Abstract
The analysis of the Indian economy, since the structural reform to dismantle the mixed economic planning and to establish market economy, is presented here with clear analysis regarding growth of the macro economy, the real economy and the social impacts in terms of employment. The picture was quite dismal until the short-term portfolio investments from abroad were introduced a few years ago. The recent upsurge of growth is thus the result of these short-term foreign investments.
Keywords
Introduction
The major argument of the proponents of ‘Economic Reform’ was that the earlier planned development in India from 1951 to 1990 has restricted the growth of the Indian economy (Ahluwalia 2002; Bhagwati 1978; Dollar 1992; Dollar and Kraay 2001; Edwards 1992; Srinivasan and Bhagwati 1999; World Bank 1996, 2000). International financial institutions have long argued that a market economy will release the tiger of India caged by the restrictions of the planned regime (Balakrishnan 2000; Sen 1996). The so-called ‘Economic Reform Programme’ has started in 1991 with a lot of expectations, but after 20 years of reforms, Indian economy in 2012 was in a sorry state with declining growth rate, high inflation and capital flights. The recent behaviour of the Indian economy with rising balance of trade deficits brought back the fear of a repetition of the bankruptcy of 1992.
The Economic Survey of 2012 presented a dismal picture of the economy of India. Slowdown in growth, particularly in industry and agriculture, persisting inflation and a volatile external environment reflected in a widening current account deficit and fluctuating rupee. India’s GDP growth in 2011–2012 has been the lowest in nine years. The Indian economy is estimated to grow by 6.9 per cent in 2011–2012, after having grown at the rate of 8.4 per cent in each of the two preceding years.
In this analysis, we have presented a critical analysis of the economy looking at its recent history, which has several ups and downs. For the purpose of analysis, we divide the whole period into two parts: (a) period of structural adjustments from 1991 to 2001; (b) period of the reformed economy since 2001. The period from 1991 to 2000 can be broadly defined as the period of structural adjustment, where the old structure of planned mixed economy was dismantled gradually and public sector enterprises were privatised in many extents. The period from 2000 to present can be broadly defined as a reformed economy when the balance of payments is yet not fully liberalised and there are still some public sector enterprises left to be privatised.
Economic Growth during the Structural Adjustments
Economic reforms started in 1991–1992. The argument of the proponents was that the previous regime of the planned economic development in India has the result of a very slow growth of the economy, the so-called ‘Hindu’ rate of growth. The ‘Reform process’ was expected to bring in a new phase of rapid economic development by removing the distortions caused by restrictive government policies under the ‘planned’ regime of 1951–1990. Let us examine what are the consequences of the ‘Reform Process’ on economic growth. Table 1 gives us the comparative figures.
Comparative Economic Growths under ‘Planned’ and ‘Structural Adjustment Regime’ in India (Growth Rates)
The overall growth rate of the GDP (Gross Domestic Product) in the ‘planned regime’ has not done that badly during 1980–1990 compared with the ‘reformed’ regime during the 1990s. In fact, in the later part of the ‘reformed’ regime from 1997 the growth rate of the economy was much worse than during the ‘planned’ regime. This is true in almost every area, per-head income, fixed capital formation, government consumptions, and growth rates for industry, agriculture and the efficiency of capital. Only in service, sector and private investments did better during the ‘reformed’ regime. In agriculture, the most important part of the economy, the performance of the ‘reformed’ regime is the worst.
The most important argument of the supporters of the ‘reformed’ regime that planned economy was inefficient, is not supported by the facts. The incremental capital-to-output ratio (ICOR) signifies the inefficiency of capital, if it is growing the economy is getting increasingly inefficient to utilise capital.
This is what had happed in the ‘reformed’ regime of the 1990s, where the ICOR had gone up from 3.65 during the 1980s to 4.35 during the 1990s and to 4.47 during 1997–2000, proving exactly the opposite of what the World Bank-IMF economists and their Indian supporters have suggested.
The saving rate during the ‘reformed regime’ was stagnant for a long time. In 1990–1991, the national saving as a percentage of the national income was 23.1; in 2000–2001, it was 23.4 per cent (Economic Survey 2001–2007). Recently, it has gone up mainly due to the massive flows of portfolio investments, which is the most volatile element in the financial status of the country and causes high level of debt. How India is going to pay these debt back when India’s balance of payments is in chronic deficits, is unknown to the government. At the same time, India has a very high level of foreign exchange reserve, signifying the inability of the Indian economy to absorb foreign capital. That is preventing rupee to go down in order to maintain India’s competitiveness in the world economy. A country must devalue when it receives foreign investments, if it is unable to do that, its balance of payments will sooner or later collapse and there would be sudden outflow of money which can destroy the economy. A situation similar to that already took place in South-east Asia in 1998; however, India has not learned any lesson from it.
Liberalisation measures have benefitted a minuscule section of the society. They have encouraged growth of monopoly houses which reflected in rapid growth of their assets. For example, assets of Tatas increased from ₹85,310 million in 1991 to ₹474,460 million in 1998–1999, that is, in just eight years. Over the same period, assets of Reliance rose from ₹36,000 million to ₹337,570 million and that of Essar rose from ₹7,560 million to ₹171,450 million. Likewise, other industrial houses also registered phenomenal growth in their assets (Standard & Poor 2001–2007).
