Government intervention

State planning

After independence, India opted to have a centrally planned economy to ensure an effective and equitable allocation of national resources for the purpose of balanced economic development. After liberalisation, the emergence of a market economy with a fast growing private sector, planning has become indicative, rather than prescriptive in nature. The process of formulation and direction of the Five-Year Plans is carried out by the Planning Commission, headed by the Prime Minister of India as its chairperson.

Mixed economy

India is a mixed economy combining features of both capitalist market economies and socialist command economies. Thus, there is a regulated private sector (the regulations have decreased since liberalisation) and a public sector controlled almost entirely by the government. The public sector generally covers areas which are deemed too important or not profitable enough to leave to the instability of capitalistic markets. Thus such services as railways and postal system are carried out by the government.

Since independence, various phases have seen nationalisation of such areas as banking, thus bringing them into the public sector, on one hand, and privatisation of some of the Public Sector Undertakings during the liberalisation period on the other.

Public expenditure

India’s public expenditure is classified as development expenditure, comprising of central plan expenditure and central assistance and non-development expenditures, comprising of capital expenditure and revenue expenditure. Central plan expenditure is money spent on development schemes outlined in the plans of the central government and public sector undertakings, while central assistance refers to financial assistance and developmental loans given for plans of the state governments and union territories.

Non-development capital expenditure comprises of capital defence expenditure, loans to public enterprises, states and union territories and foreign governments, while non-development revenue expenditure comprises revenue defence expenditure, administrative expenditure, subsidies, debt relief to farmers, postal deficit, pensions, social and economic services (education, health, agriculture, science and technology), grants to states and union territories and foreign governments.

India’s non-development revenue expenditure have increased nearly five-fold in 2003-04 since 1990-91 and more than ten-fold since 1985-1986. Interest payments are the single largest item of expenditure and accounted for more than 40% of the total non development expenditure in the 2003-04 budget. Defence expenditure increased four-fold during the same period and has been increasing due to growing tensions in the region, the expensive dispute with Pakistan over Jammu and Kashmir and an effort to modernise the military.

Administrative expenses are compounded by a large salary and pension bill, which rises periodically due to revisions in wages, dearness allowance etc. subsidies on food, fertilisers, education and petroleum and other merit and non-merit subsidies account are not only continuously rising, especially because of rising crude oil and food prices, but are also harder to rein in, because of political compulsions.

Public receipts

India has a three-tier tax structure, wherein the constitution empowers the union government to levy Income tax, tax on capital transactions (wealth tax, inheritance tax, gift tax), sales tax, service tax, customs and excise duties and the state governments to levy sales tax on intra-state sale of goods, tax on entertainment and professions, excise duties on manufacture of alcohol, stamp duties on transfer of property and collect land revenue (levy on land owned).

The local governments are empowered by the state government to levy property tax, Octroi and charge users for public utilities like water supply, sewage etc.[5] More than half of the revenues of the union and state governments come from taxes, of which half come from Indirect taxes. More than a quarter of the union government’s tax revenues is shared with the state governments. [6]

The tax reforms, initiated in 1991, have sought to rationalise the tax structure and increase compliance by taking steps in the following directions:
Reducing the rates of individual and corporate income taxes, excises, customs and making it more progressive
Reducing exemptions and concessions
Simplification of laws and procedures
Introduction of Permanent account number to track monetary transactions
Despite protests from traders, 21 of the 29 states introduced Value added tax (VAT) on April 1, 2005 to replace the complex and multiple sales tax system

The non-tax revenues of the central government come from fiscal services, interest receipts, public sector dividends, etc., while the non-tax revenues of the States are grants from the central government, interest receipts, dividends and income from general, economic and social services.

General budget

The Finance minister of India presents the annual union budget in the Parliament on the last working day of February. The budget has to be passed by the House before it can come into effect on April 1, the start of India’s fiscal year. The Union budget is preceded by an economic survey, which is released on the eve of the budget and outlines the broad direction of the budget and the economic performance of the country for the outgoing financial year.

India’s union budget for 2005-06, had an estimated outlay of Rs.5,14,344 crores (USD 118 billion). Earnings from taxes amount to Rs. 2,73,466 crore (USD 63b). India’s fiscal deficit amounts to 4.5% or 1,39,231 crore (USD 32b).

