturing.
However, India has huge scope for catch-up growth, not only with developed countries but also with other
emerging markets.
Economic growth will be led by private investment and government spending in the next five years. Private
consumption will not grow as fast as the overall economy, and net exports are forecast to exert a slight drag
on GDP growth as imports are sucked in to satisfy rapidly growing domestic demand. Growth will
continue to be led by services and industry, while the agricultural sector and its reliance on monsoon rains
poses a downside risk to the rate of economic expansion. The possibility of a reversal of capital inflows,
which have been financing India's persistent current-account deficit, also represents a downside risk--one
that has risen in prominence since the EU sovereign debt crisis deepened in mid-November. Another
downside risk to our forecast for buoyant economic growth is any further increase in commodities prices,
which would cause the current-account deficit to widen.

Inflation
After peaking at over 16% in January 2010, the annual rate of consumer price inflation moderated to 9.8%
in October in response to tighter monetary policy and slower food price inflation. Consumer price inflation
will decelerate in 2011, to an average of 6.8%, from an estimated 11.9% in 2010. In 2012-15 consumer
prices will rise by 5-6% a year, assuming the absence of shocks such as a sharp rise in commodity prices or
a failure of the monsoon in any given  year. Another factor that could increase inflationary pressures is the
deregulation of fuel prices. In June the government decided to end state control of petrol and diesel prices
in an effort to bolster the public finances. The relaxation of price controls is a crucial step towards reducing
losses at India's public-sector oil companies and containing the government's rising contingent liabilities.
Our benign outlook for global oil prices suggests that the government will be able to eliminate fuel
subsidies entirely during the forecast period, but a surge in petroleum prices would quickly feed through to
domestic fuel costs. It is also possible that the government could reimpose prices controls in the event of
another oil price shock. (see fig. in overview section)
Exchange rates
The rupee is forecast to appreciate slightly during the forecast period, from an estimated average of
Rs45.7:US$1 in 2010 to Rs42:US$1 in 2015. The currency's strengthening will be driven primarily by
strong inflows of foreign investment, attracted by India's bright economic prospects. The current-account
deficit is not expected to pose a threat to the rupee, given that it is forecast to average a moderate 1.9% of
GDP during the forecast period. Given India's high estimated average rate of inflation in 2010 and the
fairly rapid rate of price increases forecast for 2011-15, the rupee's nominal strengthening will represent a
substantial appreciation in real terms, amounting to nearly 30% in the period.

Although the rupee is currently under upward pressure, it is also vulnerable to a number of downside risks.
It will continue to be exposed to the inherent volatility of portfolio investment inflows. A bout of the jitters
on the part of foreign investors could trigger a sharp fall in the rupee's value and could easily wipe out the
modest gains that the currency is expected to make in 2011-15. The rupee could also be susceptible to
downward pressure on its value if inflation runs out of control or the government fails to enforce greater
fiscal discipline.

External sector
The current-account deficit is forecast to remain fairly steady as a share of GDP in the forecast period, at
around 2%. Substantial capital inflows will ensure that the shortfall on the current account poses little risk
to the economy, and India will continue to accumulate foreign-exchange reserves. Merchandise exports and
imports will both expand rapidly in 2011-15: exports will grow at an average annual rate of 12.4%, while
imports will rise by 13.2% a year. As a result,  the trade deficit will widen to US$264.9bn in 2015, from an
estimated US$135.3bn in 2010. Strong growth in merchandise exports and imports in the five-year period
will reflect not only robust economic growth but also the further opening of the local economy to
international trade and global production systems. The expansion of the country's manufacturing capacity
will boost its export performance as well as leading to increased demand for raw materials, while booming
domestic demand will sustain rapid growth in imports of consumer goods.

Services exports will continue to play a vital role in the country's external trade as information technology
(IT) and business-process outsourcing continue to  lure Western companies to India. Having built up
supplier relationships, India's  IT companies are expected to continue to grow rapidly, and the most
sophisticated of them will continue to move up the value-added chain. Services exports are forecast to grow
by 20% a year on average in 2011-15, enabling the services surplus to increase to almost US$159.1bn by
2015, when the value of services exports will be equivalent to around three-quarters of revenue from
merchandise exports. The income deficit, which is small at present, will widen steadily to over US$40bn in
2015, reflecting an increase in the repatriated profits of foreign companies operating in India. The current
transfers balance will stay positive, rising to US$108.7bn in 2015, driven by strong growth in remittances
from Indian workers overseas.
AGRICULTURE – THE INDIAN WAY
A common criticism of India’s economic reforms is that they have been excessively focused on industrial
and trade policy, neglecting agriculture which provides the livelihood of 60% of the population. This lead
to deceleration in agriculture growth in the mid 1990s. It is evident from the following graph.

However, the notion that trade policy changes have not helped agriculture is clearly a misconception. The
reduction of protection to industry, and the accompanying depreciation in the exchange rate, has tilted
relative prices in favor of agriculture and helped agricultural exports. The index of agricultural prices
relative to manufactured products has increased by almost 30% in the past ten years. The share of India’s
agricultural exports in world exports of the same commodities increased from 1.1% in 1990 to 1.9% in
1999, whereas it had declined in the ten years before the reforms. But while agriculture has benefited from
trade policy changes, it has suffered in other respects, most notably from the decline in public investment in
areas critical for agricultural growth. This decline began much before the reforms, and was actually sharper
in the 1980s than in the 1990s. However, there is no doubt that investment in agriculture-related
infrastructure is critical for achieving higher productivity and this investment is only likely to come from
the public sector. Indeed, the rising trend in private investment could easily be dampened if public
investment in these critical areas is not increased. The main reason why public investment in rural
infrastructure has declined is the deterioration in the fiscal position of the state governments and the
tendency for politically popular but inefficient and even iniquitous subsidies to crowd out more productive
investment.

Government price support levels for food grains such as wheat. In recent years, support prices have been
fixed at much higher levels, encouraging overproduction. Indeed, public food grain stocks reached 58
million tons on January 1, 2002, against a norm of around 17 million tons! The support price system clearly
needs to be better aligned to market demand if farmers are to be encouraged to shift from food grain
production towards other products. Agricultural diversification also calls for radical changes in some
outdated laws.
CONCLUSION
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