Does the current state of economic affairs looks more like the late 1980's & early 1990's economic situation of fiscal imbalances, unstable government, declining business confidence and low growth???
Economic Reforms- the need of the hour
Indian is more aligned to the global
markets now than it was in the 1990s era and before that. The Eurozone crisis
which surfaced in 2009 and reached its perilous best in 2011 has had an adverse
impact on the global economy and particularly the countries with which it has
bilateral trade relations. Despite various measures adopted by the European Central
Bank (ECB), the crisis seems to be far from over. The persisting crisis could
potentially hamper the fragile recovery in the U.S, which can only negatively
impact the growth prospects of India in FY13. The GDP growth for India has
already slumped to 6.5% in 2011-12 while the inflation remained sticky at 8.9%,
beyond the comfortable level of RBI. Indian rupee has depreciated ~27% from
August 2011 and that let to worsening of the trade balance as well as the
current account deficit. Further, the fiscal deficit also stands at 7% of GDP.
The situation is certainly grim considering the fact that RBI has tried its
best to get a grip on inflation and revive the growth in industrial production.
However, the developments have been largely from the monetary side and what
India needs today is an impetus from the structural side, just like in 1991.
The industry fraternity is calling for prompt reforms to drive growth and is
felt to be “the need of the hour”. Let us discuss the economic indicators
post reforms and see what India achieved out of the implementation of reforms
on the back drop of crisis in 1991.
WHAT LED TO THE ECONOMIC CRISIS IN 1990s
India, like most other developing countries
in the world followed a path of planned self-reliant development after her
Independence in 1947. From 1951 to 1991, Indian policy-makers stuck to a path
of centralized economic planning accompanied by extensive regulatory controls
over the economy. The entire development strategy was hinged on public
investment as an engine of growth resulting in large fiscal deficits arising
from excessive government spending which eventually distorted the macroeconomic
balance. India seemed to be caught in a low equilibrium trap of the so-called
3.5 per cent Hindu rate of growth till 1980s.
Prior to 1980s India’s macroeconomic
policies were conservative. Government current account surplus was used to
finance in part the deficit in capital account. However, the fiscal policies
remained loose which turned current revenue surpluses into deficits in the
early 1980s. Following which, the
government was forced to borrow at home and abroad, not only to finance its
investment, but also its current consumption. In fact the seeds for the 1991
economic crisis in India were sowed in 1980s, particularly the latter half.
The root cause of the crisis in 1991 was
the large and growing fiscal imbalance during the 1980s. These high levels of
fiscal deficit resulted in heavy borrowing by the Govt. mainly resulting in an
expansion in the money supply which in turn fuelled inflation. The immediate trigger was the Gulf War in the
second half of 1990-91, which jacked up international oil prices (and India’s
oil import bill) and reduced remittance inflows from the Gulf, thus straining
the balance of payments. This happened in the context of unstable coalition
politics in India in the period between the end of the Rajiv Gandhi Congress
government in late 1989 and the assumption of power by the Narasimha Rao
Congress government in June 1991.
The impact of the Gulf crisis on the
balance of payments situation was very adverse as a consequence of the increase
in the import bill for crude oil and petroleum products. The gulf crisis
together with the deteriorating domestic political developments had a bearing
on the image of India in the global markets. The annual growth rate of GDP at
factor cost (at 2004-05 prices) declined from 7.2% in 1980-81 to 5.3% in
1990-91 and it further declined to 1.4% in 1991-92. [Source: Economic Survey
of India- 2011-12]. While the inflation based on WPI grew from 9.3% in
1980-81 (base year: 1970-71) to 10.3% in 1990-91 and further to an alarming
13.7% in 1991-92 (base year 1980-81). Further, the gross fiscal deficit (as %
of GDP) zoomed from 7.42% in 1980-81 to 9.41% in 1990-91[Source: RBI]. Since
these deficits had to be met by borrowings, the internal debt of the government
accumulated rapidly, rising from 35 percent of GDP at the end of 1980-81 to 53
percent of GDP at the end of 1990-91. This naturally made servicing of the debt
onerous. Interest payments which were 2% of GDP and 10% of total central
government expenditure in 1980-81, rose to 4% of GDP and 22% of total central
government expenditure in 1990-91. India’s image in the international markets was
certainly tarnished and the confidence in the Indian economy was shaken. As a
result, India’s credit rating in the international capital markets declined
steeply and receipts under non-resident receipts also decelerated.