Currency System

Rupee

The Rupee is the only legal tender accepted in the India and is also accepted as legal tender in neighbouring Nepal and Bhutan, the latter’s currency value being pegged to the rupee.

The rupee is divided into 100 paise. The highest currency note printed is the 1000 rupee note, and the lowest denomination in circulation is the 10 p coin.

For higher numeric figures, India uses its own numbering system of counting in lakhs and crores. A lakh is equal to a hundred thousand, and a crore equal to ten million. The October 2005 exchange rate of about 43.5 to a US dollar, makes a crore (rupees crore) approximately equal to USUSD 230,000.

Exchange rates

Under the fixed exchange rate system, the value of the rupee was linked to the British pound sterling till 1946 and after independence, 30% of India’s foreign trade was to be determined in pound sterling. In 1975, as per the Floating exchange rate system, the value of the rupee was pegged to a basket of currencies and was tightly controlled by the Reserve Bank of India. In recent years its value has depreciated with respect to most currencies with the exception of the US dollar.

Since liberalisation, the rupee is fully convertible on trade and current account. The former has enabled Indian businessmen and workers to convert their earnings abroad into rupee at market rates, while the latter has removed all restrictions on foreign exchange for current business transactions as well as travel, education, medical expenses, etc., India has committed to gradually move towards full convertibility, albeit with some restrictions on capital accounts, in order to encourage two-way flow of capital and investment.

Determinants

Demographics

India, with a population of 1.027 billion people, is the second most populous country in the world, accounting for nearly 17% of the world’s population. Growth rate of population has shown signs of decrease, coming down from a compound annual growth rate of 2.15 (1951-1981) to 1.93 (1991-2001); despite the decrease in the death rates owing to improvements in healthcare.

The large population puts further pressure on infrastructure, social services like education and has magnified socio-economic problems like unemployment, illiteracy, etc. A positive factor has been the large working age population, which forms 58.2% of the total population, which is expected to substantially increase, because of the decrease in dependency ratio. Increased literacy, better healthcare and self-sufficiency in food production since independence, have ensured that a large population has not caused any serious problems.

Geography and natural resources

India’s geography ranges from mountain ranges to deserts, plains, hills and plateaus, while its climate varies from tropical in the south to a more temperate climate in the north. India’s total cultivable area is 1,269,219 km² (56.78% of total land area), which is decreasing due to constant pressure from an ever growing population and increased urbanisation.

India has a total water surface area of 314,400 km² and receives an average annual rainfall of 1,100 mm. Irrigation accounts for 92% of the water utilisation, and comprised 380 km² in 1974, and is expected to rise to 1,050 km² by 2025, with the balance accounted for by industrial and domestic consumers. India’s inland water resources comprising rivers, canals, ponds and lakes and marine resources comprising the east and west coasts of the Indian ocean and other gulfs and bays provide employment to nearly 6 million people in the fisheries sector. India is the sixth largest producer of fish in the world and second largest in inland fish production.

India’s major mineral resources include Coal (fourth-largest reserves in the world), Iron ore, Manganese, Mica, Bauxite, Titanium ore, Chromite, Natural gas, Diamonds, Petroleum, Limestone and Thorium (world’s largest along Kerala’s shores). India’s oil reserves, found in Bombay High off the coast of Maharashtra, Gujarat, and in eastern Assam meet 25% of the country’s demand.

Physical infrastructure

Since independence, India has allocated nearly half of the total outlay of the five-year plans for infrastructural development. Much of the total outlay was spent on large projects in the area of irrigation, energy, transport, communications and social overheads. Development of infrastructure was completely in the hands of the public sector and was plagued by corruption, inefficiencies, urban-bias and an inability to scale investment.

India’s low spending on power, construction, transportation, telecommunications and real estate, at USD 31 billion or 6% of GDP, compared to China’s spending of USD 260 billion or 20% of its GDP in 2002 has prevented India from sustaining a growth rate of around 8%. This has prompted the government from opening up infrastructure to the private sector and allowing foreign investment.

