economic reforms & liberalization

8/6/2019 Economic Reforms & Liberalization

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ECONOMIC REFORMS &

LIBERALIZATION


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THE ORIGIN OF ECONOMIC CRISIS

The origin of the crisis in 1991 : careless

macro management of the economy during the

1980s led to large and persistent macroeconomic

imbalances. The widening gap between the revenue and

expenditure of the government - growing fiscal

deficits whichhad to be met by borrowing at

home.

Large current account deficits in the balance of

payments financed by borrowing from abroad.


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THE ORIGIN OF ECONOMICCRISIS

Three Aspects

Fiscal imbalance

Fragile balance of payments situation

Inflationary pressures

The Crisis Made Economic Reforms Necessary


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TWO DISTINCT STRANDS OF REFORMS

Macroeconomic StabilizationDemand-side Management

Control of inflation (low and stable inflation)

Sustainable Fiscal position

Sustainable Balance of payments position

Structural AdjustmentSupply-side Management

Trade and capital flows reforms

Industrial deregulation

Disinvestment and public enterprise reforms

Financial sector reforms


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MACROECONOMIC STABILIZATION:

DEMAND-SIDE MANAGEMENT


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FISCALADJUSTMENT

Fiscal adjustment is necessary for dealing withproblem ofhigh inflation

Fiscal deficit

Beginning of 1970s: less than 4 per cent of GDP

1990-91 :7.8 per cent of GDP 1993-94: 7.0 per cent

1994-95: 5.7 per cent of GDP

The inflation rate: 7 per cent in 1993,

Over 10 per cent per annum in 1993-94 and 1994-95.

The government committed itself to a policy offiscal adjustment.


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FISCALADJUSTMENT

The FRBM (Fiscal Responsibility and Budget

Management) Act in 2004 : brought down the

fiscal deficit to 3.5 per cent of GDP in 2006-07

and 2.7 per cent of GDP in 2007-08.

2008- 09 massive fiscal deficit of 6.2 per cent

because of economic slowdown


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FISCALADJUSTMENT

In India, the fiscal imbalance caused mainly by imprudent

increase in public expenditure.

In 2007- 08, the government expenditure constituted 28.4

per cent of GDP.

Government's capital expenditures in key infrastructural

and social sectors should not be curtailed.

Limit the non development expenditure- subsidies, interest

payments, defense etc


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FISCALADJUSTMENT

Additional revenues by a judicious mixture of broadening

the tax base, rationalizing the tax rates and through non-

tax sources

Can also mobilize resources by targeting black money- 40per cent of GDP.

User charges on publicly provided utilities such as

irrigation, electricity, water, road transport and higher

education are much below their cost of provision.


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BALANCE OF PAYMENTSADJUSTMENT

At present balance of payments situation is not as

precarious as it was in 1990-91.

The level of foreign exchange reserves : $ 309.7 billion

end-March 2008 but fell to $ 252.0 billion at end-March2009 as a result of capital outflows following global

recession in 2008-09

Somewhat stable and sustainable balance of payments

position in the post-reform period


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Liberalized exchange rate management system

(LERMS) in the Budget for 1992-93.

A dual exchange rate fixed : 40 per cent of foreign

exchange earnings to be surrendered at official rate 60 per cent to be converted at market determined

rate.

1993-94 Budget adopted unified exchange rate regime

60 : 40 ratio was extended to 100 per cent conversion. Thus India has been following the market determined

exchange rate system since 1993.


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The exchange rate management policy of the Reserve

Bank

Policy of 'managed float regime

Reserve Bank has focused on managing volatility withno fixed rate target while allowing demand and supply

conditions to determine exchange rate movements in

an orderly way.


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MACROECONOMIC STABILIZATION:SUPPLY-SIDE MANAGEMENT


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STRUCTURAL REFORMS

Since July 1991 liberalization measures have

been undertaken to improve the supply-side of

the economy. Among these the more important

are :

Trade and capital flows reforms

Industrial deregulation

Disinvestment and public enterprise reforms

Financial sector reforms


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TRADE AND CAPITAL FLOWS REFORMS

Export promotion measures in recent years:

Export Oriented Units for promoting exports from the

agricultural and allied sectors

Broadening of areas of activity in Export ProcessingZones

Duty free import for exports

Setting up of Special Economic Zones (SEZs)

Access to capital goods, intermediates and raw materials- improving the global competitiveness of Indian exports.


