Indian Economic Policy

MEC-205
Indian Economic
Policy
VOLUME-I
(Block 1 and 2)
School of Social Sciences

Indira Gandhi National Open University
EXPERT COMMITTEE
Prof. Atul Sarma Prof. R. Nagraj Prof. K. Barik
Former Director, Indira Gandhi Institute of Professor of Economics
Indian Statistical Institute Development Research, Mumbai IGNOU, New Delhi
New Delhi & Visiting Professor
Prof. S.K.Singh Shri Saugato Sen
Institute for Human Development
Former professor of Economics Associate Professor of
New Delhi
IGNOU, New Delhi Economics
Prof. N.R. Bhanumurthi IGNOU, New Delhi
Prof. Vijay Katti
Professor, National Institute of Public
Professor and Head, Economics and Prof. Narayan Prasad
Finance and Policy, New Delhi
Trade Policy, IIFT, New Delhi (Convenor)
Prof. Pravakar Sahoo Professor of Economics,
Shri I.C.Dhingra
Institute of Economic growth, New Delhi IGNOU, New Delhi
Rtd. Associate Professor
Prof. Prem S.Vashistha Shaheed Bhagat Singh College
Rtd. Director, AGRO Economic (University of Delhi), Delhi
Research Centre,
Delhi School of Economics
University of Delhi, Delhi
COURSE COORDINATOR : Prof. Narayan Prasad

COURSE EDITOR : Prof. Rajeev Malhotra, Former Economic Advisor to Union Finance
Minister, Govt. of India
COURSE PREPARATION TEAM
Block/Unit Title Unit Writer Unit Editor
Block 1 Indian Economic Development: An Overview
Unit 1 Indian Economic Development – A Dr. Vijay Kachroo Prof. Narayan Prasad
Historical Perspective Rtd. Associate Professor
PGDAV College
Unit 2 Growth and Structure of the Indian Shri I.C. Dhingra Prof. Narayan Prasad
Economy Rtd. Associate Professor, Ms. Chetali Arora
Shaheed Bhagat Singh College
Delhi
Unit 3 Demographic Transition and Its Dr. Varun Bhushan Prof. Narayan Prasad
Implications Assistant Professor in Ms. Chetali Arora
Economics, PGDAV College,
Unit 4 Natural Resources Shri I.C. Dhingra Prof. Narayan Prasad
Rtd. Associate Professor Ms. Chetali Arora
Delhi
Unit 5 Physical and Social Infrastructure Dr. Charu Jain Prof. Narayan Prasad
NCAER, New Delhi &
Ms. Chetali Arora,
Academic Associate
IGNOU, New Delhi
Block 2 Development Strategies
Unit 6 State and Market: Indian Context Prof. P.K.Chaubey Prof. Narayan Prasad
Rtd. Professor IIPA, Ms. Chetali Arora
New Delhi
Unit 7 Economic Reforms in India Prof. P.K.Chaubey Prof. Narayan Prasad
Rtd. Professor IIPA, Ms. Chetali Arora
New Delhi
Unit 8 Major Developments in Prof. S.K.Singh Prof. Narayan Prasad
Post Economic Reform Period Rtd. Professor of Economics Ms. Chetali Arora
IGNOU, New Delhi
SECRETARIAL ASSISTANCE & GRAPHICS
Ms. Kamini Dogra
Personal Assistant
SOSS IGNOU, New Delhi
PRINT PRODUCTION
Mr. Yashpal
Assistant Registrar (Publication)
IGNOU, New Delhi
April, 2021
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CONTENTS
BLOCK 1 INDIAN ECONOMIC DEVELOPMENT:

AN OVERVIEW 7
UNIT 1 Indian Economic Development – A Historical Perspective 9
UNIT 2 Growth and Structure of the Indian Economy 31
UNIT 3 Demographic Transition and Its Implications 54
UNIT 4 Natural Resources 81
UNIT 5 Physical and Social Infrastructure 108
BLOCK 2 DEVELOPMENT STRATEGIES 137
UNIT 6 State and Market: Indian Context 139
UNIT 7 Economic Reforms in India 162
UNIT 8 Major Developments in Post Economic Reform Period 187

COURSE INTRODUCTION: INDIAN
ECONOMIC POLICY (MEC-205)
The focus of the course on Indian Economic Policy is to discuss the analytical
framework within which the economic policy has evolved over time. It highlights
the consideration that has underpinned the formulation and implementation of
the policies at the macro and at micro (sectoral) levels. Several theoretical concepts
have found an expression in this course. The economic policies conditioned the
environment and in turn were conditioned by the environment. This two-way
relationship has been examined in this course. An integrated approach to different
aspects of policy-making has been adopted.
The course is structured around six blocks. Each block is further sub-divided in
to several units. Each Unit is self-contained and has organic linkages with all
other Units.
Providing an overview of Indian economic development in historical perspective,
Block 1 presents the status of growth and structure of the Indian economy since
independence. The block also discusses the prospects and opportunities of Indian
economy in the context of domestic and international developments. Demographic
profile of India and its implications for demographic dividend and the resource
base of Indian economy both in terms of natural resources and physical and
social infrastructure have also been covered in this block.
Block 2 deals with the development strategies adopted in India. It focuses on the
policy choice exercised between state and market as the principle drivers of
economic activity in different phases of India’s development journey.
Block 3 throws light on two major economic policy instruments i.e., monetary
and fiscal policy. The four units covered in this block focus the decisive role that
has been played by the monetary and fiscal authorities in guiding a growing
economy. It highlights some of the major milestones including measures related
to the FRBM Act, the implementation of goods and services tax (GST,) the
recommendation of 15th Finance Commission and the new mandate of the
monetary policy on inflation targeting and the institutional context in which that
has to be pursued.
Block 4 on sector specific issues and policies assess growth in all three sectors
of economy i.e., primary, secondary and organised and unorganised services
sector, focusing on issues and concerns of these sectors that need to be addressed
in the respective policy initiatives for those sectors.
Block 5 analyses the External Sector and Trade Policy. It examines the emerging
external sector in India’s economy and issues to be addressed in Trade Policy.
The major issues and challenges encountered in India’s economic policy-making
have been identified and analysed in Block 6. These issues are: Poverty:
Malnutrition and Inclusive Growth; Employment and Unemployment; Social
Security measures; Regional Disparities and Ingredients of Good Governance.
Block 1
Indian Economic Development: An Overview
Indian Economic Development:
An Overview BLOCK 1 INDIAN ECONOMIC
DEVELOPMENT: AN OVERVIEW
This Block presents the evolution of the Indian economy since the Colonial period.
Covered in this block is the status and structure of the Indian economy since
independence which will enable us to know the evolution and analysis of Indian
economic policy in historical context. This block comprises of 5 Units.
Unit 1: Indian Economic Development: A historical perspective provides an

overview of India’s Colonial economy during the British period, the process
resorted by the British rulers to undermine and disrupt the traditional Indian
economy and important milestones of Indian national movement which in turn
will enable an understanding of the evolution of Indian economic policy in post-
independence period.
Unit 2: Growth and structure of the Indian economy identifies the growth
path of Indian Economy since 1951, the stages of growth through which Indian
Economy has evolved.
Unit 3: Demographic transition and its implications throws light on theory of

demographic transition, demographic profile of India, the issues related to
potential demographic dividend that can be harnessed across Indian states.
Unit 4: Natural Resources provides the status of natural resources i.e. land and
soils, water resources, biodiversity, forest mineral resources etc as availability
of these resources, their utilisation and capacity to mobilise determine the
economy’s ability to overcome the constraints on its development.
Unit 5: Physical and Social infrastructure provides a profile of the availability

of physical and social infrastructure in the country. The policy framework of
public private partnership that has facilitated the growth of transport,
telecommunication energy and social infrastructure has been examined. The
challenges confronting the infrastructure and the way ahead have also been
discussed.
8
Indian Economic
UNIT 1 INDIAN ECONOMIC Development – A Historical
Perspective
DEVELOPMENT - A HISTORICAL
PERSPECTIVE
Structure
1.0 Objectives
1.1 Introduction
1.2 India in the Eighteenth Century
1.3 British Rule: State of Colonial Economy
1.3.1 Disruption of the Traditional Economy
1.3.2 Impoverishment of the Peasantry
1.3.3 Commercialisation of Agriculture
1.3.4 Agricultural Labourers
1.3.5 Lack of Modernisation
1.3.6 Ruin of Artisans and Handicrafts
1.3.7 Status of Modern Industries
1.4 Drain of Wealth
1.5 Poverty and Famines
1.6 Macroeconomic Policy
1.6.1 Savings and Investments
1.6.2 Fiscal Policy
1.6.3 Trade Policy
1.7 Programme of Economic Reconstruction for Independent India
1.8 Let Us Sum Up
1.9 Key Words
1.10 Term-end Exercises
1.11 References
1.12 Answer or Hints to Check Your Progress Exercises
1.0 OBJECTIVES
After going through this unit, you will be able to:
get an overview of the state of India’s colonial economy during the British
period;
explain the process resorted by British rulers to disrupt the traditional Indian
economy that resulted in pauperisation of Indian people;
discuss the macroeconomic policies particularly trade and fiscal policies
during British rule; and
appreciate the important milestones of Indian National Movement which
will help you to understand the evolution of Indian Economic Policy in
post-independence period.
9
An Overview 1.1 INTRODUCTION
British rule drastically transformed India. British penetration and control brought
to India modern business and political institutions, technology, capital and
administrative practices. Many positive developments took place in the field of
agriculture, industry, finance, transport and communication. One positive feature
was the growth of the means of transport and communication. In the 1940s,
India had 65,000 miles of paved roads and nearly 42,000 miles of railway track.
Roads and railways unified the country and made rapid transit of goods and
persons possible. The Government of India also established an efficient and
modern postal and telegraph system. But this did not produce a type of economic
development capable of generating real momentum. The reason was that these
changes took place within and as part of colonial framework. To make available
to their home industry, the cheapest raw material, the British destroyed the rural
economy. To make the immense Indian market available for their industrial goods
they ruined the handicraft industry. The colonial relationship subordinated Indian
to British political and economic interests; it stimulated Indian economic
development in some way and inhibited it in other ways.
Our industry had stunted growth. Colonial government. was not keen to develop
modern industries such as automobile, aviation, chemical, etc. They did construct
a network of railway tracks criss-crossing the length and breadth of this country
but did not invest as much in social sector such as in education, technical education
or enhancement of managerial skills. They did not encourage the growth of
ancillary industry. Construction of railways in India, unlike in Europe, did not
lead to comprehensive expansion of technical base, engineering institutes and of
local managerial skill. Indians were not involved at higher levels in managing
the transport, commercial and technical side of the venture. More or less similar
was the case with our financial institutions and trade. There was no dearth of
entrepreneurial spirit in the country. Indian owned business and industry thrived
whenever imperial world was in crisis such as during two World Wars (Ist 1914-
18 and IInd 1939-45). Against this background, after reading this unit, one can
understand how India — with abundance of natural resources and having a
thriving trade with both East and the West, where every western trading company
wished to open trading centres, became a country with a stigma attached to it of
a country with a begging bowl. To understand the evolution of the Indian economic
policy post-independence, we have to get a bird’s eye view of economic
developments of pre-colonial and colonial India.
1.2 INDIA IN THE EIGHTEENTH CENTURY

In the eighteenth century the subcontinent was a major commercial hub of the
contemporary world. It was the wealth of India that attracted the British. “Nearly
every kind of manufacture or product known to the civilised world…had long,
long been produced in India. India was far greater industrial and manufacturing
nation than any in Europe or than any other in Asia.” (J.T. Sunderland, India in
Bondage, 1929, p.367). Historically, Indian economy had been dominant in the
world prior to the colonialism. The data pertaining to the share of contribution
made by major countries in the world GDP during the period 1-2003 A.D. has
been incorporated in Table 1.1.
10
Table 1.1: Share of Major Countries in World GDP 1-2003 AD Indian Economic
(Per cent of World Totals) Development – A Historical
Perspective
Countries 1 1000 1500 1600 1700 1820 1870 1913 1950 1973 2003
12 Country* 10.6 7.0 15.5 17.1 19.1 20.5 30.5 30.8 24.1 22.8 16.5
Total
Total Western 13.7 9.1 17.8 19.8 21.9 23.0 33.1 33.0 26.2 25.6 19.2
Europe
USA 0.3 0.4 0.3 0.2 0.1 1.8 8.9 18.9 27.3 22.1 20.6
China 25.4 22.1 24.9 29.0 22.3 32.9 17.1 8.8 4.6 4.6 15.1
India 32.0 28.1 24.4 22.4 24.4 16.0 12.1 7.5 4.2 3.1 5.5
Other 4.6 7.5 8.4 7.4 7.7 5.2 4.8 4.5 4.8 5.2 9.6
East Asia
Total of 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
World
Source: Adapted from Table A.6 of the Book ‘The Contours of World Economy 1-2030 AD by Late British
Professor Angus Maddison, Oxford University Press 2007, p.p. 381.
*Austria, Belgium, Denmark, Finland, France, Germany, Italy, Netherlands, Norway, Sweden, Switzerland
and the UK.
The trend in the share of major countries in the world economy during the period
1-2003 A.D. has been plotted in the Figure 1.1:
Fig. 1.1: Trend in the Share of Major Countries in World GDP
Some observations from the above table and figure showing the evolution of
global economies over 2000 years in terms of percentage contribution of GDP
can be summarised as follows:
1) Before the 18th century, India and China were the two largest economies in
terms of their share in the world GDP.
2) During the period from the First millennia CE (i.e. from 1 CE to 1000 CE)
till 14thcentury CE (where CE stands for Common Era) India has been the
largest GDP contributor to the world economy.
3) During the first 17 centuries of Common Era (i.e. from 1 CE to 1700 CE),
11
Indian Economic Development: India has been the largest GDP contributor world-wide (ranging between
An Overview
32 per cent to 24.4 per cent), with the exception of two centuries (16th and
17th), where she stood second to China by a margin of about 0.5 percentage
points at the turn of century 1500 and by about 7 percentage points at the
turn of century 1600.
4) During the period from 1700 to 1870, India’s GDP contribution slowed down
to more than half, dropping around 12 percentage points from 24.4 per cent
to 12 per cent. In the same period Western Europe shoot up by approximately
33 per cent and 11 percentage points, from ~22 per cent to 33per cent.
At the beginning of British rule in mid-18th century, India supplied quarter of all
manufacture goods in the world and Indian handicrafts constituted chief export
items of European trade. While India produced about 25 per cent of world
industrial output in 1750, this figure fell to just two per cent by 1900. The four
great textile export regions in the eighteenth century were Punjab, Gujarat,
Coramandal and Bengal.
The decline of Mughal empire did not lead to anarchy as it is sometimes believed.
There was shift in economic activity from centre to periphery. In Bengal,
Hyderabad and Awadh, former provincial governors established effectively
independent rules. A number of new successor states thus came into being, the
most powerful being dominion of Marathas.
By early 18th century, Bengal became a key region for the English Company’s
trade in textiles, and Bengal goods came to comprise nearly 60 per cent of the
English imports from Asia. The Bengal trade was often described by the factors
as ‘the best flower of the Company’s garden’ or the ‘choicest jewel’.
Import of Indian textile was largely financed by bullion. European traders

exchanged South American bullions (mainly silver) for manufactured goods and
spices from India. In case of English Co., in the first two decades of 18th century
the amount of precious metal to the total value of import was between 90 and 94
per cent.
However, the influx of bullion stopped completely after defeat of Nawab of Bengal
Siraj-ud-daula in the Battle of Plassey (June 1757).This marked the beginning of
political supremacy of the English East India Company in India. Now the
resources of Bengal financed the English Company’s investments.
1.3 BRITISH RULE: STATE OF COLONIAL

ECONOMY
1.3.1 Disruption of the Traditional Economy
Colonialism led to integration of India’s economy with the world economy but
in a subservient manner. The economic policies followed by the British led to
the rapid transformation of the Indian economy into a colonial economy whose
nature and structure were determined by the needs of the British economy. The
18th century was a period of transition. The economy became more exposed to
the world economy. And as colonial rule took root, the foundations were laid for
a new economy based on peasant exports and support for the global industrial
12
enterprise. India became a major market for British manufactures, a principal Indian Economic
Development – A Historical
source for raw materials and food, and an important entity of the British empire. Perspective
The pattern of trade changed dramatically during the 19th century. While India
had dominated world textile trade in the 18th century, it lost this position in the
19th century. The composition of trade changed. Export of textiles and import of
bullion dominated the 18th century. Export of cotton cloth dropped sharply after
1800 and import of machine-made cloth and yarn expanded. At the time of World
War-I, Indians consumed 85 per cent of cotton piece goods (fabrics, made in
standard width and length) manufactured at Lancashire. Textiles began to be
replaced by new exportable articles such as indigo, opium, silk, tobacco, and
cotton and to a limited extent by salt, sugar, and saltpetre. The basic economic
model of self-sufficient rural economy was disrupted.
1.3.2 Impoverishment of the Peasantry

The first to suffer was the agriculture sector. With the grant of Diwani (taxation
rights) of Bengal, Bihar and Odisha in1765, the policy of East India Company to
extract the largest possible revenue led to complete devastation of India’s agrarian
economy and the society in the Diwani provinces in a matter of a few years. One
indication of the prevailing impoverishment and the general chaos was seen in
the famine of 1769-70, in which about one-third of undivided Bengal’s population
was wiped off.
The Company replaced the existing land tenure system and introduced three
different systems – the zamindari in the eastern India, the ryotwari in the southern
and western India and the mahalwari in the western Gangetic plains. The purpose
was to secure the maximum guaranteed land revenue returns, at the expense of
cultivators well-being. The zamindari system or Permanent Settlement gave
property rights to zamindars and revenue was fixed in perpetuity. The peasantry
became tenants of zamindars. The ryotwari settlement gave property rights to
the peasants and the mahalwari settlement gave property rights to dominant
kinship lineages in the village. In both the ryotwari and mahalwari systems
revenue was subject to revision, approximately every 30 years. In the zamindari
areas, the peasants were left to the mercies of the zamindars who raised rents to
unbearable limits. The peasants were compelled to pay illegal cesses and were
oppressed in diverse ways. In the ryotwari and mahalwari areas, the condition
of the cultivators was no better. Here the government took the place of the
zamindars and levied excessive land revenue which was fixed as high as one-
third to one-half of the produce.
Since the primary aim of the Company was to maximise revenue income, a
common feature of all the settlements was over-assessment. One of the main
causes of the increase in poverty and the deterioration of agriculture in the 19th
century was heavy revenue assessment of the land. The rates fixed fell beyond
the paying capacity of the cultivators. Ultimately the cultivators had to rely on
the support from the local money lender, an informal source of credit. The farmer’s
assets got transferred to the money lender. Landlords and rich farmers found
lending far more profitable and safer than making productive investment in land
they owned or controlled. There were thus arrears of payment, mounting debt,
increasing land sales and dispossession. However, subsequent research established
that the effects of these changes were less spectacular than once imagined. “Land
transfers from the peasant to the professional lender,” remarks Tirtankar Roy
13
Indian Economic Development: “happened on a limited scale”(The Economic History of India 1857-1947,OUP,
An Overview
2011, p.134). He further adds, “For the very reason that land transfers between
peasants and non-peasants posed large transaction costs, much rural credit
business came into the hands of the rich peasant rather than professional
lender”.(ibid. p.135)
Agriculture suffered. It stagnated in most parts of the country and even deteriorated
over the years, resulting in extremely low yields per acre,. There was a decline in
the per capita agricultural production which fell by 14 per cent between 1901
and 1941. The fall in per capita food grains availability was even greater, being
over 24 per cent.
1.3.3 Commercialisation of Agriculture

Commercialisation of agriculture is a sign of progress towards capitalist
agriculture. In many areas, a class of rich peasants developed because of
commercialisation and tenancy legislation, but most of them preferred to buy
land and become landlords or to turn to money lending. As a result, except in a
few pockets, capitalist farming was slow to develop. Importantly,
commercialisation of agriculture did not lead to capitalist farming or improved
technology. Its main consequence was the diversion of better soil, available water,
and other resources from food crops to commercial crops.
The growing commercialisation of agriculture also helped the moneylender-cum-

merchant to exploit the cultivator. The poor peasant was forced to sell his produce
just after the harvest and at whatever price he could get as he had to meet in time
the demands of the government, the landlord and the moneylender. This placed
the peasant at the mercy of the grain merchant, who was able to dictate terms and
who purchased his produce at a price much lower than the market price. Thus, a
large share of the benefit of the growing trade in agricultural products was reaped
by the merchant, who was very often also the village moneylender.
1.3.4 Agricultural Labourers

Impoverished cultivators, most of them small peasants, tenants-at-will, and
sharecroppers, had no resources or incentive to invest for the improvement of
agriculture by using better cattle and seeds, more manure and fertilizers and
improved techniques of production. The loss and overcrowding of land caused
by de-industrialisation and lack of modern industry compelled the landless
peasants and ruined artisans and handicraftsmen to become either tenants of the
moneylenders and zamindars by paying rack-rent or agricultural labourers at
starvation wages. For most of the colonial period, landlessness had been rising.
1.3.5 Lack of Modernisation

Of the revenue that the colonial state secured, it spent very little on improving
agriculture. It devoted almost its entire income to meet the needs of the British-
Indian administration, make payments of direct and indirect tribute to England,
and serve the interests of British trade and industry.
At a time when agriculture in developed countries was being modernised and

reformed, there was a near absence of change in the technological and production
base of the Indian agriculture. “The basic set of agricultural implements”, remarks
14
Tirtankar Roy, “changed little during British rule”( The Economic History of Indian Economic
India 1857-1947, Tirthankar Roy, OUP, 2011, P.110). Indian peasants continued Perspective
to use the primitive implements they had used for centuries. For example, it is
estimated that in 1951, there were only 0.93 million iron ploughs in use while
wooden ploughs numbered 31.3 million. The use of inorganic fertilizers was
virtually unknown, while a large part of animal manure–cow dung, night soil
and cattle bones–were wasted. In 1938-39, only 11 per cent of all cropped land
was under improved seeds, their use being largely confined to non-food cash
crops.
Agricultural education was completely neglected. In 1946, there were only nine
agricultural colleges. There was hardly any investment in terracing, flood-control,
drainage, or desalination of soil. Irrigation was the only field in which some
progress was made.
Thus, the peasantry was crushed under the triple burden of the government, the
zamindar or landlord, and the moneylender. After these three had taken their
share not much was left for the cultivator and his family to subsist on. It has been
calculated, remarks Bipan Chandra “that by the end of the colonial period, the
rent and interest paid by the peasantry amounted to Rs. 1,400 million per year.
By 1937, the total rural debt amounted to Rs. 18,000 million” (India Since
Independence, Penguin, 2008 The Digital Edition, 2011, P.23).
The result was continued impoverishment of peasantry, along with an increase

in the incidence and adverse consequences of famines on the poor. People died
in millions whenever droughts or floods caused failure of crops and scarcity.
The human and institutional factors became more important than nature’s fury in
causing distress and starvation.
1.3.6 Ruin of Artisans and Handicrafts

At the beginning of the British rule in mid-18th century, India supplied quarter of
all manufactured goods produced in the world and textiles was the chief export
item of India’s European trade. British conquest destroyed the unity between
the agriculture and the manufacturing sectors that characterised traditional Indian
society. The villages lost their autonomy and self-sufficiency. The oppression
practiced by the East India Company and its servants on the craftsmen of Bengal
during the second half of the 18thcentury, forcing them to sell their goods below
the market price and to hire their services below the prevailing wage, compelled
many of them to abandon their ancestral professions.
In the wake of the industrial revolution, there was a sudden collapse of urban
handicrafts industry which had for centuries made India’s name a byword in the
European markets. Not only did this export demand gradually evaporate, but
colonial rule opened Indian markets for British manufactured goods. After 1813,
the British imposed a policy of oneway free trade upon India and the invasion
of British manufactures, in particular cotton textiles, followed immediately. Indian
goods made with primitive techniques could not compete with goods produced
on a mass scale by powerful steam-operated machines. The worst hits were cotton-
weaving and spinning industries. Other industries that suffered were silk and
woollen textiles, oil-pressing, tanning, dyeing, iron, pottery, metals, and shipping
industries. This led to ‘deindustrialisation’ or destruction of the indigenous
industry. While India produced about 25 per cent of the world’s industrial output
15
Indian Economic Development: in 1750, this figure fell to only 2 per cent by 1900. The decline of Indian handicrafts
An Overview
was reflected in the collapse of the industrial towns and cities, such as Surat,
Dacca, Murshidabad.
With introduction of railways, the destruction of Indian industries, particularly

rural artisan industries, proceeded even more rapidly. The railways enabled British
manufactures to reach and uproot the traditional industries in the remotest villages
of the country The destruction of rural crafts broke up the union between
agriculture and domestic industry in the countryside. This contributed to the
decline of the self-sufficient rural economy. This blow to the Indian handicraft
textile industry in early 19thcentury is believed to have pushed many industrial
workers into other low-paying occupations, intensifying poverty. The ruined
artisan failed to find alternative employment because of lack of growth of modern
industries. Hence, craftsmen fell back on the land as tenants, sharecroppers, and
agricultural labourers.
1.3.7 Status of Modern Industries

Under the British rule, the Indian industry suffered numerous constraints.
Between, the 1850’s (when the first major industries started) and 1914, India
created the world’s largest jute manufacturing industry, fourth or fifth largest
cotton textile industry, and the third largest railway network. Modern industrial
processes, however, did not spread easily from sector to sector. Thus, at the time
of independence, India was largely non-industrial and one of the world’s poorest
areas. The period that witnessed industrialisation of Europe, also witnessed de-
industrialisation of the Indian economy.
Although all basic requirements for economic growth were available in India:
labour (skilled), capital, market, and spirit of enterprise, yet the economy could
not regain the path it had traversed in the past. All this was largely due to the
colonial rule and the policies that were followed to sustain that regime. Indeed,
most analysis of the colonial India has attributed the unsatisfactory performance
of the economy and the absence of modern industrial development to either British
policy, which inhibited local initiative. Every time colonial grip became weak
due to crisis faced by the government, Indian industry thrived. This happened,
for instance, when Britain was drawn into the two World Wars.
The machine age in India began when cotton textile, jute and coal-mining
industries were started in the 1850s. The first textile mill was opened in Bombay
by Cowasjee Nanabhoy in 1853, and the first jute mill in Bengal in 1855.These
industries gradually expanded. By first decade of the 20thcentury, India had 206
cotton mills employing nearly 1,96,000 persons. In 1901, there were over 36
jute mills employing nearly 1,15,000 persons. The coal-mining industry employed
nearly one lakh persons in 1906.Other mechanical industries which developed
during the second half of the 19thand the beginning of the 20thcentury were cotton
gins and presses, rice, flour and timber mills, leather tanneries, woollen textiles,
sugar mills, iron and steel works, and such mineral industries as salt, mica and
saltpetre. Cement, paper, matches, sugar, and glass industries developed during
the 1930s. But all these industries had a very stunted growth.
Most of the modern Indian industries were owned or controlled by the British
capital. Only in the cotton textile industry did Indians have a large presence
from the very beginning, and in the 1930s, the sugar industry was developed by
16
Indians. There were many reasons for the domination of enterprise by British Indian Economic
managing agencies. Banks were mostly controlled by British financers. It was Perspective
not easy for Indians to get credit from Banks. Even when they got loans, they
had to pay high interest rates while foreigners could borrow on much easier
terms. Of course, Indians began to develop their own banks and insurance
companies gradually. In 1914, foreign banks held over 70 per cent of all bank
deposits in India; by 1937, their share had decreased to 57 per cent. British
enterprises in India also took advantage of their close connection with British
suppliers of machinery and equipment, shipping, insurance companies, marketing
agencies, government officials and political leaders to maintain their dominant
position in the Indian economy. Moreover, the government followed a conscious
policy of favouring foreign capital as against Indian capital.
The railway policy of the government also discriminated against Indian enterprise;
railway freight rates encouraged imports at the cost of trade in domestic products.
It was more difficult and costlier to distribute Indian goods than to distribute
imported goods. Another serious weakness of Indian industrialisation in the
colonial period was the almost complete absence of heavy or capital goods
industries, without which there can be no rapid and independent development of
industries. India lacked such basic industries as steel, metallurgy, machine,
chemical and oil in 1950. The country met about 90 per cent of its needs of
machine tools through imports. India also lagged in the development of electric
power.
The 19thcentury also witnessed the growth of plantation industries such as indigo,
tea and coffee. They were almost exclusively owned by Europeans. Indigo
manufacturing was introduced into India at the end of the 18thcentury and
flourished in Bengal and Bihar. It was used as dye in manufacturing textile.
Peasants were compelled to cultivate indigo instead of food crops. This oppression
of indigo planters was vividly portrayed by the famous Bengali writer Dinbandhu
Mitra in his play Neel Darpan in 1860. With the invention of a synthetic dye the
indigo industry gradually declined.
The tea industry developed in Assam, Bengal, south India, and the hills of
Himachal Pradesh. It was assisted by the government with grants of rent-free
land and other facilities. In time, the use of tea spread across India and it also
became an important item of export. Coffee plantations developed during this
period in south India.
The plantation and other foreign-owned industries were of hardly any advantage
to the Indian people. Their profits went out of the country. Most of their products
were sold in foreign markets and the foreign exchange so earned was utilised by
Britain. A large part of their salary bill was spent on highly paid foreign staff.
They purchased most of their equipment abroad. Most of their technical staff
was foreign. The only advantage that Indians got out of these industries was the
creation of unskilled jobs. Most of the workers in these enterprises were, however,
extremely low paid, and they worked under extremely harsh conditions for very
long hours.
Overall, industrial progress in India was exceedingly slow. Both in terms of

production and employment, the level of industrial development was stunted
and paltry compared to the developed countries of the time. It did not compensate
the output and employment loss of the handicraft industries that it had displaced.
17
Indian Economic Development: Industrial development was mainly confined to cotton, jute industries and tea
An Overview
plantations in the 19th century, and to sugar and cement in the 1930s.There had
been some development of the iron and steel industry after 1907, but as late as
1946, cotton and jute textiles accounted for nearly 30 per cent of all workers
employed in factories and more than 55 per cent of the total value added by
manufacturing.
The share of modern industries in national income at the end of British rule was
only 7.5 per cent. In terms of production as well as employment, the modern
industrial development of India was insignificant as compared with the economic
development of other countries or in keeping with the requirements of India’s
economic development. In 1950, out of a population of 357 million only
2.3 million were employed in modern industries.
Check Your Progress 1

1) State the reasons for disruption of the traditional economy of India during
the British period.
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2) Identify the reasons for increase in poverty and deterioration of agriculture
in the 19thcentury.
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3) State the reasons for destruction of the Indian indigenous industry in the18th
century.
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4) In what way were Indian enterprises discriminated during the development
of modern industries in the early 20th Century?
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18
Indian Economic
1.4 DRAIN OF WEALTH Development – A Historical
Perspective
There was the drain of India’s wealth to Britain. It was the unilateral transfer of
social surplus and potential investable capital by the colonial state and its officials
and foreign merchants to Britain. This transfer happened through the sale of
“Council Bills”, which were sold in London in sterling to purchasers of Indian
goods who received Indian rupees in exchange.
The process of the economic drain actually started after 1757. The East India
Company ceased to export bullion to Bengal as of that year, although some
marginal export of bullion occurred to other places. All the purchases in Bengal
and other parts of India were made out of the surplus of the territorial revenue of
Bengal. The part of revenue devoted to such purchases was known as ‘investment’.
Later more components got added to this economic drain. Montgomery Martin
who made a survey of the condition of the people of Bengal and Bihar from 1806
to 1816 realised the enormity of the economic drain. He concluded: “The annual
drain of £3,000,000 on British India has amounted , in thirty years at twelve per
cent (the usual Indian rate) compound interest, to the enormous sum of
£723,000,000 sterling….So constant and accumulating a drain, even in England,
would soon impoverish her.” (adopted from William Digby, Prosperous British
India p.223). Nearly one century later, William Digby too concluded that the
primary cause of India’s deplorable condition was the Economic Drain. The view
of William Digby was that the total drain amounted to £60,080 millions up to the
end of the 19th century (p.230).
There were several components of this drain of wealth. These were interest on
foreign debt incurred by the East India Company, military expenditure, guaranteed
return on foreign investments in railways, irrigation, road transport and finally,
“home charges” or paying for the secretary of state and his establishment at the
India Office in London, as well as pay and pension of civilian and military
personnel. It has been estimated that 5 to 10 per cent of the total national income
of India was in a way unilaterally exported out of the country. To find out the real
cause of poverty in India, more than hundred years ago, Dadabhai Naoroji in his
‘Poverty and Un-British Rule in India’ (1876) developed explicitly a ‘drain theory’
and according to him, this ‘economic drain’ by the alien ruler was “potential
surplus” that could have supported domestic capital formation, generating
economic expansion, had it been invested in India.
1.5 POVERTY AND FAMINES

The consequence of colonial underdevelopment was pauperisation of people,
especially the peasantry and the artisans. British economic exploitation, the decay
of indigenous industries, the failure of modern industries to replace them, high
taxation, the drain of wealth to Britain, and a regressive agrarian structure leading
to stagnation of agriculture and exploitation of poor peasants by zamindars,
landlords, and moneylenders reduced Indian people to extreme poverty.
A series of famines that ravaged all parts of India in the second half of the 19th
century contributed significantly to the incidence of poverty and deprivation in
the country. There were regular scarcities and minor famines in one or the other
part of the country throughout the British rule. In 1770, a third of the population
of Bengal reportedly died in a famine. In 1865-66 a famine engulfed Odisha,
19
Indian Economic Development: Bengal, Bihar and Madras and took a toll on nearly two million lives with Odisha
An Overview
alone losing one million people. Between 1876 and 1878, 4 million people died,
mainly in Bombay and Madras Presidencies. In 1897-97, more than 5 million
perished. Apart from these major famines, many other local famines and scarcities
occurred. William Digby, a British writer, estimated that in all over 28.8 million
people died during famines from 1854 to 1901. Another famine in 1943 accounted
for nearly a million people in Bengal. These famines and the high losses of life
indicate the extent to which poverty and hunger had taken root in India.
The grim reality of India’s poverty during the 19th century was recognised by
many English officials. “I do not hesitate to say,” remarked Charles Elliott, a
member of the Governor-General’s Council, “that half the agricultural population
do not know from one year’s end to another what it is to have a full meal.”
William Hunter, the compiler of the Imperial Gazetteer, conceded that “forty
million of the people of India habitually go through life on insufficient food.”
( British rule in India: Condemned by the British Themselves, issued by the
Indian National Party, London, p.67). “Why is it India” remarked William Digby,
“is more liable to devastation by famine than are other countries? – because
India is steadily and rapidly growing poorer.”(ibid.p.140)
In the 20th century the situation became worse. The quantity of food available to
an Indian declined by as much as 29 per cent in the 30 years between 1911 and
1941. India along with China had the lowest per capita incomes during the period
1925-34 as per the estimates of Colin Clark, whereas, the per capita income in
England was five times that of India. Moreover, the life expectancy of an Indian
during the 1930s was only 32 years while most of the West European and North
American countries, enjoyed a life expectancy of over 60 years already.

1) What do you understand by the term ‘drain of wealth’? State the process of
drain of wealth followed during the British period.
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2) Explain how a series of famines that occurred during the period 1770 to
1943 may have contributed to pauperisation of Indian people.
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20
Indian Economic
1.6 MACROECONOMIC POLICY Development – A Historical
Perspective
Indian economy during the British era suffered from low levels and growth rates
of national and per capita income, stagnant agriculture sector, falling share of
indigenous handicraft industry, weak capital goods industry base, foreign trade
oriented to feed the Industrial Revolution in Britain, prevalence of rampant poverty
and unemployment and what not. The state of the economy could be clearly
depicted with the help of the following macroeconomic indicators:
1.6.1 Savings and Investments

Expansion of an economy depends on the process of capital accumulation, which
is a function of the magnitude and utilisation of economic surplus or savings
generated in an economy for investment. The net savings in the Indian economy
from 1914 to 1946 was only 2.75 per cent of Gross National Product (GNP).
This magnitude may be contrasted with the net savings in 1971-75 when they
constituted 12 per cent of GNP and more recently in 2017-18 the share of gross
savings was 30.5 per cent of GDP. The share of total capital formation had been
6.75 per cent of GNP during 1914-46 as against 20.14 per cent of GNP during
1971-75, and 32.3 per cent of GDP in 2017-18. Moreover, the share of industry
in this low level of capital formation was small with machinery forming only
1.78 per cent of GNP during 1914-46. This figure was 6.53 per cent of GNP in
1971-75.
A considerable part of India’s social surplus or savings was appropriated by the
colonial state and deployed to finance its strategic interests. Another large part
was appropriated by the indigenous landlords and moneylenders. According to
Bipan Chandra, by the end of the colonial period, the rent and interest paid by
the peasantry amounted to Rs. 1,400 million per year. Only a very small part of
this large surplus was invested in the development of agriculture and industry.
1.6.2 Fiscal Policy

A feature of India’s governance was the role played by the State in constructing,
determining, and maintaining different aspects of the colonial structure to rule
the country. India’s policies were determined in Britain and in the interests of the
British economy and the British capitalist class. Thus, an important reason for
the underdevelopment of India was the denial of State support to industry and
agriculture. This was contrary to what happened in nearly all the capitalist
countries, including Britain, which enjoyed active State support in the early stages
of development. Some other aspects of the policy framework that guided colonial
rule in India were:
i) Regressive Tax Structure

The Indian tax structure was highly inequitable. While the peasants were
burdened with paying a heavy land revenue for most of the colonial period
and the poor with the salt tax, etc., the upper-income groups comprising
highly paid bureaucrats, landlords, merchants, and traders hardly paid any
taxes. The level of direct taxes was quite low. The number of income-tax
payers was 3,60,000 in 1946-47. It was under pressure from the national
and peasant movements that the land revenue and salt tax started coming
down in the 20th century. As late as 1900-01, land revenue and salt tax formed
53 per cent and 16 per cent of the total tax revenue of the government. 21
Indian Economic Development: ii) Military Expenditure
An Overview
The colonial state devoted almost its entire income to meeting the needs of
the British Indian administration, making payments of direct and indirect
tribute to Britain and in serving the needs of British trade and industry. The
bulk of public revenue was absorbed by the military expenditure and civil
administration which was geared to maintenance of law and order and tax
collection. After 1890, military expenditure absorbed nearly 50 per cent of
the central government’s income. In 1947-48, this figure stood at nearly 47
per cent.
iii) Meagre Spending on Development of Agriculture, Industry, and Social

Infrastructure
As pointed out earlier, a very large part of India’s social surplus was
appropriated by the colonial state, but a very small part of it was spent by it
on the development of agriculture or industry or on social infrastructure or
nation-building activities such as education, sanitation and health services.
1.6.3 Trade Policy
The two centuries (1757-1947) recorded major structural changes in the trade
policy. The period can be divided into four parts: 1759-1813, 1813-1850, 1850-
1914, and 1914-1947.
i) 1759-1813
The first period can be termed as the age of Mercantilism. During this period,
the East India Company established its political supremacy, attempted to
enforce exclusive monopolistic trade between India and Britain.
Nevertheless, the company was largely unsuccessful due to activities of
private traders. The important characteristics of the trade was that Indian
trade continued to flow along the traditional channels and its composition
was based on an exchange of fine textiles, foodstuffs and other raw materials
for precious metals and certain manufactured products. The East India
Company financed a large volume of its trade through the surplus from the
budgetary sources of its India possessions.(see 1.4 Drain of Wealth).
The East India Company used its dominant position to compel weavers and
other producers of export commodities to supply their output to the English
Company at a specified price determined by the latter. Thus the principle of
freely negotiable contract was now increasingly abandoned. The use of
budgetary surplus to finance export of goods to Europe and the silver to
finance the Company purchase of tea and silk in China led to contraction of
money supply, threw out of balance the whole banking and monetary system,
and provoked loud complaints from native traders and foreign merchants.
Due to the pressure by the private traders and the decline of Mercantilist
doctrines in England, exclusive monopoly in Indian trade was abolished in
1813, and the East India Company was debarred from trading in 1833.
ii) 1813-1850
A major structural change took place during this period in the commodity
composition of the Indian trade, which continued until the end of World
War I. India was gradually transformed from being an exporter of
22
manufacture products (largely textiles) into a supplier of primary Indian Economic
commodities, importing finished consumer goods and certain intermediate Perspective
industrial goods in return. In 1811-12, the percentage share of piece goods
(fabrics, made in standard widths and lengths) in total export values from
Calcutta was 33 per cent, in 1814-15 it was 14.3 per cent, and in 1839-40
just 5 per cent. Between 1814 and 1850, four commodities that dominated
the exports baskets were indigo, raw silk, opium and cotton.
iii) 1850-1914
The construction of railway lines in India during 1850’s and the outbreak of
Crimean War gave new impetus to the sub-continental trade. In the following
two decades, volume and value of foreign trade increased phenomenally
due to American civil war and opening of Suez Canal. There was general
reduction in oceanic freight. Rapid industrialisation of continental countries,
the US and Japan created a new level of demand for raw materials and food
stuffs. This was the great age of multilateral trade and international payments.
iv) 1914-1947
The age of multilateral trade and the frictionless gold standard exchange
system ended abruptly in 1914. The conditions under which Indian foreign
trade was conducted in post-war period were dictated by– worldwide
industrial reorganisation, growth of bilateral trading arrangements, a policy
of tariff protection, and foreign exchange controls. In addition, India, along
with the other exporters of primary commodities suffered from the World
Depression of 1929. As a result of these developments, the general trend of
India’s foreign trade during the inter-war period were showed wide
fluctuations. The last seven years from the outbreak of the World War II to
1946 were characterised by wartime controls and large-scale political
upheaval preceding India’s independence in 1947, influencing the trade
flows.
Before the uprising of 1857 the commercial policy was guided by the twin
principles of extending protection to British imports and using tariffs for revenue
mobilisation. In Bengal, the rates of duties on exports and imports were fixed at
5 to 10 percent in 1810. In line with the principle of favouring British trade and
shipping, next year the duty rates on goods carried by foreign ships were doubled.
Subsequently, the duty on British imports was reduced to 2.5 per cent. Similarly,
in view of the serious state of public finances in post-1857 period, the government
in 1859 sharply raised duties on goods including cotton textiles from Britain.
There was a public outcry in Britain and in 1862 import duty on cotton was
reduced from 10 to 5 per cent.
Throughout the period an unusual characteristic of India’s foreign trade was the
existence of a large export surplus which was not accompanied by either a rise in
her foreign exchange reserves or an increase in overseas lending. This surplus
was used for unilateral transfer of funds that India had to make to Britain as part
of the political charges or the political “tribute’’. This was debited to her external
account. It was also used to partly settle Britain’s trade deficit with US and Europe.
Tariff policy was looked upon by India nationalists as the main instrument of
British economic imperialism. Until the First World War, there was no import
duty, which could possibly offer any sort of protection to any of the Indian
23
Indian Economic Development: industries. This was, as A.K. Bagchi noted, “quite contrary to the trend in the
An Overview
rest of the world, including the British Dominions”. After 1918, under the pressure
of the national movement, the Government of India was forced to grant some
tariff protection to a few industries. But this was inadequate and ineffective.

1) Why was the capital formation low during the period 1914-46?
.......................................................................................................................
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2) Trace out the elements of Mercantilism in the trade and fiscal policy resorted
by the East India Company during the period 1759-1813.
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3) What was the nature of structural change that took place in the composition
of India’s trade during the period 1813-1850?
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4) What was the approach of the colonial state (British State) in the development
of industry and agriculture in India?
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5) State the features of tax structure in the colonial regime during the period
1900-01 to 1946-47.
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24
Indian Economic
1.7 PROGRAMME OF ECONOMIC Development – A Historical
Perspective
RECONSTRUCTION FOR INDEPENDENT
INDIA
Indian national movement was a popular people’s movement which represented
the interests of different classes and strata of the Indian society. A self-reliant
economic development that supported social justice and modernisation of the
society emerged as a common goal during the struggle for independence. In
their speeches, writings, programmes and actions, the nationalists Congress
leaders and business leaders expressed the need for planned industrialisation,
public investment in social and economic infrastructure, in both rural and urban
areas, agrarian reform and creation of modern financial system.
Since early stages of the national movement, nationalist believed in complete

economic transformation of the country based on industrialisation. In the words
of M.G. Ranade, factories could ‘far more effectively than Schools and Colleges
give a new birth to the activities of the Nation.’ Surendranath Banerjee believed
that industrial activity could help unite diverse peoples of India.
Newspaper the Bengalee in its edition on January 18, 1902 argued that: ‘The
agitation for political rights may bind the various nationalities of India together
for a time. The community of interests may cease when these rights are achieved.
But the commercial union of the various Indian nationalities, once established,
will never cease to exist. Commercial and industrial activity is, therefore, a bond
of very strong union and is, therefore, a mighty factor in the formation of a great
Indian nation.’ (adopted from Bipan Chandra, Rise and Growth of Economic
Nationalism in India, 2010, pp70-71) It was in context of this vision of
industrialisation that nationalists took up the issues of foreign trade, railways,
tariffs, currency and exchange, finance, and labour legislation. During the First
World War and after, when the social base of the national movement became
more broad-based with involvement of workers and peasant, the issue of interests
of workers and peasants were endorsed by the Indian National Congress in its
Karachi session held in March 1931. The Karachi session became memorable
for its resolution on Fundamental Rights and the National Economic Programme.
In its resolution on National Economic Programme, it declared that ‘in order to
end the exploitation of the masses, political freedom must include real economic
freedom of the starving millions.’ It, besides promising substantial reduction in
rent and revenue and living wages for workers, also emphasised state ownership
or control of key industries, mines and means of transport.
However, it was realised that the problems of poverty and unemployment and of
the economic regeneration in general cannot be solved without industrialisation
to which end a comprehensive scheme of national planning’was required.
In 1938, Subhas Chandra Bose was elected the President of the Indian National
Congress and presided over the 51st session at Haripura. In his presidential address,
he spoke of the planned economic development of independent India on socialistic
lines. He said, “I have no doubt in my mind that our chief national problems
relating to the eradication of poverty, illiteracy and disease, and to scientific
production and distribution can be effectively tackled only along socialist lines.
The very first thing which our future national government will have to do would
25
Indian Economic Development: be to set up a commission for drawing up a comprehensive plan for
An Overview
reconstruction.”
In October 1938, the Congress President, Subhas Chandra Bose, set up the
National Planning Committee (NPC) with Jawaharlal as its Chairman. The NPC
was an exception in bringing together a striking group of policymakers, politicians,
and experts from various fields covering the widest spectrum of activities in the
economy. Equally important, several business leaders actively participated in
this deliberative process led by Jawaharlal Nehru. The committee had fourteen
members selected from occupationally diverse backgrounds, four industrialists—
Ambalal Sarabhai, Puroshottam Thakurdas, Walchand Hirachand and A.D. Shroff,
five scientists, Meghnad Saha, A.K. Saha, Nazir Ahmed, J.C. Ghosh and V.S.
Dubey, three economists, K.T. Shah, Radha Kamal Mukherjee and M.
Visvesvaraya. The two other members were J. C. Kumarappa, who with his
Gandhian ideals represented the All-India Village Association and N.M. Joshi, a
representative of industrial workers.
The massive architecture of planning that the NPC sought to undertake was
evident from the division of work among its members. Eight themes were
identified, namely, agriculture, industry, demographic relations, trade, transport,
public welfare, education, and women’s role. The work of this group was an
important step in evolving a national consensus.
Indian capitalists had a long-term strategic interest in success of the national

movement and it contributed in the evolution of consensus for national
development. The capitalist class in India grew from about mid-19th century with
largely an independent capital base. It grew rapidly between 1919 and 1947.
Close to independence, indigenous enterprise had already cornered about seventy-
three per cent of the domestic market and over eighty per cent of the deposits in
the organised banking sector. In fact, by the mid-1920s, Indian capitalists began
to correctly perceive their long-term class interest and felt strong enough to take
a consistent and openly anti-imperialist position. This effort culminated in the
formation of the Federation of Indian Chambers of Commerce and Industry
(FICCI) in 1927.
Indian business leaders, with some of the most astute minds of the period in their
ranks, developed a fairly comprehensive economic critique of imperialism in all
its manifestations, whether it be direct appropriation through-home charges or
exploitation through trade, finance, currency manipulation or foreign investments.
As Sir Purshottamdas, President of FICCI, declared at its second annual session
in 1928: ‘Indian commerce and industry are intimately associated with and are,
indeed, an integral part of the national movement — growing with its growth
and strengthening with its strength.’ In a statement issued to the Press on December
25,1942, FICCI asserted: “India’s vital interests in the economic, financial an[d]
fiscal spheres have hitherto been subordinated to those of Britain and whenever
they have been in conflict, . . . Indian interests have in the past been sacrificed or
relegated to a second place.” (FICCI, Correspondence and Relevant Documents
Relating to Important Questions Dealt with by the Federation during the Year
1942-43.)
During Second World War, big three of the Indian business world — J.R.D. Tata,
G.D. Birla and Lala Sri Ram issued A Plan of Economic Development for India.
This came to be known as ‘the Bombay Plan’. The other signatories to this plan
26
were Ardeshir Dalal, Kasturbha Lal bhai, Ardeshir Darabshaw Shroff, Indian Economic
Sir Purshottamdas Thakurdas and John Mathai. Two among them– Ardeshir Perspective
Darabshaw Shroff and Sir Purshottamdas Thakurdas were the member of the
NCP of the Congress. The attitude of Indian industrialists to the economic structure
of independent India was encapsulated in the Plan. This plan too visualised far-
reaching land reforms, a large public sector and massive public and private
investment. It laid great emphasis on public investment in social and economic
infrastructure, in both rural and urban areas, importance of agrarian reforms and
agricultural research, setting up educational institutions and a modern financial
system. The views of the Indian business were, by this stage, closely aligned
with those of the Indian National Congress. The Plan therefore contained a strong
endorsement of state economic intervention and planning.
The Plan represented a turning point in the history of Indian business. It marked
the institutionalisation of a long relationship between business and nationalist
leadership as well as a historic moment when business groups, for the first time,
unhesitatingly aligned themselves with nationalist aspirations. Underlying the
Bombay Plan was the idea of a close partnership between business and the State.
It anticipated in real sense the Five-Year Plans and the industrial policies of the
future Congress governments in independent India.

1) Do you think that the goal of self-reliant economic development sought by
Indian National Movement was the driving force for industrialisation in
post-independent India? Give reasons.
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2) What was the broad consensus on national development at the time of
independence that guided the state efforts in the post-independence period?
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1.8 LET US SUM UP

British rule drastically transformed India. Although there were several positive
developments for the society and economy in the colonial period, but they did
not support a development process to modernise the economy and place it on the
path of sustainable progress. The colonial relationship subordinated India to
British political and economic interests. It stimulated Indian economic
development in some way and inhibited in it in other ways. 27
Indian Economic Development: The peace and law and order established by the Mughals in a large part of India
An Overview
had helped the economy of the empire. There was steady growth of commerce
and manufacture and of urbanisation. There was a substantial increase in both
inland and foreign trade.
In the 18thcentury the subcontinent was a major commercial hub of the world
economy. At the beginning of the British rule in mid-18th century, India supplied
quarter of all manufacture goods to the world markets and Indian handicrafts
constituted a major export item along with spices for European trade.
Colonial rule laid the foundation of a new economy based on peasant exports
and dependence on global industrial enterprise. India became a major market for
British manufactures, the big source for raw materials and food, and an important
region for the investment of British capital. It resulted in a stagnant agriculture,
a limited modern industry but with stunted growth, the pauperisation of the people,
especially the peasantry and the artisans.
The response to the colonial rule was Indian national movement for independence,
which represented the interests of the different classes and strata of Indian society.
It sought an independent self-reliant economic development as a common goal
for the people of India. A broad consensus evolved in the decade preceding
independence which laid the path to be followed for national development.
1.9 KEY WORDS

Bombay Plan : A joint proposal by a section of the big industrialists
in 1944 for setting up a planned economy in the
country. The Bombay Plan wanted the state to take
major initiatives in industrial and other economic
investments.
Drain of Wealth : The Drain of Wealth theory was systemically
initiated by Dadabhai Naoroji in 1867. It depicts
the constant flow of wealth from India to England
for which India did not get an adequate economic,
commercial or material return.
Fiscal Policy : Fiscal policy is the use of government spending
and taxation power to influence a country’s
economy.
Macroeconomic Policy : Macroeconomic policy is concerned with the
attempts of policymakers to influence the behaviour
of such macroeconomic aggregates in order to
improve the overall performance of the economy.
Mercantilism : An economic policy that is designed to maximise
the exports and minimise the imports for ensuring
national prosperity.
Pauperisation : The process of making a person or group very poor;
impoverishment.
Regressive Tax : A regressive tax is a tax imposed in such a manner
that the tax rate decreases as the amount subject to
28 taxation increases.
Trade Policy : Trade policy defines standards, goals, rules and Indian Economic
regulations that pertain to trade relations between Perspective
countries.
1.10 TERM-END EXERCISES

1) Discuss the role of the colonial state in underdevelopment of Indian economy.
2) Analyse the causes for the stagnation of agriculture during the British rule.
3) Discuss the reasons for ‘stunted’ growth of modern industries in India during
the British rule.
4) Discuss the attitude of Indian capitalist class towards the Indian National
Movement.
5) Discuss how ‘Bombay Plan’ was instrumental in evolving the Indian
economic policy in terms of introducing land reform, dominant role of public
sector, great emphasis on public investment in social and economic
infrastructure, etc.
1.11 REFERENCES
1) Angus Maddison. (2007). ‘The Contours of World Economy 1-2030 AD,
Oxford University Press 2007, p.p. 381.
2) Bagchi, A.K. (1972). Private Investment in India,1900-1939, Cambridge.
CUP
3) Bose, Sugata, and Ayesha Jalal (1998). Modern South Asia: History, Culture,
Political Economy. London: Routledge.
4) Chandra, Bipan, (1979). Nationalism and Colonialism in Modern India,
New Delhi; Orient Longman.
5) Chaudhuri, K.N. (1978). The Trading World of Asia and The English East
India Company. Cambridge. CUP.
6) Desai, A.R. (1959). Social Background of Indian Nationalism. 3rd edition.
Bombay. PBD
7) The Cambridge Economic History of India. Vol 2, ed. Dharma Kumar.
Cambridge. CUP
8) R. C. Dutt’sEconomic History of India in the Victorian Age (London, 1904;
reptd. Delhi, 1960),
9) Roy, Tirthankar, (2000). The Economic History of India, 1857-1947, New
Delhi: OUP.
10) Sarkar, Sumit. (1983). Modern India, 1885-1947. New Delhi: Macmillan.
1.12 ANSWERS OR HINTS TO CHECK YOUR

PROGRESS EXERCISES
1) See Sub-section 1.3.1
29
Indian Economic Development: 2) See Sub-sections 1.3.2 and 1.3.5
An Overview
1) See Section 1.4
2) See Section 1.5
2) See Sub-sections 1.6.2 and 1.6.3
3) See Sub-section 1.6.3(ii)
1) See Section 1.7
2) See Section 1.7
30
Indian Economic
UNIT 2 GROWTH AND STRUCTURE OF Development – A Historical
Perspective
THE INDIAN ECONOMY
Structure
2.0 Objectives
2.1 Introduction
2.2 Overall Trends
2.3 Structural Change in the Economy
2.3.1 Composition of Gross Domestic Product
2.3.2 Sectoral Share of Employment
2.3.3 Share of Organised and Unorganised Sector in Output and Employment
2.3.4 Share of Rural and Urban sectors in Output and Employment
2.3.5 Share of Consumption, Government Spending, Investment and Net Exports in
GDP
2.3.6 Share of the Public and the Private Sector in GDP
2.4 The Rise of Tertiary Sector: Composition, Causes and Prospects
2.4.1 Composition of the Service Sector
2.4.2 Causes of Rapid Increase in Tertiary Sector
2.4.3 Prospects and Opportunities
2.4.4 Limitations
2.4.5 Need for an Integrated Policy
2.5 Medium and Long-Term Growth Prospects of the Economy
2.5.1 Major Policy Initiatives in the Recent Decades
2.5.1.1 Containing Inflation and Soaring Fiscal Deficits
2.5.1.2 Beneficiary Focus and Targeted Delivery
2.5.1.3 Infrastructure
2.5.1.4 Federalism
2.5.1.5 Corporate Exits
2.5.1.6 Demonetisation
2.5.1.7 Goods and Services Tax (GST)
2.5.2 The Challenges that Remain
2.5.2.1 Non-farm Employment Opportunities
2.5.2.2 Demographic Transition and Dividend
2.5.2.3 Urbanisation
2.5.2.4 Poverty and Inequality
2.5.2.5 Environment and Climate Change
2.6 Let Us Sum Up
2.7 Term- end Exercises
2.8 Key Words
2.9 References
2.10 Answers or Hints to Check Your Progress Exercises
31
An Overview 2.0 OBJECTIVES
As you go through this unit, you will be able to:
• identify the growth path of the Indian economy since 1951;
• differentiate the stages of growth through which the Indian economy has
evolved;
• recognise the factors that contributed to rapid growth in different stages;
• become familiar with the structural change that the Indian economy has
gone through post-independence; and
• understand the medium to long-term prospects of India’s economic growth.
2.1 INTRODUCTION
Different sectors of the economy, such as agriculture, industry or services employ
natural, human, and material resources and contribute to the aggregate flow of
goods and services during a given time period which may normally be specified
as a year. This aggregate flow of final (as distinct from intermediate) goods and
services constitutes the national product of the economy. Alternately, if the
economic activity comprising the aggregate flow of goods and services is
measured in terms of the income earned by all the different factors of production
(land, labour, capital, and entrepreneurship) employed in the production process
during the year it is termed as national income. The national income, it may be
recalled, can also be measured as the aggregate expenditure in the economy in
terms of private consumption, government spending, investment and the spending
on net exports. The production, income and expenditure methods are three
methods of estimating Gross Domestic Product and other national account
aggregates. The rate of growth of the national income when compared with the
rate of growth of population indicates whether the economy is declining, stagnant
or growing. It is only when the national income grows at a rate faster than the
rate of growth of population that the per capita income shows a rising trend; the
people are able to improve their living standards and the economy is able to add
to its stock of capital, which along with technology and labour supports economic
growth. However, economic growth does not necessarily improve every citizen’s
living standards, something captured by a much broader and complex issue of
development. While the country has been performing well in terms of growth, it
seems to be lacking behind in terms of development.
The Central Statistical Office (CSO) has been producing annual official estimates
of national income and other national accounts aggregates of India since 1955
and publishing it annually in National Accounts Statistics (NAS). It is with the
help of this data that we shall study the trend in India’s national income over the
last seven decades.
2.2 OVERALL TRENDS

Post-independence, India’s economic development can be seen in terms of the
following phases, each with its characteristic pace of advancement, policy
guidance and attendant changes in the structure of the economy:
32
Phase I: 1950-1980 Growth and Structure of
Indian Economy
India’s GDP increased at an annual average rate of 3.5 per cent.1 During this
period, population has also increased at an annual average rate of over 2.00 per
cent. Therefore, the real per capita income has increased only at an annual average
rate of 1 per cent. During the first decade, real national income went up by 3.8
per cent (1.8%), this rate came down to 3.5 per cent (1.2%) in the 1960s, and 3.1
per cent (1.1%) in the 1970s. During this phase, the nation followed the Socialist
regime with the objectives of planning being—rapid industrialisation with
emphasis on developing a strong investment goods sector, poverty alleviation,
improving per capita incomes and an even distribution of income. Public sectors
played a central role to the public sector. Import substitution, export subsidies
and stringent restraints on technology and investment cooperation with the rest
of the world— kept India somewhat a closed economy. Substantial controls on
capacity expansion and licensing requirements for manufacturing industries were
also part of the policy strategy.
Phase II: 1980-1990

A reversal of trend occurred during the 1980s: the average annual rate of growth
increased to around 5.5 per cent. The socialist flavour of the Nehruvian policies
was blamed for the worsening of the growth performance of the Indian economy
by the 1970s for these policies are believed to limit the foreign competition and
make domestic firms inefficient and also limit a productivity-enhancing structural
transformation by restricting the possibilities of resource reallocation to more
productive sectors. In contrast, post-1980 period featured several pro-business
policies and reforms including import liberalisation, export incentives, exchange
rate policies, and expansionary fiscal policy.
Phase III: 1990-2008

In the first three years of the 1990s, the GDP grew at 4 per cent annually. In the
following four years, the growth rate jumped to 7.1 per cent but only to fall back
to 5.2 per cent in the succeeding five years. The underlying trend growth rate
during the decade was just over 6 per cent. However, subsequently the period
2003-08 saw the real GDP grow at 8.2 per cent annually. Meanwhile population
growth rate stabilised at around 1.1% per annum. The sustained growth at 8 per
cent plus resulted from many serious policy initiatives on the part of the
government. Significant lowering of tariff and nontariff barriers (trade policy
reforms) along with a major revamping of industrial policies, especially the
withdrawal of industrial regulation and liberalisation of foreign direct investment
(FDI) were introduced. These, coupled with favourable external environment in
the form of rising exports and increasing inflows of foreign capital, set in motion
three factors which can be described as three engines of growth.
One, consumption spending was a large contributor to the growth performance.

Decreasing relative prices of many goods and services as a result of domestic
and global competition, competitive pressures in retail finance and steadily rising
incomes compound into a powerful force, even if each of the components may
not be very large. Two, investment in new capacity was the second engine of
growth. Investment activity is characterised by a certain lumpiness, which means
1
.Prof. Raj Krishna had believed that the economy was caught in the “low level equilibrium trap
of slow growth” of 3.5 per cent annual growth rate. This came to be known as ‘Hindu Rate of
Growth’. 33
Indian Economic Development: that capacity addition comes in spurts, exceeding immediate requirements but
An Overview
anticipating a subsequent catch-up in demand. Investment spending, consequently,
goes up sharply at the beginning of a cycle and declines just as abruptly once the
desired capacity has been created. The investment cycle was on upswing. Three,
exports of both goods and services were the third engine of growth. India’s
merchandise exports got getting diversified geographically and, therefore, were
not very vulnerable to localised business cycles. All these three engines gained
an additional boost by what appears to be a sustained, across-the-board increase
in productivity.
But this phase also shared one major weakness with the previous phase: labour-
intensive manufacturing remained sluggish. The end to licensing and to the small-
scale industries reservation in most labour-intensive products did not have the
intended outcomes in this sector. The reasons for this are well-known (labour
market rigidities facing large-scale producers, infrastructure bottlenecks and
bureaucratic red tape). Unfortunately, without rapid expansion of the unskilled-
labour-intensive industry, progress towards poverty reduction and transition to a
modern economy will remain far slower than is feasible.
Phase IV: 2008-2014

The growth process slowed during 2008-09 in the wake of the global economic
crisis, although some indicators of slowdown had made their presence felt even
earlier. Global economic crisis resulted in (i) fall in inflows of foreign direct
investment, (ii) rise in outflows on account of portfolio disinvestment, (iii) decline
in export orders from developed market economies, as a result of which domestic
investment, employment and consumption slowed down. The slowdown affected
all sectors of the economy; growth rate in service sector during 2008-09 came
down to 9.3 per cent, against 10.8 in 2007-08, in agriculture to 1.6 per cent from
4.9 per cent, and in industry to 3.9 per cent from 7.4 per cent. The decline in
service activity could be attributed to lower demand for off-shoring and IT and
IT-enabled services from the US and Europe, where several economies are
grappling with debt problems. There was also an impact on financial services as
banking activity slowed down on account of higher interest rates and investors
were scared of parking their funds in stock markets. Real GDP growth rate slowed
down to 6.5% per cent during 2011-12. It continued to be low on subsequent two
years 2012-13 and 2013-14. Apart from the slow recovery in India’s export
destinations there were several domestic policy concerns including– ban on iron
ore mining, cancellation of coal blocks, delays in environmental clearances,
emergence of the Non Performing Asset (NPA) crisis and the consequent double
balance-sheet problem that resulted in this slowdown.
Another major concern at this stage, though not entirely unexpected, was the
sharp dip in the growth rate of private consumption. Four factors seem to have
contributed to this slowdown. First, it could be due to the wealth effect, resulting
from a decline in the asset (equity/property) prices. Second, the uncertainty in
the labour market and some decline in employment in India’s tradable sectors
may have moderated the growth in consumption expenditure. Third, cutbacks in
consumer credit by private banks, NBFCs and other lenders, because of their
limited deposit base and difficulties in secondary market financing because of
the knock-on effect of global financial market freezing. Fourth, during slowdown
a dominance of precautionary motive may have induced consumers to either
defer their spending decisions or shift to unbranded lower quality alternatives.
34
Similarly, the slowdown in the growth rate of gross fixed capital formation Growth and Structure of
Indian Economy
(GFCC) was an area of policy concern from the point of an early return to the
high GDP growth path. Apart from the demand shock to the economy several
reasons could have contributed to deceleration in growth of GFCF. First, surge
in domestic inflation in the first half of 2008 reinforced the tightening of monetary
policy. It affected the cost and availability of funds for investment. Second, since
inflation was largely on account of metals and fuels, bulk of it was absorbed by
industry, which affected its internal accruals and profitability, reducing the
investible funds. Third, despite monetary policy becoming accommodative in
the second half of 2008, decline in interest rates were not up to the industry
expectations.
A significant stimulus package in three tranches was put in place by the

government involving expansion in government spending and reduction in indirect
taxes to boost domestic demand. By the end of the year 2008-09, India was
rapidly returning to the buoyant years preceding 2008.
Phase V: 2014-2019 and 2019 onwards

During the period from 2014-15 to 2018-19, Indian economy registered an average
GDP growth rate of 7.5 per cent. Several initiatives taken by the government to
spur growth include — government following the 4 R approach of Recognition,
Resolution, Recapitalisation and Reforms to strengthen banks and foster clean
and responsible banking, simplification of the Labour Laws, bringing reforms in
Corporate Affairs, introduction of e-Clearances, relaxing foreign direct investment
rules, easing Know Your Customer (KYCs) for investors in Capital Markets,
rendering more support to Non-Banking Finance Companies (NBFCs)/ Housing
Finance Companies (HFCs) and Micro, Small and Medium Enterprises (MSMEs),
introduction of indirect tax reform in the form of Goods and Services Tax (GST),
introduction of Insolvency and Bankruptcy Code (IBC) for the speedy resolution
of insolvency and bankruptcy cases of companies, Demonetisation to curb black
money, corruption and counterfeit notes, which in turn opened gates for cashless
economy, etc.
India’s GDP growth moderated to 5 per cent in 2019-20 as compared to 6.8 per
cent in 2018-19, amidst a weak environment for global manufacturing, trade and
demand. The economic state of the Indian economy from 2019 onwards may be
identified as ‘pause phase’. During the pause phase the clouds over India’s
economic performance and prospects are getting bigger and darker. First, India’s
economic growth has slowed, aggregate investment has slackened and it could
get worse. Second, inflation needs to be monitored. Third, the country’s external
imbalances are growing at a time when capital flows are becoming more volatile.
Fourth, with investment momentum remaining significantly below its trend, the
persistent weakness in consumption is a concern. Consumption has typically
provided a steady and elevated floor for India’s growth. Fifth, the sub-segment
of “trade, hotels, transport and communications,” which is typically an important
source of resilience for the services sector, is slowing consistently. Sixth, growth
in agriculture may take some hit. Seventh, the fiscal-monetary mix is completely
out of work and there is hardly any flexibility on the fiscal front. More importantly,
some fiscal responsibility will warrant spending cuts and revenue enhancement
in order to shrink the fiscal deficit. Likewise, the RBI is expected to anchor
expectations without offering one-or two-year forward guidance. Finally,
the impact of Covid-19 pandemic on the Indian economy has been largely
35
Indian Economic Development: disruptive in terms of economic activity as well as a loss of human lives. Almost
An Overview
all the sectors have been adversely affected as domestic demand and exports
sharply plummeted with some notable exceptions where high growth was
observed. Tourism, Hospitality and Aviation were among the worst affected
sectors. Consumption also got impacted due to job losses and decline in income
levels of people particularly the daily wage earners. Greater uncertainty about
the future course and repercussion of Covid-19 also made the financial market
extremely volatile. There is likelihood that the three major components of
aggregate demand — consumption, investment, and exports are likely to stay
subdued for a prolonged period of time. On the supply side, shutdown of factories
and the resulting delay in supply of goods from China affected many Indian
manufacturing sectors. Some sectors like automobiles, pharmaceuticals,
electronics, chemical products etc. faced an imminent raw material and component
shortage.