Politics

India, a federal republic, has had stable democratic governments since independence. Politics is dominated by the centre-left Indian National Congress (INC), the right-wing Bharatiya Janata Party (BJP), the left-wing Communist Party of India (CPI) and CPI (Marxist) and various regional parties, which are either centre-right or centre-left. Despite the varied political spectrums they occupy, the necessity of forming coalitions for government formation, the growing middle class that generally favours liberalisation and tightening fiscal deficits, especially at the state levels, has meant that all political parties adopt a moderate view towards economic reforms.

Financial institutions

At the time of Independence, India inherited several institutions like the civil services, central bank, railways, etc., from her British rulers. Mumbai serves as the nation’s commercial capital, with the Reserve Bank of India (RBI), Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) located here. The headquarters of many financial institutions are also located within the city.

The RBI, the country’s central bank was established on 1935-04-01. It serves as the nation’s monetary authority, regulator and supervisor of the financial system, manager of exchange control and as an issuer of currency. The RBI is governed by a central board, headed by a governor who is appointed by the Central government of India.

The BSE Sensex or the BSE Sensitive Index is a value-weighted index composed of 30 companies with April 1979 as the base year (100). These companies have the largest and most actively traded stocks and are representative of various sectors, on the Exchange. They account for around one-fifth of the market capitalisation of the BSE.

The Sensex is generally regarded as the most popular and precise barometer of the Indian stock markets. Incorporated in 1992, the National Stock Exchange is one of the largest and most advanced stock markets in India. The NSE is the world’s third largest stock exchange in terms of transactions. There are a total of 23 stock exchanges in India, but the BSE and NSE comprise 83% of the volumes. The Securities and Exchange Board of India (SEBI), established in 1992, regulates the stock markets and other securities markets of the country.

Sectors

Agriculture

Agriculture and allied sectors like forestry, logging and fishing accounted for 25% of the GDP, employed 57% of the total workforce in 1999-2000 and despite a steady decline of its share in the GDP, is still the largest economic sector and plays a significant role in the overall socio-economic development of India.

Yields per unit area of all crops have grown since 1950, due to the special emphasis placed on agriculture in the five-year plans and steady improvements in irrigation, technology, application of modern agricultural practices and provision of agricultural credit and subsidies since the green revolution. However, international comparisons reveal that the average yield in India is generally 30% to 50% of the highest average yield in the world.

The low productivity in India is a result of the following factors:
Illiteracy, general socio-economic backwardness, slow progress in implementing land reforms and inadequate or inefficient finance and marketing services for farm produce.
The average size of land holdings is very small (less than 20,000 m²) and are subject to fragmentation, due to land ceiling acts and in some cases, family disputes. Such small holdings are often over-manned, resulting in disguised unemployment and low productivity of labour.
Adoption of modern agricultural practices and use of technology is inadequate, hampered by ignorance of such practices, high costs and impracticality in the case of small land holdings.
Irrigation facilities are inadequate, as revealed by the fact that only 53.6% of the land was irrigated in 2000-01 , which result in farmers still being dependent on rainfall, specifically the Monsoon season. A good monsoon results in a robust growth for the economy as a whole, while a poor monsoon leads to a sluggish growth.

Industry

Concerted efforts at industrialisation by the government, aiming at self-sufficiency in production and protection from foreign competition, for nearly four decades since independence, have encouraged a broad industrial base, both in the public and private sectors. They together account for 28.4% of the GDP and employ 17% of the total workforce. Economic reforms bought foreign competition, led to privatisation of certain public sector firms, opened up sectors hitherto reserved for the public sector and the small scale sector and led to an expansion in the production of durable consumer goods.

Post-liberalisation, the Indian private sector, which was usually run by old family firms and required political connections to prosper was faced with foreign competition and the threat of cheap Chinese imports. It has, since handled the change by squeezing costs, revamping management, focusing on designing new products and relying on low labour costs and technology.

Services

The service sector, providing employment to 23% of the work force, is the fastest growing sector, with a growth rate of 7.5% in 1991-2000 up from 4.5% in 1951-80. It has the largest share in the GDP, accounting for 48% in 2000 up from 15% in 1950. Business services (including information technology (IT) and IT enabled services), communication services, financial services, hotels and restaurants, community services and trade (distribution) services are among the fastest growing sectors contributing to one third of the total output of services in 2000.

