India’s Dream Run and Decline:

2003-08 and 2009-15

 India’s Dream Run 2003-08
• 2003-08 Indian economy began experiencing an
acceleration in growth from 5.6 to 6.5 % and to
9.1 % growth rate by 2008. It became second
fastest growing economy after China.
• From 2009-10 onwards the growth rate fell back
to 8 to 7 to 6.5 to 5.4 percent in 2015. After
revising estimation methodology, it is 6.5% for
2014-15.
• What enabled this acceleration? Why did it
decline? Do we have any again on a sustainable
basis?
• The dream run was a (private) corporate debt-led
growth that until the 2008 crisis tapped into an
exceptional rise in the world trade.
• Unlike the conventional consumption-led boom and-
bust cycles, this one was led by investment financed by
domestic savings, boosted by an unprecedented influx
of foreign private capital.
• The investment-saving gap rose to 2.3% of GDP by
2008.
• Total private capital inflows rose to a phenomenal level
of nearly 10% of GDP by 2007-08, raised corporate
debt sharply, and also perhaps contributed to a steep
rise in stock and real estate (asset) prices.
• After the 2008 Financial Crisis, export growth has
collapsed, and corporate investment demand has
contracted under adverse macroeconomic stress.
Hence, output growth has decelerated.
 Initial Conditions 2003
• After 1999 getting over Y2k fear and a dot com bubble busted, US
companies began outsourcing business process activity, India took
advantage of prior investment in IT sector.
• South Korean and Japanese capital after the 1996 Asian crisis began looking
for opportunities to migrate. Thus automobile-consumer goods-IT
opportunities began bringing massive foreign capital flows into in India.
• High interest rates in India began attracting Foreign Commercial Credit
Bonds (FCCBs).
• Further, Chidambaram the FM, in 2004 abolished the capital gains tax for
equities and extended it foreign institutional investment holding more than
365 days. This further brought FII inflows forming 30 % of FDI. About 30 % of
FDI has come to takeover Indian capital, for example Vodaphone. FDI formed
10% of GDP in 2008.
• RBI reduced the interest rates and expanded credit against the accumulated
foreign exchange reserves. Consequently, money supply expanded at an
unprecedented rate of 23 %.
• 43% of the bank credit has gone into infrastructure, namely national
highways, airports and telecommunications.
• Thus the exceptional credit boom financed the investment.
• Yet, in all in all, it was a dramatic turn around.
• The period 2003-08 was a blessing for India. World Trade dramatically
increased by 16.5 %. Indian exports also grew by 22%.
• has begun outsourcing services to India, IT sector began growing at 35% per
annum.
• Global capital started flowing into India attracted by High interest rates ,
pertinently after the busting of East Asian boom, zero % interest in Japan and
low interest rates in US.
• In 2004 Budget, Chidambaram changed the definition of FDI, even those less
than 10% fixed capital is recognized. This made virtually no difference
between FDI and FII which is the short term capital inflow into equity markets.
• Further in 2005 Chidambaram allowed Participatory Notes, which do not need
to disclose their location of origin, encouraging lot of hot money. This led to
huge rise in `round-tripping’ of capital through Mauritius.
• Further in 2005, Capital Gains tax is abolished on earnings from equity, which
made the FII un-taxable, which further lifted the flood gates. India
accumulated foreign exchange reserves crossing $330 billions by 2007-08,
much of these have come as a part of capital flows rather than current
account surpluses.
 Investment-led?
• India recorded a high growth since 2003-04 until 2007-08
averaged at 8.8 percent, a clear acceleration compared to 5.4 %
during 1998-03.
• This transition is accompanied by a dramatic rise in investment –
GDP ratio, which has increased from 25-26 % during 1990s to a
whopping 38.73 % during 2007-08.
• Studies conducted on TFPG suggest that there was no palpable
rise in total factor productivity during 1991-04. But during 2004-
08, studies have shown an improvement.
• However, even though productivity has marginally supported the
growth, it is largely investment-driven.
• Besides this, it is not matched by employment and
commensurate growth in consumption.
 TFPG estimates
1950-66 1967-80 1981-90 1991-00 2000-08
1.Acharya (2003)
GDP 3.8 3.4 5.3 6.5 7.5
TFPG 1.4 0.7 2.0 2.6 3.5
%of GDP due to TFPG 38 21 38 40

2.B.Veeramani
NDP/Worker 1.3 2.4

%NDP due to TFPG 54 69

3. V.Goldar (2005) TFPG 2.14 1.88
4. Kaur and Kiran (2005) 1.53 0.44
5. Boseworth Collin

TFPG 0.7 -0.5 2.5 1.6

Rodriks and Subramaniam 1.2 05 2.9 2.4
 FDI Inflows in India in Post Reform Era

FDI (Crores)

200000

180000

160000

140000

120000

100000

80000

60000

40000

20000

FDI (Crores)
 % of GFCF
10.00

9.00

8.00

7.00

6.00

5.00

4.00

3.00

2.00

1.00

0.00

% of GFCF
• As a result, FDI started rolling into India, fro. $200 billion in 2003
they increased to $ 600 billion in 2007.
• This has begun pushing the investment-saving gap by 2.3%. FDI
contributed 8% of total GCFC in 2008.
• Overall investment rate is pushed from 27% in 2003 to 36% in
2008, pushing the growth rate to 9%.
• The domestic corporate investment has complimented the FDI
and increased to 22%.
• Both service sector and the manufacturing sector rose at 10 % per
annum during the period.
• on a closer look the bulk of the incremental output came from
a few narrowly defined industries and services, like the
automotive industry, and telecoms and business services in
the tertiary sector
• The boom has two dimensions, real and financial.
• In the real sector, the boom was not a wide in its base.
Registered manufacturing sector increased its share,
reducing the informal sector.
• Within, manufacturing, growth concentrated in
automobiles, consumer durables. Capital goods sector
declined.
• The highest growth is recorded in infrastructural sector.
Power sector improved in capacity, yet did not reverse
it’s the over decline. High ways has increased, rural
connectivity did not improve.
• Telecommunications grew fastest among the
infrastructure, besides the airports.
• Finally, construction sector became the third source of
growth with real sector recording high growth.
• Yet, organized sector employment declined
during this phase by 3.7 million. Thus job-less
growth became the feature of this growth model.
• Consumption is largely aided by bank credit,
through house loans, car loans etc.
• Capital markets surged forward, 30% of FDI in the
form of FII have boosted the sector.
• Only 40 % of FDI remained direct, while the rest
of 30% came in for mergers and takeovers and
external commercial borrowings.
• About 10 business houses like Adani, Ambani,
GMR, GVK, Vedanta, JAYPEE, Essar and Lanco
emerged as major beneficiaries of corporate
debt, who borrowed about Rs.8 lakh crores.
• This was financed majorly by the pushing the credit by
the banking sector and rest in the capital markets. RBI
has pushed the money supply at an annual rate of 24-
26% against the FDI back up.
• The credit was also directed to infrastructural areas,
namely, real estate (24%), automobiles (9%), telecom
(42%), national highways (11%), power sector 8 %,
ports (3%).
• Housing loans, car loans, consumer loans and credit
card loans marked the bank credit profile.
• The real estate boom led the high growth story from
domestic side.
• A notable feature of the investment is that 31.9 % is contributed by
private corporate sector on a 4-year av, 40% in 2007-08. This growth of
private corporate investment is significantly high compared to the low
levels during 1999-03.
• This rapid growth of corporate investment is clearly an important
component of the story of high growth to term this as an investment-led
growth.
• But this rapid investment in corporate sector did not produce
commensurate output or employment. The share of organised
manufacturing remained 7.67 % of GDP during 2002-08, which has 29%
of capital stock. The capital-output ratios also increased to 7.75 during
2004-08.
• The total employment is in organised manufacturing has declined from
63.33 lakhs to 58.37 lakhs during 1991-2007.
• In the organised sector, The public sector employment is reduced from
18.52 to 10.87 lakhs and private sector employment has gone up only
from 44.81 to 47.5 lakhs.
• The private final consumption expenditure (PFCF) declined from 49.72 %
to 48.52% during 2005-08. Where as Gross Fixed Capital Formation has
increased from 34.29 % to 42-44% during 2003-08. So this is clearly
shows that it is the investment that caused the growth not so much the
consumption. Lets see the table
• As said earlier, the growth in India in this phase is solely
driven by investment. Problem is when it is concentrated in
few sectors, not spread, not contributed to employment, then
the growth would hit the demand constraint.
• If the investment is accompanied by productivity growth, then
it can reduce cost of production and productivity thus sustain
the profitability.
• The various studies on industry have shown that not much
progress is made on the productivity front.
• By 2008, world trade collapsed to 3.5 % and Indian exports fell
to 14 %, leading to rising current account deficit and
depreciation of Indian rupee and inflation. This has stopped
the FDI inflows since 2009.
• Corporate savings fell to 17% and overall saving rate fell to
27%.
 Fall outs
• For 2008-10 growth was maintained at 6-7 % through waiving excise
duties amounting Rs.7 lakh crores, resulting high Fiscal deficit of 5.5%.
• After the Financial Crisis of 2008, the world trade began shrinking,
India’s exports fell rapidly, while imports continued to be high. Oil
prices went up record high in 2010 to $120.
• India’s imports began surging on three counts, namely, crude oil,
electronic goods and gold imports.
• This led to CAD to reach a record level of 6.5%. (Rangarajan Committee
suggested a CAD target of 2%).
• Moody’s downgraded India’s credit rating and there was a massive
outflow of capital flows, rupee depreciated by 16% during.
• Inflation rates soared to 7.5% during 2011-12, on account of rising
crude prices and also on account of rise in prices of proteins (meat and
pulses). RBI responded with an increase in the repo rate.
• Infrastructural lending went into trouble, as companies inflated costs of
construction, and defaulted. The NPAs have increased to Rs.8 lakh
crores currently.
• Additionally, speculative sentiments spilled into the real
estate sector, given the housing loan drive, created a
construction boom. Construction was in fact the fastest
growing segment, at 14% of the industrial sector in this
period.
• In fact entire increase in the capital formation in the
household sector is accounted by the construction.
• Apart from its direct effect on investment, demand for several
industries also grew.
• As a result of high growth, government revenues too rose;
corporate profit share has increased from 1.9 to 3.9 % of GDP.
Fiscal deficit too grew due to faster growth in expenditure.
This reinforced the demand without making the financial
markets too nervous.
• Credit-GDP ratio has increased from 55 to 65 %.
• Lending to infrastructure industry increased from 2% to 32
%. This is abnormal as return on infrastructure is low, and
capital gets locked up. But sudden entry is due, lending has
gone to telecom, highways, aviation.
• It is PSU banks who did infrastructure lending, state pushed
PSU banks to this despite high degree of high risk and low
return.
• Tarapore said India is sitting on one billion subprime.
• In the downturn, banking is going to be hit badly. Kingfisher
is given a rescheduled loan, restructured assets of PSUs
have gone up from 2 to 4%, but now when NPAs are
restructured, there is going to be inevitable squeeze on
credit and which in turn affects growth.
• Hence only way out is more reforms and more FDI, banks to
be pushed further on the same basis.
• What went wrong is not acknowledged.
 Conclusions
• Economic Reforms has changed the distributional
character of the economy, but has not kept the
economy on any sustainable radical growth path.
• The acceleration of growth was based on
investment-led, FDI dependent growth rate,
unaccompanied by employment, private
consumption and productivity.
• Further, banking sector is likely causality with
increased NPAs, which are about 8% of GDP. Any
liquidation of these or other corporate debt is
likely to cause detrimental effects on growth,
thus making the future not very optimistic.
 Readings:

– Peter Robertson (2010) EPW, Oct 2, Vol. 40

`Investment-led growth: Fact or Myth’.
– R Nagaraj (2015) `End of the Dream Run 2003-08:
in Economic Growth and Distribution in India,
edited by Pulapre Balakrishnan, OUP, New Delhi.
Economic Development and
Strategy of Planning in India
 India’s Course of Development
• India was first country that became independent at the
same time embraced liberal democracy with capitalism,
among the post-colonial countries.
• India was fledgling capitalism with retarded development
under colonial rule. Anti-colonial nationalism was
ideological foundation.
• 1930 World Depression has eroded the credibility of
capitalism. The two world wars that were fought for
supremacy among imperialist countries made capitalism go
on back foot.
• The intense workers struggles the Europe and rise of social
democracy forced capitalists to offer concessions.
• The meteoric rise of Soviet Union with in a span of 15 years
gave hope for an alternative system to capitalism.
 Conceptual Shifts in Theory
• Adam Smith recognized the features of capitalist system.
• Ricardo, an ardent supporter of capitalist system, was worried over the
prospect of falling rate of profits, due to conflict between rent versus
profit.
• Marx, a critique of the capitalist system, speculated the prospect of
falling rate of profit due contradictions in the systems of surplus
expropriation and systems of profit realization.
• Several other Marxists have developed various other theories of crisis
such as over production, underconsumption, disproportionality,
overaccumulation.
• The liberal theory denied any such possibilities of crisis in the capitalist
system.
• W.W.Rostow contemplated a historical transition to capitalism.
• Simon Kuznets proposed that capitalist transformation involves a rise
in share of manufacturing and service sectors in income as well as
employment; an initial rise in inequality and a gradual decline later on.
 Global Conditions in early 20th Century
• The two world wars, besides having political reasons
such as competing Nationalisms, the failure of Gold
Standard as an international monetary mechanism, in
consequent imperialist wars for colonies discredited
capitalism as a model.
• The impressive rise of Soviet Union, which escaped `
World Depression’, from a backward country to a
superpower, made socialism, role of state and planning
as popular institutions and strategies for rapid
development.
• Keynesian economics highlighted the role of state and
need to maintain full employment through the latter in
any capitalist economy.
• Planning was also adopted during the post-war
reconstruction in Europe.
 Development Economics
• Development Economics further envisaged new paths to
rapid development through industrialisation.
• Rosenstein Rodan –emphasized the need for a strong
starting up of range of industries (Big Push)
• Ragnar Nurkse emphasized the need to identify minimum
doses of investment to push the economy out of the vicious
cycle.
• Hirschman emphasised identification of those sectors
which have maximum forward and backward linkages
(unbalanced growth).
• Jan Myrdal cautions through his model of `backwash
effects’ for a regionally equitable growth.
• Latin American Structuralists emphasised the need for
Import-Substitution Strategy against Export-led one.
• 19th Century experience taught self-reliance as moral
objective.
 Lewis Model of Growth with Unlimited
Supplies of Surplus Labour
• The celebrated Lewis model envisaged that the
investment in the modern (manufacturing +
Service) sector would set automatic mechanism
of growth and transformation.
• The surplus labour in agriculture would get
attracted to the high productive-high wage
modern sector, without diminishing agricultural
output (hence no inflation), it ensures a constant
wage, which assures a +ve profit and
accumulation. Thus the model showed the
possibilities of growth and transformation.
 W
Lewis Model
C

A
MPP

W2

B D
W1

Y1 Y
Y2
 Political Precursors to Planning in India
• In 1936 Avadi Congress adopted Planned Strategy and
appointed Jawaharlal Nehru as the first Chairman.
• In 1947 a group of 21 leading businessmen in India,
toured USA and submitted their plan called `Bombay
Plan’ that gave the responsibility of building
infrastructure to state and rest to the capitalist sector.
• Communist leader M.N Roy prepared a `People’s Plan’ of
socialist society that involved redistribution of land and
progressive nationalisation of all industries.
• Gandhians came up with a `Gandhian Plan’ with a focus
on village development.
• Thus planning as a strategy was an accepted tool and
there was a total consensus.
Indian Economy: Phases of Regimes
1. 1950-65 : Planning, Abolition of Intermediaries
2. 1965-80 : Mid-Sixties Industrial Stagnation,
Green Revolution
3. 1981-91: Partial Liberalisation and Growth
Acceleration and 1991 BoP Crisis
4. 1991-2003: Liberalisation, Structural
Adjustment, Privatisation
5. 2004-15: FDI Inflow, High Growth, Global
Recession, and Decline of High Growth
 1950-65 Phase
• A Planning Commission was made as an advisory body with
Prime Minister as Chairperson and Prof Mahalonabis, the
legendary statistician, physicist and poet as vice chairman.
• Five Year is accepted time frame for each Plan, where the
Plan is essentially a tool to allocate the financial resources
pooled from state revenues and the banking system.
• The allocation is based on formula of the technical growth
model, which uses the input-output economy-wide table as
the basic tool.
• Input-output table is a matrix of input-output coefficients
called technical coefficients that indicate the requirement the
portion of each input needed to go into every output. With
the matrix we can estimate the intermediate demand and
final demand (based the aggregate output projected).
• The limitation of the input-output technique is that the tables
are made only once in a decade and projections are subject to
the deviation from the actual due to technical change.
 Goals of Planning
• To accelerate rate of growth (to 5%).
• To achieve self-reliance in major areas of
industrial and agricultural production (Import-
Substitution Strategy).
• To accomplish rapid industrialisation.
• To eradicate mass poverty and unemployment
(Social justice and regional development).
• To achieve structural transformation.
 Second Plan: Mahalonabis Model
• Prasanta Chandra Mahalonabis was a legendary
statistician and anthropo-metrician, known for
`Mahalanobis Distance’ , `cropping cutting
method’ and famous `salt solution.’
• He set up the Indian Statistical Institute, is
considered as the father of Indian planning.
• He made the technical growth model for The
Second Five Year Plan.
 The Mahalanobis Model:
Heavy Industry Strategy
• The model imagines two sectors in the
economy, namely, capital goods sector (i) and
consumer goods sector (c); former with lower
ICOR but with a longer gestation.
• A higher relative share of capital invested in
capital goods sector would produce a slower
initial growth rate, but would soon accelerates
and exceeds the alternative strategy of higher
relative share invested in consumer goods
sector.
Mahalanobis model Growth path