1) What do you understand by ‘Hindu Rate of Growth’?
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2) What are the reasons for the slowdown of the Indian economy after the year
2008 i.e., post-global financial crisis?
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3) How do you see the impact of the post-2014 policy measures on the Indian
economy?
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36
Growth and Structure of
2.3 STRUCTURAL CHANGE IN THE ECONOMY Indian Economy
The process of development requires structural change. The structural change of

an economy takes place mainly along two dimensions: one is the changing sector-
wise shares in GDP and the second is the changing share of the labour force,
engaged in each sector. Other forms of changes encompassing the structural
change include changing share of the organised and unorganised sectors as well
as rural and urban sectors in output and employment, and also the share of
consumption, goverment spending, investment and net exports in India's GDP.
The share of public and private sectors may also be considered to reflect structural
change in the Indian economy.
2.3.1 Composition of Gross Domestic Product

The composition of GDP of an economy explains the relative significance of the
different producing sectors. When a country is in a state of underdevelopment,
primary sector (agriculture and allied occupations) makes the largest contribution
to the national income. As the country grows and gets developed, no matter how
fast the primary sector grows, in keeping with the Kuznet’s Law the contribution
of the industrial and services sectors gradually increases. The explanation for
this shift is as follows: Income elasticity of demand for agricultural products is
relatively low; as a result, with rising levels of income, the demand for agricultural
products relatively declines and that for industrial goods increases and, after
reaching a reasonably high level of income, demand for services increases
sharply. Accordingly, the shares of different sectors in the national product get
determined by the changes in the pattern of demand. On the supply side,
agriculture, being mainly dependent on a fixed factor of production, namely land,
faces a limit on its growth and is subject to early operation of the law of
diminishing returns. Industry, specially manufacturing, on the other hand, offers
large scope for use of capital and technology, which could be augmented almost
without limit with human effort. The same applies to services where application
of technologies seems to offer much larger scope. Table 2.1 below brings out the
on-going structural changes in India’s GDP.
Table 2.1: Sectoral Distribution of India’s GDP at Factor Cost (2011-12 prices) (%)
Sector 1960-61 1990-91 2000-01 2010-11
Primary 51.0 33.0 25.0 17.0
Secondary 18.0 24.0 24.0 24.5
Tertiary (Service) 31.0 43.0 51.0 58.5
Source: Economic Survery (Various issues)
Services sector is the largest sector of India. Gross Value Added (GVA) at current
prices for Services sector is estimated at Rs. 92.26 lakh crore (54.40 per cent of
total India’s GVA) in 2018-19. With GVA of Rs. 50.43 lakh crore, Industry sector
contributes 29.73 per cent, while, agriculture and allied sector shares 15.87 per
cent.
This pattern of structural change in Indian economy has deviated from the
development pattern of Western and South East Asian economies. Those
economies experienced first a shift from primary to secondary sector and only in
their advanced stage did they experience a significant shift in favour of tertiary
sector. This pattern of development enabled them to transfer growing labour 37
Indian Economic Development: force from primary to secondary sector. In India this has not been possible because
An Overview secondary sector has not expanded fast enough to absorb growing labour force.
Although the manufacturing sector has grown at a fast pace the section’s
contribution less as compared to countries. The unskilled and uneducated rural
masses have continued to struggle in the primary sector and those who have
been forced out by economic, social and political factors have joined the urban
slum sector. Moreover, the sharp increase in the share of tertiary sector in GDP
in India has occurred at a much lower level of per capita income than that in the
developed countries when they experienced a similar expansion. This pattern of
growth underlines the link between the growing poverty and unemployment and
the inadequate growth of manufacturing and building activity in the country.
This failure in turn could be attributed to absence of structural attributes like a
basic literacy in the workforce upon which further skills can be imparted, physical
infrastructure (i.e., power, roads, railways and access to ports), access to financial
capital and, crucially, policies that encourage allocation of resources through
export-oriented manufacturing.
2.3.2 Sectoral Share of Employment

There have been significant changes in the sectoral pattern of employment. The
proportion of the work force engaged in the primary sector declined by 12 per
cent between 1983 and 2004-05 and it showed faster decline between 2004-05
and 2009-10. Between 2009-10 and 2017-18, the share of employment in primary
sector further declined to 44.6 per cent. In the Secondary sector, the share of
employment increased from 21 per cent in 2009-10 to 24.4 per cent in 2017-18.
However, the Tertiary sector has performed very well in employment as its share
jumped from 25 per cent (2009-10) to 31.0 per cent (2017-18). This marks an
important phase of structural transformation for the Indian economy, in which,
the share and number of workers in agriculture has been declining with
corresponding rise in employment in non-farm sectors. Among the non-firm
sectors, service sectoris primarily driving the employment growth during 2009-
10 and 2017-18.
Table 2.2: Changes in Sectoral Shares of Employment (UPSS) (Percentages)
Primary Secondary Tertiary All
Rural 1983 81.80 8.60 9.50 100.00
2004-05 73.00 13.20 13.80 100.00
2009-10 68.60 16.70 14.70 100.00
Urban 1983 15.60 32.60 51.80 100.00
2004-05 9.40 33.30 57.30 100.00
2009-10 8.10 33.80 58.10 100.00
Total 1983 68.90 13.30 17.80 100.00
2004-05 57.00 18.20 24.80 100.00
2009-10 53.80 20.90 25.39 100.00
2017-18 44.6 24.4 31.0 100.00
2.3.3 Share of Organised and Unorganised Sector in Output and

Employment
Another way to look at the structural change in the income is to look at the
organisational pattern of the economy. The NAS divides the economy into two
38 sectors: organised sector which is identified with a modern market economy and
unorganised sector or traditional economy. The unorganised sector or traditional Growth and Structure of
Indian Economy
economy. The unorganised sector is defined to include “all unincorporated
enterprises and household industries – other than organised ones and which do
not maintain annual accounts and balance sheets.” During the last couple of
decades, organised sector has been growing faster than the unorganised sector.
This trend has been facilitated by policies like reduction in excise duties and
tariffs. It indicates growing modernisation in the organisation pattern of the
economy.
However, notwithstanding all these changes and trends towards modernisation,

the unorganised sector continues to dominate the economy with two-thirds of
the National Domestic Product (NDP) and this is not due only to the agricultural
sector. In fact, the unorganised sector is to be found not only in the unincorporated
and individually-owned, if not also in the individually-operated, enterprises, in
most other sectors of industrial origin, except, of course, public administration
and defence. A basic change here could influence the economy considerably.
2.3.4 Share of Rural and Urban Sectors in Output and

Employment
A classification of the economy between rural and urban areas is useful for a
study of the organisational set-up of industries, the type of activities dominating
the economic system in the rural and urban areas and the way of living of the
population residing in areas categorised under the two groups. Information relating
to rural-urban distribution of domestic product is available from various research
surveys and studies, including those by the NCAER. During the last two decades
the rural economy has grown much faster (7.5 per cent per annum) compared to
urban (5.6%) on the back of strong growth in the rural non-farm sector. As a
result, whereas in 1980-81, the rural sector accounted for 41 per cent of the GDP,
in 2010-11 this proportion has been estimated at 51per cent, i.e., the rural sector
is estimated to have overtaken the urban sector.
Growth in per capita income in rural India has been almost double compared to
urban India, though on a much lower base. It would mean that the fruits of
economic reforms are finally getting filtered down to rural areas.
Another important feature is that the rural economy is no more predominantly
agrarian. Whereas in 1970-71, 73.8 per cent of the rural GDP got generated in
the farm sector, this proportion has declined to 41.6 per cent in 2010-11, i.e.,
about 60 per cent of rural GDP gets generated in the non-farm sector. Moreover,
rural India has been far more resilient in the face of the abrupt turn around in the
economy than the rest of India. There are several reasons for this.
i) The government is no longer spending only on programmes that deliver the
final product to the beneficiaries – whether in the form of subsidised food,
electricity or building a dam to provide irrigation water to farmers – but has
added a new dimension wherein funds are transferred to the beneficiary.
This, in fact, gives the beneficiaries the freedom to spend the money and
mitigate leakages.
ii) India’s agriculture has been at the receiving end of a clutch of positive
imperatives. Between 2004-05 and 2011-12, MSPs were raised for common
paddy by 40 per cent and for wheat by 80 per cent, while inflation between
these two periods rose by around 24 per cent.
39
Indian Economic Development: iii) The global commodities boom has ensured new agricultural export markets
An Overview
that strangely seem insulated, even after the onset of a global recession.
iv) Farmers have hardly seen an increase in input costs, with the exception of
higher wages for labourers in the recent past, ensuring that their surpluses
are maximised.
v) Rural areas are now significantly more connected to the rest of India, largely
due to fast spread of mobile phones and road network.
vi) Several thousand farmers across the country have benefited from the farm
loan waiver scheme.
2.3.5 Share of Consumption, Government Spending, Investment

and Net Exports in GDP
As per ‘India Development Update’ report released by the World Bank in 2018–
the share of consumption in GDP has been consistently declining, particularly
the Private Consumption, while the share of Investment and Exports has increased.
While private consumption accounted for nearly four-fifth of GDP in the early
1970s, this share declined to about three-fifth in 2017. Despite its declining share,
consumption growth has been a key driver of aggregate GDP growth, contributing
on an average 3.76 percentage points to growth annually between 1971 and 2017.
After a small increase over recent decades, government expenditure has stabilised
at nearly 12 per cent of GDP. Equally salient is the steady increase in the rate of
investment. The period 2004-2008 witnessed an investment boom with the Gross
Fixed Capital Formation (GFCF) to GDP increasing from 30.7 per cent to 34.7
per cent in 2008. Post the global financial crisis, this ratio moderated to 31 per
cent in 2013. The moderation in the GFCF to GDP ratio continued in the period
from 2014-17. The ratio declined from 30.1 per cent in 2014 to 28.6 per cent in
2017. The ratio picked up to 29.4 per cent in 2018. Moderation in GFCF, a measure
of fixed asset creation raises concerns about growth of output in the economy.
India has also become more integrated into the global economy, with its trade
ratio– the ratio of exports and imports to GDP– adding up to about 40 per cent of
GDP in 2017, five times the ratio of 7.6 per cent in 1971, yet lower than the peak
ratio of 57 per cent in 2014. Exports as a per cent of GDP tripled from 7.3 per
cent in 1991 to 22 per cent in 2007, and were 25.5 per cent of GDP in 2014. The
contribution of net exports to growth has been muted, with import growth
exceeding export growth in a majority of years.
2.3.6 Share of the Public and the Private Sector in GDP

As per ‘India Development Update’ report released by the World Bank in 2018–
historically, public and private investment contributed approximately equally to
total investment, but the role of public investment in growth has diminished over
time. After peaking at 12.7 per cent of GDP in 1986-87, public and private
investment started to diverge, with public investment accounting for only
approximately 7 per cent of GDP in more recent years, compared to private
investment exceeding 20 per cent of GDP.
40
Check Your Progress 2 Growth and Structure of
Indian Economy
1) Discuss the significant factors highlighting the structural change in the Indian
Economy.
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2) Consumption spending as a component of national income has been
contributing majorly to the economic growth in India. Do you agree?
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3) Discuss the reasons behind growing contribution of the Rural Economy in
India.
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2.4 THE RISE OF TERTIARY SECTOR:

COMPOSITION, CAUSES AND PROSPECTS
2.4.1 Composition of the Service Sector
A recent study divides the service sector into three parts. Group 1 comprises
traditional services such as trade, transport, public administration, defence; Group
2 includes hotels, education, health and community and social services; and Group
3 is the modern services sector, including financial services, computer services,
business services, communications, and legal and technical services. The share
of Group 1 activities has stagnated, which is in accordance with the trend in the
OECD (Organisation for Economic Cooperation and Development) countries.
The rise in the share of Group 2 services too is in line with the trend. But what is
unusual is the rapid rise in Group 3 services since 1990. Contribution of
communications, business services, and financial services has in fact risen to the
point where it contributes more to growth of GDP than manufacturing. In
particular, communications, business services, financial services, education, health
and hotels accounted for roughly half of total growth of the service sector in
2000-20.
41
An Overview
2.4.2 Causes of Rapid Increase in Tertiary Sector
The tertiary, i.e., the non-commodity sector, has been growing at a much faster
rate than the commodity sector. This in essence means that income generated in
the process of circulation grew at a much faster pace than that in the directly
productive process, and thereby resulting in an increase in the share of the non-
commodity sector. This trend can be attributed to a number of factors, among
which the more important are as follows:
i) A very important factor has been the advent of information technology and
the knowledge economy. This has enhanced the growth of the high
productivity segment of the services sector as well as a variety of service
activities involving low productivity activities catering to a large mass of
people.
ii) A large part of the service sector consists of infrastructure such as banking,
insurance, finance, transport and communication and social and community
services such as educational and medical facilities. An urgent requirement
of development is the proper expansion of infrastructure to cater to the needs
of other sectors of the economy and the expansion of the social and
community services for the well-being of the people.
iii) Public services grow more rapidly where national Governments have
significant role in planning and production in the economy as a whole. In
fact, the ‘visible hands’ of the modern governments as reflected in the
government policies and in the expansion patterns of the national and
international authorities during the last few decades are directed towards
the creation of fast economic and social infrastructures.
iv) Operation of the demonstration effect as a consequence of the growing

mobility due to expanding foreign trade, tourism and cultural and educational
tours is another important factor.
v) Increasing urbanisation may be regarded as another cause of expansion of

the service sector in the economy. In fact, urbanisation is closely associated
with a rise in demands for infrastructure services such as communications,
public utilities and distribution services. A substantial change in the private
consumption pattern of the economy is observed with increasing
urbanisation. Many new goods and services enter into the consumption
basket.
vi) Tourism is becoming more and more international as knowledge is being

spread through television and Internet, and modern technology has made
air transport and hotel accommodations quite comfortable. Tourism in turn
has promoted all types of services.
vii) With the increasing complexities of modern industrial organisation,

manufacturing industries have become service oriented. This has been
reflected in the increasing functions of accounting, finance, legal services,
advertisement, marketing, public relations etc. Because of the prevalent
labour laws, these services are being increasingly outsourced, so that growth
in industry is actually being counted as growth in services.
42
viii) Another factor, albeit very important, has been the favourable international Growth and Structure of
Indian Economy
environment. The changing liberalised environment opened up immense
possibilities for the exports of India’s service sector. An important
contribution has been made by the IT sector, as also entertainment industry,
etc. India and the ASEAN, the 10-member regional grouping, moved closer
to completing a bilateral trade pact, but finalising a free-trade agreement
(FTA) on services and investment. The pact will enable free movement of
professionals from here such as doctors, engineers, architects and
management consultants across the ASEAN markets.
In addition to the above factors, an increase in the share of the non-commodity
sector in the GDP can also be attributed to slow growth in the commodity
producing sector. While a part of this is explained by difficulties inherent in
bringing about a fast rate of growth in the primary sector, a part is undoubtedly
due to the failure of the secondary sector and its major component, which is
manufacturing and construction, to grow at the much faster rate that was necessary
to give the commodity sector a comparable status with the non-commodity sector
in the growth rate.
2.4.3 Prospects and Opportunities

Both domestic and international factors augur well for the growth of services
sector in India.
A) Domestic Factors. Some of the important factors can be briefly stated as
follows:
i) As real per capita GDP grows, demand for services increases more than
proportionately and this, in turn, reinforces GDP growth itself.
ii) Within the services sector, demand for producer and government services,
which constitute mainly intermediate consumption, have strong multipliers
impacting on real GDP.
iii) The growth of such dynamic service activities, which are intensive users of
communication and information technology, will generate employment
opportunities on a rising scale.
iv) The process of economic growth has itself led to the emergence and
expansion of new services such as advertising, publicity, marketing, etc.
These sub-sectors provide essential service inputs to other sectors in the
economy, thereby developing strong linkages with the rest of the economy.
v) Efficient delivery of services increases the productivity of both labour and
capital in the economy as a whole. In general, services sector appears to be
highly growth-inducing with positive externalities for other services, making
services a catalytic agent of growth.
B) International Factors. Some of the recent global developments which provide

opportunities for substantial growth are as follows:
i) The fastest growing segment of services is the rapid expansion of knowledge-
based services, such as, professional and technical services. India has a
tremendous advantage in the supply of such services because of a developed
structure of technological and educational institutions, and lower labour
costs.
43
Indian Economic Development: ii) Progress in IT is making it increasingly possible to unbundle the production
An Overview
and consumption of information-intensive service activities. These activities–
research and development, computing, inventory management, quality
control, accounting, personnel administration, secretarial, marketing,
advertising distribution and legal services– are performed in all economic
sectors.
iii) Unlike most other prices, world prices of transport and communication
services have fallen dramatically. The cost of communication is becoming
independent of distance. India’s geographical distance from several important
industrial markets is no longer an important element in the cost-structure of
skill-based activities.
iv) India does not necessarily have to be a low-cost producer of certain types of
goods (e.g., computers or discs) before it can become an efficient supplier
of services embodied in them (e.g., software or music). It is possible now to
provide value added services without waiting to ‘catch up’ in technology
for production of sophisticated equipment or products.
v) The decline in the share of manufacturing in the output of rich countries

implies a relative decline in their demand for industrial raw materials and
fuels. It means that growth in exports of developing countries in the future
will depend less on natural resource endowments and more on efficiency in
providing services and serviceintensive goods.
vi) The aging of population in the developed world implies that the demand for
services will continue to grow.
As a result of the above developments, the sources of comparative advantage of

nations are vastly different now from what they were 50 or even 20 years ago.
And, there are very few developing countries which are as well placed as India
to take advantage of the phenomenal changes that have occurred in production
technologies, international trade, capital movement and deployment of skilled
manpower. It is now possible for India to take advantage of a virtuous circle of
higher growth, higher capital inflows and higher domestic incomes and savings,
which in sum can lead to further growth.
2.4.4 Limitations
However, the service sector, as at present, suffers from low productivity and
quality in spite of fairly large investment in technology. The sector faces multiple
challenges for sustained growth over the years. A number of services where India
enjoys comparative advantages experience lack of clear policy thrust. A number
of services in India are either predominantly associated with the Government or
are not liberalised enough to ensure growth through organised private initiatives.
Services like professional, legal, postal, accountancy and insurance need further
liberalisation to harness their potential. Unless sustained efforts are put in to
improve these, with the increasing importance of the services in wake of structural
adjustment and liberalisation in the economy we may get into two alternate
scenarios.
a) Economic and social position of workers in the service sector will steadily
go down– since real incomes cannot be higher than productivity for any
44
extended length of time. This means economic stagnation and consequent Growth and Structure of
Indian Economy
social tensions; or
b) The workers in this sector will use their numerical strength to get wages
higher than their economic contribution justified. This will impoverish
others– reducing everyone’s income and increasing unemployment.
Further, the growth of service sector is constrained by slower growth in the

manufacturing sector. While the inter-linkages between manufacturing and service
sectors are two-way, the expansion of certain manufacturing activities boosts
specific service industries. Many modern manufacturing companies outsource
technical and business-related services such as research and development,
financing, marketing, branding and logistics. Manufacturing industries such as
mechanical and electrical engineering or even textiles depend crucially on services
such as technical and design support, data processing, customer services, and
advertising. As manufacturing firms grow and become more specialised, services
tend to get more and more incorporated into their value chain.
Manufacturing expansion spurs the development of physical infrastructure such

as roads, ports and railways, which are critical inputs to improve manufacturing
productivity. In turn, demand for infrastructure-related services such as
transportation, telecommunication and financial intermediation grows.
Manufacturing growth, therefore, gives a boost to services. However, weaknesses
need to be addressed. We are very poor in what service customers view to be the
most important dimension– that of delivering on promises without being chased.
Recent research on a major Indian corporation revealed that it spends around 40
per cent of its time on “following up” each other. This is par for the course
around India. If that is correct, this weakness alone could wreck us.
2.4.5 Need for an Integrated Policy

The contribution of the services sector to the Indian economy has been manifold:
a 57 per cent share in GDP, growing by 10 per cent annually, contributing to
about a quarter of total employment, accounting for a high share in FDI inflows
and over one-third of total exports, and recording very fast export growth. To
make services-led growth more widespread and sustainable, it is important to
systematically and simultaneously remove those constraints from which the sector
suffers presently. To do this, a coherent integrated services policy (in line with
the agricultural and industrial policies) needs to be developed. Reforms in services
in India have evolved in an ad hoc manner rather than as part of an overall
strategy. Consequently, the depth and pace of reforms lack uniformity across
sectors. Given the strong inter-linkages between different services, opening a
particular services sector may not yield results if not backed by corresponding
reforms in other complementary services. Such an integrated services policy
should also define the sequence as well as the pace of reforms to be undertaken
simultaneously in different services. Liberalisation should be followed in a phased
manner accompanied by social policies in sectors that have surplus labour so as
to avoid creating unemployment and social unrest. This will go a long way in
sustaining the dynamism of services-led growth.
45
Indian Economic Development: Check Your Progress 3
An Overview
1) Discuss in brief the causes of the rapid increase in tertiary sector in India.
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2) Discuss in brief the limitations from which the service sector suffers in India.
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3) Outline the need for an integrated service sector policy in India.
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2.5 MEDIUM AND LONG-TERM GROWTH

PROSPECTS OF THE ECONOMY
In the medium to long-term, the expectation is that India’s pace of economic
development will pick up. There are two reasons for this expectation. One, given
the momentum in the savings and investment rates and also the fact that India’s
demographic dividend is yet to peak and there is evidence that the savings rate
for the working-age population of India, especially for those in the 30s and 40s,
is high, investment rate could potentially improve. Two, the fraction of investment
that is going towards building up infrastructure has been rising. The importance
of infrastructure for sustainable and inclusive development is now well recognised
and the government is seeking to give this a large boost. It is known that once an
economy begins to operate close to potential savings and investment rates,
sustenance of growth momentum requires productive improvements, which
depends in tern depends on improvement in human capital on skill upgradation,
technology and innovation in production. There are several initiatives underway
to address these requirements as highlighted in the earlier section. Importantly,
there is nothing preordained about India’s economic rise– i. The sustenance of
the growth story needs nourishment, not merely sound bites.
46
2.5.1 Major Policy Initiatives in the Recent Decades Growth and Structure of
Indian Economy
2.5.1.1 Containing Inflation and Soaring Fiscal Deficits
Following an agreement between Government of India (GOI) and Reserve Bank

of India (RBI), a Monetary Policy Committee (MPC) was constituted in February,
2015 with the mandate to target a headline inflation of 4 per cent, with a band of
two percentage points on either side. The framework has been successful in
containing inflation. Since April 2015, when the MPC was first convened, the
monthly headline inflation has always remained within the band except for one
month.
Discipline was also imposed on the Gross Fiscal Deficit (GFD). The Fiscal
Responsibility and Budget Management (FRBM) Act of 2003, which got a new
lease of life since 2016, determines the glide path for the ratio of GFD to GDP to
reach an eventual target of 3 per cent. The ratio declined from 4.5 per cent in
2013-14 to 3.4 per cent in 2018-19. Other macro-stability indicators have similarly
improved.
2.5.1.2 Beneficiary Focus and Targeted Delivery
In addition to re-establishing macroeconomic stability, the government also

focused on last-mile delivery of basic services to the poor, on basic safety-nets,
and on creating pathways for the benefits of growth to reach the bottom of the
socio-economic ladder. The promulgation of the Aadhaar (Targeted Delivery of
Financial and Other Subsidies, Benefits, and Services) Act, 2016 was one such
initiative that opened a major pathway to this trickle-down. By assigning a unique
identification number to every individual, the government now has the ability to
provide targeted support. Presently, Aadhaar coverage stands at more than 90
per cent of the country’s population.
Another pathway for the trickle-down is the Pradhan Mantri Jan Dhan Yojana
(PMJDY), a financial inclusion initiative. The linking of mobile numbers with
bank account numbers and subsequently Aadhaar, created a JAM (Jan Dhan,
Aadhaar, Mobile) trinity that further secured Direct Benefit Transfers (DBT) to
the intended beneficiaries.
Major schemes implemented under DBT include MGNREGS (Mahatma Gandhi

National Rural Employment Guarantee Scheme), NSAP (National Social
Assistance Programme), PMAY-G (Pradhan Mantri AwasYojna-Gramin), besides
various scholarships and fertilizer subsidy schemes. A key initiative for last-
mile delivery was the Pradhan Mantri Ujjwala Yojana (PMUY) that was launched
in 2016 to to provide LPG connections to BPL (Below Poverty Line) families. In
2018, another effort to provide a basic safety net was launched through the
Ayushman Bharat Yojana (ABY), which provides an insurance cover of
Rs. 5,00,000 for cashless treatment to each of the 100 million BPL families at a
nominal premium of Rs. 100 per month.
The creation of physical infrastructure accelerated significantly during 2014-19.

In April 2018, electricity finally reached every village in India with the effort to
electrify every home still ongoing. The construction of national highways (NH)
47
Indian Economic Development: proceeded at a rapid pace with more than 20 per cent of the existing highway
An Overview
length of 132,000 km being constructed in the last four years alone. The UDAAN
scheme was launched in 2017 to foster regional connectivity by extending flight
connectivity to Tier-3 and Tier-4 towns in the country. The infrastructure of the
North-Eastern states was a special focus and there has been a significant
improvement in connectivity with the building of key bridges, and the expansion
of railways/highways.
2.5.1.4 Federalism
Fiscal federalism strengthened significantly when the Fourteenth Finance

Commission increased the share of states in the divisible pool of central taxes
from 32 per cent to 42 per cent. Although central grants to states saw compensatory
cuts, the shift empowers states to manage their revenues and expenditures
independently. The launch of the GST (Goods and Services Tax) in July, 2017
added a new dimension to centre-state and inter-state financial relations. The
GST Council experience provides key learning for implementing cooperative
federalism in several other areas such as labour and land regulation. Niti Aayog
has helped institutionalise cooperative federalism by setting up teams from both
the states and the central government to jointly evolve strategies for addressing
development challenges. States have also been involved in a friendly competition
to improve their Key Performance Indicators (KPIs).
2.5.1.5 Corporate Exits
When the Insolvency and Bankruptcy Code (IBC) was introduced in 2016, it
consolidated the insolvency resolution process into a single law by repealing/
amending multiple rules and processes earlier in operation. IBC set a time limit
for closing of insolvency and bankruptcy cases within which assets of a defaulting
borrower are auctioned to pay off the debt owed to lending institutions. Following
the operationalisation of IBC since 2017, a significant number of non-performing
assets have been brought under its ambit. In addition to the large sums recovered
by creditors from resolution or liquidation, the introduction of a framework for
exit has improved the overall business culture of the country.
2.5.1.5 Demonetisation
The government of India took a bold step to demonetise Rs. 500 and Rs. 1000
currency with effect from 8 November 2016 midnight. It was a major decision
which had its impact on all sections of the society. It was aimed to reduce funds
to terrorism, decrease the corruption rate, eliminate counterfeit notes, and open
gates for a cashless economy. Through the demonetisation exercise, the
government has been pressing hard to become a cashless economy and is
encouraging more and more people to adopt the digital payments system for
their transactions.
2.5.1.6 Goods and Services Tax (GST)
Implemented on July 1, 2017, the Goods and Services Tax (GST)is regarded as
the biggest and substantial indirect tax reform since independence. GST has
replaced a number of Central and State taxes, made India more of a national
integrated market, and brought more producers into the tax net. It has subsumed
all sorts of indirect taxes like Central Excise Tax, VAT/Sales Tax, Service tax,
48
etc. and implement one taxation system in India. The main aim of GST is to Growth and Structure of
Indian Economy
create a single, unified market which will benefit in the development of country’s
economy. GST taxes only the final consumer. Hence the cascading of taxes (tax-
on-tax) is avoided and production costs are cut down. The system is expected to
improvise tax collections and boost up India’s economic development and break
all tax barriers between Central and State Governments.
Aided by all these features, the Indian economy rebounded back on high growth
trajectory. While rest of the world was cooling off with growth rates slowing
down, the Indian economy recorded highest-ever growth rates during the period
2014-19, clocking an average of about 7.5 per cent per annum. It is widely-
accepted that India cannot meaningfully regain its economic momentum unless
corporate investments are brought on track. The sort of demand stimulus that the
government has preferred despite supply constraints will only add to inflationary
pressures. Public investment cannot play a major role in the recovery unless
there is a significant shift of public spending away from subsidies and towards
asset creation. A private investment revival is thus the magic key. Unwinding the
current policy tangle is key to reviving animal spirits.
2.5.2 The Challenges That Remain

GDP growth in India has followed an inverted U-shaped curve, accelerating
from a low of 5.5 per cent in 2012-13 to a peak of 8.2 per cent in 2016-17 and
then decelerated to 6.8 per cent in 2018-19.The GDP growth decline is due to
rise in real interest rates, enforcement of tighter norms on Bank NPAs and
implementation of the Indian Bankruptcy Code, decline in GFCF and other factors.
Despite the promising growth trajectory that Indian economy has been
experiencing and is believed to experience, there remain several challenges that
need to be addressed to ensure welfare and development along with the sustained
growth. These include:
2.5.2.1 Non-farm Employment Opportunities
Over the years, the rural non-farm sector has been gaining importance in providing
gainful employment and additional income opportunities to the growing rural
workforce. Yet the country is still struggling to move rural workers away from
agriculture. More than 70 per cent of the rural poor are dependent on agriculture
either as cultivators or as agriculture labour. Besides, livestock rearing is again a
key livelihood of the poor. Thus, it becomes imperative to make rural non-farm
activities lucrative enough to attract the growing rural workforce. For this,
analysing the barriers of entry into this sector employment and the different
activities undertaken in each state or region becomes important.
2.5.2.2 Demographic Transition and Dividend
According to United Nations Population Fund (UNFPA), demographic dividend

means, “the economic growth potential that can result from shifts in a population’s
age structure, mainly when the share of the working-age population (15 to 64) is
larger than the non-working-age share of the population (14 and younger, and 65
and older)”.India has the largest proportion of young people in the world. The
working-age population (15–64 years) constitutes 64 per cent of the population.
The country has a distinctive 20 to 25 years’ window of opportunity which needs
to be exploited. Considering the fact the country’s IT industry employs just
0.4 per cent of the workforce– with the vast majority of Indians doing low 49
Indian Economic Development: productivity jobs in areas such as transportation or construction– development
An Overview
of a labour-intensive manufacturing sector becomes vital for the country to take
advantage of its rapidly growing population.
2.5.2.3 Urbanisation
India is urbanising at a much faster pace. As per World Urbanisation Prospect

2014, Revision report India is projected to add 404 million urban dwellers between
2014-2050. This will add additional pressure to the existing urban centres which
are already in the grip of issues like house shortages, traffic congestion, air
pollution, rising greenhouse gas emissions, poor public health, etc. resulting from
tremendous demographic pressure, inadequate infrastructure and resources to
cater, unplanned growth of the peri-urban sprawls characterise. Urbanisation
in India is inevitable thus, the need for solving the various problems associated
with it requires a combination of actions, starting with increased investment;
strengthening the framework for governance, and most importantly capacity
building for the people and the institutions engage in urban affairs. Along with
this, the country needs to avoid excessive sprawl and address infrastructure
bottlenecks, particularly in the transport, power and water sectors.
2.5.2.4 Poverty and Inequality

Poverty elimination has remained a major challenge right from independence
and lies at the core of India’s national development agenda to create a just and
equitable society. Poverty has always been a matter of concern in the Indian
economy. A significant part of the country and the population is deprived of
access to basic health care, food, drinking water, sanitation as well as financial
services, making the minimum standard of living out of their reach, largely due
to long years of centralised development and inequitable distribution of income.
Poverty is worsened by the relatively high level of income inequality. Hence,
there has always remained the need of an attempt to eliminate poverty.
2.5.2.5 Environment and Climate Change
India is both a major greenhouse gas emitter and one of the most vulnerable
countries in the world to projected climate change. The country is already
experiencing changes in climate and the impacts of climate change, including
water stress, heat waves and drought, severe storms and flooding, and associated
negative consequences on health and livelihoods. With a 1.3 billion but growing
population and dependence on agriculture, India probably will be severely
impacted by continuing climate change. This calls for innovations, new
technologies, and new approaches to economic development.
India’s ambition of sustaining its relatively high growth depends on one important
factor: infrastructure. The country, however, is plagued with weak infrastructure
incapable of meeting the needs of a growing economy and growing population.
The corporate growth and investments can also be hampered if the government
fails to close the infrastructure deficit, which some experts estimate costs 4-5 per
cent of GDP due to inefficiencies. Also in order to fulfil Sustainable Development
Goal number 9, India needs to develop quality, reliable, sustainable and resilient
infrastructure, including regional and trans-border infrastructure to support
50
economic development and human well-being, with a focus on affordable and Growth and Structure of
Indian Economy
equitable access for all.
2.6 LET US SUM UP

In this unit we have reviewed the growth profile of the Indian economy. For this
purpose we have relied upon the national income data published by the Central
Statistical Office of the Government of India. The analysis of the data has thrown
some interesting facts which are briefly stated as follows:
Over the last seven decades growth has maintained a rising trend.
Although rising, the rate of growth has been relatively slow.
The growth has been topsy-turvy; dramatic increase in some years followed
by a sharp fall in subsequent years, e.g., the period 2015-19 followed by the
year 2019-20.
Medium and long-term prospects are bright; but the economy would have
to bear the global fate. Growth rates are projected to fall over whole of the
globe.
Macro-economic stability is an essential prerequisite for achieving the growth
needed for development.
Growth does not trickle down; development must address human needs
directly.
No one policy will trigger development – a comprehensive approach is
needed.
Institutions matter, sustained development should be rooted in processes
that are socially inclusive and responsive to changing circumstances.
We have also analysed the data to examine the changes that have taken place in
the structure of the Indian economy over the last seven decades. This analysis
has brought out a unique feature of India’s economic growth: structural change
in the Indian economy has deviated from the historical experience of other
countries, to begin with, build up a strong agricultural base that laid foundations
for rapid growth of industry. This resulted in evolution of a sound industrial base
that served as a jumping pad for another transition: transition to a service/
commercial economy. India, on the contrary has made a jump from the first
stage to the third stage. The result is an absence of a strong manufacturing
foundation this has remains implications for removing poverty and
unemployment.
We will address the issues in the subsequent units of the present course.
2.7 TERM - END EXERCISES

1) Examine in brief the different phases of growth of the Indian economy since
1991.
2) “The pattern of structural change in the Indian economy has deviated from
the development pattern of Western and South Asian economies.” Examine
this statement.
3) The unorganised sector dominates the Indian economy. Do you agree?
51
An Overview 2.8 KEY WORDS
Association of Southeast : A regional grouping that promotes economic,
Asian Nations (ASEAN) political, and security cooperation among its ten
members: Brunei, Cambodia, Indonesia, Laos,
Malaysia, Myanmar, the Philippines, Singapore,
Thailand, and Vietnam.
Federalism : The distribution of power in an organisation
(such as a government) between a central
authority and the constituent units.
Fiscal Deficit : The difference between the total income of the
government (total taxes and non-debt capital
receipts) and its total expenditure.
Free Trade Agreement : A treaty between two or more countries to
(FTA) facilitate trade and eliminate trade barriers.
Gross Fixed Capital : As per RBI, Gross capital formation refers to
Formation the ‘aggregate of gross additions to fixed assets
(that is fixed capital formation) plus change in
stocks during the counting period.’
Insolvency and : The bankruptcy law of India which seeks to
Bankruptcy Code consolidate the existing framework by creating
(IBC), 2016 a single law for insolvency and bankruptcy to
resolve insolvency in a time-bound manner.
Minimum Support Prices : MSP is an agricultural product price, set by the
(MSP) Government of India to purchase directly from
the farmer.
Unorganised Sector : As per ‘Ministry of Labour and Employment’—
Unorganised sector means an enterprise owned
by individuals or self-employed workers and
engaged in the production or sale of goods or
providing service of any kind whatsoever, and
where the enterprise employs workers, the
number of such workers is less than ten.
2.9 REFERENCES
1) Ishwar C. (2019) Dhingra, Indian Economy in the Twenty-First Century,
Manakin Press, New Delhi.
2) The World Bank, (March 2018). India Development Update: India’s Growth
Story. Retrieved from http://documents1.worldbank.org/curated/en/
814101517840592525/pdf/India-development-update-Indias-growth-
story.pdf
3) Patnaik I and Pandey R. (2019). Savings and capital formation in India.
Retrieved from https://macrofinance.nipfp.org.in/PDF/PatnaikPandey-
savings_and_capital_formation_in_India.pdf
52
4) Kumar P. (May 2020). The Economic Impact of COVID 19 with special Growth and Structure of
Indian Economy
reference to India. Retrieved from http://164.100.47.193/Refinput/
New_Reference_Notes/English/06072020_125312_1021205239.pdf

PROGRESS EXERCISES
1) See Section 2.2
2) See Section 2.2
3) See Section 2.2

1) See Section 2.3

53
An Overview UNIT 3 DEMOGRAPHIC TRANSITION AND
ITS IMPLICATIONS
Structure
3.0 Objectives
3.1 Introduction
3.2 The Theory of Demographic Transition
3.3 Demographic Profile of India
3.3.1 Size and Growth Rate of Population in India
3.3.2 Birth Rates and Death Rates
3.3.3 Gender Composition of the Population
3.3.4 Literacy and Gender Composition
3.3.4.1 Gender Selective Abortions in India
3.3.4.2 Government Response
3.3.5 Age Composition
3.3.6 Life Expectancy
3.3.7 Rural-Urban Migration
3.4 Population Growth and Development
3.4.1 Population Policy
3.4.2 National Population Policy, 2000
3.5 Demographic Change and Economic Growth
3.5.1 Age Structure and Economic Growth
3.5.2 Concept of Demographic Dividend
3.5.3 Population Health
3.6 Demographic Dividend and Policy Interventions
3.6.1 Capturing India’s Demographic Dividend
3.7 Let Us Sum Up
3.9 References
3.10 Key Words
3.0 OBJECTIVES
After reading this unit, you will be able to:
understand the impact of demography on economic growth and comprehend
the concept of demographic dividend in detail;
assess the role of health, education, and employment in harnessing the
demographic window of opportunity;
recognise the constraints that a nation faces in harnessing the benefits of the
demographic dividend;
know the demographic profile of India; and
54 analyses how the population growth affects economic development.
Demographic Transition and
3.1 INTRODUCTION Its Implications
The relationship between population growth and economic development has been
debated for several decades. The early Malthusian view was the pessimistic
argument stating that population growth impedes economic growth resulting in
reduction in per-capita income and resources which results in deterioration of
quality of life. The optimistic argument emphasises that population growth
promotes economic development as experienced by several East Asian countries.
A young educated population increases productivity and contributes to invention
and innovation of technologies.
An increase in the proportion of working age population (15-59) and fall in the
proportion of dependent population of age groups (0-15) and 60+ gives birth to
a window of opportunity termed as demographic dividend. The working age
population helps in increasing savings, investment and improves the economic
prosperity and standard of living of people. However, the benefits of demographic
dividend are not automatic or guaranteed. It depends upon several factors like
education, health, employment, infrastructure, right economic policies, and good
governance. The potential demographic dividend if not actualised may turn into
demographic disaster where young population becomes a liability or permanent
burden on the economy.
3.2 THE THEORY OF DEMOGRAPHIC

TRANSITION
The process by which fertility rates eventually decline to low and stable levels
has been called demographic transition. Fertility rate is defined as the average
number of children per women in the reproductive age group. Demographic
transition postulates three stage sequences of birth and death rates which are
associated with economic development. It explains phasing out process of
population growth rates starting from virtually stagnant growth stage characterised
by high birth and death rates through a rapid-growth stage with high birth and
low death rates to stable, low growth stage in which both birth and death rates
are low. This demographic transition has been witnessed in contemporary
developed nations as they developed and one can identify the developing nations
as they move through the different stages of this transition. The issue is what
explains this transition or what are the factors that contribute to it.
First Stage of Demographic Transition

In this stage the death rates are high due to absence of effective medical aid,
primitive sanitation, and poor diets. The birth rates are also high on account of
absence of knowledge about family planning techniques, early age of marriage,
illiteracy and deep-rooted social beliefs, and customs about the size of the family
including, as an insurance against high child mortality rates. The actual rate of
growth of population is low since high birth rate is balanced by high death rate.
Second Stage of Demographic Transition

With economic development resulting in high incomes, improvement in public
health facilities there is a marked decline in mortality that raises life expectancy
from under 40 years to 60 years. However, the decline in death rate is not
immediately accompanied by decline in fertility. In this stage of demographic 55
Indian Economic Development: transition, with declining death rate, birth rate does not fall correspondingly.
An Overview
This leads to transition from stable or slow growing population to rapidly
increasing population.
Third Stage of Demographic Transition

The forces and influences of modernisation (including increase in female work
participation rate and move towards nuclear families) and economic development
causes fertility rate to decline so that falling birth rate eventually converges with
the death rate leaving little or no population growth. The characteristics of the
third stage are low birth rate, low death rate, small family size and low growth
rate of population.
3.3 DEMOGRAPHIC PROFILE OF INDIA

3.3.1 Size and Growth Rate of Population in India
The study of India’s demography is essential to understand the dynamics of
economic development and economic welfare. Theory of demographic transition
helps to understand and analyse the change in the magnitude of population.
India has around 2.4 per cent of the total land area of the world and approximately
17 per cent of the world population residing in this country. In 2011 the population
of India was 1210 million, making it the second largest in the world. Area-wise,
India is at the seventh position in the world.
India’s Demographic Phases:

A study of growth rate of India’s population can be categorised into four phases
Phase I: 1891-1921(Stagnant Population)

During the first phase of 30 years India’s population grew from 236 million in
1891 to 251 million in 1921. High birth rate was neutralised by high death rate
that ensured that population growth was stable during this period. Population
increased by 15 million only and the compound annual growth rate was just 0.19
per cent per year. India’s first stage of demographic transition was marked by
stagnant population.
Phase II: 1921-1951(Steady Growth)

During the second phase of demographic transition population grew from 251
million in 1921 to 361 million in 1951. The population grew by 110 million with
compound growth rate of 1.22 per cent per year. The death rate during this period
decreased from 47 per thousand to 27 per thousand. The fall in death rate was
mainly due to control of widespread epidemics like plague, smallpox, cholera
etc. that took heavy toll of human lives. From 1921 onwards India entered the
second phase of demographic transition marked by steady but low growth rate
of population.
Phase III: 1951-1981(Rapid Growth)

During the third phase of 30 years India’s population grew from 361 million in
1951 to 683 million in 1981. There was a record growth of population by 322
million with compound annual growth rate of 1.22 per cent per annum. With the
beginning of planning, the extension of hospitals and medical facilities was under-
56
taken on a large scale. This resulted in sharp decline in death rate to 15 per Demographic Transition and
Its Implications
thousand, but the birth rate did not fall at the same pace. It fell from 40 to 37 per
thousand and this led to population explosion during this period. A steep rise in
population growth rate (over 2 per cent) was due to a steep fall in the mortality
rate accompanied by high fertility rate.
Table 3.1: Growth of Population in India (1891-2008)
Census Populations Increase or Percentage

Year in millions Decrease Increase or
(in millions) Decrease
1891 236
1901 236 0.0 0.0
1911 252 +16 +5.7
1921 251 -1 -0.3
(1891-1921) +15 +0.19
1931 279 +28 +11.0
1941 319 +40 +14.2
1951 361 +42 +13.3
(1921-1951) +110 +1.22
1961 439 +78 +21.6
1971 548 +109 +24.8
1981 683 +135 +24.7
(1951-1981) +322 +2.14
1991 846 +161 +23.9
2001 1029 +183 +21.5
2011 1210 +181 +17.64
(1981-2011)
Source: Census of India 2001, Series 1, Paper 1 of 2001, Provisional Population Totals,
Economic Survey, 2009-10, Census 2011 (Provisional Population Totals)
Phase IV: 1981-2011 (High growth with definite signs of slowing down)
India entered the fourth phase of demographic transition marked by high
population growth with definite sign of slowing down. Total population increased
from 683 million in 1981 to 1210 million in 2011 indicating an increase of 77.2
per cent during the 30 year period. The compound annual growth rate of population
reduced from 2.14 per cent (1991-2001) to 1.64 per cent (2001-2011). Most
Indian states such as Kerala, Tamil Nadu, Andhra Pradesh, West Bengal, Punjab,
Himachal Pradesh, Gujarat and Assam have recorded low birth rates during this
phase. States like Madhya Pradesh, Uttar Pradesh, Bihar and Rajasthan will take
some more years for complete implementation of family planning programme.
57
Indian Economic Development: Table 3.2: Compound annual Growth Rate of Population
An Overview
Year Growth Rate
1891-1921 0.19
1921-1951 1.22
1951-1981 2.15
1981-2001 1.93
2001-2011 1.64
Source: Census of India 2001
Although the results from the Census 2021 have been delayed due to COVID 19,
there are indications that India is moving faster than earlier projected towards
attaining replacement level fertility rates at the state level and the consequent
stabilisation of population. Recent surveys show that in majority of Indian states
fertility rate has fallen well below the replacement level of 2.1 and the country is
fast approaching the replacement level itself. The total fertility rate of India stands
at 2.2 as of 2017.
3.3.2 Birth Rates and Death Rates

The rate of growth of population depends on birth rate and death rate. The
difference between birth rate and death rate gives us acceleration or deceleration
in the growth of population.
1) The growth of population was very low before 1921 due to prevalence of
high birth rate and high death rate. The birth rate varied between 46 and 49
per thousand and death rate fluctuated between 42 and 48 per thousand.
Table 3.3: Average Annual Birth and Death Rates in India
Decade Births per 1000 Deaths per 1000
1891-1900 45.8 44.4
1901-1910 48.1 42.6
1911-20 49.2 48.6
1921-30 46.4 36.3
1931-40 45.2 31.2
1941-50 39.9 27.4
1951-60 40.0 18.0
1961-70 41.2 19.2
1971-80 37.2 15.0
1985-86 32.6 11.1
2010-11 21.8 7.1
Source: Census of India, 1971, Age and Life Tables and Census of India 1981, Series I, Paper
1 of 1984 and Office of Register General and Ministry of Health and Family Welfare,
Annual Report (2000-01) and Economic Survey (2009-10)
2) After 1921 the gap between birth rate and death rate widened. There was
fall in the death rate from 48.6 per thousand in 1911-20 to 7.1 per thousand
58 in 2001-2010.
3) The birth rate also showed a decline after 1971 due to family planning Demographic Transition and
Its Implications
programs. States like Kerala, Tamil Nadu, Maharashtra, Andhra Pradesh,
West Bengal, Karnataka and Punjab achieved a birth rate below 20 per
thousand. But states like Haryana, Gujarat, Uttar Pradesh, Rajasthan, Bihar,
Madhya Pradesh had high birth rates ranging from 27-28 per thousand. Hence
India as a whole did not enter third stage of demographic transition.
4) The high growth rate of population in India is an outcome of consistently
high birth rate but relatively fast declining death rate.
3.3.3 Gender Composition of the Population

Gender ratio is a perfect way to find the number of women in any country. Gender
ratio shows ratio of females to that of males in India. According to Census 2011,
there were 940 females per 1000 males compared to 933 females per 1000 males
in 2001. The imbalance in gender ratio in India has been persistent, showing a
continuous declining trend since 1901, with the exception in 1981 and 2011,
when it recorded a marginal improvement. It has been found that the probability
of women to live longer than men is high. This is supported by evidence in the
advanced western countries where the proportion of women in total population
is higher than that of males. In India 108 females are born per 100 males but the
loss of more females or problem of missing women as highlighted by Prof.
Amartya Sen is due to reasons including the following:
1) Ignoring the nutrition needs of a girl child leading to higher mortality
2) High maternal mortality due to insufficient care and attention
3) Sex selection abortions due to social preference for a boy across communities
4) Female infanticide
5) Deterioration in the gender ratio at birth
Table 3.4: Gender Ratio in India
Year Females per 1000 Males
1901 972
1911 964
1921 955
1931 950
1941 945
1951 946
1961 941
1971 930
1981 934
1991 927
2001 933
2011 940
As a consequence, in 2011 females per thousand males were 940, while in Russia
it was (1,140), in Japan (1041) and in U.S.A (1029). The imbalance in gender
59
Indian Economic Development: ratio can be seen at state level. The gender ratio varied from 818 in Chandigarh
An Overview
to 1084 in Kerala in 2011. In case of Child Sex Ratio (CSR) Haryana was at the
bottom with CSR of 834 while Meghalaya and Mizoram were at the top with
CSR of 970. Pondicherry and Kerala have maximum number of women in India
while Haryana and Daman & Diu have lowest gender ratio. Few states like
Maharashtra, Karnataka and Andhra Pradesh showed improvement in gender
ratio in 2011.
There has been sharp deterioration in the gender ratio in Bihar from 946 in 1981
to 916 in 2011. In Punjab, U.P and Haryana gender ratio varies from 877 to 908
per 1000 males.
Table 3.5: Gender Ratio (female per 1000 males) in Major States of India
Arranged in Descending Order on the Basis of 1991, 2001 and 2011 Census
S. No. State 1991 2001 2011

1. Kerala 1040 1058 1084
2. Tamil Nadu 972 986 995
3. Andhra Pradesh 972 978 992
4. Odisha 972 972 978
5. Himachal Pradesh 996 970 974
6. Karnataka 960 964 968
7. West Bengal 917 934 947
8. Assam 925 932 935
9. Madhya Pradesh 932 920 930
10. Rajasthan 913 922 926
11. Maharashtra 936 922 925
12. Gujarat 936 921 918
13. Bihar 912 921 916
14. Uttar Pradesh 882 898 908
15. Punjab 888 874 893
16. Haryana 874 861 877
17. India 927 933 940
Source: Census of India 2001, Series 1, Paper 1 of 2001, Provisional Population Totals, Census
of India 2011, Provisional population, Totals.
3.3.4 Literacy and Gender Composition

Literacy is an important indicator of development. It helps in advancing
modernisation, urbanisation, industrialisation, communication, and commerce.
It plays a vital role in economic mobility, creating equality and contributing to
social development including by addressing the factors behind imbalances in the
sex ratio. The spread of education and improvement in educational status has led
to the fall in the sex ratio. As per the reports of NFHS-5 (National Family Health
Survey, 2019-20) Andhra Pradesh (68.6%), Bihar (57.8%) and Telangana (66.6%)
60
accounted for lowest literacy rates among women, while Kerala (98.3%), Demographic Transition and
Its Implications
Lakshadweep (96.5%) and Mizoram (94.4%) recorded the highest literacy rate
among women in surveyed states and UTs. Literacy according to the survey
refers to women or men who completed standard 9 or higher and women or men
who can read a whole sentence or part of sentence.
3.3.4.1 Gender Selective Abortions in India
The proportion of female in India’s total population has been low and declining
since several decades. The declining gender ratio or sex imbalances have been
the cause of grave concern since it reflects the mindsets of people. India is a
country where son is given strong preference compared to daughters in many
families. There are various social, cultural, and economic factors like economic
support, property inheritance, old age security, prestige, beliefs about religious
rituals and salvation that leads to preference for sons over daughters. The son is
seen as an insurance against old age in the absence of strong social security
system. The discriminatory allocation of good diet, medical care and other family
resources in favour of sons over daughters is due to the consideration of potential
benefits that puts sons above daughters. Daughters in many families in India are
still considered as financial liability by their parents. A study conducted by CARE
(Co-operative for American Relief Everywhere) for pre-school children in Punjab
showed that 29 per cent of male children suffered from severe malnutrition but
the proportion was 71 per cent in case of females. Consequently, infant mortality
rates are high among girl child even in states like Punjab which has the highest
per-capita income.
The sudden fall in the number of girls aged 0-6 years age group shows linkages
between invention of new medical technologies such as pre-natal diagnostic
techniques and increased incidence of sex selective abortions or female foeticide.
The advancement in medical technologies has led to misuse of sex determination
technologies such as ultrasound scanning and amniocentesis. These technologies
were introduced to determine genetic abnormalities among fetus and were used
to detect sex of the child.
The recent legislation about Medical Termination of Pregnancy embodied in

1971 Act states that abortion can be performed legally if pregnancy causes danger
to the life of the women or if it affects her physical or mental health or if the child
is going to be born with serious abnormalities. The proliferation of sex
determination tests (amniocentesis) has made it possible to kill female foetus
before birth. The unregulated sex determination and female infanticide prior to
birth has exercised a negative influence on sex ratio which is moving against the
females.
3.3.4.2 Government Response

Sex determination tests have become a part of strategy to ensure desired family
sex composition. Sex selection in fact is preferable alternative to female infanticide
or discriminatory ill-treatment of girls after birth. The response of Indian
government has been slow and ineffective.
In 1998 The Prenatal Diagnostic Techniques Regulations and Prevention of
Misuse Bill was introduced. The law covers all the clinics, hospitals and
laboratories offering prenatal testing.
61
Indian Economic Development: The salient features of the bill are as follows-
An Overview
1) Prenatal Diagnostics can only be conducted to detect genetic abnormalities
(including sex linked genetic diseases).
2) The test may only be undertaken by high-risk pregnant women who meet at
least one of the following criteria
a) Age over 35 years
b) History of 2 or more abortions
c) History of exposure to hazardous substances
d) Family history of genetic disorder
e) Any other conditions as specified by the authorities
3) Use of prenatal diagnostic technologies for indicating the sex of the foetus
is banned. Offences are punishable by both imprisonment and a fine.
The government sponsored girl child schemes like Beti Bachao Beti Padhao,
Sukhanya Samriddhi Yojana, Balika Samriddhi Yojana, Dhanalakshmi Scheme,
C.B.S.E Udaan Scheme have been introduced to bring change in social attitude
towards girl children. The government also needs to address the issues like low
levels of education, poor health, unhygienic living conditions and poverty to
uplift the status of the women in society. With economic development and high
female literacy and female labour force participation rate the gender bias against
women are bound to decline and the sex ratio will improve.
3.3.5 Age Composition

The age structure or composition of a population is the distribution by age of the
population. Age is the central concept in demography for two reasons:
1) Demographic behaviour and benefits of demographic dividend depends on
the age structure of the population.
2) Populations of different age structure relate to each other.
As populations shift from high mortality and high fertility to low mortality and
low fertility there will be a bulge in the younger age group. This youth bulge can
be a burden or dividend depending upon policies, institutions, and economic
circumstances. If the economy hits rock bottom and there is high unemployment
youth may turn to criminal activity or generate social unrest. Otherwise,
demographic dividend helps in accelerating economic growth.
In the age group 0-14 the male population is about 1 per cent more than the
female population. A higher proportion of male and female in the working age
group 15-59 live in the urban areas as compared to rural areas. The Table 3.6
shows that a declining child population (0-14) and old age group (60+) reflects a
declining dependency ratio in the rural and urban areas. An increasing working
age population reflects that India is enjoying the benefits of favourable
demographics and potential demographic dividend in near future. This youth
bulge can be demographic dividend or demographic disaster depending upon
governance, infrastructure, education, health, employment opportunities etc.
62
Table 3.6: Percentage distribution of population by Broad Age Groups to Total Demographic Transition and
population by Gender and Residence, India, 2011 Its Implications
Residence Gender Broad Age Groups (years)

0-14 15-59 60+
Total 29.5 62.5 8.0
Total Male 30.0 62.2 7.7
Female 28.8 62.8 8.4
Total 30.9 61.0 8.1
Rural Male 31.5 60.7 7.8
Female 30.3 61.3 8.4
Total 25.5 66.6 7.9
Urban Male 26.1 66.2 7.6
Female 24.9 66.9 8.2
Note: Total percentage may not add to 100 on account of rounding in broad age groups
Source: Census of India (2011)
3.3.6 Life Expectancy

Life expectancy is the number of years a newborn child would live if subjected
to the mortality risks prevailing for the population at the time of child’s birth. In
the period 1901-10, life expectancy was very low (23 years). The rise became
substantial from 1951. It was 41.3 years in 1961, 45.6 years in 1971 and 50.5
years in 1981 and 63.4 years in 2004. At present it is 69 years with women
expected to live for 70.4 years and men for 67.8 years.
3.3.7 Rural-Urban Migration

The process of economic development is associated with growth of urbanisation.
The urban population has been growing rapidly since 1961. As per cent of total
population, the urban population was about 11 per cent in 1901, about 18 per
cent in 1961, about 26 per cent in 1991, 29 per cent in 2004 and 31 per cent in
2011. With slowing of the rate of growth of population and acceleration of
industrialisation, the pace of rural-urban migration is expected to increase. Factors
like higher incomes, job security, education, health, entertainment attract people
to urban areas. The push and pull factors have played an important role in the
degree of urbanisation.
1) Elaborate the theory of Demographic Transition. Highlight the main trends
of population in India.
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
....................................................................................................................... 63
Indian Economic Development: 2) Explain the problem of missing women in India as coined by Prof. Amartya
An Overview
Sen.
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
3) Explain the pattern of population growth in India since 1891.
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
3.4 POPULATION GROWTH AND

DEVELOPMENT
Economic development is possible when a nation optimally utilises labour force
and capital so that productive potential is realised. Labour force expansion has
positive and negative effects on the process of economic development. According
to K. Sundaram the implications of growing demographic pressures in India for
the process of development in general and the progress towards poverty
eradication become clearer once we focus on the labour force consequences of
the population growth. The magnitude of the addition to the workforce brings
forth challenges pertaining to their productive absorption and capital constraints
in the labour market. Skilling and training millions of youth entering the labour
force is a herculean task for any government.
1) Population and Agriculture

The rising labour force puts pressure on land thereby reducing per-capita
cultivated area. The fall in the cultivated land-man ratio can be compensated
by making efforts to raise productivity. Irrigation potential if fully utilised
can raise agricultural productivity and fulfil the requirements of rising
population. With green revolution India has become self-sufficient in the
production of food grains, but the distribution of food grains has still remained
a critical issue. The incidence of nutritional deprivation and
undernourishment has been highest in India. Hence the challenges of food
production, food consumption and food availability have to be seen in this
light.
2) Population Growth and Per-capita Income

A high growth rate of population has been a retarding factor to raise per-
capita income. There is cumulative effect of the growth of population and
increase in economic activity. This effect depends on several factors like
64
food and nutritional adequacy, environmental degradation, infrastructural Demographic Transition and
Its Implications
pressures etc. Economic growth can also increase on sustainable basis if we
improve the education and health status of the population and create
productive employment opportunities for the people joining labour force.
The advantages and the limitations of population growth depend on the
pace of human capital formation and its deployment in productive activities.
3) Population and Unemployment

Rising population is accompanied by rise in the labour force that has a bearing
on the problem of unemployment. Millions of youth enter labour force every
year and absorption of all of them in the manufacturing and services sector
is a challenging task. Generating employment opportunities to absorb the
increasing labour force and the backlog of the unemployed pool has to be a
priority of the government. Job creation requires significant amount of
resources invested in infrastructure, tourism, manufacturing, construction,
MSMEs, railways, etc. Similarly, promotion of women’s employment
opportunities and female literacy can play a vital role in harnessing the
demographic dividend of the nation.
4) Population Growth and Environment

The demographic growth has implications on environmental resources,
including on water resources, fodder and forest products, fisheries, air quality,
soil, and other non-renewable resources. The degradation of environment
has a deteriorating impact on the quality of life and well-being of the people.
The greater reliance on solar and nuclear energy, judicious use of water
resources, afforestation and organic farming can play a significant role in
preserving the environment.
5) Population Growth and Social Infrastructure

Population growth leads to excessive pressure on social and economic
infrastructure including sewage systems, hospital facilities, education
institutions, highways, railways network, power grids, garbage-processing
plants, and other public amenities. Due to urban agglomeration, there has
been qualitative deterioration of social and physical or economic
infrastructure. The pace of rural- urban migration has further increased slums
in metropolitan cities burdening the already inadequate infrastructure
resources. India needs to increase its expenditure on health and education to
enhance labour productivity and employability. Creating quality education
institutions at primary, secondary and tertiary level and expenditures on
skill development and training are essential to take advantage of new and
innovative technologies in future. Similarly, India suffers from problem of
low doctor-population ratio and high out of pocket expenditure on health.
Hence, by increasing public expenditure on health we can improve medical
facilities and achieve goals of eradicating malnutrition and disease burden.
The task of providing housing to every Indian requires allocation of resources
and political will to execute the required social interventions.
3.4.1 Population Policy

The alarming increase in population calls for an effective population policy that
can slow down the rate of population growth.
65
Indian Economic Development: Family Planning and Five-year Plans
An Overview
India became the first country in the world to adopt an official national population
policy in support of family planning (Cadwell 1988, Visaria and Jain 1976). In
the third five-year plan (1961-66), the objective of stabilising the growth of
population within a reasonable period was put at the centre of India’s planned
development. The late 1960’s saw a shift in the emphasis of family planning
delivery from clinic-based approach to wider community extension strategy. In
1968 a demographic goal was set to reduce birth rate from 41 to 23 per 1000
within 10 years but the performance was far from desired.
By early 1970’s India experienced very high rate of population growth. The
1971 Census showed a decadal increment of 109 million. Consequently, there
was renewed emphasis on targets, compensation payments and male sterilisation.
In the fifth five-year plan Prime Minister Indira Gandhi tried to implement
population control using coercive and dictatorial powers. The Emergency in 1975
-77 saw forced sterilisation in mass camps that ended up being a failure and
undermining family planning in the country.
The rhetoric of the population control and forced sterilisation largely disappeared
in the Sixth Plan (1980-85). However, family planning became more widespread
in practice. Since Seventh Plan there were efforts to tailor family planning
programme to the conditions prevailing in different states and adoption of multi-
sectoral approach that recognised linkages between birth control and education
programmes.
To achieve family planning goals government adopted following measures:
1) Motivation programme to spread knowledge of family planning through
newspapers, radio, T.V., film, etc.
2) Involvement of private sector in contraceptive delivery to all rural and urban
population.
3) Financial incentives and political restrictions to encourage family planning.
4) Extensive sterilisation of both males and females.
With the fall in fertility rate, there was preference for boys over girls that resulted
in problem of missing women in India. In 2010, the ratio of males to females in
India had reached 108 to 100, one of the highest in the world. Kerala emphasised
on poverty reduction and human development and achieved a sharp decline in
fertility rate in India. In Kerala, more than 85 per cent of women are literate,
which means they have more power in household and opportunities in the work
force. The success of Kerala suggested that by bringing in women empowerment,
literacy, and human development we can bring in reduced fertility rates and
preferences for small family could be improved.
3.4.2 National Population Policy, 2000

The National Population Policy, 2000 was announced on 15th February 2000 with
an objective to control the rapidly growing population and stabilise it at reasonable
level.
66
Immediate Objective Demographic Transition and
Its Implications
The immediate objective is to provide for facilities to meet the unmet needs for
contraception, health care infrastructure and health personnel and an integrated
service delivery for basic reproductive and child health care.
Medium-term Objective
The medium objective is to bring Total fertility rate (TFR) to replacement level
by 2010.
Long-term Objective
The long-term objective is to stabilise population by 2045, at a level consistent
with requirements of sustainable economic growth, social development, and
environmental protection.
National Population Policy listed the following measures to achieve a stable

population by 2046.
1) Reduction of infant mortality rate below 30 per 1000 live births.
2) Reduction of maternal mortality rate to below 100 per 1,00,000 live births.
3) Health insurance cover of Rs. 5000 for couples below poverty line, with
two living children, who undergo sterilisation.
4) To achieve 80 per cent deliveries in regular dispensaries, hospitals, and
medical institutions with trained staff.
5) A special reward for women who marry after 21 and opt for terminal method
of contraception after the second child.
6) Self-help groups at village panchayat levels comprising mostly of housewives
to engage with health care workers and gram panchayats.
7) Strict enforcement of Child Marriage Restraint Act and Pre-Natal Diagnostic
Techniques Act.
8) Access to information containing AIDS, prevention and control of
communicable diseases.
9) Incentive to adopt two child small family norms. The message of small
family is to be spread through dissemination of information, education, and
communication.
10) Facilities for safe abortions to be increased. Contraceptive technology and
research in the reproductive and child health are to be encouraged.
11) Elementary education to be made free and compulsory.
12) A National Commission on Population headed by Prime Minister to monitor
implementation of new policy.
13) A National Population Stabilisation Fund renamed as Janasankhya Sthirata
Kosh (JSK) to support projects schemes, initiatives and innovative ideas
designed to help population stabilisation and provide window for canalising
resources through voluntary contributions.
67
Indian Economic Development: Achievements
An Overview
It has been estimated that 320 million births have been averted during the period
1956-2011 through family welfare programme. The incidence of acceptance of
family planning methods peaked at 62.9 million at the beginning of 2011. The
couple protection rate has gone up to 48.0 per cent (against the world average of
61 per cent).
It brings out that the demographic transition has already set in India and is moving
swiftly to its final stage. The resulting differential impact on fertility level and
on population growth rate is clearly reflected in 2011 census. India will reach the
threshold of the Net Reproduction Rate of 1 within a decade from now. The
desired family size is already close to replacement level in 10 states. In other
states it is much lower than the actual number of children born.
The population policy seems to have great potential for attaining the goal of a
stable population in the stipulated time frame. There are opportunities that are
untapped. If we seize these opportunities we can reduce birth rate, infant mortality
rate and promote adoption of small family norms in the country.
Limitations
1) Population control programme is led by government bureaucracy, which
can be effective in addressing technical matters, but here we need
transformation in the attitudes of people in the favour of small family norm.
2) The main targets laid down in the Population policy are over-ambitious.
Goals like making school education up to age of 14 free and compulsory,
reducing school drop-out rates to below 20 per cent for both girls and boys,
achieving TFR of 2.1 by 2010, reducing infant mortality rate to 42 per 1000
live births, reducing maternal mortality rate to below 100 (from 437) per
100000 live births, achieving universal immunisation of children against all
vaccine preventable diseases are too ambitious to be achieved in the stipulated
timeframe.
3) The incentives mostly in cash resulted in widespread corruption and cooking
of data. These incentives did not reach people who were living in areas
where the fertility is high (urban slums, tribal communities). The social
transformation can only be brought with effective implementation of policies
at the grass root level and requires an active participation of people.