All these negative developments led to
sharp decline in the foreign exchange reserves (excluding gold & SDRs),
from a level of Rs 5050 crores at the beginning of August 1990 to Rs 4388
crores at the end of March 1991[Source: Economic Survey Of India- 1990-91]
Foreign exchange reserves dwindled to a level that was less than the cost of
two weeks’ worth of imports. The government approached the International
Monetary Fund for financial assistance. The first recourse to IMF was made
during July-September 1990 when India drew Rs 1173 crores and followed it up
with further recourse in January 1991 and Rs 3334 crores were borrowed under
the modified compensatory and Contingency Financing Facility (CCFF).
In response to the crisis situation of
1990-91 the government decided to introduce economic policy reforms which
consisted of two distinct strands-macroeconomic stabilization and structural
reforms. While stabilization deals with demand management, structural reforms
deal with sectoral adjustments designed to tackle the problems on the supply side
of the economy.
MAJOR ECONOMIC REFORMS OF 1991-93
Fiscal
- Reduction
of fiscal deficit.
- Launching
of reform of major taxes
External Sector
- Devaluation
and transition to a market-determined exchange rate.
- Phased
reduction of import licensing (quantitative restrictions).
- Phased
reduction of peak custom duties.
- Policies
to encourage direct and portfolio foreign investment.
- Monitoring
and controls over external borrowing, especially short-term
- Build-up
of foreign exchange reserves.
- Amendment
of the Foreign Exchange Regulation Act (FERA) to reduce restrictions on
firms.
Industry
- Virtual
abolition of industrial licensing.
- Abolition
of separate permission needed by “MRTP houses”.
- Sharp
reduction of industries “reserved” for the public sector.
- Free
access to foreign technology.
Agriculture
- More
remunerative procurement prices for cereals.
- Reduction
in protection to manufacturing sector.
Financial Sector
- Phasing
in of Basel prudential norms.
- Reduction
of reserve requirements for banks, notably the cash reserve ratio (CRR)
and the statutory liquidity ratio (SLR).
- Gradual
freeing up of interest rates.
- Legislative
empowerment of the Securities and Exchange Board of India (SEBI).
- Establishment
of the National Stock Exchange (NSE).
- Abolition
of government control over capital issues.
Public Sector
- Disinvestment
programme begun.
- Greater
autonomy / accountability for public enterprises.
The newly formed government led by Prime
minister Narasimha Rao and his finance minister Dr. Manmohan Singh not only
committed itself to a comprehensive programme of structural reform, but also
accorded an overriding priority to the stabilization of the economy. The main
aim of the government was to (a) control inflation (b) fiscal correction (c)
improving the balance of payments position.
ACHIEVEMENTS OUT OF THE IMPLEMENTED REFORMS
The attention of the new
government that took office in June 1991 was primarily focused on crisis
management dealing with the balance of payments. As suggested by economists,
first three years 1991-2 to 1993-4 can be considered as period of crisis
management, when the primary objective of policy was to stabilize the economy.
The next four years 1994-5 to 1997-8 can be considered as the
post-stabilization period, when the focus of policy was on the longer-term
objective of putting the economy on a higher growth path. The stabilization
programs bore immediate fruits and India achieved strong growth between 1992-97
before the optimism was interrupted in 1998. In 1998, the country was faced with
the Asian crisis and the situation was further aggravated with the then Gujral
government announcing generous pay hikes in the Fifth Pay Commission which
proved costly for both the fiscal and economic health of the country.