Economic ‘reforms’, particularly the liberalisation measures, have enabled private companies to earn huge profits even during the latter half of the 1990s when industrial growth was sluggish. In the year 2000, net profits of Reliance industries, the largest private sector company, increased by 41.3 per cent. Net profits of Tata Steel rose by 49.7 per cent, of Grashim industries by 43.3 per cent and of Hindustan Lever by 27.8 per cent. Among the top 10 private sector companies, Telco and Larsen and Toubro were the only companies which failed to register an increase in their profits in the year 2000 (Standard & Poor).
Agriculture and the Public Distribution System
The government in a way has rendered the Public Distribution System (PDS) irrelevant. People are divided into two categories—those below the poverty line (BPL) and those above the poverty line (APL). A large number of people above the poverty line are poor but the issue prices of food grains, which were fixed for them under the PDS, are either equal to the prices prevailing in the market or even higher.
For the people below the poverty line, the issue price of wheat was raised from ₹250 per quintal in 1997–1998 to ₹450 per quintal in 2000–2001. Likewise, the issue price of rice has been raised from ₹350 per quintal to ₹565 per quintal. At these increased issue prices of food grains, most of the rural poor now find it difficult to purchase their monthly quota of ration. The food subsidy has been drastically reduced and the results are there for everyone to see. Presently, 63 million tonnes of food grains are lying in the warehouses of the Food Corporation of India and yet the people are dying of starvation in the rural areas. Table 2 indicates that due to slow growth of agriculture along with rapid rise of population, per capita availability of cereals is nearly stagnant and the availability of pulses declined seriously since 1961.
Net Availability of Cereals and Pulses
Two major factors are responsible for the present ruination of agriculture in this country. First, in its eagerness to reduce fiscal deficit, the government has substantially reduced the development expenditure in agriculture (Chand 2002; Chand and Jha 2001). Second, import liberalisation has contributed in a big way in reduction in the prices of agricultural products. Having failed in getting remunerative prices for their products, many farmers have curtailed their farm operations, which in turn have increased unemployment among the agricultural workers. Import liberalisation is thus a major cause of the existing plight of the peasantry. Suicides by many farmers in the recent past reflect the consequences of the liberalisation measures.
Effects of the reformed trade policy are being felt in agriculture in India. Rice farmers are getting bankrupt because their cost of production is more than the market price as rice is being imported from Thailand and South-east Asia. Wheat price is falling. However, because of the electoral importance of the wheat-growing regions, the farmers are receiving price supports and subsidies from the governments. Wheat is being imported from Australia. In future, it will be imported from the EU.
Poverty and Inequality
The economic reforms have contributed to increased poverty and economic inequality. First, we need to examine as to what has happened to incidence of poverty.
According to the NSS (National Sample Survey) in 1983, while 45.6 per cent of the rural population was below the poverty line, the incidence of poverty in urban areas was around 40.8 per cent. Hence, the overall incidence of poverty for the country as a whole was 44.5 per cent. By 1990–1991, the incidence of poverty had declined to 35.0 per cent in the rural areas and to 35.3 per cent in the urban areas. Taking the two sectors together, the incidence of poverty was 35.1 per cent. This implies that during the 1980s the increase in growth rate, coupled with the poverty alleviation programme, led to a significant decline in the spread of poverty. This trend was however reversed during the 1990s and the liberalisation decade witnessed a steep rise in the incidence of poverty particularly in the rural sector.
In 1998, 45.2 per cent of the population in rural areas was below the poverty line. Even overall situation was not distinctly better as at the country level, rural and urban sectors considered together 43 per cent of the population was below the poverty line. The rise in the overall poverty ratio during the post-reform period in spite of the higher GDP growth is to be attributed to the growing rural–urban divide. The 53rd round of the NSS data for 1997 (January to December) reveal that India’s rural poverty ratio has gone up by 3.42 per cent between 1991 and 1997 even as urban poverty ratio declined marginally by 1.32 per cent (National Sample Survey).
Measured in terms of monthly per capita expenditure, the poverty ratio was estimated at 33.97 per cent in the urban areas in 1997 against 35.29 per cent at the beginning of 1991 (46th round of NSS data). On the other hand, the proportion of rural population in the poverty bracket had risen over the same period to 38.6 per cent from 35.04 per cent (National Sample Survey).
The 54th round of NSS for 1998 conducted between January and June 1998 shows a widening of disparity between rural and urban expenditure at both current and constant prices. In absolute terms, the average per capita expenditure at current prices rose from ₹244 in 1991 to ₹382 in 1998 in rural areas and from ₹370 to ₹648 in urban areas. At constant prices, the expenditure has actually declined from ₹164 in 1991 to ₹153 in 1998 in rural areas and rose from ₹257 to ₹269 in urban areas (National Sample Survey).
Supported by the World Bank, India government has introduced a new method to calculate the poverty rate so as to hide the facts and propagate a massive reduction of the poverty rate which, given the increasing rate of unemployment, cannot be supported by the facts.
