Indian Economy : The Baby Elephant

Postat den 4th April, 2012, 08:01 av Aman Agarwal, Delhi

I. Introduction

India, the largest secular democracy in the world, is home to 1.21 billion people (i.e. about 17.4 % of world population). In terms of economics, India accounts for 2.5% of world GDP in US dollar terms and 5.5 % in purchasing power parity (ppp) terms. India’s rich civilisation’s history dates back to over 10,000 years, going back to the Harrapan and Mohanjadaro periods having high appreciation for Architectural layout of townships and structured lifestyles. In the last 5,000 years till the recent invasion by the Mugal and the British, India was referred as the Golden Bird with the highest possible respect for Women and mankind. Texts and temples of these periods clearly reflect the richness in the society and the importance of Gold in a common man’s life for use as cloths, utensils and for consumption as part of food. The currency regime in India (the then Hindutav Raj / Bharat / Hindustan) goes back to about 1000 BCE with the creation of coins in gold and hence forth in silver for long periods of reins much prior to the Chandragupta Maurya glorious period of 350BCE. Chanakya’s (Kautilya) work “Arthashastra” is the 1^st ever written text in Economics in 350 BCE (2362 years back) outlining the way a kingdom is to be run ; the role of a King ; the functions, duties and role of his officials and the way civilian function in the society. Kautilya’s teachings given in the Arthashastra (meaning Economics in Sanskrit) holds good in today’s time. This can be observed to in use in political economics by various nations globally even today, though Adam Smiths work of “Wealth of Nations” is no longer valid in today context. Hence, I always refer to Chanakya (more commonly known as Kautilya), a teacher, as the Father of Economics.

Indian (the then Hindustani) has been a firm supporter of free trade and commerce and the one to introduce spices and woollens to European civilization. There has been a strong feeling of moving together hence there were no restrictions on labour moments or doing trade with any civilization in the history. This has been the prime reason for India to lose its independence to British for over 200 years and be invaded by the Mugals. Over centuries, India has been divided into smaller sections and today is almost 1/5 in land mass of what it used geographically be referred as Bharat / Hindutva Raj. I am proud to say that India has always been a Peace Loving Nation with No History of ever attacking any Nation to conquer despite being invaded and split into smaller sections centuries after centuries. Even today, India happens to be truly a multi-cultural, multi-ethnic, multi-lingual (with over 25 Registered languages out of over 600 known languages each having independent script and over 4000 dialects), multi-religious (all possible religions and religious leaders making India their home) harmonious society. I feel it is critical to know India before one wishes to move forward to make an attempt to understand as to where the growth and stability in the civilization’s functioning comes from.

The Changing Structures in the World Economic sphere are inducing creation of new dimensions on how finances move from one region to the other mobilizing growth and development. The Indian Economy in the last two decades from the beginning of the economic reform process in 1991 has restructured itself to integrate itself with the World Economy not loosing its touch for domestic orientation. India is fortunate to enjoy a diverse demographic and societal setup, which induces opportunities for growth for domestic and overseas investors. The youth of India, which comprises of over 60% of the total 1.21 billion population (726 million) being below 45 years of age and a budging middle class of over 350 million (equivalent to US population or half of Unified Europe’s population) is setting the pace for need of more goods and services factored in both by domestic and international corporations/agencies for the next two decades.

In this short piece I have tried to make an attempt to outline the economics of India. An attempt has been made to give an overview of what the current scenario is and the way it is expected to optimise the externalities India is flushed with being an honourable member of the global village.

II. India and the World Economy

There are over US$ 6 trillion worth of transactions that take place worldwide on a daily basis, which is equivalent to the total world trade every year. The persistent rise in the dispersion of current account balances of the world as a whole, wherein the sum of surpluses match the sum of deficits has grown substantially since the World War II. Since 1990, the un-regulated financial markets were set to induce growth for emerging and developed economies. However the economies have been hit one after the other with the fashion and need for market driven capitalist and liberalized economic systems. The emergence of the crisis in the last 30 years since 1982 beginning with USA (1982, 1989, 2007-08, 2010), India (1991), Russia (1992, 1998), Mexico (1994), East and South East Asian (1997), Brazil (1999), Argentina (2001) and the most recent financial turbulence observed in 2008 in US and Europe (Italy, Greece, Spain, Portugal, Iceland and others on a look out for Bank Bailouts in 2008-11) has an estimated impact of over US$ 8 trillion with over US$ 3.5 trillion already proposed for bail out by the US Treasury clearly bringing forth the failure of Banking and Financial Institutions which serve as the back bone of an economy and life blood of organizations producing goods and services to boast economic activity.