Crisis Management period
1991-92 to 1993-94
The achievements in the post
reform period are commendable. GDP growth which fell to as low as 1.4% in
1991-92, was quick enough to bounce back to 5.4% in 1992-93 and 5.7% in
1993-94. Industrial GDP growth which declined to -0.1% in 1991-92 also
recovered to 3.6% in 1992-93 and 6.1% in 1993-94 while the agricultural GDP
fell to -1.4% in 1991-92 only to bounce back at 6% in 1992-93 and followed it
up by a growth of 3.1% in 1993-94. Gross domestic savings (as % of GDP)
remained stable at 2.6% in 1991-92, 2.2% in 1992-93 while declining at 1.3% in
1993-94. Gross fixed capital formation (as % of GDP) also remained stable at
22.6% in 1991-92, 23% in 1992-93 and 21.5% in 1993-94. However, the absolute
figures do tell a different story. The growth in Gross domestic savings (at
current prices) declined to 6.8% in 1991-92, however bounced back in the
following year with a growth of 14.7% and 17.2% in 1993-94. Growth in Gross
Fixed Capital formation ( at current prices) which also dipped to 9.2% in
1991-92, bounced back in 1992-93 with a strong growth of 16.7% and followed it
up with a growth of 7.6% in 1993-94.
The gross fiscal deficit (as % of
GDP) which reached an alarming 9.4% in 1990-91 was immediately brought down in
1991-92 to 7% and was maintained at 7% for 1992-93 but again reached at 8.2% in
199-94. The current account deficit (as % of GDP) which zoomed at 3% was
brought down to 0.3% in 1991-92 and 1.7% in 1992-93. Inflation which touched
13.7% in 1991-92 was on account of higher growth in money supply (19.3%) was
also brought down in 10.1% in 1992-93 and thereby to 8.4% in 1993-94. The
growth in money supply was also checked at 14.8% in 1992-93 but again zoomed
higher at 18.4% in 1993-94.
Reserves as number of months of
import (import cover) which fell to 2.5 months in 1990-91 was replenished to
5.3 months in 1991-92, 4.9 months in 1992-93 and 8.6 months in 1993-94. The
growth in exports (in USD terms) which dropped to -1.5% in 1991-92, grew at
3.8% and 20% in 1992-93 and 1993-94 respectively.
Post Stabilisation
Period 1994-95 to 1997-98
The aim of policy in the
post-stabilization period was to achieve sustainable acceleration in growth and
here too the results were impressive. GDP grew at an average rate of 6.5%
backed by 7.9% growth in Industrial GDP. Agricultural GDP achieved an average
growth of 3.2% during this period. The lower growth in the agricultural GDP can
be related to absence of any major reform in agriculture in this period. Gross
Domestic Savings (in absolute terms) achieved an average growth of 18.6% while
Gross fixed capital Formation (in absolute terms) grew at an average rate of
18.3%. The average share of Public sector in Gross Fixed Capital Formation
declined from 43% (1991-94) to 36% (1994-98) while that of the Private sector
increased from 57% (1991-94) to 64% (1994-98).
The average gross fiscal
deficit (as % of GDP) remained at a stable rate of 6.8%. The average rate of
inflation between this periods remained at 7.4% while average growth in M3 was
at 17.5%, a tad higher than the expectations of the Government. Reserves as
number of months of import of the year (import cover) were comfortable at an
average 7 months while the current account deficit remained at an average rate
of 1.3% of GDP. Exports (in USD terms) grew at an average rate of 12.3%. Debt
service ratio of the country declined from 27.7% in the period between 1991-94
to 23.7% in the period 1994-98.
Growth period 1998-99 to
2007-08
During this period, Indian GDP
grew at an average rate of 7.2% on the back of 7.8% growth in Industrial GDP
while Agricultural GDP achieved an average growth of 3.3%. Gross Domestic
Savings grew at an average growth rate of 17% while Gross fixed capital
formation grew at an average rate of 16%. The average share of the private
sector increased to 73% in the Gross Capital Formation during this period.