The growth in the service sector is attributed to increased specialisation, availability of a large population of highly-educated and fluent English-speaking workers on the supply side and on the demand side, increased demand from domestic consumers resulting from growth in personal incomes and from foreign consumers interested in India’s service exports or those looking to outsource their operations. India’s IT industry, despite contributing significantly to its balance of payments, accounted for only about 1% of the total GDP or 1/50th of the total services.

Banking and finance

The Indian money market is classified into: the organised sector (comprising private, public and foreign owned commercial banks and cooperative banks, together known as scheduled banks); and the unorganised sector (comprising individual or family owned indigenous bankers or money lenders and non-banking financial companies (NBFCs)). The unorganised sector and microcredit are still preferred over traditional banks in rural and sub-urban areas, especially for non-productive purposes, like ceremonies and short duration loans.

Indira Gandhi nationalised 14 banks in 1969, followed by seven others in 1980 and made it mandatory for banks to provide 40% (since reduced to 10%) of their net credit to priority sectors like agriculture, small-scale industry, retail trade, small businesses, etc. to ensure that the banks fulfil their social and developmental goals.

Since then, the number of bank branches have increased from 10,120 in 1969 to 98,910 in 2003 and the population covered by a branch decreased from 63,800 to 15,000 during the same period. The total deposits increased 32.6 times between 1971 to 1991 compared to 7 times between 1951 to 1971. Despite an increase of rural branches, from 1,860 or 22% of the total number of branches in 1969 to 32,270 or 48%, only 32,270 out of 5 lakh (500,000) villages are covered by a scheduled bank.

Since liberalisation, the government has approved significant banking reforms. While some of these relate to nationalised banks (like encouraging mergers, reducing government interference and increasing profitability and competitiveness), other reforms have opened up the banking and insurance sectors to private and foreign players.

Socio-economic characteristics

Poverty

The National sample survey organisation (NSSO) estimated that 26.1% of the population was living below the poverty line in 1999-2000, down from 51.3% in 1977-1978. The criterion used was monthly consumption of goods below Rs. 211.30 for rural areas and Rs. 454.11 for urban areas. 75% of the poor are in rural areas (27.1% of the total rural population) with most of them comprising daily wagers, self-employed households and landless labourers. The major causes for poverty are unemployment or under-employment, low ownership of assets (especially productive assets like land and farm equipment) and illiteracy.

Since the early 1950s, successive governments have implemented various schemes, under planning, to alleviate poverty, that have met with partial success. All those programs have improved upon the strategies of the Food for work programme and National Rural Employment Programme of the 1980s, which attempted to use the unemployed to generate productive assets and build rural infrastructure.

In August 2005, the Indian parliament passed the Rural Employment Guarantee Bill, the largest programme of this type, in terms of cost and coverage, which promises 100 days of minimum wage employment to every rural household in 200 of India’s 600-odd districts. The question of whether economic reforms has reduced or increased poverty has fuelled debates without generating any clear cut answers and has also put political pressure on further economic reforms, especially those involving downsizing of labour and cutting down agricultural subsidies.

Corruption

Corruption has been one of the pervasive problems affecting India, along with many developing countries, which has taken the form of bribes, evasion of tax and exchange controls, embezzlement, etc. The economic reforms of 1991 reduced the red tape, bureaucracy and the Licence Raj that had strangled private enterprise and was blamed for the corruption and inefficiencies. Yet, a 2005 study by Transparency International (TI) India found that more than half of those surveyed had firsthand experience of paying bribe or peddling influence to get a job done in a public office.

The chief economic consequences of corruption are the loss to the exchequer, an unhealthy climate for investment and an increase in the cost of government-subsidised services. The TI India study estimates the monetary value of petty corruption in 11 basic services provided by the government, like education, healthcare, judiciary, police, etc., to be around Rs.21,068 crores. India still ranks in the bottom quartile of developing nations in terms of the ease of doing business, and compared to China, the average time taken to secure the clearances for a startup or to invoke bankruptcy is much greater.