1) Critically examine the link between population growth and economic
development in India.
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68
2) How does population growth hinder economic development in India? Discuss Demographic Transition and
Its Implications
the measures that have been undertaken in India to check population growth.
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3) Examine the population policy and government measures to control
population growth in India.
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3.5 DEMOGRAPHIC CHANGE AND ECONOMIC

GROWTH
India has witnessed rapid population growth from 448 million in 1960 to 1.04
billion in 2000 to 1.21 billion in 2010. India’s population is currently growing at
a rate of 1.4% per year. This rapid growth of population has been accompanied
by an unparallel decline in mortality rates and an increase in income per-capita.
3.5.1 Age Structure and Economic Growth

There have been two significant breakthroughs regarding the impact of
demography on economic growth. The first is the effect of changing age structure
of the population and the second relates to population health.
The age structure of the population can have a large effect on economic growth.
This can be due to shifts as a result of baby booms and busts and their echo
effects. The baby boom is not caused by increase in births but by the sharp
reduction in infant and child mortality due to increased access to vaccines
antibiotics, safe water and sanitation. This type of baby-boom starts with higher
survival and fertility declines as couples recognise that fewer births are needed
to reach their targets for surviving children and those targets are moderated.
Presence of more children requires more resources for food, clothing, housing,
medical care, and schooling. This gives boost to consumption led growth. The
babies born will reach working ages with period of 15-25 years where they become
productive and contribute to the process of economic growth and development.
3.5.2 Concept of Demographic Dividend

Demographic Dividend is an accelerated economic growth that a nation
experiences once in a lifetime when working age population grows at a faster
pace than dependent population, provided that government policies and
69
Indian Economic Development: institutions are conducive to create employment opportunities for an expanding
An Overview
labour force. Demographic dividend is a window of opportunity when the share
of working age population in total population rises, which is known to have
many benefits flow to its people. Before the dividend begins the nation is burdened
with high dependency ratio, with a large and growing share of population below
working age of 15. Once the dividend period has passed share of elderly population
rises and they have to be provided with pension and health benefits. Demographic
dividend lying between two periods is characterised by low dependency ratio
and high share of working age population.
The Population Reference Bureau defines Demographic Dividend as follows

“The demographic dividend is the accelerated economic growth that may result
from decline in a country’s mortality and fertility and the subsequent change in
the age structure of the population. With fewer people to support a country has
window of opportunity for rapid economic growth if the right social and economic
policies are developed and investments made.”
Demographic Dividends are composite of five distinct forces-
1) The swelling of labour force as baby boomers reach working age.
2) The ability to divert social resources to investments in physical capital, job
training and technological progress.
3) The rise in women’s work-force activity or labour force participation rate
that naturally accompanies a decline in fertility.
4) The working age or age between 15 years to 59 years is prime age for savings
which augments accumulation of physical and human capital and
technological innovation.
5) With increase in life expectancy there is boost to savings that occur, as the
incentive to save for longer periods of retirement increases.
The East Asian miracle happened because demographic change accounted for
approximately 2 percentage points of growth rate of income per-capita,
representing one-third of the supposed miracle. East Asian’s rapid economic
growth was spurred by its demographic transition with decline in the fertility.
Fertility decline lowers youth dependency immediately but does not appreciably
affect the working age population for 20-25 years. As the share of working age
population increases and dependent population declines there is an opportunity
for economic growth.
However, demography dividend is not destined. An increase in working age

population or productive population does not automatically lead to acceleration
of economic growth. In order to capitalise the demographic dividend we need
appropriate policies and institutions that would enable this working age population
to find productive employment opportunities, thereby boost economic growth.
In the absence of right policies and good governance, a nation may find itself
with large number of unemployed or underemployed working age individuals.
This unemployed pool in some instances would promote state fragility and failure
with adverse political, social, economic, and ecological spill overs. Demographic
dividend in that scenario gets turned to demographic disaster.
India began reaping the benefits of demographic dividend in the early 1980’s,
70 more concretely in 1990s and is expected to reap till 2040. India has 20 more
years to realise the benefits of this demographic dividend. India needs visionary Demographic Transition and
Its Implications
policies in the field of education, health and employment and speedy decision
making to increase and sustain GDP, reduce poverty, and enhance human
capabilities of our citizens. We need to ensure employment-intensive growth
and social inclusion for the next quarter century to capitalise on the demographic
window of opportunity.
3.5.3 Population Health

Health is a strong driver of economic growth. A productive and healthy workforce
can be easily absorbed in the labour market thereby maximising the benefits of
demographic dividend. Healthy populations have higher savings rates and better
cognitive skills. They also attract higher foreign direct investment. According to
Bloom (2011), healthier countries experience faster growth in average income
and that a 10-year gain in life expectancy translates into as much as 1 additional
percentage point of annual growth of income per-capita.
India’s health and nutrition indicators are very poor relative to the developed
and developing nations. This is because healthcare has been one of the most
neglected sectors of development and has suffered from persistent neglect in the
public policy. The lack of effective public involvement with health matters in
India has played no small part in the resilience of India’s health predicament.
(Dreaze and Sen, 2013)
It is important for India to develop a comprehensive vision of health care for the
country. This should be accompanied by better health delivery mechanism through
institutional change and by devoting greater proportion of GDP to public
expenditure on health. This has to go hand in hand with cultivation of greater
efficiency and accountability in public services. Lessons can be learnt from states
like Tamil Nadu, Kerala and Himachal Pradesh that have demonstrated the
possibility of making rapid progress in health at an early stage of development.
India can also learn from countries like Thailand, Brazil, Mexico, and China that
have transformed health policies for the well-being of their citizens.
3.6 DEMOGRAPHIC DIVIDEND AND POLICY

INTERVENTIONS
According to National Population Stabilisation Fund, India’s population stands
at 1.34 billion constituting 17.25 per cent of the world population and growing at
1.2 percent per annum. India will have around 1.53 billion people by 2030 and
will boost of world’s largest working age population which is expected to touch
962 million by 2030. The growth rate of labour force will continue to be higher
than the dependent population. This shows that India’s demographic window of
opportunity or demographic dividend shall witness huge potential during this
period.
According to the Economic Survey 2014-15 ‘300 million youth will enter the
labour force by 2025 and 25 per cent of the world’s workers in the next three
years will be Indians. Population projections indicate that in 2020, the average
age of India’s population will be lowest in the world around 29 years compared
to 37 years in China and United States of America, 45 years in West Europe and
48 years in Japan.’ Consequently, while the global economy is expected to witness
71
Indian Economic Development: a shortage of young population of around 56 million by 2020, India will be only
An Overview
country with a youth surplus of 47 million. (Report on Education, Skill
Development and Labour Force (2013-14) Volume III, Land Bureau, 2014). India
will not only have a young work force to fulfil its domestic needs but also an
opportunity to become the global hub for skilled work-force. ( Niti Aayog, 2017).
According to Dyson “More than half of the demographic growth during 2001-
2026 will occur in the northern states like Bihar, Madhya Pradesh, Rajasthan
and U.P. The populations of these four states will increase around 45-55 per cent
over this period, but those of other states will grow by only about 20-30 per
cent.” Unleashing the demographic dividend is one of the biggest challenges
that India faces today. Some states like Kerala, Goa, Tamil Nadu, Andhra Pradesh,
Punjab, Himachal Pradesh and West Bengal have surpassed average age of 29
years and hence shall be experiencing population ageing soon. States like Bihar,
Madhya Pradesh, Rajasthan, and Uttar Pradesh have huge potential demographic
dividend that can be utilised if timely action is taken. Equipping the young
population with health, education, employment opportunities and adequate skills
is of paramount importance.
The demographic window of opportunity has several challenges.
1) Education and Skills

Human resource development plays an important role in unlocking
demographic dividend. Investment in education helps in increasing
productive labour force and empowers them with increased knowledge and
skill. The public expenditure on education has been very low (around 3.6
per cent) as against the goal of 6 per cent. The current contribution is
significantly less if we aim universalisation of elementary education,
universal provision of resources, universal enrolment and retention and
growth in secondary and higher education. Education can act as a powerful
instrument of social change and economic development. The quality of
education needs to be addressed immediately which is possible if we increase
investment in education and allocate resources judiciously.
Education empowers youth with skills and vision that help them contribute
productively in today’s knowledge economy. India dreams of becoming skill
capital in today’s world. For that we need to work on the quality of India’s
primary, secondary and tertiary education. Quality education augments
knowledge, skills and productivity of students who later on get employed
productively in different sectors of the economy. Hence education is the
back-bone of young India’s ability to harness the demographic dividend.
Girl’s education can further serve as an instrument for promoting fertility
decline. Education raises the opportunity cost of having children and hence
working and educated women prefer having less number of children. The
cost of investment per child also goes up as parents invest more in health
and education of each child raising productive capacity of future generation.
States need to adopt specific policy measures in the field of education-
i) Improving access to education considering high dropout rates among
senior students.
ii) Removing gender disparity in the higher age group and in the rural
areas.
72
iii) Improving quality of education, including pupil-teacher ratios and Demographic Transition and
Its Implications
provision of amenities in schools, especially in view of the declining
learning levels. (Economic Survey 2014-15).
Southern states had harnessed the benefits of demographic dividend since
they had higher education enrolment and better quality of education and
learning levels. The northern states have huge demographic potential due to
declining fertility rate. They have time to plan and pursue policies in several
areas like education, health, gender issues and employment generation to
garner the benefits of demographic opportunity.
2) Employment
The benefits of demographic bonus with diminishing dependency ratio
cannot be reaped unless the country’s working age population to total
population improves in the face of expansion in employment opportunities.
The benefits of demographic dividend are neither automatic nor guaranteed.
India’s economic growth has not been very employment friendly. The quality
of available employment has fallen as the share of unorganised and casual
work in total employment has risen. Roughly 93 per cent of the workforce
is employed in the informal sector. India’s high rate of informality is a drag
on its economic development and source of economic inequality. Informal
workers lack job security and are vulnerable to shocks such as loss of income
and illness. They earn less, work in unsafe environment and are hence less
productive compared to the formal workers.
India experienced three paradoxes of economic growth (Santosh Mehrotra,
2016)
i) There has been social inclusion but very little inclusive growth. Inclusive
growth can be defined as one where output growth is accompanied by
employment growth. When the growth is inclusive, the benefits of
growth reach the bottom sections of the society. It was found that, despite
high growth rate of national income, most of the increase in the
employment took place in unregistered enterprises in the form of
informal employment.
ii) In the period of sustained rapid economic growth from 2005-10
manufacturing employment declined in the absolute terms and services
employment barely grew at all. Employment increase has been
concentrated in construction sector which absorbed unskilled workers
leaving agriculture, due to slow agricultural growth and chronic rural
distress driven by shrinking farm size.
iii) The female labour force participation rates have been falling, despite
rising per-capita income. Women’s labour force participation rate
dropped from 42.7 per cent in 2004-05 to 31.2 per cent in 2011-12 and
further to 27.4 per cent in 2015-16. The participation rates are lower in
urban areas and among the educated women.
India is at a crucial point of its demographic dividend since window of

opportunity will not last forever. The youth must get productive jobs in
agricultural and non-agricultural sector for the demographic dividend to be
realised.
73
Indian Economic Development: The realisation of India’s demographic dividend depends upon favourable
An Overview
demographics and capacity to create productive employment opportunities
for youth. We have the advantage of being youngest nation on the planet but
we still have not skilled our youth sufficiently and created ample job
opportunities. Youth unemployment is one of the biggest challenges that
our nation is facing today. To overcome this challenge we have to adopt
certain policies:
A) Efficient Infrastructure
Economic infrastructure includes reliable roads, railways, telecommunications,
water supply, sanitation, agricultural needs etc. Social infrastructure also
comprises of education and health services that needs to be improved
considerably. Investment in education and training will equip the youth with
different skills and enhance their employability capabilities. Expansion of
primary and secondary schools along with quality up gradation can help in
achieving goal of universalisation of literacy and promote employment
opportunities. Expansion of health services will promote demand for doctors,
paramedical personnel and other diagnostic centre that will enlarge
employment.
Provision of rural infrastructure can be tapped as an important source of

employment generation. Connecting roads in rural areas to urban areas and
four lane highways projects should be encouraged. Prime Minister’s Gram
Sadak Yojana is aimed at connecting all villages with pucca road and is a
labour-intensive project.
B) Information Technology
IT industry has opened employment opportunities for educated youth and
has a great future. Government has a major role in expanding computer
education to rural areas and bottom sections of the society so that the
capabilities of youth are directed towards IT jobs.
C) Small Scale Industries
In the manufacturing sector, small scale industries contribute 86 per cent of

the employment while medium and large scale industries contribute 14 per
cent of the employment. The major problem with SSI units is credit and
upgradation of technology. The government’s initiatives in providing higher
amount of credit through MUDRA schemes would enlarge employment
generation.
D) Reformed Outlook towards Informal Sector
Informal sector employs a large proportion of casual workers and self

employed workers in total labour force. Around 93 per cent of the work-
force is absorbed in the informal or unorganised sector. Hence it is important
to make it easier and accessible for the job seekers to find self-employment
in productive work during the transformation of economic structure into
organised system. All the legal and regulatory hurdles in form of difficulties
in availability of credit and marketing should be addressed by the government
immediately. Encouraging the informal sector by providing the workers
social security and cash transfers would help them to sustain lives and
74 improve their standard of living.
3) Environmental Issues Demographic Transition and
Its Implications
The future population growth will have a major impact upon country’s
demand for water, food production, forest products, non-renewable resources,
etc. The aim is to ensure that development is sustainable where the needs of
present generation are met and the resources for future generation are secured.
The rapid urbanisation and growth of industrial production had a major
impact on environmental quality. Hence it is important to ensure that benefits
of demographic dividend do not come at the cost of the environment.
4) Family Planning Programme

India’s demographic window of opportunity involves acceleration of fertility
decline. The expansion of family planning services and satisfying India’s
unmet need for contraception would help India bring down the total fertility
rate below replacement level. Secondly vaccination against childhood disease
would improve the probability of infant and child survival and lower fertility
rate. Expansion of coverage of established and inexpensive vaccinations
such as those against polio, tetanus, measles or inclusion of expensive
vaccinations against rotavirus, pneumococcal disease and Haemophilus
influenza type b (Hib) would address the leading causes of child death in
India.
The provision of high-quality family planning and reproductive health care

services will certainly benefit the bottom sections of the society and women.
The faster pace of fertility decline will also ensure that growth of youth
entering labour force decline which would enhance employment prospects
and increase standard of living of people. Parents can invest in health and
education of their children that would help in building skilled and productive
workforce of our nation. Family planning is also instrumental in reducing
pressure on environmental resources.
5) Good Governance
In a nation where institutions function efficiently there is transparency in
legal system, low level of corruption, respect for property rights and sanctity
of contracts exist, the development accelerates at a fast pace. A good
governance model is the key ingredient to balanced growth, equity and
stability in the nation. It helps in channelising the resources in an efficient
manner so that youth gets productively absorbed in the agriculture,
manufacturing and services sector. Policies that promote inclusive economic
growth avoid severe trade imbalances and reduce inflation should be
encouraged. The governance model comprises not only of prudent fiscal
and monetary policies but also well developed and competitive financial
markets. Labour markets with labour reforms can ensure that rights of
workers are protected and secured.
The daunting challenge of training large workforce and skilling them while
ensuring quality and speed with the help from private and public sector is
before us. To realise the benefits of demographic dividend India needs
reforms in primary, secondary and higher education along with health
infrastructure that can equip the young population. We also need to correct
the mismatch between demand and supply of skills and address these issues
in time-bound manner. Massive effort is needed in improving investment in
social infrastructure, empowerment of women and skill development. 75
Indian Economic Development: In the long run population growth shall necessitate administrative reforms
An Overview
and decentralisation of governance. With millions of people getting added
every year we need modern technology and strong public service delivery.
With the help of information and digital technology India can remove
multiple layers of governance. Schemes like direct benefit transfer, Jandhan
yojana, e-payment under Mahatma Gandhi National Rural Employment
Guarantee facilitated the beneficiaries and were useful social sector
programmes. The success, however, depends upon greater degree of
accessibility to information for the public, greater accountability,
transparency, efficiency and proper execution of policies of the government.
3.6.1 Capturing India’s Demographic Dividend

India has the advantage of harnessing the benefits of demographic dividend but
this is neither obvious nor guaranteed. It requires favourable policies and
institutions along with good governance to reap the benefits in time bound manner.
The proper execution of right policies will reduce the gap between potential
demographic dividend and the actual demographic dividend. India has huge
potential and opportunities in health and education sector. The establishment of
Public Health Foundation of India and National Rural Health Mission is significant
step in promotion and protection of health including training and deployment of
health professionals who focus on prevention, treatment and care. Similarly India’s
demographic dividend is nothing but education dividend based on empirical
findings of research papers. The secondary and higher education will equip India’s
youth with skills that are needed in knowledge and technology based economy.
The productive work-force and ample job opportunities are essential in unlocking
the demographic dividend.
A new model of development is essential to capture demographic dividend. The

model should emphasise on three pillars of development- Education, Health and
Employment. India needs combination of various approaches and policies and
proper execution to harness the window of opportunity. The model of development
should reconcile growth rate with employment generation and ‘decent work for
all’ as its ultimate objective. Instead of spending on subsidies the government
should spend resources on development of rural infrastructure in form of minor
irrigation and watershed development that raises productivity and employment
opportunities.
Poor states like Bihar, Madhya Pradesh, Rajasthan and Uttar Pradesh have been
experiencing falling fertility rates and rising share of working age population.
But favourable demographics are not supported by quality education and
productive employment opportunities for millions of youth entering labour force.
Hence the untapped demographic potential will go waste if not acted upon at the
right time. The role of government is to identify skill gaps in different states and
execute the policies that are suitable to capture the demographic dividend.
1) Explain the concept of Demographic Dividend. Is India’s demographic
transition supportive of enabling her to harness this dividend?
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76
....................................................................................................................... Demographic Transition and
Its Implications
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2) In order to realise the demographic dividend India needs reforms in education,
health and employment generation. Explain.
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.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
3) Youth unemployment is one of the biggest challenges that our nation is
facing today. Explain. What are the policies that government should adopt
to overcome this challenge?
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3.7 LET US SUM UP

Demographics matter for economic development. India has several advantages
that can make potential demographic dividend become actual demographic
dividend. But there are several constraints as well that make the gap between the
potential and the actual demographic dividend difficult to bridge. Demographic
dividend manifests itself when there is careful interaction of demographic change
with policies in the areas of education, health, trade, governance, labour market
conditions and capital markets. A productively employed working age population
is the key to realisation of actual demographic dividend. A healthy workforce
that is educated and productively absorbed in different sectors is always an asset
for a nation. To attain the goal of absorption of millions of youth entering labour
force every year we need to emphasise on improved health care facilities, human
resource development skills, quality education, reduction of malnutrition and
productive employment opportunities. The effect of labour force participation
rates especially female labour force participation shall also determine India’s
ability to unlock the demographic dividend. This window of opportunity will
close around 2040. Hence, given the limited time and resources and huge
unemployed pool of manpower it is a challenging task for any government. It
will not take much for the demographic dividend to turn into demographic disaster
How effectively India tackles this issue will determine its progress to becoming
a developed nation in the near future.
77
An Overview 3.8 TERM - END EXERCISES
1) “India has the advantage of harnessing the benefits of demographic dividend
but this is neither obvious nor guaranteed.” Explain.
2) “The Demographic Dividend is one time opportunity and is expected to last
for 25 years.” In the light of the statement explain the challenges on the way
of reaping demographic dividend in India.
3) Write Short Notes on:
i) National Population Policy
ii) Age Structure of the population
iii) Population Health
4) ‘The problem of imbalance in the gender ratio in India is a disturbing
revelation showing a continuous trend of decline in gender ratio since 1901.’
Explain the problem of missing women in India. What has been the response
of Indian government in its attempts to improve the gender ratio?
3.9 REFERENCES
1) Agrawal, A.N. & Agarwal, M.K. (2017). ‘INDIAN ECONOMY’ Problems
of Development and Planning. New Age International (P) Limited,
Publishers.
2) Bloom, David (2011). “Population Dynamics in India and Implications for
Economic Growth”, PGDA, Harvard School of Public Health. Working paper
no.65.
3) Dreze,Jean and Amartya Sen (2013). An Uncertain Glory: India and its
Contradiction. Penguin.
4) Dyson, Tim, Robert Cassen and Leela Visaria (eds.) (2004). Twenty-first
Century India: Population, Economy, Human Development and the
Environment, Ch.2 New Delhi: OUP.
5) Government of India, Economic Survey various issues including 2012-13,
2013-14, 2014-15, 2015-16 (Vol.II)
6) Government of India, NITI Aayog (2017). Three Year Action Agenda 2017-
18 to 2019-20 (April).
7) Government of India, Ministry of Health and Family Welfare. National
Family Health Survey, 2005-2006.
8) Kapila, Uma. (2017). “Demography and Development”, Academic
Foundation Publication.
9) Mahajan, Madhur M. (2020) INDIAN ECONOMY, Pearson India Education
Services Pvt. Ltd.
10) Mehrotra, S., (2016). “Realising the Demographic Dividend” Policies to
Achieve Inclusive Growth in India, Cambridge University Press.
11) Todaro, Michael P. & Smith, Stephen C. (2017). Economic Development
Published by Pearson Education, Limited.
78
12) Ruddar Datt & Sundharam (2018). “Human Resources and Economic Demographic Transition and
Its Implications
Development”,S. Chand Publishing.
13) Sen, Amartya. (1999). Development as Freedom. New York: Knopf.
14) Sen, Amartya. “Missing women.” British Medical Journal 304 (1992): 587-
588.
3.10 KEY WORDS

Crude Birth Rate : The number of children born alive each year per
1000 population.
Death Rate : The number of deaths each year per 1000
population.
Demography : A study of the different aspects of population.
Demographic Dividend : It is an accelerated economic growth that a nation
experiences once in a lifetime when working age
population grows at a faster pace than dependent
population provided that government policies and
institutions are conducive.
Demographic Transition : The theory postulates three stage sequences of
birth and death rate which is associated with
economic development. It explains phasing out
process of population growth rates from virtually
stagnant growth stage characterised by high birth
rates and death rates through a rapid-growth stage
with high birth rates and low death rates to stable,
low growth stage in which both birth rates and
death rates are low.
Life Expectancy : It is the number of years a new born child would
live if subjected to the mortality risks prevailing
for the population at the time of child’s birth.
Population Growth Rate : It is calculated as the difference between the birth
rate and the death rate of a given population after
adjusting for immigration and emigration.
Total Fertility Rate : It is defined as the average number of children
per women in the reproductive age group.
Youth dependency ratio : The proportion of young people under age 15 to
the working population aged 16-59 in a country.

PROGRESS EXERCISES
1) See Section 3.3
79
Indian Economic Development: 3) See Sub-section 3.3.1
An Overview
1) See Section 3.4
2) See Section 3.4
2) See Section 3.6
3) See Section 3.6
80
Demographic Transition and
UNIT 4 NATURAL RESOURCES Its Implications
Structure
4.0 Objectives
4.1 Introduction
4.1.1 Knowledge of Natural Resources
4.2 Land and Soils
4.2.1 Land Utilisation in India
4.2.2 Issue of Land acquisition
4.2.3 Need for a Comprehensive Land-Use Policy
4.2.4 Soils
4.3 Cropping Pattern in India
4.3.1 Crop Diversity
4.3.2 Future Cropping Pattern in India
4.4 Water Resources
4.4.1 Water Issues and Solutions
4.4.2 National Law on Water
4.5 Biodiversity
4.5.1 The Biological Diversity Act, 2002
4.6 Forest Resources
4.6.1 Present Position
4.6.2 National Forest Policy
4.7 Mineral Resources
4.7.1 Features of Minerals
4.7.2 New Mineral Policy, 2008
4.7.3 Acquiring Mineral Sources Abroad
4. 8 Allocation of Natural Resources
4. 9 Environment and Economic Development
4.9.1 Environmental Protection in India
4.9.2 National Environment Policy, 2006 (NEP)
4.10 Let Us Sum Up
4.12 Key Words
4.13 References
4.14 Answers or Hints to Check your Progress Exercises
4.0 OBJECTIVES
As you go through this Unit, you will begin to appreciate the:
importance of natural resources in the growth process of an emerging
economy like India;
significance of policies to create an eco-system for optimum utilisation of
natural resources;
81
Indian Economic Development: the present status of knowledge and availability of different natural resources
An Overview
in India;
policy framework guiding the use of natural resources in India; and
need for a comprehensive resources-use policy and suggested outline for
such a policy.
4.1 INTRODUCTION
The availability of resources, their utilisation, and the capacity to mobilise
additional resources, determine an economy’s ability to overcome the constraints
on its development. As the world’s resources grow scarce, India faces an uphill
task to secure the resources required for its progress and future. On the demand
side, growth in population and urbanisation is increasing competition for all kinds
of resources. Meanwhile, resource supplies are being constrained by geopolitical
factors and inadequate complementary infrastructure to support resource
exploration and generation at a required pace. As a result of this double-edged
scarcity, concerns are growing over the availability and prices of resources. Yet,
approached imaginatively, the quest for efficiency of resource use can become
an important source of economic growth and job creation.
As in most other Emerging Economies (EEs), a large proportion of population of

India is dependent upon agriculture and other primary activities which consist in
direct exploitation of natural resources. The natural resources of India, as the
following survey indicates, are varied and provide an adequate basis for building
a diversified modern economy.
4.1.1 Knowledge of Natural Resources

Information on stock of natural resources is much better in case of India than in
most EEs. Basic resource survey agencies have been in existence for a century
or more and systematic surveys and investigations of resources have been
undertaken by them.
Work on mapping and surveys of natural resources has expanded greatly under
the Five-Year Plans. Some of the institutional arrangements put in place in this
regard are:
The older agencies, such as the Survey of India and the Geological Survey,
have been expanded to enable them to undertake larger programmes of work,
and new agencies have been created to undertake specialised tasks or surveys
in fields which had not been covered earlier.
The Indian Bureau of Mines was established in 1950 to undertake an
economic assessment of natural resources and to formulate programmes of
development.
The Oil and Natural Gas Commission, established in the late 1950’s to
undertake exploration and development of petroleum resources, has been
responsible for major discoveries of oil and natural gas in Assam, Gujarat
and Bombay High.
The Central Water and Power Commission (now bifurcated into two),
established in 1945, has the responsibility for the coordination of hydrological
investigations and assessment of natural resources.
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A Soil Land Use Survey has been established under the Indian Council of Natural Resources
Agricultural Research; systematic soil surveys are being undertaken by it in
cooperation with the State Departments of Agriculture.
The newly introduced Forest Survey, the State of Forest Report which is
published at regular intervals, etc. are regular source of information and
data for policy-makers.
The national laboratories and institutes of scientific research also undertake
studies relating to evaluation for utilisation of natural resources.
The experience under the Plans has demonstrated the need for further expansion
or acceleration of work in some directions: a greater use of modern survey and
mapping techniques and an adequate economic assessment of natural resources.
Investigations of soil fertility and assessment of groundwater reserves will need
to be improved to provide data for an intensive use of chemical fertilizers and
efficient water management, which are essential for the successful use of the
new high-yielding varieties of seeds or other programmes of intensive cultivation.
Modern survey techniques, such as aerial photography, aero-magnetic survey
and remote-sensing, which have advanced very rapidly in recent years, but which
are not used adequately by the Indian survey agencies will need to be used much
more. The use of these techniques reduces the time requirements of surveys and
preparation of maps; makes it possible to survey inaccessible areas and helps in
the location or estimation of reserves of minerals and other natural resources.
4.2 LAND AND SOILS

India measures 3,214 kms. from north to south and 2,933 kms. from east to west
with a total land area of 32,87,782 sq. kms and a coastline measuring 7516.5
kms., plus 1,197 islands. It is the seventh largest landowner in the world after
Russia, Canada, China, the U.S.A., Brazil and Australia in that order. In brief,
India is a vast country and has a considerable strategic significance on account
of its location, size, and economic resources. Standing at the heart of the Indian
Ocean, the country is in a much better position than any other in the area to
control the Indian Ocean routes, most of which touch the Indian ports. The air
routes between Europe, West Asia, Africa and East Asia, South-East Asia and
Japan also pass through India. It gives India an advantage in terms of international
mobility of persons and commodities.
4.2.1 Land Utilisation in India

The available land, on the basis of its use, can be classified into two parts, viz.,
(1) Agricultural land, and (2) Non-agricultural land.
A) Agricultural Land
It includes net sown area,current fallows and land under miscellaneous tree crops
and groves. Agricultural land in India totals a little over 50 per cent of the total
geographical area in the country. This is the highest among the large or medium-
sized countries of the world, indicating -
the influence of favourable physical factors such as large area, the extent of
plains and plateaus and a very small extent of arid areas (about 15.8 per cent
of the country’s geographical area is arid.)
the extension of cultivation to a large proportion of the cultivable land.
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Indian Economic Development: But, because of the large population of the country, arable land per capita is not
An Overview
high; the figure of 0.14 hectares is lower than the average for the world (0.22)
and is only one-fourth of the U.S. (0.59) figure. About 15 per cent of the sown
area is multi-cropped (sown more than once in a year), while one-fourth of the
gross cropped area is irrigated. Most of the multi-cropped area is irrigated and
the security provided by irrigation facilities is a major factor in intensive
application of labour and inputs to obtain high yields.
B) Non-agricultural Land
This includes land under forests, permanent pastures and other non-agricultural
uses (towns, villages, roads, railways, etc.) and land classified as cultivable waste
as well as barren and uncultivated land of mountain and desert areas.
Three important changes in the land utilisation witnessed during the last seven
decades are:
reclamation of waste and fallow lands
a significant increase in the ‘area sown more than once’.
a significant fall in the land area under cultivation.
Perspective. It is clear that the total supply of land is a fixed factor. Therefore,
what is required is that an effective rationing of land among the varied uses be
made. As far as possible, no further encroachments on cultivable land should be
allowed; priority should be given to the use of non-cultivable land for non-
agriculture uses. This will not only save cultivable land for agriculture but will
also promote a balanced regional development.
4.2.2 Issue of Land Acquisition

With increasing population, explosive urbanisation and growing industrialisation
land resources are increasingly coming under stress. The issue merits serious
attention and calls for satisfactory solution.
Compulsory land acquisition continues to foment profound distress and often
violent resistance in many parts of the country. At the heart is a colonial law of
1894, which equipped government with powers to compulsorily acquire land at
low costs. This was widely used to coercively obtain land from millions of usually
impoverished, and often tribal, landholders, for large dams and public
infrastructure projects. Their pauperisation led to democratic as well as militant
struggles which rocked many parts of the country.
But public discontent grew further in the last three decades, when governments
used this power to compulsorily acquire arable lands for private industry and
real estate developers. A politically volatile – and ethically complex – debate has
grown around whether governments should use the power vested in it for public
good, to force landowners to sell their land to private industry.
There is a larger context to it, including concerns of food security. The policy
needs to be based on a fair and just reading of the Doctrine of Eminent Domain.
When the state recognises private property, the private owner is the absolute title
holder. However, the state is the paramount title holder. Should it need a piece of
land for a clear and apparent public purpose – building a highway, for instance –
it can resort to land acquisition. Of course, this should be done with generous
84 compensation and not just a textual interpretation of ‘market rate’.
The Doctrine of Eminent Domain cannot be misused to acquire land for favoured Natural Resources
industrialists or real estate companies. That would be a gross misuse. As we saw
in West Bengal in the Left Front years, it would lead to crony capitalism and
sweetheart deals. If private players want to build factories or condominiums,
they must buy from the farmer directly.
However, it is not as if private companies should be free to buy agricultural land

at will. As a pre-requisite to a new land acquisition law, India needs a proper,
digital, and easily available (it must be online, for instance) map of its entire
land area. This map must establish exactly which tracts of land are fertile and
suitable for multi-crop cultivation. Such land is a national asset. It is critical to
growing food for our 1.3 billion people and serve as a bulwark for food security.
Therefore, it must be a ‘no go’ area for industry.
One view is that governments should not coerce landowners to part with their
lands for profit-led corporate entities. Let private industry negotiate with
landowners, and give them what they demand, if they voluntarily agree to sell
their lands. The problem with this view is that it would amount to exposing
powerless farmers to highly unequal negotiations with powerful corporate bodies,
which might arm-twist or short-change them. In addition, a just land acquisition
law needs to recompensate agricultural workers and tenants; provide land for
land, jobs, and a house. None of these would be on offer by unregulated purchases
by private industry.
A fair deal for all persons who will be displaced by industry can be ensured only
if all or most affected persons first freely consent to the purchase. It should then
be mandatory for industry to approach government, at least above a certain
threshold and for public purpose; and for government to ensure that they get
paid fairly that the landless and tenants are also compensated, and all are humanely
rehabilitated.
The country is in the throes of potentially explosive competing land hunger of

peasants and large industry. It is the duty of the state to ensure that displacement
is minimised, and all displaced persons get a fair deal. It cannot do this by just
standing by and hoping markets will protect the poor.
4.2.3 Need for a Comprehensive Land-use Policy

Although India is one of the fastest growing economies in the world, its growth
potential has been compromised by resource misallocation, especially when it
comes to land. India is one of the most land-scarce countries in the world, and
demand for land has accelerated with the increase in the pace of industrialisation
and urbanisation. But huge distortions in land markets have slowed the pace of
growth. If these resources could be used more efficiently, India has the potential
to achieve double-digit growth.
Conventional wisdom has focused on the labour market as being the most distorted
in India. But there are even bigger distortions in the other factor markets.
Distortions in land markets are much bigger than those in labour markets. A
comparison of factor misallocation indices at the district level has shown that an
increase in the misallocation of all factors is associated with a huge decrease in
output per worker in the manufacturing sector. Most of this decline originates
from the misallocation of land and buildings. This appears to be at the root of 85
Indian Economic Development: much of the misallocation of output, and it accounts for a large share of the
An Overview
differences in productivity.
If land is so highly misallocated, this has repercussions on capital allocation

through financial markets.
The two are interconnected. Most bank loans require some form of collateral to
guarantee the loan. Land is simply the best form of collateral due to its immobility
(i.e. the debtor cannot run off with land). While borrowers can often pledge 80
per cent of the land value against loans, for most other forms of fixed investment,
the loan-to-collateral value ratio is substantially lower.
Misallocation in labour market inputs has no adverse impact on the allocative

efficiency of financial loans. When it comes to land misallocation, however, the
consequent degree of financial misallocation has only worsened over time as
large manufacturing firms have moved out from cities and into rural areas in
search of more land.
Distorted land markets are a breeding ground for crony capitalism and political
subsidies. While the policy focus on improving land administration and regulation
is well-placed, there are bigger growth benefits that can be derived from shifting
the policy focus from reducing land “regulatory tax” to increasing land revenue
tax. This will enable more efficient firms to grow faster and increase the budgetary
revenue to maximise finance for development, and additional revenues needed
for investments in infrastructure, urbanisation, housing, and social programmes.
Broadening the tax base will not only enable India to improve efficiency in
resource use and accelerate growth, but it will also make growth more inclusive.
4.2.4 Soils
Long ago, Aristotle described soil as the stomach of the plant. Even now over 90
per cent of the world’s food comes from the soil and less than 10 per cent comes
from both inland water and the oceans.
The cropping pattern of the country is greatly influenced by the soils and the
elements of the physical environment. The Indian Council of Agricultural
Research divides the soils found in the country into eight major groups which
are: (i) Alluvial soils including the coastal and deltaic alluvium; (ii) Black soils
of varying types; (iii) Red soils, including red loams; (iv) Laterite and lateritic
soils; (v) Forest soils; (vi) Arid and desert soils; (vii) Saline and alkaline soils;
and (viii) Peaty and organic soils. Keeping in view their extent and agricultural
importance, the first four, viz., alluvial, black, red and laterite soils in that order,
form the most important soil groups in the country. Almost the entire cultivated
area in the country is covered by these soils.
Alluvial soils are suitable for the cultivation of almost all kinds of cereals,
pulses, oilseeds, cotton, sugarcane, and vegetables.
Black soils are known for their fertility. They give good yields despite
continued cultivation and without proper manuring. Cotton, cereals, oilseeds
and many kinds of vegetables and citrus fruits are some of the crops suited
to black soils.
86
Almost all kinds of crops can be grown on red soil, although it seems to be Natural Resources
more suitable for the cultivation of rice, ragi, tobacco and vegetables.
Laterite soils are suitable, among others, for rice and sugarcane.
Different types of soils distributed evenly throughout the country, abounding in
fertility and higher yields, and highly responsive to improved inputs are found in
the country. For example, we find the desert-like region of Rajasthan on the one
hand and the rich cultivable land of Gujarat on the other. The variety of soils
coupled with the fact that we have in the East the world’s highest rainfall zone
and in the West one of the driest regions along with every shade of climate
throughout the country, makes possible the production of almost every kind of
crop starting from those of the temperate zone to tropical production.
However, through constant use the quality of these soils has deteriorated.
Moreover, large tracts of land have been eroded. It has been estimated that about
106 million hectares is suffering from varying degrees of soil degradation.
Localised soil waterlogging and salinity are most severe in India (27 per cent of
irrigated land), Pakistan (20 per cent) and China (15 per cent).
Although our Plans have given priority to soil conservation and land stock
improvement, we can identify the following difficulties in containing the
degradation of land resources and bringing them back to productive uses:
i) issues related to management of community land;
ii) lack of infrastructural development;
iii) high investment and long gestation;
iv) non-availability of institutional finance due to low credit worthiness of the
beneficiaries having marginal and sub-marginal lands.
4.3 CROPPING PATTERN IN INDIA

By the term ‘crop pattern’ we mean the crop - wise distribution of the cultivated
land area between different crops, the changes in the distribution over time, and
the determinants of this distribution. The crop pattern in India presents some
distinct features as follows:
4.3.1 Crop Diversity

Being a country almost of a continental size, India is endowed with a variety of
soils, which make it possible to grow almost every kind of crop. The various
crops being cultivated in India can be grouped into (a) food crops, (b) fibres, (c)
oilseeds, (d) drugs and spices. Food crops are both of a cereal and non-cereal
type. Among the cereals the more important are rice, wheat, besides maize, jowar,
bajra, barley, etc. The more important non-cereal food crops are pulses like gram,
moong, urad, etc. Among fibres, cotton and jute are the important crops. Among
oilseeds, groundnut is the most important besides rapeseed and mustard. Similarly,
a number of spices and medicinal crops are also cultivated throughout the country.
Newer crops are emerging – products of tree crops, of the jungle and so on–
which rakes in large sums of money while the going is good.
The Indian farmer has adopted a necessity-oriented approach. He has concentrated

on food crops in preference to commercial crops: about three-fourths of the total
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Indian Economic Development: sown area in the country has been devoted to the production of food crops. Some
An Overview
of this has been induced by agricultural pricing policies of the government.
Figures in per cent
Fig. 4.1: Share in Value of Agricultural Output
Recent trends indicate that agriculture mix has been undergoing a silent and
steady shift away from grains (refer Figure 4.1). With rising incomes, this change
is driven by consumers’ tastes and preferences. The composition of the production
basket is also changing as is evident from the rising share of high value
commodities (fruits, vegetables, fisheries, and livestock products). The value of
output of these commodities has gone up from 40.6 per cent in Triennium Ending
(TE) 1992-93 to 47.4 per cent in TE 2018-19, while the share of foodgrains has
come down from 31 per cent to 24.7 per cent over the same period. This will be
good for the farmers as it helps augment their incomes and achieve household
food security.
Preponderance of Cereals among Food crops
Within the broad group of food crops, cereals like Wheat and Rice dominate.
About 82 per cent of the land area under food crops has been put to the cultivation
of cereals.The attraction of cereal crops, as already stated, is explained by their
relatively better prices and less risk in production, and finally, the availability of
better-quality seeds. As a result of this tendency per capita availability of cereals
has improved from 334.2 gms. per day in 1951 to 407.4 gms. in 2018, and India
has successfully transformed itself into a ‘net exporter’ of cereals from the position
of a ‘net importer’, the per capita availability of pulses (otherwise a nutrition
rich food) has declined from 60.7 gms. per day in 1951 and 74.9 gms in 1959 to
only 35.5 gms in 2018. Since 2015 there has been a major break-through in
production of pulses. Their total output has gone up by more than 50 per cent in
this short-period.
Inferior cereals like jowar, bajra, maize, millets, barley, etc. account for a little
less than one-fourth of the total area under cereal cultivation.
These crops are cultivated under dry conditions. Although the productivity is
low, the crops are safer and are not sensitive to the vagaries of monsoon. Therefore,
the farmers often have resorted to their cultivation as an insurance against misery
arising out of crop failure.
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4.3.2 Future Cropping Pattern in India Natural Resources
In India, the policy objectives regarding the future crop pattern should be based
on the following considerations:
A) Rise in Income Levels
As the economy grows, the level of income will rise. It is only to be expected
that this would involve an increasing demand for superior cereals. Simultaneously,
as the size of India’s middle class increases, there will be changes in consumption
patterns leading to significantly increased demand for higher value crops.
Therefore, in the long run it is imperative that crop pattern is adjusted to the
changing requirements by shifting land under cultivation from inferior crops to
superior crops.
B) Need for Diversification
There is a need for diversifying the crop pattern by encouraging the cultivation
of different crops, due to the following reasons:
It will ensure stability in over-all agricultural production, in as much as
some crops may always compensate for fall in output of some other crops.
The shift to high-valued crops will raise the total value of agricultural output.
It will provide a base for increasing surplus of those products that are in
increasing demand abroad. It will help to raise foreign exchange for the
economy.
The farmers with a reasonably-sized land, co-operatives with land of very
small farmers pooled in, will gain from stable or higher incomes.
C) Need to adapt to Water Scarcity
It is high time that crop pattern changes should be introduced in regions
increasingly faced with water shortages. Crops like rice and sugarcane have been
described as “parasites on water”. These crops may be substituted by light
irrigated crops like millets, pulses, oilseeds, cotton, fruit, flowers and vegetables,
especially in water scares areas. There is no case in the present context of India’s
food economy to grow rice in Punjab and Haryana or Western Utter Pradesh or
sugarcane in Parts of Maharashtra.
D) Need to adapt to National Priorities

A “desirable cropping pattern” should contribute towards national priorities,
namely: employment generation,sustainability, higher productivity ensuring stable
farm income and food-security, combating climate change, etc. By implication,
a desirable cropping pattern should be one which favours crops which are labour-
intensive and have greater second-round employment effects. Simultaneously,
given water as a binding constraint, the cropping pattern should attempt to
maximise returns to this input and favour crops that are ecologically sustainable.
The agriculture productivity should also be enhanced to make sure farmers are
assured of minimum returns and that there are no food shortages in the times of
climate extremities.
This last point calls for a little further attention. At a global level, India is one of
the richest nations in terms of biological diversity. India supports 15,000 species 89
Indian Economic Development: of flowering plants, 317 species of mammals, 969 species of birds, 389 species
An Overview
of reptiles, 206 species of amphibians, and so on. In any sustainable agricultural
system, the concern regarding bio-diversity cannot be ignored.
4.4 WATER RESOURCES

Water is the most important source of energy in the Indian economy. About 25
per cent of electricity generated in the economy is from the hydel sources. The
other important use of water is in irrigation. In a country where agriculture anchors
the economy, availability of water can make all the difference; it can either
stimulate the economic activity or depress it altogether.
The important sources of water can be classified into: (i) surface water, and (ii)
ground water. Surface water is available from such sources as rivers, lakes, etc.
Ground water is available from wells, springs, etc. Other sources of water which
have not as yet been tapped in the country, but nevertheless represent a potential
source are: wastewater, saline lakes, saline springs, etc. Surface water sources
are replenished by rainfall.
Of the two sources, surface water is more important and possesses potential for
growth in future. Surface water is available in the form of vast network of rivers
available in the country.
Overall, India possesses large reservoirs of water, but these are inadequate as
compared to country’s requirements. Compared to countries such as the USA,
which stores about 5,000 cubic meters per capita and China, which stores around
1,000 cubic meters per capita, India’s dams can only store 200 cubic meters per
person.
Fig. 4.2: Estimates of Demand for Water in India
Through the decades, profligacy in the use of water by industrial units and during
irrigation has brought the country close to a “water famine”. In fact, many parts
of India are already water-stressed, with per capita availability significantly less
than the national average. At about 1,000 cubic meters, the national average, too,
falls way short of the ‘comfort point’ set by the World Bank. No wonder many
states remain at daggers drawn over sharing water from rivers that flow through
them.
90
4.4.1 Water Issues and Solutions Natural Resources
The principal issues facing the country are as follows: (i) Demand for water is
increasing from all sectors, (ii) Lack of a rational water pricing policy between
and within sectors is further driving demand, (iii) Policies and institutions
mandated to solve conflicts are directly or indirectly contributing to further
conflicts, (iv) New conflicts are increasingly arising within states rather than
between states, and (v) Conflicts over groundwater are widespread across the
country.
Solutions
The following solutions suggest themselves:
1) The one over-riding lesson from the global resolution in the provision of
public services is that competition matters. Hence, it is important to unbundle
the bulk provider of the irrigation system from the distribution function.
Further, there should be variety of forms– cooperatives, and private sector
players– to handle water distribution to farmers.
2) There is a need to increase user charges for the services provided, as well as
to increase budgetary support. But user charges or tariffs linked to costs can
only be possible if services are provided in an efficient and accountable
manner.
3) It is by ensuring the economic and social development of local communities
and their participation that India can hope to build major dams.
4) The government should give formal water entitlements to people as with
land and other property rights. Once established, such entitlements give rise
to a fundamental and healthy changes including improvement in efficiency
of resource use.
Four interconnected programmes as follows assume significance in this context:
(i) watershed development programme, (ii) renovation of all water bodies linked
to agriculture which have fallen into disuse, (iii) correcting the deterioration of
public irrigation works, notably state canal systems, due to cumulative neglect
of maintenance and repair over the years, and (iv) rainwater harvesting.
Another encouraging development is that more and more futuristic technologies

are being readied in research labs to make desalination and water treatment
processes more energy efficient.
4.4.2 National Law on Water

Why is a national law on water necessary?
1) Under the Indian Constitution water is primarily a State subject, but it is an
increasingly important national concern in the context of:
a) the judicial recognition of the right to water as a part of the fundamental
right to life;
b) the general perception of an imminent water crisis, and the dire and
urgent need to conserve this scarce and precious resource;
c) the severe and intractable inter-use and inter-State conflicts;
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Indian Economic Development: d) the pollution of rivers and other water sources, turning rivers into sewers
An Overview
or poison and contaminating aquifers;
e) the long-term environmental, ecological and social implications of
projects to augment the availability of water for human use;
f ) the equity implications of the distribution, use and control of water;
g) the international dimensions of some of India’s rivers; and
h) the emerging concerns about the impact of climate change on water
and the need for appropriate responses at local, national, regional, and
global levels.
It is clear that the above considerations cast several responsibilities on the
Central government, apart from those of the State governments. Given these
and other concerns, the need for an overarching national water law is self-
evident.
2) Several States are enacting laws on water and related issues. These can be
quite divergent in their perceptions of and approaches to water. Some
divergences from State to State may be inevitable and acceptable, but extreme
and fundamental divergences will create a very muddled situation. A broad
national consensus on certain basics seems very desirable.
3) Different State governments tend to adopt different legal positions on their

rights over the waters of a river basin that straddles more than one State.
Such legal divergences tend to render the resolution of inter-State river-
water conflicts extremely difficult. A national statement of the general legal
position and principles that should govern such cases seems desirable.
4) Water is one of the most basic requirements for life. If national laws are
considered necessary on subjects such as the environment, forests, wildlife,
biological diversity, etc., a national law on water is even more necessary.
Water is as basic as (if not more basic than) those subjects.
5) Finally, the idea of a national water law is not something unusual or

unprecedented. Many countries in the world have national water laws or
codes, and some of them (for instance, the South African National Water
Act of 1998) are widely regarded as very enlightened. The considerations
behind those national codes or laws are relevant to India as well, although
the form of a water law for India will clearly have to be guided by the nature
of the Indian Constitution and the specific needs and circumstances of this
country.

1) Outline the significance of the size of land area and its location for the
Indian economy.
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2) What in your view would be a desirable future cropping pattern for India? Natural Resources
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3) Highlight the different issues related to water availability and its use in
India.
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4.5 BIODIVERSITY
India contains a great wealth of biological diversity in its wetlands and in its
marine areas. There are about 350 species of mammals, 1,224 species of birds,
408 species of reptiles, 197 species of amphibians, 2,546 species of fishes, and
15,000 flowering plants. The importance of these biological resources cannot be
over emphasised for the continued wellbeing of Indian population.
A large number of both flora and fauna are faced with threat of extinction because
of the increasing demand being made on natural resources.
The government has responded by taking several measures including legislative

measures, among which the more important is the Biological Diversity Act, 2002.
4.5.1 The Biological Diversity Act, 2002

The Act covers conservation, use of biological resources and associated
knowledge prevalent in India for commercial or research purposes or for the
purpose of bio-survey and bio-utilisation. It provides a framework for access to
biological resources and sharing the benefits arriving out of such access and act.
The Act also includes in its ambit the transfer of research results and application
for intellectual property rights relating to Indian biological resources.
4.6 FOREST RESOURCES

Forests produce the requisite raw materials for industries, defence,
communications, domestic use, and other public purposes. They contribute to
the country’s exports and create a large volume of employment in the primary,
secondary, and tertiary sectors. They also provide materials like fuelwood, small
timber, fodder, etc. for direct use by the agriculturists. The benefits from forests
in the matter of soil conservation, recreation, wildlife, etc. have been well-
recognised.
93
An Overview
4.6.1 Present Position
Forests occupy about 807.3 lakh hectares or about 24.5 per cent of the total
geographical area. (Of this dense forest category, i.e., 40 per cent or more of the
area covered by trees, amounts to about 58.0 per cent.) About 433 lakh hectares
or 61.0 per cent are exploitable; another 178 lakh hectares or about 25 per cent
are potentially exploitable. Among the States, Madhya Pradesh has the maximum
forest area of 77,265 sq.km., followed by Arunachal Pradesh (68,045 sq.km.)
and Chhattisgarh (56,448 sq.km.).
The area under forests in India is low not only as compared to the forest area in
countries like Japan (64 per cent), Sweden (66 per cent), South Korea (63 per
cent), Canada (27 per cent), and USA (25 per cent), but is also much less than the
norm of 33 per cent of the total reported area recommended in the National
Forest Policy of 1952. The per capita forest land in India is 0.06 hectares as
against the world average of 2.06 hectares. Further, the productivity of Indian
forests is very low: 1.2 cubic meters per hectare per year as against the world
average of 2.1 cubic meters.
Forests in India are still under huge pressure and are shrinking over time. Firstly,
the rate of forest land diverted towards development projects has been happening
at an unprecedented rate. But this diversion also happens because there is no
value seen in forests– other than the cost that has to be paid for diversion of land
by the project proponent. Instead, there is value in the dam, road or mine for
which the land is needed. So, this pressure on forest land is bound to increase.
We must also note that forests are the last remaining public lands in the country
and the acquisition of private land will become even more expensive and
contentious in future.
Secondly, the compensatory plantation done to replace the original, natural forests
during diversion of forestlands for projects have so far yielded no impactful
results. Some of these new areas were even earmarked for other projects or
expansion of existing ones, even though they remain classified under
government’s Recorded Forest Area ( in terms of legal status).
Thirdly, forests are under pressure to meet local needs and on account of illegal
extraction. Today, it is an inconvenient truth that the poorest people in India live
in the country’s richest forests. The management of this green wealth has not
brought any benefits to the locals. Amid all this, while deforestation arid forest
diversion will grow, we do not have any viable strategies for re-greening these
lands. Thus, we will lose them gradually.
So how do we change this? One, we need to urgently value the economic,

ecological and livelihood potential of forests and to incorporate this into national
accounts. We need a robust methodology to bring the tangible (what we can
measure) and intangible costs together. Though there is much talk about green
accounting, the methodology is weak. For instance, there is no real assessment
of minor (non-timber) forest produce. Other assessment of the contribution of
forests to livestock or the hydropower sector is inflated or non-existent.
Two, we need to use this methodology to pay for standing forests. The 12th and
13th Finance Commissions allocated funds for standing forests, but this is a
pittance. We, then, need states to transfer payment for standing forests– protected
94
for biodiversity, watershed, or other purposes– to local custodians. This will Natural Resources
build local economies and local support for forest protection.
Three, at least 60 per cent of districts in India are affected by forest fires each
year, and the top 20 districts in terms of fire frequency are located mainly in the
Northeast, a joint report by the Ministry of Environment and Forests and Climate
Change (MoEFCC) and World Bank has brought that out.
The top 20 districts in terms of area affected by fire from 2003 to 2016 account
for 48 per cent of the total fire-affected area, the report found. In line with other
parts of the world, people are the main driver of fires in India and forest fires are
distributed close to people and infrastructure. Forest fires contribute to climate
change by releasing carbon stored in trees, undergrowth, and soil into the
atmosphere.
We need to use robust accounting methodology to increase the productivity of

the remaining forest land. But we know that the business of cutting and planting
trees that survive cannot be successful without the engagement of people who
live in the forest. This has to be seen as the new opportunity for employment and
economic growth. The way ahead is to build inclusive economies using green
wealth.
4.6.2 National Forest Policy

The national forest policy was first enunciated in 1952 and subsequently revised
in 1988. The important distinguishing features of this policy are as follows:
1) The policy lays emphasis on the conservation of forests and meeting the
requirements of the tribal and rural people. The Scheduled Tribes and Other
Forest Dwellers Act, 2006 has been enacted in pursuance of this policy.
2) Tribals will also be associated with the protection, regeneration and
development of forests, and cooperatives run by them or by the Government
will replace the present contractor system which has resulted in unchecked
devastation of reserved forests.
3) Realising the fact that uncontrolled expansion of forest-based industries
would adversely affect the conservation objective, the revised policy has
made the following stipulations:
No forest-based industry, except in the small-scale and cottage sectors,
would be permitted unless sustained availability of raw material is
ensured.
As far as possible, a forest-based industry should produce its own raw
material requirements.
Natural forests would not be made available to industries for undertaking
plantations and for other objectives.
Forest produce would not be supplied to industries at concessional rates.
The initial results of the new policy have been mixed. Under the Green India
Mission, it is proposed to increase forest cover by 5 million hectares and improve
the quality of forests on another five million hectares over the next 10 years. The
Green India Mission is one of eight missions under the National Action Plan on
Climate Change. It aims to increase forest cover on 5 million hectares (ha) of
95
Indian Economic Development: forest/non-forest land and improve the quality of forest cover on another 5 million
An Overview
ha. Funding for the scheme to come from the Plan outlay and convergence with
the Mahatma Gandhi National Rural Employment Guarantee Scheme, the
compensatory afforestation management and planning authority, and the national
afforestation programme.
The Union government to provide 90 per cent of the funds for implementing the
scheme in the north-eastern states, and 75 per cent of the funds for other states.
State governments to meet the balance requirement.
Forest policy in India is victim of the fact that decision-making on environmental

issues in India is quite fragmented. While the ministry of environment and forests
implements various central laws– including the Forest Conservation Act 1980–
the state governments, too, have powers in this domain. There are other ministries
and decision-making authorities that are involved as well. If that is not all, the
Supreme Court and other (Green) tribunals, too, are active participants in the
ongoing story of India’s forests. Other stakeholders– tour operators, villages
located in forest areas and various illegal, interest groups such as timber smugglers
and poachers also manage to exercise influence through the political system.
All this makes for serious collective action problems. As a result, formulating
coherent policies for forest and wildlife conservation and implementing them
effectively are well-nigh impossible.
4.7 MINERAL RESOURCES

The mineral resources of India encompass a wide range of products that are
necessary for a modern developed economy. There are, according to the
Geological Survey of India, 50 important minerals and 400 major sites where
these minerals occur. (Out of total land area of 3.28 million sq.kms, hard rock
area covers 2.42 million sq.kms.). These can be divided into four categories as
follows:
1) Minerals of which India’s exportable surplus can dominate the world market;
to this category belong iron-ore and mica;
2) Minerals of which the exportable surplus forms an important factor; these
include manganese ore, bauxite, gypsum and others;
3) Minerals in which it appears that the country is self-sufficient, like coal,
sodium salts, glass sand, phosphates, bauxite, etc.;
4) Minerals for which India has to depend largely or entirely on foreign markets
like copper, nickel, petroleum, lead, zinc, tin, mercury, platinum, graphite,
etc.
The various minerals can also be classified into three categories based on their
nature and end use. These three categories are: (i) Fuels like coal, lignite, natural
gas and petroleum; (ii) Metallic minerals like bauxite, iron-ore, manganese, etc.;
(iii) Non-metallic minerals like phosphorite, graphite, gypsum, limestone, mica,
etc.
96
4.7.1 Features of Minerals Natural Resources
Minerals provide a base for the rapid industrialisation of the economy. The
changeover to an open market economy has opened further avenues for faster
industrial growth and greater requirement of minerals, “besides the fact that the
geological setting of the country holds great promise for a boom in mineral
productions.” [Expert opinion is that given the size of deposits in South Africa
and Australia, large reserves can be expected in India also (because of similar
geological structures). A recent Price Waterhouse Report has identified India as
the most promising mining location worldwide.]
Notwithstanding this, India’s spending on exploration is only about 0.8 per cent
of the global spending with private sector contributing only 3 per cent of that.
There are a few essential aspects that need to be worked into a proper mineral
policy.
1) The mineral resources are very unevenly distributed.

The Great Plains of Northern India are almost entirely devoid of any
known deposits of economic minerals.
Jharkhand and Odisha on the north-eastern parts of peninsular India
possess large concentration of mineral deposits, accounting for nearly
three-fourths of the country’s coal deposits and containing highly rich
deposits of iron-ore, manganese, mica, bauxite and radioactive minerals.
Mineral deposits are also scattered over the rest of the peninsular India
and in parts of Assam and Rajasthan.
With the implementation of the new UN lawon the Exclusive Economic
Zone (EEZ), new areas in deep seas, hitherto unexplored, would become
available to us. These areas are believed to contain rich deposits of oil,
gas, manganese, nickel, cobalt and copper.
2) The country is deficient in certain minerals like crude oil or petroleum;
Nearly 80 per cent of the present domestic demand is being met by imports.
In view of the rising prices of these minerals in international markets, it
would be necessary, on the one hand, to curb their growing use in the
economy, and, on the other hand, sustained efforts should be made to augment
the domestic sources of supply of these minerals.
3) There are minerals which are lucrative foreign exchange earners. Efforts
should be made to devise a suitable policy to have a proper utilisation of
these minerals keeping in view the national interests.
4) Due to paucity of funds, the mining industry is mired in obsolete technology,

for decades. India’s mining sector is in trouble. The sector’s troubles stem
from profit-seeking, poor regulation, and galloping demand from countries
such as China. This has led to courts stepping in and banning all mining
activity in a region. Environmental clearance, and the human cost involved,
are other matters the industry has just begun to deal with.
97
An Overview
4.7.2 New Mineral Policy, 2008
A committee was set up in the late-2005 under the chairmanship of Anwar-ul-
Hoda. The New Mineral Policy, 2008 has incorporated most of the
recommendations made in the Hoda Committee Report.
i) The new policy manifestly recognises that private sector will be the main
source of investment in reconnaissance and exploration. It takes a pragmatic
view of the risks associated with the business of finding/producing minerals
and therefore ensures security of tenure and rights of transferability of various
awards– reconnaissance permits (RPs), prospecting licenses (PLs) and
mining leases (MLs).
ii) The new policy provides for introducing Long Area Prospecting Licences
to help the investors achieve economies of scale. These licences will be
given only with regard to non-bulk minerals which, from the investors’ point
of view, is a high-risk, high reward area.
iii) The policy emphasise that mining is a standalone industrial activity, it can
thrive in conjunction with value-addition activities.
iv) Export policies will be formulated after taking stock of the mineral
inventories and short, medium and long-term needs of the country. It is
stated in the policy document that efforts shall be made to export minerals
in value-added forms as far as possible.
v) The policy envisages steps to be taken by the governments to facilitate
financing of mine development and exploration which are integral to the
mining projects.
vi) There is also a plan to develop appropriate capital market structures to attract
risk investment in survey and prospecting. Flow of ‘risk funds’– from capital
market and venture funds– will be eased with policy interventions. The public
private partnership model would be useful for building mining infrastructure.
vii) The policy seeks to bring certain level of uniformity in mineral administration
in the country.
Further, acting on the recommendations of the Ashok Chawla committee, the

Government sought to seek outside help to increase the pace of mapping of
potential mineral reserves in India to meet a government target that aimed to
complete prospecting for natural resources in the five years beginning April 1,
2012.
India’s mining sector is set for a cleanup. Some of the steps in that regard are:
Setting up of coal regulator to set methodologies for price fixation by Coal
India;
Competitive bidding for allocation of captive blocks to private companies;
Improved coal supply for power plants as coal and power ministries iron
out differences over issues in new supply pacts;
Higher production by Coal India as fresh clearances start coming after Prime
Minister Office’s (PMO’s) intervention;
98
Improved iron ore availability in Karnataka after mines restart operation Natural Resources
following implementation of Resettlement and Rehabilitation (R&R)
schemes;
Continued downfall in iron ore output and exports from Goa and Odisha at
the back of allegations of illegal mining.
4.7.3 Acquiring Mineral Sources Abroad

In view of the worsening commodity-crisis, the government has been advised to
adopt the Chinese Model of buying foreign minerals and mining rights. The
principal focus in the Chinese Model is on acquisition of ownership of reserves
in coal, oil and gas.
Acquiring mineral reserve in other resource-rich nations is considered key to

India’s energy security, owing to domestic constraints in exploiting reserves and
the global rise in commodity prices. Also, holding such assets acts as a strategic
tool in energy diplomacy for developing and maintaining foreign relations.
4.8 ALLOCATION OF NATURAL RESOURCES

With growth gaining pace not only in India but in many emerging economies,
the pressure on natural resources is on the rise. Innovations and technological
progress have opened up undreamt vistas of use of natural resources. This in turn
implies unprecedented opportunities to make private profit from publicly-owned
goods.
Crony capitalism, which involves both corrupt politicians and unscrupulous

businessmen in a close embrace to manipulate and use the discretionary powers
vested in government for private profit. The allocation of publicly controlled
natural resources and land is the biggest playground for this collusion.
In 2012 judgement on 2G case, the Supreme Court made a serious attempt to

control such collusion; it has made efforts to ensure that the resource rents should
go to the public treasury.
There are different methods to distribute scarce resources like (i) first-come-
first-served method, (ii) auction, and (iii) open access, etc.
i) First-come-first-served: In the first-come-first-served method all the
intending buyers are put in a queue. The available resources are allotted to
an entity as per the sequence in the queue. The process is complete when
the last available unit has been allocated. On the face of it this method appears
both transparent and non-discriminatory, and hence worth adopting. But a
major shortcoming of this method is that in our system, somebody or the
other will always get or, more likely be given, advance information so that
they can position themselves up ahead in the queue.
ii) Auction or competitive bidding: The Supreme Court (SC), like the Ashok
Chawla committee earlier, has come out strongly in favour of auction method
of allocating the right to publicly controlled resources. The SC in its order
said: “When it comes to alienation of scarce natural resources like spectrum
etc. the state must always adopt a method of auction by giving wide publicity
so that all eligible persons may participate in the process. Auctions or
99
Indian Economic Development: competitive bidding would be the more appropriate method as it is likely to
An Overview
lead to allocation of resources to those who can use them most efficiently.
But this method also suffers from various limitations. (i) Designing an auction
requires prior consideration about how many licenses should share the
resource to ensure an adequate level of competition– and that is a judgement
call that can be distorted by ulterior motives. (ii) Any workable auction will
also have to have some qualifying criteria on who is eligible to complete
and that is even more liable to manipulation. (iii) The experience shows that
disclosure requirements are often lax which allows interested parties to
corner resources through front companies. (iv) This method can be used
when there are technical or logistical reasons for apportioning and giving
licensees de facto ownership rights. But that is not always necessary. The
Supreme Court has also held this view.
iii) Open Access. An alternative is to provide open access to the resources to all
eligible users against a usage charge, which could be calibrated to ensure
that the demands on the resources match availability. Open access with pay-
per-use is better for maintaining competition and easing entry by new players.
Open access will not work when the resource deplete with overuse. It would
lead to what has been described as the tragedy of commons, where it is in the
commercial interest of each user to extract as much as possible without regard to
optimum rates of exploitation. When a resource can be over-exploited, the right
of access to the resource has to be organised so as to create checks for staying
within sustainable yields or by setting up barriers to excessive exploitation. One
approach, typically followed in mineral and oil concessions, is to give the licensee
long-term rights over a well-defined resource block. In principle, the licensee
should be interested in avoiding unsustainable rates of exploitation that reduce
the total return over time.
Another approach, typically followed in forestry, is to give short-term rights of

access with controls that specify the amounts that can be extracted. This approach
depends on honest and effective policing, and the evidence from the past history
of forestry in India does not give any grounds for confidence that it would work
ultimately, the goal must be to eliminate the discretionary powers of politicians
and bureaucrats to choose concessionaries, instead they should be chosen through
a system of public auctions, both for outright transfer of rights or for public-
private appropriation of resource rents, ensure free and fair competition and create
incentives for each user to stay within the limitations of optimal exploitation. It
is necessary that the competition for natural resource markets, must be transformed
to competition in those markets. A truly transparent and honest system will require
some independent scrutiny of the design and the rulers of process that all resource
concessionaries should follow.