The gross fiscal deficit (as %
of GDP) remained high at 7.9% during this period while the Government continued
on fiscal consolidation. Inflation remained comfortable at 5.1% while the
average growth in M3 remained at 17%. Exports grew at an average rate of 17%
during this period with negative growth in 1998-99 and 2001-02 while growth
picking to 26% during 2004-08. The debt service ratio declined considerably
during this period to 12%. This
was mainly due to fiscal consolidation after passing of the Fiscal
Responsibility and Budget Management Act (FRBMA) in 2003.The forex reserves
grew at an average rate of 28% during this period under consideration.
The global economic
crisis in 2008 and its aftermath
Indian economy which was cruising ahead at
an average growth rate of 7.2% during the period 1998-08 was bunged and hit
hard by the global economic crisis during 2008. As a bitter consequence, the
impact of the crisis was felt on the economy in 2009. GDP growth fell to 6.7%
in 2009 from an average rate of 9.5% during the preceding three years, WPI
inflation zoomed to 8.1% from an average rate of 5.3% during 2005-08, forex
reserves declined by 19% YoY in 2009 to USD 252 billion and the import cover
declined to 9.8 months from an average of 12.8 months during 2005-08. The
Government was quick to respond and took prompt measures such as the
announcement of stimulus packages in different sectors in order to revive the
growth of the economy to the pre crisis levels. The measures undertaken had an
adverse bearing on the fiscal balance of the economy (the fiscal deficit as %
of GDP increased to 8.4% in 2009 from an average rate of 5.3% during 2005-08)
and stretched the debt burden of the Government in order to finance the fiscal
deficit (internal borrowings increased 150% to Rs 325977 crore in 2009 from an
average of Rs 130220 crore during 2005-08). RBI on the other hand maintained an
expansionary monetary policy which was
reflected in 400 basis points reduction in CRR, 4.25 percentage point reduction
in the repo rate, 2.75 percentage point reduction in reverse repo rate and
several other conventional as well as non-conventional windows for access to
liquidity. The policies both fiscal as well as monetary worked and the economy
bounced back with a growth of 8.4% in 2009-10, while inflation was also tamed
at 3.8%. The gross fiscal deficit (as % of GDP) although remained elevated at
9.4% owing to the stimulus packages implemented. In fact, the turnaround was
probably quicker than what the economists had predicted. India hogged the
limelight of being one of the fastest growing nations and attracted a colossal
amount of foreign funds. Much of the attention was also because of the fact
that the advanced economies were still in recession.
India followed it up with a 8.4% growth in
GDP for 2010-11 while the fiscal deficit (as % of GDP) also came down after the
removal of the stimulus packages. However, the inflation reached 9.6% in
2010-11 resulting in high interest rates and investors holding capex decisions.
Infact the RBI was unsuccessful in taming the inflation and the inflation
remained stubborn at 8.9% in 2011-12 also. The Eurozone crisis which emanated
in 2009 reached to unmanageable proportions in 2011 and had its effect on the
global economy. The GDP growth for India slowed to 6.5% in 2011-12. The growth
in the industrial GDP declined to 4.5% while the agricultural GDP growth
declined to 1.9% in 2012. The current account deficit zoomed to 4.2% of GDP in
2012 while the fiscal deficit reached 7% of GDP, beyond all estimations by the
Government. The foreign exchange reserves declined by 3.4% YoY at USD 294398
million and the Indian rupee depreciated by 27% YoY against USD as on August
2012.
As
all the broad indicators have altogether turned negative and the policies
brought about by the Government failed to revive the economy. India’s credit
rating has been downgraded by S&P to negative from stable and has been
warned of further downgrades, if the economy doesn’t pick up. The lack of
reforms have hit the investors’ sentiment and resulted in decline in foreign
investment flows while the forex reserves have also declined in 2012.
There were higher
expectations from the man behind the stellar reforms implemented back in 1991.
