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India: Economic Overview
FIN 680D/ FIN 360A
MAR 680V/ MAR 356E/ INB 670C
P.V. Viswanath
Economic History: 1950-1990
Post-independence India had a mixed economy,
i.e. including both private and public sectors.
The reasons for a strong public sector were:
– Greate inequality in income distribution – doubts as
to the viability of free markets
– Free trade would probably have led to exploitation by
stronger foreign countries
• Exports were seen as a drain of resources from the
country.
Post-independence economy
Foreign Investment was seen as foreign domination.
The quickest path to economic development was seen
to be rapid industrialization, which would probably not
happen without government intervention
– Capital goods and heavy industry were seen as particularly
needed.
– Planning was needed to ensure industrial growth and the
concomitant agricultural and service growth, as well as
employment growth
Objectives
The broad objectives were:
– Rapid growth in production with a view to achieving
a higher level of national and per-capita income.
– Full employment
– Reduction of inequalities in income and wealth
– Socialistic pattern of society with a democratic
framework, based on equality and justice and
absence of exploitation.
Policy Measures for Industrial
Development
Trade and Regulatory Regimes designed to
shield industrial producers from competition
– High tariffs
– Industrial licensing of production and investment
– Monopoly and Restrictive Trade Practices (MRTP)
Act
– Foreign Exchange Regulation Act (FERA)
– Export Restrictions
Industrial Policy
Directed allocation of subsidized credit through
the commercial and developmental banking
system
Administered interest rates and financial
institutions required to lend for specific purposes
at the administered rates.
Fixed, overvalued exchange rates; this ensured
cheap imports for the government.
Industrial & Agricultural Policy
Price control for many products
Rigid labor laws that made it difficult to lay off
workers.
Direct public investment in industrial activities.
Management of the agricultural sector to ensure
reasonable supplies of food grains, edible oils,
sugar and cotton to the domestic market.
Agricultural Policy
Procurement prices were fixed, which , in times
of surplus, worked as a minimum support price.
At times of deficit, the government mandatorily
procured a part of the grain at the procurement
price and distributed it to poorer people through
ration shops.
Fertilizer, irrigation, power and credit were
subsidised for the agricultural sector.
Agricultural and Fiscal Policy
The need to mop up excess production led to
trade restrictions.
– Quantitative restrictions on exports and imports,
through licensing
– Canalization – the use of a single parastatal for
imports and exports; the use of minimum export
prices.
– High income tax rates
Social Policies
Higher education was emphasized (IITs and
IIMs)
Growth-oriented strategy as a means of
mitigating poverty and unemployment.
However, structural inequalities in land
ownership, availability of water, access to credit
etc. led to growth without income and
employment growth for poorer people.
Social Policies
Land reform (at least in some states)
Alleviation of poverty through special programs
and policies, such as asset creation programs,
employment generation programs, minimum
needs programs.
Intervention programs to solve the problems of
malnutrition and hunger.
Did the policies work? Industry
Industry grew 6% p.a. between 1951 and 1989
There was little competition; hence there was
little R&D.
The capital-input ratio went up considerably;
total factor productivity dropped. Capacity
utilization fell.
Deeply entrenched interest groups.
Agricultural Progress
Between 1950 and 1980, food grain production
increased by 2.8% p.a., due primarily to productivity
gains and multiple cropping.
But, investment growth slowed.
R&D suffered, development of irrigation lagged behind
plan targets.
There was a substantial rise in subsidies for food and
fertilizer and for credit, water and electricity.
India became self-reliant, but at great cost.
Social Progress
From 1970-88, the proportion of population below
poverty dropped from 46.17% to 37.76% in urban areas
and from 58.75% to 48.69% in rural areas.
Average life expectancy improved from 32.1 in 1950-51
to 58.7 in 1990-91. The death rate dropped from 27.4
to 12.5 during the same period.
Literacy was 52.2% in 1990-91 compared to 18.33% in
1950-51.
But compared to other developing countries, this was
not good.
The crisis and the change
A massive rise in the government deficit spilled
over to the current account deficit because it was
financed by external debt.
External shocks, such as increased oil prices,
decreased access to concessionary loans from
abroad
Structural rigidities in the Indian economy made
Indian products non-competitive, globally.
The solution
A twofold solution:
– Make the economic structure more competitive
– Contain the government deficit
Effects:
– Structural Change and
– Fiscal stabilization.