1) What are the major issues related to biodiversity and forestry that India
must address in keeping with its current needs and future objectives?
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100
2) Why should India have a policy to acquire mineral resources located abroad? Natural Resources
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3) Examine the different methods used in natural resource allocation. Based
on your understanding and India’s recent experience in undertaking those
allocations, suggest the preferred approach in that regard.
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4.9 ENVIRONMENT AND ECONOMIC

DEVELOPMENT
Environment has been defined as the aggregate of all the external conditions and
influences affecting the life and development of an organism. It comprises the
whole range of external influences acting on an organism, of both the physical
and the biological forces of nature surrounding the human individual. All living
beings are part of balanced and interacting eco-system: they draw sustenance
from the solid, liquid, and aerial resources on the earth. They undergo passage
through the phases of reproduction, sustenance, and extinction. The ultimate
source of energy for the entire ecosystem is the solar energy. The ecosystem
consists of subsystems such as sea, forests, water reservoirs, plants, trees, insects,
animals in a forest– all of them are inter-connected in a network of devourer-
devoured relationship. None of the elements in the network is useless or
purposeless, each one of them helps to regulate the balance of the subsystem.
Bio-gas-chemical cycles are essential for the process of reproduction in the
physical environment. The process of reproduction is in balance as long as the
natural cycles, their interrelations and the hierarchy of the food-chain are not
disturbed.
There are many different models of the relationship between the environment
and the economy. The simple model depicted in Figure.4.3 illustrates the four
functions of the environment in supporting economic activity and the effects of
this activity on the environment. These four functions are life-support, supply of
natural resources, absorption of waste products and supply of amenity services.
The economy is represented in Figure 4.3 by households consuming goods and
services, and firms producing with natural resources provided by the environment,
with labour and man-made capital provided by households.
101
An Overview Goods and Services
Firms Households
Labour and Capital
The economy
The environment
Waste
Life support
absorption
Amenity
Natural resources
Fig. 4.3
Man’s desire for joy and comfort has led him to exploit nature’s free goods to the
extent of reducing its natural capacities for self-stabilisation. As countries
industrialise, they increase their global footprint, which is the pressure they put
on the Earth’s resources. The footprints of Europe and Japan are about 4.7 global
hectares per person, and the USA’s is 9.7. India’s footprint at present is 0.8 and
China’s has reached 1.6. Mankind’s overall global footprint, which was about 60
per cent of the global biocapacity in the 1960s, has already reached 130 per cent.
This gets reflected in growing environmental problems. Environmental problems
centre on human activities resulting in pollution of the atmosphere, oceans, and
land. These range from the global (greenhouse warming and ozone depletion) to
the regional (acid rain and desertification), national (deforestation) and local
(soil erosion, contamination of freshwater resources and urban pollution). The
relevance of such concerns and the priority attached to each varies between the
developing and developed countries.
4.9.1 Environmental Protection in India

Rapid growth has become an obsession with decision makers. Growth is important
for the resources it generates, but the welfare of the Indians at whom this growth
is being targeted also depends on the quality and integrity of their living
environment.
Rapid growth means more mega-projects for infrastructure, mining and

manufacturing, and a rapid expansion of urban areas. All large projects involving
the exploitation and use of natural resources and urban expansion have
environmental consequences which may involve one or more of the following:
large-scale land use changes often in ecologically sensitive areas;
displacement of a large number of people from their homes and livelihood
sources;
extensive interventions in natural hydrological regimes;
disruption of local biotic regimes;
102
loss of forest cover, especially owing to mining projects since a very large Natural Resources
proportion of the unexploited mineral wealth of India, including coal, lies
in forest land; and
a substantial increase in the air and water pollution load which may be of
local, regional, national, or even global concern.
The environmental consequences of rapid urbanisation will become a growing
concern. Vehicle ownership is expected to go up by a factor of seven. But with
higher vehicle efficiency standards, more public transport in cities and a shift of
freight traffic to rail and coastal shipping, growth in energy consumption for
transport and the consequential environmental impact may go up by about five
times. The requirements of the growing urban population for living and working
space, water and waste disposal will have environmental consequences that will
have to be managed. Rural-urban conflicts for scarce water and landfill sites for
solid waste disposal will arise.
For example, used paper cups thrown outside juice and coffee shops (indicators
of rising incomes) could be behind the disappearing population of honeybees
that pollinate 80 per cent of all crops. The same is true of the use of plastic in our
daily lives, which is finding its way into our food chains, plant and animal based.
As World Wildlife Fund Study shows that India is already using 50 per cent
more ecological resources each year than can be replenished by nature.
India is ranked a disappointing 101st out of 146 countries for which the
Environmental Sustainability Index (ESI) was prepared in early 2005 (The most
sustainable country is Finland and the least sustainable is North Korea). The ESI
is based on 21 indicators and 76 measurements, including natural resource
endowments, past and present pollution levels, and policy efforts. Another waking
reminder comes from the Environmental Performance Index 2012 which has
placed India at 125th place.
State-wise, the best performing state in India in terms of the ESI is Manipur,
followed by Jammu and Kashmir and Tripura. All these states are sustaining
their stocks of natural resources. They face less stress on their environmental
systems and are exerting lower impacts on environment and health. The lowest
ranking states are Gujarat, Punjab and Haryana. These states have diminished
stocks of natural resources, especially in terms of air and water quality. They
also score low on land use pattern.
Environmental degradation and diseases are responsible for 23 per cent of child
mortality, according to a World Bank report. Moreover, the costs of environmental
damage are equivalent to 5.7 per cent of the country GDP (in 2009). However,
the report says, India can make green growth a reality by putting in place strategies
to reduce the damage at a minimal cost of 0.02 per cent to 0.04 per cent of its
average annual GDP growth rate.
In short, the present mode of development is wholly unsustainable. The clash

between growth imperatives and the environment will become sharper. Therefore,
a decision-making framework that anticipates this and puts in place a mechanism
that reconciles growth, land acquisition and environmental protection is good
for growth, social justice and the environment. The key lies in five elements:
i) full provision of data and information on project design and impact;
103
Indian Economic Development: ii) stakeholder engagement from an early stage, where necessary in public
An Overview
hearings;
iii) negotiated solutions in which people’s rights are affected;
iv) generous compensation, relief, and rehabilitation assistance; and
v) careful monitoring by an independent watchdog.
4.9.2 National Environment Policy, 2006 (NEP)

The NEP 2006 is being described as a statement of India’s commitment to making
a positive contribution to international efforts.
The NEP builds on the earlier policies, like the National Forest Policy, 1988,
National Conservation Strategy and Policy Statement on Environment and
Development, 1992, National Agricultural Policy, 2000, National Population
Policy, 2000, and National Water Policy, 2012.
Its major features are as follows:
i) The dominant theme of the policy is to ensure that the livelihood of people
dependent on forest products is secured through conservation.
ii) It focuses on conservation of critical environmental resources, livelihood
security for the poor, integration of environmental concerns in economic
and social development and judicious use of the resources.
iii) To achieve sustainable development, environmental protection shall
constitute an integral part of the development process and cannot be
considered in isolation from it.
iv) Environmental Impact Assessment will continue to be the principal
methodology for appraisal and review of new projects.
v) The assessment processes are being revised. Under the new arrangement,
there will be significant devolution of powers to the State/Union Territory
level.
vi) It also seeks to revisit the Coastal Regulation Zone notifications to make
the approach to coastal environmental regulation more holistic and, thereby,
ensure protection to coastal ecological systems, waters, and the vulnerability
of some coastal areas to extreme natural events and potential sea level rise.
vii) Involvement of Panchayati Raj Institutions and urban local bodies has been
highlighted.

1) Examine the relationship between economic development and environment.
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104
2) Discuss in brief the different steps taken in India for protection of Natural Resources
environment.
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3) State in brief the principal features of national environment policy 2006.
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4.10 LET US SUM UP

We have reviewed above a brief profile of the major natural resources of India.
Undoubtedly, India is blessed with a variety of resources. But the supply of these
resources is to be viewed against their requirements on the one hand and possible
utilisation within the given range of technology, on the other. The potential
available in a number of resources matches requirements, but the present
utilisation of almost all resources falls short of the requirements. Therefore, what
is immediately required is:
1) Intensive surveys should be undertaken within the country to explore and to
identify the hitherto unknown utilisable resources. This is true in the case of
both renewable and non-renewable resources. This will require chalking
out an integrated multi-pronged national policy.
Equally important is the need to make an efficient use of available recorded
or proven resources. This requires several interrelated steps: better
technology, use of by-products, multipurpose use of resources, location of
industries such that the transport cost of combining resources from different
areas are minimised, etc.
2) There is the need to take such conservation measures that sustain the output
over a longer period. Our forefathers designed institutions and practices to
cope with the divergence between the individual and social rates of discount
and its adverse effect on sustainable resource use. In good times and bad, by
invoking the spirits or scriptures, and by creating institutions for conservation
from above or below, our forebearers ensured sustainable use of natural
resources. It is possible even now to revive the institutions by nurturing
community consciousness.
3) All the above considerations will call for an effective organisational set-up.
Privatisation by itself cannot be an end. In the recent past there has been
105
Indian Economic Development: clear evidence of deals and attempts at deals for the transfer of publicly-
An Overview
owned resources to private hands on terms which are more than generous to
the private parties and involve substantial losses in potential income as well
as other costs to the public exchequer.
4) With rapid globalisation under way demand for scarce natural resources
like land, water, mines etc. has been increasing at a fast rate. These natural
resources are increasingly being grabbed by the mafia who have seen in
these resources an opportunity for their sustainability. The mafia can easily
hold on to this loot by bribing politicians, bureaucrats and other officials at
different tiers of governance. Further, adverse consequences of the recent
loosening up of the forest laws needs to be closely watched.
In the interest of swift economic development these considerations cannot be

ignored. There is perhaps a larger role for the civil society to provide oversight
and mobilise social action in this regard.

1) Mention in brief the different agencies engaged in task of exploring natural
resources in India.
2) Make a brief review of the availability of soil, forest, and mineral resources
in India.
3) Outline the need for a comprehensive natural resource use policy in India.
4) Outline the need for environment protection in India.
4.12 KEY WORDS

Biodiversity : Also called biological diversity, it is the variety
of all forms of life found on Earth.
Emerging Economies : Economies that are transitioning from a low
income, less developed, often pre-industrial
economy towards a modern, industrial economy
with a higher standard of living.
Governance : Governance has been defined to refer to
structures and processes that are designed to
ensure accountability, transparency,
responsiveness, rule of law, stability, equity and
inclusiveness, empowerment, and broad-based
participation.
Labour-intensive : Labour intensive refers to a production process
where the relative proportion of labour as
compared to other factors of production is more.
Marginal Land : Marginal land is land that has little or no
agricultural or industrial value. Marginal land
has little potential for profit and often has poor
soil or other undesirable characteristics.
Unsustainable : Something that cannot be maintained at the
current rate or level.
106
Natural Resources
4.13 REFERENCES
1) Ishwar C. Dhingra, (2020). Resource Base of the Indian Economy, Manakin
Press, New Delhi.
2) Government of India: Economic Survey, 2018-19.

PROGRESS EXERCISES
1) See Section 4.2

1) See Sections 4.5 and 4.6
3) See Section 4.8
1) See Section 4.9
2) See Section 4.9
107
An Overview UNIT 5 PHYSICAL AND SOCIAL
INFRASTRUCTURE
Structure
5.0 Objectives
5.1 Infrastructure in India
5.1.1 Meaning and Significance
5.1.2 Nature of Infrastructure
5.1.3 Types of Infrastructure
5.1.4 Infrastructure and Economic Growth
5.1.5 Role of Public Private Partnership in Infrastructure
5.1.6 Budget Allocations for Infrastructure Sector
5.1.7 Social and Physical Infrastructure
5.2 Privatisation and Commercialisation of Infrastructure
5.2.1 Need for Privatisation and Commercialisation
5.2.2 Prerequisites for Private Investment
5.3 Physical Infrastructure: Growth and Policy Issues
5.3.1 Transport
5.3.1.1 Road
5.3.1.2 Railways
5.3.1.3 Shipping and Ports
5.3.1.4 Aviation
5.3.2 Telecommunications
5.3.3 Power
5.3.4 Banking
5.3.5 Housing and Urban Infrastructure
5.4 Social Infrastructure: Growth and Policy Issues
5.4.1 Education
5.4.2 Health
5.5 Infrastructure: Challenges and Way Ahead
5.6 Let Us Sum Up
5.7 Key Words
5.8 References
5.0 OBJECTIVES
state the need for infrastructural development in India;
distinguish between physical and social infrastructure sector;
explain why both physical and social infrastructure are crucial for India’s
growth;
identify the issues requiring policy attention arising out of India’s economic
108 growth; and
pinpoint the issues crucial in infrastructure policy in the Indian economy. Physical and Social
Infrastructure
5.1 INFRASTRUCTURE IN INDIA

In Economic literature, infrastructure is popular by the name “Overhead Capital”
or “Social Overhead Capital”. The famous economist A.O Hirschman stated that
Social Overhead capital is the “basic services without which primary, secondary
and tertiary productive activities cannot function”. Importance of infrastructure
in facilitating economic and social activity cannot be under-emphasised.
Sustainable Development Goal (SDG) 9 aims to “Develop quality, reliable,
sustainable and resilient infrastructure, including regional and trans-border
infrastructure, to support economic development and human well-being, with a
focus on affordable and equitable access for all”.
This unit focuses on both the physical and social infrastructure sector; its
importance in the economic growth, recent trends and government policies
towards infrastructural development and challenges faced by the sector.
5.1.1 Meaning and Significance

Infrastructure means those basic services and support systems that facilitate
different economic activities, thereby helping in the development of a country.
Infrastructure comprises of activities such as (i) transport, (ii) communications,
(iii) energy, (iv) aspects related to economic activity that contribute to increase
in productivity of natural resources, such as irrigation, drainage, afforestation,
etc., (vi) science and technology, (vii) information system, (viii) finance and
banking, (ix) civic amenities like piped water supply, sanitation and sewerage,
solid waste collection and disposal, and piped gas, and (x) human resource services
like education and health. Core Infrastructure incorporates all the main types of
infrastructure, for instance, roads, highways, railways, public transportation,
water, and gas supply, etc. Core assets provide essential services and have
monopolistic characteristics. It is useful to view infrastructure as physical
infrastructure like roads or bridges and the infrastructure services like
transportation, in this case. Most infrastructure services and part of physical
infrastructure are non-tradable, and therefore their availability cannot be readily
augmented through imports. They need to be domestically produced. Investors
seeking to invest in core infrastructure look for five different characteristics:
income, low volatility of returns, diversification, inflation protection, and long-
term liability matching.
5.1.2 Nature of Infrastructure

The infrastructure sector has certain peculiarities that help us to distinguish this
sector from other sectors of the economy. Among these, the more important
distinguishing features can be identified as follows:
i) Public Goods: Most of the physical infrastructure services have some
elements of public good in them. These services are available to the public;
the consumers may be charged for these services or the same may be supplied
free. But even when they are supplied against a price, it is not always possible
to exclude those consumers who chose not to pay for them.
ii) Externalities: The social benefit of the infrastructure services far exceeds
the cost involved in their generation. This, in turn, creates problems in pricing 109
Indian Economic Development: of these services. It makes it difficult to price them in order to recover the
An Overview
cost fully.
iii) Monopolies: Due to the inherent nature of infrastructure services, it is difficult
for more than one supplier to exist in one location. It thus creates the
possibility for monopolies and their regulation.
iv) Public Sector Domination: The existence of externalities particularly in the
field of social welfare has resulted in a dominant position by public sector
in production and supply of infrastructure services.
v) Lumpy Investment: Infrastructure prospects, more generally, require lump
sum investment, i.e., any expenditure on a part of the project is not useful
until the whole project is ready for operations. A half-way road or a rail line
are of no use. Similarly, investment in energy is useful only when the whole
system of generation, distribution and its reach to the ultimate consumer is
ready.
vi) Indivisibilities: Lump-sum investment, in turn, is the result of indivisibilities,
a characteristic feature of most infrastructure projects. One cannot divide
and sub-divide such projects in small parts and activate them. These are
indivisible.
Infrastructural facilities are very necessary and vital for the smooth functioning
of the economy. According to Dr V. K. R. V. Rao, “The link between infrastructure
and development is not a once for all affair. It is a continuous process and progress
in development has to be preceded, accompanied and followed by progress in
infrastructure; if we are to fulfil our declared objectives of a self-accelerating
process of economic development”.
5.1.3 Types of Infrastructure

Infrastructure can be put into several different types including:
Soft infrastructure: These types of infrastructure make up institutions that
help maintain the economy. These usually require human capital and help
deliver certain services to the population. Examples include the healthcare
system, financial institutions, governmental systems, law enforcement, and
education systems. Soft infrastructure refers to all the institutions that
maintain the economic, health, social, and cultural standards of a
country. This includes educational programmes, official statistics,
parks and recreational facilities, law enforcement agencies, and emergency
services.
Hard Infrastructure: These make up the physical systems necessary to
run a modern, industrialised nation. Examples include roads, highways,
bridges, as well as the capital/assets needed to make them operational (transit
buses, vehicles, oil rigs/refineries). The assets constituting the hard
infrastructure support multiple services that are important intermediaries in
the production process. Thus, roads support transportation services that are
important to move inputs and outputs of a production process.
Critical Infrastructure: These are assets defined by a government as being
essential to the functioning of a society and economy, such as facilities for
shelter and heating, telecommunication, public health, agriculture, or civic
amenities, etc.
110
5.1.4 Infrastructure and Economic Growth Physical and Social
Infrastructure
Infrastructural facilities are vital for the smooth functioning of the economy.
They are like wheels of development without which the economy will not be
able to function properly. Provision of adequate infrastructure, both in terms of
quantity and quality, is essential for sustenance of economic growth. They
contribute to improvement in factor productivity and by providing amenities
that enhance the quality of life. The role of infrastructure development in economic
growth has been well recognised in the literature. Discussed below are some of
the most critical significance of economic infrastructure and its impact on the
economy.
1) Productivity and Growth: Better quantity and quality of infrastructure can

directly raise the productivity of human and physical capital and hence
growth (e.g. by providing access, roads can: (i) improve education and
markets for farmers’ outputs and others by cutting costs, (ii) facilitate private
investment, (iii) improve jobs and income levels for many). Studies reveal
that 1 per cent growth in the stock of infrastructure often associates with
1 per cent growth in per capita GDP.
2) Contributes to Domestic Market Development: Infrastructural development

also contributes to domestic market development. Rural roads in the
developing countries have a major effect in improving marketing
opportunities and reducing transaction costs. The marketing of agricultural
commodities can account for 25-60 per cent of final prices of food stuffs in
developing countries. About half of the marketing costs are attributable to
transport. Thus, proper infrastructure can reduce the cost of marketing which
in turn contributes to domestic market development.
3) Infrastructure mobilises Savings (Domestic and Foreign). Infrastructure

development typically involves high levels of upfront financial investment,
given the heavy capital expenditure required during the construction stage.
Thus, mobilising savings for infrastructure development becomes
indispensable. In the globalised era infrastructure facilities plays an important
role in attracting foreign capital. Foreign direct investment as well as portfolio
investment flows to those countries where adequate infrastructure facilities
are available.
4) Infrastructure Generates Employment Opportunities: Infrastructure is a base

for larger investment, development of industry and agriculture which in
turn creates more employment opportunities. Infrastructure improves
mobility, productivity and efficiency of labour.
5) Infrastructure and Social Development: Infrastructure increases the

employment opportunities which increase the income level of the people
further enhancing the standard of living of the people. Thus, infrastructure
development will change the total outlook of the society and will lead to
social development.
6) Assists to Reduce Poverty: Creation of infrastructure helps to reduce poverty

by improving the quality of life. Access to clean water and sanitation has
direct consumption benefits in reducing mortality and morbidity that
increases the productive capacity of the poor. Access to transport can
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Indian Economic Development: contribute to higher and more stable incomes enabling the poor to manage
An Overview
risk. Transport infrastructure has been found to expand opportunities for
non-farm employment in rural areas. Improved rural transport can also ease
the introduction of improved farming practices by lowering the costs of
modern inputs.
7) Promotes Social Change: Infrastructural facilities also act as an instrument
of social change. Development of industries, transport facilities and education
changes the outlook of people. Apart from these, even science, technology
and growth of towns and cities will lead to a changed economic outlook.
8) Infrastructure and National Defence: Infrastructure development in terms
of proper transport and communication facilities, adequate facilities for
research and development, proper military schools etc. increase the strength
of the nation from defence perspective.
5.1.5 Role of Public Private Partnership in Infrastructure

Infrastructure may be owned and managed by governments or by private
companies, such as a public utility or railway companies. Traditionally most
roads, major airports and other ports, water distribution systems, and sewage
networks have been publicly owned, but this is changing as now one finds many
energy and telecommunications networks are privately owned, so are airports,
roads and civic infrastructure. Government-owned and operated infrastructure
may be developed and operated in the private sector or in public-private
partnerships. Besides supplementing the public resources, public-private
partnerships (PPPs) enable the public sector to benefit from private sector technical
expertise, experience and efficiency, and transfer project-related risks to the private
sector. In infrastructure, PPPs have helped addressing financial gaps. However,
the actual performance of infrastructure sector PPPs has been mixed. While a
few sectors like roads and highways and airports have been able to attract
significant private investments, most others like ports, water treatment and
recycling, health and education have seen limited traction. Over the last decade,
the share of private investments in the sector fell from 37 per cent in 2008 to
about 25 per cent in 2018. A number of important steps have been initiated by
the government to provide a boost to infrastructure PPPs over last few years.
One of the most significant has been the setting up of the National Investment
and Infrastructure Fund (NIIF), with the government contributing around
Rs. 20,000 crore. A number of policy-related measures aimed at improving
liquidity in infrastructure investments have also been taken such as announcement
of Infrastructure Investment Trust guidelines by SEBI in September 2015,
promulgation of the Insolvency and Bankruptcy Code, 2016 and the November,
2018 directive by SEBI to large corporates to fund at least 25 per cent of their
borrowings through the corporate bond market with effect from Financial Year
(FY) 19-20.
While these initiatives are steps in the right direction, there are a few other areas
which need to be addressed on a priority basis given the global experience in
public private partnerships. Firstly, there is a need to consolidate and update the
existing PPP guidelines based on the experience gained across individual sectors
over the last few years as well as best practices in other countries. Secondly,
need to formulate an enabling framework to renegotiate concession
112 agreements. Finally, there is an urgent need for a dispute-resolution process for
Public Private Partnership (PPP) arrangements, as long-pending disputes have Physical and Social
Infrastructure
significantly adverse financial impact and act as a deterrent for private partners.
5.1.6 Budget Allocations for Infrastructure Sector

The social and economic transformation of society depends on availability of
inclusive and sustainable infrastructure amenities to the people and the ability of
the economy to address its infrastructure bottlenecks. In the past decade (FY
2008-17), India invested about $1.1 trillion on infrastructure. The challenge is to
step-up annual infrastructure investment so that lack of infrastructure does not
become a binding constraint on the growth of the Indian economy. In order to
reach the GDP target of $5 trillion by 2024-25, India needs to spend about $1.4
trillion (Rs. 100 lakh crore) over these years on infrastructure, including social
and economic infrastructure projects. To achieve this objective, a Task Force
was constituted to draw up the National Infrastructure Pipeline (NIP) for each of
the years from FY 2019-20 to FY 2024-25. NIP is set to enable a forward outlook
on infrastructure projects which will create jobs, improve ease of living, and
provide equitable access to infrastructure for all, thereby making growth more
inclusive. As per the detailed reports of the task force, total project capital
expenditure in infrastructure sectors in India during the fiscals 2020 to 2025 is
projected at over Rs. 102 lakh crore, around 70 per cent of this is amounted by
sectors such as Energy (24%), Roads (19%), Urban (16%), and Railways (13%).
5.1.7 Social and Physical Infrastructure

A country’s level of human and economic development is closely related to its
levels of achievement in physical and social infrastructure. While physical
infrastructure is an important determinant of domestic production, good social
infrastructure is vital for human development as well as economic progress
through better educated, better skilled, and healthier citizens, or citizens with
better human capabilities.
Social infrastructure
Social infrastructure refer to basic services such as health, education, skill
formation and training that contribute to human resource development and its
quality. It also includes sanitation, drinking water, housing, sewerage, etc. Social
infrastructures are also termed as social overheads. These social overheads
indirectly support the economic systems as they contribute to productivity
improvements. Besides meeting some social objectives, the social infrastructure
supports growth in the long run. For example, consuming education services
does not directly affect economic activities like production and distribution of
goods, but indirectly helps in the economic development of the country by
producing the skill and knowledge sets in the form of scientists, technologists
and engineers, who contribute to economic activity. Social infrastructure
enhances social well-being and furthers economic growth by providing basic
services and facilities which allow businesses to develop and flourish.
Trends in Social Sector Expenditure
As per Economic Survey 2020-21, the expenditure on social services (education,
health and other social sectors) by the Centre and States combined as a proportion
of GDP increased from 6.2 to 8.8 per cent during the period 2014-15 to 2020-21
(BE). This increase was witnessed across all social sectors. For education, it
increased from 2.8 per cent in 2014-15 to 3.5 per cent and for health, from 1.2
per cent to 1.5 per cent during the same period. Refer Table 5.1. 113
Indian Economic Development: Table 5.1: Trends in Social Service Sector Expenditure by the Centre and States
An Overview combined (as a % to GDP)
Item 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21

RE BE
Expenditure 6.2 6.6 6.8 6.7 6.7 7.5 8.8
on Social
Services of
which:
i) Education 2.8 2.8 2.8 2.8 2.8 3.0 3.5
ii) Health 1.2 1.3 1.4 1.4 1.4 1.5 1.8
iii) Others 2.1 2.5 2.6 2.4 2.6 3.0 3.5
Source: Economic Survey 2020-21
Note: 1. Social services include, education, sports, art and culture; medical and public health,
family welfare; water supply and sanitation; housing; urban development; welfare of SCs, STs
and OBCs, labour and labour welfare; social security and welfare, nutrition, relief on account of
natural calamities etc. 2. Expenditure on ‘Education’ pertains to expenditure on ‘Education,
Sports, Arts and Culture’. 3. Expenditure on ‘Health’ includes expenditure on ‘Medical and
Public Health’, ‘Family Welfare’ and ‘Water Supply and Sanitation’
School and Higher Education Infrastructure

Since the Indian economy will have the highest young population in the world
over the next decade, the country’s growth and development in the coming years
will primarily rely upon its ability to provide high-quality educational
opportunities to them. The progress in school and higher education infrastructure
is given in Table 5.2.
Table 5.2: Increase in Number of Recognised Schools, Colleges and Universities

Infrastructure
Year Primary and Secondary and Colleges Universities
Upper Primary Sr. Secondary
Schools (in lakhs) Schools (in lakhs)
2011-12 11.93 2.12 34852 642
2018-19 12.37 2.76 39931 993
Source: Education Statistics at a Glance, 2018 & U-DISE+ Report and AISHE Report 2018-19,
M/o Education
Physical Infrastructure
Physical infrastructure implies those infrastructures which directly support the
process of production and distribution in the economy. It is directly concerned
with the needs of such production sectors as agriculture, industry, trade, etc.
They indirectly increase the factor productivity and the economy sees the impact
immediately. Physical infrastructure leads to growth in the short run. A few such
examples are energy, irrigation, transportation, telecommunication, banking,
insurance, technology, finance, etc.
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Check Your Progress 1 Physical and Social
Infrastructure
1) What is the importance of infrastructure in a country’s development? What
kind of activities does it comprise?
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2) What are the types of infrastructure?
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3) Describe the relationship between infrastructure and Economic Growth with
reference to the experience of the Indian Economy.
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4) Distinguish between social infrastructure and physical infrastructure and
there importance for the economy.
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5.2 PRIVATISATION AND

COMMERCIALISATION OF
INFRASTRUCTURE
The heavy-industry-led-growth strategy embodied in our earlier plans
contemplated an active role for the state in all spheres of economic activity.
Investment in infrastructure became the exclusive preserve of the public sector.
The public sector, although it recorded phenomenal growth, could not live up to
115
Indian Economic Development: the opportunities and expectations offered by the changing technology and
An Overview
evolving new international environment. With the onset of the 1980s, it was
becoming increasingly clear that there was no alternative but to commercialise
the infrastructure sector and open it to private enterprise and capital. Private
participation in infrastructure development depends upon its capability to
commercialise the infrastructure services.
5.2.1 Need for Privatisation and Commercialisation

The different factors that call for immediate privatisation and commercialisation
of infrastructure can be identified as follows:
Massive Investment Needs: Infrastructure development requires massive

investments and it is not possible for the state to meet all the investment needs.
Managerial Constraints in the Public Sector: While the infrastructure business

is becoming more complex, public sector has not been able to meet the managerial
challenges and as a result, the supply could not grow at the desired pace. The
fiscal stringency has also created a demand for accountability for public spending.
Therefore, a demand has arisen for commercialisation and greater privatisation

of infrastructure sector in order to inject greater efficiency.
Changes in Technology: The possibility of marginal pricing and exclusion

provides greater scope for commercialisation. Technological changes have made
it possible to unbundle the infrastructure service thereby introducing the elements
of competition. The use of new technology enables the charging of the marginal
user.
Globalisation: The availability, quality, cost and reliability of infrastructure

services are key factors in attracting foreign investment. Globalisation has been
aided significantly by advances in transport, telecommunication and storage
technology.
New Dynamism in World Capital Market: Since 1990s the capital markets,
domestic as well as global, have witnessed a significant re-emergence. During
this period there has been a nearly four-fold increase in gross private capital
flows to the developing countries. Private flows are now around three times the
official development assistance. Thus, the private sector now has access to the
kind of resources needed for infrastructural development.
5.2.2 Prerequisites for Private Investment

Entry of private capital in infrastructure sector is not merely a matter of simple
policy initiatives. A few other important and critical areas would have to be
identified and a suitable environment created.
Commercialisation of Infrastructure: Infrastructure services should not be

treated as public goods. In this regard, the possibility of commercialisation will
depend on the ability to segregate payers and prevention of any incidence of
‘free riding’. Thus the excludability is a key factor in commercialisation.
Pricing Policy: The role of private sector is not restricted to that of provident of
funds. It has to play the role of efficient and accountable operator of the facility.
116
The issue of pricing of infrastructure services becomes critical here. In this sphere Physical and Social
Infrastructure
the long track record of uneconomic pricing and prevalence of subsidies will be
major obstacles.
Demand Orientation of Services: The existing procedure of financing

infrastructure facilities is based on plan allocation and is mainly supply-oriented.
Insufficient stress on the existing infrastructure and the anticipated demand has
resulted in deviations in different counties and consequently a large part of such
investments are not providing sufficient returns. Privatisation will necessitate a
demand-oriented approach.
The challenge for policy is to find appropriate market signals which indicate the
future trend of infrastructure demand and to coordinate the supply of such facilities
in such a manner that investment in infrastructure provides appropriate returns.
Allocation of Risk: Allocation of risk is of key importance in commercialisation

of infrastructure. The risk should be appropriately demarcated and allocated to
different stake-holders. This is important for two reasons:
i) There is a tendency among the private shareholders to shift the risk to the
government.
ii) There is also a tendency among the shareholders to shift the risk on each
other.
Direct Participation by the Government: While the existence of elements of
monopoly in infrastructure will necessitate regulation by the government,
constraints in financing and user charging will render the direct participation by
the government necessary. Therefore, a transparent framework for promotion of
synergistic firmness of public-private partnership in infrastructure is required.
A Suitable Regulatory Framework: Most of the infrastructure projects are right

candidates for developing as a ‘natural monopoly’. These cost per unit scale of
output. But these units cannot be allowed, in the interest of public welfare, to
eschew competition. A healthy guided competition is required for sound growth.
This presupposes the existence of an effective regulatory system.
5.3 PHYSICAL INFRASTRUCTURE: GROWTH

AND POLICY ISSUES
5.3.1 Transport Sector
Transport is an essential economic infrastructure for the rapid development of
any region. The lack of transport facilities retards the process of economic
development even if a region is endowed with rich natural resources. Transport
has been recognised as an indispensable ingredient of a country’s overall
development.
5.3.1.1 Roads
India has the one of largest road network across the world, spanning over a total
of 59 lakh km of road length. This road length includes National Highways (NHs),
Expressways, State Highways (SHs), district roads, PWD roads, and project roads.
In India, road infrastructure is used to transport over 60 per cent of total goods
117
Indian Economic Development: and 85 per cent of total passenger traffic. Road transportation has gradually
An Overview
increased over the years with the improvement in connectivity between cities,
towns, and villages in the country.
Market size
As of March 01, 2019, the total length of National Highways in India stood at
132,499 km. Huge investments have been made in the sector with total investment
increasing more than three times from Rs. 51,914 crore in 2014-15 to Rs. 158,839
crore in 2018-19. The total national highways length increased to 122,434 kms
in FY18 from 92,851 kms in FY14.
However, the roads sector has been facing several issues including:
i) lack of equity with developers,
ii) higher cost of financing,
iii) shortfall in funds for maintenance,
iv) unavailability of land for the expansion of NHs,
v) significant increase in land acquisition cost,
vi) bottlenecks and checkpoints on NHs which could adversely impact benefits
of GST, and
vii) the value of NPAs in the infrastructure sector (including roads and highways)
has been increasing, with NPAs at around Rs. 2.6 lakh crore as of August
2016.
Issues with financing
As observed by the Standing Committee on Transport (2016), the Ministry of
Road Transport and Highways does not have its own source of revenue other
than budgetary support from the central government, also huge budget allocations
by the central government would be unsustainable in the long-run. Hence, there
is a need to set up Ministry’s own dedicated financial institutions to generate
funds for development of the road sector.
As noted by the Standing Committee on Transport (2018), road development

needs concerted efforts in the form of mobilisation of funds from other sources
as private sector involvement has been depleting in recent years.
Targets vs Performance
Achievement of construction targets (for NHs) has ranged between 55 per cent
and 70 per cent during the period 2014-15 to 2019-20. The targets could not be
met due to shortage of funds as noted by the Standing Committee on Transport
(2017). Other reasons for incomplete projects include delays in obtaining
clearances, poor financial and technical performance of the contractors, and law
and order issues. The Economic Survey 2018-19 also highlighted issues, such
as time and cost overruns, due to delays in project implementation, procedural
delays, and lesser traffic growth than expected, which increased the risk factor
of the projects resulting in stalling of projects.
Project Delays and increase in Project Costs

The Committee on Public Undertakings (2017) had noted that from 1995, till
June 2016, out of the total 388 projects completed, only 55 projects were
118
completed on or before time. Delays in the completion of the projects were Physical and Social
Infrastructure
mainly attributed to: (i) the long time taken in land acquisition, and obtaining
environment and forest clearances, (ii) poor performance of concessionaires due
to economic slowdown, (iii) cash flow problems, and (iv) law and order
issues. Such delays increase project costs, eventually making certain projects
unviable.
Government Initiatives
Some initiatives undertaken by the government are as follows:
The Government of India has allocated Rs. 111 lakh crore (US$ 13.14 billion)
under the National Infrastructure Pipeline for FY 2019-25. The Roads sector
is expected to account for 18 per cent capital expenditure over FY 2019-25.
Government of India approved the launch of Phase-III of its rural road
programme Pradhan Mantri Gram Sadak Yojana (PMGSY) which aims at
consolidation of 1,25,000 kms through Routes and Major Rural Links that
connect habitations to Gramin Agricultural Markets (GrAMs), Higher
Secondary Schools and Hospitals with an estimated cost of Rs. 80,250 crores
for the period 2019-20 to 2024-25.
A total of 65,000 km of roads and highways are to be constructed under
Bharatmala Pariyojana.
100 per cent FDI is allowed under the Automatic route subject to applicable
laws and regulations.
Connectivity in Remote Areas: The Ministry of Road Transport and
Highways also allocates funds towards the development of highways in
areas with poor connectivity. Some of these projects include the Special
Accelerated Road Development Programme in North East (SARDP-NE),
Externally Aided Projects and Roads Projects in Left-Wing Extremism
Affected Areas.
In order to accelerate the pace of construction, large number of initiatives
has been taken to revive the stalled projects and expedite completion of
new projects by the Ministry of Road Transport and Highways. These
include:
i) Streamlining of land acquisition and acquisition of major portion of
land prior to invitation of bids.
ii) Award of projects after adequate project preparation in terms of land
acquisition, clearances, etc.
iii) Close coordination with other Ministries and State Governments
iv) One time fund infusion
v) Regular review at various levels and identification/removal of
bottlenecks in project execution
vi) Proposed exit for Equity Investors
vii) Securitisation of road sector loans
viii) Disputes Resolution mechanism revamped to avoid delays in completion
of projects.
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Indian Economic Development: 5.3.1.2 Railways
An Overview
The Indian Railways is among the largest rail networks in the world. The Indian
Railways route length network is spread over 1,23,236 km, with 13,452 passenger
trains and 9,141 freight trains from 7,349 stations plying 23 million travellers
and 3 million tonnes (MT) of freight daily. The railway network is ideal for long-
distance travel and movement of bulk commodities, apart from being an energy
efficient and economic mode of conveyance and transport. Indian Railways is
the preferred carrier of automobiles in the country.
Government of India has focused on investing in railway infrastructure by making

investor-friendly policies. It has moved quickly to enable Foreign Direct
Investment (FDI) in railways to improve infrastructure for freight and high-speed
trains. At present, several domestic and foreign companies are also looking to
invest in Indian rail projects. Foreign Direct Investment (FDI) inflows into
Railways Related Components from April 2000 to June 2020 stood at US$ 1.12
billion.
Government initiatives
Few initiatives taken up by the Government are:
Freight on Priority: Railways has embraced a “Freight on Priority” policy
by pushing for an aggressive customer-centric approach to expand the freight
carried not only from the traditional segments but also by attracting new
customers to its fold.
India entered a new era of mobility with Vande Bharat Express - India’s
first high-tech, energy-efficient, self-propelled train. This is a prime example
of the success of Make in India movement. This train will be proliferated
across India and also exported globally.
The Railways is undertaking measures for improving speed of both passenger
and freight trains. Indian Railway is constructing more than 3000 km of
Dedicated Freight Corridor (DFC), which would enable freight trains to run
at speed of 100 kmph.
Dedicated Freight Corridors which are special tracks and arrangements for
goods trains are getting completed at unprecedented speed. They are expected
to decongest the existing Indian Railway network, increase the average
speed of goods trains from existing 25 to 70 kmph., run Heavy Haul trains,
facilitate the running of longer (1.5 km) and double stack container trains,
connect the existing ports and industrial areas for faster movement of goods,
ensure an energy efficient and environment friendly rail transport system as
per global standards, increase the rail share from existing 30 per cent to 45
per cent and reduce the logistic cost of transportation.
New Services in Passenger Operations with PPP in Train Operations:
Railways is now undertaking a partnership approach for passenger train
operations in order to enhance overall service quality and operational
efficiency. This aims at improving the passenger experience and bringing
modern technologies and private investments
India has made a huge leap of self-sufficiency in manufacturing related
activities of the Railways. India is now building modern trains for itself and
exporting it as well. For instance, in Uttar Pradesh only, the Locomotive
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Works in Varanasi is becoming a big electric locomotive centre in India. Physical and Social
Infrastructure
The railway coaches which are being built here are now being exported to
foreign countries also.
A National Rail Plan (NRP) 2030 has been developed with a view to develop
infrastructure by 2030 to cater to the traffic requirements upto 2050. Based
on the NRP, a Vision 2024 document has been prepared to develop
infrastructure by 2024 to enhance modal share of Railways in freight
transportation to more than 40 per cent and to cater to the traffic requirements
upto 2030.
Electrification has been accorded high priority as a part of the national goal
to transform India into a green nation. 66 per cent of track length has been
electrified by November 2020. Railways aim to complete electrification of
its entire broad-gauge network by 2023. The speed of electrification has
been greatly scaled up from a level of 1176 km in 2014-15 to 5276 in 2018-
19 and 4378 km in 2019-20.
Government has enhanced the role of the PPP beyond providing maintenance
in the areas such as redevelopment of stations, building private freight
terminals and private container train operations.
5.3.1.3 Shipping and Ports
Ports are economic and service provision units of remarkable significance since
they act as a place for the interchange of two transport modes, maritime and
land, whether by rail or road. With a coastline of about 7,517 km. Indian ports
and shipping industry plays a vital role in sustaining growth in the country’s
trade and commerce. According to the Ministry of Shipping, around 95 per cent
of the country’s trading by volume and 70 per cent by value is done through
maritime transport. The country has 12 major ports and 212 notified non-major
(minor/intermediate) ports along the coast-line and sea-islands. Many ports in
India (such as Mundra Port, Sikka Port, Hazira Port, etc.) are evolving into
specialised centres of economic activities and services and are vital to sustain
future economic growth of the country. Over the last decade, there has been a
steady increase in handling of cargo traffic at Indian ports (refer Table 5.3). The
compound annual growth rate of total cargo throughput at Indian ports during
the period 2001-02 to 2018-19 was 7.4 per cent.
Table 5.3: Growth of Cargo at Indian Ports
Parameters 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19
Trends in India’s Select: Macro Parameters
Total Cargo 2.2 4.1 8.2 1.9 5.8 6.6 6.1
Source: Based on Data from Major ports and Non-major ports.
However, Indian ports face several infrastructural and operational challenges.

They include: (i) Operational efficiency of Indian ports still lags behind the global
average. For instance, the turnaround time (TAT) at major ports was approximately
2.5 days in 2018-19, whereas global average benchmark is 1-2 days. (ii) last
mile connectivity to the ports is one of the major constraints in smooth movement
of cargo to/from the hinterland. Around 87 per cent of Indian freight uses either
road or rail for transportation of goods where a significant share experiences
“idle time” due to capacity constraints on highways and railway lines. Water-
121
Indian Economic Development: borne transport which is much safer, cheaper and cleaner, compared to other
An Overview
modes of transportation accounts for less than 6% of India’s modal split.
Significant savings can be achieved by shifting movement of industrial
commodities like coal, iron ore, cement and steel to coastal and inland waterways.
(iii) location of industries / manufacturing centres vis-à-vis the ports is such that
the country has a greater container exporting cost than that compared with
competitors like China. Hence, greater savings could be possible with the presence
of major manufacturing and industrial zones in coastal regions in India.
Government initiatives
The Indian Government plays an important role in supporting the ports sector. It
has allowed Foreign Direct Investment (FDI) of up to 100 per cent under the
automatic route for port and harbour construction and maintenance projects. Ports
sector in India has received a cumulative FDI of US $ 1.64 billion between April
2000 and March 2019. In March 2018, a revised Model Concession Agreement
(MCA) was approved to make port projects more investor-friendly and make
investment climate in the sector more attractive. In addition to this, project
UNNATI has been started by Government of India to identify the opportunity
areas for improvement in the operations of major ports. Under the project, 116
initiatives were identified out of which 91 initiatives have been implemented as
of November 2018.
Sagarmala – a Port-led Development Programme

The concept of Sagarmala was approved by the Union Cabinet on 25th March
2015. As part of the programme, a National Perspective Plan (NPP) for the
comprehensive development of India’s 7,500 km coastline, 14,500 km of
potentially navigable waterways and maritime sector has been prepared.
Components of Sagarmala Programme are:
Port Modernisation and New Port Development: De-bottlenecking and

capacity expansion of existing ports and development of new greenfield ports
Port Connectivity Enhancement: Enhancing the connectivity of the ports to

the hinterland, optimising cost and time of cargo movement through multi-modal
logistics solutions including domestic waterways (inland water transport and
coastal shipping)
Port-linked Industrialisation: Developing port-proximate industrial clusters

and Coastal Economic Zones to reduce logistics cost and time of EXIM and
domestic cargo.
Coastal Community Development: Promoting sustainable development of

coastal communities through skill development and livelihood generation
activities, fisheries development, coastal tourism etc.
Coastal Shipping and Inland Waterways Transport: Impetus to move cargo

through the sustainable and environment-friendly coastal and inland waterways
mode.
The Indian government plans to develop 10 coastal economic regions as part of

plans to revive the country’s Sagarmala (string of ports) project.
122
Achievements Physical and Social
Infrastructure
Some of the achievements of the government include: Turnaround time at major
ports in India has decreased at a rapid pace from 82.32 hours in FY17 to 59.51
hours in FY19. Five times more growth in major ports’ traffic recoded during
2014-18, compared to 2010-14. Increased efficiency has led three times increase
in net profits of major ports between FY14-18.
5.3.1.4 Aviation
As of 2019, India is the ninth largest aviation market with a passenger throughput
of 344 million. As of 2021, the sector has 91 international carriers comprising of
5 Indian carriers and 86 foreign carriers connecting over 40 countries; and the
sector is contributing US $ 72 billion to GDP. The Ministry of Civil Aviation is
the nodal authority responsible for the formulation of national policies and
programmers for development and regulation of the civil aviation industry in the
country. The growth of airlines traffic in the Indian aviation industry is almost 4
times above the international average. In the year 1991, a total of 10,717,400
passengers were carried in Indian airlines. This number grew multifold to
139,822,450 in 2017. In addition to a robust GDP growth driving increased spends
on air travel, low fares have led to a rise in demand in smaller-towns of India.
India Airlines market despite of being the fastest growing market, has been one
of the toughest aviation markets in the world due to–
- High fuel prices (a sales tax of nearly 30 per cent is levied on jet fuel which
jacks up flight operations for airlines; also, there is an excise duty of 11 per
cent levied on jet fuel since October 2018);
- Poor and insufficient infrastructure (air traffic is increasing, consequently
space is decreasing to accommodate them);
- Low cost carriers have made the market extremely price sensitive, rigid
regulations, i.e., ample regulations and laws still hold back the industry and
do not provide room for improvement and profits.
Post reforms of 1991, aviation sector saw a major reform in its structural and
operational context. The major reforms that redesigned the aviation sector were:
1) Liberalisation: Repealing of the monopolistic Air Corporation Act in 1994
was followed by heavy disinvestment in the two public sector airlines– Indian
Airlines Corporation and Air India International, leading to the opening up
of the domestic sector to private players, bringing in more competition and
the resulting benefit of reduced fares.
PPP model: Amidst the constrained fiscal position, the government has given
way to new financing models for the development of airports. Public Private
Partnership (PPP) model i.e. Build Operate and Transfer (BOT), Build Own
Operate and Transfer (BOOT) have been tried for development of Airports
in India. For instance, in November 2018, the Government of India approved
a proposal to manage six AAI airports under public private partnership (PPP)
situated in Ahmedabad, Jaipur, Lucknow, Guwahati, Thiruvananthapuram
and Mangaluru.
2) Open Sky Policy: The Open Sky Policy which allows foreign airlines of
any country or ownership to land at any port on any number of occasions
123
Indian Economic Development: and with unlimited seat capacity brought in a massive change in the aviation
An Overview
sector. That is, the Government opened the skies to private players.
3) FDI Policy: Government has put in place an investor friendly policy on FDI
in the aviation sector, under which 100 per cent FDI (Automatic up to 49
per cent and Government route beyond 49 per cent) is permitted in scheduled
Air Transport Service/Domestic Scheduled Passenger Airline, while for NRIs
100 per cent FDI is permitted under the automatic route. Also, foreign
investment in M/s Air India Ltd is brought on a level playing field with
other scheduled airline operators with the amended FDI policy which enables
foreign investment by NRIs into M/s Air India Ltd. up to 100 per cent under
automatic route. According to data released by the Department of Industrial
Policy and Promotion (DIPP), FDI inflows in India’s air transport sector
(including air freight) reached US$ 1,904.37 million between April 2000
and June 2019.
4) Low Cost Carriers (LCC): In 2003 Low Cost Carrier (LCC) entered the
domestic aviation industry which led to substantial fall in the market
share of Legacy carriers such as Air India, Indian Airlines and Jet
Airways giving rise to fierce price wars between various airlines. The
period following the introduction of the LCCs has been one of rapid
growth for the Indian airline industry as they enhanced the affordability
of air travel and hence the demand for air travel in India.
5) Greenfield Airports: A greenfield airport denotes a project that lacks
constraints, imposed upon it by prior work or existing infrastructure. In
2007, the Indian government finalised the policy on greenfield airports.
According to the new policy, state governments wanting to set up a greenfield
airport could either do so themselves or through any designated entity or a
joint venture company. For instance, the Government of Andhra Pradesh is
to develop Greenfield airports in six cities under the PPP model.
5.3.2 Telecommunications
India is currently the world’s second largest telecommunications market with a
subscriber base of 1.19 billion and has registered strong growth in the past decade
and half. The telecommunication industry in India is rapidly growing and
witnessing many developments. The sector is becoming more competitive day-
by-day, with the introduction of new players (which in turn has led to sharp and
steady decline of average revenue per user) and has truly revolutionised the way
we communicate and share information The exponential growth is primarily
driven by affordable tariffs, wider availability, roll out of Mobile Number
Portability, expanding 3G and 4G coverage and the onset of 5G technologies,
evolving consumption patterns of subscribers and a conducive regulatory
environment. The industry has undergone a major process of transformation
through several policy reforms and regulations. These include:
1) Liberalisation: With the announcement of the New Economic Policy in July

1991, the telecom sector was declared open to the private sector. This initiated
the transformation of the once government owned monopolistic telecom
market to a multi-operator open competitive market.
2) National Telecom Policy of 1994: In 1994, the government announced the

124 National Telecom Policy which further stimulated the growth of the
industry by provision of world class services at reasonable rates, Physical and Social
Infrastructure
promotion of exports, stimulation both domestic and foreign direct
investments.
3) The Telecom Regulatory Authority of India Act, 1997: Established Telecom

Regulatory Authority of India (TRAI) which was necessary to regulate the
private players in the telecom sector.
4) New Telecom Policy of 1999: Laid down a clear road map for future reforms
by opening by all the sectors in telecommunications to private players.
5) National Telecom Policy 2012: Launched to provide secure, reliable,

affordable and high quality converged telecommunication services anytime,
anywhere for an accelerated inclusive socio-economic development.
6) National Digital Communications Policy 2018: Launched to ensure digital

sovereignty. For instance, under it the government aims to provide universal
broadband connectivity at 50 Mbps to every citizen.
7) Technological Innovations: The growth of telecom industry has also

been fuelled by the launch of newer telecom technologies like 3G, and
Broadband Wireless Access (BWA), and emergence of cloud technologies.
Efforts are continuously made to develop affordable technology for
masses and reinvigorate the maturing urban markets and help in bringing
balanced growth of economy.
8) FDI Policy: FDI cap in the telecom sector has been increased to 100 per
cent from 74 per cent; out of 100 per cent, 49 per cent will be done through
automatic route and the rest will be done through the approval route. FDI of
up to 100 per cent is permitted for infrastructure providers offering dark
fibre, electronic mail and voice mail. FDI inflows into the telecom sector
during April 2000 – March 2019 totaled to US$ 32.82 billion, according to
Department for Promotion of Industry and Internal Trade (DPIIT).
5.3.3 Power
Power is one of the most critical components of infrastructure crucial for the
economic growth and welfare of people. India’s power sector is one of the most
diversified in the world. Sources of power generation range from conventional
sources such as coal, lignite, natural gas, oil, hydro and nuclear power to viable
non-conventional sources such as wind, solar, small hydro and biomass. The
country’s achievements in the power sector in the recent years have been
outstanding. Electricity generation (both from conventional and non-conventional
sources) increased from 808.5 billion units (BU) (in 2009-10) to 1389.1 BU (in
2019-20), a growth of around 72 per cent. As of January 2021 the national electric
grid in India has an installed capacity of 377.261 Giga Watts (GW).
The Government is implementing reforms towards a secure, affordable and

sustainable energy system to power a robust economic growth. Some of the key
policy reforms in the power sector include:
Liberalisation: India’s generation capacity has increased considerably. This

increase is attributed to the delicensing of power generation in 2003, which
enabled unrestricted participation of private sector companies. India now has 125
Indian Economic Development: the institutional framework it needs to attract more investment for its growing
An Overview
energy needs. Between April 2000 and June 2019, the industry attracted US$
14.54 billion in Foreign Direct Investment (FDI), accounting for 3 per cent of
total FDI inflows in India. Also, Government allows private-sector investment
in coal mining, and has opened up the country’s oil and gas retail markets.
Pricing Reforms: The country is taking advantage of the important energy pricing
reforms in the coal, oil, gas, and electricity sectors which are fundamental to
further opening the energy market and improving its financial health.
Energy Security: India’s electricity security has improved markedly through the
creation of a single national power system and major investments in thermal and
renewable capacity. It is taking significant steps to enhance its energy security
by fostering domestic production through the most significant upstream reform
of India’s Hydrocarbon Exploration and Licensing Policy (HELP) and building
up dedicated oil emergency stocks in the form of a strategic petroleum reserve.
Around 750 million people in India gained access to electricity between 2000
and 2019, reflecting strong and effective policy implementation. As of April 28,
2018, 100 per cent village electrification achieved under Deen Dayal Upadhyaya
Gram Jyoti Yojana (DDUGJY). The country’s energy deficit reduced to 0.7 per
cent in Financial Year (FY) 18 from 4.2 per cent in FY14. Also, the country’s
rank jumped to 24 in 2018 from 137 in 2014 on World Bank’s Ease of doing
business - “Getting Electricity” ranking.
Renewable Energy: India’s power system is currently experiencing a major shift

to higher shares of variable renewable energy. With solar and wind power
becoming cheaper, cleaner sources of energy have also become affordable. As of
November 2020, the country’s renewable power capacity is the 4th largest in the
world generating 136 GW, which is about 36 per cent of our total capacity.
The government is pursuing a very ambitious deployment of renewable energy,

notably solar, and has boosted energy efficiency through innovative programmes
such as replacing incandescent light bulbs with LEDs (under the Ujala scheme).
And it is addressing the serious health problems caused by air pollution for its
major cities, providing 80 million households with liquefied petroleum gas
connection (under the Pradhan Mantri Ujjwala Yojana scheme), thereby reducing
the exposure from biomass cooking stoves, a major cause of respiratory diseases.
Financial Health: The government is working to improve the financial viability

of the power sector which is dealing with surplus capacity, lower utilisation of
coal and natural gas plants, and increasing shares of variable renewable energy.
For instance, Ujwal Discoms Assurance Yojana (UDAY) was launched by the
Government of India to encourage operational and financial turnaround of State-
owned Power Distribution Companies (DISCOMS).
The power generation situation in the country has improved in the last few years.
In June 2017, the Minister of Power announced that India has become a power
surplus country, with no shortage of electricity or coal. Despite this, the sector
continues to face several issues. Access to power and the quality of power supplied
to consumers is still poor. India also continues to face both energy deficit (0.7%)
and peak deficit (2%). The deficit situation is worse in certain states such as
Jammu and Kashmir, and the north-eastern states. Despite all villages being
126
electrified, continuous supply of electricity continues to remain a challenge. Physical and Social
Infrastructure
Another key issue is the poor financial health of the electricity distribution
companies, which is affecting their ability to buy power and improve the supply
network. While their debt to banks was addressed to a certain extent by UDAY,
the debt they owe to power plants remains a concern.
5.3.4 Banking
The Indian banking system consists of 18 public sector banks, 22 private sector
banks, 46 foreign banks, 53 regional rural banks, 1,542 urban cooperative banks
and 94,384 rural cooperative banks as of September 2019. The banking industry
infrastructure has been undergoing revolution wherein the information technology
and electronic funds transfer system have emerged as the twin pillars of modern
banking development. Online infrastructure and internet connectivity allow digital
and direct transfer of Government services and subsidy benefits to the citizens’
bank accounts. The industry has undergone structural transformation through
the years as directed by the following policies and reforms:
i) First Phase of Banking Sector Reforms based on the Narasimham committee

report 1991 included the following measures— lowering Statutory and
Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR), Prudential norms,
Capital Adequacy Norms, Deregulation of Interest Rates, Recovery of Debts
by setting up Special Recovery Tribunals, enhanced competition from new
Private sector banks (which were allowed to raise capital contribution from
foreign institutional investors up to 20 per cent and from NRIs up to 40 per
cent).
ii) Second Phase of Banking Sector Reforms based on Narasimham committee
report 1998 included the following measures— Opening up of New Areas
(Insurance, credit cards, asset management, leasing, gold banking, etc.) and
New Instruments (Interest rate swaps, cross currency forward contracts, etc.,
Risk Management and Strengthening Technology (with electronic funds
transfer, centralised fund management system, etc.), increase in FDI limit,
adoption of Global Standards and Information Technology (by introduction
of e-banking, telephone banking, etc.), management of NPA, guidelines for
Anti-Money laundering, Base Rate System of interest rates, etc.
iii) Financial Inclusion: Financial Inclusion is a national priority as it is an enabler
for inclusive growth by providing an avenue to the poor for bringing their
savings into the formal financial system, an avenue to remit money to their
families in villages besides taking them out of the clutches of the usurious
money lenders. A key initiative towards this commitment is the Pradhan
Mantri Jan Dhan Yojna (PMJDY), which involves ensuring access to
financial services, namely, Banking/Savings & Deposit Accounts,
Remittance, Credit, Insurance, Pension in an affordable manner.
One of the leading issues concerning the banking sector is that of mounting
stressed assets which have plagued the banking sector, especially the public sector
banks since long. Several initiatives have been undertaken and are also underway
to strengthen the regulatory and supervisory frameworks aimed at increasing the
resilience of the banking system. These include:
Recapitalisation of Public Sector Banks: Government announced Indradhanush

plan for revamping Public Sector Banks (PSBs) in August 2015 by infusing capital 127
Indian Economic Development: of Rs. 70,000 crore over a period of four financial years. Capital infusion is
An Overview
aimed at supplementing the achievement of regulatory capital norms by PSBs
through their own efforts and, in addition, based on performance and potential,
augmenting their growth capital.
Merger of Public Sector Banks: Since 2016, effective action has been undertaken
to consolidate Public Sector banks by way of amalgamation. The merger of banks
is expected to facilitate the creation of strong and competitive banks in the Public
Sector space to meet the credit needs of a growing economy, absorb shocks and
have the capacity to raise resources without depending unduly on the State
exchequer.
In 2014, the Committee to Review Governance of Boards of Banks in India (P.J.

Nayak Committee) was also constituted. Its key recommendations focused on
enhancing the governance and management of public sector banks which
continued to have a large presence in India’s banking sector.
Resolution of Stressed Assets: The resolution mechanism is instituted through

Insolvency and Bankruptcy Code (IBC), 2016 which provides a market
mechanism for time-bound insolvency resolution enabling maximisation of value.
5.3.5 Housing and Urban Infrastructure

Usually, urban infrastructure builds up gradually in sync with the progress of
industrialisation, as has been experienced by the western world. In contrast to
this, in India, urbanisation and the attached pressure to build the urban
infrastructure have not been gradual in sync with the industrial growth. This is
because of the rapid pace with which the urban population has been growing.
This increase is because of two reasons– first is the natural increase of urban
population and second is the migration from rural to urban areas. This migration
has been more so surging post 1990 reforms when Indian economy and especially
the urban areas started to experience rapid economic growth. According to Census
2011, 377.1 million Indians comprising 31.14 per cent of the country’s population
lived in urban areas. As per the estimates by the UN, urban India accounted for
close to 34 per cent of its total population in 2018 and the number is forecasted
to exceed 50 per cent by 2046. (Refer Table 5.4). This necessitates investments
in housing, road network, urban transport, water supply, power-related
infrastructures, smart cities, and other forms of urban management.
Table 5.4: Urbanisation in India
Persons in Million Decadal Growth in

Numbers Population %
2001 2011 1991-2001 2001-2011
Total 1029 1210 21.5 17.6
Rural 743 833 18.1 12.2
Urban 286 377 31.5 31.8
Urbanisation is a major driving force behind Indian economic growth and

contributes close to 60 per cent of its Gross Domestic Product. While urbanisation
process resulted into economic growth in the country, but equally it is true that,
128 there exist number of problems associated with the urbanisation. Some of them
include: urban air and water pollution resulting in global warming and climate Physical and Social
Infrastructure
change; exorbitant levels of urban solid waste, inadequate urban transport.
Policy Initiatives
The urbanisation in India is inevitable thus, the need for solving the various
problems associated with it requires a combination of actions, starting with
increased investment; strengthening the framework for governance, and most
importantly capacity building for the people and the institutions engage in urban
affairs.
Recognising the vast impact that Urbanisation has on the environment, the Indian
government committed its Intended Nationally Determined Contribution (INDC)
to United Nation Framework Convention on Climate Change (UNFCCC) in 2015.
The INDC centres around India’s policies and programmes on promotion of clean
energy, resilient urban centres, promotion of waste to wealth, safe, smart and
sustainable green transportation network, abatement of pollution and efforts to
fight the build-up of carbon by enhancing the carbon sink through creation of
forest and tree cover.
The government of India has launched various programmes to address urban

governance issues and gaps in infrastructure. Some of the key programmes include
the Atal Mission for Rejuvenation and Urban Transformation (AMRUT), Heritage
City Development and Augmentation Yojana (HRIDAY), Smart Cities Mission,
Clean India Mission and R-Urban Mission.
The Real Estate (Regulation and Development) Act, 2016 (RERA): The RERA
is one of the significant reforms implemented in the real estate sector with an
objective to ensure regulation and promote real estate sector in an efficient and
transparent manner and to protect the interest of home buyers.
The Pradhan Mantri Awas Yojana- Urban (PMAY-U)– which envisions ‘Housing
for All-Urban’, was launched in June, 2015 to provide pucca house with basic
amenities to all eligible urban poor by 2022.
The country is participating in the United Nations’ “New Urban Agenda”, which
aims to make cities more networked, closer to their citizens and more sustainable
in the future. In the “Housing for all” project, the government aims to provide
affordable housing even for the poorest – a total of 20 million houses in more
than 2,500 cities. And with the “Smart Cities Mission”, more than 100 urban
spaces are to be transformed into digitally networked conurbations.
5.4 SOCIAL INFRASTRUCTURE: GROWTH AND

POLICY ISSUES
5.4.1 Education
India holds an important place in the global education industry. By 2030, India is
set to have the largest working age population in the world. Not only do they
need literacy but they need both job and life skills. This provides a great
opportunity for the education sector. India’s educational system broadly comprises
school education (elementary, secondary and higher secondary), higher education
(general and professional) and vocational education. The Ministry of Human
129
Indian Economic Development: Resource Development (MHRD) is the nodal ministry for the sector. Expenditure
An Overview
in education sector as percentage of GDP increased from 2.8 per cent in 2014-15
to 3.1 per cent in 2019-20. As per the data released by Department for Promotion
of Industry and Internal Trade (DPIIT), the total amount of Foreign Direct
Investment (FDI) inflow into the education sector in India stood at US$ 2.47
billion from April 2000 to March 2019.
India has seen a rapid expansion in the higher education sector since 2001. There
has been a dramatic rise in the number of higher education institutions (HEIs)
and enrolment has increased fourfold. The Indian higher education system is
now one of the largest in the world, with 993 Universities, 39931 Colleges and
10725 Stand Alone Institutions. Despite the increased access to higher education
in India, challenges remain. Low employability of graduates, poor quality of
teaching, weak governance, insufficient funding, and complex regulatory norms
continue to plague the sector. India’s gross enrolment ratio (GER) in 2018-19
was 26.3 per cent but still far from meeting the MHRD’s target of achieving 50
per cent GER by 2035.
Indian educational policy and reforms emphasised on overcoming challenges to
improve low enrolment ratio in higher education, low quality of teaching and
learning, constraints on research capacity and innovation, uneven growth and
access to learning opportunities, etc. Some of the major initiatives taken by the
Government of India are:
SWAYAM (Study Webs of Active learning for Young Aspiring Minds)– a
programme initiated by Government of India and designed to achieve the
three cardinal principles of Education Policy viz., access, equity and quality.
The National Digital library of India (NDLI)– a project initiated under the
National Mission on Education through Information and Communication
Technology (NMEICT) to develop a virtual repository of learning resources
with a single-window search facility.
The Mission of Unnat Bharat Abhiyan to leverage the intellectual capital of
higher educational institutions for the upliftment of rural India.
The Pandit Madan Mohan Malaviya National Mission on Teachers and
Teaching (PMMMNMTT) to address issues related to teachers and teaching.
Prime Minister Research Fellows (PMRF) scheme to support 1000 bright
undergraduate students every year, for direct admission in the research
programmes in the reputed institutions like IISc, IITs.
The National Institutional Ranking Framework (NIRF) adopted by the
MHRD to rank institutions of higher education in India.
Sarva Shiksha Abhiyan – a Centrally Sponsored Scheme in partnership with
State Governments for universalising elementary education across the
country.
National Education Policy 2020: The National Education Policy (NEP),
2020 – approved by the Union Cabinet on 29th July 2020 to make way for
large scale, transformational reforms in both school and higher education
sectors – is built on the foundational pillars of Access, Equity, Quality,
130
Affordability and Accountability. Key highlights of the policy include: Physical and Social
Infrastructure
- Ensuring Universal Access at all levels of school education;
- Early Childhood Care and Education with new Curricular and
Pedagogical Structure;
- Reforms in school curricula and pedagogy;
- Emphasis on promoting multilingualism and Indian languages;
- Assessment reforms;
- Equitable and inclusive education;
- Robust and transparent processes for recruitment of teachers and merit-
based performance;
- Exposure of vocational education in school and higher education system;
- Increasing GER in higher education to 50 per cent by 2035;
- Holistic Multidisciplinary Education with multiple entry/exit options;
- Expansion of open and distance learning to increase GER.
- The Centre and the States to work together to increase the public
investment in Education sector to reach 6 per cent of GDP at the earliest.
In pursuance with the Prime Minister’s vision for ‘Transforming India’,
Ministry of Human Resource Development took a leap forward in
transforming education sector with the motto of “Education for All, Quality
Education”. MHRD has launched—
(i) Pradhan Mantri Innovative Learning Program– DHRUV; (ii) NISHTHA–
National Initiative for School Heads’ and Teachers’ Holistic Advancement;
(iii) Integrated Online junction for School Education ‘Shagun’; (iv) a five-
year vision plan named Education Quality Upgradation and Inclusion
Programme (EQUIP); (v) Several new schemes in Higher Education
Department to boost research and Innovation culture in the country.
Degree level full-fledged online education programme started to provide
quality education to students of deprived sections of the society as well as
those who do not have access to higher education. Through this initiative
Gross Enrolment Ratio will be increased.
Looking ahead
In 2030, it is estimated that India’s higher education will adopt transformative
and innovative approaches and will emerge as a single largest provider of global
talent, with one in four graduates in the world being a product of the Indian
higher education system.
5.4.2 Health
Depending on the level of care required, healthcare in India is broadly classified
into three types. This classification includes primary care (provided at primary
health centres), secondary care (provided at district hospitals), and tertiary care
institutions (provided at specialised hospitals like AIIMS). Primary health care
infrastructure provides the first level of contact between health professionals
and the population. Broadly, based on the population served and the type of
131
Indian Economic Development: services provided, primary health infrastructure in rural areas consists of a three-
An Overview
tier system. This includes Sub-Centres (SCs), Primary Health Centres (PHCs),
and Community Health Centres (CHCs). A similar set up is maintained in urban
areas.
Issues concerning the Healthcare sector in India include:

A) Shortfall at different levels of the healthcare delivery system. As of 2018,
there is a shortage of 2,188 CHCs, 6,430 PHCs and 32,900 SCs.
B) Shortfall of doctors. As of 2018, there is a shortfall of 46 per cent of doctors,

and 82 per cent of specialists including surgeons, obstetricians,
gynaecologists, physicians, and paediatricians in Primary Health Centres
across India. Certain reasons identified for the shortage of personnel in
government facilities include: (i) poor working environment, (ii) poor
remuneration making migration to foreign countries and to the private sector
more attractive, and (iii) procedural delays in recruitment and poor forward
planning for timely filling up of positions.
C) Low public health spending in healthcare. The public health expenditure

(sum of central and state spending) has remained between 1.2 per cent to
1.5 per cent GDP between 2008-09 and 2018-19, which is relatively low as
compared to other countries. This has been resulting in high out of pocket
healthcare expenditure. It is estimated that 65 per cent of the health
expenditure is borne by consumers in India
Some of the major initiatives taken by the Government of India to promote Indian
healthcare industry are as follows:
Pradhan Mantri Swasthya Suraksha Yojana (PMSSY): a Central Sector
Scheme, announced in August 2003 to address imbalances in availability of
tertiary care hospitals and improve medical education in the country. It has
two components– Setting up of new AIIMS, and up-gradation of existing
State/Central Government Medical College/Institutions (GMC).
Mission Indradhanush: launched in 2014 to strengthen and re-energise the
programme and achieve full immunisation coverage for all children and
pregnant women at a rapid pace.
Ayushman Bharat Yojana: a national initiative launched as the part of
National Health Policy 2017, in order to achieve the vision of Universal
Health Coverage (UHC). The Ayushman Bharat comprises of two inter-
related components, (i) Establishment of Health and Wellness Centres, and
(ii) Pradhan Mantri Jan Arogya Yojana (PM-JAY)
Pradhan Mantri Jan Arogya Yojana (PMJAY): Launched in September 2018
under the Ayushman Bharat programme, PMJAY aims to provide a cover of
Rs. five lakh per family per year to 10.7 crore families (no cap on family
size and age) belonging to poor and vulnerable population for secondary
and Tertiary Healthcare.
The National Medical Commission Act, 2019: A legislation passed by
Parliament to provides for a medical education system which ensures: (i)
132 availability of adequate and high quality medical professionals, (ii) adoption
of the latest medical research by medical professionals, (iii) periodic Physical and Social
Infrastructure
assessment of medical institutions, and (iv) an effective grievance redressal
mechanism.
The Government of India is planning to increase public health spending to
2.5 per cent of the country’s GDP by 2025.
Looking Ahead
Healthcare has become an important cornerstone in India’s development plan,
with various initiatives including Ayushman Bharat- Health and Wellness Centers
(HWCs) and Pradhan Mantri Jan Arogya Yojana (PM-JAY), Swachh Bharat,
Digital India, Skill India, Start-up India, Make in India etc. In synergy, these
initiatives will comprehensively address the healthcare challenges of India, such
as reducing overall burden of diseases, lowering out-of pocket expenditure,
augmenting healthcare infrastructure and promoting access to quality care.
However, to provide assurance of healthcare for all, the government must
recognise and address the rising concerns and sustainability of the private
healthcare providers, which account for 70 per cent of bed capacity expansion
over the past decade and cater to 60 per cent of inpatient care demands of the
country. As healthcare services and coverage expand, successful implementation
will require a parallel concerted push towards quality assurance, appropriate
governance and regulation, improving referral pathways as well as leveraging
appropriate technologies and innovations at all levels. This will be possible only
with effective collaborations between all the stakeholders, including the private
sector.
5.5 INFRASTRUCTURE: CHALLENGES AND WAY

AHEAD
The Government of India has launched various critical infrastructure projects
like Power for All, Smart Cities Mission, Swachh Bharat mission, and many
more with an objective to build world class infrastructure in the country. However,
as per Ministry of Statistics and Programme Implementation’s (MoSPI) Flash
report of January 2018, it is observed that around 20 per cent of the central
sector projects are delayed beyond their scheduled date of completion. Managing
these complex projects has always been a challenge, especially since these projects
are long-term, involve multiple stakeholders, bring-in new technologies, and
constrained resources. Most of the infrastructure projects are delayed primarily
due to regulatory approvals, issues on land acquisition, shortage of skilled
resources, ineffective dispute resolution mechanism, and geological challenges.
Some of the major challenges faced in the infrastructure development in the
country are:
Land Acquisition: Land acquisition has been the single largest roadblock for the
development of infrastructure. Several projects have been stalled or delayed due
to land acquisition issues. The causes behind delays in land acquisition includes
resistance from farmers or local communities whose land is being acquired and
lack of well-planned, efficient, and demonstrable rehabilitation packages for
displaced persons.
Delay in regulatory and environmental clearance: There are various categories
of approvals required across the project cycle at every stage, right from the pre-
133
Indian Economic Development: tendering stage to post-construction causing delays in the process. Clearly, better
An Overview
governance will be a big help in mitigating long delays in infrastructure projects.
Funding Constraints: There is increasing reliance on the private sector for

developing and maintaining infrastructure that need funds for projects that are
often capital intensive and have a high gestation period. The private investment
in infrastructure projects is typically in the form of debt raised by developers.
India’s long-term debt market is not deep enough. Equity markets are not
favourable for financing projects either, because of uncertainties involved in
execution and returns. These issues remain unresolved and continue to create
problems in financing infrastructure projects.
Capacity of private players: Infrastructure projects in India are becoming larger

in size and complexity, and such projects require financial patronage and
additional project management skills, which most medium-to-small Indian
companies currently lack.
Way ahead
Land acquisition: Earlier, the government had made cabinet approval mandatory
for leasing, licensing, or transferring land. By relaxing transfer regulations for
land it owns, the government has taken a positive that should resolve the delay
of projects by procedural issues, and complement the guidelines to resolve land
issues.
Fast-track policy and regulatory reforms for efficient implementation: Sponsoring

agencies need to make a concerted effort to develop strong performance
management systems to drive timely execution of projects including defining
performance standards for nodal agencies and creating a transparent and accurate
tracking mechanism as well as performance-linked incentives and penalties.
Dispute Resolution: To eliminate the issues of delays and litigations, a

Performance Review Unit should be given powers to gather information from
nodal agencies on clearances and incentivise or regulate this.
Facilitate Funding for Infrastructure Projects: In this direction, setting up of

Infrastructure Debt Funds (IDFs) and reduction in ‘withholding tax’ on the interest
paid on these bonds are some other positive measures that are expected to facilitate
the flow of long-term debt into infrastructure projects. Furthermore, introducing
PPP mode by allowing the private sector into some former fully government-
owned infrastructure sectors, such as telecommunications and domestic civil
aviation, has also produced exemplary results. A significant start has been made
in involving the private sector in the provision of transport infrastructure.