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INDUSTRIAL DEREGULATION

In India in the industrial sector controls tookvarious forms:

industrial licensing which regulated entry and

expansion;

reservation of a large number of industries for the

public sector as well as small scale sector;

time consuming procedures required for the setting of

industrial units;

price and distribution controls on various industrial

products.


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Long time taken by the industrial licensing authorities togive clearance to proposals

Projects could not be completed within time

Licensing authorities often denied industrial units rightto produce more than licensed capacity.

Maximization of output from a given licensed capacity gotundermined.

Policy of price control: resulted in misallocation of

resources and disregard to costs. Licensing system led to political and bureaucratic

corruption

Used by powerful vested interests to throttle competition.


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Limit on the size of the companies which was earlier

enforced under the Monopoly and Restrictive Trade

Practices Act has now been scrapped.

This will allow industrial units to grow to optimum sizeand enjoy the benefits of economies of scale

The industrial location policy has been both simplified

and liberalized


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New industrial policy July 1991 : deregulation of

the industrial economy and opening up a large

number of industries to the private sector.

These relaxations eased t

he entry barriers w

hich

should make the industrial sector more

competitive


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The requirement of industrial licensing has been

abolished for all but 5 product categories.

These are alcohol, cigarettes, hazardous chemicals,

industrial explosives, electronics aerospace anddefense equipment (all types).

Core industries like iron and steel, electricity, air

transport, shipbuilding, heavy machine industries, etc.

opened up for the private sector


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PUBLIC SECTOR REFORMS AND

DISINVESTMENT

Public sector originally intended to be the engine of

self-sustained economic growth.

Hold the commanding heights of the economy, lead to

tech

nological advance. Generate adequate investible surpluses.

Public sector contributed to the expansion of the

industrial base.

Failed to generate sufficient internal resources for itsfurther expansion


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DISINVESTMENT

Government gave greater managerial autonomy to

public enterprises

Promoted private sector competition in areas where

social considerations are not paramount Partial divestment of equity in selected enterprises


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DISINVESTMENT

Equity amounting to Rs. 51,609 crore in publicsector undertakings was disinvested to publicsector financial institutions, mutual funds,

private corporate and general public till 2007-08.

Had talked of disposing of loss-making PSUs,well performing PSUs were to be givenautonomy

No evidence of any such initiative in practice.

Government policy limited to selling off sharesof prime PSUs


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FINANCIAL SECTOR REFORMS

A vibrant, competitive financial system is

necessary to support the structural reforms in

the real economy.

Over the years, the Indian banking and thefinancial system has made impressive progress

in terms of both geographical spread and

functional reach.


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FINANCIAL SECTOR REFORMS

Brought down both statutory liquidity ratio and cash

reserve ratio in a phased manner.

Commercial banks attaining capital adequacy norms

and good accounting standardsh

ave been given freedomto set up new branches without the approval of the RBI.

Banks can now also rationalize their branch network by

relocating branches, opening of specialized branches,

setting up controlling offices, etc.


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AN APPRAISAL OF ECONOMIC

REFORMS


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REFORMS

Since July 1991 the government has undertaken

both stabilization programs and structural

reforms as two components of the economic

reform package.

The objectives of the stabilization and structural

reform programs have been achieved only partly


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REFORMS

The annual point to point inflation rate which

was below 2 per cent till the end of May 2002,

rose to as high as 12.6 per cent on August 9,

2008.

As far as fiscal imbalances are concerned, the

fiscal deficit of the Central government which

was 5.6 per cent of GDP in 1991-92 declined to

2.7 per cent of GDP in 2007-08.

However, it rose to 6.2 per cent of GDP in 2008-09

6.8% (budget estimate) of GDP in 2009-10.


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REFORMS

In the real sectors, the structural reforms have

shown mixed results.