The Right to Information Act (2005) and equivalent acts in the states, that require government officials to furnish information requested by citizens or face punitive action, computerisation of services and various central and state government acts that established vigilance commissions have considerably reduced corruption or at least have opened up avenues to redress grievances. [8]

Occupations and unemployment

Agricultural and allied sectors accounted for about 57% of the total workforce in 1999-2000, down from 60% in 1993-94. While agriculture has faced stagnation in growth, services have seen a steady growth. Of the total workforce, 8% is in the organised sector, two-thirds of which are in the public sector. The NSSO survey estimated that in 1999-2000, 106 million, nearly 10% of the population were unemployed and the overall unemployment rate was 7.32%, with rural areas doing marginally better (7.21%) than urban areas (7.65%).

Unemployment in India, like most other developing countries, is characterised by chronic underemployment or disguised unemployment. Government schemes that target eradication of both poverty and unemployment, attempt to solve the problem, by providing financial assistance for setting up businesses, skill honing, setting up public sector enterprises, reservations in governments, etc. The decreased role of the public sector after liberalisation has further undermined the need for focusing on better education and has also put political pressure on further reforms.

Regional imbalance

One of the critical problems facing India’s economy is the sharp and growing regional variations among India’s different states and territories in terms of per capita income, poverty, availability of infrastructure and socio-economic development. For instance, the difference in growth rate between the forward and backward states was 0.3% (5.2% and 4.9%) during 1980-81 to 1990-91, but had grown to 3.3% (6.3% and 3.0%) during 1990-91 to 1997-98.

The five-year plans have attempted to reduce regional disparities by sanctioning industrial development in the interior regions, but industries still tend to concentrate around urban areas and port cities. Even the industrial townships in the interiors, Bhilai for instance, resulted in very little development in the surrounding areas. After liberalisation, the disparities have grown despite the efforts of the union government in reducing them.

Part of the reason being, manufacturing and services and not agriculture are the engines of growth, in which the forward states are better placed, with infrastructure like well developed ports, urbanisation and an educated and skilled workforce which attract manufacturing and service sectors. The union and state governments of backward regions are trying to reduce the disparities by offering tax holidays, cheap land, etc., and focusing more on sectors like tourism, which although being geographically and historically determined, can become a source of growth and is faster to develop than other sectors.

External trade and investment

Global trade relations

Until the liberalisation of 1991, India was largely and intentionally isolated from the world markets in order to protect its fledging economy and achieve self-reliance. Foreign trade was subject to import tariffs, export taxes and quantitative restrictions, while foreign direct investment was restricted by upper limit equity participation, requirements on technology transfer, export obligations and government approvals, which were needed for nearly 60% of new FDI in the industrial sector. These restrictions ensured that FDI averaged only around USD 200 million annually between 1985-1991 and a large percentage of the capital flows consisted of foreign aid, commercial borrowing and deposits of non-resident Indians.

India’s exports were stagnant for the first 15 years, due to the predominance of tea, jute and cotton manufactures, whose demand were generally inelastic. Imports in the same period consisted predominantly of machinery, equipment and raw materials due to the nascent industrialisation. Post-liberalisation, the value of India’s international trade has become more broad based and gone up to Rs. 63,080,109 crores in 2003-04 from Rs.1,250 crores in 1950-51. India’s major trading partners are China, United States, UAE, UK, Japan and the European Union.

India is a founder-member of General Agreement on Tariffs and Trade (GATT) since 1947 and its successor, the World Trade Organization since its inception. While participating actively in its general council meetings, India has been crucial in voicing the concerns of the developing world. For instance, India has continued its opposition to the inclusion of such matters as labour and environment issues and other non-tariff barriers into the WTO policies.

Balance of payments

Since independence, India’s balance of payments on current account has been negative for most of the years, owing to a larger share of imports vis-a-vis exports. Since liberalisation, incidentally precipitated by a balance of payment crisis, India’s exports have been consistently rising, covering 80.3% of India’s imports in 2002-03, up from 66.2% in 1990-91.

Although India is still a net importer, since 1996-1997, India’s overall balance of payments (current account balance + capital account balance) has been positive, largely on account of increased foreign direct investment and deposits from non-resident Indians, which until then, was occasionally positive on account of external assistance and commercial borrowings. As a result, India’s foreign currency reserves stood 141 billion USD as on 2005-2006.

India’s reliance on external assistance and commercial borrowings has decreased since 1991-1992 and since 2002-2003, it has been repaying them. Declining interest rates and reduced borrowings have decreased India’s debt service ratio to 14.1% in 2001-02 from 35.3% in 1990-91.