BB0029 - Economic reforms process in India

Feb drive 2011

Bachelor of Business Administration-BBA Semester 6

BB0029 - Economic reforms process in India

Subject code – BB0029  (4 credits)

Marks 60

Q.1. What are the different objectives of fiscal policy? Who controls and revises fiscal policy in India?

Ans : Objectives of fiscal policy :

1. Development by effective Mobilisation of Resources:

The principal objective of fiscal policy is to ensure rapid economic growth and development. This objective of economic growth and development can be achieved by Mobilisation of Financial Resources. The central and the state governments in India have used fiscal policy to mobilise resources.

The financial resources can be mobilised by :-

Taxation : Through effective fiscal policies, the government aims to mobilise resources by way of direct taxes as well as indirect taxes because most important source of resource mobilisation in India is taxation.

Public Savings : The resources can be mobilised through public savings by reducing government expenditure and increasing surpluses of public sector enterprises.

2. Efficient allocation of Financial Resources:

The central and state governments have tried to make efficient allocation of financial resources. These resources are allocated for Development Activities which includes expenditure on railways, infrastructure, etc. While Non-development Activities includes expenditure on defence, interest payments, subsidies, etc.

3. Reduction in inequalities of Income and Wealth:

Fiscal policy aims at achieving equity or social justice by reducing income inequalities among different sections of the society. The direct taxes such as income tax are charged more on the rich people as compared to lower income groups. Indirect taxes are also more in the case of semi-luxury and luxury items, which are mostly consumed by the upper middle class and the upper class. The government invests a significant proportion of its tax revenue in the implementation of Poverty Alleviation Programmes to improve the conditions of poor people in society.

4. Price Stability and Control of Inflation:

One of the main objective of fiscal policy is to control inflation and stabilize price. Therefore, the government always aims to control the inflation by Reducing fiscal deficits, introducing tax savings schemes, Productive use of financial resources, etc.

5. Employment Generation:

The government is making every possible effort to increase employment in the country through effective fiscal measure. Investment in infrastructure has resulted in direct and indirect employment. Lower taxes and duties on small-scale industrial (SSI) units encourage more investment and consequently generates more employment. Various rural employment programmes have been undertaken by the Government of India to solve problems in rural areas. Similarly, self employment scheme is taken to provide employment to technically qualified persons in the urban areas.

6. Balanced Regional Development:

Another main objective of the fiscal policy is to bring about a balanced regional development. There are various incentives from the government for setting up projects in backward areas such as Cash subsidy, Concession in taxes and duties in the form of tax holidays, Finance at concessional interest rates, etc.

RBI controls and revise fiscal policy in India.

Q.2. When did the major this reform happened in the last twenty years in India? What were the changes in it?

Ans : India was a latecomer to economic reforms, embarking on the process in earnest only in 1991, in the wake of an exceptionally severe balance of payments crisis. The need for a policy shift had become evident much earlier, as many countries in east Asia achieved high growth and poverty reduction through policies which emphasized greater export orientation and encouragement of the private sector. India took some steps in this direction in the 1980s, but it was not until 1991 that the government signalled a systemic shift to a more open economy with greater reliance upon market forces, a larger role for the private sector including foreign investment, and a restructuring of the role of government.

India’s economic performance in the post-reforms period has many positive features. The average growth rate in the ten year period from 1992-93 to 2001-02 was around 6.0 percent, as shown in Table 1, which puts India among the fastest growing developing countries in the 1990s. This growth record is only slightly better than the annual average of 5.7 percent in the 1980s, but it can be argued that the 1980s growth was unsustainable, fuelled by a buildup of external debt which culminated in the crisis of 1991. In sharp contrast, growth in the 1990s was accompanied by remarkable external stability despite the east Asian crisis. Poverty also declined significantly in the post-reform period, and at a faster rate than in the 1980s according to some studies (as Ravallion and Datt discuss in this issue).

However, the ten-year average growth performance hides the fact that while the economy grew at an impressive 6.7 percent in the first five years after the reforms, it slowed down to 5.4 percent in the next five years. India remained among the fastest growing developing countries in the second sub-period because other developing countries also slowed down after the east Asian crisis, but the annual growth of 5.4 percent was much below the target of 7.5 percent which the government had set for the period. Inevitably, this has led to some questioning about the effectiveness of the reforms.

Opinions on the causes of the growth deceleration vary. World economic growth was slower in the second half of the 1990s and that would have had some dampening effect, but India’s dependence on the world economy is not large enough for this to account for the slowdown. Critics of liberalization have blamed the slowdown on the effect of trade policy reforms on domestic industry (for example, Nambiar et al, 1999; Chaudhuri, 2002).  However, the opposite view is that the slowdown is due not to the effects of reforms, but rather to the failure to implement the reforms effectively. This in turn is often attributed to India’s gradualist approach to reform, which has meant a frustratingly slow pace of implementation. However, even a gradualist pace should be able to achieve significant policy changes over ten years. This paper examines India’s experience with gradualist reforms from this perspective.

