IE 2 - Unit 1 - Macroeconomic Scenario and policy Options IDR 2017 - Manoj Panda PDF

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MACROECONOMIC SCENARIO AND POLICY The high growth phase of to recorded in NI during has and the earlier anticipation that the economy may again witness similar phase soon stands revised Yet, the overall growth performance of the Indian economy is judged as among the best comparative scale across nat...

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MACROECONOMIC SCENARIO AND POLICY OPTIONS

Manoj Panda IDR. 2017. INTRODUCTION 1. The high growth phase of 8% to 10% recorded in India’s NI during 2003-2010 has not continued and the earlier anticipation that the economy may again witness similar high growth phase soon stands revised downwards. 2. Yet, the overall growth performance of the Indian economy is judged as among the best on a comparative scale across nations in a global environment of economic slowdown. 3. It is being perceived that a potential growth rate of 7% to 8% in GDP may be considered as a new normal for India in medium term. 4. Manoj Panda says that the formation of a new government at the centre with a huge mandate in the mid-2014 election presented a historic opportunity for introducing another generation of economic reforms. a. Such programmes include Make in India, Start-up India, and programmes related to skill development, sanitation, and digitization, among others. b. This focus on development and spread of entrepreneurialability of the people has been viewed by many as a welcome move contributing to long-run sustainability of growth. c. The government has tried to redesign the institutional architecture in certain spheres. The NITI Aayog has been set up as the think tank of the government for formulating major policy initiatives. d. The Insolvency and Bankruptcy Code passed by the Parliament is another welcome move providing a framework for time-bound resolution of insolvency of corporates, individuals, and partnership entities. e. The Reserve Bank of India (RBI) has been mandated to keep inflation within the targeted range and is being assisted by a Monetary Policy Committee to determine the bank's policy rate. 5. In the meanwhile, the international economic environment continues to remain vulnerable. Although there are signs of recovery, the global economic slowdown that started with the financial crisis in 2008 has persisted even after 8 years.

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6. International Comparison: India's GDP in US dollar terms stood at closeto 2.1 trillion in 2015. a. India’sPCYat $1,600 is considerably lower than that of other big emerging economies like Brazil ($7,900), China ($8,500), Russia ($9,200), and South Africa ($6,700). b. When adjusted for purchasing power parity (PPP), India's PCY is about PPP $4,000, but the relative ranking of India among BRICS remains the same. c. The BRICS countries, which were considered to have possessed huge growth potential before the global crisis in 2008, are struggling to come out of the crisis. 7. In order to meet the current global average of $10,000 by 2047, India needs to grow at 7% to 8% per year. The government needs to sustain infrastructure and social investment and maintain a policy framework that encourages private investment along with productivity growth. 8. Against this backdrop, this chapter attempts a review of macroeconomic developments in the Indian economy from a medium-term perspective. Figure 2.1 :Five-year Moving Average of GDP Growth

MACROECONOMIC DEVELOPMENTS GDP GROWTH 1 Figure 2.1 (see above) depicts the GDP growth in the Indian economy a 5-yearly average basisduring the last 65 years. 2 The average growth rates fluctuated around 4% before mid-1980s and occasionally touched 5% only to return to the average soon after. 2

3 It did go up to 5%-6% during the second half of the 1980s supported by an aggressive fiscal policy and mild reforms. 4 However, the macroeconomic policy regime follow then nearly broke down in 1991. 5 P.V. Narasimha Rao andManohan Singh initiated a set of wide-ranging market oriented reform measures by abolishing industrial and trade licensing policy and bringing down the importtariffand domestic tax rates to more competitive levels. 6 These measures were continued by other governments indicating a broad political consensus. 7 The benefits of economic reforms are clearly visible in the long-term growth rate in aggregate national income. 8 The average growth rate during the 1990s ranged between 5% and 7%. 9 A decade after the reforms, i.e. by the year 2000,growth improved further and remained high at 7%-9% during 2003 and 2010 giving rise to new optimism. 10 However, the global financial crisis hit theeconomy in 2008 and the annual growth rate dropped to 6.7%. 11 The fiscal stimulus provided then to counter the crisis restored the growth to above 8.5% over the following two years.Since 2011—12, the Indianeconomyhas witnessed a relatively low growth between 6.5% and 7.5% and has not been able to restore the high growth achieved earlier. 12 On the whole, the exponential trend growth rate in GDP has been 13 7% during the 25 years since reform 1991—92 to 2015—16 14 as against a trend rate of 4% over the quarter century prior to the reforms 1966-67 to 1990-91. 15 Analyst broadly agree that India has the potential to attain a long term growth rate of 7% to 8%, though there might be some medium term fluctuations depending upon exogenous factors. AGRICULTURE