Capital-goods
intensive y2
y1
Consumer
Goods-intensive

Time
 Macro Indicators

1950-64 1965- 1980-90 1991- 2004-15

80 04
GDP Growth Rate 4.1 3.2 5.8 5.6 7.2

Agriculture 3.1 2.3 3.9 2.1 3.4

Manufacturing 7.4 3.8 6.5 5.8 6.1

Service Sector 4.7 4.3 6.8 7.2 7.4

Investment/GDP Ratio 9.5 18 24.5 25.6 34

 Industrial Growth Rates
Industry manufacturing GDP
1951-65 6.9 6.9 4.0
1966-80 4.2 4.8 3.6
1951-80 5.4 5.3 3.6
1981-91 7.0 7.4 5.6
1981-2008 6.2 6.2 5.9
1992-2008 6.7 6.6 6.5
1951-2008 5.4 5.4 4.5
 Changing Composition of Industry

1950 1960 1970 1980 1993-94 2004-05

Basic Goods 22.33 25.11 32.28 33.23 35.5 45.7

Capital Good 4.71 11.76 15.25 14.98 9.3 8.8

Intermediate 24.59 25.88 20.95 21.33 26.5 15.7

Consumer 48.37 37.25 31.52 30.46 28.7 29.8

Durable 5.68 3.46 3.41 5.4 8.5

Non-Durable 31.57 28.11 28.11 23.3 21.4

 Period 1951-66
• The growth achieved during 1951-66 was about 3.8 % against a
target of 5 %.
• Agricultural output rose at 3% during 1950s but fell to 2.3% in
mid-60s, averaging 2.8%.
• The 60s foodgrains growth was due to area expansion resulting
form Zamindari abilition.
• Industrial output grew at 7.9% during 1950s, fell to 4.8% in
mid-60s. However, industrial capacities were vastly improved in
areas like metals, machine building, ship building, heavy
chemicals, transport and communication.
• Mid-sixties unforeseen disturbances like two wars that
diverted expenditures to defence, four major droughts that
severely reduced foodgrain growth, population pressure,
Korean war crisis that led to devaluation, ending of American
aid, have all affected the growth performance. Nehru’s death
in 1964 and L.B.Shastri death in 1966 led to leadership vacuum.
• A Plan holiday was observed during 1966-69.
 1965-73
• The troubled times continued during 1965-73. Withdrawal of
American aid from $1.3 to $ 1 bilion during the Nixon tilt in
1972 posed a major threat.
• Devaluation in 1966 did improve exports, while inflation
spiraled to 25%. Fall in foreign exchange reserves proved
costly for growth.
• Indira Gandhi’s government (4th Plan) responded with
restricting industrial growth with tightening licensing and
holding down capacities through MRTP. Self-Reliance became
the slogan.
• The silver lining was agriculture began responding to
introduction of new technology.
• There was also severe unrest over growing poverty, it was
realised poverty is not addressed through trickle down.
• Growth rate continued to be about 3.5, termed as `Hindu
Growth’ rate sarcastically by late Raj Krishna. The effects of FE
shortage were apparent on economic growth and
employment.
 1974-84
• 5th Plan (1975-80) was formulated under difficult times of inflation, poor
growth, BoP problems. 2-prongued strategy was adopted – i)drive
against black marketers, and ii) to curb the demand to tackle the
inflation rate of 30% in 1974.
• However, a wheat loan from Russia and bilateral trade led to recovery of
industry. This has enabled India to withstand first oils shock in 1973,
Bombay High oil production helped the second one in 1979.
• Through public investment in large dams, irrigation potential was
increased that enabled proliferation of HYV adoption.
• Food grain production finally lifted from 83 mt in 1966 to 153 mt in 1977
and food imports were completely stopped.
• The 5th Plan growth rate increased to 4.5%.
• Efforts to boost exports through partial liberalization began paying
dividends from 1981, thus making 6th Plan growth accelerate to 5.5 %.
• Manufacturing sector did not recover its momentum of 1960s.
• Even though poverty alleviation measures were introduced through
special measures such as IRDP schemes, reduction through agricultural
growth were more prominent.
 1985-90
• The seventh plan growth recorded even better rate of 5.8 %.
• The partial liberalisation undertaken since 1981, export-
promotion schemes, increased public expenditure at the
cost of high fiscal deficit etc contributed to higher growth.
• India also resorted to commercial borrowing that made
surge in imports, increasing the current account deficit.
• Collapse of Soviet Union in 1987 turned out to be a severe
blow that led fall in exports. However, increased remittances
from Gulf workers kept the BoP situation manageable.
• 1991 Gulf War and blocking of remittances from Gulf
deteriorated foreign payment situation bad.
• India went for IMF conditionality loan which compelled it to
undertake large scale liberalisation and drastic change in the
controlled industrial policy.
 Gulf war Golbal
Reform Shock meltdown
+ drought

1st Oil Shock Drought+2nd oil shock

Bangladesh
war
 references
• Chapter 1 Pulapre Balakrishnan Economic
Growth In India, OUP, 2008
• PN Dhar Indian Economy /: Past Performance
and Current Issues in Lucas and Papanek
edited Indian Economy: Recent Developments
and Future Prospects, OUP 1988
 Major Constraints to Growth
Constraints 1950-80
• Incremental Capital Output Ratios have
increased steeply by mid-sixties and continued
up to Seventies.
• Inflationary pressures arising from domestic
foodgrain shortages plagued the economy
during 1950-74, until the Green Revolution was
launched in 1966, the country became self-
reliant by 1974-75.
• Tax collection remained poor.
• Foreign currency reserves remained modest,
making it a constraint for importing.
Understanding Employment and
Unemployment in India
 Measurement
• CSO gives data on organised sector, while NSSO collects for informal labour.
• Data on employment and unemployment is collected by NSSO under two
classification: First, on status of work. Second, extent of period of employment.
• If a person is engaged in one economic/non-economic activity for a longer
period is considered as worker of principal status; and if for a part time in an
economic activity as subsidiary status (mostly women and children).
• under three categories: Usual activity Status (US), Current Weekly activity
Status (CWS) and Current Daily activity Status (CDS). The US employment
means a person spent relatively longer period during the 365 days as the
Principal Usual Activity Status of the person.
• A person is called as employed in case of CWS basis if he/she engaged in
economic activity even for majority days in last one week. And if he/she is
engaged majority of the at least one day in the preceding week is called as
employed on the basis of CDS. Each of these categories are projected for entire
workforce from a sample. Usual status employment is more reliable, the rest
two depends on the statistical robustness of sampling.
 Data Limitations
• Weakness of these is that even if one person is employed only
for 6 months, he/she is considered as employed under US, if a
person is employed only in that particular week would be
considered under weekly status, if one day employed, would
be considered employed under daily status. Hence we do
have completely reliable statistics on employment and
unemployment.
• Second, in a country where there are large number of small
and marginal farmers exist, and good amount of disguised
unemployment exists, these employment definitions make
little sense. Because, under disguised unemployment, workers
are seen to be employed for longer period since they have no
other alternatives.
• Third, given seasonality in agriculture this data does not
reflect the variations in employment.
 Structure
• India has a total labour force of 46.85 crore (PS+SS) in 2004-
06. out of this 34.57 crore are rural (73.8%) and 12.27 cr are
urban (26.18%). Among rural workforce 21.92 cr are males
and 12.6 are females; in urban 9.36 crore are males and 2.91
cr are females.
• Out of the total workforce, according to NSSO, 45.78 cr are
employed (97.7%) suggesting an unemployment of 2.7% only.
Within, it is distributed as 11.5 crore urban employment and
34.28 crore rural employment.
• 4.7% of the labour force are graduates and above, 5.8% are
higher secondary, 11.1 are secondary and 47.8 % are literates.
• We have a rate of population growth of 1.93% per annum,
labour force growth rate of 1.03% and 0.98% of employment
growth rate.
Percentage Share of Employment by Industry

Sector 1993-94 1999-00 2004-05

Agriculture 48.5 45.3 43.5

Manufacturing 15.4 15.32 17

Construction 3.78 4.78 5.33
Service Sector 32.32 34.6 34.17
Trade, Hotel & 9.88 13.78 12.75
Restaurant (30.32) (39.83) (37.31)
Transport, storage & 3.32 3.87 4.5
Communication (10.27) (11.18) (13.17)
 Employment Growth Rates
US (PS+SS) CDS
1983-94 1994-00 1983-94 1994-00
Agriculture 1.51 -0.34 2.23 0.02
Mining and Quarry 4.16 -2.85 3.68 -1.91
Manufacture 2.14 2.05 2.26 2.58
Elect, Gas, water 4.5 -0.8 5.31 -3.58
Construction 5.32 7.09 4.18 5.21
Trade 3.57 5.04 3.8 5.72
Transport, Commerce 3.24 6.04 3.35 5.52
Financial services 7.18 6.2 4.6 5.4
Community social 2.9 0.5 3.85 -2.08
services
Total employment 2.04 0.98 2.67 1.07
 Compound Growth Rate of Sectoral GDP, Employment and GCF
Pre-Reform (1975-1989) Post-Reform (1990-2004) Overall (1975-2004)