The methodology for collecting data on consumption expenditure was changed by the NSS for the 55th round and the government got the estimates of the poverty, which were not comparable with the earlier estimates. One of the major flaws is to assume that the rate of poverty in the villages around an urban centre is the same as the city itself. The minimum level of calorie intake for the poverty line is now reduced from 2,400 to 1,800; the minimum level of income for the poverty line is now reduced to ₹4,000 per year from ₹5,000 previously. If we keep the earlier criteria, the poverty level can very well reach 77.5 per cent. However, these were not taken into account by the economists of the World Bank (Dollar and Kray 2001) which still cite the official figure of 26 per cent.
The NSS data for 1999–2000 revealed that the rate of growth of total employment fell sharply from 2.04 per cent per year during 1983–1994 to 1993–1994, to only 0.80 per cent per year in the 1993–1994 to 1999–2000 period. On the other hand, labour force has grown at a rate of 2.0 per cent per annum during the same period. How can poverty go down when unemployment is increasing which only the World Bank and the India government can answer.
However, since these biased estimates of poverty based on the data obtained from the 55th round of the NSS showed lower incidence of poverty, the government adopted some tactics to show by any means that the incidence of poverty declined during the decade of economic reforms. This approach of the government of manipulating the methodology to obtain convenient results is both unethical and contradictory to its own finding. An overwhelming 79 per cent of workers in the unorganised sector, or 394.9 million workers or 86 per cent of the working population, live on an income of less than ₹20 a day, according to the National Commission for Enterprises in the Unorganized Sector (Sengupta 2008).
Based on the 66th round of the national sample survey for 2009–2010, if the average monthly consumption expenditure is taken as the benchmark of what an individual needs to survive, the poverty line would be ₹66.10 for urban areas and ₹35.10 for rural regions, while about 65 per cent of the population will be below the poverty line.
As a result, of the reform measures of the 1990s, income inequalities have increased. In 1992, the lowest 40 per cent households had accounted for 20.6 per cent of the national household expenditure. Their share however declined to 19.7 per cent in 1997. In contrast, share of the top 10 per cent households in the national household expenditure rose from 28.4 per cent to 33.5 per cent over the same period. This accentuation of income inequalities may be attributed to the reform measures of the 1990s, which on the one hand denied employment opportunities to the common people but enriched business community (National Sample Survey, National Commission for Enterprises in the Unorganized Sector, Sengupta 2008).
Employments during the ‘Structural Adjustment Period’
The most important indicator of success of an economic regime is in the employment generations. In this matter, the ‘reformed’ regime has little to demonstrate. There is no reliable statistics regarding unemployment in India, so we do not know how far the fear of the ordinary people about the ‘Reform-Process’ as job-destroyer is justified. The only statistics, the government produces on employment, are on the organised sector of the economy, which is a very small part of the economy. We can only guess, what is the real situation for the whole of the economy from these statistics, as given in Table 3.
Employments in the Organised Sector (in million persons)
Increase in employments in the public sector was much higher during the ‘planned’ regime of the 1980s than during the ‘reformed’ regime of the 1990s. This is true for both the manufacturing and the construction sector. In the private sector, although the total generations of employment are higher during the ‘reformed’ regime, in the construction sector it has failed.
In manufacturing if we look at the detail, we can see that the employment actually went down from 6.85 million, in 1998 to 66.2 million in 2000; in agriculture employment went down from 1.49 million in 1992 to 1.42 million in 2000; in mining it went down from 1.12 million in 1994 to 1.01 million in 2000. The only sector that has showed improvement is the service sector of finance, real estate, etc., where employment went up continuously from 1991. A revised estimate presented in Table 4 gives a similar picture.
Employment in Organised Sectors—Public and Private
From the data obtained from the 55th round of the NSS, it is obvious that the usual status unemployment rose by 2.3 per cent in the liberalisation period. Unemployment increased far more, that is, 5.7 per cent in terms of daily status over this period. The main factors, which have contributed to persistently increasing unemployment, are drastic reduction in development expenditure by the government, indirect lay-off of workers in public sector undertakings, massive retrenchment of workers in the private manufacturing sector and closure of a large number of small-scale factories in different parts of the country (Economic Survey 2008; Report on Conditions of Work and Promotion of Livelihoods in the Unorganised Sector, 2008). The daily status of unemployment had risen from 6.03 per cent in 1993–1994 to 7.32 per cent in 1999–2000. There is no official statistics on how many jobs were destroyed during the period of ‘Economic Reform’ (National Accounts Statistics, 2000–2007). From various fragmented information we can compile a list, which is certainly not exhaustive.
Coal Mines: 20,000 already lost, another 95,000 are waiting to be unemployed. Coal is being imported from Australia and China.
Mica Mines: 8,000 lost their jobs.
Fertiliser: 12,000 lost their jobs, now fertiliser is being imported.
Mining Machinery: 4,000 people have lost their jobs; machineries are imported from Britain.
Steel: 20,000 workers have lost their jobs, another 23,000 in (IISCO) were waiting to be unemployed. Steel is being imported from Korea.