Q.3. Briefly discusses the problem of fiscal imbalances.

Ans : Fiscal imbalance :

Fiscal imbalance is a mismatch in the revenue powers and expenditure responsibilities of a government. In the literature on fiscal federalism, two types of fiscal imbalances are measured: Vertical Fiscal Imbalance and Horizontal Fiscal Imbalance. When the fiscal imbalance is measured between the two levels of government (Center and States or Provinces) it is called Vertical Fiscal Imbalance. When the fiscal imbalance is measured between the governments at the same level it is called Horizontal Fiscal imbalance. This imbalance is also known as regional disparity. While Horizontal Fiscal Imbalance requires equalization transfers, Vertical Fiscal Imbalance is a structural issue and thus needs to be corrected by re-assignment of revenue and expenditure responsibilities between the two senior order of the governments.

Problems of Fiscal imbalances :

1. Chronic fiscal imbalances, major systemic financial failure and severe income disparity are seen as top risks for the world economy in the next decade, the World Economic Forum (WEF) said in its Global Risks 2012 report on Wednesday.

2. "Being in the forefront of public debate in recent years, chronic fiscal imbalances and severe income disparity emerged this year as the two most likely economic risks to manifest in the coming 10 years," the WEF said in the report, published in preparation for the annual meeting of business leaders, policymakers and academics at Davos, Switzerland, later this month.

3. The survey found that severe income disparity and chronic fiscal imbalances were the most likely risks to manifest in the next decade while major systemic financial failure received high-impact scores.

4. "The potentially potent combination of chronic labor market imbalances, chronic fiscal imbalances and severe income disparity, when amplified by extreme demographic pressures, could lead to a retrenchment from globalization and the emergence of a new type of critical fragile states – formerly wealthy countries that descend into a spiral of decay as they become increasingly unable to meet their social and fiscal obligations," the report said.

5. In emerging economies, the context and the challenge is different, the report said.

"Rapid economic growth in emerging economies has fuelled an impatient expectation that a rising tide will lift all boats, but social contracts may not be forged quickly enough to rectify increasingly visible economic inequalities and social inequities."

6. Failure to meet demands for civil and political rights could also have harmful consequences, the report said. The report is based on a survey of 469 experts from industry, government, academia and civil society and surveys 50 global risks across five categories: economic, environmental, geopolitical, societal and technological. The survey assesses the perceived impact and likelihood for each risk over a 10-year time horizon using a five-point scale to indicate the severity of impact.

Q.4. When did the second generation reforms start? What are the different charges that were made to it?

Ans :  Second generation reforms :

The term `second generation reform' is being increasingly used in India by ministers, mandarins and the media to refer to a general continuation of the process of economic reform and liberalisation initiated by the Centre at the behest of the International Monetary Fund in the early 1990s.

Second generation reform does, of course, involve a continuation of economic reform as construed by the IMF _ but the term has a set of very specific connotations which, for reasons hinted at but not spelt out in this article, have not been identified as such in public discourse.

The term `second generation reform' was coined by the IMF in the context of the perception by some that the globalisation of the world economy, while benefiting developing countries to a degree with an increase in trade and investment, would also create certain problems of a magnitude sufficient to result in their near or complete marginalisation.

This risk was acknowledged by the fund too inasmuch as it recognised the possibility of globalisation leading to what it referred to as ``bouts of exchange market volatility, the collapse of financial institutions and other financial crises'' as also marginalisation defined as ``a process that threatens to leave behind those countries that fail to harness the forces of globalisation to accelerate economic progress''.

Changes made to it :

The concept of second generation reform was evolved by the IMF to insulate developing countries from marginalisation in the wake of globalisation. According to the fund, globalisation would not only enhance the benefits of sound economic policy but also acerbate the costs of bad policy. Ergo, developing countries should adopt a policy, the effectiveness of which can be tested against the criterion of whether the state is fulfilling ``its proper role in a market economy by creating a level playing field for all sectors and implementing policies for the common good, particularly social policies that will help to alleviate poverty and provide more equal opportunity.''

The IMF intended that second generation reform would supplement basic reform structured on the achievement of balance of payments viability, reduction of government deficits, trade liberalisation and a reduction of the role of the state. As the former IM F Managing Director, Mr. Michel Camdessus, put it, ``we have learned that this first generation reform is not, by itself, enough either to accelerate social progress sufficiently or to allow countries to compete more successfully in global markets.''

Given the ambiguity associated with the term in India, it would be worthwhile to examine second generation reform as described by Mr. Camdessus in somewhat greater detail. In his opening remarks to the IMF conference on second generation reforms held las t November, Mr. Camdessus had pointed out that, for several decades before the 1980s, policy formulation for economic development had proceeded in a rather compartmentalised fashion. Growth was pursued through so-called `development' policies.