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16 Agricultural income growth has been low around 3% on a medium to long-term basis. 17 Known for its supply constraint, it has rarely attained a growth rate of 4% on a 5 year average basis (Table 2.1). 18 Even though the growth rate of 3.8% recorded during the last decade has been an improvement over the historical average, food price inflation noticed in recent past means that supply is lagging behind the demandgenerated by the growth process as well as changingdemand patterns. 19 Agricultural production is shifting in favour of non-foodgrain crops. 20 Foodgrain production has been growing at about 0.5% higher than the population growth rate of 1.3% per annum mostly due to increase in yield rather than area (Figure 2.2). 21 Direct per capita consumption demand for cereals is nearly stagnant. 22 a rise in aggregate demand for cereals is basically due to 23 population growth and 24 An indirect demand forfeed to produce protein-based animal products. 25 Of the total net food grains production of 232 million tonnes in 2014, 26 procurement accounted for 60 million and 27 public distribution for 44 million tonnes (i.e. a total of 104 million tonnes). 28 Cereals exports from India has been about 25 million tonnes on an average during 2010— 14 and partly contributed to a decline in government stocks. 29 Despite higher price rise, pulses production has seen sharp fluctuations and is not able to keep pace with demand. 30 Non-foodgrain output growth has been due to twin factors of rise in a

Area

b Yield

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31 Cotton, tobacco, and potato have been among the fastest growing crops contributing to farmers' income, though sluggish rise in production of oilseeds and sugar has been a matter of concern in recent years. 32 The consumption pattern in India across all income classes has shifted from cereals to noncereal food items such as milk and milk products, eggs, fish and meat, and fruits and vegetables which are major sources of protein and vitamins. 33 The increase in household demand for such items has been induced by income gain for all sections of the population in the last decade either coupled with the relatively elastic demand for them. a

directly due to the growth process or

b indirectly due to the poverty reduction schemes 34 The Indian rural economic scene is no longer dependent only on agricultural activities as non-agricultural activities have emerged as the major source of rural income over time. 35 Even in this scenario, agricultural production and investment must receive due consideration to 36 meet consumption and intermediate demand for agricultural products and 37 for managing food inflation which adversely affects the level of living of the people, particularly the low-income group. 38 Technological developments, and consequent land and labour productivity rise, will be important factors for enhancing agricultural growth. INDUSTRY 1. The industrial sector led the GDP growth during the initial 30 years of the development process after Independence (1950-1980) with a growth rate of above 5.3% as against overall GDP growth of 3.7%. a. It laid the foundation for production of basic and capital goods following the Mahalanobis model. b. The share of industry in GDP increased from 16% to 26% over the same period of 1950-1980. 2. Industrial share fluctuated between 25% and 28% since 1981[So not much growth in the share of Industry in GDP since 1981]. Industrial growth just kept pace with GDP growth on a medium-term basis, but was marked by a high degree of volatility in the short run. 3. Industry includes (with value added share in brackets for 2011-12) 5

a. mining and quarrying(10.4%) b. manufacturing (58%) c. Electricity, gas, and water (0.6%) d. Construction (30.5%) 4. As per the new series, total industrial real value added has grown between 4.0% and 7.4% since 2011—12, but a. mining and quarrying, and construction fell in absolute level in 2012—13 and manufacturing grew by just 0.5%in 2014—15. b. Construction which absorbs a fairly good proportion of the casual workforce grew at an average rate only 3.7% from 2012—13 to 2015-16.

5. Going by the use-based classification in index number of industrial production, the slowdown in manufacturing has been widespread across its sub-sectors. As Figure 2.3 shows manufacturing output grew at fairly comfortable rate from 2001 to 2007; but a. growth has been slow in all components except basic goods during 2008-15. b. Capital goods and consumer non-durables have particularly been more adversely affected. SERVICES 39 The service sector has been the major driver of economic growth in India since 1990 with share in GDP rising from 38% in early 1980—81 to 53% in 2015—16. 40 The service sector in India employs 31% of the labour force.