Rubber: Rubber farmers are committing suicides in South India; rubber is being imported from Malaysia; 8,000 workers of Dunlop are unemployed. There is increasing volume of imports of tires from abroad.
Railway Wagon Industry: 12,000 are about to be unemployed, while wagons are imported from a number of countries.
Aluminium foils: 6,000 already lost their jobs; these are imported from the US.
Medicines: In 1995, India made it compulsory for the drug industries to have foreign partners and to pay royalty. India government had closed down public sector medicine manufacturing plants, job losses were about 1,000. Medicine price since then went up by about 400 per cent. In 2001 all price controls of medicines are abolished, very soon medicine price will sharply increase.
Electricity: The World Bank had made it a rule that India has to import electrical machineries from China if it wants loans from the World Bank in the reformed electricity sector in India. Indian public sector electrical machinery manufacturing companies are not in the list of approved contractors of the World Bank. Major job losses are expected in this sector very soon.
Railway Engines: 6,000 people will lose their jobs when this sector will be privatised soon.
Aluminium: Already 4,000 have lost their jobs, others are waiting to be unemployed. Aluminium products are being imported from the US. (Source: Standard & Poor)
Most of the job losses are the result of the trade policy imposed upon India by the World Trade Organization as part of the ‘Economic Reform’ process. World Bank has anticipated that even in 1992 when it gave about US$10 billion loan to India to pay compensations to the future unemployed workers in the industrial sector of India. Now EU is offering similar kind of loan to India. It is essential to understand that the purpose is to scale down Indian industry in particular to open the economy for imports as part of the liberalised trade policy, the essential ingredient of the ‘Economic Reform’ process. India is not alone in this matter. In Thailand, after the devastating economic crisis of 1998, the World Bank-IMF has advised Thailand to close down as many industries as possible (Aoki, Murdock and Okuno-Fujiwara 1996).
This is not a great success for the ‘reformed’ regime. However, what the statistics could not tell us is the growing fear of job losses, replacements of permanent jobs by temporary jobs. Areas where jobs are being created are not the areas where jobs are being destroyed. Given the immobility of Indian labour and linguistic racism that exist in India, the result will be increasing unemployment. The economy was nearly reformed by 2000. The analysis provided below gives the picture of that ‘reformed economy’.
Reformed Economy: Developments Since 2000
Bubble is an economic condition created by sudden influx of funds to an economy either by the short-sighted policy of the government to stimulate the economy by increased public expenditures and borrowings from foreign sources or by external factors like sudden inflows of funds from abroad. When a country is in bubble it forgets that there can be some unknown dangers lurking round the corner; but it is intoxicated in thinking that the flow of funds will last forever. The warning that uncontrolled inflows of foreign funds can make the adjustments in the balance of payments difficult is well known (Domar 1950; Lary 1946). The adjustment normally happens like a storm, which may ruin the country’s finances. The questions can be raised whether the economy of India since 2004 is in such a bubble or it has experienced self-sustained growth suddenly. A number of economies of the world have experienced these bubbles and the end result is always misery. Japan has experienced it from 1985 to 1993, and then it went into a long depression from which it is yet to recover. Britain has gone through it from 1988 to 1991, and then it had severe depression until 1997. South-east Asia and East Asian countries, Thailand, Indonesia, South Korea went through this bubble from 1992 to 1998 and then collapsed completely. India itself has seen a bubble from 1985 to 1990 and it went bankrupt in 1991.
The newspapers from India are giving a very optimistic picture for India. The economy, which has been on a high growth path of 8–9 per cent for the three years from 2004, was expanding faster in 2007 at 9.2 per cent. Significantly, the 9.2 per cent GDP growth in 2007 came about despite the slowdown in farm-sector growth to just 2.7 per cent in 2007 came 6 per cent in 2006 (National Accounts Statistics, 2000–2007; National Sample Survey, 2001–2006; Standard & Poor 2001–2007). This picture mesmerises the analysts. ‘Reforms are driving growth’, Finance Minister P. Chidambaram said recently, ‘Reforms have brought in investment, fostered competition, and enhanced productivity and efficiency.’ The opinions of prominent Indian economists are the same. However, question should be raised, what is behind this glamorous picture. Is it truly a success story of the reform process or just a bubble about to be burst if the situation that created this bubble will disappear suddenly?
Growth Picture of the Reformed Economy
The annual average growth rate, in constant price, during the Seventh Plan (1985 to 1990) was 3.6 per cent; during the Ninth Plan of 1997 to 2002 it became 3.5 per cent. India’s high rate of growth started in 2003, when the GDP (Gross Domestic Product) grew, in constant price, grew at the rate of 8.6 per cent per year followed by 7.6 per cent in 2004. However, the annual average for the period from 2000 to 2004 was 6 per cent, which is not very different for the annual average of 5.8 per cent, for the period of the earlier bubble of 1985 to 1989 (Economic Survey 2007).
In 1988 the rate of growth was already 10.1 per cent. That period 1985 to 1990 was during the plan period, where ‘Reforms’ were not introduced. Thus, the source of the current high rate of growth must lie elsewhere, not on the ‘Reforms’. If we look at the source of the bubble of 1985–1989, we may get the clue.