GDP Emp GCF GDP Emp GCF GDP Emp GCF

Agriculture & 2.60 1.52 0.14 2.55 -0.36 3.59 2.89 0.59 1.80
Allied
Manufacturing 6.14 1.39 5.98* 6.49 -0.37* 4.98 6.42 0.53 5.97
Service sector 5.63 2.57 4.94 7.75 0.52 5.66 6.69 1.50 5.50
Wholesale, Trade 5.28 1.61 4.53 8.02 1.28 4.33* 6.44 1.40 2.47
& Hotel
Transport, 5.65 1.80 4.07 9.83 -0.21* 3.96 7.18 0.71 5.01
Storage &
Communication
Finance, 7.91 6.06 4.80 7.89 1.60 3.45 8.61 3.33 6.22
Insurance &
Real estate etc.
Community, 5.60 2.48 5.99 6.94 0.52 9.90 6.04 1.52 6.09
social & Personal
Services
 . Employment and Investment Elasticity

Sector Pre-Reform (1975- Post-Reform (1990- Overall (1975-2004)

1989) 2004)
Dependent Variable: LnEmp LnGCF LnEmp LnGcf LnEmp LnGCF
Log Employment
Agriculture & Allied 0.39 0.08* -0.11 -0.10 0.20 0.15

Manufacturing 0.22 0.15 -0.05* 0.14* 0.08 0.09

Service sector 0.45 0.46 0.07 0.08 0.22 0.27
Wholesale Trade, hotel 0.30 0.12 0.16 0.03* 0.22 0.09
Transport 0.32 0.23 -0.03 -0.03* 0.09 0.13
Finance, real estate 0.73 0.99 0.21 0.39 0.39 0.51
Community 0.44 0.37 0.08 0.04 0.25 0.22
• What we observe is that growth rate of employment has fallen
from 2.04 to 0.98% in usual status and in current daily status too
fallen from 2.67 to 1.07%.
• The decline is sharpest in agriculture and mining, there is boom in
the construction activity. The service sector employment growth
rate increased till 2000, but declined later.
• Employment rates declined during liberalisation period sharply
compared to previous period. However, during 1999-05, there is an
improvement in manufacturing, urban service sector, rural self
employed. But much of the increase is only in rural self-employed.
• There is serious fall in the employment elasticity in all the three
sectors, decline in agriculture is most prominent and manufacturing
sector to follow.
• While GDP is growing at 8.78 percent, employment is growing 0.98
percent.
• Usually we expect that growth of income is necessary for
employment situation to improve. However, this is only under
conditions of constant capital-output ratios. Even when labour
productivity increases, the demand for labour would rise
faster. But if this accompanied by increased capital-labour
ratio, then labour demand would rise much more slowly.
• Compound Growth Rate of Sectoral Capital-Labour Ratio
Pre- Post- Overall
Reform Reform Period
(1975-89) (1990-04)
Agriculture & Allied 2.03 2.20 1.81
Manufacturing 8.58 8.61 7.48
Service sector 1.01 3.76 2.35
Wholesale, Trade & Hotel 8.93 2.41 4.65
Transport, Storage & 1.95 5.04 3.75
Communication
Finance, Insurance & Real estate -3.95 2.21 -0.38*
etc.
Community, social & Personal 2.55 4.36 3.13
Services
• At the aggregate economy level, output and employment
rates are showing divergence, at the state level there is no
one-to-one correspondence.
• A.P, Goa, HP, Karnataka, WB – has lower growth in
employment despite a high SDP
• Assam, Bihar, Punjab, -have high employment with lower SDP
rates.
Quality of Employment:
• We have seen that organised sector employment growth rate
has fallen from 1.2% during 1983-94 to 0.53% during 1994-00
and -0.31 % during 2000-05. Public sector employment
growth has fallen from 1.52% to -0.03 %. Private sector
employment even though has increased from 0.45% to 1.87%,
it did not compensate the absolute loss in organised
employmnet.
• So when organised sector employment declined, but overall
employment still increased, then what kind of employment
increased. It is only informal sector employment, that too in self-
employed in agriculture and employment in construction that
increased.
• Given the dualism in the labour market, 93% in agriculture, 80% in
manufacture and 89% in service sector is informal labour. This
unorganised sector employment has increased from -1.73% during
1989-94 to 2.16% in 1994-00.
• The real problem is that of quality of employment. Given 33% of
working poor below poverty line, in our country the low paying,
insecure, unsafe employment is the problem.
• As far as real wages are concerned, there has been an increase over
period. However, the rate of increase has fallen from 5% to 2.5%
despite improvement in the labour productivity.
 Table 1: Labour force participation rates
Usual status (PS+SS) Current daily status
1999- 2004- 1993- 1999-
1993-94 2004-05
2000 05 94 2000
Rural males 56.1 54 55.5 53.4 51.5 53.1
Rural females 33 30.2 33.3 23.2 22 23.7
Urban males 54.3 54.2 57 53.2 52.8 56.1
Urbanfemales 16.5 14.7 17.8 13.2 12.3 15
FDI in India: Issues and
Perspectives
 FDI: Pre-Reform Stance
• Foreign Currency Reserves are crucial for modern
development. Foreign trade is important and global
exchange of technology would quicken the process of
development. The logic of Globalisation and multilateral
trade under WTO are based on the idea that global capital
flows would promote greater global trade and development.
• Foreign capital covers host of entities such as the physical
capital, financial capital, technological knowhow and
management practices.
• However, during 1947-90 given the colonial experience as
well as the contemporary global scenario, India was relatively
restrictive about foreign investment. It was relying on
bilateral and multilateral aid, on long term loans.
• FDI was permitted in limited quantities where India is
deficient in technology through license agreements,
technology transfer agreement and capital goods.
 Pre-reform history
• Technology imports were preferred over financial and technical
collaborations. Even technological licensing were subjected to
restrictions on royalty rates and technical fees.
• FDI was permitted in designated industries, with joint ventures
as the form with domestic partners, foreign equity was not to
exceed 40% in total capital of the firm, of course with clauses
on export obligation, promotion of R&D.
• FERA (1974) stipulated foreign firm to have an equity up to 40
% with exemptions at discretion, setting branch plants were
disallowed, foreign subsidiaries were induced to gradually
dilute their equity to less than 40%. Law also prohibited use of
foreign brands, encourage hybrid domestic brands such as
Hero Honda, Maruthi-Suzuki, Hindustan-Lever, Phillips India
Ltd, etc.
• The policy essentially aimed at stabilising domestic supply at
reasonable prices, to disallow foreign capital dominance and
dependence.
 Criticism of Dirigism
• The critics of dirigism have criticised that such restrictive policy
retarded domestic technical capability ( reflected in poor
technical quality of Indian goods); loss of export opportunities of
labour-intensive manufacturing in contrast to many Asian
counterparts such as Taiwan, Hong Kong, South Korea, China.
• Moreover, such policy of restrictive foreign capital is said to have
encouraged `rent-seeking’ by domestic partners on imported
technology with little effort to improve product quality,
innovation, export effort (Ahluwalia 1985), eg., automobiles.
• But dumping aside these arguments, economist who worked on
issues like technology, like K.Subramaniam, showed that such a
policy reduced cost of technology of imports, enabled domestic
partners to develop through `learning-by-doing’, for eg., TELCO,
BHEL, pharmaceutical industries.
• However, 1980 saw a gradual relaxation of rules on foreign
investment, entry of Suzuki, Pepsico, all marked the shift.
 The Analytical Perspectives
• Will the FDI necessarily benefit a nation? boost its GDP?
create employment?, create export potential? Managerial
potential?
• Neoliberal perspective of FDI takes a view that FDI is a source
for: a)additional external finance, risk capital against debt-
capital, b)augmenting fixed investment, potential to create
output and employment. Like in Latin America, East Asia in
1980s.
• The crucial questions to the policy are how the benefits are
spread between foreign firms and the domestic, what is the
cost of foreign capital to the domestic economy. In case of
domestic capital, the proceeds will remain in the country
while for in case of foreign capital the proceeds will flow out.
 Microeconomic perspective
Caves (1996) studied effects of FDI on output and employment.
1. In case, entry of foreign firms result in creation of domestic
monopoly, then benefits of such investments are limited, unless
checked by strong anti-trust laws.
2. Similarly, if foreign firms displace domestic firms, then also social
benefits are marginal.
3. If foreign firms take over domestic firms to form monopolies then
also the effect is the same.
• Industrial Organisation Theory also takes a view that foreign firms
try to take firm-specific advantage – including market power. The
foreign firms usually have an advantage in finances, technology;
strength of domestic firms lies in cheep labour, location,
marketing network. How does the both negotiate their roles will
determine the outcome.
• So a social cost-benefit approach is a meaningful method to
assess the potential effects of FDI.
• If we take this view, then countries should not blindly invite FDI, but
should channel it into desired directions for the long term benefits. A
world with unequal resources and technological capabilities, FDI should
not lead to domestic de-industrialisation.
• Whether the technology spill-over happen depends on the nature and
terms of FDI, but not automatically.
• The experience of several counties which followed open gates policy for
FDI suggests that it is not necessary that technology spill-over,
employment generation will happen. [Bruton, 1989].
• There are examples where FDI has created sweatshops making use of
absence of labour laws, created informal sector jobs, and not capable of
alleviating poverty. There are many cases of new international division
of labour in which global production is turning to third world to exploit
cheap labour and environment in totally unacceptable way.
• So rather than an unregulated open-door policy, a regulated approach r
is desirable Sanjaya Lall (1989).
• Instead of importing foreign capital to get their technology, preferred
option could be domestic firms offering financial investment, while
technology is outrightly purchased from foreign firms.
 Data, Trends and Issues in India
• Data on FDI in India is available on the basis of approved and
realised by industry at state level.
• FDI is recorded under five broad heads:
1. RBI automatic approval route upto 51% equity.
2. Foreign Investment Promotion Board (FIPB) –discretionary
approval over and above 51% foreign equity.
3. Acquisition of shares (since 1996)
4. External Commericial Borrowing (ECBs) – ADR, GDR
5. NRI deposits with RBI
• Ideally FDI should get reflected in i)capital formation, ii)formation
of new firms and factories, ii) increase in foreign equity holding in
firms, iii) mergers and acquisitions.
 Composition of Capital Inflows
Item 1995-96 2001- 2002-03 2003- 2004- 2005- 2006- 2007-
02 04 05 06 R 07 PR 08 P
1 2 3 4 5 6 7 8 9
Total Capital Inflows ( Net)
US $ Million 4089 8551 10840 1673 28022 25470 45779 108031
6
of which:
1 Non- Debt Creating 117.5 95.2 55.5 93.7 54.6 84 63.3 56.9
Inflows
a) Foreign Direct 52.4 71.6 46.5 25.8 21.4 34.9 48 29.9
Investment **
b) Portfolio 65.1 23.6 9 67.9 33.2 49.1 15.3 26.9
Investment
2 Debt Creating 57.7 12.4 -12.3 -6 35.2 41 63.4 38.9
Inflows
a) External 21.6 14.1 -28.6 -16.5 7.2 6.9 3.9 2
Assistance
b) External 31.2 -18.6 -15.7 -17.5 19.4 10.8 35.9 20.5
Commercial
Borrowings #
c) Short term Credits 1.2 -9.3 8.9 8.5 13.5 14.5 14.4 16.4
d) NRI Deposits $ 27 32.2 27.5 21.8 -3.4 11 9.4 0.2
e) Rupee Debt -23.3 -6.1 -4.4 -2.2 -1.5 -2.2 -0.4 -0.1
Service
3 Other Capital @ -75.2 -7.6 56.8 12.3 10.2 -25 -26.7 4.2