Nation’s worldwide are en-tasked with responsibly to build sustainable future for all, while maintaining appropriate environmental discipline and stable socio-economic growth. The changing structure of world investment, trade, capital flow and the need for deeper integration, strengthening regulatory framework and signalling system is greater (Agarwal, Agarwal and Agarwal, 2006). Globalization has altered the economic frameworks of both developed and developing nations in ways that are difficult to comprehend. Innovation has seeded the need to finance development and growth in rural regions. Also the emergence of unregulated global markets appears to have moved towards a more stable and growth oriented economic globe. What is needed today is to develop sensitivity sensor systems to promote technology within the financial framework as an integrated approach to keep markets from busting and causing socio-economic panics.

India in 2011-12 has been fortunate to observe a growth rate of 6.9% after having shown a sustained growth of 8.4% between 2003-2011 (except in 2008-09 of 6.7%). The economic growth of 6.9%, as against the budgetary target of 8% in February 2011, has been welcomed within India and overseas as fair and optimistic, given the global feel of long sustained financial turmoil in developed region of the world having double dip recession in United States, debt crisis in large parts of Europe, two decades of uncertain Japan financing Asia, hardening crude prices and high levels of un-employment globally. India stands challenges to strengthen its self sufficiency and domestic productive capacity with the needs to service the middle class of over 350 million and the bulging youth of about 726 million.

The areas which are looked up internationally to understand an economy and its trajectory are the monetary policy framework, the budget projections, macro-economic factors (Inflation, GDP growth, Per Capita Income, PPP, Savings Rate, FDI Flows, Foreign Exchange Reserves/Policy), political economy, stock markets, sectoral growth (service sector, industrial and agriculture). One can get a good glimpse on these from the two basic framework documents – The Economic Survey and The Five Year Rolling Plan (12^th Five Year Rolling Plan beginning 1^st April 2012).

India’s monetary policy framework and the associated procedures for operating monetary policy have evolved over time with the changes in the underlying macroeconomic structure and growth in the financial markets. One of the landmark developments, inducing independence to RBI in its conduction of monetary policy, was the abolition of the system of automatic monetisation of fiscal deficit from April 1997. Also the introduction of auctioning system for the government securities enabled the RBI to switch from direct to indirect instruments of monetary control. With the opening up of the economy and deregulation of the financial sector in 1991, the stability of money demand function had become a big question. The RBI, hence switched from a monetary targeting framework, adapted in the mid-1980s, to a multiple indicator approach. Under the multiple indicator approach, various indicators such as rates of return in different markets, movements in currency, credit positions, fiscal positions, inflation rate, trade, capital flows, exchange rate, refinancing and transactions in foreign exchange – available on a high frequency basis – are juxtaposed with output data for drawing policy perspectives. The Evolution process for this approach is still in process and helps the RBI to restructure and re-define the use of multiple factors to enable them refine the monetary policy framework. For the macroeconomic assessment the indicators are drawn from the RBI’s industrial outlook survey, inflation expectations survey, professional forecasters’ survey and capacity utilisation survey. In the last decade, the overnight interest rate has also emerged as the operating target of monetary policy.

In the period post 1991 and prior to 2007, India has observed a decline in macroeconomic volatility (both in output as well as inflation). The period was marked by strong GDP growth coupled with low / stable inflation and low interest rates. This was attributed to (i) structural changes that had increased macroeconomic flexibility and stability such as improved management of business inventories made possible by advances in computation and communication, increased depth and sophistication of financial markets, deregulation in many industries, the shift away from manufacturing to services and increased openness to trade and international capital flows etc. ; (ii) International confidence in India’s growth coupled with good luck ; (iii) improved performance of macroeconomic policies ; (iv) non-availability of options for markets which could provide secure investment heaven and consumption base. This was made possible as an outfall of the changes introduced by the RBI in the monetary policy framework to induce stability in the system and to effectively monitor monetary movements in a complex society with largely free movement of labour and capital.