A comparison of two bubbles can help us to understand the picture and its perspectives (see Table 5). The average growth rate for the period 1985 to 1989 was 5.8 per cent; for the period 2000 to 2004, it became 6.0 per cent, not a great advertisement for the ‘Reform’ process.
Annual Rate of Growth of Gross National Product, in Constant Price (in per cent)
The Cause of the Last Bubble of 1985–1989
The bubble of 1985–1989 was caused by unprecedented increase in borrowings from abroad and in domestic creation of money. We get the clue from Table 6.
Financial Picture of the Last Bubble
Balance-of-payment deficits, along with budget deficit of the government, went on increasing due to increased expenditures of the government for mainly non-investment purposes. That has forced India to borrow from abroad to pay for these deficits. Foreign borrowings went up and up. From 1985 to 1989, within five years, foreign borrowings per year increased by more than 100 per cent. The total foreign borrowing for that period was a massive ₹120.8 billion. Increased domestic borrowings were the results of increased budget deficits, which had the results of increased money supply and the resultant inflation (Basu 1995; IMF-International Financial Statistics).
By 1990–1991, when the Soviet Union, which used to absorb 20 per cent of India’s exports, has collapsed and the remittances from the Indian workers in the Middle East suddenly vanished due to the invasion of Kuwait by Iraq, India found it impossible to pay back what it had borrowed and went bankrupt. As a result, the ‘Reform’ process to dismantle the planning process was imposed upon India in 1991. The person in charge of Indian finance, as during the bubble of 1985 to 1989, is the same person who became the finance minister in charge of the ‘Reforms’ since 1991 and now the Prime Minister of India in 2007 presiding over another bubble.
Financial Picture Behind the Recent Upsurge of Recent Growth-rate in the ‘Reformed Economy’
The recent upsurge of growth rate is the result of injections of huge funds to the economy either increased by increasing budget deficits or by foreign borrowings. A new picture is added which was absent during the earlier bubble of 1985–1989 (Basu 1995). That is the short-term borrowings from abroad and allowances for foreigners to participate in the country’s stock market and real estate developments.
In 1990 non-development expenditure of the government was ₹69.2 billion. In 2000 it became ₹298.9 billion and ₹461.9 billion in 2004. The rate of growth of non-development expenditure was 332 per cent for the period 1990 to 2000 and 567.4 per cent for the period 1990 to 2004. The rate of growth of development expenditure was 219 per cent for the period 1990 to 2000 and 382.7 per cent for the period 1990 to 2004. Non-development expenditure fuels both increased money supply and inflation. India has experienced both.
The budget deficits that were created by these massive increases in expenditures went up from ₹57.2 billion in 1990 to 256.3 billion in 2004 with a rate of growth of 348.6 per cent during that period. The tax rate did not go up to cover the expanding expenditure of the government; instead, the government went on borrowing from both home and abroad. The tax to GDP (Gross Domestic Product) ratio was 15.43 per cent in 1990; it was 16.30 per cent in 2004. Foreign capital inflows were ₹4.3 billion in 1990, which became ₹8.3 billion in 2000 and ₹11.7 billion in 2004 (Economic Survey 2008; Reports of the Task Force on Direct Taxes, 2002–2006).
The alarming factor is that short-term debt is increasing at a very fast rate. The ratio of short-term debt to total debt went up from 2.8 per cent in 2002 to 6.7 per cent in 2006. Foreign investments of short-term nature or portfolio investments went up from US$9.3 billion in 2002 to US$12.2 billion in 2005. Investments by foreign institutional investors in India went up from US$377 million in 2002 to US$9.9 billion in 2005. However, at the same time foreign direct investment of long-term nature was increased by a much slower rate from US$3.7 billion in 2002 to ₹4.7 billion in 2005 (Economic Survey 2008).
At the same time, India’s deficits in the trade balance went up from US$33.70 billion in 2002 to US$51.84 billion. Total deficits in the balance of payments of India went up from US$2.47 billion in 2002 to 9.19 billion in 2005. Financing of these deficits requires more borrowings. Total foreign borrowings went up from ₹163 billion in 1991 to ₹548.1 billion in 2005 or an increase by 3.36 times. Commercial borrowings went up from ₹197.3 billion in 1991 to ₹125.5 billion in 2005 or by 6.36 times. In the mean time, foreigner’s purchased shares of Indian companies went up from ₹6.5 billion in 1991 to ₹61.9 billion in 2005 or by 9.5 times. In fact, that type of purchases went up within a year from ₹42.8 billion in 2000 to ₹67.7 billion in 2001 because of certain changes in the legal restrictions on such purchases that were there before (Economic Survey 2009).
Foreign Funds in the Stock Market in the Reformed Economy
India has witnessed over a decade of portfolio flows and with each passing year, portfolio flows have gained in their significance and have played a key role in the overall Indian economy. Although investment by foreign institutional investors are typically synonymous with portfolio investments in India, investments in Global Depository Reserve and offshore funds should be included in any analysis relating to portfolio flows.