1) Discuss the recent policy initiatives undertaken by Government of India
towards transport infrastructure development in India.
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134
2) Review the importance and present position of the education sector in the Physical and Social
Infrastructure
Indian economy.
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3) What are the major challenges in front of Indian infrastructural development?
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5.6 LET US SUM UP

Infrastructure which can be categorised into physical and social infrastructure
represents the support system that facilitate economic activities and hence the
economic growth. Besides promoting productivity and growth, infrastructure
contributes to domestic market development, it mobilises savings, generates
employment opportunities, leads to social development and social change.
Infrastructure development has remained a national priority, and has played a
pivotal role in helping the country emerge as one of the fastest growing economies
in the world. Several reforms (like Power for All, Smart Cities Mission, Sagarmala,
UDAY, etc.) have already happened across various sub-sectors of infrastructure
including, roads, airports, ports, power and urban utilities and progress have
been however much remain to be achieved to sustain and enhance economic
growth. Also, it is imperative that infrastructure development occurs in a
sustainable manner.
5.7 KEY WORDS

Infrastructure : The stock of fixed capital equipment in a country,
which facilitates different economic activities and
thereby help in economic development of the
country.
Physical Infrastructure : It is directly concerned with the needs of such
production sectors as agriculture, industry, trade,
etc.
Social Infrastructure : It is concerned with the supply of such services
as meet the basic needs of a society like health
services, drinking water, sewerage, sanitation,
electricity, education facilities etc.
Hard Infrastructure : It refers to the large physical networks necessary
for the functioning of a modern industrial nation. 135
Indian Economic Development: Soft Infrastructure : It refers to all the institutions which are required
An Overview
to maintain the economic health, and cultural and
social standards of a country.
5.8 REFERENCES
1) The Concise Oxford Companion to Economics in India by Kaushik Basu;
Annemie Maertens (Editor) ISBN: 9780198063131.
2) India’s Economic Reforms and Development by Isher Judge Ahluwalia; I.
Little (Editor) ISBN: 9780198082231.
3) Handbook of the Indian Economy in the 21st Century by Ashima Goyal
(Editor) ISBN: 9780198097532.
4) Facilitating Infrastructure Development in India, ADB’s Experience and
Best Practices in Project Implementation by Asian Development Bank.
5) IEG paper on ‘Infrastructure in India: Challenges and the Way Ahead’ by
Pradeep Agrawal, IEG Working Paper No. 350, 2015.
6) Economic. Survey 2019-20. Volume 1. Government of India. Ministry of
Finance. Department of Economic Affairs. Economic Division.
7) IBEF Indian Infrastructure- Industry Analysis Reports 2019

PROGRESS EXERCISES
3) See Section 5.5
136
Physical and Social
Infrastructure
Block 2
Development Strategies
137
BLOCK 2 DEVELOPMENT STRATEGIES
The state and market as institutions play significant role in the process of economic
development. However, the role of these two institutions in India as an instrument
of economic development has changed over time.
During the first four decades of development planning, India relied heavily on
the public sector which was favoured as the engine of development. During this
period, the state played mainly the regulatory, entrepreneurial and planning role.
However, after 1991 the inward-looking development strategy was replaced by
outward-oriented strategy popularly known as liberalisation, privatisation and
globalisation (LPG) strategy, wherein private sector is considered as an engine
of growth. Under this strategy, free functioning market acts as the guiding force
in the major policy decisions and state works more as facilitator and promoter of
economic activities and less as regulator. This block deals with re-defining the
role of state and market and changing development strategies adopted over a
period of time. The Block comprises three units.
Unit 6: State and Market: Indian Context throws light on the various forms of
state intervention in economic activities, state’s intervention for achieving the
goal of efficiency and promoting equity and state’s intervention in market as
envisaged in Indian Constitution.
Unit 7: Economic Reforms in India covers the rationale behind economic

reforms, the constituents of economic reforms and impact of economic reforms
on Indian economy.
Unit 8: Major Developments in Post Economic Reforms Period identifies the

key challenges on the road to India’s development, analyse the hurdles in the
process of restructuring public sector undertakings, highlights the pros and cons
of public and private partnership, and underlines the need for insolvency and
bankruptcy code (IBC) and the problems associated with it.
138
State and Market: Indian
UNIT 6 STATE AND MARKET: INDIAN Context
CONTEXT
Structure
6.0 Objectives
6.1 Introduction
6.2 State and Market
6.2.1 State and Government
6.2.2 Market: Meaning and Forms
6.2.3 Premises of Market
6.3 State Intervention in Market: Instruments and Institutions
6.3.1 Ownership and Operation
6.3.2 Regulation and Control
6.3.3 Promotion and Support
6.3.4 Protection
6.4 State Intervention in Market for Efficiency
6.4.1 Rationale for State Intervention in Market
6.4.2 Public Goods
6.4.3 Externalities
6.4.4 Monopoly Power
6.4.5 Information Asymmetries
6.4.6 Merit and Demerit Goods
6.5 State Intervention in Market to Promote Equity
6.5.1 Goods Markets
6.5.2 Factor Markets
6.6 State Intervention in Market and Indian Constitution
6.6.1 General Direction
6.6.2 Particular Areas
6.7 State Intervention and State Interference
6.8 Let Us Sum Up
6.10 Key Words
6.11 References
Appendix 6.1
6.0 OBJECTIVES
differentiate between State and Government;
describe different meanings of Market;
139
Development Strategies identify different forms/instruments of State intervention;
delineate the neoclassical rationale for State intervention in Market for
efficiency;
discuss the rationale for State intervention in Market for equity;
explain State intervention mandated in the Constitution of India; and
distinguish between intervention and interference.
6.1 INTRODUCTION
Political economy as evolved in the last few centuries in the West, dealt with the
role of State in relation to economic affairs– both of public nature and private
nature. As managing the State paraphernalia and making it help run the economy
needed resources, fiscal operations of finding ways of mobilising resources and
expending them had been an important aspect of a State’s economic activities.
With evolving complexities, monetary operations were generally parted from
treasury functions of the government and entrusted with an independent and
specialised agency, mostly within government domain and invariably under a
separate law.
Societies and countries could progress because there were in existence certain
institutions, which evolved over time practically in all civilised societies with
variations and at differing pace. A legal framework ensuring existence of private
property, an inheritance system for some assets and protection of contractual
obligations has been a ubiquitous feature. It was realised quite early that many
of resources are consumed in common and there had to be institutions to resolve
issues should they arise in possession or use of such resources. In State-led
societies, this task was given to or assumed by the State. State intervened in the
economy for improving efficiency, enhancing equity, stabilising its activity level
and balancing tradeoffs when they arose.
In the context of development, the expressed aspiration of post-war liberating

colonies, led State in many newly independent countries to assume direct charge
of running certain industries, besides educational and health facilities, regulating
several others to seek efficiency and/or equity and promoting still others like
financial institutions. In part, this was a reflection of the apparent success of the
planning apparatus in the erstwhile USSR. But the USSR broke up and the
constituents pursued market-oriented policies– known as perestroika (reforms)
and glasnost (open-ness).
Relationship between State and Market across space and time has not been the
same. So-called capitalism where quality and quantity of state invention distinctly
differed from so-called socialism but both existed side by side for pretty long
time. When most countries allowed market better, individual countries and regions
differed not necessarily in proportion to the level of development. Over time, it
appears that market dominated state and sought state to be a facilitator rather
than a competitor by devising such formal institutions and designing them in
such a way that market flourish and help the country grow. However, when crises
struck such as the Great Depression of 1930s, the Great Recession of 2008-09 or
Covid-19, the market operators sought the help from the State. In other times,
either market sought or state sought the partnership between private sector and
public sector in many development arenas which were traditionally taken up in
140
public sector for a pretty long time. This partnership had to be in terms of sharing State and Market: Indian
Context
of resources, risk and revenue. Anyway, there have been swings in the relationship
between the two, market and state, in terms of domination, competition and
cooperation. However, the unit, given the limitation of space, would not devote
much time on this aspect.
The focus of this unit is on State intervention in individual markets for improving
both the efficiency and equity of outcomes. In addition, State plays paternal role
of encouraging or discouraging consumption of certain goods. It also chooses to
regulate as well as promote quite a few private activities, including those of
economic nature. The unit devotes space to discuss the nature of State and market,
the rationale of State intervention in market for efficiency and equity. It also
discusses State intervention in the context of India.
6.2 STATE AND MARKET

State and market are two great institutions which humans have evolved over
time, among several others, to resolve inter-personal or inter-group issues in
people’s life that arise from living together. Both are overarching in their scope.
Broadly speaking, one is political and the other is economic; but they also seek
to intervene in each other’s sphere.
State supposedly evolved to perform watch and ward functions, to defend the
society from external aggression and internal disturbances while market evolved
to benefit from voluntary exchange of goods (and services) which was greatly
facilitated with the invention of money as medium of exchange.
However, State has often been intervening in, some would argue even meddling
in, the economic spheres of life. Justifications varies from time to time, giving
impression that State and market are hand in glove. Property rights and inheritance
laws as well as people’s entitlements and obligations, which were traditionally
evolved have been recognised by the State which either accorded sanction or
tweaked them a little here and there. Nevertheless, formal state institutions always
alongside informal societal institutions where institutions mean the rules of
conduct for individuals and other entities to avoid conflicts should they arise.
Generally, there is a tendency for State to assume greater scope by formalising
institutions and occasions arise for them.
6.2.1 State and Government

It would be pertinent to point out basic difference between State and government
though they may be used interchangeably. State has four essential elements of
population, territory, sovereignty, and government. In fact, government works
for the State as its agent. People are a collectivity of individuals connected
intractably. Territory belongs to the State over which it has sovereignty and
jurisdiction; and government is supposed to preserve, protect and defend that
territory. While State is sovereign, the government is not. In a democracy, it is
often asserted that people are sovereign as they choose the State, rather the
government, they would like to be governed by.
Government keeps coming and going as per rules of the State– best codified in
the Constitution. While State may appear to be abstract, it is which asserts
sovereignty of a community of people. All individuals living in the territory, 141
Development Strategies except those belonging to foreign States, are members of the State as its citizens.
In India, there are 130 crore people, with 99.5 per cent being the citizens. While
a few Indian citizens may be non-resident, few foreign citizens may be residents
in India. In contrast, government is concrete, visible, and active, and involves a
subset of people– some as representatives of people and some as employees in
their service. For example, in India, there are around 545 MPs in the House of
People, over 4000 MLAs in Stare Assemblies and over 30 lakh members in
Panchayats and Municipalities, who are direct representatives of the people at
some level of government.
Further, the form of government may vary from State to State. Government may
be monarchial, aristocratic, dictatorship or democracy. It may have a presidential
form or parliamentary one. It may be federal– with several fixed or flexible
constituents, or unitary with centralised or decentralised administrative set-up.
If federal, it may have several levels or tiers of governments. State exists
independently of the form of government while people may choose the form of
government.
However, the word State may have several meanings in popular usage. For
example, in the Constitution of India, India is a State as well as a Union of
States. (So is the case of the US.) Modern government normally has three wings,
legislature, executive and judiciary. But the Constitution of India, for legal
purposes, defines the State in Art 12, in relation to Fundamental Rights which
must be adjudicated by Judiciary, as:
… “the State” includes the Government and Parliament of India and the
Government and Legislature of each of the States and all local or other authorities
within the territory of India or under the Government of India.
Finally, in the context of intervention, phrases State intervention and government

intervention mean one and the same thing. When, however, it comes to failure,
the phrase used is government failure– not State failure.
6.2.2 Market: Meaning and Forms

It seems, at some point in antiquity, quite possibly in different periods in different
places, humans realised that voluntary exchange between two humans might
lead to specialisation– thus to division of labour, and thereby raising production
levels and thus bettering the possessions of both the exchangers. The same holds
in inter-societal exchanges which might have been rare in the days when a society
could still raid on other societies to improve upon its possessions. Once, a society
is able to produce enough to maintain a regular army, it evolved as a State to
defend itself against other societies. Rules for conduct of human affairs within a
society had to be framed. Instruments might have had to be devised. For example,
money is an instrument to facilitate exchange or transactions in market.
Size of market depends on the level of specialisation and division of labour, said
Adam Smith. He is in fact referring to the size of economy in today’s parlance,
which is generally measured in terms of Gross Value Added (GVA). Another
connotation, as in microeconomics, is a market for a commodity– good or service,
or for a factor. Still another connotation is regular market referring to market
place or periodic market referring to frequency. Nowadays, it may be real or
virtual!
142
Market expanded as many goods got commoditised or commodified. For example, State and Market: Indian
Context
labour was not directly bought and sold earlier on wages, the labour price per
unit of time– notwithstanding existence of slavery wherein a person can be bodily
sold; later, it became like any other commodity. Many services like legal advocacy,
consultancy, teaching, training, research, marketing, are also now on sale. In
management science, market may mean a verb for advertisement.
Normally, we associate market with a place where we carry out purchase and
sale of goods. Some are regular and some organised on periodic basis and some
on occasions like festivals. There are virtual markets as well, as we are now
becoming used to. However, in Economics, for analytical purposes, markets can
be classified as asset markets, goods markets, and service markets; goods markets
and factor markets; financial market, bond market and money market, etc. They
present a platform with certain conditions to facilitate voluntary exchange of
goods and services. Based on level of competition, they may be called monopoly,
monopolistically competitive or oligopoly. The nature of State intervention
invariably depends on the structure of the market. However, State intervention
always take the form of influencing either the prices, quantity, or quality standards,
or all of them.
If an institution means a set of rules to conduct affairs in a given domain,

transactions such as exchange of goods and services, lending or borrowing of
money, leasing, or mortgaging of assets (including intellectual property), accepting
deposits and loaning them out or conducting other financial services like
underwriting risk, all constitute separate markets– some of them may be inter-
related.
There are conventions to transact business, some of which are instantaneous,

some over time, some with attendant warrantee and conditionalities, some for
future dates. For various reasons, the State may find it necessary to intervene by
framing laws– rules, regulations, orders, guidelines etc.
6.2.3 Premises of Market

Market presupposes existence of property rights over resources and commodities–
ownership of property by individuals, families, businesses, communities, and
governments. Non-government ownership is often designated as private. Some
properties are said to be common property. Property itself may be tangible or
intangible. The former is physical – moveable and immoveable while the latter
is mostly financial or intellectual. Market presumes that such property rights are
alienable or transferable. So, farming field, town house, government bond, and
molecule patent are all alienable. There may be new kind of rights like club
membership, right to smoke or right to vote. You may have right to smoke in a
railway coach which you may exchange it for consideration with someone who
may find it obnoxious but you cannot legally exchange your voting right. So,
you may have right to use but not to exchange. Likewise, you cannot pass on
your right to smoke or right to vote to your children. They extinguish with your
passing away. Government may give land to use but not to sell. Ownership is
itself is a bundle of rights and you may possess some of those while others may
be possessed by others. You rent in a house and you use; you lease in a piece of
land and you cultivate it; you mortgage your financial papers and use borrowed
money for some purpose, and you have an intellectual property and permit its
use by others. In addition, it also presupposes existence of some rules of 143
Development Strategies inheritance of properties that survive the owner though some of them extinguish
with the person.
Chattel (i.e., personal possession not related to real estate) seems to be the first
form that came to be accepted as property and slaves appear to be the worst form
of property. Both are the cases of means of production as are land, workshops,
tools, and equipment. Socialist thinkers believe that means of production which
occasion the employment of a sizeable number of workers have to be socially
owned whereas capitalist proponents support private ownership. While some
believe that private property provides incentive to exert harder, there are some,
like Ludwig von Mises, who think that prices cannot be formed in the absence of
private property over means (factors) of production.
There is often a distinction made between private property and personal property
and another between consumption goods (means of consumption) and capital
goods (means of production).
Mutual transfer of properties, including money, in a voluntary exchange is the

basis of market. In case, there is a breach of generally acceptable behaviour
there exists some mechanism, namely legal redress, to enforce it.
However, market may not exist in certain cases as goods may have peculiar
characteristics. Or market may exist but may not yield efficient outcomes. So,
private property may be a necessary condition for market to function, but not
sufficient. Likewise, rules for succession or inheritance of certain properties are
a necessary institution for a society but not sufficient.

1) Differentiate between State and Government.
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2) State the different meanings of State in political sense.
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3) Explain different nuances of a market.
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144
4) What are essential premises of market in terms of voluntary exchange? State and Market: Indian
Context
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6.3 STATE INTERVENTION IN MARKET:

INSTRUMENTS AND INSTITUTIONS
State intervenes practically in all spheres– economic, political, and social. In
economic sphere, there are general interventions in the economy and there are
interventions specific to individual markets. For example, RBI interventions
aiming at supply of money which is for the economy as a whole, while
interventions by TRAI to influence telecom sector in terms of price, quantum,
and quality or standards are specific to the market for telecom services. State
devises a variety of methods which are used for intervention and a variety of
institutions through which intervention is carried out.
Beside policy formulation, legislation of law, framing of rules, and outlining

guidelines, market specific instruments of State interventions can take the shape
of production, provision, promotion, protection, restriction (on price, quantum
or standards), regulation (on labour or environment), control and sharing
information.
Likewise, there are variety of institutions through which interventions are carried
out. These institutions are named as agency, association, authority, bureau, boards,
committee, commission, corporation, council, foundation, institution, office,
organisation, society or trust, which all have somewhat different legal status and
organisational complexion. There may be ad hoc task forces, working groups,
panels of experts, etc. Similarly, broad sectoral interventions take the shape of
plan, scheme, programme, project, campaign, and mission.
For the purpose of elaboration, this unit chooses to classify micro interventions
as they are, into four groups in terms of (i) Ownership and Operation, (ii)
Regulation and Control, (iii) Promotion and Support, and (iv) Protection.
6.3.1 Ownership and Operation

There may be certain strategic industries/market where State does not trust private
owners as it does normally. This is in the case of core defence, police activities
or mintage, coinage, and note-issuing, which once upon a time private parties
engaged in. There may be sectors where private capital may be shy as it may not
have enough capital or venture may be too risky. State may choose to have
monopoly over space industry or atomic energy industry or mining of atomic
mineral resources. But the Government of the day may ideologically decide to
control the commanding heights of the economy or establish a socialistic pattern
of society. Or it may find no reason to do business. For example, in India, following
Parliament’s resolution to establish socialistic pattern of society in December
1955, the Industrial Policy Resolution of April 1956 included a whole set of 17
industries to be exclusively owned and operated by the Government. It included,
145
Development Strategies besides arms and ammunition, atomic energy, and minerals, electricity, railways,
ships, aircrafts, coal, iron and steel, etc. If such industries are in private hands,
they could be nationalised. The government or its agency, corporation, or
company, would own, operate, control, and manage all operations related to
production or disposal of the produce. Now, the circle is moving to the other
side; instead of nationalisation of private enterprises, privatisation of state
enterprises is being contemplated and carried out. As of now the move is towards
public private partnership, if not outright privatisation, divest mentor joint
ownership and operation.
6.3.2 Regulation and Control

There may be another set of industries essential for developing infrastructure or
essential consumer goods, the government could think of regulating or controlling
output and/or price. Once, the government compulsorily procured a certain portion
of food grains at lower prices and thereafter decided to offer support prices in
case market prices fell below that level. Further, once upon a time it was thought
textile mills could compete with handloom and khadi which needed to be
encouraged for employment and, therefore, their output could be controlled.
License to produce was one of the conditions one had to fulfil before starting
operations. Many metals, cement, antibiotics, fertilizers, machine tools, sugar,
road transport, etc. could be put in that category. There was an Act, called Essential
Commodities Act passed in 1955, which permitted the government to control
production, supply and distribution of certain commodities like drugs, foodstuffs,
fertilizers, etc., under certain circumstances. There are several other regulations
put in place to assure, for example, quality of goods and services. Several agencies
have now been put in place to certify quality of products by marking as ISI,
Hallmark, Agmark, Ecomark, BSIV, etc.
6.3.3 Promotion and Support

Many industries may need financial support or promotion– say, in export.
Government creates development finance institutions such as NABARD, SIDBI,
NHB or EXIM Bank to support industries and trade. It also floats boards and
councils to promote the interests of specific industries.
Needless to say, government generally support supply side of market through

S&T/R&D activities, development of general infrastructure – including clusters,
estates, market yards and other common facilities. It also supports technical
education, training for skills, and extension centres.
6.3.4 Protection
Certain industries may need protection, besides support, from competition with
easily substitutable products. There were hundreds of items which were reserved
for production by small scale industries (micro and small enterprises). Under
WTO obligations, slowly, protection by reservation has been withdrawn. However,
there is still Purchase Preference Policy and Price Preference Policy. Under the
former, government departments are supposed to give preference for products
from small scale industries and under the latter, they could pay up to 15 per cent
higher price than the lowest quotation from industry of any scale.
146
Check Your Progress 2 State and Market: Indian
Context
1) List the various instruments of specific market interventions.
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2) List the institutions and modes of State intervention in market.
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3) Explain the meaning of regulation in the context of intervention in market.
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6.4 STATE INTERVENTION IN MARKET FOR

EFFICIENCY
State is supposed to protect life, liberty, and property of the individuals while
market is about voluntary exchange of properties– though with quite extended
meaning. It is obvious that State emerged after institution of private property
had already come into existence. However, according to Marxist literature, State
and market are said to be in hand-in-glove.
State is often pressed into service to intervene in the market should its legitimate
functioning result in socially undesirable consequences. State is also asked to
intervene in the market if the latter is found to be inadequate or incomplete in
certain respects. Such a situation is called market failure as it results in higher
prices and lower quantities compared to efficient operation of market.
In this section, the rationale of market intervention of State is afforded in terms

of production and consumption as well as price, quantity, and quality. The purpose
is to improve efficiency or reducing deadweight loss to the society. Let it be
clear that these interventions are in white markets which follow all laws of the
land. It is possible that some interventions may induce parties to go into black or
conduct illegal operations.
147
Development Strategies 6.4.1 Rationale for State Intervention in Market
Neoclassicals provide for clear-cut price formation in market under the condition
MR = MC following certain simple assumption. They also highlight instances
where markets are not functioning efficiently or may not be complete or may not
exist altogether. They called that market failure or, breakdown of competition.
Two major sources are (1) existence of externalities with production or
consumption of private goods and (2) existence of market power or monopoly
power or imperfect competition. Another source of market failure is (3) existence
of imperfect and incomplete information. Purists may reduce everything into
violation of assumptions of perfect competition (an idealised world) while
practical people recognise existence of the extreme case of externalities as (4)
existence of public good, as a separate reason. Further, from a society’s perspective
there are goods which merit consumption and there are goods whose consumption
ought to be discouraged. For market, on their own may not be able to enforce
this distinction. So, (5) existence of merit and demerit goods is another reason
for state intervention.
In the case of perfect competition, marginal revenue (MR) of the producer, often
called marginal benefit (MB), is equivalent to marginal social benefit (MSB) as
there are no spillovers of benefit. So, MR=MB=MSB. Likewise, marginal cost
(MC) is equivalent to marginal social cost (MSC) as no cost is externalised. So,
MC=MSC. Usual equilibrium condition of MR=MC (or MB=MC) translates
into MSB=MSC and thus efficient voluntary exchange ensures efficient social
outcome. There is neither excess production nor shortage. When there is
divergence between the two– private and social, this parity breaks down. Market
will fail to produce socially efficient output or outcome. In such a situation, an
external intervention in the market is required. For long, it has been suggested in
neoclassical tradition that the intervention should come from the State. This is
the rationale for State intervention. We briefly discuss these five instances of
market failure to produce efficient social outcome, leading to State intervention.
6.4.2 Public Goods

There are certain goods which have certain peculiar characteristics such as non-
rival consumption and non-excludability. Rival consumption means if I consume
more, then less is available to you. If there is a shirt and if I wear it, it is not
available to you. If I take away a portion of bread, less is available to you. This
is true of any private good. But take the case of viewing a serial on TV, my
viewing does not impact your viewing it. Both of us enjoy together with no
rivalry. So, is the case with municipality produced street light. Excludability
means one can be excluded from consumption if one does not fulfil say certain
conditions to enjoy it. In a market, one who is not paying for the good or paying
less than the prevailing price, can be excluded. One who is not major may be
denied purchase of a cigarette pack or a bottle of liquor even though he is willing
to pay. One may not be enrolled for a Ph.D. if he has not done a Master’s degree.
However, one may not be denied the consumption of streetlight or security by
defence forces even when one is not contributing to production of these services.
There is no way anybody can be excluded from consuming such goods. Either
the prevalent technology does not permit it or cost of excluding is too high. It is
148 often argued that marginal cost of supplying public goods like TV signals is
almost zero, it may not be necessary to price them. But its supply does cost, say State and Market: Indian
Context
in terms of high fixed cost, it is suggested that it should be public funded. Then,
there exists problem of free-ridership as true preferences for such goods may not
get revealed.
Public goods are goods which are non-rival in consumption and non-excludable
from consumption whereas private goods which are both rival and excludable.
However, it is not true that all goods in existence can be categorised in these two
mutually exclusive groups. Goods may be non-rival but still excludable. Few
more students may be accommodated in the class as marginal cost of teaching
them is zero and consumption is non-rival up to a limit when the class size becomes
too large for effective learning to take place. Such goods are often called club
goods. There are goods, such as fishing in international water, where fishers are
non-excludable, but extraction of fish is rival: more for me and less for you or
more today and less tomorrow. So may be the case with oil extraction from two
nearby wells with common stock underground. Such goods are often referred to
as commons or common goods. Club goods and common goods are also referred
to as quasi-public goods or semi-public goods.
For pure private goods, equilibrium condition MSC = MBA= MBB where A and
B are two consumers, decides the quantum of good that would be produced
while in case of pure public goods, equilibrium condition MSC = MBA+ MBB
should decide that quantum. In the case of a private good, marginal benefit curves
are horizontally added while in the case of public good, they have to be vertically
added. Needless to say, market may not produce any such good. State is therefore
called for, for production of public goods.
We may further note that (1) public goods may be national or local or global
depending upon their area of outreach and (2) there also exist public bads (global,
national and local), like variety of pollutions, which have to be reduced or removed
by the State.
6.4.3 Externalities
Most activities related to production of goods, and some involving consumption
of goods, also produce bads, which impact others, called third parties– as they
are neither producer (first party) nor consumers (second party) who benefit from
production of the good. This phenomenon is known as externalities. Sugar or
textile or leather factories produce effluents which find way into local water
streams impacting those living nearby or depending on them for water. People
living in the vicinity suffer from the polluted streams in terms of health hazards
and incur expenditure on protection or medical treatment. Some of the production
activities do produce benefits which accrue to those who do not pay for those
benefits. A classic example is beekeeping. While collecting nectar bees pollinate
the trees in the orchard. Free software or basic education are treated in the same
category. Thus, we see externalities are negative or positive. The short point is
that social cost or social benefit diverge from their private counterpart. Third
party cost/benefits are also known as external cost/external benefit (EC/EB).
Generally, marginal equilibrium conditions are written as:
149
Development Strategies For Negative Externality: MSC = MC (MPEC) + MEC while MR=MSB
For Positive Externality: MSB = MR (MPEB) + MEB while MC=MSC
where Marginal Private Economic Cost (MPEC) represents marginal cost and
Marginal Private Economic Benefit (MPEB), marginal revenue. MEC and MEB
are Marginal External Cost borne and Marginal External Benefit enjoyed by a
third party. Since private parties tend to equate marginal (private) cost with
marginal (private) benefit, quantum produced may not be socially efficient. While
focusing on negative externalities, it was argued by Pigou to adopt ‘polluter
pays’ principle. The suggestion is externalities should be internalised. Since then,
many other suggestions have been offered. Allocation of tradable pollution permits
is one. Subsidisation sought by private parties to adopt technologies to help reduce
pollution is another. Coase had argued for assignment of property rights and
private negotiation, but negotiation need to be enforced by State. So, State
intervention is needed in such cases as well.
6.4.4 Monopoly Power

When there is only one producer, monopoly is obvious but monopoly power in
terms of fixing price is not that obvious. A monopolist dealing in a commodity
with an inelastic demand has higher monopoly power than one who is dealing in
a commodity with an elastic demand. Elasticity of the demand curve faced by a
firm depends on the number of firms in the market as also on substitutes (implying
cross elasticity). Oligopolistic and monopolistically competitive firms have thus
also some monopoly power. Thus, there is a degree of monopoly with firms not
in a fully competitive market. Since for a firm in a fully competitive market,
price is equal to marginal cost (P=MC), the divergence between the two, that is
excess of P over MC, will determine the monopoly power. Lerner devised an
index with formula as
Degree of Monopoly Power = (P– MC)/P,
which is zero when P=MC and 1 when marginal cost is zero. Since MC is equal
to MR in equilibrium and MR=P(1- (1/e) where e is the measure of elasticity, the
degree of monopoly can be shown to be equal to 1/e. Monopoly power is inverse
of the elasticity of demand.
There may be good reason to permit monopolies in certain cases. Like in natural
monopolies, it benefits the society to harness potential of a technology in terms
of economies of scale. However, if producers are few or if a producer controls a
good proportion of market, they enjoy market power, which manifests in the
form of goods offered at a higher prices. In both cases, State is invited to intervene
by regulating prices in addition to quantity and quality so that social outcomes
are optimum. Monopoly restricting laws have been enacted in most countries.
Competition Commissions are also instituted by the governments in many
countries, including in India, to oversee that market power or market dominance
is not misused to the disadvantage of consumers.
6.4.5 Information Asymmetries

One of the basic assumptions behind perfect competition is prevalence of full
and complete knowledge among buyers and sellers of goods, which is hardly
150
ever the case in reality. With growing economic complexities, though knowledge State and Market: Indian
Context
has increased, so has ignorance or lack of adequate information to make good
economic decisions. There is another aspect, information is often asymmetric
between the two parties that may be involved in pursuing a transaction. State
tries to reduce this asymmetry. There are acts and institutions setting quality
standards to take care of– safety in case food articles, quality in case of metals,
control of pollution, etc. Samuelson quotes the case of Eben Byers who was a
steel mogul in the US. He took drug Radithor sold as an aphrodisiac and cure-all
to relieve himself from his ailments. Byers died from its consumption. Later on,
it was discovered that Radithor was distilled water laced with radium. State has
a role in addressing such informational deficiencies.
6.4.6 Merit and Demerit Goods

There are often goods demanded by some people that may not be considered
desirable by the society. State as an important pillar of society is expected to
encourage consumption of merit goods. For example, children may not value
education and its demand may be low. Competitive market may produce very
little education to meet the needs of everyone. State encourages its consumption
by subsidising it or making it free of tuition fee. Inoculation, immunisation,
vaccination, sponsorship of cultural festivals may all fall in that category.
Similarly, there may be goods such as intoxicating drugs tobacco, cigarettes or
alcohol, the consumption of which a State may want to discourage. State could
discourage consumption through several ways including imposing heavy taxes,
restricting or banning the production. Some States in India have prohibited the
consumption of alcohol or tobacco. At the moment, Gujarat and Bihar have banned
production, imports and consumption of alcohol, while Haryana has lifted the
ban imposed earlier.

1) What are the reasons for State interventions in specific markets?
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
2) Explain the rationale of State intervention in the market on account of
externalities in production and consumption.
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
151
Development Strategies 3) What is meant by a demerit good? How does government intervene in the
market for demerit goods?
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6.5 STATE INTERVENTION IN MARKET FOR

EQUITY
Market, even if technically efficient, is no guarantee for ensuring equitable
outcomes in an economy. This is one reason why people could be against an
unhindered play of markets. It is often reported that in market economies the
share of better-off sections of the economy improved is proportionately at the
expense of the less fortunate. Relative share of the worse-off actually comes
down substantially even though, generally speaking, every section becomes better-
off in absolute terms. State often redistributes property, puts ceilings on specific
kind of property like land, discourages concentration of wealth and through
taxation redistributes incomes by supply public goods that are consumed more
by the less well off sections of the economy or by subsidising some of their
consumption. This helps in addressing the equity concerns in the economy.
This section discusses the market interventions whereby State influences

distribution of income among sections that contribute to production. It generally
implies intervention in factor markets. However, certain goods, mainly necessities,
may require the State to intervene in their specific order to ensure a more equitable
access/distribution of such goods perspective. In contrast to intervention for
efficiency, intervention for equity might increase deadweight loss of the society.
6.5.1 Goods Markets

Final Consumer Goods
State regulates prices for certain goods, including by the requirement to display
maximum retail price for most goods. Many drug prices are notified with ceiling.
In India, quite often, Essential Commodity Act is invoked to stabilise prices of
onions, potatoes, salt, etc. Some agricultural products attract minimum support
prices and procurement is made by some government agency, chiefly Food
Corporation of India, at harvest time. At the same time, buffer stock of certain
commodities, like wheat and rice, is maintained and it is released in market when
prices rise.
Intermediate Inputs and Capital Assets

Irrigation water, power and chemical fertilizers like urea are sold to farmers in
India at subsidised rates. In the similar vein, capital assets like milch cattle or
pump sets were once subsidised for below poverty line households, with
differential subsidy amounts– depending upon the social category the beneficiary
belonged to.
152
6.5.2 Factor Markets State and Market: Indian
Context
Labour Market
State often imposes Minimum Wage Act to improve wage levels in the labour
market. It is generally welcome though quite a few economists find it
counterproductive, not without logic, as it might increase unemployment by
discouraging use of labour intensive techniques in production. The law is
applicable for low level of workers– unskilled, semi-skilled and skilled. Beside
price intervention, there are several other interventions seeking job security and
income security. However, for most of India’s independent history, minimum
wages have not been fully enforced in most states. Of late, it has been argued
that a floor on wages has been created by the MGNREGA guaranteed wages in
many states, including in the backward states where minimum wages were not
enforced in reality.
Credit Market
State may use a policy of differential rates of interest for different sectors to
ensure adequate flow of credit, interest subvention for equity consideration and
even in the context of tax policy. In India, such lending is called priority sector
lending and sectors include agriculture, micro enterprises, higher education,
affordable housing, etc. where certain floors in terms of credit flows are also
enforced.
Entrepreneurship
State encourages private initiative if the promoters have good workable ideas by
extending tax benefits, concessional credit and even training. Recent examples
are Startup India and Standup India initiatives. Besides, there are interventions
at creating skill sets among youth through state intervention or attempting
vocational education.

1) How are interventions for equity different from those for promoting
efficiency?
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.......................................................................................................................
2) Explain how intervention in the labour market by regulating wages may be
counterproductive?
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153
Development Strategies 3) How is intervention for development of entrepreneurial skill helpful in
promoting equity considerations in a society?
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6.6 STATE INTERVENTION IN MARKET AND

INDIAN CONSTITUTION
Part IV of the Constitution of India embodying the Directive Principles of State
Policy, makes it amply clear that these principles, though not enforceable by any
court, are fundamental in the governance of the country and that the State is
obliged to apply these principles in enacting laws. These are said to be forerunners
of the recognition by the UN of the right to development as an inalienable human
right. Several Supreme Court judgements allow even tweaking of Fundamental
Rights for pursuing Directive Principles provided that tweaking does not touch
the basic features of the Constitution.
6.6.1 General Direction

Laws are the basic forms of intervention in the national life, ostensibly for the
betterment that a Welfare State should stand for. As Art 38 says, State shall strive
to promote the welfare of the people by promoting justice and reducing inequalities
as enshrined in the Preamble to the Constitution. Development involves many
aspects of life– social, economic, and political; and State may intervene in many
of them. Directly relevant for this unit, however, are two clauses of Art 39 that
direct the State to secure:
(b) that the ownership and control of the material resources of the community
are so distributed as best to sub-serve the common good; and
(c) that the operation of the economic system does not result in the concentration
of wealth and means of production to the common detriment.
From these two clauses, it appears that the State accepts the primacy of private
ownership of material resources (Clause 39 (b)) and of market price mechanism
(Clause 39 (c)) but asserts its interventionist power to correct distribution of
material resources as well as to influence price mechanism so as to secure best
welfare outcomes. There are several other Articles, all in Part IV, which can be
seen as construing market intervention: Right to work (Art 41), Provision of just
and human condition of work (Art 42), Living wage for workers (Art 43), and
Participation of workers in management of industries (Art 43A). Organisation of
agriculture and animal husbandry on modern and scientific lines (Art 48) and
Protection and improvement of environment and safeguarding of forests and
wild life (Art 48A) can also be accepted to fall in the same category.
154
6.6.2 Particular Areas State and Market: Indian
Context
One can well see that there are suggested areas of market intervention– whether
regulation or promotion, in the Seventh Schedule under Art 246 that delineates
subject-matter of laws to be made by Parliament and by the Legislatures of States.
List I (Union List) roughly enumerate them generally under entries 22 through
61, List II (State List) does so under entries 13 through 32, and List III (Concurrent
List) lists them under 20 through 38. Many other entries also have relevance for
market intervention while some of the entries noted above may not strictly be
related with market intervention. Generally, there is separation in intervention
between the two level of governments, Union and State. But there may be areas
where Union and States are dealing with separate aspects of the same area, like
mining or industry or communication. There may be an area where both the
governments are competent to legislate, like electricity, but if there is conflict
then the Parliamentary Act shall prevail over the Legislative ones. For rough
mapping of entries of three lists across sectors, see the Appendix.
It may be noted that market intervention here means influencing production,

consumption, and transportation as well as price, quantity, and quality. It should
be noted that we have avoided mentioning fiscal and monetary instruments as
they indirectly influence the market except those fiscal instruments which may
be called sin taxes.
State intervention can be broadly classified as establishment, development, and

welfare in economic matters. Development and welfare functions can be partly
effected through intervention in market functions– sometimes to promote
efficiency but at others to promote equity. However, any efficiency measure will
have implications for equity and vice versa.

1) Which article of the Constitution of India specifically suggest that State has
power to intervene in market?
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2) Where are listed areas of legislative intervention in the Constitution of India
for Union and the States?
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155
Development Strategies 3) What is the significance of the Concurrent List in the Constitution of India?
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6.7 STATE INTERVENTION AND STATE

INTERFERENCE
There is a subtle difference between intervention and interference. Intervention
is welcome move by a third party to resolve an issue between two parties, to
improve the outcome. Interference is a move that is often resisted, not welcome,
by the party which finds it disruptive, making outcome worse. Intervention is
considered a positive move while interference is a negative one. What if a move
by the State is welcome by one party and rued by the other?
State may not always be right. It is quite possible that State is unnecessarily
intervening without good reasons. It is also possible that a State intervention
may continue beyond the time it is needed. It is possible that it might become
excessive and found to become interference. It is also possible that government
has not well understood the situation and may have unnecessarily intervened.
Something considered good in 1950s might not be needed in 2000s, suggesting
that such moves have outlived their utility. There may be generational shift or
ideological shift about the role of State. Their continuance might have
counterproductive. Yet, a party may be gaining at the cost of another or the country
as a whole.
It may be pointed that 1500 Parliamentary Acts that were found archaic, were
repealed in recent years– quite a few of them were economic, impinging upon
market functioning.
In India, we often discuss the movement from LPQ (License, Permit and Quota)
raj to LPG (Liberalisation, Privatisation and Globalisation) regime. Reforms of
1950s are said to have been relevant during that period. Reforms of 1990s are
currently continuing in the same direction. For example, liberalisation means
removal of restrictions. So, restrictions are being removed gradually.
There may be several reasons for unnecessary intervention. One of them is rent-
seeking nature of politicians and bureaucracy. Another is regulatory capture by
industrial biggies whereby regulators get willingly captured by private interests.
Still another is pursuit of self-interest by regulators. Similarly, often electorate
demand, or political objectives of a ruling party may not be very rational or in
the larger interest of the country. There are several others. Scholars of late have
asserted that there exists what one can call government failure.
156
6.8 LET US SUM UP Context
State is perhaps the most important institution humans have evolved to sustain
social living and resolve conflicts that may arise in societal affairs. Market is
one of such societal affairs. It intervenes in market in general but also in specific
markets to influence level of production, level of prices, quality of products or
standards of service, etc. It devises several instruments as well as institutions
through which it intervenes. It is to be appreciated that the relationship between
State and Market has not been the same across space or time in terms of
dominance, competition and cooperation. Despite a tendency of assertion by
market, State is called for stabilisation in terms of crises; at other times, market
seeks its entry through partnership into the development areas that for a long
time were preserve of the State.
Neoclassical economists have over time enumerated the reasons as to when and
where State is called upon to intervene in market for specific goods under the
assumption that State is most efficacious institution to improve the outcomes.
Microeconomic interventions can be undertaken for both purposes– improving
efficiency and enhancing equity.
Efficiency interventions generally try to improve welfare (the sum total of

producer surplus and consumer surplus and, if relevant, government revenue)
and decrease deadweight loss which may be caused by imperfection in
competition or presence of externalities. If the operation of a factor market results
in further deterioration in the extant inequality, State may intervene to ameliorate
the worsening of inequality. There are other interventions directly hitting at
distribution but, in this unit, focus has been on those interventions which directly
relate to specific markets.
The unit has also broadly touched the direction for intervention in market generally
and specific markets through legislation as suggested in the Constitution of India
which divides the areas of legislation between the Union and the States. It also
hints that State may not always be right in intervening or choosing right kind of
institution and instrument.
6.9 TERM- END EXERCISES

1) What do you mean by market failure? What factors can cause a market
failure?
2) What do you mean by State or Government intervention? What does an
intervention try to impact?
3) Explain neoclassical arguments favouring State intervention in specific
market.
4) Show how a factor market may be efficient but not just.
5) Explain the significance of Article 39 (b) of the Constitution of India from
the angle of market failure and government intervention.
6.10 KEY WORDS

Demerit Goods : Goods that consumers may like but are actually harmful
though they do not appreciate it and therefore their 157
Development Strategies consumption is discouraged, are known as demerit
goods.
Externality : Uncompensated effect of an activity on a third party
who may neither be a producer nor a consumer of the
activity.
Intervention : An action intentionally carried out to sustain an activity
or resolve an issue between two parties engaged in an
activity.
Market : An arrangement, actual or virtual, facilitating voluntary
exchange between two parties.
Market Power : Ability of a firm (or a group of firms) to dictate prices
or quantity of goods and services i.e. keep prices above
or quantities below the level that would have prevailed
under competition.
Merit Goods : Goods that are seen as being useful to consumers, but
may not be appreciative and their consumption is
generally encouraged by society or government.
Ownership : A bundle of rights over a real, financial, or intellectual
property, which can be separated and held by different
parties.
Private Goods : Goods that are rival in consumption and consumers can
be excluded with ease are called private goods.
Public Goods : Goods that are non-rival in consumption and consumers
cannot be excluded altogether are public goods.
Regulation : A directive, law, or rule maintained by an authority to
control an activity or process.
State : A human institution of organised political community
or body politic.
6.11 REFERENCES
Books on Microeconomics, Public Finance, and Environmental Economics which
include relevant chapters, would be good enough for the Unit. www.britannia.com
and www.tutor2u.net could be websites among those which can be consulted.
Constitution of India contains reasons for intervention in market in Part IV and
Part XI– particularly Chapter I. For swings in the relative importance between
market and State and changing complexion of the relationship between the World
Development Reports of 1996 and 1997 would be an interesting read. However,
one can profitably read following books/articles for advanced understanding:
1) Francis M. Bator (1958). The Anatomy of Market Failure, Quarterly Journal

of Economics, Vol. 72, No.2. Available on internet.
2) Bernard Salonie (2000). Microeconomics of Market Failure, The MIT Press,

Cambridge, Massachusetts.
158
3) Gordon Tullock et al. (2002). Government Failure: A Primer in Public Choice, State and Market: Indian
Context
Cato Institute, Washington.
4) Clifford Winston (2006). Government Failure versus Market Failure:

Microeconomics Policy Research and Government Performance, AEI-
Brookings Joint Centre for Regulatory Studies, Washington.

PROGRESS EXERCISES
1) Government is only one component of State, other being People, Territory,
and Sovereignty.
2) State word is also used for the constituent units of a State as it has practically
all elements of State as defined in Political Science, the difference in some
contexts being that ‘sovereignty’ being replaced by ‘autonomy’ in their
designated spheres. States may be clubbed with Union Territories in certain
references in India.
3) Market may mean the whole economy or its size, generally measured in
terms of GVA. It may have broad types such as goods market, labour market,
etc. But then, it has microeconomic connotation of market for a particular
good.
4) Existence of private property or still better alienable property and laws of
inheritance.
1) Production, provision, promotion, protection, restriction (on price, quantum
or standards), regulation (on labour or environment), control and sharing
information.
2) Agency, association, authority, bureau, board, committee, commission,
corporation, council, foundation, institution, office, organisation, society or
trust.
3) Price, quantity, and standards.
1) Existence of public goods, externalities, incomplete information, market
power, merit/demerit goods.
2) Social cost is higher than private cost as part of the cost born by some third
party. Social benefit is higher than private benefit as some benefit accrues
to a third party.
3) Goods that are preferred by consumer but are discouraged for consumption
by others in consumer’s interest.
1) Efficiency mimics with equilibrium price and quantity in perfect competition.
In markets where it does not obtain equilibrium price is higher but equilibrium
159
Development Strategies quantity is lower. As a result, there is some deadweight loss. Efficiency
interventions try to reduce them. Equity intervention seek to disturb market
equilibrium as its outcomes are perceived to be injurious to certain interests—
say, labour.
2) Pegging wages at more than equilibrium level is likely to create surplus
labour as supply quantity increases while demand quantity decreases. It
might result in lower income to wage earners.
3) Enhancement of entrepreneurial skills is likely to improve entrepreneur’s
income.
1) Article 39(b).
2) Seventh Schedule of the Constitution under Article 246.
3) Both Parliament and State Legislature can legislate on the subject. Should
there be a contradiction, legislation by Parliament shall prevail.
1) Intervention is welcome while interference is resisted.
2) Rent-seeking, regulatory capture, pursuit of self-interest, and irrational
electoral demand.
160
APPENDIX 6.1 Context
An attempt to map subject areas across three lists of VII Schedule

Subject-matter Union List State List Concurrent List
Land and Property 18 6
Agriculture 14
Animal Husbandry 15, 16 17
Irrigation 17
Fisheries 57 21
Forests and Wild Life 17A, 17B
Mining 6, 53, 54, 55 23
Industries, Factories, etc. 7, 52, 58, 59 24, 27 18, 33, 36, 37
Industrial Disputes 61
Trade and Commerce 41, 42 26 33
Banking, Money Lending, etc. 45, 46 30
Insurance 47
Communication (Transport) 22, 23, 24, 25, 13 31, 32
26,27,28,29,30,
Electricity 38
Intellectual Property 48
Trading corporation 43, 44 32
Gas and Gas Works 25
Monopoly, Combinations, etc. 21
Trade Unions, Social Security 22, 23, 24
Price Control 34
Economic and Social Planning 20
161
UNIT 7 ECONOMIC REFORMS IN INDIA
Structure
7.0 Objectives
7.1 Introduction
7.2 Economic Reforms: Meaning and Nature
7.3 India’s Path to Economic Transformation
7.3.1 Planned Economic Development
7.3.2 Import Substitution in Industrialisation
7.3.3 License Permit Quota Raj
7.3.4 Public Sector Expansion and Nationalisation
7.3.5 Beginning of Economic Reforms
7.4 Onset of Current Economic Reforms
7.4.1 The Crisis
7.4.2 Assessment and the Response
7.4.3 Some Initial Steps Taken by the Government
7.5 Reforms for Macroeconomic Stabilisation
7.5.1 Fiscal Reforms
7.5.2 Monetary and Financial Reforms
7.5.3 Currency Exchange Reforms
7.6 Reforms for Microeconomic Structural Adjustment
7.6.1 Liberalisation of Business
7.6.2 Privatisation of Public Sector Units and Disinvestment
7.6.3 Globalisation of the Economy
7.7 Generations and Waves of Economic Reforms
7.8 Let Us Sum Up
7.9 Term-End Exercises
7.10 Key Words
7.11 References
7.0 OBJECTIVES
define economic reforms;
contrast efficiency-seeking reforms with equity-seeking reforms;
delineate the nature of neoliberal economic reforms;
narrate the crisis brewing in 1980s and precipitated by Gulf War in 1990;
shed light into the background necessitating current genre of reforms;
explain macroeconomic stabilisation and structural adjustment programmes;
and
make a distinction between the first generation and the second generation
reforms.
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Economic Reforms in India
7.1 INTRODUCTION
Every day, we in India keep hearing, or reading news about some or the other
economic reforms that have been brought in or would be brought in shortly.
They are either introduction of new interventions or withdrawal of old
interventions by the government in managing the economic affairs of the country–
particularly in the structure and operation of markets.
In the previous Unit, it was discussed as to why and how government intervenes
in the market and also why and how, at times, it chooses to withdraw certain
interventions. Introduction, modification, and withdrawal of government
interventions depend partly on ideology, partly on evolving situation– both internal
and external, and partly on the efficacy of the prevalent institutions to meet the
development objectives.
Interventions brought in by the government are said to be ‘reforms’ when they

are significant and, generally pro-active but they are short of being a revolution.
It seems significant institutional/instrumental changes have often been called
reforms and technological or social ones, revolutions. The latter are not necessarily
always prompted or promoted by government but they invariably have a
significant consequence for a society. Reforms too could be social– anti-sati or
anti-slavery; economic– agrarian and industrial; political– parliamentary and
electoral, etc. So could be revolutions– American or French Revolution on political
front and Industrial Revolution or Green Revolution on economic front. However,
reforms in this Unit will mean economic reforms and only those undertaken by
the government. They thus refer to reforms in economic policy and management
of the government.
In India, there were a set of reforms carried out after independence in several
institutional arrangements, the first being in the sphere of land relations. They
were duly referred to as reforms by policymakers and scholars though in legislative
parlance few of the Acts were named ‘reforms’ (Even introduction of expenditure
tax in mid-1950s was called a tax reform). Likewise, when in early 1990s steps
were taken to liberalise business, privatise government enterprises, and open the
economy for international trade and investment, they have been called reforms
by policymakers and scholars alike but not necessarily in legalese where the
word often used is regulation or management.
This unit proposes to explain the meaning and nature of economic reforms carried
out since independence and post 1991, and discuss the features and contours of
reforms carried out during these two different periods.
The unit is, however, intended to explain rather than assess the neoliberal reforms
in terms of the political economy, which may not be very charitable. Assessment
is invariably coloured by one’s ideological persuasion.
7.2 ECONOMIC REFORMS: MEANING AND

NATURE
Reform means improvement, amendment, correction, or rectification of an
intervention that has proved less than satisfactory in its performance or found to
be inadequate or inappropriate in terms of meeting its intended outcomes. They
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Development Strategies could be carried out in agriculture, industry, labour, and trade sectors; in banking,
insurance, and other financial sectors; and even education and health sectors.
There could also be fiscal reforms – tax and expenditure reforms; monetary
reforms– banking and financial; or currency reforms – exchange rate system and
convertibility reforms. Pan-economy reforms are often said to be macroeconomic
reforms – particularly when they address stabilisation issues, while sectoral
reforms are often said to be microeconomic reforms as they influence production
levels and prices of individual commodities. Yet, there may be such
macroeconomic policies which embed microeconomic dimensions – say
differential rates of interest for different sectors or differential charges for different
power or transport categories of users.
As the economic context changed in Europe after industrial revolution,
governments slowly but steadily moved towards compulsory education for
children or imposing restrictions on their employment in factories. As feudal
system gave way to capitalist order, demand for uniform adult suffrage emerged
and, after a lot of dilly-dallying, it was eventually granted. These were termed as
industrial reforms by scholars.
In India, we know of several social reforms for curbing many evil practices
during medieval period as well as during the British Raj. Several political reforms
were also undertaken in India after independence– the biggest being universal
uniform adult suffrage. Electoral reforms were given shape. Administrative
reforms and governance reforms have also been undertaken.
In much of the current Indian discourse, economic reforms have reference to
liberalisation of business, privatisation of public undertakings, and globalisation
of the economy which were ushered in 1991. If one carefully analyses the purposes
behind the reforms undertaken after independence but before 1991 and those
undertaken after 1991, one would discover that earlier set of reforms were
generally equity seeking while later set of reforms are efficiency promoting.
Proponents of equity seeking reforms argued that better distribution of income
and wealth will also improve growth via demand side while opponents thought
such moves would compromise growth as these would dent improvement in
savings. Majority of analysts in those days were proponents of equity seeking
reforms. Another way to differentiate the pre-1991 and post-1991 reforms could
be in terms of their scope. The latter were more widespread and coordinated,
unlike the attempts, even at promoting market efficiency in the pre-1991 period,
such as in 1980s. Pre-1991 reforms attempted to establish a socialistic pattern of
society where there was a pervasive regulatory control by the State. The public
sector was expected to reach the ‘commanding heights’ of the economy with
clearly demarcated priority sector industries reserved for this sector. Reversal of
emphasis on public sector from the commanding heights of the economy since
1991, was said to unleash the market forces. Present genre of reforms has variously
been said to be market-oriented, pro-market, market-friendly, pro-business and
pro-competition, as tilt towards market was seen to be promoting competition.
Some have considered it a State- retreat.
Welfare measures undertaken post-independence were considered liberal as
similar measures were undertaken by the Liberal Party in early 20th century when
it was in power in Britain. These were in contrast to those pursued by Conservative
Party. In addition, there were measures which put restrictions on operation of
private enterprises, which were said to be left-of-the centre and progressive (as
164
opposed to reactionary). Since, in the present dispensation, restrictions were to Economic Reforms in India
be liberalised, political thinking classified such reforms as neoliberal rather than
liberal as (political) liberalism is altogether different from (economic)
liberalisation.
Neoliberalism is said to be a phrase for resurgence of 19th century ideas of laissez

faire and free-market capitalism. Liberalism in contrast had several shades but
largely came to be associated with progressivism which suggested State to regulate
market activities from welfare angles and undertake welfare-oriented policies.

1) Define economic reforms.
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2) Differentiate between equity-seeking reforms and efficiency-seeking
reforms.
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3) Explain the meaning of neo-liberal reforms.
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7.3 INDIA’S PATH TO ECONOMIC

TRANSFORMATION
India’s journey began as a newly independent poor underdeveloped nation in
1947 – the year of its independence from the British rule. At that time, India was
one of the poorest nations in the world in terms of income, wealth and material
capacity. The country remained a virtually closed economy for nearly four decades
after its independence, following an inward-looking development strategy. The
first few plans focused on growth with strengthening of the manufacturing sector
emphasizing heavy industries to form the backbone of the economy. Other
principal areas of planning were agriculture and social development i.e. housing 165
Development Strategies and poverty alleviation. Some of the measures that shaped the development
process in general and the process of industrialisation, in particular, involved the
following:
7.3.1 Planned Economic Development

Post independence, the key goal was to achieve self-reliance in all possible
dimensions of economic activities of the nation. Accordingly, a diversified
industrial production base was meticulously planned out for India, ranging from
simple consumer items to sophisticated capital goods and heavy machinery. Since
1951, India has grown as a planned economy with the inception of First Five
Year Plan. India’s initial development strategy, aimed at a ‘socialistic pattern of
development’. There was lack of faith in the market and the role of the State was
considered the need of the hour. Trade received very little attention; while the
nation’s trade policy was characterised by pervasive import and exchange control.
The architecture of India’s post-colonial development policy framework was
inspired by the soviet model of development. Indeed, the foundations of India’s
2nd Five Year Plan model (Mahalanobis, 1953) closely resembled Feldman’s model
developed in the Soviet Union in the 1920s, which argued for a larger share of
investment in the capital goods sector that may slow down growth in the short-
run but would result in a much higher growth rate in the long run, accompanied
with higher levels of consumption. As India was about to launch the Second
Five Year Plan, Parliament passed in late 1954, a resolution establishing a
socialistic pattern of society in India (which meant no more than seeking to be a
welfare state within a capitalist order and a more egalitarian society). The focus
thus shifted to industrialisation where a five-fold strategy was invoked: promotion
of import-substitution led industrial development, tilt towards heavy industry in
the pattern of industrial development, commanding heights of the economy
(industrial space) for the public sector, regionally balanced industrial development,
and promotion of small scale industries in the sphere left for private sector with
a view to improving employment through reservation of items for production.
Industrial Policy Resolution of 1948 was revised to strengthen government control
in the Industrial Policy Resolution of 1956. Several private enterprises in
manufacturing, transport, and services were nationalised in 1950s– and some
more after 1955. The purpose was to check concentration of income and wealth
and, thus, economic power in a few hands. Freight equalisation policy was
implemented right from 1952 up to 1993, whereby transportation cost of
industrially ‘essential’ items such as coal, steel, cement, etc. would be the same
irrespective of distance. It is pointed out that eastern and central regions which
had natural competitive advantage lost, whereas western, northern and southern
regions gained.
7.3.2 Import Substitution in Industrialisation

National Planning Committee (1938) had suggested that India should focus on
mother industries so that it is self-reliant. Mother industries are those industries
that make other industries run successfully: power industry; industries for
production of metals, heavy chemicals, machinery, and tools; and communication
industries such as railways, telegraphs, telephones, and radios. Later, atomic
energy and space were added. Besides self-reliance, there was a view that India
did not have much to offer by way of exports in order to be able to import capital
and essential goods for industrialisation.
166
As there were limited foreign exchange (forex) reserves, in view of low export Economic Reforms in India
potential of the economy, quantitative restrictions in terms of import license were
imposed, in addition to high tariffs on intermediate and consumer goods, moderate
tariffs on capital goods, and ban on import of some items. The control was further
tightened in view of foreign exchange crisis during 1957-58 when the first loan
had to be negotiated with the IMF. A market developed for use of these licenses
and rent-seeking became rampart. Only in mid-1980s, some relaxations were
afforded.
7.3.3 License Permit Quota Raj

The Industries (Development and Regulation) Act of 1951 made it compulsory
for all new undertakings to seek license and for all existing undertakings to get
registered. It was amended in 1953, requiring an undertaking to seek permission
to produce new articles, to carry out substantial expansion, and to shift to a new
location. And the applications were to be examined for half a dozen factors by
the License Committee set up by the Act of 1951. Licensing was itself a
cumbersome process: application to be cleared by Directorate General of
Technical Development, then forwarded to the License Committee which would
issue a letter of intent, based on which applicant could move to seek permission
to import goods, enter into foreign collaboration, acquire land, issue new capital
beyond a small limit or seek loan from a financial institution. Thus, barriers to
entry were high.
This was all done with a view to prevent concentration of economic power, to
ensure balanced regional development, and to encourage small scale industry
(which were exempt from seeking license) and labour-intensive technology–
though reservation of items for exclusive production started only in 1967 with
47 items and the list expanded periodically till 1989.
However, when an assessment of working of licensing system was made, it came

to the fore that it did not serve the objective of the Industrial Policy Resolution
1956 as economic-power and regional concentration both increased. Industrial
houses were able to manipulate the system and licensing authorities were willing
to be manipulated for a consideration. Public sector financial institutions also
favoured large industrial houses. The lesson learnt was not the recognition of
government failure, but a thinking that led to further tightening of regulation for
industries to make them fall in line. So, Monopolies and Restrictive Trade
Practices Act was brought in 1970 providing for a Commission, which was set
up to pursue the said objectives.
7.3.4 Public Sector Expansion and Nationalisation

Before Independence, there were some departmentally run commercial ventures
such as postal service – including telegraph and telephone service, and railways
(largely nationalised by 1944), besides captive ventures of 18 ordnance factories
and central public works department. Provinces also had irrigation departments
and captive public works departments. However, immediately after Independence,
some public sector undertakings with ownership of the Government were started
and by the time Planning Commission was established their number was five.
These include Indian Telephone Industries, Damodar Valley Corporation, National
News Print Limited, Oriental Insurance Limited, and Indian Rare Earths Limited.
167
Development Strategies A new industrial policy resolution was passed in 1956 in the Parliament, following
the resolution on socialistic pattern of society. This policy resolution expanded
the sphere of public sector and contracted that of private sector. With a view to
creating and expanding infrastructure, generating financial resources,
redistributing income and wealth, balancing regional development, and
substituting imports by domestic production, quite a few industries were
nationalised for one or the other reason– some for strategic importance of the
industry, some in the interest of working class when industries were found falling
sick, and some to safe keep technology.
Government of India and state governments went on creating and expanding

public sector undertakings. By 1990, the number had reached 230 under
Government of India. Majority of these are under the aegis of Department of
Public Enterprises but there are about two dozen other departments which had at
least one public sector enterprise– as statutory corporation or government
company.
Reserve Bank of India, after its nationalisation in 1949, was entrusted with
regulation of banks through Banking Regulation Act of 1949.Imperial Bank was
nationalised as State Bank of India in 1955. Life Insurance of India was created
in 1956 by merging more than 200 insurance and provident fund companies—
including 16 foreign insurers. Most people recall nationalisation of 14 major
banks in 1969, of 6 major banks in 1980, and of 107 general insurance companies
(55 into companies and 52 insurance arms of companies) into General Insurance
Corporation of India in 1972 with four subsidiaries for operations.
With independence, Government had asserted that it could nationalise any private
or foreign venture. Starting with Air Corporation Act in 1953, Air India (an
initiative of TATA) was nationalised and half a dozen regional airlines were
merged and nationalised as Indian Airlines. One by one, electricity, steel, iron,
coal, and oil industries were nationalised.
7.3.5 Beginning of Economic Reforms

However, after nationalisation of 6 major banks in 1980 (following the
nationalisation of 14 banks in 1969), thinking started changing as it was felt that
not only the goal of equity was not being satisfactorily realised but that of growth
(efficiency) was also getting compromised. As a result of the oil price shock in
1979, there was pressure on forex reserve, the IMF was approached for a loan of
SDR 5.0 billion to be availed over four years 1981-1984 under Extended Fund
Facility with relatively lower rate of interest but it attracted conditionalities in
terms of liberalisation of imports–particularly to exporters, adjusting public
expenditure, tilting policies towards supporting private sector, etc. These
conditionalities were substantially complied with but there was a lot of domestic
criticism. As BoP situation improved, Government of India did not avail the last
installment of SDR 1.1 billion. Meanwhile, it may be noted that China, post-
Mao, had started moving towards market-oriented reforms around this time, or
few years earlier.
With Rajiv Gandhi in power in 1984, and a new generation of ideas, easing of
State control on industries in terms of expansion, import requirement, lowering
of taxes, were also attempted. Capacities created beyond authorised levels were
regularised with some limits. Under ‘broad-banding’ diversification into related
168
product did not now require a new license. Cement, steel, and fertilizers industries Economic Reforms in India
were decontrolled. Licensing for companies with investment below a certain
level, willing to locate away from urban centres was not necessary. Definition of
MRTP firms was relaxed. Imports for modernisation were liberalised. List of
open general license (OGL) for import of capital and intermediate items was
expanded, which permitted imports without tariff. Diversification was made
liberal. Security and Exchange Board of India (SEBI) was constituted in 1988
by an executive order, to oversee the security market as price rigging was rampant.
Communication infrastructure was laid out. Political reservations on Planning
Commission came to the fore: Rajiv Gandhi called it a pack of jokers. These
steps had to be halted as political support was lacking and bureaucracy was
recalcitrant. These steps were held as hesitant reforms. It was also the time, the
USSR adopted glasnost and perestroika and by the end of 1989, expediting the
breakdown of the iron-curtain that divided the West from the Soviet East
Noticing that growth rate had considerably slowed down in 1970s for several
reasons not the least of which was the bureaucratic over-zealousness in keeping
control over everything, certain measures were taken in mid-1980s to relax the
controls, particularly on imports. Such measures helped improve the growth
performance of the economy, however macroeconomic imbalances also gained
current.
While growth rate had improved in 1980s– thanks to relaxations on restrictions,

deficit financing on government side, and liberal imports and unrestrained
commercial borrowing generally made two macroeconomic parameters of fiscal
deficit and current account deficit, unsustainable.