Since 1991-92 till 2008-09, GDP increased at the

rate of 6.4 per cent per annum. In the first two years of structural reforms, there

was near stagnation in the industrial sector.


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REFORMS

Industrial growth picked up in the Tenth

Plan period

Industrial growth - 11.6 per cent in 2006-

07

Industrial growth averaged 8.2 per cent

per annum over the Tenth Plan period.


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REFORMS

During 1995-96 to 2001-02 saving rate was 23.5

per cent of GDP while the investment rate was

24.5 per cent of GDP

Since 2002-03, both

saving and investment ratehave picked up strongly.

Saving rate in 2007-08 was 37.7 per cent of GDP

while investment rate was 39.1 per cent of GDP


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REFORMS

The Eleventh Plan began well, economy grew at

the rate of 7.7 per cent per year in the Tenth

Plan.

8.9 per cent growth

in th

e firsth

alf of 2010-11,India continues to be one of the fastest growing

economies in the world

The industrial sector recorded a growth of 9.5 per

cent during April-November 2010


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REFORMS

GDP at constant (2004-05) prices in the year

2009-10 shows a growth rate of 7.4 per cent

Growth rate in agriculture, forestry and fishing

sector in 2009-10 : 0.2 per cent manufacturing sector : 10.8 per cent

The per capita income (at 2004-05 prices) during

2009-10 is Rs. 33,588, growth rate of 5.6 per cent


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AN APPRAISAL OF ECONOMIC REFORMS

Growth in the Indian economy steadily increased :1979 -

2003, averaging 5.7% per year Has seen a decade of 7%+ growth

Indias economy has been one of the stars of globaleconomics in recent years, growing 8.2% in 2004, 9.6% in2006 and 9.2% in 2007

GDP growth of 6.7% in 2008-09 GDP growth of 7.2% in 2009-10

GDP growth pegged at 8% plus for 2010-11

This has reduced poverty by 10%

India became the second fastest growing major economy inthe world, next only to China


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AN APPRAISAL OF ECONOMIC REFORMS

Agriculture is the predominant occupation inIndia, accounting for 60% of employment.

Service sector accounts for 28% of employment

Industrial sector accounts for 12% ofemployment

The share of agriculture and allied sectors inGDP has declined gradually from 18.9% in

2004-05 to 14.6% in 2009-10.During the same period, the share of industryhas remained the same at about 28%


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REFORMS

The share of services has gone up from 53.2%in 2004-05 to 57.2% in 2009-10

Performance of the Indian service sector

significant.

Industrial sector growing at 8.2%, 2009-10

while it grew at 3.9% in 2008-09

Service sector growing at 8.7%, growth of

9.8% in 2008-09Manufacturing growth from 3.2 % in 2008-09

to 8.9 % in 2009-10.2009-10 economy grew by 7.9%.


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GDP and Related Indicators

GDP and Related

Indicators

2008-09 2009-10

GDP (current market

prices) Growth Rate

12.7% 10.6%

GDP (2004-05 prices)Growth Rate

6.7% 7.2%

Savings Rate% of GDP 32.5% NA

Capital Formation (rate)%

of GDP

34.9% NA

Per Cap. Net National

Income

(factor cost at current

prices)

Rs 40141 Rs 43749

Population 1154 million 1170 million


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SHORTCOMINGS OF ECONOMIC REFORMS

Absence of a broader development strategy:

wrong to conclude that a well designed industrial

strategy & heavy State intervention have no

positive role to play in industrial growth e.g. SKorea


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Wrong sequencing of reforms: fiscal

correction done through reduction in tax rates &

compression of capital expenditure, compression

of government expenditure without ensuring that

private investors fill the gap, liberalizing imports

of capital goods before adopting strategy for

technology advancement of domestic capital

goods sector


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Hasty pace of reforms: deterioration in quality

of industrial structure- reduction in industrial

growth, reduction in growth of capital goods

industries, shift of exports away from

manufacturers, arresting growth of industrial

employment

Prerequisites of reforms ignored: shock of

reforms reduced if society has reached certain

minimal level ofhuman development e.g. SKorea, Malaysia & Thailand


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Absence of human development goals as

integral part of the strategy:

Incomplete structural transformation, poverty, low

level ofhuman development, poor health, education,

unemployment, access to public services etc Lack of

basic requirements for a decent living

Nutrition standards, access to education and basic

health, water supply and sewerage.