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41 The sector covers a wide range of activities such as trade, hotels, restaurants, tourism, transport, storage, communication, banking, insurance, business services, real estate, social and personal service, public administration, and defence. 42 Trade, transport, tourism, and personal services contribute substantially to employment generation. 43 Most of subsectors in services have continued to perform well in recent years except the segments community, social, and personal services. 44 Services play a key role in the country's exportsaccounting for above 3.5% of world trade in services with software development as the major exporting sector in India during the last 20 years. 45 Software development, communication, and air transport haveattractedsubstantial foreign investment. 46 Business services, which include information technology and information technology enabled services (IT-ITES), continue to rise even after the global crisis contributing to above 5% of GDP and creating large volume of jobs for skilled and semi-skilled manpower. 47 Within the service sector, 48 'finance, insurance and business services' has emerged as the largest segment accounting for 40% of income generation in 2015—16 49 'trade, hotel, transport and communication' accounting for 36% and 50 'community, social and personal services' the balance 24%. CONCLUSION: 51 The network of effective system laid out during the last 20 years has revolutionized communication in India and playing a very important role on the social and work related communication among the people, particularly the youth. 52 In other words the communication revolution in India (with a growth rate of more than 20% p.a. for last 20 years) is a result of conscious policy decision of the government helped India leapfrog in its IT-ITES service exports and other commercial activities. SAVINGS AND INVESTMENTS 1. Typical of an underdeveloped economy, the gross domestic savings rate in India was a. 9% to 10% of GDP in the early 1950s. b. Along with growth, the savings rate too rose slowly to double by the mid-1970s and c. Remained at 20% till the late 1980s 7

d. Rising to 25%in 1999-2000. e. It started rising further 2003-04 onwards, and reached a peak at 36.7% in 2007— 08. 2. A savings rate of this order was comparable to several East Asian economies, which witnessed a high growth regime and was viewed as a structural break in the Indian economy. 3. But, savings dropped to 32% in 2008—09 due to the global crisis and has remained around 30%-34 % in recent years. 4. All 3 sources of savings - household, corporate, and government— contributed to the decline in total savings rate after 2008. However, a. The private corporate sector recovered to 13%of GDP in 2014-15 improving over its earlier peak in 2007. b. The public sector attained a savings rate of 5% of GDP in 2007—08, but has mostly remained below 1.5% since then. c. Household savings, the largest component of total savings in India, too started recovering but dropped subsequently from 25% in 2009—10 to 19% in 2014—15. i. Household financial savings has fallen by 3% to 4% of GDP, while ii. physical savings by households recorded an increase[last 2-3 years, however,has seen a reversal in trends and financial savings have increased once again] iii. High inflation rate turns real earnings on financial savings negative for households who then allocate larger proportion of their savings into nonproductive assets like gold. iv. According to Manoj Panda, a low inflation regime assuring 2% to 3% real interest rate for households would encourage higher financial savings by households. v. The recent policy measures taken for financial inclusion by ensuring banking services to the poor is expected to induce financial savings among the lower income groups, though the total size might not turn out to be large. 5. [According to a August 2018 report by India Ratings – a private rating agency - during 201112 to 2016-17 (FY12-FY17), the share of the household sector in total saving was 60.93%, while private corporations accounted for 35%, and the remaining 4.07%, was from the public sector.] 8

6. The series on gross capital formation rate has stayed above the total domestic savings rate by 1% to 2% points, the difference between the two being financed by foreign savings or net capital inflows. a. Gross capital formation rate exceeded the domestic savings rate by 4% to 5% in 2011—12 and 2012—13 indicating a capital inflow driven investment recovery. b. This recovery did not last long and gross capital formation declined by 3-4% from 2012—13 to 2014-15. 7. Both public and private sectors have contributed to the aforementioned decline. a. Public sector investment, which reached 9.4% of GDP in 2008—09, declined subsequently to 7.4% in 2014—15. b. Private sector investment too declined by more than 2% from 28.1% in 2007—08. 8. The revised NAS series indicated private investment of 29% and 28% in 2011—12 and 2012 —13 respectively, though it fell subsequently to 25 % in 2014—15. 9. According to Vijay Joshi [the reading we did in the last semester], corporate leverage is high in India as reflected by the highest debt-equity ratio among emerging market economies and major Indian companies are facing a 'debt hangover' due to excessive borrowing during high-growth phase. 10. This subsequently resulted in an increase in stressed assets of the banking system and reduced capacity to lend. Restoration of the investment rate would be an important factor for realizing a higher growth rate for the economy. FISCAL DEVELOPMENTS

Note 1: 53 If revenue expenses of the government exceed revenue receipts, it results in revenue deficit. 54 Similarly, if the capital disbursements of the government exceed capital receipts, it leads to capital account deficit.