1) State reasons for adoption of import substitution in industrialisation of the
country.
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2) Explain the meaning of license, permit and quota (LPQ) raj.
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3) State two major international developments that help change the development
thinking.
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169
7.4 ONSET OF CURRENT ECONOMIC REFORMS
7.4.1 The Crisis
Fiscal profligacy of 1980s resulted in high fiscal deficit, public debt and external
debt, thus creating internal and external imbalances. By 1990-91, gross combined
(Union and State) fiscal deficit had crossed 10 per cent of GDP, combined public
debt to 70 per cent of GDP, and external national debt ($83 billion) to 30 per cent
of GDP– partly because of gradual withdrawal of foreign concessional aid. Debt
service burden of the Union Government was more than 35 per cent of its revenue
receipts. But more than that, forex reserves were so low as to account for only
7.0 per cent of total debt. Short-term debt to forex reserves was 145 per cent,
making its debt-service ratio 35 per cent of exports. Current account deficit in
the Balance of Payments crossed 3.0 per cent of GDP, largely on account of a
gradual liberalisation of imports without the commensurate improvement in
exports. Inflation also accelerated to double digit level despite three consecutive
good monsoons and harvest.
Changes in the international context associated with the gulf war, triggered by
Iraq attacking Kuwait in mid-1990, put India into a serious crisis as its import
bill swelled and export receipts plummeted, and, thus, current account deficit on
balance of payment accentuated. In this scenario, NRIs started withdrawing their
deposits in foreign currency from banks. Short-term foreign capital also out-
flowed. As a consequence, forex reserves depleted down to $1.2 billion in January
1991 and further depleted to $0.6 billion by June 1991– just equivalent to about
three-weeks’ imports. There was thus a full-blown BoP crisis at hand.
India sought help from the International Monetary Fund (IMF) to tide over BoP
crisis by seeking an emergency loan of $2.2 billion. IMF gave a standby loan of
$0.72 billion in January 1991 to be utilised in three months’ time. For the first
time, the country came to the brink of default in servicing the debt. India had to
airlift some part of its gold stock (primarily the gold confiscated from smugglers)
out of its forex reserves to Bank of England and Union Bank of Switzerland as
collateral to secure loan on terms that were not too steep. This was the time when
India had a caretaker government headed by PM Chandrashekhar (March-June
1991) at the Centre. With its back against the wall, the country had no option but
to set into motion comprehensive economic reforms. It is often said that the
crisis of 1991 was predictable, given the buildup of macroeconomic imbalances
in 1980s, but the Gulf war precipitated it.
The loan contracted was too little. It was natural for the new Government which
came into power with PV Narasimha Rao as Prime Minister and Manmohan
Singh as Finance Minister to approach for a loan of $2.5 billion dollars from
IMF and another of $0.5 billion from the World Bank. IMF and the World Bank
were willing to rescue the Indian economy but sought compliance with
conditionalities, as is their wont, in terms of implementing reforms package
involving macroeconomic stabilisation policies and microeconomic (sectoral)
structural corrections. IMF gave loan of SDR1.656 billion (equivalent to $2.2
billion) under non-concessional stand-by arrangement with a window of 15
months at 7.1 per cent rate of interest. World Bank which normally gives project
specific loans, did come around to giving a loan of 0.25 billion for structural
adjustment. Though these loans were not concessional, yet they were cheaper
170
than commercial ones– which were not available easily as the country’s credit Economic Reforms in India
rating had dropped considerably.
Manmohan Singh and P.V. Narasimha Rao initiated the reforms in June 1991
with the presentation of the Union Budget. They found the conditionalities
attached to the loans taken from international financial institutions as prudent
pieces of advice but set up committees to suggest details for the path to reform
the economic management of the country. These were efficiency seeking reforms.
If there had to be a check on merger or acquisition of private firms, it was not to
check monopoly or restrictive trade practices but to promote economic efficiency.
If a public sector unit had to be sold (privatisation) or partly sold (divested), it
was for improving its economic performance. The sole purpose was to improve
efficiency in the economic system.
7.4.2 Assessment and the Response

Following two paragraphs of the budget speech of Manmohan Singh on 24 July
1991, sum up the direction that was to be taken over the subsequent three decades:
“In the macro-management of the economy, over the medium-term, it should be

our objective to progressively reduce the fiscal deficit of the Central Government,
to move towards a significant reduction of the revenue deficit, and to reduce the
current account deficit in the balance of payments. It is only such prudent
management that would enable us to curb the exponential growth in internal and
external debt and limit the burden on debt servicing, for the Government and the
country, to manageable levels. Indeed, we must make a conscious effort to reduce
the internal debt of the Government and the external debt of the nation, so that
we rely more and more on our own resources to finance the process of
development.”
“Macro-economic stabilisation and fiscal adjustment alone cannot suffice. They

must be supported by essential reforms in economic policy and economic
management, as an integral part of the adjustment process, reforms which would
help to eliminate waste and inefficiency and impart a new element of dynamism
to growth processes in our economy. The thrust of the reform process would be
to increase the efficiency and international competitiveness of industrial
production, to utilise for this purpose foreign investment and foreign technology
to a much greater degree than we have done in the past, to increase the productivity
of investment, to ensure that India’s financial sector is rapidly modernised, and
to improve the performance of the public sector, so that the key sectors of our
economy are enabled to attain an adequate technological and competitive edge
in a fast-changing global economy. I am confident that, after a successful
implementation of stabilisation measures and the essential structural and policy
reforms, our economy would return to a path of a high sustained growth with
reasonable price stability and greater social equity.”
7.4.3 Some Initial Steps Taken by the Government

Immediate response of the Central Government, within 10 days in power, was in
terms of devaluation of rupee. The custodian of the value of rupee RBI devalued
rupee, in quick succession on 1 July and 3 July 1991, by 9 per cent and 11 per
cent against currencies of major trading partners, viz., US Dollar, British Pound,
German Deutsch, and Japanese Yen (Chinese Yuan was not that important at that
171
Development Strategies stage). This was expected to make exports competitive. Commerce Ministry
withdrew export subsidy and thus saved some public expenditure, as well as
moved towards removing distortion in market prices. After an experiment with
dual exchange rate for a year, external value of rupee was allowed to be determined
by the market forces. In other words, rupee moved from fixed exchange regime
to floating exchange rate. This was most important macroeconomic stabilisation
measure on external front.
In the financial sector, RBI had freed banks to charge interest rates beyond floor
rate, depending upon the risk perception of the borrower. Budget speech of 1991
suggested formation of a high-level committee (Narasimham Committee) to look
into the structure, organisation, functions and procedures of financial institutions.
It was felt that administrative intervention on interest rate had outlived its utility.
It was pointed out that powers of Capital Controller of India (Government) would
be transferred to SEBI which would be empowered through appropriate
legislation. Likewise, Foreign Exchange Regulation Act (FERA, 1973) was set
to be liberalised for non-resident Indians to make investment in India.
Recognising that entry barriers were promoted by proliferation of licensing regime

and that it actually led to increase in the degree of market concentration, Finance
Minister announced the new Industrial Policy as a part of his Budget Speech on
24 July 1991 (and second part on small scale industries on 6 August, 1991)).
These committed the Government to take a series of initiatives in the five areas
of (a) Industrial Licensing, (b) Foreign Investment, (c) Foreign Technology
Agreements, (d) Public Sector Policy, and (e) MRTP Act. Highlighting that many
small and medium sized entrepreneurs were hampered by the restrictive licensing
regime, it was abolished, except for a set of industries in the categories of security
and strategic importance, hazardous chemicals, overriding environmental reasons
and items of elitist consumption. They were further liberalised. Items reserved
for small scale industries were left untouched in 1991 but gradually done away
with. List of industries reserved for public sector was pruned from 17 (in 1956)
to 8.
While freeing Indian industry from official control, it said, opportunities for
foreign investment should be exploited as it would bring in attendant advantages
of technology transfer, management techniques, marketing strategies and export
potential. Direct approval would be given up to 51 per cent. Likewise, Indian
industries would be allowed to negotiate the terms of technology with foreign
counterparts and this may induce Indian industry to undertake more research
and development activities.
Public sector units which have done very valuable work in early years of the
Indian economy, post-independence were now, in many cases, a burden on the
public resources. In particular, the sick mills which were taken over by the
Government continued to be sick. They were to be referred to the Board for
Industrial and Financial Reconstruction. While there was no reason for public
sector to supply consumer goods and services, it had expanded into these sectors.
Emphasis was for the public sector to operate in reserved or strategic areas or
where reasonable profitability was being maintained. Those public undertakings
that were performing well were to be given management autonomy. Competition
with private sector was to be encouraged. And in some cases, disinvestment of
equity share was to be carried out.
172
MRTP Act was to be so tweaked that industries need not seek any prior approval Economic Reforms in India
for expansion, merger, takeover, amalgamation, or diversification. MRTP
Commission could, suo moto or on complaint, check if any industrial
establishment was indulging in monopolistic, restrictive, or unfair trade practices
and take appropriate action.

1) What triggered the BoP crisis in 1991?
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2) Why did the Government negotiate non-concessional loans with IMF and
World Bank?
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3) What were some immediate steps taken by the Government to address the
BoP crisis?
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7.5 REFORMS FOR MACROECONOMIC

STABILISATION
It can broadly be said that the World Bank as a development bank lends over a
long-term horizon which generally helps a country with finances to carry out its
long-term projects, while International Monetary Fund help a country to tide
over short-term Balance of Payments difficulties. Both generally provide finance
in terms of certain foreign currencies constituting Special Drawing Rights
(SDR)presently – U.S. dollar, Euro, Chinese yuan, Japanese yen, and Pound
sterling. Both help a country in terms of desired foreign currency assets, which
can be used for meeting international liquidity obligations. As lenders, both the
institutions have been found to impose certain conditions – often referred to as
conditionalities if the borrowing country is not able to procure credit from
173
Development Strategies commercial channels on affordable terms. World Bank insists on reforms in
specific sectors– often called structural adjustments, and IMF insists on reforms
in macroeconomic policies – fiscal, monetary and exchange rate policies. But
both consult each other on each negotiation as IMF has started giving loans for
medium terms which goes beyond original mandate of tiding over BoP difficulties.
7.5.1 Fiscal Reforms

An important macroeconomic parameter of focus under the stabilisation
framework is fiscal deficit. In a world where fiscal deficit is considered inevitable
or unavoidable for spurring growth, containing unemployment, and carrying out
welfare measures (not, necessarily reducing inequality), containment of fiscal
deficit to a reasonable level is considered a desirable first step in stabilsing an
economy. Beyond that desired level of fiscal deficit, not only is the value of
domestic currency threatened and can get eroded internally but it can lose value
externally as well. This desired level of fiscal deficit would vary from country to
country and is usually contested by academicians and scholars, but policy-makers
may agree that a for a developing country like India it could be around 3 per cent
of GDP.
This fiscal balance has to be ensured by managing efficiently both revenue side
– basically taxation and expenditure side so that borrowing is not too high and
that debt servicing does not dominate revenue expenditure through rising interest
payment. Keeping this in mind, tax rates which went on increasing during 1950-
70, were moderated substantially – guided by the thinking underpinning the
Laffer’s curve hypothesis. Tax nets were widened while exemptions and
deductions were pruned; tax structure was reoriented in favour of direct taxes as
indirect taxes are seen to be price distortionary and regressive in nature; attempt
was made to change the basis of indirect taxes from gross sales proceeds to
value added; customs duties had to be brought down in keeping with the new
economic thinking as well as in compliance to WTO rules; attempts were made
to realise higher profits and dividends from public sector enterprises; efforts
were also made to recover cost from sale of services provided by government
(whether transport, power or irrigation); and improved fees were realised for
use/allocation of natural resources through better price discovery mechanism
(whether oil, gas, coal, minerals, or spectrum). There were political impediments
and success was limited as some of these steps were also undermined by scams.
Attempts were made to streamline public expenditure by abolishing/and improved

targeting of subsidies; downsising/rightsising staff, abolishing administered price
mechanism in some sectors like oil and gas; lowering interest payment by
improving management of public borrowings; and moderninsing and rationalising
defencespending.
Despite a slew of reforms, the two sides of the budget could not match well,
necessitating heavy borrowing and at times borrowing to service past borrowing.It
was finally considered prudent to bind the government by Fiscal Responsibility
and Budget Management (FRBM) Act, which could be passed in 2003. The Act
has put limits to fiscal deficit, revenue deficit, level of debt and contingency
liabilities and stipulated annual reduction in each of them. Though the Act had
provided an escape route to deal with situation that arose during 2008, yet the
Act itself had to be amended in 2012 and 2015. Timelines for meeting the FRBM
174 targets had to postponed repeatedly.
7.5.2 Monetary and Financial Reforms Economic Reforms in India
Fiscal policy relates to the Government and has to be formulated to provide

finances to the Government and implemented under the guidance of the Ministry
of Finance, by different administrative agencies. Monetary policy and financial
policy are formulated and implemented largely by the country’s Central Bank
which is the Reserve Bank of India (RBI) in the case of India. Fiscal and the
monetary policy are financially linked through Government’s debt instruments.
The Indian financial system of the pre-reform period essentially catered to the
needs of planned development in a mixed-economy framework where the
Government sector had a predominant role in the economic activity. It was felt
that there had been too much direction and regulation from government on
financial sector operations, in terms of investment, credit allocation, branch
expansion, and even internal autonomy of financial institutions. As a result, Public
Sector Banks and other financial institutions failed to use their commercial
judgement in ensuring efficiency in their operations with respect to rate of return,
profitability, maintaining capital adequacy, minimising non-performing assets,
or providing satisfactory customer service. They turned to become ‘service’
organisations whose financial problems would inevitably be taken care of by the
Government. This had to change.
Traditional monetary and financial instruments were largely inflexible– not

reflecting demand and supply forces of the market, and there was urgent need
for reforms. India embarked on a substantial liberalisation in the early nineties.
Two official reports, viz., the Report of the Committee on Financial System
(Reserve Bank of India, 1991) and the Report of the Committee on Banking
Sector Reforms (Government of India, 1998),both chaired by M Narasimham
established the foundation of the financial sector reforms post 1991. The
Narasimham Committee1991, devoted to enhancing operational freedom in the
commercial banking sector, recommended measures like reduction of pre-emption
of banks’ investible resources [via a reduction of cash reserve ratio (CRR) and
statutory liquidity ratio (SLR)1] and gradual elimination of the administered
interest rate structure. Narasimham Committee 1998 recommended further
measures for modernising the banking sector through better regulation and
supervision, and introduction of prudential norms. It also suggested a review of
the bank ownership structure in India.
Other elements of financial sector reforms in India include significant reduction

of fiscal dominance of monetary policy2 (including removal of automatic
monetisation of fiscal deficit); dismantling of the complex administered interest
rate structure to enable the process of price discovery; providing operational and
functional autonomy to public sector institutions; preparing the financial system
for increasing international competition; opening the external sector in a calibrated
1
gradual reduction of CRR from 15% to about 4%, and reduction in the SLR from nearly 40% to
21.5% between the early 1990s and the mid-2010s have made a huge improvement to the
availability of lendable resources to the banking sector.
2
Fiscal dominance of monetary policy has moderated in India as a result of a series of fiscal and
monetary policy reforms that include, (i) moving to a market-determined interest rate system by
introducing auctions of government debt, (ii) phasing out of the automatic monetisation of fiscal
deficits through the two Supplemental Agreements between the Government of India and the
Reserve Bank of India, and (iii) curbing the monetisation of debt by enacting the Fiscal
Responsibility and Budget Management (FRBM) Act, 2003 that prevented the Reserve Bank
from subscribing to primary issuances of government securities from April 1, 2006. 175
Development Strategies manner; and promoting financial stability in the wake of domestic and external
shocks. More recently a number of measures have been initiated towards
inculcating a credit culture through enforcement of creditors’ rights, and hastening
the process of credit recovery. All these measures were designed to create an
efficient, productive and profitable financial sector.
Information technology has played a key role in this transformative journey of

Indian banking. Technology has enabled more effective, lower cost and real-
time delivery of financial services, through the establishment of a modern
payments system. Also, Information Technology has allowed development of
several instruments of liquidity and finance. Following global trends, many
development finance institutions also assumed the role of, or converted into,
commercial banks and some commercial banks were allowed into insurance and
mutual funds business. In the recent years, quite a few non-banking financial
institutions – investment companies, loan companies, housing finance companies,
infrastructure companies – have emerged and are doing well and some
development financial institutions such as NABARD, SIBDI, EXIM, and NHB
are also performing well. While banks and non-banking financial institutions are
regulated by RBI, quite a few regulatory bodies have been instituted to look
after insurance business, pension funds, etc. Securities and Exchange Board of
India (SEBI) which regulates capital market/stock exchanges has been strengthen
and the Forward Markets Commission (FMC) which looks after commodity
futures has also been reformed.
7.5.3 Currency Exchange Reforms

Under import substitution strategy and paucity of earnings through exports,
allocation of foreign exchange by RBI was severely restricted through complex
import licensing system. Rupee remained linked to sterling pound for along time
till 1975 when it was pegged with a basket of currencies involving India’s
important trade partners. This remained in effect till 1993. In July 1991, in quick
succession through two devaluations, value of rupee was brought down by around
20 per cent. This was a part of understanding arrived at with the IMF for securing
standby loan. Since 1993, rupee is on floating exchange rate and its external
value (with respect to each currency) is determined by market forces though
RBI does intervene in foreign exchange market if it finds that there is excessive
volatility by buying or selling foreign currencies in spot as well as in futures
market. Thus, ours is a managed float system or managed flexible regime as are
most of other countries.
As India wanted to attract Foreign Direct Investment, it liberalised conversion

of rupee into foreign currencies but only on the current account. Once, India
built sufficient forex reserves in terms of foreign currency assets, it gradually
permitted its resident companies to convert rupee into foreign currencies to
facilitate overseas investment. This is in effect conversion of rupee on capital
account. Restriction on capital account convertibility however continue, we have
some distance to travel before full capital account converitabilty. This is perhaps
a lesson drawn from South-East Asian crisis in the late 1990s.
176
Check Your Progress 4 Economic Reforms in India
1) Why was Fiscal Responsibility and Budget Management Act legislated?

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2) Explain the role of Cash Reserve Ratio and Statutory Liquidity Ratio.
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3) State the status of convertibility of rupee.
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7.6 REFORMS FOR MICROECONOMIC

STRUCTURAL ADJUSTMENT
We all often hear that Economic Reforms mean liberalisation, privatisation, and
globalisation (LPG), which have replaced license, permit, and quota (LPQ) as
the latter had run out their course and had become stale, corrupt, and counter-
productive creating a high cost economy. This section intends to explain the
meaning of LPG and some steps that were taken up in India.
7.6.1 Liberalisation of Business

If restrictions are imposed by the Government on private economic activities,
the policy regime may be termed as a regulated and controlled business regime.
By contrast, if no restrictions are imposed, the policy regime may duly be called
one of laissez faire (a French phrase for let do or let go) – a euphemism for free
market. However, in a society with State, economy cannot be completely free of
restrictions (or incentives). When some of existing restrictions are removed or
relaxed, it can be said that economic activity is being liberalised: it is about
removing the burden of restrictions. In case restrictions are further tightened,
policy can be said to be restraining or constraining one. It is quite possible that in
some spheres, in any given period, policies are made more restrictive and other
areas, more liberal.
177
Development Strategies In industrial sector, India had managed to create considerable barriers to entry
and expansion: license for entry, license for expansion, license for diversification,
license for imports of capital goods and intermediate goods, permission for
amalgamation, control on issue of shares and debentures, restrictions on prices –
of goods, services and factors, compulsory procurement of a portion of output
by government, check on foreign investment, restrictions on foreign collaboration
for technology and even on location of industry. These were once the order of
the day in the pre-reform era of the 1970s and 1980s. There were certain
restrictions on factor markets – particularly, labour – for wages and social security.
These were said to be choking the initiative and enterprise of the people. However,
it was pointed out that big industrialists could still circumvent almost all the
restrictions with connivance or cooperation of rent-seeking bureaucracy for graft.
Those who could manipulate the system, developed vested interest in its
continuation; they could reap monopoly profits as the competition they faced
was very low or even non-existent. The end result was corruption and delays in
execution of projects. General assessment was that this hampered growth
(efficiency) without promoting social justice (equity).
Government of India, with Prime Minister Narasimha Rao and Finance Minister
Manmohan Singh, in July-August 1991 and in April 1993, spearheaded many
liberal provisions or undertook promotional measures in the areas of (a) licensing
business, (b) foreign investment, (c) foreign technology agreements, (d)
establishment, merger, amalgamation, takeover of companies or appointment of
directors in corporate governance, and (e) exiting from business. Licensing was
made mandatory only for 18 categories– later reduced to 15 by delisting
refrigerators, air-conditioners, and washing machines. Procedures for foreign
investment and foreign technology collaboration were sought to be promoted.
Labour laws were made a little easier for businessman.
One wonders whether the move was to de-bureaucratise the processes or promote
marketisation. It was perhaps both.
7.6.2 Privatisation of Public Sector Units and Disinvestment

By 1990, the world had changed; its zeitgeist had changed. The new mantra was
‘government’s business is not to do business’ or ‘government has no business to
do business’. This was in tune with the trend towards privatisation of public
assests. There was a time in 1940s when nationalisation was seen as way
forwarded in the capitalist world, particularly in the UK, even in the wake of the
World War II and then there came a time in 1980s when privatisation became the
mantra for reforming economic management.
It was felt during 1980s in India that government was unnecessarily directly
operating industries in many areas where it ought not to and that many of public
sector units were not performing up to the mark by parameters set for them. In
the former case, Government could simply withdraw by selling its stakes. This is
called disinvestment. In the latter case, undertakings were to be so reformed that
they perform well even if meant partnership with private sector in terms of
ownership and/or management. But the issue soon became who would buy a
loss-making unit? Buyers insisted that they would cut down staff which was
oversized or non-performing. Short of funds, Government decided to sell shares
of performing undertakings. Moreover, shares of such companies could be sold
178 at high premium. In certain cases, one Government company bought the shares
of another Government company and, thus, Government could get non-debt Economic Reforms in India
creating capital receipts.
Various models were tried for privatisation. There could be three simple models:
(i) ownership, (ii) organisational, and (iii) operational. Disinvestment or
divestment is related to ownership question. Sometimes, it is suggested that Indian
Railways may be corporatised. Here ownership does not change but organi–
ational structure changes; it is no more run by the department or a board under it.
Corporation works at arm’s length distance. Unit can be leased to private hands
for long period.
Disinvestment of ownership, if made for 50 per cent or more along with handing
over control and management is called strategic disinvestment. If dilution is for
less than 50 per cent, which it has to be in case of undertakings in (strategic)
areas reserved for public sector, it is called non-strategic. Government sold some
of its hotels and some of the companies like BALCO completely. Government
keeps selling part of its shares through several methods. To begin with it sold
shares to other public sector financial companies like LIC and GIC. There have
been around 200 successful attempts.
There is another experiment called public-private partnership which was

attempted particularly in building up the momentum on development of
infrastructure projects.
7.6.3 Globalisation of the Economy

The term globalisation has several meanings, varying from exposure to
competition with the world leaders in a particular product market to free trade in
goods, services and factors. Globalisation of an economy with world economy
could be thought in terms of economic relations but they ought to be in terms of
interface of markets rather than between governments and in terms of bilateral
(or multilateral) flows rather than unilateral flows like aid. But if Government of
one country bans imports, puts quota restrictions or creates a high tariff wall by
imposing 300 per cent duty, how could producers in a country sell even if there
were buyers in another country. There could be rationale behind such restrictions:
protection of domestic industry from competition, insufficiency of forex
availability due to weak export earnings, etc. However, it is argued that such
measures protects inefficiencies of domestic producers and harms the consumers.
Removal of such restrictions could induce domestic producers to be either
competitive or switch to other products. In other words, open the economy for
trade and investment creating the scope for consumers to benefit with better
quality and invariably cheaper products.
We know that multinational and transnational corporations have plants in several

countries. They produce goods and services in the host countries and sell in the
domestic markets of the host country, instead of exporting from home country,
as it saves them transportation cost. This requires movement of capital across
borders. Thus, globalisation of an economy would mean:
a) Reduction in tariff barriers with a view to allowing freer flow of goods to
and from the country;
b) Freer flow of foreign capital in terms of investment – both direct and portfolio
– by ensuring conducive atmosphere and easy approval of projects;
179
Development Strategies c) Freer flow of technology through purchase or lease of IPRs; and
d) Freer movement of labour and manpower.
When India started liberalising its economy, WTO was under negotiation in
Uruguay Round. It became operational in 1995 and sought freer trade through
unrestricted competition by removal of non-tariff barriers and substantial reduction
in tariff barriers as also removal or reduction of subsidies. WTO extended the
areas traditionally covered by GATT (General Agreement on Trade and Tariff)
by including GATS (General Agreement on Services) and TRIPS (Trade Related
Intellectual Property Rights), and TRIMS (Trade Related Investment Measures).
Thus, goods, services, technology, and capital were covered in some way.
Since Doha Round of WTO could not be satisfactorily concluded, countries have
simultaneously gone for forming Free Trade Areas, Comprehensive Economic
Cooperation/Partnership, Customs Union, etc. European Union is the chief
example, though not related with failure of WTO. India has negotiated quite a
few, in fact more than two dozen, regional or bilateral partnerships.

1) Distinguish liberalisation from laissez faire.
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2) Explain the meaning of disinvestment in a public sector enterprise.
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3) Delineate the elements of globalisation of an economy.
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7.7 GENERATIONS AND WAVES OF ECONOMIC

REFORMS
Reforms are often said to be a continuing process but scholars and policymakers
have a tendency to categorise reforms into certain categories– calling them as
180
levels, generations, waves, or, following digital style, versions. It is also suggested Economic Reforms in India
that while neoliberal reforms have a universal constitution, different nations may
have different pace and sequence. IMF scholars suggest that they may not exactly
fall in neat time sequence. They also suggest that reforms may be guided by two
perspectives: (i) global and (ii) national. We shall adhere to national perspective.
While following neoliberal direction, different nations will have some uniqueness
of their own in terms of pace and sequencing as their economic conditions differ.
Politics and bureaucracy will determine the pace and sequencing. For example,
such reforms were halted when India had unstable governments with limited
terms in the late 1980s and the late 1990s. Reforms may have suffered, rather
reversed, during the East Asian Currency Crisis or the Great Recession of 2008-
09 and there was call for more open global financial architecture.
At the end of last century, it was assessed that reforms that were easy to implement
in terms of resistance of bureaucracy or politicians, were carried out in the initial
phase. First, they were to be carried out in terms of conditionalities imposed by
loan sought from IMF and WB. Second, they could be carried out by executive
actions, not seeking political support, as recommended by the committees set up
for the purposes. Devaluation of rupee, ease of restrictions for establishing an
enterprise and expansion of capacity, easing import restrictions, de-reservation
of items for small scale industries, diluting government shares in public sector
undertakings, etc. did not require legislative interventions. They have been called
first generation reforms and the period was identified as 1991-1999. In terms of
digital jargon, they have been termed as Reforms 1.0 under Prime Minister PV
Narasimha Rao and Finance Minister Manmohan Singh during 1991-96. Some
reforms in the subsequent period were in the nature of deepening of measures
previously taken so that reversing them was not easy anymore.
In order to appreciate the distinction between generations of reforms, one should

remember the difference between an Act and the Rules under it. Practically, every
Act passed by a Legislature has a clause “Power to Make Rules” by the Executive.
Rules generally describe the procedure, forms, schedule, direction, fees, fines,
etc. but can include regulations, orders, bylaws, etc. Executive makes them and
is obliged to submit to the Legislature for scrutiny within a limited period, which
in practice is scant. Changing rules is far easier than changing Act. Second
generation reforms are said to be those that require legislative sanctions through
enactment or amendment. There are others who think that the second generation
reforms refer to consolidation of first generation reforms plus reforms related to
legal, regulatory, and political institutions. During 1999-2004, for example, many
Acts were passed under NDA government, which had bearing on Economic
Reforms. Some of them are: Repeal of Urban Land Ceiling Act, Prevention of
Money Laundering Act, Fiscal responsibility and Budget Management Act,
Central Vigilance Commission Act, and Competition Act. In compliance, several
regulatory authorities were instituted. Subsequently, many Reform Acts were
passed by UPA government: Factory Regulation Act, Limited Liability Partnership
Act, Replacement of Companies Act of 1956 by Companies Act of 2013, etc. It
does not mean that no legislative attempts were made in 1991-96. For example,
SEBI was given statutory status in 1992.
Some scholars and policymakers, deliberating on 25 years of Economic Reforms

in 2016, recommended an agenda for Economic Reforms 2.0. Others have referred
181
Development Strategies to this agenda forpost-2014 reforms as Reforms 3.0 or even Third Wave of
Reforms. What does it mean? Some say it is about reforms in governance,
including judiciary. Some say it is formalisation of the economy, which means,
thanks to ILO, formalisation of informal enterprises and informal jobs. Others
have included in this agenda steps for extension of taxation nets/base, digital
modes of payments, etc. Still others like to include the formalisation of shadow
economy.
Many reforms were carried out since 2014, Goods and Service Tax being the
major one. Monetary Policy Committee was instituting by amending RBI Act in
Finance Act of 2016 and is a major step in monetary management where three
members are nominated by Government of India.
Though there is no agreement on clearly marking of generations of neoliberal

reforms yet there is some convergence. Some would include social security
measures and some would include the local government reforms, which have
little to do with neoliberal strand. Analytical clarity is lacking in the area. Yet,
roughly speaking, first, second and third generation reforms can be associated
with executive, legislative, and governance actions.

1) Distinguish between first generation reforms and second generation reforms.
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2) Explain the meaning of formalisation of economy.
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7.8 LET US SUM UP

Indian economy is said to have embarked upon reforms in 1991 though it is
acknowledged that a few steps towards present genre of reforms were taken in
1980s– in the wake of conditionalities agreed for a whopping SDR 5.0 billion of
loan from IMF in the first half of 1980s. It must be noted that economic reforms
carried out in 1950s were quite different in content, orientation and objectives
than those which had to be carried out since 1991. There are several ways of
distinguishing them. In this unit, they have been distinguished as equity-seeking
reforms and efficiency-seeking reforms. Reforms in the post-1991 context are
recognised as neoliberal in political terms and market-oriented in economic terms.
182
A background of policies pursued during 1950-80 is discussed in a way that they Economic Reforms in India
present a contrast to the direction taken up thereafter. Our colonial past, huge
economic disparities, ideological thinking of the times, nationalisation of
industries in the West and success of development planning in the USSR had
largely guided our course of economic policy in those days.
Despite improvement in growth performance in the decade of 1980s, the

macroeconomic fundamentals were mismanaged and Gulf War of 1990
precipitated the economic crisis at home. By now, mandate of IMF had changed
in view of breaking-up of Bretton Woods system of fixed exchange rate and it
was seeking more fundamental reforms than just devaluation of currency to correct
persistent BoP deficit. IMF-World Bank combine was clear about the direction
of change in domestic policies. The domestic economic thinking was also slowly
converging towards the same.
Some immediate steps were taken like devaluation of rupee much before IMF
loan was agreed upon or enunciation of new industrial policy. Some Committees
were immediately set up to suggest course of reforms to be taken up in due
course. But Indian economy chose its own pace and sequencing, being careful
that reforms have ‘human face’.
Trends in macroeconomic stabilisation policies are illustrated under captions of

fiscal reforms, monetary and financial reforms, and currency exchange reforms
while those of microeconomic structural adjustments are discussed under
liberalisation of business, privatisation of public sector units and disinvestment,
and globalisation of the economy.
A categorisation of reforms in terms of their content and objectives has been

provided in terms of identifying different generations or waves of neoliberal
economic reforms.
7.9 TERM- END EXERCISE

1) Discuss the nature and features of neoliberal reforms.
2) Differentiate between intervention of restriction and that of liberalisation.
3) What do you mean by disinvestment? Why should ownership of a public
sector undertaking be diversified?
4) Delineate characteristics of macroeconomic stabilisation reforms.
5) Approach to define formalisation of an economy.
7.10 KEY WORDS

Disinvestment : Selling government equity in a public
enterprise to a private or public enterprise
whereby sale proceeds are appropriated by
the Government as non-debt creating capital
receipt.
Economic Reforms : Correcting mismatch between instruments of
intervention and objectives in economic
affairs of a country by the government.
183
Development Strategies Financial Reforms : Improving the nature of interventions in
financial markets comprising banks and non-
bank financial institutions as well as stock
market so as to meet the desired level and
composition of savings and investment. It
may involve regulatory framework.
Fiscal Reforms : Correcting interventions in tax- and non-tax
instruments, expenditure pattern, and debt
mix in a way that they meet the fiscal
objectives of the government.
Globalisation : Opening economy for trade and investment
by relaxing restrictions of movement of
goods, services, capital and intellectual
property.
Liberalisation : Relaxing the restrictions imposed on carrying
out business operations.
Nationalisation : Acquisition of a private enterprise, in part
or full, by a government.
Privatisation : Sharing ownership (or management) of an
existing public sector enterprise with private
parties or completely selling public assests.
Stabilisation Programmes : Interventions that improve stabilisation
parameters of fiscal balance, balance of
payment, price inflation, and unemployment.
Structural Adjustment : Interventions that lead to reduce market
Programmes distortions—basically, price distortions.
7.11 REFERENCES
There are several sources related to this topic– some explaining, some supporting,
some opposing, and some critiquing economic reforms in general or particular
reforms or in relation to Indian economy. Any good book on Indian economy
would provide the facts. The World Bank and IMF websites would also be good
sources to help one understand the direction of reforms that have been suggested,
if not imposed, by the duo. Yet, one would greatly benefit from
1) Bhaduri, Amit and Deepak Nayyar, (1996). The Intelligent Person’s Guide
to Liberalisation, New Delhi: Penguin.
2) McCartney, Matthew, (2016). Political Economy, Growth and Liberalisation
in India 1991-2008, Routledge.
3) Mohan, Rakesh (edited), (2017). India Transformed: 25 Years of Economic
Reforms, Penguin Random House.
Some websites such as rbi.org.in and indiareforms.csis.org and several entries
under Wikipedia could be consulted for developments in areas related with
economic reforms.
184
PROGRESS EXERCICES
1) Correction in instruments and institutions of government intervention to
meet the objectives in better terms.
2) Reforms that primarily seek redistribution of income and wealth, and possibly
consumption in favour of the disadvantaged sections of the society are equity-
seeking ones while those that focus on improving growth performance
through efficient use of resources are efficiency-seeking ones.
3) Neoliberal reforms are those reforms which attempt to make market work
with less restrictions and withdrawal of State from activities which market
could perform. Since political liberalism got historically associated with
‘progressivism’ which advocated restrictions on market and increased role
of State, policy of relaxation of restrictions on market functioning was
considered to be neoliberal.
1) Dominant view of the leaders of Independence was that Indians do deserve
to have all comforts of the Western world. Since our limited export potential
could not allow to import unrestricted amount of goods and gadgets, we
decided on an industrialisation strategy which favoured produced substitutes
of imported goods in home.
2) For a pretty long time, one needed a lot of licenses or permits to start and
run an industrial enterprise. For purchase of scarce material, say steel or
cement or sugar, one needed to have a permit. If one needed imported material
needing foreign exchange, in addition to license or permit, one was assigned
a quota. The regime was popularly called license, permit and quota raj in
contrast to liberalisation, privatisation and globalisation one.
3) One was market-oriented Economic Reforms which were initiated in
Communist China in 1978 under the leadership of Deng Xiaoping after the
death of Mao Zedong in 1976. The other was enunciation of Glasnost and
Perestroika in the erstwhile USSR under the leadership of Mikhail
Gorbachev.
1) Invasion and occupation of Kuwait by Iraq in August 1990 and Iraq’s refusal
to vacate it led a wide scale War against it under the leadership of the US
army in which 35 nations had participated. It swelled import bill and slumped
exports, plummeting forex reserves.
2) As India’s creditworthiness had come down, external commercial borrowings
became difficult. Second, non-concessional loans from international agencies
are still cheaper. Internally, also, there was a feeling that reforms are called
for.
3) Government of India devalued rupee against foreign currencies, drastically
modified the industrial policies, and made several taxation changes, and
also set up several committees to make recommendations to the Government. 185
Development Strategies Check Your Progress 4
1) Despite introduction of several reforms, fiscal parameters such as revenue
deficit and fiscal deficit were not reaching the desired levels whether at
Union or State level. The Act was a kind of imposition of self-discipline.
2) Cash reserve ratio (CRR) keeps banks fairly liquid while statutory liquidity
ratio (SLR) directs credit towards government by purchase of government
bonds. Cash reserves with the Central Bank, do not normally earn interest
to the bank while government bonds do. However, CRR checks the credit
creating activity and SLR crowds out finance for private sector.
3) As of now, rupee is convertible into foreign currencies on the basis of market
forces. However, it is not normally convertible on capital account.
1) Liberalisation means relaxation in restrictions while laissez faire means
absence of restrictions.
2) Divestment or dilution of government ownership in a public sector enterprise.
Proceeds accrue to government as non-debt creating capital receipt.
3) When residents (including companies) of an economy are free to produce
anywhere or consume anywhere or products of anywhere, an economy is
said to be globalised. It amounts to freedom to trade and freedom to
investment; in practical terms, it means lessening of restrictions on imports/
exports and investment. Movement of labour is not articulated at the same
level.
1) First generation reforms are usually reckoned with those that can easily
accomplished through executive orders, with minimal legislative requirement
while seconds generation reforms need political sanction through legislation.
2) Bringing informal segments of an economy, including jobs, into formal
contact with the government through any channel.
186
UNIT 8 MAJOR DEVELOPMENTS IN POST
ECONOMIC REFORM PERIOD
Structure
8.0 Objectives
8.1 Intoduction
8.2 Privatisation and Restructuring of Public Sector
8.3 Difference between Disinvestment Privatisation
8.3.1 Forms of Privationsation
8.4 Need for Privatisation
8.5 Disinvestment in India
8.6 Problems Related to Disinvestment Process/Modes
8.7 Conditions Required for Success of Privatisation Policy
8.8 Public Private Partnership (PPP)
8.9 PPP Models in India
8.9.1 Government Incentives for PPPs
8.10 Challenges of PPP
8.11 Insolvency and Bankruptcy Code (IBC)
8.12 Concept and Importance of IBC
8.12.1 Objectives of IBC
8.12.2 The Insolvency and Bankruptcy Code Ecosystem
8.12.3 Salient Features of IBC
8.12.4 Working of IBC
8.13 Let Us Sum Up
8.15 Key Words
8.16 References
8.0 OBJECTIVES
Having gone through this unit, you will be able to:
explain the concept of privatisation;
distinguish between disinvestment and privatisation;
analyse the hurdles in the way of restructuring of public sector undertakings;
highlight the pros and cons of public private partnership;
narrate the suitability of public private partnership;
discuss the need for insolvency and bankruptcy code (IBC); and
point out the problems and performances of IBC.
187
8.1 INTRODUCTION
The economic systems world over have been deregulated and controls that existed
in the past have been relaxed in great measure. At the same time, governments
have been attempting to open more economic activity to private players– both
domestic as well as foreign. Liberalisation, Privatisation and Globalisation (LPG)
forms part of a wider reform process, as discussed in the previous unit. The
narrative of “Rising India” over the past quarter century describes India’s
economic rise and, as a consequence of that rise, India’s globalisation and
integration with rest of the world. Further, there is a growing recognition that
India was liberating itself from the historical past.
The turn of the century was when a new narrative about independent India began
to take root internationally. India had not only come out of a serious economic
crisis in 1991-92, but had landed on its feet. Trade liberalisation, industrial
delicensing and decontrol and fiscal stabilisation contributed to an increase in
the share of foreign trade and manufacturing output in national income,
contributing also to improved prospects for growth. Investors’ confidence in the
economy got a boost, resulting in a build-up of its growth potential. New firms
began to come up and so did new industries. However, the slowing down of the
economy in the second decade of this millennium be it due to cyclical or structural
factors, has raised questions about India’s growth potential and the government’s
management of the economy. A new narrative can only be built on the foundations
of improved economic performance. A return to the earlier growth path is
predicated upon altering recent perceptions about India’s economic prospects
and policies, the political choices made and geopolitical options explored.
The most contentious of all economic reform measures since 1991, is
disinvestment. Disinvestment and privatisation have been two policies common
to all Central Governments since 1991. The economic reforms initiated in the
country provide the policy environment towards public private partnership (PPP)
in infrastructure development. Insolvency is a complex subject. Bankruptcy laws
accept that business ventures can fail and allow entrepreneurs to get a fresh start.
The passage of the Insolvency and Bankruptcy Code in May 2016 was a key
reform which is set to alter the relationship between debtors and creditors. Given
this backdrop and the more general narrative on India’s economic reforms since
1991 discussed earlier, this unit will discuss various facets of three ongoing
debates having repercussion on the performance of Indian economy and these
are:
i) Privatisation and restructuring of public sector,
ii) Public private partnership, and
iii) Insolvency and bankruptcy code (IBC).
8.2 PRIVATISATION AND RESTRUCTURING OF

PUBLIC SECTOR
Privatisation describes a direction of change or a fundamental reordering of claims
in a society. Its meaning depends on the point of departure– the public-private
balance previously forged in a particular domain. The term ‘privatisation’ connotes
a wide range of ideas. In its narrow sense it is the process of transferring ownership
188 of a business, enterprise, agency, public service or public property from the public
sector (i.e., government) to the private sector. In the wider sense it means Major Developments in Post
Economic Reform Period
government outsourcing of services or functions to private firms. According to
V.V. Ramanadham (1989) privatisation is a term that is employed to convey a
variety of ideas. The idea that it most prominently suggests is that of
‘denationalisation’ (in the sense of transferring the ownership of a public enterprise
to private hands).
Another idea in vogue is ‘liberalisation and deregulation’ unleashing forces of
competition1. The concept of privatisation is, in fact, to be understood, not merely
in the structural sense of who owns an enterprise, but in the substantive sense of
how far the operations of an enterprise are brought within the discipline of market
forces.
8.3 DIFFERENCE BETWEEN DISINVESTMENT

AND PRIVATISATION
Though privatisation and disinvestment are terms that are used interchangeably,
there is a difference between them with regard to the ownership. Disinvestment
may or may not be an outcome of privatisation. When it comes to defining the
term, privatisation involves transforming the ownership of a public sector business
to the private sector known as a “strategic buyer”. In privatisation, full ownership
is transferred to the strategic partner. In a broader sense, privatisation refers to
transfer of any government function to the private sector including governmental
functions like revenue collection and law enforcement.
In disinvestment, the same transformation process happens while retaining 26
per cent or in some cases 51 per cent of share right (i.e. the voting power) with
the public sector organisation. Here, the ownership is not transferred to strategic
buyer. Divestment is said as the opposite of Investment. Investment means
acquisition of certain assets; divestment means the release of assets. A business
may be that a particular arm of it is not compatible with its core business and
hence may decide to shelve or divest this business. Divestment may be done for
various economic or social reasons.
8.3.1 Forms of Privatisation
Various forms of privatisation vary in the extent to which they move ownership,
finance, and accountability out of the public sector. The spectrum of alternatives
runs from total privatisation (as in government disengagement from some policy
domain) to partial privatisation (as in contracting-out or vouchers). Thus,
privatisation may include policies anywhere along this spectrum; however, the
implications of privatisation vary with its degree. According to Ramanadhan
(1989) privatisation cover three sets of approaches like ownership, organisational,
and operational measures. It is important to remember that all these measures
more often are equated with transfer of ownership and transfer of managerial
and operational control to private hands.
1
Competition plays a key role in ensuring productive, efficient, innovative and responsive markets.
It ensures availability of ‘goods’ and ‘services’ of acceptable quality at affordable price to the
consumers. Competition law, also referred to as anti-trust law, aims at promoting or maintaining
market competition by regulating anti-competitive conduct. The first Indian competition law
was the Monopolies and Restrictive Trade Practices (MRTP) Act, enacted in 1969 to encourage
fair play and fair deal in the market besides promoting healthy competition. In line with the
international trend and to cope with changing realities introduced by the reforms of 1990s, India
reviewed the MRTP Act, 1969, and enacted the Competition Act, 2002. 189
8.4 NEED FOR PRIVATISATION
The industrial policy of July 1991 is considered as a precursor of economic reforms
which brought a change in the approach towards Public Sector Undertakings
(PSUs). In the affairs of the public sector, it has been a game of politics throughout,
and still is, despite the talk of structural adjustments and economic reforms.
Some of the important factors leading to the need for privatisation are as under:
i) PSUs in India have no autonomy. As a result, a culture has developed that

their major clientele are not the customers who pay for their services, but
the ministers and officials of their controlling ministries.
ii) PSUs have many objectives imposed on them, some of which affect their
efficiency and profitability. In fact, PSUs suffer from multiple principals
and multiple objectives. As a rule, interventions through PSUs are both
inefficient and costly. India needs privatisation to improve efficiency and to
liquidate recurring liabilities for the government.
iii) Ownership should not matter to performance. That it does in India is a

reflection on the poor understanding of business by the bureaucracy. It also
indicates their lack of accountability. Poor performance only impacts on
government budgets, not on individual officials.
iv) It is important to note that there are limitations being government as owner.
Rao (1998) has emphasised that “the enterprise comes under a Ministry of
Government, and is subject to scrutiny by Parliament. The Government of
the party in power exercises ownership through the Minister while the
permanent civil service translates the will of the Government through the
management of the enterprises. But the Minister and civil servant are
temporary occupants of the owner’s chairs because of frequent changes in
their portfolios. There are controls exercised on the enterprise at all levels.”
v) “Public sector managers, who perform better in the liberated circumstances

of private sector enterprises, have been known to complain that they are
crippled by various regulations in a public sector entity. Unless a radical
transformation is made to liberate the public sector manager from multiple
scrutiny by organs of investigation and vigilance, a level playing field cannot
be established between the public sector and the private sector”
(Venkitaramanan, 2005).
Privatisation per se does not lead to efficiency. Decontrol is probably a more

important principle than privatisation; and many of the supposed positive attributes
of privatisation can be imparted to public enterprises. In India, wholesale transfer
of assets to private sector both on grounds of efficiency and equity is not easily
acceptable. On the other hand, organisational efficiency requires a different
approach. The framework of principal-agent relationship in private ownership
has an advantage over public ownership. In the sense that both the principal and
the agent have stakes in the efficient functioning of the enterprise and there is
unanimity on the objective function to be maximised.
190
Check You Progress 1 Major Developments in Post
1) Provide wider meaning of privatisation.
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2) Distinguish between privatisation and disinvestment.
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3) What are the different forms of privatisation?
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4) Point out the need for privatisation in India.
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8.5 DISINVESTMENT IN INDIA

Disinvestment in public enterprises was proposed as a policy option in the
Industrial Policy Statement of July 1991. The Government will divest its equity
in piecemeal. Reforms in public sector undertakings (PSUs) have taken many
forms, ranging from privatisation to subjecting them to a hard budget constraint,
introducing competition to toning up financial sector. India’s disinvestment has
its roots in economic compulsion. Disinvestment can cover various forms. Which
forms and which units are chosen at any time is guided by market conditions and
the desire to get the maximum value for currently owned assets. This is a matter
of careful examination and surveillance of much strategic thinking. For framing
proper strategies of disinvestment of shares of PSUs, a committee under the
191
Development Strategies chairmanship of Dr C. Rangarajan was appointed in 1993 which recommended
disinvesting up to 49 per cent of PSUs equity for industries explicitly reserved
for the public sector and over 74 per cent in other industries. But the then
Government did not take any decision on the Committee’s recommendations.
The Government constituted a five-member Public Sector Disinvestment

Commission under the Chairmanship of Shri. G.V. Ramkrishna in August 1994
for drawing a long-term disinvestment programme for the PSUs referred to the
Commission. The Commission submitted a dozen reports suggesting a slew of
measures including strategic sale, equity sale and closure, besides making general
recommendations on 58 PSUs. However, in November 1999, the Commission
was wound up and a Department of Investment and Public Asset Management
was created under Ministry of Finance.
Successive governments since 1991 declared their intent to disinvest but little
progress has been made over the years. The record of performance of Government
on disinvestment has been uniformly poor. The present process of disinvestment
of PSUs is indiscriminate, unplanned and lacks clear policy on the government’s
part. According to department of investment and public asset management, since
the inception of the process of disinvestment in 1991-92 to January 2020 an
amount of Rs 3,54,307.75 have been mobilised through disinvestment proceeds.
The process of disinvestment has evolved from public offering of shares to

strategic sale of equity to select partners to complete asset selling. The strategic
sale method confers a better valuation and paves the way for a technological up-
gradation of the target company. The main disadvantage of the sale of minority
stakes has been lower realisation as management control is not transferred.
Minority sales also give the impression that the main objective of the government
is to raise funds for reducing its fiscal deficit, and not to improve performance or
governance. Yet, because the share offer route is politically more acceptable, all
governments have relied on it.
8.6 PROBLEMS RELATED TO DISINVESTMENT

PROCESS/MODES
Controversies abound with regard to the mode of disinvestment. Ultimately, the
issue relating to disinvestment revolve around three questions– why, how and
how much. Dr G. S. Gupta (1998) has pointed out that the question of how to
privatise raises several issues:
i) Which approach is the best for which unit?
ii) Are various approaches substitutes/complementary?
iii) How to motivate politicians/bureaucrats/employees/ towards privatisation?
iv) When to sell assets/equity?
v) How to value assets/equity?
vi) What proportion of equity to sell? Whom to sell; retail investors, multinational,
expatriates, NRIs?
vii) Does privatisation fetch sustainable revenue?
viii) How to close in the absence of exit policy/voluntary retirement scheme?
192
ix) How to sequence privatisation? Major Developments in Post
x) Would disinvestment crowd out private investment?
There is no definite answer to any of these questions. These problems are very
complex and it is not possible to find out an easy way out.
Abhijit Roy (2002) has observed that Indian opinion seems to be divided in two
camps. The privatisers say that “the government has no business to be in business”
hence divestment is the only way out. The other camp holds the view that the
government should not hand over the family silver to crooks and charlatans who
dominate Indian businesses. Nor do they want the government companies to be
handed over to the MNCs. Whatever the merits of the arguments, one cannot
ignore either of these two opinions. One does not have to be dogmatic in one’s
approach. The goal should be to achieve a vibrant corporate sector in the medium
term consisting of various types of ownership patterns. E. A. S. Sarma (2004)
has rightly observed that the disinvestment policies of the successive government
remained hazy.
Lessons of privatisation in other countries and the Indian experience support

adoption of a pragmatic approach to privatisation, rather than its total rejection.
It is clear that privatisation has not been very popular. PSUs would have to be
freed from control by ministries. And this freedom would have to be structured
institutionally. There is the need for distancing government from control and
management over public enterprises to enable them to run more efficiently.
Autonomy must be the object, not raising revenues. Ownership must not mean
interference in governance and management of companies by government
representatives.
8.7 CONDITIONS FOR SUCCESS OF

PRIVATISATION POLICY
The mixed empirical evidence on privatisation is warning against sweeping
generalisations about the impact of privatisation. Dr Mahbub Ul Haq (the man
behind Human Development Reports published by of the United Nations
Development Programme) has cautioned economies privatising their public sector,
as part of a structural adjustment and economic reform programme, must bear in
mind that they do not commit the “seven sins of privatisation”. The seven sins of
privatisation are:
i) confused objectives,
ii) lack of transparency,
iii) concentration of assets,
iv) lack of competition,
v) a poor financial strategy,
vi) the dominance of fiscal objective of financing deficits, and
vii) lack of political consensus.
Revenue maximisation should not be the objective of privatisation. Efficiency
and equity are the relevant objectives and the success of privatisation should be
evaluated against these objectives. Long-term efficiency gains are more important
193
Development Strategies than short-term revenue gains. The lack of transparency in the privatisation process
is counter-productive and facilitates abuse. Often privatisation has become a
way of enriching a minority, resulting in gains for private fronts. This exposes
privatisation to political controversy. Privatisation should not simply imply
transfer of rents from the public to the private sector. Privatisation should not
result in a greater concentration of assets. Rather, the process of divestment of
public equity must ensure greater competition through more dispersed ownership.
Privatisation cannot be based on an unrealistic labour strategy. The ‘golden
handshake’ should not exceed the sale value of the assets being privatized. The
first requirement after privatisation of an enterprise is to retire a country’s debt,
and relieve future generation from this burden. Privatisation should not be carried
through executive orders but through the Parliament and after an open debate
which facilitates a consensus. Executive orders can be reversed and this creates
uncertainty, often sub-optimal reaslisation of proceeds from privatisation.
The Eleventh Finance Commission (2000) has noted in its report that major
structural reforms initiated in the nineties have virtually by-passed the PSUs. It
points out that PSUs should be freed from the shackles of ministries, and their
management has to be autonomous, professional, accountable, transparent and
durable for a good length of time. It is important to note that the centre’s efforts
at privatisation of the PSUs have not gone beyond a fractional disinvestment of
a few profit-making PSUs. There has been no uniformity of views either among
the political parties or among the economists about the necessity for privatisation.
“Contrary to popular supposition, neither the theory nor the empirical evidence
on privatisation provides unqualified support for the belief that privatisation leads
to outcomes superior to those under public ownership” (T T Ram Mohan, 2001).
Privatisation of public sector units has never been an easy task. Across the globe,
countries have tackled the hurdles in very different ways. But their governments
have weighed the good it could deliver with the odds it may bring and evened
the two out amicably. The privatisation process entails a very careful analysis of
specific circumstances including the specific setting of an enterprise and larger
socio-economic context. All that can be done is to build and sustain pressure on
the government to get out of activities with which it ought not to be involved,
and concentrate on those with which it should, like education, health, the supply
of drinking water and other essential services. Only then will a perspective emerge.
The scales seem to tilt in favour of the disinvestment process, no matter how
much is the protest from political and vested quarters. After all, disinvestment
has not been an easy job for any country in the world. Privatisation is not an end
in itself. It is a means of ensuring the efficiency of PSUs and the markets they
operate in. Government may have the right intentions, but it needs a better method
to accommodate the realities of a noisy political economy.

1) Trace the evolution of disinvestment policy in India.
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194
2) Highlight the problems associated with modes of disinvestment. Major Developments in Post
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3) Narrate the factors leading to success of Privatisation policy.
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8.8 PUBLIC PRIVATE PARTNERSHIP (PPP)

The expression PPP is a widely used concept world over but is often not clearly
defined. There is no single accepted international definition of what a PPP is
(World Bank, 2006). A public-private partnership, or P3, is a contract between a
governmental body and a private entity, with the goal of providing some public
benefit, either an asset or a service. Public-private partnerships typically are long-
term and involve large corporations on the private side. A key element of these
contracts is that the private party must take on a significant portion of the risk
because the contractually specified remuneration – how much the private party
receives for its participation – typically depends on performance. In the Indian
context, the term PPP is used very loosely. According to the National Public
Private Partnership Policy 2011, “a Public Private Partnership (PPP) means an
arrangement between the government/statutory entity/government owned entity
on one side and a private sector entity on the other, for the provision of public
assets and/or public services, through investments being made and/or management
being undertaken by the private sector entity, for a specified period of time,
where there is well defined allocation of risk between the private sector and the
public entity and the private entity receives performance linked payments that
conform (or are benchmarked) to specified and pre-determined performance
standards, measurable by the public entity or its representative”.
Since the need for infrastructural development in India is on the rise, the public
private partnership is the way to go forward as it provides innovation and diversity,
higher productivity, efficient and cost-effective delivery of projects. Facing
constraints on public resources and fiscal space has brought about renewed interest
in PPP. With the announcement of industrial policy of July 1991, a new wave for
PPP was felt and it was decided to allow private participation in the power sector
which opened up the doors for independent power producers. The National
Highways Act, 1956 was altered in 1995 to empower private support. In 1994,
through a focused offering process, licenses were conceded to eight-cell cellular
telephone utility administrators in four metro urban areas and 14 administrators
in 18 state circles. The overarching objectives of such partnerships are: 195
Development Strategies i) Harness private sector efficiencies in asset creation, maintenance and service
delivery;
ii) Provide focus on life cycle approach for development of a project, involving
asset creation and maintenance over its life cycle;
iii) Create opportunities to bring in innovation and technological improvements;
and,
iv) Enable affordable and improved services to the users in a responsible and
sustainable manner.
In short, the main objectives of pursuing PPP model in India relate to the following:
i) Expansion and improved infrastructure
ii) Risk sharing.
iii) Optimum allocation of resources.
iv) Innovations.
v) Aid in growth of other sectors.
(vi) The catalyst for the economy.
vii) More employment generation.
viii) Improves the image of the country.
ix) Attract FDI.
PPP Cell under Department of Economic Affairs (DEA): For looking at various
aspects of PPP, the PPP cell was set up in 2006 in the Department of Economic
Affairs (DEA), Ministry of Finance which acts as the Secretariat for Public Private
Partnership Appraisal Committee (PPPAC), Empowered Committee (EC), and
Empowered Institution (EI) for the projects proposed for financial support through
Viability Gap Fund (VGF). The PPP Cell is responsible for policy level matters
concerning PPPs, including policies, schemes, programmes, model concession
agreements and capacity building. The PPP Cell is also responsible for matters
and proposals relating to clearance by PPPAC, scheme for financial support to
PPPs in infrastructure (VGF Scheme) and India Infrastructure Project
Development Fund (IIPDF).

1) Provide meaning of PPP.
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2) Explain the need for PPP in India?
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3) What is the administrative machinery for PPP in India? Major Developments in Post
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8.9 PPP MODELS IN INDIA

In India, PPPs take a wide range of forms varying in purpose, involvement of the
private entity, legal structure and risk-sharing. The private sector participation in
the infrastructure building have taken place broadly through corporatisation of
existing PSUs (e.g. GAIL, ONGC, IOC, etc.), greenfield investment for
development of new projects, PPP in the form of BOT or BOOT model in the
road sector and concession agreements with the private sector such as rehabilitate,
operate, and transfer. India majorly follows 3 types of PPP models out of many
models available. They are:
i) Hybrid Annuity Model (HAM)
ii) Build-Operate-Transfer (BOT)
iii) Engineer-Procure-Construct (EPC)
HAM is a mixture of BOT and EPC where the financing, risks, operations, etc.
are distributed between Government and a private partner. The following table
would show the difference in these models:
BOT EPC HAM
Risk Private Public Private (60 per cent)
Public (40 per cent)
Finance Private Public Private (60 per cent)
Public (40 per cent)
Operations and Management Private Public Private
Revenue Private Public Public
Source: https://www.jatinverma.org/public-private-partnership-in-india)
i) BOT (build operate transfer) models used for two-thirds of the total PPP
projects in India. User-fee based BOT model widely used in medium- to
large-scale projects, especially in energy and transport (road, ports and
airports). Annuity-based BOT model commonly used in sectors/projects not
meant for cost recovery by levying a fee on sectors such as health and
education.
ii) Modified design-build (turnkey) contracts yield time and cost saving benefits;
also enable efficient risk-sharing and improve quality.
iii) Performance- based management/ maintenance contracts suitable for sectors

(water supply, sanitation, solid waste management and road maintenance)
constrained by the availability of economic resources to improve efficiency. 197
Development Strategies 8.9.1 Government Incentives for PPPs
The Government has facilitated the PPP sector by offering:
i) Viability Gap Funding (VGF): Viability Gap Funding of up to 40 per cent
of the cost of the project can be accessed in the form of a capital grant.
ii) India Infrastructure Project Development Fund (IIPDF): It helps the
Central and the State Governments and local bodies through financial support
for project development activities (feasibility reports, project structuring
etc.) for PPP projects.
iii) India Infrastructure Finance Company Ltd (IIFCL): It provides long-
term debt for financing infrastructure projects that typically involve long
gestation periods since debt finance for such projects should be sufficient to
meet the requirements.
iv) Foreign Direct Investment (FDI): Up to 100 per cent FDI in equity of
special purpose vehicles (SPVs) in the PPP sector is allowed on the automatic
route for most sectors.
The proposals shall include the requisite information necessary for satisfying
the eligibility criteria.
8.10 CHALLENGES OF PPP

Despite the success of PPP model in India, there is ample scope to improve its
working. Along with the advantages of the PPP projects, the negatives have also
surfaced in the forms of various bottlenecks and challenges. “The Indian public
sector suffers from peculiarly Indian constraints. Political interference in
recruitment, competitive trade union activity (witness the posters in every railway
station), rigidities on salaries and writs in courts on service matters, reduce the
efficiency of personnel management in the public sector. Activities of oversight
agencies – vigilance, comptroller and auditor general, etc– cause extreme risk
aversion in decision-making, reducing the efficiency of procurement and
operational decisions” (Somanathan and Natarajan, 2019).
In addition to above constraints, Gautam Ray (2014), has observed that “despite
progress and bright future prospects, investors continue to face many challenges
and perceive many hurdles. At the same time, project authorities are finding it
difficult to implement initiatives that are afflicted by higher cost, inflation and/
or unrealistic estimates of streams of expected revenue, and some approved
projects get delayed or abandoned because investors cannot secure financial
closure due to their unrealistically aggressive bids. Litigation and disputes over
land acquisition and other issues present further problems. Perhaps the most
important challenge before state governments is to develop well-designed PPP
projects in social infrastructure so that private investors, including NGOs, are
sufficiently motivated to invest”.
To develop the PPP projects in India, the Kelkar Committee (2015) recommended
that:
i) PPPs should not be used by the government to evade its responsibility for
service delivery to citizens.
198
ii) This model should be adopted only after checking its viability for a project, Major Developments in Post
in terms of costs and risks. PPP structures should not be adopted for very
small projects, since the benefits are not commensurate with the costs.
iii) PPP must not be a short cut only to save money or bridge fiscal gaps or
transfer risks; it should be used to improve service quality or bring efficiency
improvements.
iv) The prevention of Corruption Act, 1988 should be amended to distinguish
between genuine errors in decision making and acts of corruption by public
servants.
The Committee has emphasised that India’s success in deploying PPPs as an
important instrument for creating infrastructure will depend on a change in attitude
and in the mind-set of all authorities dealing with PPPs, including public agencies
partnering with the private sector, government departments supervising PPPs,
and auditing and legislative institutions providing oversight of PPPs. It is pertinent
to note that PPPs have contributed towards the growth and development of the
Indian economy in multiple ways. Combining the professionalism of the corporate
sector with the welfare objectives of the state has resulted in projects which are
known for their world class facilities and advanced amenities. For example,
several airports including Mumbai airport and the T3 of Delhi airport are built
on the PPP model. The PPP has seen several successful infrastructural projects
over the past decade.
It has rightly been observed that “selection of right PPP model for a right project
at a right time through realistic planning would go a long way in providing
meaningful and hassle-free infrastructure development, which ultimately would
increase the infrastructure standards and thereby sustain the overall
macroeconomic developments of the country” (Lakshmanan, 2008).

1) Discuss the different models of PPP adopted in India.
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2) What incentives government provide for having PPP in India?
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199
Development Strategies 3) Describe the challenges and how to go forward with PPP in India?
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8.11 INSOLVENCY AND BANKRUPTCY CODE

(IBC)
India’s financial distress resolution mechanism is broken. Companies that fall
into hard times spend six or eight years trying to resolve the situation. Banks are
saddled with massive amounts of non-performing loans that are a drain on their
resources and also affect their willingness to lend to new and deserving projects.
Ultimately, the honest and successful companies and individuals that borrow
from the banks pay for these inefficiencies in terms of higher interest rates. Over
the past 20 years, there have been a number of attempts to reform India’s
insolvency regime. None of them have been fully effective. While one can find a
number of specific reasons for their failure, the one overarching reason (at least
in the case of laws) is the lack of legal infrastructure to effectively implement the
laws. Our courts are overburdened, understaffed, and lack basic physical
infrastructure.
In late 2014, Ministry of Finance setup the Bankruptcy Legislative Reforms

Committee (BLRC), under the chairmanship of Dr T K Viswanathan (former
Union law secretary), with the objective of building a full-fledged bankruptcy
code. Based on the committee’s recommendations, the government introduced
the “Insolvency and Bankruptcy Code”. After half-a-century of efforts and nine
committees, insolvency in India has become easier. The IBC 2016, addresses all
these endeavours to prevent insolvency, provides a market determined and time-
bound mechanism for resolution of insolvency, wherever possible, along with
facilitators for quick and effective resolution, and promotes ease of exit, wherever
required.
In this context, it is well to remember that the economy witnessed freedom of

entry in the 1990s and freedom to compete in the 2000s. The IBC Code of 2016
provides the ultimate economic freedom, freedom to exit, and a mechanism to
address honest business failures..
18.12 CONCEPT AND IMPORTANCE OF IBC

Bankruptcy is a legal status usually imposed by a Court, on a firm or individual
unable to meet debt obligations. As all businesses cannot succeed, it is perfectly
normal for some businesses to fail, making it important to emphasise on corrective
action. India’s new Bankruptcy Code– “Insolvency and Bankruptcy Code, 2016”
attempts to create a formal insolvency resolution process (IRP) for businesses,
either by coming up with a viable survival mechanism or by ensuring their speedy
liquidation. The code makes a clear distinction between insolvency and
bankruptcy. The former is a short-term inability to meet liabilities during the
200
normal course of business. The latter is a longer-term view on the business. The Major Developments in Post
code envisages a new regulator– the Insolvency and Bankruptcy Board of India.
The implementation of the IBC has been one of the most important reforms in
recent years. Banks and other creditors can now take the defaulting company to
the National Company Law Tribunal to initiate insolvency proceedings. There is
now a real chance that promoters can lose control and are no longer in a position
to take creditors for a ride.
8.12.1 Objectives of IBC

The objectives of IBC are:
i) to promote entrepreneurship,
ii) availability of credit,
iii) balancing interests of all stakeholders by consolidating and amending laws
relating to reorganisation and insolvency resolution of corporate persons,
partnership firms and individuals in a time bound manner and for
maximisation of value of assets of such persons and matters connected
therewith or incidental thereto.
iv) to simplify and expedite the Insolvency and Bankruptcy Proceedings in India.
v) to protect the interest of creditors including stakeholders in a company.
8.12.2 The Insolvency and Bankruptcy Code Ecosystem

Following are the components of IBC ecosystem:
i) National Company Law Tribunal (NCLT) – The adjudicating authority (AA),
has jurisdiction over companies, other limited liability entities.
ii) Debt Recovery Tribunal (DRT) has jurisdiction over individuals and
partnership firms other than Limited Liability Partnerships.
iii) The Insolvency and Bankruptcy Board of India (IBBI) – apex body for
promoting transparency and governance in the administration of the IBC;
will be involved in setting up the infrastructure and accrediting IPs
(Insolvency Professionals (IPs) & IUs (Information Utilities).
iv) It has 10 members from Ministry of Finance, Law, and RBI.
v) Information Utilities (IUs) – a centralised repository of financial and credit
information of borrowers; would accept, store, authenticate and provide
access to financial data provided by creditors.
vi) IPs- persons enrolled with IPA (Insolvency professional agency (IPA) and
regulated by Board and IPA will conduct resolution process; it will act as
Liquidator/ bankruptcy trustee; they are appointed by creditors and override
the powers of the board of directors.
vii) IPs have the power to furnish performance bonds equal to assets of the
company under insolvency resolutions
viii) Adjudicating authority (AA) – would be the NCLT for corporate insolvency;
to entertain or dispose of any insolvency application, approve/ reject
resolution plans, decide in respect of claims or matters of law/ facts thereof.
201
Development Strategies 8.12.3 Salient Features of IBC
The following are the salient features of the IBC:
i) IBC proposes a paradigm shift from the existing “debtor in possession” to a

“creditor in control” regime. An impartial law respecting rights of all creditors
by acknowledging that all classes of creditors to play a vital role in the
insolvency process. However, the ‘secured lenders’ will have significant
influence over the reorganisation process.
ii) The code aims to resolve insolvencies in a strict time-bound manner – the
evaluation and viability determination must be completed within 180 days.
Moratorium period of 180 days (extendable up to 270 days) for the Company.
For start-ups and small companies the resolution time period is 90 days which
can be extended by 45 days.
iii) Introduce a qualified insolvency professional (IP) as intermediaries to oversee

the Process. Insolvency professionals will assist in the resolution, liquidation
and bankruptcy proceedings envisaged in the code. This will help in
preserving value and time.
iv) Provides for the setting up of “Insolvency and Bankruptcy Board of India”
(IBBI) to regulate professionals/agencies dealing with insolvency and
informational utilities.
v) Emphasis on symmetry of information between creditors and debtors by

ensuring availability and access to essential information to all creditors by
setting up of Information Utilities as a depository of financial information.
vi) The code allows the corporate debtor itself to initiate the insolvency–
resolution process once it has defaulted on a debt. Also, operational creditors
(including the Centre, State governments and local authorities) are permitted
to initiate the resolution process.
The Code has a clear-cut grievance resolution mechanism for various stakeholders
involved in insolvency resolution. Only the National Company Law Tribunal
(NCLT), National Company Law Appellate Tribunal (NCLAT) and the Supreme
Court have the jurisdiction to deal with any appeal concerning the Code. At its
heart, it suggests a commercial resolution without burdening the courts
excessively. It would result in a better business environment and ease in debt
rising.
8.12.4 Working of IBC

The law heralds a new era in how India’s economy resolves bad debts and
inconsistent treatment in resolving cases. The threat of IBC is forcing debtors to
pay up, as operational creditors have recovered more than Rs. 1 lakh crore even
before their insolvency applications were admitted by NCLTs.
“In over three years of the Insolvency and Bankruptcy Code, the number of
bankrupt companies liquidated under the regime has far exceeded the number of
corporate resolutions, by nearly four times. According to the data released by the
Insolvency and Bankruptcy Board of India (IBBI), while 156 of the cases admitted
under the Corporate Insolvency Resolution Process (CIRP) have been resolved
202
till September 2019, the liquidation process has started in as many as 587 cases. Major Developments in Post
Thus, IBC has liquidated many more companies than it has resolved.
It should be noted that IBC has provided creditors and other stakeholders the
ammunition to obtain the maximum value for stressed assets by shifting the
balance of power from debtors. The IBC, undoubtedly, since the time of its
enactment has evolved considerably. According to the World Bank, before IBC,
the time taken to resolve stressed loans was 4.3 years and recovery rate was 26
per cent for financial creditors. There has been a marked improvement in the
recovery process which is already leading to billions of dollars being invested in
the country due to the protection of creditor rights.
In December 2019 the Union cabinet approved fresh amendments to the

Insolvency and Bankruptcy Code (IBC) aimed at strengthening its functioning.
The amendments seek to ring-fence assets of companies from offences committed
by the previous management or promoters. The government should now step up
its efforts to ensure that the promise of speedy resolution, one of the most appealing
aspects of the IBC, is delivered upon.
A lot has been said and written on the IBC. Implementation of the IBC is a real
challenge. This is an innovative law awaiting correct execution. In 2019, with
the Supreme Court upholding the Insolvency and Bankruptcy Code (IBC) in its
entirety, the resolution process will move faster now. The success of the ambitious
IBC is dependent on its institutions like the regulator, the adjudicating authority
and the professionals involved. Nevertheless, IBC 2016 is an evolving legislation,
still being interpreted by courts and being constantly amended to harmonise IBC
with our related legal policy.