4 Total (1 To3) 100 100 100 100 100 100 100 100
Memo:
Stable flows + 33.7 85.6 82 23.7 53.2 36.4 70.3 56.7
 Table 155 : Foreign Investment Inflows
Year A. Direct investment B. Portfolio investment Total (A+B)
Rupees US $ Rupees US $ Rupees US $
crore million crore million crore million
1 2 3 4 5 6 7
1991-92 316 129 10 4 326 133
1992-93 965 315 748 244 1713 559
1993-94 1838 586 11188 3567 13026 4153
1994-95 4126 1314 12007 3824 16133 5138
1995-96 7172 2144 9192 2748 16364 4892
1996-97 10015 2821 11758 3312 21773 6133
1997-98 13220 3557 6794 1828 20014 5385
1998-99 10358 2462 -257 -61 10101 2401
1999-00 9338 2155 13112 3026 22450 5181
2000-01 18406 4029 12609 2760 31015 6789
2001-02 29235 6130 9639 2021 38874 8151
2002-03 24367 5035 4738 979 29105 6014
2003-04 19860 4322 52279 11377 72139 15699
2004-05 27188 6051 41854 9315 69042 15366
2005-06 39674 8961 55307 12492 94981 21453
2006-07 103367 22826 31713 7003 135080 29829
2007-08 140180 34835 109741 27271 249921 62106
2008-09 161536 35180 -63618 -13855 97918 21325
2009-10 176304 37182 153511 32375 329815 69557
 FDI Inflows in India in Post Reform Era

FDI (Crores)

200000

180000

160000

140000

120000

100000

80000

60000

40000

20000

FDI (Crores)
 % with Total FDI inflows(+)
45

40

35

30

25

20

15

10

% with Total FDI inflows(+)