The year 2002–2003 was highlighted by significant events; both locally and internationally that had a bearing on the Indian economy. By end March 2003, cumulative portfolio investments totalled nearly US$16 billion, which constituted nearly 11 per cent of the country’s stock market capitalisation.
The Union Budget, 2003, announced that dividends would be exempt from tax in the hands of a shareholder. Henceforth, dividends declared by an Indian company would not be liable to Indian taxes. However, the Indian company will be liable to pay 12.81 per cent (including surcharge) dividend distribution tax. Further, long-term capital gains arising on transfer of equity shares (held at least for one year) in a listed company, acquired between 1 March 2003 and 28 February 2004 would be exempt from tax. These initiatives were specifically targeted at attracting portfolio investments into India. India has emerged as the most favoured private equity (PE) destination attracting $2.21 billion of private equity investment in 2006 as against just $1,992 million in 2005. India was followed by China with $1.72 billion. Singapore came third with $1.53 billion (Standard & Poor). Foreign institutional investors increased their total investment in the domestic stock market in 2009–2010 to over ₹47,690 crore ($10.4 billion).
Foreign Funds in Real Estate
India’s Foreign Direct Investment inflows have doubled to $2.9 billion during April–July 2006 as compared to the $1.5 billion during the same period in 2005. Sensing the demand of foreign investors, the Indian government has liberalised the laws relating to FDI in February 2005. Now Non-resident Indians (NRIs) and Overseas Corporate Bodies (OCBs) can invest up to 100 per cent in the real estate sector (Economic Survey 2009).
Foreign Direct Investment in real estate is now possible without the need for permission by the Foreign Investment Promotion Board. Currently, FDI in India is targeting township, housing, construction development projects, built-up infrastructure, etc. The Indian government repealed the Urban Land Ceiling Act in 2001 and a large quantum of land is now free for construction. Investment is now allowed for smaller projects of just 25 acres.
Impact of Reforms on the Real Economy since 2000
The sudden upsurge of growth rate of the national income in India has very different effects on the real economy. The two most important aspects of people’s life are employment and food (Table 7). From these points, the ‘Reform’ programme has little to offer during the entire period from 1991 to 2005.
Index of Production of Foodgrain (1981 = 100)
Production of rice has improved from 1991 to 1999 but since then it has declined; it is true also about wheat and all food-grains. As a result, the net availability of pulses per head went down from 41.6 grammes in 1991 to 35.9 grammes in 2004. Availability of cereals per head also went down from 468.5 grammes in 1991 to 427.4 grammes in 2004. Inflation has also taken its toll. Cost of living index of industrial workers went up from 201 in 1990 to 538 in 2005. For agricultural labourers, it went up from 145 in 1990 to 360 in 2005. For the urban non-manual persons, it went up from 169 in 1990 to 463 in 2005. Thus, all sections of the population are affected very badly from the inflation and reductions in the availability of food (Economic Survey 2009).
Inflation: Cost of Living (Index: 1980 = 100)
The average rate of increase of the cost of living during the period of 1986 to 1989 was 6.38 per cent for the industrial workers but the average annual increase during the ‘Reform’ period since 1991 is now 11.17 per cent (Table 8). For the agricultural labourers, it went up from 7.6 per cent during the planned economy to 9.88 per cent in the ‘Reformed’ economy and for the urban non-manual people it went from 6.52 per cent to 11.59 per cent. Thus, the living conditions of the people in the ‘Reformed’ economy does not paint a rosy picture (Economic Survey 2009).
Employment during the ‘Reformed Economy’ since 2000
Data for employment is available only up to 2003; thus, we can compare the situation between 1991 and 2003 regarding employments in different sectors of the economy for the both private and the public sector. As we can see from Table 7, employment increase only marginally during this period of 12 years of the ‘Reformed’ economy; it has declined in the public sector in both mining and manufacturing. In the private sector, too, employment declined in the mining, constructions; in agriculture it increased only marginally. In other sectors, it increased mainly in the finance sector. The improvements in the private sector could not compensate for the decline in employment in the public sector. The ratio of employment to gross national income declined significantly during the ‘Reformed’ period (Table 9). Thus, it proved the inefficiency of the ‘Reformed’ economy regarding the generation of employment prospects for the country.
Employment in the Organised Sectors (millions)
It is a myth that the global financial crisis left India virtually unscathed. In fact, India is the biggest victim of financial crisis-induced poverty, according to data obtained from the United Nations Department of Economic and Social Affairs (UNDESA). The UNDESA data estimate that the number of India’s poor was 33.6 million higher in 2009 than would have been the case if the growth rates of the years from 2004 to 2007 had been maintained. In 2009 alone, an estimated 13.6 million more people in India became poor or remained in poverty than would have been the case at 2008 growth rates.
In other words, while a dip from the 8.8 per cent growth in GDP averaged from 2004–2005 to 2006–2007 to the 6.7 per cent estimated for 2008–2009 may be nothing like the recession faced by the West, its human consequences for India were probably worse. The 2.1 per cent decline in India’s GDP growth rate has effectively translated into a 2.8 per cent increase in the incidence of poverty. According to the UNDESA’s World Economic Situation and Prospects, 2010, 47 million more people globally became poor or remained in poverty in 2009 than would have been the case at 2008 growth rates, and 84 million more than would have been poor at 2004–2007 growth rates. Of these, 19 and 40 million, respectively, are in South Asia.