The 2008 crisis, with its epicentre being US, Europe and other regions of the developed world, did not have an immediate significant impact on it Indian financial markets and trade flows. The possible reasons attributable primarily to this effect were (i) the macro-prudential approach to regulation (ii) multiple indicator based monetary policy, (iii) calibrated capital account management, (iv) management of systemic interconnectedness, (v) robust market infrastructure for OTC transactions and (vi) a conservative approach towards financial innovation (vii) inefficient market systems. This shield seems to have been weakened in 2011-12 for India. The NPA positions accumulated by the banks and financial institutions in large part of the developed worlds post 2000 has still not been attended to by the banking industry and respective regulatory authorities in the last 4 years of marked financial turmoil. This is turning out to be the prime cost factor for reduced global economic growth and inducing contagion effect to emerging markets. This is clearly visible from the Growth trends of India falling to 6.9% from 8.4% (average of last 8 years) with most of the macro-economic factors being stable.

The Reserve Bank of India (RBI) has been able to curtail the Money Supply (M3) growth to 13% as against 17-22 % (between 2005-2008). The Multi objective and multi instruments approach followed by the RBI in formulating the monetary policy has helped in interpreting developments in financial system and taking prompt corrective action. Also the measures such as putting in place robust systems for reducing counterparty risk in OTC transactions through CCP arrangements and regulation of shadow banking institutions to address the interconnectedness issues have helped in containing the impact of the crisis.

The Economic Survey presented on the 15^th March 2012 has shown largely that India performed well in both agriculture (2.5% leading to 14% of GDP) and services growth (9.4% leading to 59% of GDP) given a high double digit inflation (WPI) for most of the fiscal year. There has been a steep downfall in the industrial growth (3.9% leading to 27% of GDP) both due to fall in international demand and bank’s seizing themselves to pump liquidity into the system following high NPA positions. This has been despite RBIs repeated efforts to instruct banks to finance different segments of the economy and not holding on to liquidity. The 150 basis point of cut in the CRR in February 2012 is another step by RBI in this direction.

The Union Budget 2012-13 which followed the economic survey has been well drafted to touch all sectors of the Indian Economy, however has little to contribute given the high level of Fiscal Deficit (5.9%), high levels of idol liquidity (savings rate of over 33% and Foreign Exchange Reserves of over US$ 293 bn) and wastages of resources as an outcome of corruption and distribution systems. The Key outlining facets of the budget have been (a) central subsidies to be kept under 2% of GDP and to be further brought down to 1.75% of GDP over the next 3 years ; (b) Rs. 30,000 crores to be raised through disinvestment ; (c) introduce FDI in Muti-brand retail ; (d) investment in the 12^th Five year rolling plan to go upto Rs. 50,00,000 crore (Rs. 5 trillion i.e. US$ 0.1 trillion) ; (e) agriculture credit to be raised to Rs. 5,75,000 crores (Rs. 0.575 trillion i.e. US$ 12 billion) ; (f) national urban health mission to be launched (g) Unique Identification (AADHAR) similar to US Social Security Number to be given adequate funds for enrolment of 40 crore persons (i.e. 0.4 billion person) ; (h) to induce mechanism to control un-accounted money (black money & corruption) ; (i) to introduce new tax proposal in light of Direct Tax Code (DTC) and Good & Service Tax (GST) ; (j) increase in income tax exemption levels ; (k) standard rate of excise duty to be raised from 10% to 12% ; (k) service tax rates to be raised from 10% to 12% across all services ; (l) no change in peak customs duty of 10% on non-agro goods ; (m) fiscal deficit to be target at 5.1% in 2012-13 (from 5.9% in 2011-12) ; (n) a relief to hear the Finance Minister mention the need to allow the Rupee to strengthen by not keeping it artificially weak (a cause which we at IIF have been voicing regularly for last 15 years) ; (o) central government debt to be at 45.5% of GDP (compared to 50.5% as targeted in the 13^th Finance commission) (p) introduce amendment to the FRBM Act (Fiscal responsibility and Budget Management Act, 2003) as part of the Finance Bill 2012. A series of other proposals have been put forward in the budget window dressing the balance sheet to optimize net positive effect on revenues to the government instead of meeting social welfare and relief to the middle class or common man of India. Given the strong base of world renowned economic experts currently presiding in the government economic policy framework, the budget is a poor reflection of the intelligence and their ability to service the society at large, for which the government is in place. India today not only has a potential to service its own people by providing relief but also provide for growth impetus to international investment and economic frameworks of both developed and emerging markets.