Q.5. How are economic reforms and movement of price interrelated?

Ans :  Relation between economic reforms and movement of price :

The Indian economy is the fourth largest economy of the world on the basis of Purchasing Power Parity (PPP). It is one of the most attractive destinations for business and investment opportunities due to huge manpower base, diversified natural resources and strong macro-economic fundamentals. Also, the process of economic reforms initiated since 1991 has been providing an investor-friendly environment through a liberalised policy framework spanning the whole economy.

The growth and performance of the Indian economy in the world market is explained in terms of statistical information provided by the various economic parameters. For example, Gross National Product (GNP), Gross Domestic product (GDP), Net National Product (NNP), per capita income, Gross Domestic Capital Formation (GDCF), etc. are the various indicators relating to the national income sector of the economy. They provide a wide view of the economy including its productive power for satisfaction of human wants.

In the industrial sector, the Index of Industrial Production (IIP) is a single representative figure to measure the general level of industrial activity in the economy. It measures the absolute level and percentage growth of industrial production.

Price movement in the country is reflected by the wholesale price index (WPI) and the consumer price index (CPI). WPI is used to measure the change in the average price level of goods traded in the wholesale market, while the Consumer Price Index (CPI) captures the retail price movement for different sections of consumers. There are at present four consumer price indices covering different socio-economic groups in the economy. These four indices are Consumer Price Index for Industrial Workers (CPI-IW); Consumer Price Index for Agricultural Labourers (CPI-AL); Consumer Price Index for Rural Labourers (CPI -RL) and Consumer Price Index for Urban Non-Manual Employees (CPI-UNME).

All such economic indicators not only measure/analyse the present performance of an economy but also help in predicting and forecasting its future growth prospects.

India’s economic performance in the post-reforms period has many positive features. The average growth rate in the ten year period from 1992-93 to 2001-02 was around 6.0 percent, as shown in Table 1, which puts India among the fastest growing developing countries in the 1990s. This growth record is only slightly better than the annual average of 5.7 percent in the 1980s, but it can be argued that the 1980s growth was unsustainable, fuelled by a buildup of external debt which culminated in the crisis of 1991. In sharp contrast, growth in the 1990s was accompanied by remarkable external stability despite the east Asian crisis. Poverty also declined significantly in the post-reform period, and at a faster rate than in the 1980s according to some studies (as Ravallion and Datt discuss in this issue).

Q.6. Write an essay (around 120 words) on the positive and negative efforts of economic reforms.

Ans : Positive and negative effects of economic reforms :

India’s recent government census data reveals remarkable progress in human development: an increasing literacy rate, reduced population growth, and a declining infant mortality rate throughout the country.

The evidence runs counter to those who argue that India’s growth is only helping the rich, thus widening the poverty gap. The first phase of economic reforms in the 1990s led to an initial spurt in growth of over 7 per cent a year. Continuous reforms in key sectors subsequently increased growth to 8.94 per cent during the later period of 2003-04 to 2007-08, helping to buffer India against the financial crisis. GDP growth declined to 6.7 per cent in 2008-09, but in 2010 the economy revived and the robust 8.9 per cent growth in GDP for the first half of 2010-11 raises the possibility of a faster recovery to pre-crisis levels.

Among the Indian states, the best performer in terms of growth during 2002-2009 was Gujarat, followed by Bihar, Orissa, Haryana and Uttarakhand. The best performer in 2008-09 was Bihar, with a growth rate of 16.59 per cent; the good growth performance of backward states like Bihar and Orissa is helping these states to improve the literacy rate and health indices and reduce poverty.

Economic Reforms are not ends in itself. Its success is appraised on the whetstone of whether it has been able to better the quality of life of the people for whom these reforms are meant. While one school of opinion avers that effects of reforms on the overall population of India will be slow and steady, critics say that reforms have made the rich richer and the poor poorer.

The reforms were launched at a time when in the words of Mr. Manmohan Singh, "it was recognised that the old economic instrument had become instrument of harassment, delay and corruption and had to be changed." Now fifteen years later we have bounced back. We can’t proud of trade reforms, abolition of licensing opening up of industries the private sector and financial reforms. The changes are more perceptible in our urban landscape where owners of two wheelers have switched over to Maruti, Santro, Sumo and Qualis. As sleek cars zip through six lanes and highways a communication revolution has removed the hassles in business and lent more punch in the entertainment world, cellphone, credit cards, internet, email, satellite channels, etc. While the famous D Lake in Kashmir has been lost to terrorists, the loss of Kashmir has bet the gain of Kerala where tourism industry is thriving. There is indeed a change in the mindset. People are willing to tale risk to make money; in other words, there is reward for enterprise. Indie economic reforms have coincided with a technological revolution, too and the small computer is fast changing Indian society. There empowerment for those who dare.