The UNDESA report attributes this increase in poverty to a combination of reduced household incomes, rising unemployment and pressure on public services. Job losses in India were primarily in export-oriented industries like textiles, while employment levels in Indian firms catering to the domestic market were largely unaffected, the report says. Monetary and fiscal policy intervention gave Indian growth some resilience, while safety nets like India’s National Rural Employment Guarantee Act (NREGA) helped to mitigate the effects of the slowdown.
Recent Problems in Balance of Payments
India’s external debt climbed 6.6 per cent to $326.6 billion by September 2011. The ratio of short-term external debt to foreign exchange reserves stood at 22.9 per cent. The ratio of short-term debt to foreign exchange reserves rose to an 11-year high at the end of September 2011, raising concerns about the sustainability of the external obligations. The rise in external commercial borrowings has also raised concerns about corporate balance sheets, as rapid rupee depreciation has pushed up the debt service burden. India was the fifth most externally indebted country in 2009 in terms of external debt stock, said World Bank in its report on Global Development finance, 2011.
However, there are other structural reasons for the fall of rupee over the last year. Since 1992 when the reform process, imposed on India by the IMF and World Bank, had started, rupee has depreciated by about 70 per cent against US dollar. However, considering the trade pattern of India, rupee has appreciated in recent years since 2007 against the basket of currencies of six major trading partners of India. That made the Chinese products cheaper in India than in China itself, and India has lost already 36 per cent of the employments of its manufacturing industries to China. Thus, a fall of the exchange value of rupee is beneficial to protect Indian economy against these Chinese invasions.
Most of India’s import costs, about 80 per cent, are due to petroleum. India has deficits in trade. Value of India’s exports in 2011 was of $303 billion, but the cost of imports in 2011 was about $488 billion, thus creating a huge gap, which normally gets filled up by remittances of the Indians working abroad and foreign investments. Short-term foreign investments are attracted by the prospect of the Indian economy which used to have a very high growth rate, but it has gone down since 2011. That has discouraged flows of investments. Increasing price of crude petroleum has increased the cost of India’s imports, too.
Foreign investors are worried that due to the deficits in India’s balance of payments, India’s foreign debt, which is now $327 billion in 2012, will go up. With the obligation of current debt service of $85 billion a year, India may have difficulties to repay the debt, particularly when the short-term debt of India is about 22 per cent of the total debt. Short-term debts can be recalled anytime thus creating a situation of default for India if the reserve of India’s foreign currencies and gold will go down due to continuous deficits in the balance of payments. Large current account deficits, which resulted from an overvalued currency after a difficult inflation process as well as the abnormal debt management policy, have caused the accumulation of sizable short-term dollar or euro or yen denominated debt. The rapid expansion in the private financial sector had created a situation of poor quality loan portfolios and a possible banking crisis because the captains of Indian industry avoid paying back their loans. These are factors that have exposed India to the risk of exchange rate devaluation and defaults.
If India could keep the current account balance within moderate bounds, with deficits not exceeding 5 per cent of GDP, it would reduce vulnerability to speculative attacks on rupee by international foreign currency dealers. Speculative attacks are more intense when the deficits are financed by short-term debt or other easily reversible financial instruments like derivatives (bets on financial futures) or shares of Indian companies, which were invited by Chidambaram in 2007 by allowing foreigners to invest in the stock market and the real estate sector.
The experience of the Asian crisis of 1997–1998 put privatised financial markets as the main culprit. In the affected Asian countries, traditional sources of fundamental imbalances were absent. With the exception of Thailand, real exchange rates had not displayed any significant appreciation in the years leading to the crises, and although a slowdown in export growth had been recorded in some of the economies of the region since 1996, it had come after several years of very strong expansion. The loan portfolios of financial institutions, on the other hand by contrast, had deteriorated significantly with massive amount of non-performing loans as the private sectors were unable to pay back, and the corporate sector was excessively indebted and financially fragile, which resulted from years of poor management and wrong investment decisions. Weaknesses in the financial and corporate sectors seem to be the only common factor in all affected countries in the region. The crisis then was intensified by the herd behaviour of the private foreign investors, not only in terms of joining in the stampede out of a currency but also in their propensity to flee from other countries in the same region. The situation is the same in India today.
The vulnerability of an economy to a balance of payments crisis increases significantly when the level of international reserves is inadequate, which was the case during the 1980s in India but not today (Table 10). The level of liquid monetary assets in the country is a natural measure of potential demand for foreign currency from the domestic private commercial sector. Even if the currency is not fully convertible or purchases of foreign exchange are severely restricted, the money supply could fuel the demand for foreign currency through parallel markets of the black money holders or through the Hawala traders.