The 12^th Five Year Rolling Plan aims at “faster, sustainable and more inclusive growth”. The plan is outlined to focus on Agriculture, Infrastructure (including Telecommunications) and Industrial Growth. The five objectives identified by the Finance Minister in the plan are – to focus on domestic demand driven growth ; private investment growth though appropriate improved environment ; address supply bottlenecks in agriculture, energy and transportation sector (particularly in coal, power, national highways, railways and civil aviation) ; address the problem of malnutrition and healthcare ; expedite coordinated implementation of decisions being taken to improve delivery system, governance and transparency (specially addressing the problem of black money and corruption)

When we look at the macro-economic factors outlined in the economic survey for the current and previous years it is clearly visible that India has been able to keep most of these factors stable if not improve in the current year given strong force of economic downturn and contagion effects impacting India’s growth trajectory. Inflation had hit the double digit figure during the financial year 2011-12 with food inflation around 20% and fuel inflation crossing 14%, which was creating imbalance not only in the treasury positions but also pushing the common man to the edge. This is not something that is specifically happening with India. If we look at almost all developed and emerging economies, inflation has been on a strong upturn due to cost-push factors as a fall out of the international crude oil price rise, weakening of domestic currencies, poor bank liquidity positions and debt stress positions. The year-on-year inflation for CPI (urban), CPI (rural) and CPI (combined) has been 8.25%, 7.38% and 7.65% respectively in January 2012. Headline WPI inflation remained persistently high and sticky at 9% during 2011, softening to 6.6% in January 2012. Though we are still not in the danger zone as are most developed countries which have inflation to the tune of 3-4 times of the average of last few decades, however it is critical that the government and RBI puts in place policies to induce negative growth of inflation to bring relief to the common man and induce growth projected at 8.1% for 2012-13.

If we look at the GDP growth, a figure of 6.9% is fair and optimistic keeping in view the base being higher from the last year and large amounts of capital flows reverting to US and Europe due to the double dip recession with exorbitant negative trade balances in US and serious debt crisis leading to economic collapse of series of EU member nations. This reversal of flows has lead to a Foreign Exchange Reserve depletion of over US$ 100 bn in the financial year 2011-12. However given the growth impetus and strong domestic orientation, the net Foreign Exchange reserves stand at US$ 297 billion (as against a high of US$ 322.2 billion in August 2011 and US$ 274 billion at the beginning of the 2011-12). The Per-capital income has also been able to contain itself at US$ 1,200 (though in absolute Rupee value there is an increase from Rs. 53,331 to Rs. 60,972). Given the strong purchasing power (PPP), India has sustained itself to be amongst the top best three purchasing power countries in the world. Not to forget that the purchasing power in India typically gets originated from domestic factors as against external cheap imports in case of US and China.

The Savings Rate of 33% has been a saviour to the economic downturn and threats of un-employment and large number of Indian workforce retrenched and returning back home. Keeping in mind that India has a parallel economy as strong as the normal economy provide for a buffer for any kind of recession with actual savings rate being 1.75% times and the GDP growth being 1.5% more than the official figures. The FDI flows in 2011-12 have seen a big jolt due to the bleak economic scenario globally, however given the trends observed in the increase in FX Reserves it is expected to improve in 2012-13. The Government of India needs to have re-look at the FX Reserve Policy both from the perspective of putting the excessive reserve to productive use and by allowing the exchange rate to float freely and appreciate given strong currents of deprecation of the US dollar, Euro and Great Brittan Pound, which are the major currencies in the basket of currencies in-accordance with trade balances.

It is interesting to note the way India has dynamically adapted itself to a multi-party coalition government system. This is critical to mention as the growth wheel is beyond control of any one or group of political parties. This is clearly visible from the way the economic growth and financial development of the India in the last 15 years has emerged being extensively independent to Political reign. The difference being observed is that the factors identified in the five year rolling plan get different weight-age (priority) through investment and governmental focus, however all factors are to go hand-in-hand not changing the composition of the wheel for growth and success. This trend de-linking politics from stock market has been observed post 2008. The market movements of sensex (BSE Sensex / NSE Nifty-Fifty) and the different sectoral sensex (in all exchanges throughout India) are not guided by the discussion/decision undertaken at the parliament in sessions or political announcements made from time to time. BSE which has over 100 years of history (since 1873), used to always have it sensex have sharp moves in-accordance with the Parliamentary Sessions and Political waves till 2008. The role of international corporations interlocking their subsidiary units on the exchange and the FII investments have helped the stock exchanges mature and develop independent structures. One must not forget that unlike US and European Markets, the wealth invested in Indian Stock Markets is less than 8% of the total wealth of the nation and its people. This provides for various core sectors like agriculture, manufacturing, services and others to serve as the main engines for economic growth and financial development of India.