Note2:

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55 In government finance, budget deficit is the sum of revenue account deficit and capital account deficit 56 Alternatively, aBudget Deficit is the mismatch when expenditure exceeds revenue. It occurs when the current expenses of the government exceed the amount of income being received through standard operations (current and capital). 57 Budgetary deficit is usually expressed as a percentage of GDP. Note 3: 58 A fiscal deficit occurs when a government’s total expenditures exceed the revenue that it generates, excluding money from borrowings. Deficit differs from [fiscal] debt, which is an accumulation of yearly deficits. 59 Primary deficitis one of the parts of fiscal deficit. While fiscal deficit is the difference between total revenue and expenditure, primary deficit can be arrived by deducting interest payment from fiscal deficit. 60 So while budget deficit is the difference between total receipts and total expenditure. If borrowings and other liabilities are added to budget deficit, you get Fiscal deficit. Now, Manoj Panda states, 1. Revenue receipts of the centre and states together were down to 18.7% of GDP in 2009— 10 but recovered to 20.8% of GDP in 2014—15 consisting of i. tax revenue of 16.6% and ii. non-tax revenue of 4.2%. b. The centre's tax revenue accounted for 10.8% of GDP (Table 2.4) and the states' taken together another 5.8%. 2. The combined expenditure of the central and state governments a. rose by 2% of GDP to 28.4 % in 2008—09 over 2007—08 (Table 2.3) due to the expansionary fiscal policy followed by the government to overcome the global crisis. b. It reduced to 27% in 2013—14, but rose again to 28% during 2014—15 and 2015— 16 (RE). c. It may be noted that the central government accounts for a little less than 50% of the combined expenditures of the centre and states.

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3. Revenue deficit, which was as low as 0.2% of GDP in 2007-08, rose to 5.7% in 2009—10 and remains high at 3% in 2015-16 (RE).

Budget Deficit (Source: Trading Economics website)

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4. Gross fiscal deficit of the consolidated government stood at 6.9% of GDP in 2014—15. a. It had come down to 4.1% of GDP in 2007-08 due to adoption of Fiscal Responsibility and Budget Management (FRBM) target set then, but more than doubled to 8.3% in 2008—09 and further rose to 9.3% in 2009—10 (Table 2.3) b. indicating that fiscal imbalance after the global crisis was of similar magnitude existed at the time of 1991 crisis. c. Fiscal consolidation measuresadopted subsequently have gradually brought down the fiscal deficit level. d. Further consolidation is needed since it is currently close to 3% higher than the 2007—08 level (2.5% of GDP).

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5. Subsidy by central government has come down 1.7% of GDP in 2015—16 RE. a. Petroleum and fertiliser subsidies have fallen due to sharp fall in world market prices and orientation towards market-driven prices. b. Food subsidy went up sharply due to rising difference in procurement price by the Food Corporation of India (FCI) and issue price in public distribution system (PDS). The Food Security Act adopted in 2014 further added to the subsidy bill. 6. Subsidies were introduced to attain specific social objectives but involved large leakages in the delivery system. a. There is an urgent need to review the subsidy schemes for better targeting. b. The biometric-based identifiers, initiated by the previous government and continued by the present government, are unique to individuals and are expected to help in better targeting the subsidies.

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Subsidy by Central Government (Source: Bloomberg)

FOREIGN TRADE 1 The foreign trade policy changes were at the centre of the structural reform measures in the 1990s. Opening up of the economy to trade and capital flows has played a major role in increasing growth and efficiency during the last 25 years. EXPORTS 1 India's exports rose in an impressive manner from US$ 19 billion in 1990—91 to 310 billion in 2011—12 recording a 17-fold rise in two decades (Figure 2.4).

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61 In 2014—15, merchandise exports accounted for 15.4% of GDP and services another 7.5%.Merchandise trade grew by an average rate of 30% in 2010—11 and 2011—12 indicating recovery of trade after the global crisis. However, the recovery did not last long and exports have hardly grown since 2012—13 and in fact have contracted in absolute levels for several months. 62 India ranks as the 8thlargest service exporter in the world. India's share in world s...