However, Dr. Manmohan Singh has been grossly unsuccessful to implement anything
meaningful in the two regimes as Prime Minister of India. Series of scams like
Telecom 2G, Mining and Coalgate have been unearthed and it seems there are more
in the offing. These kinds of situations give rise to political tensions and
period of uncertainty among global investors. Thus, drying the foreign capital
flow which is detrimental from growth perspective of India. After building a
status of repute, India’s image has been stained in the global sphere owing to
these negative developments, even if the lack of economic performance be left
apart.
INDIA
HOLDING UP KEY BILLS
India has been delaying key
reforms to push the economic growth of the economy. Although the reforms are
unlikely to be as aggressive as those put in place two decades ago, however,
the implementation will certainly improve the image of the nation in the global
arena. However, there are political hindrance in placing the bills and there
implementation, which results in holding up of the key bills.
Some of the important
bills pending in the Parliament
2009
·
The
Indian Trusts (Amendment) Bill, 2009
·
The
Securities and Exchange Board of India (Amendment) Bill, 2009
2010
·
The
Direct Taxes Code Bill, 2010
·
The
Judicial Standards and Accountability Bill, 2010
2011
·
The
Cable Television Networks (Regulation) Second Amendment Bill, 2011
·
The
National Highway Authority of India (Amendment) Bill, 2011
·
The
Mines and Minerals (Development and Regulation) Bill, 2011
·
The
Companies Bill, 2011
·
The
National Food Security Bill, 2011
·
The
Land Acquisition, Rehabilitation and Resettlement Bill, 2011
·
The
Lok Pal Bill, 2011
·
The
Pension Fund Regulatory and Development Authority Bill, 2011
2012
·
The
Small Industries Development Bank of India (Amendment) Bill, 2012
Source:
PRS India
NEED
TO ADDRESS IMBALANCES:
India's
Social Indicators: G-20 Emerging Economies Perspective
|
Country
|
Poverty*
|
Malnutrition**
|
Employment***
|
Argentina
|
0.87
|
2.3
|
56.5
|
Brazil
|
3.8
|
2.2
|
63.9
|
China
|
15.92
|
4.5
|
71
|
India
|
41.64
|
43.5
|
55.6
|
Indonesia
|
19.73
|
3.4
|
61.8
|
Mexico
|
3.44
|
5.3
|
57.1
|
Russia
|
0
|
n.a.
|
56.7
|
Saudi
|
n.a.
|
5.3
|
47.2
|
Africa
|
17.35
|
n.a.
|
41.1
|
Turkey
|
2.72
|
n.a.
|
42.3
|
Source: World Bank.
|
* Percent of population
earning less than $1.25 a day at PPP.
|
** Percent of children
malnourished, weight for age (under 5 years).
|
*** Percent of
population aged 15+.
India’s fiscal imbalances have remained
large despite a sustained period of high economic growth. Large budget deficits
and high public debt have limited the scope of fiscal consolidation. The State
Governments also have to tighten their fiscal policies in order to achieve the
desired results. Government have to cut down on the subsidies which has
remained high since the 1990s, while have to boost capital expenditure which
remains near to the ground. The prime reason for higher subsidies is due to
dismal social indicators for India as compared to other emerging nations.
Recent subsidy reforms, including liberalization of petrol prices, are a step
in the right direction. Additional reforms include replacement of some
subsidies with targeted support (e.g. cash vouchers), and accelerating development
of the National Population Register and Unique Identification number (UID) to
help target subsidies more effectively.
The net tax revenue as % of GDP has
remained low and is yet to pick from the average rate of 1990s, despite reforms
implemented. This calls for reforms in the Tax code. A nationwide Goods and
Services Tax (GST) will simplify the tax system, widen the tax base and
increase revenues in the long run. At the same time reform of the personal and
corporate income tax code is long overdue. The scope of the government’s
proposal for a new Direct Tax Code (DTC), which has provisions to limit
deductions and widen the tax base, could be expanded. Finally, more ambitious
revenue raising reforms should also be considered.
Greater spending efficiency of government
programs is key to square the stated consolidation objectives with high social
and infrastructure needs. Clearance of land reforms and reducing red tape,
while improving governance and policy predictability, are also critical for social and economic development.
Monthly-Insight
A Collective team effort....
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