1) The concept of IBC adopted in India. Highlight the importance of IBC.
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2) Point out the objectives and ecosystem of IBC.
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203
Development Strategies 3) Discuss the working of IBC.
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8.13 LET US SUM UP

Public sector enterprises were considered necessary when they came into
existence. The current thinking is that the reasons, howsoever plausible in the
past, are no longer valid for the continued existence of the public sector.
Disinvestment in public sector enterprises (PSEs) was proposed as a policy option
during the initial phase of economic liberalisation in 1991. Privatisation means
transferring control to a private party. This can be done with or without
transferring ownership. Disinvestment, which is a form of ownership transfer,
comes under the umbrella of privatisation. Disinvestment means no transfer of
control even if public shareholding is diluted. The objectives of privatisation
are: greater efficiency, revealing the true and full cost of the service provided,
promotion of technological advancement, development of capital markets,
broadening the wealth and achieving widespread private ownerships in society,
raising extra-revenues for the government, and reducing the power of public
employee unions.
The public Private Partnership (PPP) is an agreement between the government
and the private sector for the purpose of provisioning of public services or
infrastructure. With a common goal in mind the public and the private sector
bring on their experiences and strengths resulting in the accomplishment of mutual
objectives. Using the finances of the private firms to complete the PPP ventures
has led to conservation of national and governmental resources. The PPPs are
ensuring the effective utilisation of state assets in a manner that is productive as
well as profitable. Infrastructure created using these partnerships is of a superior
quality.
India lacked an ecosystem that encouraged dismantling of companies and sale of
its divisions. Insolvency and Bankruptcy Code, 2016 is considered as one of the
biggest insolvency reforms in the economic history of India. This was enacted
for reorganisation and insolvency resolution of corporate persons, partnership
firms and individuals in a time- bound manner for maximisation of the value of
assets of such persons. In order to, realise the benefits of IBC, the time taken to
find and implement resolutions has to come down drastically.

1) Explain the concept of privatisation. Provide an overview of the reasons for
privatisation.
2) What are the methods of privatisation? Which methods are being followed
in India? Examine the problems and prospects of privatisation in India.
204
3) What is disinvestment? What is the difference between privatisation and Major Developments in Post
disinvestment? What conditions are needed for making disinvestment policy
a success?
4) What do you mean by the concept of Public Private Partnership (PPP)?
Which sector is most suitable for PPP policy?
5) What policy is being followed by the government of India regarding PPP?
How has India benefited from PPP collaboration? Give concrete examples.
6) What precautions are needed for going to PPP agreement? Explain the
challenges being faced by PPP projects in India?
7) Explain the concept of Insolvency and Bankruptcy Code (IBC). How can
you distinguish between Insolvency and Bankruptcy? What factors propelled
the enactment of IBC in India?
8) Describe the objectives, importance and salient features of IBC in India.
Which are the components of eco-system to implement the IBC?
9) Discuss the working of IBC in India. What challenges are being encountered
by IBC? How does government trying to meet such challenges?
8.15 KEY WORDS

Autonomy : Autonomy is the capacity to make an informed
and uncoerced decision. Autonomous
organisations or institutions are independent or
self-governing.
Corporatisation : Corporatisation refers to the restructuring or
transformation of a state-owned asset or
organisation into a corporation. These
organizations typically have a board of directors,
management, and shareholders. However, unlike
publicly traded companies, the government is the
company’s only shareholder, and the shares in
the company are not publicly traded.
Cyclical Slowdown of : In simple words, a cyclical economic slowdown
Economy is a part of the business cycle having its peaks
and troughs. The economy will be moving in
cycles with periods of peak performance followed
by a downturn and then a trough of low activity.
These are expected to be short-term problems that
could be addressed with an adequate mix of fiscal
and monetary policies.
De-licensing : De-licensing refers to the policy of opening the
economy and abolishing government control by
removing the earlier restrictions and licenses.
Fiscal Stabilisation : Foremost among the techniques of stabilisation
is fiscal policy. Fiscal policy as a tool of economic
stability, however, has received its due
importance under the influence of Keynesian
205
Development Strategies economies only since the depression years of the
1930s. In India the commonly used term is “fiscal
consolidation” which refers to a process where
government’s fiscal health is getting improved
and is indicated by reduced fiscal deficit. Fiscal
consolidation is a reduction in the underlying
fiscal deficit. It is not aimed at eliminating fiscal
debt.
Golden Handshake : Golden Handshake, is an independent decision
(also known as of employee to end his employment based on
VRS in India) some decided agreement or contract, so as to
terminate the legal relationship of employer –
employee.
Structural Slowdown of : A structural slowdown is a more deep-rooted
Economy phenomenon that occurs due to a one-off shift
from an existing paradigm. The changes, which
last over a long-term, are driven by disruptive
technologies, changing demographics, and/or
change in consumer behaviour. In such a scenario,
a monetary and fiscal stimulus won’t be enough
to revive the economy. Fixing such problems
would require the government to undertake some
structural policies. The best example in this
regard would be the reforms that were carried
out to address the crisis in 1991.
8.16 REFERENCES
1) GoI. November 2015. Report of the Committee on Revisiting and
Revitalizing the Public Private Partnership model of Infrastructure,
Department of Economic Affairs, Ministry of Finance, New Delhi https://
www.pppinindia.gov.in/infrastructureindia/documents/10184/0/kelkar+Pdf/
0d6ffb64-4501-42ba-a083-ca3ce99cf999
2) GoI, 2011. National Public Private Partnership Policy, Draft for consultation,
Department of Economic Affairs, Ministry of Finance, New Delhi https://
ppp.worldbank.org/public-private partnership/sites/ppp.worldbank.org/files/
documents/India_draftnationalppppolicy_EN.pdf
3) Gupta, G.S. (1998): Privatisation: Theory, Practices and Issues, The Indian
Economic Journal, Vol. 46, October -December (No.2)
4) Hans, Aman, November 22, 2017. Rebooting public private partnership in
India, NITI Aayog, GoI, New Delhi https://niti.gov.in/writereaddata/files/
document_publication/REBOOTING%20PPP%20IN%20INDIA_blog.pdf
5) Jain, Mukesh (2019). Some Emerging Trends in The Evolution of Insolvency
and Bankruptcy Code (IBC), 2016, Outlook.
6) Nagaraj, R (2008). Disinvestment and Privatisation in India Assessment
and Options in Asian Development Bank edited Trade Policy, Industrial
206
Performance, and Private Sector Development in India, Oxford University Major Developments in Post
Press, New Delhi, for the Asian Development Bank.
7) Ram Mohan, T.T. December 29, (2001). Privatisation: Theory and Evidence,
Economic and Political Weekly, Vol. 36, Issue No. 52.
8) Ray, Gautam, 2014. PPP projects in India: Progress, prospects and problems,
in Commonwealth Governance and Growth.
9) Rebello, Joel and Atmadip Ray, (2019). With IBC about to be 3, a look at
the hits & misses and the road ahead, The Economic Times, April 24.
10) Rodriguez, Juan (2019). Public-Private Partnership Pros and Cons.
11) Roychoudhury, Arup (2016). Rajya Sabha passes Bankruptcy Code, Business

Standard, May 12.
12) Sharma, Samrat (2019). Insolvency Code progress report: Nearly 4 times
as many cases in liquidation as in resolution, Financial Express.

PROGRESS EXERCISES
1) See Section 8.2
2) See Section 8.3
3) See Sub- section 8.3.1
4) See Section 8.4
1) See Section 8.5
2) See Section 8.6
3) See Section 8.7
1) See Section 8.8
2) See Section 8.8
3) See Section 8.8
1) See Section 8.9
2) See Sub- section 8.9.1
3) See Sub- sections 8.10
207
Development Strategies Check Your Progress 5
1) See Section 8.12
3) See Sub-sections 8.12.4
208
MEC-205
Indian Economic
Policy
VOLUME-II
(Block 3 and 4)

EXPERT COMMITTEE
Prof. Atul Sarma Prof. R. Nagraj Prof. K. Barik
Former Director, Indira Gandhi Institute of Professor of Economics
Indian Statistical Institute Development Research, Mumbai IGNOU, New Delhi
Prof. S.K.Singh Prof. Pravakar Sahoo
Former professor of Economics Institute of Economic
New Delhi
IGNOU, New Delhi Growth, New Delhi
Prof. N.R. Bhanumurthi
Prof. Vijay Katti Shri Saugato Sen
Professor and Head Economics and Associate Professor of
Trade Policy, IIFT, New Delhi Economics
Prof. Prem S.Vashistha IGNOU, New Delhi
Shri I.C.Dhingra
Rtd. Director, AGRO Economic
Rtd. Associate Professor
Research Centre,
COURSE EDITOR : Prof. Rajeev Malhotra, Former Economic Advisor to Union Finance
Minister, Govt. of India
Block 3 Monetary and Fiscal Policies
Unit 9 Inflation and Monetary Policy Mr. M. Rahul Prof Narayan Prasad
Dy. Director, Department of & Ms. Chetali Arora
Economic Affairs, Ministry of
FinanceNew Delhi
Unit 10 Capital Market and Its Regulations Dr. Alok MishraUniversity of Prof. Narayan Prasad
Hyderabad
Dr. Iti Mishra, ICFAI,
Hyderbad
Unit 11 Fiscal Policy and Fiscal Dr. Manish Gupta and Prof. Narayan Prasad
Responsibility and Budget Ms. Smriti Mehra, &Ms. Chetali Arora
Management (FRBM) Act National Institute of Public
Unit 12 Major Development on Union State Prof. Tapas Sen Prof. Narayan Prasad
Relations Rtd. Professor, National &Ms. Chetali Arora
Institute of Public Finance
and Policy,New Delhi
Block 4 Sector Specific Issues and Policies
Unit 13 Agriculture: Issues, Concerns, Policy Dr. J.C.Sharma Prof. Narayan Prasad
and Programmatic Initiatives Rtd. Sr. Economic Adviser Ms. Chetali Arora
Government of India, Ministry
of New and Renewable Energy,
New Delhi
Unit 14 Large Scale Industries in India: Shri I.C. Dhingra Prof. Narayan Prasad
Issues and Policy Rtd. Associate Professor, Ms. Chetali Arora
Delhi
Unit 15 Micro, Small and Medium Ms. Chetali Arora, Prof. Narayan Prasad
Enterprises (MSMEs): Issues and Academic Associate
Policy IGNOU, New Delhi
Unit 16 Services Sector I: Organised Sector- Dr. J.C.Sharma Prof. Narayan Prasad
Issues and Policy Rtd. Sr. Economic Adviser Ms. Chetali Arora
Government of India
Unit 17 Services Sector II: Informal Sector- Dr. J.C.Sharma Prof. Narayan Prasad
Issues and Policy Rtd. Sr. Economic Adviser Ms. Chetali Arora
Government of India
Ms. Kamini Dogra
Personal Assistant
PRINT PRODUCTION
Mr. Yashpal
Assistant Registrar
IGNOU, New Delhi
April, 2021
ISBN :
Printed at:
Contents
BLOCK 3 MONETARY AND FISCAL POLICIES 7

UNIT 9 Inflation and Monetary Policy 9
UNIT 10 Capital Market and Its Regulations 24
UNIT 11 Fiscal Policy and Fiscal Responsibility and Budget 45
Management (FRBM) Act
UNIT 12 Major Development on Union State Relations 75
BLOCK 4 SECTOR SPECIFIC ISSUES AND POLICIES 103

UNIT 13 Agriculture: Issues, Concerns, Policy and Programmatic 105
Initiatives
UNIT 14 Large Scale Industries in India: Issues and Policy 135
UNIT 15 Micro, Small and Medium Enterprises (MSMEs): 158
Issues and Policy
UNIT 16 Services Sector I: Organised Sector - Issues and Policy 175
UNIT 17 Services Sector II: Informal Sector - Issues and Policy 202
BLOCK 3
MONETARY AND FISCAL POLICIES
Monetary and Fiscal Policies
BLOCK 3 MONETARY AND FISCAL
POLICIES
Economic policies are statements of aims and ideals to be achieved through
various policy instruments outlined by the government to guide the process of
economic development. Broadly speaking, we can distinguish between two types
of instruments of economic policy viz., Macroeconomic policies (or aggregate
policies), and Microeconomic policies (Sectoral policies)
This block deals with two important instruments of macroeconomic policy:
1. Monetary Policy
2. Fiscal Policy
Apart from these two instruments, the block also deals with inflation, capital
market and its regulation, fiscal responsibility and budget management (FRBM)
Act.
Unit 9 entitled ‘Inflation and Monetary Policy’ throws light on inflation, its
measurement factors influencing inflation, operating procedures and mechanisms
involved in monetary policy.
Unit 10 on ‘Capital Market and its Regulations’ focuses on organisational

structure, role, function and performance of Indian capital market, Indian equity
market, currency market, derivative market and corporate debt market.
Unit 11 entitled ‘Fiscal Policy and Fiscal Responsibility and Budget

Management (FRBM) Act’ examines how changes in government spending
and taxation affect equilibrium level of income and interest rate in terms of IS-
LM framework. The Unit also covers discussion on operation of fiscal policy,
the need to adopt FRBM Act and appreciate the genesis of GST and its
implementation.
Unit 12 on ‘Major Development on Union State Relations’ spells out the

principles governing fiscal federalism, the role of Finance Commission as an
institution in fiscal federalism, the recommendations of 14th and 15th Finance
Commission and the dimensions and issues involved in contemporary Centre
and state fiscal situation in the country.
8
Inflation and Monetary
UNIT 9 INFLATION AND MONETARY Policy
POLICY
Structure
9.0 Objectives
9.1 Introduction
9.2 Money
9.2.1 What is Money?
9.2.2 How Do We Measure Money?
9.3 Inflation
9.3.1 What is Inflation?
9.3.2 Inflation Measurement in India
9.3.3 Costs of Inflation
9.4 Money and Prices
9.4.1 Theoretical Perspectives on Money and Prices
9.4.2 Causes of Inflation
9.5 Monetary Policy in India
9.5.1 Objectives of Monetary Policy in India
9.5.2 Instruments of Monetary Policy in India
9.5.3 Monetary Policy Transmission
9.5.4 Evolution of Monetary Policy in India
9.5.5 Inflation Targeting Framework
9.6 Let Us Sum Up
9.8 Key Words
9.9 References
9.0 OBJECTIVES
The purpose of this unit is to develop among learners an understanding of the
framework and operating procedure of the monetary policy in India. After going
through this unit, you will be able to:
explain what money is and what inflation means and how money affects
inflation;
discuss what the instruments of monetary policy are;
appreciate the evolution of monetary policy in India; and
state the Inflation Targeting Framework in India.
9.1 INTRODUCTION
In this unit, we would be discussing inflation and monetary policy in India.
Inflation is an economic issue that is a common topic of discussion for the public
9
Monetary and Fiscal Policies as well as policymakers and researchers alike. It is an economic phenomenon
that has a realisable impact on the daily lives of every citizen. You must have
often heard your grandparents narrating stories about how, during their childhood,
they were able to buy things for very small amounts of money compared to the
present. They might remark that money has lost its value. Inflation, simply put,
refers to the rate of increase in the prices of commodities during a given period.
With a positive level of inflation, you are able to buy lesser amounts of goods
and services using the same amount of money. Therefore, before we discuss
inflation, it is important to understand what money is and how it affects the
prices in the economy. We also discuss the monetary policy framework in India
and see how it has evolved over the years, in sync with the requirements of the
evolving economy.
9.2 MONEY
9.2.1 What is Money?
Money is something that we encounter in our daily lives. Despite this, it may be
difficult for someone to define what money is or how it functions. Money is
defined as anything that is generally acceptable as a medium of payment.
Essentially, money serves three purposes:
It acts as a store of value: Money can be a means to save a person’s
endowments, including labour, and used later for transactions. That is, income
or wealth of individuals can be kept in the form of money and used for
transactions in the future. It allows purchasing power to be taken forward
from present to future. Thus, money acts as a store of value.
It acts as a unit of account: Money acts as a common denominator on
which all prices are measured. The value of goods and services exchanged
in the economy is measured in terms of money.
It acts as a medium of exchange: Since money has the above two features,
it is generally acceptable as a means of payment for exchange of goods and
services. Without money, any exchange in the economy would require a
double coincidence of wants. That is, a transaction would take place only if
both parties in the transaction had something that the other needed. With a
generally acceptable means of payment, the need for double coincidence of
wants is obviated by separating the transaction into two parts. First, the two
parties engage in a transaction where one party gives money in exchange
for the good or service he or she needs. In the second part of the transaction,
the recipient of money in the first transaction uses the money to buy the
goods or services that he or she requires.
Historically, many items have been used as money. Items with intrinsic value
such as gold and silver were a form of money used for transactions in some
societies. This form of money is called commodity money. Different societies
have used everything from salt and grain to stones and precious metals as money
at different points of time in history. Even in modern societies, commodities are
known to have been used as a generally accepted means of payment. An interesting
and often quoted example of commodity money is the use of cigarettes for
transactions in Nazi prisoner of war camps during the second World War. The
prevalent form of modern money is fiat money. Fiat money has no intrinsic value.
10
Its value is derived from a government order or a fiat. The coins and currency Inflation and Monetary
Policy
notes that we use in our daily lives are examples of fiat money.
9.2.2 How Do We Measure Money?

Any measure of the quantity of money should include the quantity of assets used
in the economy for transactions. Currency notes and coins are obvious candidates
for money. In addition to these, chequeable deposits may also be considered part
of the money supply. In this manner, you may think of many other assets that
could be considered for inclusion in the measure for money supply. It must
therefore be clear to you that while defining money is a theoretical or conceptual
matter, measuring money supply is an empirical question. RBI has the following
measures of money supply:
Reserve Money (M0)= Currency in circulation + Bankers’ deposits with the RBI
+ ‘Other’ deposits with the RBI
Narrow Money (M1) = Currency with the public + Demand deposits with the
banking system + ‘Other’ deposits with the RBI
M2 = M1 + Savings deposits of post office savings banks
Broad Money (M3) = M1+ Time deposits with the banking system
M4 = M3 + All deposits with post office savings banks (excluding National
Savings Certificates)
‘Other’ deposits with the RBI include deposits from foreign central banks,
multilateral institutions, financial institutions and sundry deposits net of IMF
Account No.1.
9.3 INFLATION
9.3.1 What is Inflation?
As you know, the price of a commodity refers to the amount of money you give
in exchange for buying a unit of that commodity. The general price level refers
to a measure of the overall price level in an economy. Inflation is the rate of
increase in the general price level over a period of time. However, it is not
straightforward to arrive at such a general price level, as in reality, such a measure
does not exist. What we can do, at best, is to construct a measure that could be
considered to represent this hypothetical value. To arrive at a single measure for
the overall prices in the economy, we often look at a weighted average price of a
basket of goods and services consumed by a representative consumer in the
economy. This is achieved through the construction of a price index, which is a
weighted average of price relatives of goods and services in a representative
consumption basket. The changes in the price index over a given period reflect
the changes in the prices of the goods and services in the consumption basket
and therefore their growth rates are used as a measure of inflation.
9.3.2 Inflation Measurement in India

In India, two major types of price indices are used for calculation of inflation.
These are the Consumer Price Index (CPI) and the Wholesale Price Index (WPI).
As the name suggests, CPI reflects the average retail price level as faced by the
consumers. There are four measures of CPI in India. CPI (Rural, Urban and
11
Monetary and Fiscal Policies Combined), CPI (Industrial Workers), CPI (Rural Labourers) and CPI
(Agricultural Labourers). Table 9.1 gives more details about the price indices
used in India. Out of these, the most important one is CPI-Combined, being used
for monetary policy purposes. CPI, separately for rural and urban areas, have
been estimated for a longer duration in India.The base year for CPI (Industrial
Workers) was recently updated to 2016 from the earlier base of 2001. On the
other hand, WPI reflects the price level for the first point of wholesale or bulk
transactions. In India, WPI is taken as a proxy for producers prices (i.e. prices
faced by producers), which unlike other countries are not estimated. The current
WPI series has a base year of 2011-12. It is also calculated based on Laspeyres
price index formula.
Table 9.1: Different Price Indices in India

Name of the Index Base Year Organisation Compiling the Index
CPI (Rural, Urban and 2012 National Statistical Office
Combined)
CPI (Industrial Workers) 2016 Labour Bureau
CPI (Agricultural Labourers) 1986-87 Labour Bureau
CPI (Rural Labourers) 1986-87 Labour Bureau
WPI 2011-12 Office of Economic Adviser,

Department for Promotion of
Industry and Internal Trade
9.3.3 Costs of Inflation

Inflation is generally thought of as imposing hardships on the citizens. High
inflation is thought to make goods and services unaffordable. However, if incomes
rise at a rate that is at least as much as the rate of inflation, the goods and services
would continue to remain affordable. However, there may be other, not so
obvious, economic costs of inflation. One cost associated with high inflation is
one that arises from the fact that people may choose to hold lower cash with
themselves and keep a larger amount in the banks as deposits. This would mean
frequent visits to the bank to withdraw money for their daily transactions. The
inconvenience of frequently visiting the bank is dubbed as shoe-leather cost of
inflation. With input prices frequently changing during a high inflation scenario,
firms have to change the prices of their products frequently. The cost associated
with frequently changing the posted prices is called the menu cost of inflation.
As such, if frequent price changes are not synchronised, it may lead to the
introduction of relative price distortions leading to inefficient allocation of
resources in the economy. High inflation also introduces uncertainty into economic
decisions. Firms and households may find it difficult to differentiate between
relative and general price changes. Further, high inflation may lead to undesirable
redistribution of income in the economy. Low-income households are usually
dependent on wage payments and cash holdings for their day-to-day transactions.
During a case of high inflation, cash holdings lose their real values quickly. If
wages are not indexed to inflation, as may be the case in the informal sector, it
may take a while before wages respond to increased prices. On the other hand,
richer households which hold wealth in non-cash assets would not be affected as
much. This means that high levels of inflation may widen the gap between the
12 rich and the poor in the economy.
Inflation and Monetary
9.4 MONEY AND PRICES Policy
9.4.1 Theoretical Perspectives on Money and Prices

Depending on the school of thought followed, the theory of how money supply
affects prices and other economic variables varies. In the classical perspective,
the price level was determined by the quantity of money in the economy. This
view, called the Quantity Theory of Money, which was later revived by the
Monetarist school, has been a dominant explanation for the relationship between
money and prices. We can express this in the form of the equation of exchange:
M×V=P×Y
Where, M is the quantity of money, V is the income velocity of money – the
number of times a rupee is used in transactions, that is the number of times on an
average a rupee changes hand, P is the price level and Y is the output produced in
the economy. Output being supply determined in the Classical view and the
velocity of money determined by payment technology and institutional factors,
being unchanged in the short-run, this identity says that an increase in the quantity
of money would lead to a proportionate increase in the prices. Thus, with these
assumptions, the equation of exchange translates into the quantity theory of
money, explaining that the price level is determined by the quantity of money.
The equation of exchange can be represented in terms of growth rates by taking

logs on both sides and differentiating with respect to time. We get,
1 �� 1 �� 1 �� 1 ��
+ = +
� ��
Which is nothing but,
Growth rate of money supply + Growth rate of velocity of money =
Inflation + Growth rate of output
Rearranging, we get,
Inflation = Growth rate of money supply + Growth rate of velocity of money –
Growth rate of output
With a stable velocity of money, growth in it is zero. Output is dependent on the
factors of production. It is then straightforward that in the quantity theory of
money, the inflation level is under the ultimate control of the monetary authority
through the control on the quantity of money. The monetary authority can vary
the inflation rate under this framework by varying the growth rate of money.
In the Keynesian perspective, money affects income via interest rates. An increase
in money supply lowers the interest rate and stimulates aggregate demand and
income. In an economy with excess capacity, higher aggregate demand should
only lead to use of the earlier unused capacity in the economy and therefore
should not lead to inflation.
In the late 1950s-60s, the Phillips Curve relationship came into the limelight,
which provided a link between inflation and unemployment. According to this
relationship, in the short-run there is a tradeoff between inflation and
unemployment: an economy could achieve a lower unemployment rate by
13
Monetary and Fiscal Policies stimulating demand in the economy at least in the short-run if it was willing to
tolerate a higher level of inflation. In the long-run, however, this relationship is
expected to breakdown as workers would want their wages adjusted to the higher
rates of inflation and therefore, as a consequence, unemployment again rising.
9.4.2 Causes of Inflation

As we have seen above, the quantity of money is an important determinant of the
level of inflation in the economy. The monetarist, Milton Friedman stated,
“Inflation is always and everywhere a monetary phenomenon.” There is
considerable agreement that, in the long-run money supply growth can be seen
as a major determinant of inflation. In the short-run, however, fluctuations in the
demand and supply conditions can have a major impact on the movement in the
level of prices. Higher government spending, for example, can raise the level of
aggregate demand in the economy and therefore put upward pressure on prices.
This is an example of ‘demand-pull’ inflation. Another cause of inflation is
increase in the costs of production due to increases in the costs of raw materials
and other inputs. This is called ‘cost-push’ inflation. Sudden changes in supply
conditions can alter the level of prices of the commodities concerned. You might
have observed that years with deficient rainfall, prices of agricultural commodities
witness sharp spikes. Insufficient rainfall affects production of agricultural
commodities and therefore may lead to shortfall in the supply of these
commodities, thus affecting the prices. These supply side factors are not generally
expected to be affected by monetary policy.
For economic analysis, overall inflation (also called headline inflation) is usually
divided into a “Core” part and a non-core part. Core inflation refers to that
component of inflation that is long-term in nature. That is, Core inflation is
calculated by separating out the volatile components of inflation that cause
fluctuations in the short-term. These, in the context of a developing economy
like ours, are usually components like food items that depend on seasonal and
weather factors to determine their supply or fuel items that may be influenced by
supply side shocks in the international markets. One would expect Core inflation
to be more responsive to monetary policy than non-core inflation.
1) Consider an economy with a constant velocity of money. Money supply

grows by 10 per cent per year and real income grows by 5 per cent per year.
As per the Quantity Theory of Money that you have learnt above, what is
the average rate of inflation?
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
2) Download the yearly data on M3 (from average monetary aggregates) and

nominal GDP of India (GDP at current prices) for years 2004-05 onwards
from RBI’s Database on Indian Economy (https://dbie.rbi.org.in/). Now
for each year, calculate the velocity of money by dividing the nominal GDP
14
for each year by the corresponding M3 number. Plot this as a line chart for Inflation and Monetary
Policy
these years. What trend do you observe in the velocity of money? What do
you think are the reasons for the observed trend? What do you think would
be the effect of greater number of digital transactions on the velocity of
money?
9.5 MONETARY POLICY IN INDIA

9.5.1 Objectives of Monetary Policy in India
As the monetary authority of the country, the Reserve Bank of India formulates,
implements,and monitors the monetary policy of the country. As per the Preamble
of the Reserve Bank of India Act 1934, the primary objective of monetary policy
is to maintain price stability while keeping in mind the objective of growth. This
is a direct consequence of its mandated function to “regulate the issue of Bank
notes and keeping of reserves with a view to securing monetary stability in India
and generally to operate the currency and credit system of the country to its
advantage”. As we have seen, maintaining price stability is crucially dependent
on the money supply in the economy. A high level of inflation may have an
adverse effect on growth. Therefore, the objective is to maintain a low and stable
level of inflation in the economy. Further, achieving high growth in the economy
requires that credit flows to the most productive sectors of the economy.
9.5.2 Instruments of Monetary Policy in India

As the monetary policy framework has evolved over the years, the operating
procedure of RBI’s monetary policy has also evolved. RBI relies on a set of
direct as well as indirect policy instruments to conduct its monetary policy. During
the initial years, the focus of RBI was to regulate the demand and supply of
credit through bank rate, reserve requirements and Open Market Operations.
As we have seen earlier, the need to finance government deficit dominated the
monetary policy actions during the period between the 1950s and 1970s. Selective
credit control mechanisms were used to channel credit to priority sectors. Between
1970 and 1990, the Statutory Liquidity Ratio (SLR), the share of net demand
and time liabilities (NDTL) that a bank is required to maintain in safe and liquid
assets, such as, unencumbered government securities, cash and gold, was
increased several times. Within the period of 1980’s, with a view to regulating
liquidity and to provide resources for vital public sector investment within the
framework of national priorities without generating reserve money, it was decided
to increase the SLR. During the 1980s, a number of money market instruments
such as inter-bank participation certificates (IBPCs), certificates of deposit (CDs)
and Commercial Paper (CP) were also introduced.
Another important monetary policy instrument during the period was the Cash
Reserve Ratio (CRR). The Cash Reserve Ratio (CRR) refers to the average daily
balance that a bank is required to maintain with the RBI as a percentage of its
Net demand and time liabilities (NDTL) that the RBI may notify from time to
time in the Gazette of India. If the average daily balance held at RBI by a scheduled
bank during any fortnight is below the minimum prescribed, the bank shall be
liable to pay a penal interest on the amount of shortfall. CRR as a monetary
policy instrument can be used to influence the money supply by the monetary
15
Monetary and Fiscal Policies authority. An increase in CRR would lead the banks to have lesser amounts of
money with them for lending with the same amount of deposits. This would
reduce the amount of credit created and therefore reduce the money supply through
the money multiplier process. In the 1980’s the CRR was changed in different
time periods as one of the important policy measures.
With liberalisation in the Indian economy and the financial sector reforms, there
was a shift from direct to indirect, market based policy instruments. In the period
1990-91, the Narasimham committee had recommended that the CRR should
continue to be used as an instrument of monetary control. But it was recognised
that the existing levels were high and needed to be brought down. The year
1996-97 was significant in many ways in relation to the conduct of monetary
policy in India. It was the first time the CRR was reduced sharply by 4 percentage
points within a financial year in the five phases. The CRR was brought down to
9.5 per cent and SLR to 25 per cent by 1997. The process of deregulation of
interest rates was also initiated in the early 1990s simplifying the complex
structure of deposit and lending interest rates.
Following the Narasimham Committee-II Report (1998), the Interim Liquidity

Adjustment Facility (ILAF) was introduced in April 1999, to determine the
corridor for money-market rates. With subsequent revisions, the revised Liquidity
Adjustment Facility (LAF) was announced in October 2004 and has now emerged
as the principal operating instrument of monetary policy. The LAF consists of
overnight as well as term repo auctions. Repurchase agreements, called repo
(repurchase options) or reverse repo are agreements in which two parties agree
to sell and repurchase the same security. They are usually used for overnight
borrowing. Under a repurchase agreement the seller sells specified securities
with an agreement to repurchase the same at a mutually decided future date and
price. Similarly, the buyer purchases the securities with an agreement to resell
the same to the seller on an agreed date at a predetermined price. Such a transaction
is called a repo when viewed from the perspective of the seller of the securities
and reverse repo when viewed from the perspective of the buyer of the securities.
Under the LAF, the repo rate is the rate at which the Reserve Bank provides
overnight liquidity to banks against the collateral of government and other
approved securities under the liquidity adjustment facility (LAF). On the other
hand, the rate at which the Reserve Bank absorbs liquidity, on an overnight basis,
from banks against the collateral of eligible government securities under the
LAF is called the reverse repo rate.
With the LAF, repo rate has become the single independent policy rate. The
reverse repo rate is placed below the repo rate. Under the LAF, a Marginal
Standing Facility (MSF) was also instituted. MSF is a facility under which
scheduled commercial banks can borrow additional amounts of overnight money
from the RBI at a penal rate of interest. The MSF rate and reverse repo rate
determine the corridor for the daily movement in the weighted average call money
rate with the repo rate in the middle of the corridor (Figure 9.1). The LAF operates
through daily repo and reverse repo auctions thereby setting a corridor for the
short-term interest rate consistent with the policy objectives.
In the current monetary operating framework, reliance on direct instruments of

monetary policy has been reduced and liquidity management in the system is
carried out through open market operations (OMO) in the form of outright
16 purchases/sales of government securities and repo and reverse repo operations
under Liquidity Adjustment Facility (LAF). The LAF enables RBI to modulate Inflation and Monetary
Policy
short-term liquidity under varied financial market conditions in order to ensure
stable conditions in the overnight (call) money market.
Bank rate is the rate at which RBI is ready to buy or rediscount bills of exchange
or other commercial papers. The Bank Rate is published under Section 49 of the
Reserve Bank of India Act, 1934. This rate has been aligned to the MSF rate and,
therefore, changes automatically as and when the MSF rate changes alongside
policy repo rate changes.
Market Stabilisation Scheme (MSS) is an instrument for monetary management

was introduced in 2004. Surplus liquidity of a more enduring nature arising from
large capital inflows is absorbed through the sale of short-dated government
securities and treasury bills. The cash so mobilised is held in a separate
government account with the Reserve Bank.
Marginal Standing Facility
Corridor
Repo Rate
Reverse Repo Rate

Fig. 9.1: The Liquidity Adjustment Facility Framework
9.5.3 Monetary Policy Transmission

Monetary policy transmission is the process through which monetary policy
affects the ultimate policy target. That is, it is the process through which a change
in the policy rates by RBI, through changes in lending rates of banks, deposit
rates, asset prices and economic activities, ultimately affects the inflation rate.
As such, it is a complex process involving uncertainty in the channel, quantum,
and timing of impact.
Monetary policy acts through influencing the cost and availability of credit. A
change in RBI’s policy rate, through its impact on the short-term interest rates
and further on rates of longer-term instruments, affects the cost of funds for
banks. This would affect the rate at which banks would be willing to lend as well
as the rate that they would be willing to offer their depositors. For example, a
reduction in the policy rate leads to a lower cost of funds for the banks and
therefore lower lending rates. This would induce households and businesses to
avail greater credit from the banks and thus boost the aggregate demand in the
economy. The higher demand in the economy would put upward pressure on
wages and prices. Lower interest rates also boost the demand for assets and thus
increasing their prices. Higher asset prices imply greater wealth for the asset
owners and therefore may lead to greater spending in the economy, thus again
boosting the demand and pushing overall prices up. Lower interest rates could
also impact inflation through the exchange rate channel. Lower interest rates
imply lower returns for foreign investors and therefore may lead to capital flight
from the country. This would cause the currency to depreciate. This means that
imports are much morecostlier now compared to earlier, causing prices to go up.
The effectiveness of monetary policy essentially depends on the institutional
framework available for transmitting impulses released by the central bank. It 17
Monetary and Fiscal Policies has been observed that monetary policy transmission in India has been slow and
generally incomplete. India has a financial system dominated by commercial
banks. A major part of the total liabilities is in the form of deposits. A large
number of deposits have maturity over one year meaning that the changes in
policy rates would only impact new deposits. High NPAs have also impacted the
profitability and liquidity of the banks affecting the transmission process.
9.5.4 Evolution of Monetary Policy in India

The approach to monetary policy has been evolving over the years as per the
requirements of a dynamic economy since the inception of RBI as the country’s
central bank in the year 1935. Overall price stability and growth have been the
broad guiding principles of monetary policy. RBI was nationalised in 1949 and
Banking Regulation Act was enacted the same year. The latter required the banks
to maintain a Statutory Liquidity Ratio (SLR) as a percentage of their net time
and demand liabilities in the form of cash, gold or approved securities (Mohanty,
2017). During the initial decades after independence of the country, the role of
RBI was to support the developmental efforts of the government by ensuring
adequate flow of credit to the priority sectors of the economy. Owing to the
primacy of public investment in the development policy during this period, there
was persistent deficit financing. Issuance of ad-hoc treasury bills by the
government leading to automatic monetisation of deficits, as well as ensuring
flow of funds from banks through higher SLR were the main modes of financing
Government deficits. The monetisation of deficits, war with Pakistan in 1971,
oil price shocks during 1973 and 1979, as well as droughts in 1973 and 1979 led
to high inflation during the 1970s (Mohanty, 2017). Inflation increased from 10
per cent in 1972-73 to 25 per cent in 1974-75.
The Sukhamoy Chakravarty Committee formed in 1982 to assess the working of

the monetary system, recommended primacy of price stability in monetary policy.
Chakravarty Committee recommended a monetary targeting framework. Between
the 1980s and late 1990s, a monetary targeting framework was followed by the
RBI for monetary policy. Development and price stability continued to be the
primary objectives of monetary policy. Under this framework, broad money (M3)
was the intermediate target of monetary policy.
As you would know, the 1990s was a decade of many broad-based and
transformative reforms in the Indian economy. Due to the developments and
reforms in the financial sector, indirect instruments such as interest rates had
started gaining effectiveness as transmitters of policy signals. Liberalisation in
the financial markets made money demand unstable. Further, due to the greater
integration of the Indian economy with the global economy and the ensuing
inflow of foreign capital made it difficult to completely control the money supply.
Due to these reasons, RBI shifted to a “Multiple Indicators” approach in 1998-
99. Under this approach, Monetary policy was formulated based on a wide set of
variables and more emphasis was put on the rates channel for monetary policy
(Mohanty, 2011).
In September 2013, RBI set up an expert committee headed by its then Deputy
Governor, Dr. Urjit Patel, with a view to strengthen the monetary policy
framework while among other things, making it transparent and predictable. It
recommended that inflation should be set as the nominal anchor for monetary
18 policy framework and that it should be set as the predominant objective of
monetary policy. A nominal anchor is a variable that policy makers can use to Inflation and Monetary
Policy
“tie down” price level or its path (Mishkin, 1999).
Inflation expectations play an important role in shaping price behaviour.

Therefore, the ideal nominal anchor should be able to track inflation expectations.
The Committee recommended CPI-Combined headline inflation as the inflation
indicator for monetary policy. According to the committee, in the post-2011 period,
inflation expectations had been following CPI inflation and was affected by both
fuel and food inflation. Therefore, CPI headline inflation was the appropriate
target for monetary policy.
Table 9.2: Monetary Policy phases in India
1950s to 1980s 1980s to 1998 1998 to 2016 2016 to Present

Developmental Monetary Multiple Indicators Flexible Inflation
Central banking Targeting Approach Targeting
and Credit
Broad money (M3) Multiple indicators CPI inflation target
Planning &
as an intermediate including interest (currently of 4 per
Targeting
target and Reserve rates, broad money, cent +/–2 per cent
Credit planning Money (M0) as credit by banks and band)
operating target financial institutions,
capital flows, inflation
rate etc.
9.5.5 Inflation Targeting Framework

What Urjit Patel Committee (RBI, 2014) recommended was a framework for
monetary policy is called the Flexible Inflation Targeting framework. Various
economies globally have followed inflation targeting since the late 1980s. An
inflation targeting regime follows a monetary policy framework with a mandate
for price stability through a numerical target for inflation. This brings in greater
transparency and accountability into the operation of monetary policy as well as
greater operational independence for the monetary authority. The Government
of India and RBI entered into a Monetary Policy Framework Agreement on 25th
February, 2015 which required RBI to bring inflation below six per cent by January
2016 and the target inflation for 2016-17 and all subsequent years as 4 per cent
with a band of +/– 2 per cent. The RBI Act 1934 was amended in May 2016 to
introduce Flexible Inflation Targeting Framework in India. The Government of
India notified a medium-term inflation target of 4 per cent with a band of +/– 2
per cent for the period from August 5, 2016 to March 31, 2021. RBI would be
deemed to have failed in achieving the target if the inflation in any consecutive
three quarters is either above 6 per cent or below 2 per cent. In case of failure to
meet the target, RBI is required to present a report to the Central Government
detailing the reasons for the failure to meet the target, remedial actions proposed
to be taken by RBI and the estimated time in which the target would be achieved
through the recommended actions. RBI is also required, once every six months,
publish a Monetary Policy Report, explaining (a) the sources of inflation; and
(b) the forecasts of inflation for the period between six to eighteen months from
the date of publication of the document.
A Monetary Policy Committee (MPC) was instituted to determine monetary

policy. For this purpose, the Reserve Bank of India Act, 1934 was amended by
19
Monetary and Fiscal Policies the Finance Act, 2016. MPC consists of six members, out of which three members
are from RBI and the other three are appointed by the Central Government as
notified by the Central Government. The composition of MPC as follows:
a) the Governor of the Bank– ex officio Chairperson;
b) Deputy Governor of the Bank, in charge of Monetary Policy– ex officio
Member;
c) one officer of the Bank to be nominated by the Central Board– ex officio
Member; and
d) three persons to be appointed by the Central Government– Members.
The MPC is to meet at least 4 times in a year. The quorum for a meeting of MPC
is four of which at least one is to be the Governor and, in his absence, the Deputy
Governor who is a Member of the MPC. MPC determines the policy rate in
order to achieve the inflation target. Decisions are based on majority votes by
the members of the MPC present in the meeting. Each Member of the Monetary
Policy Committee has one vote. In case of a tie of votes, the Governor may have
a second or casting vote to resolve the tie. After each meeting of MPC, RBI
publishes the resolution adopted by the Committee. On the 14thday, the minutes
of the proceedings of the MPC are published.

1) In your opinion, is inflation targeting an appropriate monetary policy regime
for a developing country like India? Why or why not?
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
2) Look at the latest available Bi-monthly Monetary Policy Statement –
Resolution of the Monetary Policy Committee (MPC). What is the decision
of the MPC with respect to the repo rate? What is the assessment made by
MPC on the growth and inflationary outlooks for the economy? How do
you think these assessments have influenced the decision on the policy rate?
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
9.6 LET US SUM UP

In this unit, we have looked at the concepts of money and inflation and the link
between the two. After going through the unit, you would now be able to analyse
the current trends in inflation and understand the causes of inflation from an
20
economic perspective. We have also looked at the objectives of monetary policy Inflation and Monetary
Policy
in India, its instruments and how it has evolved over the years. Over the years,
RBI has moved from direct to indirect instruments for monetary policy. You
would realise that the developments in monetary policy framework in the country
has paralleled the overall liberalisation and modernisation efforts in the rest of
the economy. The current monetary policy framework in India is the flexible
inflation targeting framework with a numerical target of 4 +/– 2 per cent inflation.
9.7 TERM- END EXERCISES

1) What is money and what functions does it serve? Which of these functions
do the following satisfy and which they do not?
a) Gold coins
b) A credit card
c) A painting by M.F. Hussain
d) A fixed deposit
2) What is inflation? How is it measured in India?
3) What are the costs of inflation? Do you think there are any benefits to
inflation? Why do we not want zero inflation?
4) What is the Quantity Theory of Money and how does it explain the
relationship between money growth and inflation?
5) What are the objectives of monetary policy in India? How has the monetary
policy evolved? What is the current monetary policy framework in the
country?
6) What are the monetary policy instruments used by the Reserve Bank of
India?
9.8 KEY WORDS

Money : Money is anything that is generally accepted as a
medium of exchange. Apart from being a medium of
exchange, it serves as a unit of account and a store of
value.
Inflation : The rate of increase in the general price level over a

period of time. It is measured usually in terms of the
growth in a price index such as the Consumer Price
Index.
Statutory Liquidity : The share of NDTL that a bank is required to maintain

Ratio in safe and liquid assets, such as, unencumbered
government securities, cash and gold. Changes in
SLR often influence the availability of resources in
the banking system for lending to the private sector.
Open Market : These include both, outright purchase and sale of

Operations government securities, for injection and absorption
of durable liquidity, respectively.
21
Monetary and Fiscal Policies Market Stabilisation : This instrument for monetary management was
Scheme introduced in 2004. Surplus liquidity of a more
enduring nature arising from large capital inflows is
absorbed through the sale of short-dated government
securities and treasury bills. The cash so mobilised is
held in a separate government account with the
Reserve Bank.
Bank Rate : It is the rate at which the Reserve Bank is ready to

buy or rediscount bills of exchange or other
commercial papers. The Bank Rate is published under
Section 49 of the Reserve Bank of India Act, 1934.
This rate has been aligned to the MSF rate and,
therefore, changes automatically as and when the
MSF rate changes alongside policy repo rate changes.
Cash Reserve Ratio : The Cash Reserve Ratio (CRR) refers to the average
daily balance that a bank is required to maintain with
the RBI as a percentage of its Net demand and time
liabilities (NDTL) that the RBI may notify from time
to time.
Reverse Repo : The rate at which the Reserve Bank absorbs liquidity,
on an overnight basis, from banks against the
collateral of eligible government securities under the
LAF.
Liquidity Adjustment : The LAF consists of overnight as well as term repo

Facility auctions. Progressively, the Reserve Bank has
increased the proportion of liquidity injected under
fine-tuning variable rate repo auctions of range of
tenors.
Marginal Standing : A facility under which scheduled commercial banks

Facility can borrow additional amount of overnight money
from the Reserve Bank by dipping into their Statutory
Liquidity Ratio (SLR) portfolio up to a limit at a penal
rate of interest. This provides a safety valve against
unanticipated liquidity shocks to the banking system.
9.9 REFERENCES
1) Agreement on Monetary policy Framework between the Government of
India and the Reserve Bank of India, 2015
2) Ashima Goyal 2014 “History of Monetary Policy in India Since
Independence”, Springer Briefs in Economics
3) Deepak Mohanty 2011 “Changing contours of monetary policy in India”
Speech at the Royal Monetary Authority of Bhutan, Thimphu, 1 December
2011
4) Deepak Mohanty 2017 “Eight Decades of Monetary Policy in India” in
India’s Economy: Pre-liberalisation to GST—Essays in Honour of Raj Kapila
22
5) Frederic S. Mishkin 1999 “International Experiences with Different Inflation and Monetary
Policy
Monetary Policy Regimes”, National Bureau of Economic Research Working
Paper 6965
6) RBI 2014, “Report of the Expert Committee to Revise and Strengthen the
Monetary Policy Framework” January 2014, Reserve Bank of India
7) Reserve Bank of India Act, 1934 (As amended by the Finance (No. 2) Act,
2019)
8) Viral Acharya 2017, “Monetary Transmission in India: Why is it important
and why hasn’t it worked well”, Inaugural Aveek Guha Memorial Lecture
November 2017, Tata Institute of Fundamental Research (TIFR)

PROGRESS EXERCISES

1) A useful reference could be “Report of the Expert Committee to Revise and
Strengthen the Monetary Policy Framework” which can be downloaded
from the RBI website.
2) See the RBI website for the latest monetary policy statement.
23
UNIT 10 CAPITAL MARKET AND ITS
REGULATIONS
Structure
10.0 Objectives
10.1 Introduction
10.2 Role, Significance and Function of Capital Market
10.3 Stock Market Development in India
10.4 Structure and Performance of Indian Stock Market
10.5 Equity Derivatives in India
10.5.1 Exchange-Traded and Over-the-Counter Derivative Instruments
10.6 Currency Derivative Market in India
10.7 Long-Term Government Bond and Corporate Debt Market in India
10.7.1 Outlook for Development of Corporate Debt Market
10.8 Let Us Sum Up
10.10 Key Words
10.11 References
10.0 OBJECTIVES
develop an understanding of the organisational structure, role, function and
performance of the Indian capital market;
explain the radical restructuring of the Indian capital market in the wake of
the new economic policy in 1991; and
discuss the role, function and structure of Indian Equity Market, Currency
Market, Derivative Market and Corporate Debt Market.
10.1 INTRODUCTION
A dynamic and efficient financial system plays a pivotal role in any economy for
efficient allocation of resources from the surplus segments to deficit segments.
The financial system consists of financial markets, financial intermediation and
financial products or instruments. A thriving and vibrant economic system requires
a well developed financial structure with multiple intermediaries operating in
the market with different risk profiles. Further, a financial system helps to increase
output by moving the economic system towards the production frontier. This
involves transforming a given amount of wealth into more productive forms. It
induces public and investors to hold lower saving in the form of precious metals,
real estate, land, consumer durables and idle cash balances and to replace these
assets by financial instruments such as bonds, shares, preference shares, units
etc. As a result a financial system helps to increase the volume of productive
24
investments. It encourages investment activity by reducing the cost of finance Capital Market and Its
Regulations
and risk. This is done by providing insurance services and hedging opportunities
and by making financial services such as remittances, discounting, acceptance,
and guarantees available. Finally, it not only increases greater investment but
also raises the level of resource allocational efficiency among different investment
channels. The broad picture of the Indian Financial System is presented in the
schematic diagram as Figure 10.1. The financial system in India is characterised
by progressive liberal policies, vibrant equity and debt markets and prudent
banking norms.
Financial Institutions
Funds Commercial Banks

Insurance Companies Funds
Mutual Funds
Provident Funds
Deposits/Shares Non-Banking Financial Loans
Companies
F S
u e
Suppliers of Funds
n c
d u Demanders of Funds
s r
Individuals Individuals
i
Businesses Business
Funds t
Governments Governments
i
Private e
Placement s
Securities
Financial Markets
Funds Money Market Funds

Capital Market
Securities Securities
Fig.10.1: Indian Financial System

Source: Author
Capital market is an integral part of the financial market. The capital market is a
market for financial assets which have a long or indefinite maturity. Capital market
is broadly categorised into two parts such as primary and secondary market. In
the primary market, new stock or bond issues are sold through a mechanism
popularly known as underwriting. In the secondary market shares that have been
issued are traded through organised exchanges such as stock exchanges, over
the counter, etc. The capital market consists of stock or equity market, debt
market,derivative market, foreign exchange market and commodity market. These
markets are providing the facilities for buying and selling of the variety of financial
claims and services. The corporations, financial institutions, individuals, and
governments trade in financial products on these markets either directly or through
brokers and dealers on organised exchanges or off exchanges. The capital market
participants on the demand and supply sides of these markets are financial
institutions, agents, banks, brokers, dealers, lenders, savers and others who are
interlinked by the laws, contracts, covenants, and communication networks. The 25
Monetary and Fiscal Policies primal role of the capital market is to channelise investments from investors
who have surplus funds to the ones who are running a deficit. Financial regulator
such as the Security Exchange Board of India (SEBI) oversees the capital markets
in their designated jurisdictions to ensure that investors are protected against
fraud among other duties.
Reforming and liberalising financial markets began in the wake of the country’s
1991 balance-of-payments crisis. The thrust of these reforms was to promote a
diversified, efficient and competitive financial system, with the ultimate objective
of improving the allocation of resources through operational flexibility, improved
financial viability, and institutional strengthening. The pace of reform was,
however, slower than those in product markets, partly because the introduction
of stricter prudential controls on banks revealed significant problems in asset
portfolios. Prior to the reforms, state-owned banks controlled 90 per cent of bank
assets– compared with approximately 10 per cent at end-2005– and channelled
an extremely high proportion of funds to the government. Interest rates were
determined administratively; credit was allocated based on government policy
and approval from the Reserve Bank of India (RBI) was required for individual
loans above a certain threshold. Capital markets were underdeveloped, with stock
markets fragmented across the country. The major stock market acted mainly in
the interest of its members, not the investing public. Derivative markets did not
exist and comprehensive capital controls meant that companies were unable to
bypass domestic controls by borrowing abroad. Concerns over the 1997-98 Asian
financial crisis and its contagion effects further spurred Indian authorities to
strengthen the domestic financial system. Reforms were, and continue to be,
based on several principles: (i) mitigate risks in the financial system; (ii) efficiently
allocate resources to the realsector; (iii) make the financial system competitive
globally, and (iv) open the external sector. The goal was to promote a diversified,
efficient, and competitive financial system which would ultimately improve the
efficiency of resource allocation through operational flexibility, enhanced financial
viability, and institutional strengthening.
The economic impact of COVID-19 is shaping up to be significant, however

uneven, across the Indian financial markets. Major structural economic reforms
in India such as demonetisation on 8th November 2016 and implementation of
Goods and Services Tax on 1st July 2017 poses a major challenge on Indian
equity market and foreign exchange market. The outbreak of global COVID-19
pandemic crisis has impacted the Indian economy, like others, by restricting
people, minds, innovations, goods and services. This has reflected in terms of
reduction in consumption demand, production and supply chain management,
investments, worsening of unemployment, reduction in the volume and receipts
of exports and imports, consequently a reduction in the growth rate.
10.2 ROLE, SIGNIFICANCE AND FUNCTION OF

CAPITAL MARKET
The capital market facilitates the transfer of capital (financial) assets from savers
to investors. It provides a significant amount of liquidity which refers to how
easily an asset can be converted to currency without loss of value. The major
functions of the capital market include efficient dissemination of information
enabling quick valuation of financial instruments, providing insurance against
26 market risk and price risk, enabling broad-based participation, providing
operational efficiency through simplified transaction procedures, lowering Capital Market and Its
Regulations
settlement timings and lowering transactional costs. Apart from these, the capital
market plays a vital role in advancing integration between real and financial
sectors, equity and debt instruments, long-term and short-term funds, private
sector and government sector, and domestic and external funds. It also speeds up
growth and development by directing the flow of funds into efficient channels
through investment, disinvestment and reinvestment. Thus the various roles of
the capital market contribute to mobilisation of savings and acceleration of capital
information, promotion of industrial growth, raising of long-term capital,
provision of a variety of services, and efficient and optimum channelisation of
funds.
Fig. 10.2: Components of Indian Corporate Securities Markets

Source: Author

1) What are the constituents of financial system?
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27
Monetary and Fiscal Policies 2) Who are the different participants in a capital market?
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3) List the major functions of a capital market.
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10.3 STOCK MARKET DEVELOPMENT IN INDIA

To understand the role of a stock market in the process of the socio-economic
development process, let’s start with posing a question: why do stock markets
exist? Why is it important? In common parlance, a stock market is defined as a
public market where investors can buy and sell shares on the stock exchange.
The stocks are also known as common stock or equities and represent a fractional
ownership of the business in a company, firm or industries. Stock markets have
existed for centuries. Since its inception, the stock market has served multiple
purposes. The most important being to provide the companies with a means to
raise capital for investment and operational expansion. It also helps investors/
savers earn a return on their savings when they invest in the stock market and
allows firms to spread their risk by diversifying their business across sectors,
assets, industries, and geographies. This way of raising capital can help companies
to expand their operation alongside the creation of jobs in the economy. From
the larger perspective of economics, the increase in employment increases
purchasing power and therefore consumer spending, production and improves
supply chain management. The government benefits from tax revenues to advance
provisioning of public goods and thus economic growth and development. Apart
from conducive fiscal and monetary policies, a stock market plays a pivotal role
to promote investment activity in an economy.
A developed stock market is considered as the major barometer of economic

growth because (a) it provides an additional channel (along with banks and
financial institutions) for encouraging and mobilising domestic savings, (b)
ensures improvements in the productivity of investment through the market
allocation of capital, (c) increases managerial discipline through the market for
corporate control. In brief, the various indicators of stock market development
are Market Capitalisation Ratio (MCR)1, which is considered as a measure of
stock market size. In terms of the economic significance, market capitalisation
as a proxy for the market size is positively related to the ability to mobilise
28
1
The MCR is defined as the value of listed shares divided by GDP.
capital and diversify risk. The next major indicator is market liquidity, which is Capital Market and Its
Regulations
measured by value-traded ratio and turnover ratio. Value traded ratio equals the
total value of traded shares in the stock market divided by GDP. While, in turn,
turnover ratio is the value of total shares traded divided by market capitalisation.
The next important indicator of stock market development is the volatility
parameter, which conceptualises the asset price movement in a stock market and
conveys important signals for its development.
The average value of market capitalisation ratio (MCR) for India from 2003 to
2019 was 76.26 per cent. The minimum MCR was 45.93 per cent in 2003 and
the maximum was 149.51 per cent in 2007. In the latter part of 2007, the US
subprime lending crisis broke out and in no time it became a global economic
crisis. Due to this, the MCR fell drastically to 53.98 per cent. In the wake of
demonetisation undertaken by the Central Government on 8th Nov 2016, MCR
declined to 68.27 per cent from 72.08 per cent in 2015. Moreover, with the advent
of Goods and Service Tax (GST) on 1st July 2017, the MCR increased to 87.89
per cent and then declined to 75.81 per cent in 2019 and continued on a declining
trend subsequently because of COVID-19 pandemic. The stock market turn over
ratio (TOR) was 68.25 per cent on an average from 2003 to 2019. In 2003, the
TOR was 94.47 per cent. It had grown to 142.99 per cent during the global
financial crisis period in 2008. However, in the demonetisation period of 2016, it
declined to 51.18 per cent and further to 50.87 per cent during the GST period in
2017. It increased to 58.07 per cent in the post GST period in 2018 and then
declined to 28.89 per cent in 2019 and continued the trend during COVID-19
pandemic period. The average value of the stock market value traded ratio (VTR)
was 51.96 per cent with a minimum of 28.96 per cent in 2013 and a maximum of
93.97 per cent in 2007. It declined to 77.19 per cent in 2008 on account of the
global financial crisis and further to 34.94 per cent in 2016 because of
demonetisation before recovering to 44.71 per cent in 2017. Finally, the average
value of the stock price volatility from 2003 to 2017 was 21.83 per cent. The
minimum was 12.76 per cent in 2017 and a maximum of 43.74 per cent in 2009.
10.4 STRUCTURE AND PERFORMANCE OF

INDIAN STOCK MARKET
There are 23 stock exchanges in India, the first being the Bombay Stock Exchange
(BSE), which began formal trading in 1875, making it one of the oldest in Asia.
In 2010, the number of stock exchanges in India reduced to 19 as the Magadh,
Mangalore, Hyderabad and Saurashtra Kutch stock exchanges have been
derecognised by the market watchdog SEBI. As of Jan 17, 2020 the total number
of recognised stock exchanges in India has reduced to 9 (see Table 10.1) as the
Hyderabad Securities and Enterprises Ltd (erstwhile Hyderabad Stock Exchange),
Coimbatore Stock Exchange Ltd, Saurashtra Kutch Stock Exchange Ltd,
Mangalore Stock Exchange, Inter-Connected Stock Exchange of India Ltd, Cochin
Stock Exchange Ltd, Bangalore Stock Exchange Ltd , Ludhiana Stock exchange
Ltd, Gauhati Stock Exchange Ltd, Bhubaneswar Stock Exchange Ltd, Jaipur
Stock Exchange Ltd, OTC Exchange of India , Pune Stock Exchange Ltd, Madras
Stock Exchange Ltd, U.P. Stock Exchange Ltd, Madhya Pradesh Stock Exchange
Ltd, Vadodara Stock Exchange Ltd, Delhi Stock Exchange Ltd and Ahmedabad
Stock Exchange Ltd have been granted exit by SEBI.
29
Monetary and Fiscal Policies Table 10.1: List of Stock Exchanges in India (As of Jan 2020)
S. Name of the Recognised Segments Permitted Recognition

No. Stock Exchanges Valid upto
1. Bombay Stock Exchange a. Equity Permanent
Limited, Mumbai b. Equity Derivatives
c. Currency Derivatives
(including Interest Rate
Derivatives)
d. Commodity Derivatives
e. Debt
2. Calcutta Stock Exchange Ltd Permanent
3. India International Exchange a. Equity Derivatives 28-Dec-20

(India INX), Gujarat (Equity Index Derivatives
& Single Stock
Derivatives)
b. Commodity Derivatives
d. Debt
4. Indian Commodity Exchange Commodity Derivatives Permanent
Limited, Navi Mumbai
5. Metropolitan Stock Exchange a. Equity 15-Sep-20
of India Ltd., Mumbai b. Equity Derivatives
Futures)
d. Debt
6. Multi Commodity Exchange Commodity Derivatives Permanent
of India Ltd., Mumbai
7. National Commodity & Commodity Derivatives Permanent
Derivatives Exchange Ltd.,
Mumbai
8. National Stock Exchange of a. Equity Permanent
India Ltd., Mumbai b. Equity Derivatives
Derivatives)
d. Commodity Derivatives
e. Debt
9. NSE IFSC Ltd., Gujarat a. Equity Derivatives Permanent
(Equity Index Derivatives
& Single Stock Derivatives)
b. Currency Derivatives
c. Commodity Derivatives
d. Debt Securities
(Masala Bonds)
Source: SEBI
Note: India International Exchange Ltd and NSE IFSC Ltd have Single Segment across all
asset/product classes.
30
Before 1994, India’s stock markets were dominated by BSE. In other parts of the Capital Market and Its
Regulations
country, the financial industry did not have equal access to markets and was
unable to participate in forming prices, compared with market participants in
Mumbai (Bombay). As a result, the prices in markets outside Mumbai were often
different from prices in Mumbai. These pricing errors limited the order flow to
these markets. Explicit nationwide connectivity and implicit movement toward
one national market have changed this situation (Shah and Thomas, 1997). NSE
has established satellite communications which give all trading members of NSE
equal access to the market. Similarly, BSE and the Delhi Stock Exchange are
both expanding the number of trading terminals located all over the country. The
arbitrages are eliminating pricing discrepancies between markets.
Over the last few years, there has been a rapid change in the Indian securities
market, especially in the secondary market. Advanced technology and online
screen-based transactions have modernised the stock exchanges. In terms of the
number of companies listed and total market capitalisation, the Indian equity
market is considered large relative to the country’s stage of economic
development. Metropolitan Stock Exchange of India Limited (MSE) is recognised
by the Securities and Exchange Board of India (SEBI) under Section 4 of
Securities Contracts (Regulation) Act, 1956. The Exchange was notified as a
“Recognised Stock Exchange” under Section 2(39) of the Companies Act, 1956
by Ministry of Corporate Affairs, Govt. of India, on December 21, 2012. MSE
offers an electronic, transparent and hi-tech platform for trading in Capital Market,
Futures and Options, Currency Derivatives and Debt Market segments. The
Exchange has also received in-principle approval from SEBI for operationalising
SME trading platform. MSE commenced operations in the Currency Derivatives
(CD) Segment on October 7, 2008, under the regulatory framework of SEBI and
Reserve Bank of India (RBI). MSE launched Capital Market Segment, Futures
and Options Segment and flagship index ‘SX40’ on February 9, 2013, and
commenced trading from February 11, 2013. Trading in the ‘SX40’ index
derivatives began from May 15, 2013. ‘SX40’, is a free-float based index
consisting of 40 large-caps, liquid stocks representing diverse sectors of the
economy. The Debt Market Segment of MSE was launched on June 7, 2013, and
trading commenced from June 10, 2013. The Exchange started live trading in
cash-settled Interest Rate Futures (IRF), on Government of India security, in its
Currency Derivative Segment from January 20, 2014.
On 9th Jan 2017, the Hon’ble Prime Minister of India, Shri Narendra Modi
inaugurated India International Exchange Ltd. (IFSC), India’s first international
exchange. BSE is the first stock exchange in India to receive approval from
SEBI on 26th September 2011 to launch Small and Medium Enterprises (SME)
platform. The Platform facilitates capital raising by small and medium enterprises
including start-up companies which are in their early stages of growth. It also
provides easier entry and exit options for informed investors like angel investors,
Venture Capital funds (VCFs) and Private Equities (PEs) etc. and equity financing
which lowers the debt burden leading to lower financing cost and healthier balance
sheet. SME IPO Index with a Base value of 100 as on 16th August 2012 is aimed
at tracking the companies listed on the SME platform was launched on 14th
December 2012. As on 31st August 2020, its value was 1,435.44.
31
Monetary and Fiscal Policies BSE is the first stock exchange in India to lunch startups platform on 22nd
September 2018. The ‘Startup Companies’ seeking to be listed on the BSE Startups
Platform should be in the sector of IT, ITES, Biotechnology and Life Science,
3D Printing, Space Technology, E-commerce, Hi-tech Defence, Drones, Nano
Technologies, Artificial Intelligence, Big Data, Augmented/Virtual Reality,
Egaming, Exoskeleton, Robotics, Holographic Technology, Genetic Engineering,
Variable Computers Inside Body Computer Technology and other high-tech
industries.
However, the Indian stock market is dominated by Bombay Stock Exchange and
(BSE) and National Stock Exchange(NSE) which are occupying the 11th and 12th
largest exchange in the World with the market capitalisation of 1.83 trillion and
1.41 trillion dollars respectively as of 2019. The average listed companies in
Indian stock exchanges during the period from 1983 to 2018 was 4370 companies
with a minimum of 1151 companies in 1983 and a maximum of 5999 companies
in 1996. The latest number of companies in 2018 is 5065 companies. For
comparison, the World average in 2018 based on 70 countries is 597 companies.
A higher number of listed companies in Indian stock exchanges means that more
companies use equity financing in their business. In February 2020, all the
securities markets in the World is nosediving coupled with a precipitous fall in
crude oil prices. India’s market capitalisation to GDP ratio is 81 per cent compared
to 51 per cent in Germany (Bloomberg). The market capitalisation of both BSE
and NSE decreased by 6.2 per cent as on February 29, 2020, in comparison to
previous month post to the first detection of COVID-19 patient in India on 30th
Jan 2020 in the State of Kerala.
A snapshot of the growth rates, stock returns, volatility of stock prices, and FII
net flows by comparing the major three events such as demonetisation,
implementation of GST and the impact of COVID-19 is presented in Table 10.2.
The demonetisation phase is considered from 9th November 2016 to 30th June
2017 and from 1st July 2017 to 29th January 2020 as treated as a post-GST phase.
Similarly, the period starting from 30th January 2020 to 20 April 2020 are included
in COVID-19 phase.
The growth rate of S&P BSE Sensex stock price shows a negative growth
(–22.65 per cent) during COVID-19 pandemic phase as compared to positive
growth rates of 12.07 per cent and 31.9 per cent during post demonetisation and
GST phases, respectively. However, the other stock indices such as mid-cap,
small-cap and all sectors except health care show drastic negative growth rates
during COVID-19 phase as compared to demonetisation and GST phases. Both
the returns and volatility series of stock indices reveal a precarious scenario
during COVID-19 phase in comparison to other events.
All the stock indices except healthcare show negative returns and high volatility
during this ongoing COVID-19 pandemic. Among three major stock indices as
reported in Table 10.1, the growth and return of small-cap companies are a worse
performer as compared to mid-cap and BSE Sensex, whereas, the BSE Sensex
stock price is more volatile as compared to mid-cap and small-cap stock indices.
Nevertheless amongst the sectors, realty, metal, Bankex and auto are a worse
32
Capital Market and Its
Table 10.2:Trends of Growth, Stock Returns and Volatility of Stock Prices, and FII flows during the phase Regulations
of Post Demonetisation, Post GST and COVID-19 pandemic
Variables COVID-19 Pandemic Post Demonetisation Post GST
Growth Return Volatility Correlation Growth Return Volatility Growth Return Volatility
Stock
Indices
SENSEX -22.65 -0.54 2.77 0.15 12.07 0.08 0.51 31.96 0.05 0.59
Mid-cap -24.15 -0.59 2.13 0.22 12.99 0.08 0.67 6.38 0.01 0.72
Small-cap -25.96 -0.63 1.99 0.27 18.07 0.11 0.70 -4.70 -0.01 0.70
BSE100 -22.78 -0.55 2.65 0.16 12.01 0.08 0.55 23.29 0.04 0.60
BSE200 -22.76 -0.55 2.58 0.16 12.34 0.08 0.55 22.14 0.03 0.60
BSE500 -23.24 -0.56 2.53 0.17 13.16 0.08 0.55 19.36 0.03 0.60
Sectorial
Indices
Auto -30.95 -0.77 2.69 0.21 5.18 0.04 0.81 -22.16 -0.04 0.90
Bankex -33.17 -0.84 3.29 0.16 17.66 0.11 0.77 33.87 0.05 0.82
Cap-Goods -30.12 -0.74 2.43 0.24 19.04 0.11 0.74 2.82 0.01 0.85
Con-dura -21.22 -0.49 2.25 0.11 28.33 0.16 0.91 60.88 0.08 0.84
FMCG -7.76 -0.20 2.25 0.06 21.40 0.12 0.74 10.33 0.02 0.65
Healthcare 5.76 0.09 1.96 0.17 -6.93 -0.05 0.74 0.45 0.00 0.78
IT -19.16 -0.46 2.45 0.13 -0.15 0.00 0.83 63.96 0.08 0.81
Metal -34.63 -0.90 3.27 0.16 8.40 0.05 1.16 -14.95 -0.02 1.27
Oil and Gas -20.67 -0.51 2.62 0.18 10.91 0.07 0.76 9.57 0.02 0.93
Power -21.47 -0.50 2.18 0.26 11.92 0.07 0.74 -12.93 -0.02 0.77
PSU -28.13 -0.70 2.58 0.21 5.11 0.03 0.74 -17.41 -0.03 0.92
Realty -41.76 -1.11 2.73 0.23 38.45 0.21 1.45 21.17 0.03 1.22
TECK -17.87 -0.42 2.40 0.12 1.94 0.01 0.74 44.66 0.06 0.73
FII Flows
Aggregate
Flows
Purchases 9.0 - 49.46 -0.10 11.99 - 61.47 10.6 - 57.34
Sales 7.9 - 45.10 -0.16 9.27 - 49.80 9.7 - 65.92
Net -21.3 - 492.96 0.10 -27.20 - 1081.92 -163.8 - 5394.32
Equity -
Purchases 13.6 - 63.15 0.07 12.16 - 61.47 12.2 - 63.78
Sales 8.0 - 47.09 -0.05 9.38 - 50.97 9.5 - 58.88
Net -69.9 - 1997.07 0.13 -587.07 - 8503.84 171.1 - 6845.09
Debt
Purchases 65.9 - 209.65 -0.27 86.15 - 408.56 - - -
Sales 39.9 - 142.78 -0.26 65.16 - 303.68 313.7 - 6197.72
Net 42.7 - 807.85 0.07 1252.35 - 15856.43 148.2 - 5943.26
Source: Mishra, Rath and Dash (2020) 33

Monetary and Fiscal Policies performer in terms of stock returns as well as the growth of the stock price. Since
the demand for healthcare products and services are important during this COVID-
19 pandemic, which could perhaps reflect in showing a positive stock price returns
with low volatility. The second-best performer during this ongoing pandemic is
Fast-Moving Consumer Goods (FMCG) companies, which also show a relatively
less affected sector as compared to other sectors. The net FII flows figures
demonstrate a negative growth during all three phases, but this indicator is less
volatile in COVID-19 phase as compared to the other two events. This implies
that although the average gross sales are higher than average gross purchase,
growth of FII outflows from Indian financial market is still lower in COVID-19
phase as compared to post demonetisation and post-implementation of GST phases
(Mishra, Rath and Dash, 2020).