 Trends
• From the data, we understand that total FDI flown so far on Oct 2010
stands at $232 bn. Compared to $2 bn in 1990, we are in a
comfortable situation. India and China are exceptions compared to
rest of the developing countries which are net exporters of FDI while
we are net recipients.
• The sectors that attracted FDI in India are electronic equipment,
transport industry, service sector, telecommunications, fuel and
power, food processing, drugs and pharma.
• 44% of FDI has come from Mauritius route, 8 % from US and 20 %
from EU. Service sector in 2008-09 received 22% which is highest,
computer hardware 12%, telecom 8%, construction 6%, real estate
6%, automobiles 4%.
• Mumbai received 33.5 %, New Delhi received 16.5%, Ahmedabad
6.87%, Bangalore 6.8%, A.P received 4.4%.
• The composition of FDI is 72% is long terms FDI, 2.5 % portfolio
investment, 22% reinvested earnings, 2.5 % in other capital.
• FDI inflow between 1991-01 was meagre, but later on it increased at
exponential rate.
 India-China Comparison
• India did not receive FDI as much as China did. But in last five
years, we received phenomenal inflows. From 2007-08 India
received $ 32 bn when China received 45 bn. There are now
similarities between India and China, in China’s real estate is
flooded by FDI. India too opened up.
• But China attracted lot of FDI into its manufacturing sector, where
as India had a major share in services and real estate.
• Do countries that receive large inflows of FDI grow faster?
Evidence is ambiguous. China is an example of success, Brazil is
otherwise, where much of the FDI has gone into acquiring
financial control of firms. In India, share of FDI in fixed capital
formation is 2-3 %, much of GFCF is domestic. Yet contribution of
FDI to growth cannot be denied.
 FDI in India: Some Assessment
• Much of the FDI arrived into consumer goods markets such as
electronics, hardware, automobiles, washing machines etc. The
consumer choice has certainly widened.
• There was an apprehension initially that it would wipe out domestic
firms, but in practice while some Indian firms disappeared but many
became strategic partners and even competitors. On other hand, many
consumer goods industries are reportedly running below their capacity,
given the narrow market which easily gets saturated.
• FDI has finally contributed to accumulation of foreign exchange reserves.
For quite some time many foreign firms did not bring much money
instead started raising money from Indian market. This could be
dangerous, which will ultimately lead to capital flight.
• FDI has not contributed much to growth of exports in India, evidence
shows that FDI supported firms share in exports did not cross even 10
per cent. So they are aiming at Indian market.
• There is a large discrepancy between approval and actual.
Bulk of the approvals is for infrastructure, telecom,
automobiles and consumer durables; very little has gone
into capital goods.
• In Telecom sector, more FDI is spent on imported
equipment rather than on the manufacturing of the same.
• Much of the FDI has come into fully owned subsidiaries,
whose patents are registered abroad. Most of them have
not issued IPOs
• Larger share of funds are used for acquiring control rather
than on capital formation.
• 42% of FDI has come to acquire managerial control over
domestic firms (which can appear better than Brazil where
it is 70%), 28% has come as portfolio investment. Only
about 40% of FDI is of long terms in nature. There has been
lot of mergers and acquisition activity since 1999.
• Whether FDI brought technology and caused technological spill-over is
another issue. There is evidence that FDI has created some competition
in some sectors, in some others not. This has created wider choice.
• In Automobiles, many firms like Hyundai and Ford have set up assembly
units, they ship CKD kits and SKD kits. Later in recent times they set up
complete production units.
• In several consumer goods, foreign firms have resorted to contract out
actual production which gives some expertise to domestic companies.
• There is also evidence about a decline in competition due increased
spurt in mergers and acquisitions. Overtime, specially in the recent
times there has been a steady price escalations in several non-durables,
due o monopolisation of industry.
• FDI role in creating employment is not very remarkable, since much of it
came into capital intensive sectors.
• Overall, we can conclude that it eased out FE position, did not improve
our exports, brought capital formation, evolved partnership, helped
growth but not employment.
 Recent Studies
• A Unit level study of 83 firms from Prowess data in India for 1991-2015,
by Swati Verma (2015) in EPW showed that the net foreign exchange
contribution after accounting for imports, foreign expenses etc is
negative. She has reported that her data suggests that FDI has
contributed to worsening of current account deficit.
• The persistent negative net impact on BoP is observed from technology
intensive industries since 2003. A net outflow of FE from developing
countries is observed from several international studies (Lall 1978;
Smits 1988; Jansen 1995; Chudnovsky and Lopez 2004).
• G D Sandhya ,N Mrinalini, Pradosh Nath Vol. 49, Issue No. 30, 26 Jul,
2014 in EPW study noted that FDI has chased high growth areas rather
stimulating low growth sectors like IT, auto, and pharma. They
observed that FDI made use of infrastructure and human capital.
Technology is brought only after ensuring patent protection.
• Mondal & Pant (2015) study indicated that while there is improvement
in efficiency of firms, there is no positive change in R & D expenditures
of domestic firms, who are becoming junior partners to Foreign firms by
providing sales networks and production facilities.
 Recent policy initiatives
• FDI is allowed virtually in all sectors of manufacturing except
defence production.
• FDI in infrastructure did not take off, after a Enron fiasco. US is
pressing to open up in nuclear power.
• Of late, there is increasing clamour to open more areas open for
FDI, such as retail sector, agriculture, education, legal services,
newspaper, health, insurance etc.
• Allowing FDI in retail can seriously affect small vendors and shop
keepers. This is expected to increase investment in cold storages,
supply chains etc, but can draw huge margins. It is not proved that
retail trading is no longer profitable in India.
• FDI in education
 References
• R Nagaraj (2003) `Foreign Direct Investment in
India in the 1990s: Trends and Issues’, EPW,
April 26.
• Mondal and Pant (2015)
• Swati Verma (2015) Current Account Fallouts
of FDI in Post-Reform India: Evidence from
Manufacturing Sector’ EPW, Sep 26, No.39
 Fiscal Consolidation in
Post-Reform Period: Issues
and Perspectives
 Perspectives on Fiscal Imbalances
• Cropping up of fiscal imbalances between government revenues and
expenditures since 1980s has been a sustained problem in Indian
economy.
• Targets on fiscal deficits have been fixed by respective Finance
Commissions and we also have a legislation, FRBM Act 2005, attainment
of fiscal deficit targets has been a sacred goal.
• According to Neoliberal view, fiscal deficit leads to monetisation of debt,
hence inflation, eroding real interest rate. This reduces investment and
hence growth. This has no firm theoretical basis, but is founded on an
empirical estimates for US, in India the evidence is always is in contrast,
fiscal deficits only have a positive correlation with GDP growth, of course
with inflation.
• Inflation, India has been a structural phenomenon, emanating from
foodgrain prices, rather than demand-pull. Yet the establishment view is
fiscal deficits are decried as undesirable and unsustainable.
• A related concern is the share of resources appropriated by the public
sector. There is a view that downsizing government is an important part
of fiscal restructuring.
 Demonising Public Debt ?
• 11th Finance Commission argued to bring down FD from 9-8 % to 5-6%,
and public debt-GDP ration from 65.2 % to 55%. 12th FC reduced the
target to 3%, but due to 2008 crisis they could not, given the tax
concessions that were given to the industry.
• It is important to have a clear idea about why fiscal scenario is
worrisome and requires what sort of correction. It is important to
understand the alternative modes of fiscal adjustment, it may still be
arbitrary to fix any target without proper basis.
• Is it that the public debit-GDP ration really at uncomfortable level? Does
it pose solvency problem to the solvency of the Treasury and viability of
the economy?
• From a purely accounting view point public debt does not constitute any
net liability of the economy as a whole, why because since financial
assets are held by the rest of the economy exactly offset government
debt. It is not like an individual debt.
• Even a large transfer in the form interest payment do not erode the
community’s consumption ability or investment ability. They why does
this becomes issues of worry?
• 3 issues: the burden of public debt; will FD lead to high debt-GDP ratio?;
and what are the bad effects of public debt?
 Burden of Public Debt
• One reason is the when interest payments are very large, transfers
to holders of government securities from the rest of the
community can have an adverse impact on income distribution.
Second, given the rates and structure of taxes, large interest
payments simply mean a higher ratio of private disposable income
to GDP. This may encourage private consumption at the expense
of capital accumulation and provision of public goods and
services. Wealth effect can lead to greater distortionary impact on
the use of available goods and services.
• These adverse effects of large public debt can be outweighed by
appropriate taxation. But taxes themselves may cause distortions
in efficient allocation of resources.
• When governments are not able to raise adequate revenues
public debt ratio can pose difficulties. You are raising present
consumption to the loss for future generations. Hence comes the
question of sustainability. Can the government resort to borrowing
to meet consumption expenditure and interest payments?
 Canonical views on sustainability
a) For any tax-GDP ratio, sustainability condition of borrowing is
interest rates on govt debt should be less than nominal GDP
growth rate. When this condition is satisfied, in spite of public
debt, revenue deficit and interest payment rising over time, their
ratios to GDP stabilise in long run.
b) Lowering of tax or enhancement of debt-financed govt
consumption raises the long-run values of public debt-GDP and
other ratios, but do not alter the sustainability condition (i.e.,
GDP rate> interest rate).
c) Under the canonical scenarios one need not worry about the
govt’s `inability’ to provide some essential public services on
account of high interest payments-tax collections, associated with
large public debt. It can and not only provision of basic services
but even the interest payments through borrowing, it only
requires the sustainability condition to hold.
 Some Caveats to this Model:
• An important problem with the canonical model is that it assumes the
interest rate and growth rate to remain unaffected irrespective of the
govt’s fiscal stance – a difficult one. Larger interest rates are offered to
attract public borrowing.
• At a given tax-GDP ratio, larger interest payment implies a larger
disposable income-GDP ratio, this tends to raise consumption at the
expense of investment, the growth rate of GDP gets reduced. It also
can be shown that a large public consumption-GDP ratio larger than
some critical value, public debt becomes unviable without increasing
tax-GDP ratio. Critical values is given by r/y. As long as Public
Consumption/GDP ratio exceeds r/y, borrowing is unsustainable.
• However, an increase in consumption need not have an adverse impact