Initial Reforms
Trade policy reforms have done away with most
quantitative restrictions and reduced tariff levels
Industrial policy has removed barriers to entry
and limits on growth in the size of firms
Regimes for foreign investment and foreign
technology have been liberalized considerably
Domestic tax structure has been rationalized.
The financial sector is being deregulated.
Second-generation reforms
Privatization of public sector undertakings
– Very slow, but steady. BHEL
Exit policy for labor
Reforms of the agricultural sector
Reforms of the state government
Real Net National Product
Growth in Industrial Production
Atul Kohli, “Politics of Economic Growth in India, 1980-2005,”
Economic and Political Weekly, April 2006, pp. 1251-1259 and
1361-1370
Changes post-1991
Disparity in growth across states
Move towards service sector
Lack of industrial growth
Income inequalities
High poverty in the rural sector – farmer suicides
Continued casteism, gender inequality,
communal unrest
Microfinance
Lack of rural development was thought to be due to lack
of production assets and credit.
The government introduced easy credit programs
through Regional Rural Banks.
These banks improved access to credit of better-off
farmers, but failed to reach the vast numbers of
landless people, microentrepreneurs, agricultural
labourers and illiterate women.
Cheap credit skewed development to richer farmers.
Microfinance
Early Rural Credit programs failed because:
– procedures of rural banks were unduly complicated
and costly
– the sole emphasis on production loans was ill-guided
– the poor were able to save, but had no opportunity of
depositing their savings
– transaction costs were prohibitive
– financial products were unsuitable
Microfinance in India
National Bank for Agriculture and Rural
Development (NABARD) concluded from a study
that:
– Microfinance programs have to be savings-led, not
credit-driven.
– The poor have to have a say in their design.
The NABARD program with the help of the RBI
based itself on the work of self-help groups
(SHGs).
SHGs
SHGs are successful because they are selfdirected,
largely homogeneous in terms of caste and
activity,
build a common fund from very small regular
savings and interest income
lend to their members for periods of 1-3 months
at an interest rate of 2-3% per month.
SHG Banking
The NABARD program piggy-backs on the work of
established SHGs by providing them refinance.
This program works because India already has in place
a network of rural banks.
By March 2005 SHG banking reached 1.6 million
savings-based groups with 24 million members,
covering over 120 million people from the lowest strata
of the rural population.
The program is in the hands of local agencies, driven by
local SHG ownership.
Microfinance
Why does it work?
Incentives
Group Monitoring
Economic Discrimination
Two theories of employee discrimination:
– Statistical Discrimination – desired characteristics
are more prevalent in the sought-after group. Hence
employees belonging to this group are preferred.
– A recent study concluded that SC/ST graduates of
the 2006 IIM-Ahmedabad batch got jobs with lower
pay offers.
– The study found that after adjusting for weaker
academic performance, there was no discrimination.
Economic Discrimination
Preference-Based Discrimination (Becker)
If employers prefer to associate with employees
of a certain background, then that characteristic
will be priced – employees of the favored group
will be preferred even if there is no difference on
efficiency grounds.
This may be changed by advertising, marketing
and misconceived associations between group
affiliation and economic performance.
Capital Account Convertibility
CAC based on the theory that capital will flow from high
capital-endowment countries to low capital-endowment
countries, from low-return-to-capital countries to highreturn-to-capital countries.
But CAC often led to movement of capital from
developing countries to developed countries.
One reason is information asymmetry problems in
developing countries combined with contract
enforcement difficulties.
Capital Account Convertibility
Preconditions:
– Low governmental fiscal deficit as a proportion of
revenues
– Contract enforcement
– Line of credit
Shareholder Dispersion: Why?
Helps stock market liquidity
Which, in turn, helps market efficiency and
– Information aggregation
Prevents control of government by corporate sector,
leading to subversion of political system.
From the firm’s point of view, IPOs directed to
shareholders at large, rather than Financial Institutions
will keep the cost of capital lower. This will ensure
economic efficiency.
Shareholder Dispersion: Why not?
Agency costs
– Leads to divergence between managerial goals and
shareholder goals
– Reduced investment in monitoring of managers
– Inefficient investment
Need strong market for corporate control and
well-regulated securities market to offset this.
Empirically, dispersed share-ownership is a
characteristic of developed economies.
Shareholder Dispersion: The facts
As of end Mar 2007, promoters held 54.94% of
total shares, individuals held 13.78% and
institutional holdings accounted for 14.64%