Disadvantaged groups, the Scheduled Castes and

Scheduled Tribes , minorities benefited less than they

should have.

Regional imbalances have emerged across and even

within States.


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IS THE GROWTH MODEL SUSTAINABLE?


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A new spirit of economic freedom - one of themost exciting emerging markets

A series of ambitious economic reforms-deregulation, stimulating foreign investment

India firmly into the front ranks of the rapidlygrowing Asia Pacific region

No conflict between its political and economicsystems.


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Skilled managerial and technical manpower

A middle class whose size exceeds the populationof the USA or the European Union - a distinct

cutting edge in global competition Growth of skill intensive activities

- IT services

- Pharmacy and Bio technology


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Growth in the manufacturing sectorcomplemented the countrys excellent growthmomentum.

The growth rate of the manufacturing sector rosesteadily from 8.98% in 2005, to 12% in 2006.

Robust investment and high savings rates.

Gross capital formation as a percentage of in GDP

rose from 22.8% in 2001, to 35.9% in 2006.Gross rate of savings as a proportion to GDP

registered solid growth from 23.5% to 34.8% forthe same period.


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ISTHE

GROWTH

MODE

L SUSTAINABL

E?

A services led economy

A narrow manufacturing sector

Socio-economic reforms Institutional and infrastructure bottlenecks in

the system

International trade: behind China in trade of

goods, but a major exporter of servicesA slow opening up to international trade and

investment


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IS THE GROWTH MODEL

SUSTAINABLE?

Can India skip the stage of industrialization?

The limits of specialization in skill intensive activities

Services cannot be the engine of development before themanufacturing sector develops

Have a small direct impact on employment

Indias low cost labor unutilized

Tends to increase divergence among states

May have adverse effects on other sectors


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IS THE GROWTH MODEL

SUSTAINABLE?

Employment: jobless growth since 1990s

Infrastructure a major bottleneck

Poverty and inequality

Public deficit and debt- limited funds

Infrastructure

Education, health, basic amenities


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IS THE GROWTH MODEL

SUSTAINABLE?

India currently accounts for only 1.5% of worldtrade as of 2007

Steady growth over the last two decades butuneven

Uneven growth across social groups, economicgroups, geographic regions, and rural andurban areas

Unemployment rate is 7.2% (2007)

60% of Indias 1.1 billion population living offagriculture, droughts and floods increasing,poverty alleviation-a major challenge.


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IS THE GROWTH MODEL

SUSTAINABLE?

Cross the double digit growth barrierMake development more inclusive

Correct weaknesses in government systems,structures and institutionsFiscal ConsolidationReview public spending, mobilize resources

and gear them towards building theproductivity of the economy

Areas of concern - double digit food inflation,the ambiguous nature of recovery in exportsand fiscal pressures


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Employment by sectors, 1990-2005,in %

67

52

13

19

2128

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1990 2005

Services

Industry &bat.

Agriculture

Share of

services in

employment

(28%) smaller

than in GDP

(51%)


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LONG TERM PROSPECTS: GROWTH

POTENTIAL

Demographic trends: a window of opportunity

- Strong increase in working age population

- Dependency rate falling

Actual growth will depend on level of savings

and investment

It also depends on the pace of reforms andliberalization


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An Economic Idea of India

Strengthsy sustained growth at 6.4 for

over a decade

y strong export potential, currenta/c deficit low

y healthy forex reserves

y low external debt

y political consensus on reforms

y deepening financial sector

y knowledge base advantagedemographic surge

Weaknessesy fiscal deficit high, debt GDP ratio

high

y fiscal situation of states worsey inadequate infrastructure, huge

funding need

y unsatisfactory investment climate

y rising gap between rich and poor

states, peopley dependence on oil imports,

monsoons

y social indicators below world

average

economic reforms & liberalization

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