on the growth rate when the economy has excess capacity. In the
neoclassical model, growth rate is independent of investment, but this is
in a very long run; in the medium run investment does raise growth
rates, even the endogenous theory of growth established this Harrod-
Domar result.
• Other Caveats: Instead of debt-GDP ration, if the debt-private
income is considered, the govt can factor-in the distortionary
effects of taxes more realistically and works out a more reasonable
ratio for sustainability. Here the growth rate should exceed the
post-tax interest rates for borrowing to be viable.
Central Bank Holdings of Govt Securities
• It is commonly held that public debt refers to all financial liabilities
of the govt, including that of Central Bank. But while examining
the sustainability, govt securities held by central bank should not
be counted, because it is an organ of the govt. Nor the interest
payment to it. In India securities held by RBI were not insignificant,
even though over period these have undergone.
 Liabilities and Assets
• In developing economies, state is a development state; liabilities here
also creates some assets. When borrowing meets some capital
expenditure alone –how does the sustainability condition alters?
• Now the sustainability requires, the income growth rate to exceed the
interest rate less returns on the assets. Loan financed capital
expenditure should lead higher growth, hence lower debt-GDP ratio.
• But when borrowing meets capital expenditure + part of public
consumption (public goods)+interest payments, the sustainability
condition requires growth rate to exceed the (post-tax) interest rate
minus returns on the assets.
• Even when borrowing is used to finance consumption and investment,
the composition becomes important for its implications for the growth
outcome. Cost of borrowing will in the long run be a weighted average
of (a) post-tax interest rate and (b) the post-tax interest rate minus the
return on government investment. Larger proportion spent on
investment, lesser will be the cost.
 Borrowing, Crowding-out & Crowding-In Effects
• Normally we may expect that when debt financed govt expenditure will
raise interest rates and this would crowd-out private investment.
However, if the economy operates with excess capacity, debt-financed
demand, capacity utilisation, profits – all rise, as an expansionary policy
can raise the GDP.
• What about the interest rate effect? First, crowding-in can materialise
despite an increase in interest rates, second, interest rate effect depends
on what kind of govt expenditure is in place. Third, most important,
crowding-out argument usually ignores the increasing role played by the
financial markets, i.e., stocks, mutual fund, pension fund etc. When
expansionary fiscal policy improves investment sentiment, there will be
an increase in the supply of funds in spite of debt financing of govt. So
long economy has an excess capacity, govt expenditure is supported by
borrowing, may thus raise private capital formation along with
household expenditure.
• Once the economy has attained full employment, any increase
in consumption or investment, no matter how it is financed will
reduce private absorption. At full employment (a)both private
consumption and private investment will decline, (b) higher the
debt-reliance, larger the fall in private investment; (c) yet, the
public investment will outweigh a fall in the private investment.
• However, the outcome depends on the composition of govt
expenditure to improve infrastructure, education, health, law &
order, administration will raise profits and aggregate demand.
• So far as the model financing is concerned, the use of SLR may
produce some crowding-out effects. But monetised deficit
raises aggregate flow of finances, this can create crowding-in
effect.
• So net effect is therefore contingent on so many factors.
 Fiscal Deficit: some unlearning
• Fiscal deficit as defined in India, is a gap between the aggregate
expenditure and the sum of revenue receipts, proceeds from
disinvestment in public sector undertakings, recovery of past
loans and other non-debt creating receipts. The problem with this
definition is that this clubs various kinds of expenditure and
revenues which do not have the same implications for
sustainability of a budgetary program.
Different Sources of Borrowings can have different effects:
• We already mentioned, govt securities held by central bank
should not be regarded as part of public debt and since
monetised debt produces crowding-in effect. Likewise,
monetised deficit also does not lead to any interest burden, in a
growing economy up to a point, it does not produce any
inflationary impact. Thereby, fiscal deficit by itself does not
indicate the extent or even a sign of crowding-out effect.
 Disinvestment Path
• Much more misleading is the treatment of public sector undertakings
and recovery of loans on the same footing as tax collections. When PSU
shares are sold or recovers the past loans there will be some pressure on
financial markets, it need not be different than public debt effect – i.e.,
crowding -in or -out effects.
• Second, unlike tax receipts, non-debt creating receipts like disinvestment
proceeds reduces earnings of the govt by way of interest and dividends.
From the viewpoint of budgetary viability, there can thus be a doubt
that reduction of fiscal deficit through disinvestment cannot but be
worse than tax financing. This is not to deny the chance of disinvestment
backed by change in management, incentives and work environment in
PSUs to contribute to budgetary viability. But such measures do not
necessarily need disinvestment. The first best option certainly not be
through disinvestment.
• The disinvestment in PSUs is indeed related to political economy of
resource ownership rather than efficient use of resources.
Reduction of Govt Expenditure
• The three components of public expenditure, i.e., consumption,
investment and transfers –all these have different implications
for future receipts of govt. It is not aggregate expenditure, but
it’s composition is what matters. Reduction of capital
expenditure than revenue expenditure is bad for GDP growth.
Reduction of revenue expenditure to reduce revenue deficit
means govt running away from its basic duties.
Budgetary Objectives with and without Tax Constraint:
i. Optimum distribution of full employment output between
consumption and investment.
ii. Optimum balance between households and public investment
iii. Optimum division between private and public investment
iv. Equitable (post-tax) income distribution.
 Budgetary Implications of these Objectives
a) An equitable distribution of income implies an optimum tax-transfer,
presumed when marginal benefit on consumption, investment and private
consumption are equal.
b) Govt revenue expenditure (defence, law&order, public goods etc) are to be
fixed at a level where MSB=MBPC
c) Equi-marginal principle should also apply in division of aggregate investment
between the public and private sectors. This requires optimal taxes and
subsidies securing optimal composition.
d) All govt consumption expenditure and transfer payments should be met from
revenue receipts (no revenue deficits) and public investment be met through
borrowing. The test book principle instructs govt to target a zero revenue
deficit and a fiscal deficit no more no less than optimum level of public
investment plus net subsidy on public investment.
e) Non-tax sources: monetised deficit in limits has no interest implications, so
under severe tax constraint this can be resorted to.
f) Borrowing from public: borrowing at lower interests through open market
operations, rather than SLR, are useful.
g) Restructuring Govt Expenditure: many times emphasis is placed on capital
expenditure reduction. But one should consider those which have positive
externalities. It is easier to tax income generated though public investment
than private investment.
Income Inequality and Poverty
• The above mentioned ways of budgetary borrowing can have
positive effects on income inequality and poverty.
• In India studies have shown that poverty reduction has high
correlation with improvement of agriculture, employment and
education. Govt expenditure has a close relation with these. Food
and fertiliser subsidies and farm credit tend to raise food grain
output and reduce foodgrain prices. Social development has
tremendous indirect effects.
• The current and capital expenditure for poverty elimination are
larger than what is suggested under the first best solution. But
the positive externalities support this approach.
• Larger expenditure on agriculture and poverty alleviation violates
slightly the first best principles of allocative efficiency and loss to
some GDP.
 Changed Fiscal Stance in India
• At the first sight, India’s fiscal stance did not show any such alarming
situation of creating domestic debt trap, neither before reforms nor
later. The public debt-GDP ration remained around 65% for two
decades between 1981-00, during 2005-10, it is brought down to 48%.
• [ US has 119%, Portugal 95%, France 85%, UK 81%, EU 82%,
Japan 220%, Greece 112%, Iceland 109%, Singapore 92%]
• Fiscal deficit remained as high as 10% in 1991, hovered around 8-9%
during 1991-00, is also brought down to less than 3% in 2005-7, but
went up slightly to 6.8% in 2010, due to 3G auctions bought down to
4.8%.
• Crucial condition of sustainability of deficit financing, ie., nominal
growth rate always is at 14% safely above interest rate (10%). Hence
sustainability is a non-issue.
• Before jumping to this conclusion, we should look at some parameter
more carefully.
 Post-reform Fiscal Stance
• Since 1995 public debt-GDP ratio was brought down but went up
again during 2005-10.
• The public debt less RBI holdings of securities, call it Public Liability
has showed a steep rise in 1990s, as RBI credit to govt became even
negative.
• Moreover, the govt’s Incremental Financial Liability less monetised
deficit, (call it Fiscal Gap, which represents the increase in govt debt
plus reduction in financial assets – a better measure than fiscal
deficit). During 1991-98 fiscal deficit showed a downward trend, but
fiscal gap increased. Thus contrary to widely held belief that reduction
of FD per se did not contribute to the fiscal health of the economy.
• The fiscal deficits were rather harshly reduced during 1991-97 and
2000-08, mostly by reducing capital expenditure and disinvestment,
because of which the interest burden increased. Capital expenditure is
brought down from 6.8% to 1.6% in 2009-10.
• The revenue deficits went down much more slowly, hovered around
4% during 1991-00, went upto 6.8% during election years, but were
finally brought down to less than 2 %. The interest burden has
increased in 1990s and has come down during 2005-10.
• The saving grace is that nominal GDP always remained above
interest rate. But this is not good enough.
• The tax-GDP ratio has gone down from 20% to 16% during 1991-
05. This shows a falling tax buoyancy in India.
• Even the primary deficit that rose in 1991-00 to 4% is brought
down to negative figure in 2006, even though went up during
2008-10.
• With a falling tax-GDP ratio, means increase in disposable income
(of the rich by double), and fall in fiscal deficits achieved by a 5%
cut in capital expenditure-GDP ratio suggests a highly unequal
fiscal stance taken during the reform period.
• Government has lost its teeth to address issues like eduction,
health and agrarian distress since it has committed to reduce its
revenues along with revenue expenditure, a much needed
sacrifice for `fiscal restructuring’.
 Item Average Average 2004-05 2005-06 2006-07 2007-08 2008-09
1 1990-00 2000-01
to 2008-
09
Central Government
Finances (% of GDP)
a) Total Revenue 9.2 9.9 9.7 9.7 10.5 11.5 10.6 R
Receipts E