India’s Agriculture sector engages over 70% of India’s population. This has had fall to 68% in 2006 from 75% in the 1980s and is again observing a return. Agriculture is the prime sector which is the feeder industry for all other sectors of the Indian Economy. Agriculturalists in India lacked financial support and financing mechanism from 1970 to 1998 despite extensive growth in agro-technology and creation of Kisan Credit Card (an outfall of suggestion and research proposals made by IIF in 1997-1998). This has served to be a blessing in disguise. Indian agriculture remained organic and is looking forward to the 2^nd Green Revolution. This has helped India reduce risk of Food Security, create extensive buffers, provide food grains to the neighbouring countries in times of troubles and emerge as one key economic supplier of organic food to the world (especially Europe). Manufacturing has been weak and needs to be strengthened. There has been extensive protection given by the government, which has been on a down turn for last 2 decades with phased reduction in subsidies/tax benefits. Hence there is the transformation of the manufacturing sector using global markets to factor low cost of production for servicing the needs of Indian and Global markets. The PPP model (Government Partnership providing fund/support ; Foreign Partner providing finances/know-how and Indian Local Partner putting project on ground with additional financial support from local markets/banks) has started to reap fruits in the last decade. However the growth in manufacturing is tremendously slow due to very little support from the banking and financial industry being conservative. The Service’s sector figuratively has grown from mere 5% in 1970s to over 50% in 2000s (59% in 2011-12). The growth must not be confused with real growth in service sector. The sharp shift has been due to re-allocation of sectors within the agro based/manufacturing industry moving themselves to Service’s sector which enjoy special tax facilities/rebates. A large proportion of the service sector contribution is mere shift of labels quantifying industries/sectors as services (earlier in agriculture or manufacturing). Most developed economies have a service sector contribution to the tune of 75%-80% of GDP. There is still a huge buffer of over 30% growth in services sector to optimize growth potential given global trends and India’s potential (natural resources and human capital).

The Fiscal position has drawn special attention of the Industry, Governments and International Agencies. The level of 5.9% Fiscal deficit for 2011-12 has been a matter of concern when one looks at developed economies. The UPA alliance government had taken a Fiscal regime from NDA led government of about 11% (combined centre & state as per IMF definition), which was henceforth reduced to 4% by 2007-08. One must not forget that India is still an emerging economy with low base strands in key sectors of the economy with dire requirements of huge investment both by government and industry to fulfil basic needs of large population of India. The government though the PPP mode has entailed a large number of mega infrastructure projects (including telecommunications and power) going forth till 2025. The fiscal spending is hence bound to be there. It is not clear though as to the magnitude of Fiscal spending being part of long-term capital growth momentum and that being used to meet current working capital requirements / non-productive wasteful expenditures by the government. It is also interesting to note that the Debt/GDP ratio stands at 63% and the Interest/Budgetary receipts are at 31%, which are important financial measures to be looked upon in light with Fiscal deficit figures.

Conclusion

Given the sheer size, demographic structure and the growth needs of the Indian economy the following rates are comfortable zones for positive growth projections (a) an Inflation rate of 5% – 6% ; (b) a GDP Growth rate of 7.5% ; (c) Savings Rate of 33% – 35% ; (d) M3 Growth of 13% ; (e) Fiscal Deficit of 4.5% within a range of ± 25 basis points; (f) Foreign Exchange Reserves of US$ 200 billion ; (g) FDI flows of US$ 50 billion ; (h) External Debt stock at US$ 300 billion ; (i) Rupee to strengthen given that it is strongly establishing itself as reserve currency in various emerging markets to stabilize around US$ 1 = Rs. 30 through market mechanism ; (j) Agriculture sector to grow by 5% (having potential of over 10%) ; (k) Industry (manufacturing) to grow by 15% ; (l) Services to grow by 20%.

Considering the Political economy, the international and domestic confidence has grown stronger as the wheel of reforms (economic & financial) and growth cannot be channel by change in power with coalition governments in place for over 12 years (post 1998). There certainly has been re-orientation of sector focus, which is given importance due to political alliance / orientation; however the critical components outlined in the Five Year Plans are expected to move forward in an upward direction.

I see India as a baby elephant (over 75% of population being vegetarian, huge size and slow moving aptitude) bulging with energies to swim the tough waters/terrains of global financial turmoil with self sufficiency and deep embedded multi-religious family oriented harmonious democratic structures defining the strength for economic growth and financial development of tomorrow’s Bharat / Hindustan (India).

Jai Hind