Main Indicators: 2006 to 2011
Rapid decline of the exchange value of rupee in 2012 can imply a number of aspects. It can mean that rupee is adjusting for the growing inflation in India and the resultant falling export volumes; or it can mean that there is a fear for the greater deficits in balance of payment due to rapidly rising cost of imports of petroleum. It can also mean fear among the so-called short run institutional investors, who have invested through Mauritius that the government may clamp down on them soon through GAAR (General Anti-Avoidance Rules). It can also mean India is heading for a disaster after having a reckless party financed by foreign borrowing as it had happened in 1991.
In 2004 India has allowed India’s black money, which was taken out of India through Hawala channels, to come back to India through Mauritius, where there is no capital gains tax, as new foreign investments thus avoiding taxes in India but instead receiving subsidies. In 2007, India has allowed freedom for the foreigners to invest in the stock market and the real estate sector of India. Due to these measures, growth rate of India shot up suddenly since 2007 because of the massive inflows of short-term investments, the most volatile component of a country’s balance of payments.
Conclusion
The ‘Reformed’ economy has produced two India, one very tiny part of the economy, including the IT sector, the financial services and trading sector, has prospered. However, there is a general decline in agriculture, construction and mining. The growth of the economy is fuelled by increasing flows of short-term foreign investments both in the share market and in the real estate business, which has suddenly raised the growth rate since 2004. The balance of payments still has deficits along with the balance of trade. The only positive factors in India’s external account are the growth of exports of IT-related services and remittances from the Indians living abroad. The real economy and employment have not responded positively yet to the so-called ‘Reforms’. In the case of India’s earlier bubble of 1985 to 1989, the cause was the sudden increase of government consumptions for non-development purposes financed by foreign borrowings and short-term foreign funds parked in India. In the current bubble, the cause is the sudden inflows of foreign funds to satisfy the appetite of speculative demands in the share market and real estate business. Borrowings by Indian companies from foreign sources are a major factor in this scene.
The danger is that these speculative inflows of funds from abroad can dry up suddenly if there is any indication that due to increasing balance-of-payment deficits the exchange rate of rupee may fall (Domar 1950; Kregel 2008; Lary 1946). That would provoke a speculative drive against the rupee and there would be a general exodus of foreign funds from the share market, thus, to bring down the economy and invite serious depression in the economy destroying millions of jobs in India. A crisis of that nature has already erupted in the East Asian countries and Russia in 1978. India was protected at that time because its capital market was closed from the foreign speculators. That is not true anymore. The process of withdrawal of foreign funds has started already as the world economy is about to enter the phase of depression.
For the long run solution, it is essential to look at the composition of India’s balance of payments. Military and non-military spending should be from non-Western sources to reduce the costs. New transport policy away from road transport and private transport should be implemented to reduce the level of petroleum consumption. Increased and better public transport, redesign of the cities, reduced freight rates of railways, increased emphasis on both nuclear and solar energy also can help India greatly. Automobile running on electricity and hybrid vehicles also can reduce India’s petroleum consumption, which is the most important cost of imports.
As in 1984–1989 India government had the emphasis only on the growth rate of the economy and forgot about the danger of borrowing from abroad to enhance these growth rates. During 1984–1989 India had achieved a very high growth rate of more than 10 per cent per year, but as soon as the foreign exchange facility provided by the Soviet Union disappeared in 1991, India was unable to repay its debt. The same situation may develop soon for India if the foreign investors suddenly go away along with their investment and there will be a rapid fall of the India’s foreign exchange reserve. It is essential to accept that the financial liberalisation introduced by Chidambaram in 2007 has created a bubble in the Indian economy with the resultant very high inflation, which is eroding India’s competitiveness in the international market by making India’s exports very expensive with rising cost of production and increasing debt of India’s corporate sector. The only way out is to reintroduce sanity and put emphasis on job creation rather than just growth rates.
Difference between China and India is very obvious. China had put emphasis on the manufacturing industries by inviting foreign direct investments in plants and machinery. India has put emphasis on short-term borrowings to stimulate the economy artificially. China has devalued the exchange rate of yuan in 1994 by 40 per cent and kept it almost fixed since then. India has re-valued rupee and has a flexible exchange rate knowing full well that inflows of foreign funds will increase the exchange rate of rupee thus making India’s exports increasingly uncompetitive in the world economy. China does not allow foreign institutional investors to invest in the Chinese share market or in the real estate sector, but India does. China has not relaxed its control on the capital market, but India is going steadily towards an open economy thus inviting the danger of a sudden collapse when the speculative bubble would burst.
To protect the economy from the speculative bubbles, India should have devalued rupee much earlier, should have closed the foreign exchange market for rupee, banned participations of foreign funds in the share market and in the real estate business, could have very tight control on the capital flows, have control over the foreign borrowings by Indian private companies and should have rejuvenated public investment programme in agriculture and manufacturing to promote employment.
Without a vigorous public investment that feeds the private investments, the country could not be developed for the satisfaction of the people at large. Success or failure of any economic programme is measured by the welfare it generates for the people. Economic and administrative reforms are needed in India but these reforms should be aimed at reduction of corruptions, increased efficiency, increased employments and reduction of inequality and poverty. Given the rapidly declining prospect, it is high time to change tracks from a totally free enterprise economy to a regulated economy for the benefit of the people.