b) Total Expenditure 16 15.7 15.8 14.1 14.1 14.3 ** 16.9 R

E

c) Revenue Deficit 3 3.2 2.5 2.6 1.9 1.1 4.5 RE

d) Fiscal Deficit 5.9 4.7 4 4.1 3.4 2.7 6.1 RE

e) Net RBI Credit to 0.7 -0.5 -1.9 0.8 -0.1 -2.5 3.3 RE
Centre

f) Interest Payments 4.2 4.2 4 3.7 3.6 3.6 3.6 RE

g) Domestic Debt 48 58.5 61.4 60.4 59 57.7 56.6 R

E
Chart E India: Fiscal Deficit, Primary Deficit and Market
Borrowings (in Rs crore)

700000

600000

500000

400000

300000

200000

100000

0
2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10

-100000

GFD GPD MB(CS)

 Concluding Remarks
• For a given tax-GDP ratio, sustainability of debt financing depends on
whether GDP growth is higher than the interest rate, also on composition
of government expenditure, mode of financing, return on government’s
capital expenditure, extent of monetized deficit.
• Fiscal deficit is too hybrid concept and not give clues about sustainability of
debt financing.
• In countries with large preexisting pubic debt and low growth rate,
sustainability is an issue.
• Though Indian scenario does not suggest that we are heading towards an
internal debt trap. In nineties, aggregate investment demand stagnated,
tax-GDP ratio declined with a fall in public investment and rise in revenue
deficit. During 2014-16 too investment stagnated, with no significant FDI
coming. Reduction of public investment, reduction of fiscal deficit and
public debt are mechanically followed.
• Considerable room exists on boosting public expenditure by raising tax-GDP
ratio, resorting to moderate deployment of SLR, greater reliance on
monetized deficit.
 Readings
• Mihir Rakshit “Perspectives on Correcting
Fiscal Imbalances in Indian Economy” in
Money and Finance in the Indian Economy,
Selected Papers, vol.II, Oxford University
Press, New Delhi, 2009.
• Economic Survey 2009-10.
Public Sector Performance:
Issues and Perspectives
 Public Sector Performance
• The public sector in India defined in its broadest measure
accounts for roughly around 25% of GDP. It increased from a mere
10% in 1960-61 to a quarter now.
• The GVA of administrative departments (what Adam Smith called
sovereign duties), like law and order, general administration,
defence, health, education) accounts for 8-9%.
• Natural monopolies like railways, postal system (called
Departmental enterprises) account for 3-4%.
• Non-Departmental Enterprises, which are often referred as public
sector enterprises (like BHEL, SAIL, ONGC, Banks, etc) account for
12-13 %.
• NDE can be divided into financial and non-financial services.
• Public sector provide for 65% of country’s organised employment
in 2010. It used to be 80% before reforms.
 Different Perspectives
• This large share or contribution of PSUs to output and employment
attracted attention from diverse quarters, the critiques raising an
issue that there is no need for government to run hotels, airlines and
textile mills, these are clearly private goods and state does not have a
capacity to run profitably. Inefficiency is seen as emblematic of PSUs,
state support to PSU has contributed to large fiscal imbalances and
balance of payment problems (Tendulkar & Bhavani, Bhagawati, Joshi
&Little etc)
• There are others who argue that , given the historical circumstances,
state role was the only option for a rapid industrialisation, creation of
employment. The public sector played a great complimentary role for
development and still has wide and deep role to play for a stable and
equitable growth.
• Without denying of any of these arguments, there are positions that
take a view that public sector presence is desirable in strategic sectors
on even some non-economic factors, and evolve institutional
mechanisms to manage the conflicting aims such as making PSUs
viable and at the same time making them immune from political
interference. Many options like setting up holding companies,
disinvestment, signing MoUs with management are tried with varying
degrees of success.
• Since 1990s, public sector expansion is stalled with missionary
zeal, many of state and central level PSU were closed down, those
which are running with profits, their equity is sold in the stock
markets. A corporate discipline is contemplated with change in the
ownership profile, with a tacit prospect of eventual handing over
of them to private market. However, experience and political
expediency seem to have changed the stance to `private-public
partnership’.
Performance of PSUs: A Factsheet
• Since Independence, the output of PSUs as a share of GDP has
peaked in 1991-92 at 26.1%. More or less remained thereon.
• The output of PSUs, has particularly grew faster during 1978-92,
gone up from 15% to 26%, suggesting that it has significantly
contributed in accelerating the GDP growth in those years. In spite
of growing import competition and industrial deregulation, public
sector maintained its share in the output.
 PSU performance
• In contrast, the public investment, after peaking in 1986-87 at 12.5 %, is
halved to 6.4% in 2001-02, taking the ration back to 1950s level.
• Its indisputable that for 20 years, public sector managed to deliver
roughly an unchanging share of output even when its investment share
is drastically going down.
• Corroborating this evidence, the ACOR has declined from 7 in 1981-82
to 4.4 in 2002-03, suggesting an increase in productivity.
• A decline in ACOR mean a shift in investment to less capital-intensive
activity, but the share of infrastructure (mining, power, gas, water,
transport and communications) – which is capital intensive essentially,
its share has increased from 33% in 1974-75 to 53.5 % in 2001-02,
hence ACOR decline is genuinely due to increased efficiency, not by
design.
• This is also consistent with findings on increased total factor
productivity and – an increased output with decline in investment and
employment, what Liebenstein called in X-inefficiency – has declined.
 PSU employment
Fall in Public Sector Employment
• Public sector share in organised employment was 74% in 1980-81 and
this has come down, yet it provides 65% of total organised sector
employment in 2008.
• A bloated workforce, employed often on non-economic considerations
in PSUs is opined by some as a reason for its efficiency. But the
evidence suggests that despite such pressures the trend in growth rate
in employment has declined from 6% in 1970s to a negative -1.0% in
2002-03, the negative figure continues to this date.
• The total public sector employment has declined from 190.57 lakhs in
1991-92 to 176.74 lakhs in 2008-09, a loss of 13.26 lakh jobs as a result
of reforms.
• Interestingly, the female employment however has gone up from 23.47
lakhs to 30.4 lakhs during the same period – a rise of 7 lakhs, while 21
lakh males lost their job.
• Without denying the need to unload the over-staffing, what can be
claimed that public sector employment growth is drastically reduced
and it possibly contributed to its increased productivity.
 PSU Efficiency
Improvement in Thermal Power Plants
• Gross inefficiency in power sector is widely held as the chief
reason for the putative poor performance of PSUs.
• But the average plant load factor (PLF) for all the thermal power
plants has witnessed an uninterrupted rise from 44.3 % in 1979-90
to 74.8% in 2004-05. Since the power sector roughly accounts for
one third of total public investment, such an improvement can
surely contribute to the overall productivity growth noted earlier.
But whether physical parameters suggest improvement in
financial indicators such as profitability? That depends on pricing.
 Public Sector Savings
• The public sector savings as percentage of GDP has peaked in 1976-77 at
4.9% and declined progressively thereon into a negative figure in 1988-
89.
• But the share of non-departmental non-financial enterprises (NDNFE)
savings share to GDS has risen rapidly during 1980-81 to 1994-95. In
fact, the share of non-financial PSUs has been substantial since
beginning for the first 4 decades.
Profitability of Central PSUs
• The considerations to be held before evaluating profitability of PSUs, the
concept of net profit ration may not be appropriate. First, PSUs have to
invest in not only plant and machinery, but also in social overheads (like
roads, buildings that wont get any rents) they will have to provide
massive amounts to depreciation. Second, PSU capital structure is not
aimed at profit maximisation or shareholder’s investment, but provision
of goods and services for which markets are missing.
• Third, very often PSEs start with high proportion of debt provided in the
beginning, once it commences production it starts with high debt-equity
ratio. Finally, therefore, it is gross profits which is more relevant, not net.
• The gross profitability of central PSUs has increased from 8 % in
1970s to 21% in 2003-04 – a respectable figure by any
reasonable evaluation.
• However, if you exclude petroleum sector, which has high mark-
up ratio, then the gross profitability is lower, but still a rising
trend is seen at 18%.
• Therefore, it is not the central PSUs responsible for any poor
performance of NDNFEs. This leaves out utilities like power
(SEBs), ports, irrigation and transport corporations. But these
include administrative services, which account for sizeable share
in plan expenditure, profitability analysis cannot be done.
 Problem of Pricing
• Lets take the SEB’s revenue-cost ratio since 1993-94, as a proxy for its financial
performance. When its PLF has gone up from 44% to 74%, the revenue-cost
ratio has actually declined from 82.2% to 75% during 1975-05.
• Similarly, the revenue-cost ratio of railways declined from 120% to 84% in
2003, but this turned into positive balance during 2007-08. similarly, the
revenue-cost ration of RTCs have declined from 91.4% in 1991-92 to 88% in
2003.
• There could be three possible reasons for this fall in revenue-cost ratio, first, a
relative faster rise in costs, second, an increase in inefficiency, and third, poor
pricing or low recovery user charges. We have seen that the efficiency in PSUs
actually gone up, hence it is not the principal culprit. Then the suspicion zeroes
on poor pricing.
• If one sees the PSU’s share in national income price deflator, its share in the
last 40 years stood rock steady at 83%. The relative price never exceeded
overall price level. This means that public sector prices rose slower than the
overall price level, evidently affecting its financial position adversely. Due to
equity considerations, PSU were underpriced that caused them losses which is
a political decision, not an economic outcome.
 A Recapitulation
1. There is an improvement in the efficiency of resource use in
public sector in aggregate terms since the second half of 1980s,
with a corresponding fall in ACOR.
2. Improvements in physical efficiency in past may reflect in a fall
in public sector employment growth.
3. Thermal power plants in India that account for the bulk of
power generation show an uninterrupted rise in efficiency.
4. Despite these trends in rise in productivity, the financial losses
seem to be due to poor pricing of utilities like transport, power,
irrigation, etc.
 Implications
• What accounts for this improved performance of public sector? Market
oriented reforms might have contributed to some extent. But this
explanation would be facile in the absence of a causal explanation
between reforms and the desired effect. Given the financial losses at
the end of 1980s, the threat of privatisation and retrenchment of
workers arguably could have had positive effects.
• But there are other convincing answers, like in the post-reform period
there is an increased autonomy, second, growing competition in the
product market.
• The budgetary support to NDNFEs between 1960-05 has come down
and share of internal resources (depreciation and net savings) rose,
both as a proportion of GFCF. The budgetary support was 97.6% in
1963-64, it came down to 16.9% in 1996-97.
• The share of internal resources went up from 11.2 % in 1963-64 to 73%
in 2002-03. Cost consciousness and competitive pressures might have
led this improvement, yet this has not translated into an improvement
in financial indicators, since pricing seem to be holding down.
• The problem of inadequate electrical pricing, incomplete
metering of power usage and recovery of user charges are too
well known problems. Railway finances were a victim of coalition
politics and competitive populism. In case of RTC, profitable
routes are opened for private participation, reducing RTC traffic
which reduced its revenues. So appropriate pricing can take care
of much of its financial losses.
• Alternatively, budgetary support can be extended by monetizing
the debt, in the face of strong savings ratio, as is done by China. In
the absence of any such measures, pricing is the only solution for
recovery of losses. This is what Lalu has done, in the name of
tatkal tickets and increasing freight fare he made railway budget
viable.
• Infusion of foreign capital in public utilities is highly problematic
with high risks, as realised by India in Dhabhol power plant issue.
Nor any hasty exit of state in public utilities becomes an political
option at a time democracy is being deepened
• The neoliberal reforms incorrectly diagnosed public
ownership to be the main culprit for poor performance. One
can accept that ownership changes could allow freedom to
charge market-related prices to those who can pay. But most
of public utilities like power, irrigation, transport have
externalities, hence pricing cannot be conceived in terms of
mere marginal terms, it is related to public policy,
entrepreneurial freedom has little significance in these
industries.
• Moreover, more than ownership, what is important is market
structure. Hence public utilities, which are merit goods and
have positive externalities, are better served to all with the
pubic ownership.
References:
• R.Nagaraj (2006) : `Public Sector Performance
since 1950: a Fresh Look’, EPW, June 24.
• Atul Sharma: `Performance of Public
Enterprises in India’ in Dilip Mookherjee
edited Indian Industry: Theory, Policy and
Performance, OUP, 1997.