1) Why is a developed stock market considered as a barometer of economic
growth?
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2) What is market capitalisation ratio?
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3) Explain the structure of Indian Stock Market. What are the various reforms
brought through these years in this market?
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34
4) How has the Indian Stock market been performing during the times of GST Capital Market and Its
Regulations
implimentation and demonetisation?
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10.5 EQUITY DERIVATIVES IN INDIA

A derivative security is a financial contract whose value is derived from the
value of something else, such as a stock price, a commodity price, an exchange
rate, an interest rate, or even an index of prices. Derivatives may be traded for a
variety of reasons. A derivative enables a trader to hedge some pre-existing risk
by taking positions in derivatives markets that offset potential losses in the
underlying or spot market. In India, most derivatives users describe themselves
as hedgers (Fitch Ratings, 2004) and Indian laws generally require that derivatives
be used for hedging purposes only. Another motive for derivatives trading is
speculation (i.e. taking positions to profit from anticipated price movements). In
practice, it may be difficult to distinguish whether a particular trade was for
hedging or speculation, and active markets require the participation of both
hedgers and speculators. The third type of trader, called arbitrageurs, profit from
discrepancies in the relationship of spot and derivatives prices, and thereby help
to keep markets efficient. Equity derivatives trading started in India in June 2000,
after a regulatory process which stretched over more than four years. In July
2001, the equity spot market moved to rolling settlement. India’s experience
with the launch of the equity derivatives market has been extremely positive, by
world standards. NSE is now one of the prominent exchanges amongst all
emerging markets, in terms of equity derivatives turnover. There is an
increasing sense that the derivatives market is playing a major role in shaping
price discovery.
10.5.1 Exchange-Traded and Over-the-Counter Derivative

Instruments
OTC (over-the-counter) contracts, such as forwards and swaps, are bilaterally
negotiated between two parties. The terms of an OTC contract are flexible and
are often customised to fit the specific requirements of the user. OTC contracts
have substantial credit risk, which is the risk of the counterparty that owes money
defaults on the payment. In India, OTC derivatives are generally prohibited with
some exceptions: those that are specifically allowed by the Reserve Bank of
India (RBI) or, in the case of commodities (which are regulated by the Forward
Markets Commission), those that trade informally in “hawala” or forwards
markets. An exchange-traded contract, such as a futures contract, has a
35
Monetary and Fiscal Policies standardised format that specifies the underlying asset to be delivered, the size
of the contract, and the logistics of delivery. They trade on organised
exchanges with prices determined by the interaction of many buyers and sellers.
In India, two exchanges offer derivatives trading: the Bombay Stock
Exchange (BSE) and the National Stock Exchange (NSE). A snapshot of turnover
in BSE is presented in Table 10.3. However, NSE now accounts for virtually all
exchange-traded derivatives in India, accounting for more than 99 per cent of
volume in 2003-2004. Contract performance is guaranteed by a clearinghouse,
which is a wholly-owned subsidiary of the NSE Margin requirements and
daily marking-to-market of futures positions substantially reduce the credit
risk of exchange-traded contracts, relative to OTC contracts (Asani Sarkar,
2006).
In the exchange-traded market, the biggest success story has been derivatives on
equity products. Index futures were introduced on June 12, 2000, followed by
index options on June 4, 2001, and options and futures on individual securities
in July 2001 and November 2001, respectively. As of 2005, the NSE trades futures
and options on 118 individual stocks and 3 stock indices. The NSE currently
provides trading in futures and options contracts on indices such as Nifty 50
index, Nifty IT index, Nifty Bank index, Nifty Midcap 50 index, Nifty
Infrastructure index, Nifty PSE index, and Nifty CPSE. All these derivative
contracts are settled by cash payment and do not involve physical delivery of the
underlying product. Derivatives on stock indexes and individual stocks have
grown rapidly since inception. In particular, single stock futures have become
hugely popular, accounting for about half of NSE’s traded value in October 2005.
NSE has the highest volume (i.e.the number of contracts traded) in the single
stock futures globally, enabling it to rank 16 among world exchanges in the first
half of 2005. Single stock options are less popular than futures. Index futures are
increasingly popular and accounted for close to 40 per cent of traded value in
October 2005. NSE launched interest rate futures in June 2003 but, in contrast to
equity derivatives, there has been little trading in them. One problem with these
instruments was faulty contract specifications, resulting in the underlying interest
rate deviating erratically from the reference rate used by market participants.
Institutional investors have preferred to trade in the OTC markets, where
instruments such as interest rate swaps and forward rate agreements are thriving.
As interest rates in India have fallen, companies have swapped their fixed rate
borrowings into floating rates to reduce funding costs. However, it may be noted
that the detailed discussion of Equity Derivative instruments is beyond the scope
of this unit. Table 10.4 presents the turnover of stock options in both BSE and
NSE in panel A and B respectively. The NSE witnessed a domestic market share
of 84 per cent in the cash market segment with 100 per cent market share in the
equity derivatives segment during fiscal 2017 (Annual Report of NSE, 2017).
36
Table10.3: Turnover (BSE) in Indian Equity Derivatives Market Capital Market and Its
Regulations
Period No. of Index Stock Index Option
Trading Future Future Call Put
Days Turnover Turnover Notional Notional
(` crore) (` crore) Turnover Turnover
(` crore) (` crore)
2010-11 254 154.08 0.00 0.00 0.25
2011-12 249 178,448.82 10,215.70 200,089.59 418,252.79
2012-13 249 122,373.70 3,418.27 3,230,231.91 3,797,249.17
2013-14 251 63,493.81 54,609.21 5,705,316.57 3,349,884.08
2014-15 243 48,632.28 9,794.23 10,112,605.17 10,016,621.27
2015-16 247 13,097.14 1,349.66 2,560,540.64 1,825,708.15
2016-17 248 2,266.96 203.07 1,254.89 3,214.45
2017-18 246 3,217.54 36.73 5.92 2.28
2018-19 248 39.16 17.78 1,308.50 884.63
2019-20* 183 8,362.57 150.63 13,190.06 6,432.51

Source:BSE and SEBI
Note: * indicates upto 31st Dec 2019, Turnover in notional value.
Table 10. 4:Turnover in Indian Equity Derivatives Market (BSE & NSE)
Period Panel-A Stock Options (BSE) Total
Call Put
No. of Premium Notional No. of Premium Notional No. of Notional
Contracts Turnover Turnover Contracts Turnover Turnover Contracts Turnover
(` crore) (` crore) (` crore) (` crore) (` crore)
2010-11 0 0.00 0.00 0 0.00 0.00 5,623 154.33
2011-12 39,848 0.00 1,277.28 7,657 0.00 191.82 3,22,22,825 808,476.00
2012-13 1,78,313 0.00 5,185.77 2,09,557 0.00 5,059.86 26,24,43,366 7,163,518.70
2013-14 6,67,365 0.00 22,185.51 8,77,355 0.00 23,945.21 30,19,42,441 9,219,434.44
2014-15 30,10,092 0.00 93,854.42 27,00,450 0.00 81,233.89 50,54,78,869 20,362,741.27
2015-16 10,09,439 374.25 31,904.12 14,13,452 351.32 42,408.54 10,62,09,394 4,475,008.26
2016-17 0 0.00 0.00 0 0.00 0.00 1,23,538 6,939.37
2017-18 3 0.00 0.18 0 0.00 0.00 44,701 3,262.65
2018-19 2 0.00 0.08 0 0.00 0.00 31,167 2,250.14
2019-20* 8,472 8.96 626.03 7,876 7.58 583.24 2,90,395 29,345.04
37
Panel-B
Period Stock Options (NSE) Total
Call Put
No. of Notional Notional No. of Premium Notional No. of Notional
Contracts Turnover Turnover Contracts Turnover Turnover Contracts Turnover
(` crore) (` crore) (` crore) (` crore) (` crore)
2010-11 2,42,73,560 15,710 7,77,109 82,34,833 4,765 2,53,235 103,42,12,062 2,92,48,221
2011-12 2,45,65,283 13,331 6,71,770 1,19,29,088 6,282 3,05,261 120,50,45,464 3,13,49,732
2012-13 4,24,99,219 22,583 13,02,779 2,42,78,974 11,705 6,97,648 113,14,67,418 3,15,33,004
2013-14 5,03,00,025 29,812 15,43,895 2,98,74,406 16,617 8,65,594 128,44,24,321 3,82,11,408
2014-15 6,12,04,473 43,345 22,43,382 3,02,74,736 18,387 10,39,170 183,70,41,131 5,56,06,453
2015-16 6,53,22,962 39,014 23,25,030 3,49,76,212 22,380 11,63,144 209,86,10,395 6,48,25,834
2016-17 6,12,05,774 65,782 41,47,488 3,09,00,238 29,788 19,59,998 139,97,46,129 9,43,70,302
2017-18 8,62,82,094 1,02,165 67,28,007 4,01,29,282 46,053 29,27,002 191,38,78,548 16,49,84,859
2018-19 12,35,10,308 1,28,529 85,17,920 6,34,76,234 71,481 40,64,454 316,48,02,420 23,76,00,705
2019-20* 9,44,82,765 96,372 58,15,639 5,46,53,714 61,374 31,37,545 367,40,28,197 24,64,27,009
Source: BSE, NSE and SEBI

Note: * indicates upto 31st Dec 2019, Turnover in notional value.
Table 10.5: Turnovers in Index Derivatives

(Per cent)
Period BSE NSE MSEI**
Index Index Index Index Index Index
Futures Options Futures Options Future Option
2010-2011 100.00 - 19.17 80.83 NA NA
2011-2012 22.38 77.62 13.61 86.39 NA NA
2012-2013 1.76 98.24 9.99 90.01 NA NA
2013-2014 0.75 99.25 10.00 90.00 45.13 54.87
2014-2015 0.24 99.76 9.33 90.67 100.00 -
2015-2016 0.30 99.70 8.52 91.48 - -
2016-2017 33.65 66.35 5.62 94.38 - -
2017-2018 99.75 0.25 3.44 96.56 - -
2018-2019 1.75 98.25 2.67 97.33 - -
2019-2020* 85.77 14.23 2.06 97.94 - -
Source: BSE, NSE, MSEI and SEBI

Note: * indicates upto 31st Dec 2019, ** Trading in equity derivatives segment for Index future
and option has commenced from May 15, 2013
Table 10.5 reports the turnovers in index futures and index options in three stock
exchange such as Bombay Stock Exchange (BSE), National Stock Exchange
(NSE), Metropolitan Stock Exchange of India Limited (MSEI). The turnover
per cent in both BSE and NSE for the index futures are affected in the year of
38
2016, 2017 and 2019. This may be due to the impact of demonetisation, Capital Market and Its
Regulations
implementation of GST and the Global pandemic impact of COVID-19
respectively. However, there is not much impact noticed in the case of index
options during the same period.
10.6 CURRENCY DERIVATIVE MARKET IN INDIA

Currency derivative is a contract between the seller and buyer, whose value is to
be derived from the underlying asset, the currency amount. A derivative based
on currency exchange rates is a future contract which stipulates the rate at which
a given currency can be exchanged for another currency as at a future date.
Currency future contracts allow investors to hedge against foreign exchange risk.
Currency Derivatives are available on four currency pairs viz. US Dollars (USD),
Euro (EUR), Great Britain Pound (GBP) and Japanese Yen (JPY). Cross Currency
Futures and Options contracts on EUR-USD, GBP-USD and USD-JPY are also
available for trading in Currency Derivatives segment (NSE).
Foreign exchange derivatives are less active than interest rate derivatives in India,
even though they have been around for longer. Over-the-counter (OTC)
instruments in currency forwards and swaps are the most popular. Importers,
exporters and banks use the rupee forward market to hedge their foreign currency
exposure. Turnover and liquidity in this market have been increasing, although
trading is mainly in shorter maturity contracts of one year or less (Gambhir and
Goel, 2003). In a currency swap, banks and corporations may swap its rupee-
denominated debt into another currency (typically the US dollar or Japanese
yen), or vice versa. Trading in OTC currency options is still muted. There are no
exchange-traded currency derivatives in India.
10.7 LONG-TERM GOVERNMENT BOND AND

CORPORATE DEBT MARKET IN INDIA
The corporate bond and long-term Government Securities market is a vital
segment of the capital market. The corporate bond market is at the budding phase
in India. The corporate bond market remains restricted for participants, largely
arbitrage driven and also highly illiquid. The lack of development is anomalous
for two reasons: First, India has developed world-class markets for equities and
equity derivatives supported by high-quality infrastructure. Second, the
infrastructure for the bond market, particularly the government bond market, is
similarly of high quality. Until 2007, information on the Indian corporate bond
market turnover was incomplete and largely anecdotal. In 2007, however, the
Securities and Exchange Board of India (SEBI) launched initiatives to ensure
more comprehensive reporting of the over-the-counter (OTC) bond market.
Current volumes are running at low levels– around 140 transactions amounting
to about USD80 million per day. But corporate bond markets worldwide are
typically illiquid, so it may be overly optimistic to expect India to develop a
uniquely liquid corporate bond market. Nonetheless, a more liquid market should
eventually contribute to lower costs of capital for issuers. India’s corporate
turnover ratio is quite high at 70 per cent in 2007, comparing favourably with
most other emerging East Asian corporate bond markets. However, the small
total of outstanding corporate bonds in India means that the secondary market is
small and relatively illiquid, irrespective of the turnover ratio (ADB Working
Paper Series No. 22). 39
Monetary and Fiscal Policies 10.7.1 Outlook for Development of Corporate Debt Market
The development of a corporate bond market in India has lagged in comparison
with other financial market segments owing to many structural factors. While
primary issuances have been significant, most of these were accounted for by
public sector financial institutions and were issued on a private placement basis
to institutional investors. The secondary market, therefore, has not developed
commensurately and market liquidity has been an issue.
The Government had constituted a High-Level Committee on Corporate Bonds

and Securitisation (Patil Committee) to identify the factors inhibiting the
development of an active corporate debt market in India and recommend necessary
policy actions. The Committee made several recommendations relating to
rationalising the primary issuance procedure, facilitating exchange trading,
increasing the disclosure and transparency standards and strengthening the
clearing and settlement mechanism in the secondary market. The
recommendations have been accepted in principle by the Government, RBI and
SEBI and are under various stages of implementation.
The two stock exchanges, namely, the Bombay Stock Exchange (BSE) and the
National Stock exchange (NSE), as well as the industry body Fixed Income,
Money Market and Derivatives Association of India (FIMMDA) have since
operationalised respective trade reporting platforms. While all the exchange trades
in corporate bonds get captured by concerned exchange’s reporting platform,
OTC transactions can be reported on any of these platforms. The aggregated
trade information across the platforms is being disseminated by FIMMDA on its
website. BSE and NSE have also started order-driven trading platforms in July
2007. In practice, however, trading continues to be largely OTC. SEBI has also
implemented measures to streamline the activity in corporate bond markets by
reducing the shut period in line with that of G-sec, reducing the size of standard
lots to Rs. one lakh and standardising the day count convention. Further, to
streamline the process of interest and redemption payments, Electronic Clearing
Services (ECS), Real-time Gross Settlements (RTGS) or National Electronic
Funds Transfer (NEFT) are required to be used by the issuers.
Further progress is anticipated concerning rationalising the primary issuance

procedures, which is a critical step for moving away from the predominance of
private placements. To reduce the settlement risk and enhance efficiency, the
Patil Committee has also proposed setting up of a robust clearing mechanism.
The settlement was proposed to be initially on DVP I basis (i.e. trade by trade
basis) to address the counterparty settlement risk and gradually migrate to DvP
III (net settlement of funds as well as securities) to impart enhanced settlement
efficiency. (The delivery versus payment (DVP) modules can be broadly classified
into three broad categories viz. DVP I, DVP II and DVP III. Under DVP I, the
fund’s leg as well as the securities leg are settled simultaneously on a contract-
by-contract basis. Under DVP II, while the securities leg is settled on a contract-
by-contract basis, the fund’s leg is settled for the net amount). Under DVP III,
both the funds and the securities legs are settled for the net amounts.)
Patil Committee has recommended two important measures to be initiated by

the Government, namely rationalisation of stamp-duty, and the abolition of tax
deduction at source, as in the case of government securities. As the corporate
40 debt markets develop and RBI is assured of the availability of efficient price
discovery through significant increases in public issues as well as secondary Capital Market and Its
Regulations
market trading, and an efficient and safe settlement system, based on DVP III
and STP is in place, RBI is committed to permitting market repos in corporate
bonds. In the medium term, considering the overall macro-economic situation,
the ceiling for foreign investment in both government securities and corporate
debt will continue to be calibrated as an instrument of capital account
management. In particular, a more liberalised access to foreign investment would
be appropriate when, among other things, an efficient and safe settlement system
is well entrenched, aggregate consolidated public debt to GDP ratio reaches a
reasonable level, say less than 50 per cent, and the corporate debt market acquires
depth and liquidity with a significant role for insurance and pension funds in
India. In the past, government securities dominated the debt market in India,
partly on account of the fiscal dominance and the absence of contractual savings.
In the absence of contractual savings only banks tended to deploy their funds in
the corporate bond market, mainly through private placement. RBI is hopeful
that the recent slow but steady development of insurance sector, mutual funds
etc. coupled with the existence of a reliable government securities market and
the availability of robust reporting, trading and settlement mechanisms would
lead to the rapid development of a vibrant corporate debt market. A framework
for the development is already available through the recommendations of the
Patil Committee, the implementation of which has already been taken up by the
various agencies (Dr. Y. V. Reddy, 2007).

1) State the reasons for trading in the derivatives.
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
2) Which instruments are traded in the exchange traded markets?
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
3) What are the various reforms and recommendations made with respect to
the Indian corporate debt market?
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
41
10.8 LET US SUM UP
Globalisation and financial liberalisation in India have ushered in a battery of
changes in the financial architecture of the economy, as a result of which the
resultant gain of the global integration of domestic and foreign financial markets
has thrown open new opportunities but at the same time exposed the financial
system to significant risks. While the capital market reforms are impressive,
there are still areas that present major problems. The long term debt and corporate
debt market present the biggest problems. As a result of which, many large Indian
companies look to foreign capital markets for longer-term debt and equity. Despite
this, the prevailing economic conditions both at domestic and global levels
suggests that the Indian stock market will continue to grow even though the
USA and European markets have yet to recover from recession effect. The market
ecosystemof the corporate debt market in India is yet to evolve in terms of enabling
vibrancy and depth. The enactment of the Insolvency and Bankruptcy Code (IBC),
2016, which incorporates relevant resolution frameworks introduced earlier, is
expected to strengthen investors’ confidence in the corporate bond market. The
2016-17 Union Budget announcement of setting up of Credit Enhancement Fund
could leverage the access of the infrastructure companies into the corporate bond
market, complemented by the large exposure framework laid down by the Reserve
Bank (RBI, 2019).

1) Discuss the role and scope of a well-developed capital market in the growth
process of the economy.
2) Trace the developmental reforms of the capital market in India and assess
the impact of these reforms in the growth of Equity and the foreign exchange
market.
3) Discuss the current scenario and shortcomings of the corporate debt market
in India.
4) Discuss the functions of SEBI. What are the significant steps taken by the
SEBI to develop the Indian Equity Market?
5) Explain the structure, conduct and performance of the Equity Derivatives
market in India.
6) Explain the structure and performance of the Indian Currency Derivatives
market.
7) Explain why the Indian Corporate Debt market is the nascent stage. Suggest
necessary reforms.
10.10 KEY WORDS

Derivatives : Derivatives are financial contracts whose value
is linked to the value of an underlying asset
Equity Derivatives : Equity Derivatives are a type of derivative

whose value is derived, at least partly, from
underlying equity securities including stocks,
stock indexes.
42
Foreign Institutional : A foreign institutional investor (FII) is an Capital Market and Its
Regulations
Investor (FII) investor or investment fund investing in a
country outside of the one in which it is
registered or headquartered.
Hawala : An informal, unregulated mode of transaction,

that usually occurs so as to smuggle foreign
currency to and fro your country.
Hedging : Hedging is a risk management strategy

employed to offset losses in investments by
taking an opposite position in a related asset.
Hybrid Securities : A hybrid security is a single financial security

that combines two or more different financial
instruments. They generally combine both debt
and equity characteristics.
Over-the-counter (OTC) : Over-the-counter (OTC) is the trading of

securities between two counterparties executed
outside of formal exchanges and without the
supervision of an exchange regulator.
Speculation : Speculation is the practice of engaging in risky

financial transactions in an attempt to profit
from short term fluctuations in the market value
of a tradable financial instrument.
Stock Market : A stock market is a marketplace where buyers

and sellers meet to trade i.e. buy and sell shares
of publicly listed companies.
10.11 REFERENCES
1) Ajay Shah and Susan Thomas (2001). “The evolution of the securities markets
in India in the 1990s”,Technical report, IGIDR.
2) Indian Securities Market: A review, Volume V, 2002, National Stock
Exchange of India Limited, Mumbai.
3) Reddy, Y. V. (2007). “Developing Debt Markets in India: Review and
prospects”, Speech at Washington, the USA on October 18, 2007, http://
rbidocs.rbi.org.in/rdocs/Bulletin/PDFs/82026.pdf
4) Mishra, Alok and Vyas Iti (2011). “Linkage Dynamics of India Financial
Markets: A Theoretical and Empirical Perspective, VDM Verlag Publication,
Germany.
5) Vyas, Iti (2019). “Economics of Financial Markets in India: Operation,
Integration and Efficiency”, Akhand Publishing House, Delhi.
6) Mishra, A. K., Rath, B. N., & Dash, A. K. (2020). Does the Indian financial
market nosedive because of the COVID-19 outbreak, in comparison to after
demonetisation and the GST? Emerging Markets Finance and Trade, 57, 1–
31.
43
Monetary and Fiscal Policies 7) Vyas, I. (2014). Vertical financial markets integration and efficiency in India
with special reference to economic crisis. Prajnan-Journal of Social and
Mangement Sciences, XLIII(3), 265–301.
8) Vyas, I., & Mishra, A. K. (2016). Does global financial crisis integrate the
regional market in Asia more strongly? Malaysian Management Journal,
20, 13–39.
9) Vyas, I., Prasad, N., & Mishra, A. K. (2011). Causal nexus between stock
price, demand for money, interest rate, foreign institutional investment, and
exchange rates in India: A post subprime crisis analysis.Indonesian Capital
Market Review, 3(2), 81–100.

PROGRESS EXERCISES
1) See Section 10.1
2) See Section 10.1
3) See Section 10.2

1) See Section 10.3
2) See Section 10.3
3) See Section 10.4
4) See Section 10.4

1) See Section 10.5
3) See Section 10.7
44
Capital Market and Its
UNIT 11 FISCAL POLICY AND FISCAL Regulations
RESPONSIBILITY AND BUDGET

MANAGEMENT (FRBM) ACT
Structure
11.0 Objectives
11.1 Introduction
11.2 Theoretical Analysis: IS-LM Framework
11.2.1 Implications of IS-LM Framework for Fiscal Policy
11.3 Concepts of Fiscal Policy
11.3.1 Objectives of Fiscal policy
11.3.2 Implications of Fiscal policy
11.4 Fiscal Policy in India
11.4.1 India’s Fiscal Policy Architecture
11.4.2 Fiscal Policy until 1990s
11.4.3 Fiscal Policy 1990s Onwards
11.5 The FRBM Act
11.6 The Global Financial Crises and the Fiscal Policy
11.7 Goods and Services Tax (GST)
11.8 Let Us Sum Up
11.10 Key Words
11.11 References
11.0 OBJECTIVES
state the concept and components of fiscal policy;
examine how changes in government spending and taxation affect
equilibrium level of income and interest rate in terms of the IS-LM
framework;
discuss the fiscal policy in India since independence;
recognise the need to adopt the Fiscal Responsibility and Budgetary
Management Act;
discuss the role of fiscal policy to meet the challenges arisen out of global
financial crises 2008; and
appreciate the genesis of GST, its implementation and trend of GST
collection.
45
11.1 INTRODUCTION
During the aftermath of the Great Depression in 1930s, British economist John
Maynard Keynes first argued for the role of government to push the economy
out of the slump. His book The General Theory of Employment, Interest and
Money is the foundation of the Keynesian economics. He argued for the role of
fiscal and monetary interventions by the government to influence the aggregate
demand. According to Keynes, high unemployment in Britain and the United
States was the result of a deficiency in the aggregate demand. At the time of the
Great Depression, Keynes favoured fiscal policy measures to stimulate the
demand. This started a new school of thought in the discipline of economics, the
Keynesian economics.
Much of the debate over economic policy in Great Britain at that time focused
on the desirability of government spending on public works as a cure for
unemployment, what we would now term an expansionary fiscal policy action.
Keynes and others argued that such actions would increase output and
employment. Such expenditures would act both directly and indirectly because
they would increase the income and hence consumer expenditure of those
employed on the public works projects, thus generating secondary employment.
Major tools of Fiscal Policy are:
a) Government Spending: Change in government spending (revenue or capital

expenditure) that directly impacts the GDP and is often used as a counter-
cyclical measure.
b) Taxes: Change in the taxes such as the changes in direct and indirect taxes
can influence the behaviour of agents in the economy and therefore impact
the GDP.
In this unit we dwell into understanding the functioning of such policy changes.
The unit discusses the theoretical framework for understanding the fiscal policy.
For this purpose we shall use the IS-LM framework to examine how changes in
government spending and taxation effects equilibrium level of income and interest
rate in the economy. Thereafter, we shall discuss India’s fiscal policy experience
since independence. It is further sub-divided into sections which describe the
evolution of fiscal policy until the 1990s, following the major economic reforms
of the 1991 till the next step of fiscal discipline and consolidation based on the
FRBM Act. Lastly, we shall talk about the new fiscal framework, recent
developments in the fiscal policy space including implantation of the GST. The
unit ends with the discussion of the 15th Finance Commission and the challenges
that the fiscal policy space currently faces.
11.2 THEORETICAL ANALYSIS: IS-LM

FRAMEWORK
Let us recall that we have studied IS-LM framework in Unit 2 of the course
Macro-economic analysis (MEC-002) in general. In order to examine the impacts
of the various tools of fiscal policy on aggregate income, savings and interest, it
is desirable to have a re-look at the IS-LM framework.
46
A central notion in the Keynesian model is that an equilibrium level of output Fiscal Policy and Fiscal
Responsibility and Budget
requires that total output be equal to the aggregate demand. In our model, this Management (FRBM) Act
condition for equilibrium can be expressed as:
Y = AD (1)
where, Y represents total output (GDP) and AD stands for aggregate demand or
desired expenditures on output.
Aggregate demand (AD) consists of three components:
household consumption (C),
desired business investment demand (I),
and the government sector’s demand for goods and services (G).
Thus, in equilibrium we have Y = AD = C + I + G (2)
The simple form of Equation (2) and of the identities discussed later results from
overlooking some complexities in the definitions of GDP and national income.
To begin with we are dealing with a ‘closed’ economy, hence exports and imports
do not appear in Equation (2). We later extend the simple model to include the
components of exports and imports. We also assume that prices are constant,
that is, all the variables are real variables and hence the changes in these variables
are also in real terms.
In the Indian context, National Accounts Statistics (NAS) provides the break-up
of the GDP components. The GDP (or Y in the model) is calculated as:
GDP = PFCE + GFCE + GCF + NX
Where,PFCE (C in Equation 2) is private final consumption expenditure by
households
GFCE (G in Equation 2) is government final consumption expenditure
GCF (I in Equation 2) is gross capital formation
NX is net exports (exports – imports).
Figure 11.1 shows the share of the major components of the GDP in India since
1990-91. It is clear that the private final consumption expenditure by the household
constitutes majority of the GDP. We now look at each of these components in
details to understand how changes in fiscal policy influence the GDP.
Fig. 11.1: Trends in share of major components of GDP in the overall GDP of India
Source: CMIE 47
Monetary and Fiscal Policies The components of Aggregate Demand
I) Consumption
The private final consumption expenditure (PFCE) by the household
constitutes the largest part of the GDP in India, though its share has declined
overtime. It formed 56.73 per cent of the total GDP (at constant prices) in
2019-20.
Keynes believed that the level of consumer expenditure is seen as a stable

function of disposable income, where disposable income (YD) in our simple
model is national income minus net tax payments (YD = Y tY), where t
represents the tax rate. The specific form of the consumption-income
relationship, termed the consumption function, proposed by Keynes was:
C C c 1 t Y
C C c 1 t Y
Fig. 11.2: The consumption schedule
The intercept term, which is assumed to be positive, is the value of

consumption when disposable income equals zero. As such, it can be thought
of as a measure of the effect of variables other than income, i.e. of variables
not explicitly included in this simple model on consumption. The parameter
c, the slope of the function, gives the increase in consumer expenditure per
unit increase in disposable income. In notation, we frequently use
c C/ Y
where, is called delta representing change or difference. It may be recalled
that it is the marginal propensity to consume and is a function of several
social-cultural and personal factors.
II) Government Spending

Government spending (G) is a second element of aggregate demand.
Government spending is assumed to be controlled by the policy maker and
therefore does not depend directly on the level of income. It is therefore
sometimes represented as (Ḡ ) with the bar on top denoting that the variable
is constant in the equation. We assume that the level of tax receipts (T) is
also controlled by the policy maker and is a policy variable.
III) Investment
Investment is also a key variable in the Keynesian system. Change in the
desired business investment expenditure was one of the major factors that
Keynes thought was responsible for changes in income. Indeed, investment
plays a dual role, it adds to aggregate demand and also to capacity creation,
resulting in improved aggregate supply. We take the following function to
explain the relationship of investment with the rate of interest (Figure 11.3).
48
Fiscal Policy and Fiscal
� = � ̅ − ��, � > 0 Responsibility and Budget
Investment (I) contains an autonomous part and is inversely related to the
interest rate (i) as it is the cost of borrowing more capital. b is the
responsiveness of investment to the interest rate. Higher b implies that even
with a smaller change in interest rate, the investment will change by a greater
magnitude. As interest rate goes up, investment in the economy declines by
the unit ‘b’.
Figure 11.3: The investment schedule
Source: Dornbuschet. al., Macroeconomics, 11thed.
The Goods Market Equilibrium: The IS Curve

Describing the real sector of the economy, the IS curve (Fig. 11.4) represents the
condition that aggregate demand (AD) equals national product (Y).
AD = C + G + I
such that:
C C c 1 t Y; I I bi; G G
AD A c1 t Y bi
where, A C I G
In equilibrium, Y = AD
This implies Y AD A c1 t Y bi
Y c1 t Y A bi
Y 1 c 1 t A bi
1
Y g A bi where, g
1 c1 t
A Y
Or i (3)
b g b
g can be understood as the multiplier. The slope of the IS curve is determined

by the value of the multiplier and responsiveness of investment to the interest
rate (b).
49
Fig. 11.4: The IS schedule
The Money Market Equilibrium: LM Curve

The demand for real money balance (L) is a positive function of the real income
and a negative function of the real interest rate (Figure 11.5). It is given by:
L = kY – hi, such that k, h > 0
Fig. 11.5: The demand for real balances schedule

The money market equilibrium: Describing the money market of the economy,
the LM curve (Figure 11.6) represents the condition that demand for real balances
equal real money supply. The nominal stock of money M is determined by the
Central Bank, the Reserve Bank of India (RBI) for India. We take the nominal
stock of money as given at M̄. We also assume prices to be constant at P̄, hence
M
the real money supply is . At equilibrium, demand for real balances = supply
P
of real balances, that is,
M
L=
P
M
This implies, kY – hi =
P
1 M
i kY (4)
h P
Fig.11.6: The LM Schedule

50
The equilibrium interest rate in the economy is determined by the interaction of Fiscal Policy and Fiscal
the goods and money market (through Equations 3 and 4). The equilibrium level Management (FRBM) Act
of income is hence gets simultaneously determined.
i
LM
i E
Interest Rate
IS
0 Y
Y0
Income, Output
Fig. 11.7: The IS-LM and determination of equilibrium in the economy

11.2.1 Implications of IS-LM Framework for Fiscal Policy
Change in government spending ( G ): If there is an increase in the government

spending such that the increase in spending is expressed as G , this shifts the IS
curve outwards to the right. At this stage there is no change in LM curve. The
new equilibrium income and interest rate level is determined where the new IS
curve intersects the LM curve (E’). The change in the equilibrium level of income
will be:
Y g G
The new interest rate will be higher than the original interest rate and the change
in Y is much more than the initial change in G.
Mechanics: Recalling what has been studies earlier, the increase in autonomous
government spending increases the aggregate demand (AD) in the economy
shifting IS curve to IS'. This raises the output to Y''. The increase in income
increases the demand for real balances in the economy. Given that the money
supply is fixed by the RBI, interest rate has to rise (from i to i' so that money
market reaches equilibrium. This increase in interest rate decreases the investment
and hence a decline in the overall AD and output also declines to Y'. This decline
in private investment as a result of increasing government spending (increase in
public investment) is also known as crowding-out effect of public investment.
Since government spending has to be financed, usually from increased government
borrowings, it leaves less of the country’s savings to be borrowed by the private
sector and that also raises the cost of borrowing for the private sector, leading to
crowding-out of private investments. However, evidence from India suggests
otherwise, as there exist infrastructural bottlenecks. Hence increasing the public
investment actually crowds-in the private investment. Between 1971-71 to 2002-
03, there has not been evidence of crowding-out of the private investment due to
public investment, rather complementarity is observed between the two1.
Lekha S. Chakraborty; Fiscal Deficit, capital formation and crowding out: Evidence from India.
1
51
Fig.11.8: Increase in government spending

Increase in government spending is an expansionary fiscal policy. In case of a

contractionary fiscal policy measure, the government can reduce the autonomous
government spending, shifting the IS curve leftward and reducing the equilibrium
level of interest rate and income.
Change in taxes (t): A change in the proportional income tax rate (t) is not as
straight forward. Since the change in the income tax affects the disposable income,
it changes the consumption. Let us consider an increase in tax rate from t to t'
(for e.g., increase in personal income tax from 10 per cent to 20 per cent). This
increase in taxes clearly reduces the consumption expenditure by the household
as they now have less income at their disposal. A change in the tax rate is going
to affect the slope of the IS curve as it changes the multiplier. With taxes being
increased to t' (contractionary fiscal policy), the slope of the IS curve will increase
and the overall value of the multiplier will decrease. A reduction in the value of
multiplier implies that income/GDP will not change as much with the changes in
any of its components.
Fig. 11.9: Increase in proportional income tax

Source: Author
Mechanics: As we can see in Figure. 11.9, the slope has increased and the IS has
shifted to IS'. There will be no change in LM as there is no change in the money
market. With the shift in IS, the new equilibrium income and interest rate is
achieved at Y' and i'. As the tax rate has gone up, the disposable income in the
hand of consumers decrease. This lowers the consumption demand (C) and
decreases the overall aggregate demand (AD). Since the AD decreases the
equilibrium income in the economy, the demand for real balances also decrease,
but as earlier the supply is fixed. The interest rate reduces as a consequence. This
reduction in interest rate increases the investment demand but not by as much to
offset the earlier decline in AD.
52
Check Your Progress 1 Fiscal Policy and Fiscal
1) Fill in the blanks. Management (FRBM) Act
i) In the Indian context, the consumption expenditure incurred by

......................................... constitutes the majority of GDP.
ii) The IS schedule shows the ................................. equilibrium.
iii) The decline in private investment as a result of increasing government
spending is known as .............................................
2) In terms of the IS-LM framework, explain the mechanics of increasing
government spending on a closed economy which is initially in equilibrium.
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
11.3 CONCEPT OF FISCAL POLICY

We define fiscal policy to encompass any decision to change the composition of
or timing of government expenditures or to vary the burden, structure, or frequency
of tax payment. Governments all around the world use fiscal policy tools as
counter cyclical measure i.e., to stabilise economy from cycles of boom and
bust.
Fiscal policy aims at using its three major instruments– taxes, spending and
borrowing– as balancing factors in the development of the economy. According
to Arthor Smithies, fiscal policy is a policy under which government uses its
expenditure and revenue programme to produce desirable effects and avoid
undesirable effects on the national income, production and employment. Fiscal
policy consists of the use of taxes, government spending and public debt
operations to influence the economic activities of the community in desired ways
and is concerned with the allocation of resources between the public and private
sectors and their use for the attainment of stability and growth. Although the
effects of fiscal policy are extensive, they are particularly measurable in areas
such as employment, price stability, savings and investment, and the balance of
payment. The prime aim of such a policy is to maintain a high level of employment
without inflation.
11.3.1 Objectives of Fiscal Policy

Formulation of fiscal policy presumes the identification and clear recognition of
the institutional aspects of government finance, such as tax system, tax incidence
and shifting, budget formulation and execution and financial management. The
focus of budgeting is on the attainment of efficiency in the allocation of resources
within the public sector and is influenced at each stage by the goals of the fiscal
policy. The changes in government income or expenditure have been designed
to affect the level of activity in the economy as a whole. An understanding of the
fiscal policy is essential for gaining proper perspectives on the different aspects
53
Monetary and Fiscal Policies of budgeting. In the recent years, importance of fiscal policy has increased due
to economic fluctuations.
The budgetary fiscal policy can play a key role in the process of economic
development by (i) mobilising additional resources, (ii) maintaining economic
stability, (iii) allocating resources into socially necessary lines of development,
(iv) reducing extreme inequality in income and wealth, and (v) providing the
necessary incentive to the private sector for its healthy growth. The fiscal policy
thus has not one goal. It has a multiplicity of goals. Hence, they cannot be achieved
by any one set of policies. There may be conflicts between some of these other
goals and stabilisation goals. In the context of economic growth, the fiscal policy
has to be so framed as to avoid an inflationary pressure in the economy.
11.3.2 Implications of Fiscal Policy

Fiscal policy is so wide-ranging that selection of a combination of differing
objectives is both complex and controversial. The decisions that the government
makes over fiscal policy can have important implications for business. In today’s
globalised economy, tax policy is not conducted in a vacuum. Taxes can influence
the choices of both business and labour. Supply-side economists argue that
economic activity is quite sensitive to changes in tax rates, particularly the highest
marginal rates. What causes governments to ignore budget deficits in some
circumstances and not in other? Business also needs to understand the effect a
change in fiscal policy is likely to have on aggregate demand. In recent decades,
the ratio of government expenditure to GDP has increased in most countries. In
many countries its present level cannot be financed by ordinary sources of revenue.
As a consequence, many governments have been compelled to borrow heavily.
If a country borrows too much money, it has to pay a great deal of interest every
year in order to service that debt.
The greatest obstacle to proper use of fiscal policy is that changes in fiscal policy
may be necessarily bundled with other changes that please or displease various
stakeholders. This is true for a tax cut for some favoured constituency. The problem
of making good fiscal policy in the face of such obstacles is, in the final analysis,
not economic but political. There are many practical limitations or drawbacks to
the actual working of the fiscal policy. The objective of fiscal policy in modern
society cannot be promoted in isolation. It has to be coordinated with monetary,
credit and debt policies to be effective. The questions relating to the manner of
financing deficit or disposing of surplus in a budget have close relationship with
monetary and credit policies.
Monetary and fiscal policies can be best understood in the context of the events
that shape them. Such an analysis can assist in choosing policies that improve
rather than disrupt short- and long-term economic performance. Of particularly
interest are the circumstances and policies surrounding the recent recession.
11.4 FISCAL POLICY IN INIDA

11.4.1 India’s Fiscal Policy Architecture
India adopted a federal form of governance in post-independence period. The
Constitution of India (Article 1) states that India, that is Bharat, shall be a Union
54 of States. The Indian Constitution provides the overarching framework for
country’s fiscal policy with the assignment of taxation powers and expenditure Fiscal Policy and Fiscal
responsibilities being divided between the Union and State governments. The Management (FRBM) Act
Seventh Schedule of the Constitution of India specifies the legislative domain of
the Union and States Governments in terms of three lists namely, (a) Union List
(or List I), (b) State List (or List II), and (c) Concurrent List (or List III). These
lists represent the powers conferred upon the Union Government, State
Governments, and shared powers between the two respectively. All residuary
powers are vested with the Union. The Constitution also provides that for every
financial year, the government shall place before the legislature a statement of
its proposed taxation and expenditure provisions, also known as the budget, for
legislative debate and approval. The Union and the State governments each have
their own annual budgets. Details on this aspect has been provided in the next
unit (Unit 12).
11.4.2 Fiscal Policy until 1990s

The formation of a Planning Commission, prompted by Prime Minister Nehru’s
commitment, was announced in the Finance Minister’s Budget Speech in
February, 1950. The Commission was established on 15th March, 1950 through a
cabinet resolution with primary objectives of formulating medium to long term
plans, advising on allocation of funds to Ministries in the Union Government
through annual budget, approving the plan of each State. The resolution clearly
indicated that the Commission would essentially be an advisory body which
would make recommendations to the Cabinet. The Planning Commission, by
virtue of its mandate to prepare Five-year Plan came to exercise allocative powers.
One of the roles that it performed was to approve Plans of each of the states and
allocate transfer of funds from the Union government to States, both tied and
untied under the Plan.
The main fiscal impact of the planning process is the division of expenditures
into plan and non-plan components. The plan components relate to items dealing
with long-term socio-economic goals as determined by the ongoing planning
process. They often relate to specific schemes and projects. Furthermore, they
are usually routed through central ministries to state governments for achieving
certain desired objectives. These funds are generally in addition to the assignment
of central taxes as determined by the Finance Commissions. In some cases, the
state governments also contribute their own funds to the schemes. Non-plan
expenditures broadly relate to routine expenditures of the government for
administration, salaries, and the like2.
The objective of the initial five-year plans during the 1950s and 1960s was mainly
to become a self-sufficient nation and increase the growth rate of the economy
through strengthening the public sector enterprises. Taxation was used as an
instrument for transferring resources to the Government to enable it to undertake
large-scale public investment in an effort to spur economic growth. Both direct
and indirect taxes were focussed on extracting revenues from the private sector
to fund the public sector. The combined centre and state tax revenue to GDP
ratio increased from 6.03 per cent in 1950-51 to 15.47 per cent in 1987-88. For
the central government this ratio (i.e., central taxes net of devolution to GDP
ratio) was 3.43 per cent of GDP in 1950-51 with the larger share coming from
2
The distinction between plan and non-plan government spending has been dispensed with and
now the classification of government spending follows the categorisation of revenue and capital
spending. 55
Monetary and Fiscal Policies indirect taxes at 2.20 per cent of GDP and direct taxes at 1.23 per cent of GDP.
Given their low direct tax base, the direct tax-GDP ratio of state governments
was 0.53 per cent while their share of indirect taxes in GDP was 1.61 per cent in
1950-51. Furthermore, the fiscal policy was geared towards achieving the
economic objectives of (i) promoting employment through grant of tax incentives
to new investment; (ii) reducing inequality through progressive taxes on income
and wealth; (iii) reducing pressure on balance of payments through increase of
import duties; and (iv) stabilising prices through tax rebate in excise duties on
consumption goods3.
The systemic evolution of tax system in India started with the implementation of
a number of recommendations of the Taxation Enquiry Commission in 1955-56
which was appointed in April, 1953. The Commission submitted its report in
December, 1954. However, the government invited the British economist Nicholas
Kaldor to examine the possibility of reforming the tax system. The findings and
recommendations of Kaldor was published in a report in 1956. Kaldor found the
system is inefficient and inequitable given the narrow tax base and inadequate
reporting of property income and taxation. He also found the maximum marginal
income tax rate at 92 per cent to be too high and suggested it be reduced to 45 per
cent. In view of his recommendations, the government revived capital gains
taxation, brought in a gift tax, a wealth tax and an expenditure tax (which was
not continued due to administrative complexities).
Despite Kaldor’s recommendations, for both corporate and personal income taxes
the highest marginal income tax rates continued to be very high. The Direct
Taxes Enquiry Committee of 1971 found that the high tax rates encouraged tax
evasion and following its recommendations in 1974-75, the highest marginal
rate for personal income tax was brought down to 77 per cent.
Fiscal policy during the 1970s focused on achieving greater equity and social
justice and both taxation and expenditure policies were employed towards that
end. Accordingly, income tax rates were raised to very high levels, with the
maximum marginal rate of personal income tax moving up to 97.5 per cent
including the surcharge. India’s expenditure norms remained conservative till
the 1980s. From 1973-74 to 1978-79 the central government continuously ran
revenue surpluses (Figure 11.10). The gross fiscal deficit (GFD) also showed a
slow growth with certain episodes of downward movements. Over the years, in
addition to the commitment towards a large volume of developmental expenditure,
the Government’s expenditure widened to include rising subsidies. Large interest
payments on growing debt and downward rigidity in prices further contributed
to increased expenditure. Revenues, on the other hand, were less buoyant leading
to the emergence of sizeable revenue deficits (RD) in the Central government
budget from 1979-80 onwards.
During the decade of 1980s, the Indian public finances were in a state of disarray.
We find considerable fiscal deterioration took place during the 1980s and it
eventually became unsustainable, although the growth rate did rise significantly
with the enhancement in public investment in infrastructure.While the revenue
deficit (RD) of the central government as percentage of GDP increased from 1.4
per cent in 1980-81 to 2.44 per cent in 1989-90, its gross fiscal deficit (GFD) as
percentage of GDP also increased during this period, increasing from 5.71 per
cent in 1980-81 to 7.31 per cent in 1989-90.
56 3
Rao and Rao, 2006
10.00 Fiscal Policy and Fiscal
Gross fiscal deficit Management (FRBM) Act
8.00
6.00
4.00
2.00
revenue surplus
0.00
-2.00
1970-71
1971-72
1972-73
1973-74
1974-75
1975-76
1976-77
1977-78
1978-79
1979-80
1980-81
1981-82
1982-83
1983-84
1984-85
1985-86
1986-87
1987-88
1988-89
1989-90
1990-91
Note: Deficit (+) / Surplus (–)
Fig. 11.10: GFD and RD of the Centre ( per cent of GDP)
Source: DBIE and CMIE
The State governments had revenue surplus during 1974-75 to 1986-87 with the
exception of 1984-85 (Figure.11.11). Their fiscal position also deteriorated in
the late 1980s.
3.50
Gross Fiscal Deficit Revenue Deficit
3.00
2.50
2.00
1.50
1.00
0.50
0.00
-0.50
-1.00
-1.50
1970-71
1971-72
1972-73
1973-74
1974-75
1975-76
1976-77
1977-78
1978-79
1979-80
1980-81
1981-82
1982-83
1983-84
1984-85
1985-86
1986-87
1987-88
1988-89
1989-90
1990-91
Note: Deficit (+) / Surplus (–)

Fig. 11.11: GFD and RD of the States ( per cent of GDP)
Source: DBIE and CMIE
Rising deficits and debt reduced the quality of the expenditure with increase in
expenditure on interest payment at the cost of social and developmental
expenditure. The Government sought to reduce its deficit through increase in
taxes. An important reform in the indirect taxes was recommended by the Indirect
Tax Enquiry in 1977. It recommended introduction of the input tax credit to
convert the cascading manufacturing tax into a manufacturing value added tax
(MANVAT). But this was implemented as a modified value added tax (MODVAT)
in 1986 in a phased manner covering only selected commodities (Rao and Rao,
2006).
The other main central indirect tax is the customs duty. Customs duties were
hiked to augment revenue and to protect domestic industry. In 1985-86 the
57
Monetary and Fiscal Policies government presented its Long-Term Fiscal Policy stressing on the need to reduce
tariffs, have fewer rates and eventually remove quantitative limits on imports.
Some reforms were attempted but due to revenue raising considerations the tariffs
in terms of the weighted average rate increased from 38 per cent in 1980-81 to
87 per cent in 1989-90. By 1990-91 the tariff structure had a range of 0 to 400
per cent with over 10 per cent of imports subjected to tariffs of 120 per cent or
more4.
The 8th Finance Commission whose operational period was 1984-1989 made it
clear that in considering competing claims on resources, the overriding
consideration would be national interest. The 8th FC also made the tax devolution
more progressive by leaning in favour of the backward states. It also set 5 per
cent of the net proceeds of sharable excise duties exclusively for non-plan revenue
deficit.
In 1970-71, direct taxes contributed to around 16 per cent of the central

government’s revenues, indirect taxes about 58 per cent and the remaining 26
per cent came from non-tax revenues. By 1990-91, the share of indirect taxes
had increased to 65 per cent, direct taxes shrank to 13 per cent and non-tax
revenues were at 22 per cent.
While the institutional arrangements in place initially appeared adequate for

driving the development agenda, but the sharp deterioration of the fiscal situation
in the 1980s led to the balance of payments crisis of 1991.
11.4.3 Fiscal Policy 1990s Onwards

The political uncertainties both domestic (assassination of Prime Minister Rajiv
Gandhi) and abroad (The Gulf War) added to the existing fiscal deterioration of
the country. Rising oil prices led to greater burden of the fuel subsidy along with
increasing external debt that eventually led to a balance of payment crisis in
1991. The crisis brought about the most important economic reforms which
opened up the economy to private players both domestic (dismantling of the
License Raj system) and from abroad. Fiscal policy was also re-aligned with
these policy changes.
To improve the falling tax receipts and to rationalise the tax structures, Tax Reform
Committee was formed with the view to achieve set targets. The Tax Reforms
Committee (TRC) concentrated on finding a suitable framework to reform both
the direct and indirect tax structure in the country. The committee recommended
two major reforms on direct taxes– one was the simplification and rationalisation
of the direct tax structure (The Chelliah Committee, 1992); the other was to
introduce a service tax to widen the tax base (The Chelliah Committee, 1994).
As a part of the subsequent direct tax reforms, the personal income tax brackets
were reduced to three with rates of 20, 30 and 40 per cent in 1992-93. Financial
assets were removed from the imposition of wealth tax and the maximum rate of
wealth tax was reduced to 1 per cent. The Personal income tax rates were reduced
again to 10, 20, and 30 per cent in 1997-98. These rates have largely remained
the same since then with the exemption limit being increased and slab structure
raised from time to time. A subsequent 2 per cent surcharge to fund education
was later made applicable to all taxes.
58 4
Rao and Rao, 2006
The basic corporate tax rate was reduced to 50 per cent and the rates for different Fiscal Policy and Fiscal
closely held companies were made uniform at 55 per cent. In 1993-94, the Management (FRBM) Act
distinction between the closely held and the widely held companies was removed
and the uniform tax rate was brought down to 40 per cent. The rate was further
reduced to 35 per cent with a 10 per cent tax on distributed dividends in 1997-
98. Even after these reforms, some companies continued to take advantage of
the exemptions and tax deduction that were there in place for backward places,
export promotion and technology development. This led to the phenomenon of
“zero-tax companies” whereby imaginative arrangements were used to leverage
all these tax incentives with an intent to minimise tax liabilities. To counter this
trend, the Minimum Alternative Tax (MAT) was introduced in 1996-97 that
required a company to pay a minimum of 30 per cent of book profits as tax.
Under the indirect taxes, the MODVAT credit system for excise was expanded to
cover most commodities and provide a comprehensive credit system by 1996-
97. The eleven rates were merged into three with a few luxury items subject to
additional non-rebatable tax in 1999-2000. The three rates were merged in to a
single rate and renamed as central VAT (CENVAT) in 2000-01. There remained
three additional excises of 8, 16 and 24 per cent. In case of custom duties, in
1991-92 all duties on non-agriculture goods that were above 150 per cent were
brought down. The ‘peak rate’ was brought down to 40 per cent in 1997-98, 30
per cent in 2002-03, 25 per cent in 2003-04, and 15 per cent in 2005-06. The
number of major duty rates was also brought down from 22 in 1990-91 to 4 in
2003-04. These four rates covered almost 90 per cent of customs collected from
items.
This period also saw the introduction of the service tax in 1994-95, which was
subsequently expanded to cover more and more services. Given that the Indian
economy was having an increasingly large service component, the service tax
increasingly became a major source of revenue. Eventually, provisions were made
for allowing input tax credits for both goods and services at the central indirect
tax level.
In line with the tax reform plans, the share of the direct taxes in the overall
revenue receipts started increasing from 1994-95. In 1995-96, about 54 per cent
of revenues came from indirect taxes while around 20 per cent were from direct
taxes. In 2000-01, the share of indirect taxes had gone down dramatically to
around 45 per cent while the contribution from direct taxes had increased to
about 26 per cent. By 2005-06, indirect taxes accounted for approximately 43
per cent while the direct taxes share was about 35 per cent (Figure 11.12)
Fig. 11.12: share in the revenue receipts of the Central Govt. (in per cent)
59
Source: DBIE
Monetary and Fiscal Policies On the expenditure side, the strategy was to reduce the subsidies and cutting
down on non-capital expenditures. However, the existing debt burden meant
that the interest component would take a long time to ebb. In 1995-96, of the
central government’s revenue expenditures, 9 per cent went to subsidies, 13 per
cent to defence and 36 per cent to interest payments. Even after the changes in
the fiscal policy, the expenditure pattern did not recordmuch change. In 2000-
01, defence and interest remained at 13 per cent and 36 per cent, respectively,
while subsidies increased slightly to 10 per cent. By 2005-06, the interest
component had come down to 30 per cent and defence and subsidies each took
up 11 per cent (Figure 11.13).
Fig. 11.13: Share in total revenue expenditure of the Central government (in per cent)
Source: DBIE
Even though the fiscal situation of the government improved with the
aforementioned measures in the first half of the 1990s, the fiscals started showing
signs of distress from 1997-98 with the rising fiscal and revenue deficit. The 11th
FC expressed concerns over the feature of fiscal deficit being driven more and
more by the revenue account.
Fig. 11.14: Key fiscal indicators for States as a per cent of GDP
Source: CMIE, DBIE
The situation was grim at the state level as well. The average debt-to-GSDP ratio
increased from 18.3 per cent during the 1980s to 20.8 per cent during the 1990s.
It further worsened during 1997-2002 and increased by about 6 percentage points
60
to 26.8 per cent and reaching high of 31.8 per cent in March, 20045. A study by Fiscal Policy and Fiscal
Rajaraman et al. (2005) examined the debt sustainability of all the states in India Management (FRBM) Act
for a period of 10 years from 1992-93 to 2002-03 using the indicator approach.
They found a sharp increase in debt of major states during 1997-02 relative to
the average debt level of 1992-97 with the interest rate on the state debt exceeding
the nominal growth rate of GSDP during the quinquennial of 1997-02. This
necessitated the need for debt consolidation measures and institutional reforms
to stabilise debt at both the Centre and the State level. The central government’s
revenue deficit climbed up to 4.4 per cent of GDP in 2002-03 while the GFD was
at 5.91 per cent of GDP. By 2003-04 the combined liabilities of the centre and
the States were up at 81.09 per cent of GDP from 70.59 per cent in 2000-01. The
external liabilities were however kept under control at only 1.67 per cent of GDP
in 2003-04.
There was an urgent need of some new fiscal discipline framework. After around
three years of discussions, the Fiscal Responsibility and Budgetary Management
(FRBM) Act was adopted in 2003.

1) What are the various fiscal implications of the planning process?
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
2) What was the focus of fiscal policy during 1970s?
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
3) What has been the consequence of increasing deficit and debt in 1980s?
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
4) State the major initiatives taken towards reforms in direct taxes in 1990s.
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
5
Atri Mukherjee et.al. (2017) 61
11.5 THE FRBM ACT
As alluded to above, periods of macroeconomic instability in India have invariably
been pre-dated by fiscal adventurism. In the 1980s, for example, the combined
fiscal deficit had widened to 8.6 per cent in 1984-85 and breached 9 per cent of
GDP in the ensuing years. Following the crisis, fiscal corrections were pursued
along with structural reforms. A combination of these macro policies and other
reforms stabilised the economy. However, later in the 1990s, combined fiscal
deficits again rose sharply to over 10 per cent. This time the government willingly
introduced the Fiscal Responsibility and Budget Management Bill in Parliament
in the year 2000. The Bill received the assent of the President of India on 26
August 2003 and it became effective from 5 July 2004.
The main objectives of the act were to (a) introduce transparent fiscal management
systems in the country; (b) introduce a more equitable and manageable distribution
of the country’s debts over the years and (c) aim for fiscal stability for India in
the long run. The FRBM Act proposed that the central and state fiscal deficit
would each be progressively reduced to reach 3 per cent of GDP keeping in
mind two considerations – a) consistency with the forecast trend of household
financial savings and b) the target being considered sufficient for reducing the
stock of outstanding government liabilities to the level of 50 per cent of the GDP
within 10 years6.
Even though the Constitution enables the adoption of fiscal rules through the
prescription of a ceiling on borrowing by the Union and the States, no such
legislation was passed. It was only in the FRBM Act, that the limit on the
borrowings were imposed indirectly.The FRBM Act, 2003 is a law enacted under
Article 292 of the Constitution (read with Article 283) empowering the
government to borrow upon the security of the Consolidated Fund of India ‘within
such limits, if any, as may from time to time be fixed by Parliament by law and to
the giving of guarantees within such limits, if any, as may be so fixed’. Article
293 stipulates restrictions on the power of State governments to borrow.
The Ministry of Finance initiated studies to analyse the international legislative

practice in controlling public debt and deficits to suggest a draft ‘Public Debt
and Guarantee Limitation Act’ for India. The draft sought the elimination of the
revenue deficit within five years, a steady reduction in the fiscal deficit, capping
the growth rate of the stock of liabilities at the growth rate of net tax revenue
receipts, the elimination of asset-liability mismatches on a book value basis within
10 years and capping outstanding guarantees to 10 per cent of outstanding
liabilities. These provisions not only capped public debt using endogenous
budgetary variables (book value of physical and financial assets) but also
mandated revenue generation to recoup the progressive use of borrowings for
consumption resorted to in the past and the eventual use of borrowed funds for
creation of productive assets.
Given the prevailing fiscal stress in the 1990s and the draft of the Public Debt
and Guarantee Limitation of India, the Finance Minister constituted a committee
on January 17, 2000 under the chairmanship of Dr. E.A.S. Sarma, then Secretary,
Department of Economic Affairs, Ministry of Finance to study all cognate aspects
62 6
NK Singh Committee Report.
and prepare a draft legislation. The Committee submitted its Report on 4 July Fiscal Policy and Fiscal
2000. It identified three categories of indicators for numerical fiscal targets with Management (FRBM) Act
specific time frames: (i) revenue and fiscal deficits; (ii) total liabilities/debt; and
(iii) borrowing from the RBI. Eight deficit indicators were considered but for
simplicity and focused attention, the Committee recommended ceilings for only
two – fiscal and revenue deficits. It sought to discourage excessive deficit for
accumulating capital assets by mandating a progressive reduction in the fiscal
deficit by 0.33 per cent of GDP at the end of each financial year so as to reduce
to the fiscal deficit to no more than 3 per cent of GDP in five years ending on 31
March 2006. The Committee also recommended the complete elimination of the
revenue deficit in five years ending on 31 March 2006 through annual reductions
of 0.5 per cent of GDP, and to build up an adequate revenue surplus thereafter.
This would ensure the observance of the ‘golden rule’, i.e., revenue surpluses
would be used for the purpose of discharging liabilities in excess of assets. In
addition to limits on the deficit, the proposed legislation also limited guarantees
to 0.5 per cent of GDP in any given financial year. The committee also advocated
a debt-GDP ratio of 50 per cent in a period of 10 years commencing on 1 April
20017.
Karnataka became the first state to enact its FRBM Act in September 2002
followed by Kerala (2003), Tamil Nadu (2003) and Punjab (2004). At the Union
govt. level, the Act and the Rules made under the Act were brought into force on
5 July 2004. West Bengal and Sikkim were the last two states to implement the
FRBM Act in July and September 2010, respectively.
In July, 2004, a Task Force led by Dr Vijay L. Kelkar recommended various

measures for implementation of the FRBM Act and substantially, a path of
revenue-led fiscal consolidation. The Committee also recommended the
introduction of a comprehensive tax on all goods and service replacing Central
level VAT and State level VATs. It recommended replacing all indirect taxes
except the customs duty with value added tax on all goods and services with
complete set off in all stages of making of a product. Other states also implemented
the legislation to avail the benefits under the incentive scheme recommended by
the 12th Finance Commission (12th FC). Some of the major recommendation of
the 12th FC to restructure the public finances include:
1) By 2009-10, the combined tax-GDP ratio of the Centre and the States should
be increased to 17.6 per cent, primary expenditure to a level of 23 per cent
of GDP and capital expenditure to nearly 7 per cent of GDP.
2) The combined debt-GDP ratio with external debt measured at historical
exchange rates should, at a minimum, be brought down to 75 per cent by the
end of 2009-10.
3) The system of on-lending should be brought to an end over time and the
long-term goal for the Centre and States for the debt-GDP ratio should be 28
per cent each.
4) The fiscal deficit to GDP ratio targets for the Centre and the States may be
fixed at 3 per cent of GDP each.
5) The centre’s interest payment relative to revenue receipts should reach about
28 per cent by 2009-10. In the case of States, the level of interest payments
relative to revenue receipts should fall to about 15 per cent by 2009-10.
7
NK Singh Committee Report 63
Monetary and Fiscal Policies 6) The revenue deficit relative to GDP for the Centre and the States, for their
combined as well as individual accounts should be brought down to zero by
2008-09.
7) Each State should enact a fiscal responsibility legislation, which should, at
a minimum, provide for
eliminating revenue deficit by 2008-09;
reducing fiscal deficit to 3 per cent of GSDP or its equivalent, defined
as the ratio of interest payment to revenue receipts;
bringing out annual reduction targets of revenue and fiscal deficits;
bringing out annual Statement giving prospects for the State economy
and related fiscal strategy; and
bringing out special Statements along with the budget giving in detail
the number of employees in Government, public sector, and aided
institutions and related salaries.
Other measures to expand the tax base and increase revenues were the introduction
of the securities transaction tax (STT) in 2004 and the fringe benefit tax (FBT) in
the budget of 2005-06 (Rao and Rao, 2006).
The fiscal deficit for the Central government apparently declined from 4.34 per
cent in 2003-04 to 2.54 per cent in 2007-08, achieving the target of 3 per cent of
GDP one year in advance and the revenue deficit also apparently came down
from 3.5 per cent of GDP in 2003-04 to 1.1 per cent of GDP in 2007-08, and
closer to the target of nil in 2008-09. Though several studies have attributed this
fiscal consolidation in the first phase of the FRBMA to high GDP growth and tax
buoyancy. Simone and Topalova (2009) estimate that two-thirds of the fiscal
adjustment in this period was due to revenue gains. Study by Dholakia et al.
(2011) pointed out that much of the improvement in the financial position of the
Central government arose due to revenue buoyancy.
Fig.11.15: Fiscal and revenue deficit for the Centre as a percentage of GDP
Source: DBIE
The basis of these claims lay in unprecedented nominal growth in GDP. The
nominal year-on-year growth rate of both direct and indirect central taxes (net of
transfers to States) increased consistently from 2001-02 onwards. These dynamics
64
translated into a considerable rise in the net central tax/GDP ratio, particularly Fiscal Policy and Fiscal
the net central direct tax/GDP ratio, which more than doubled between 2001-02 Management (FRBM) Act
and 2007-08. Inflation was moderate and growth was buoyant at 9.6 per cent in
2006-07. This benign macroeconomic environment was disturbed by the global
financial crisis.
11.6 THE GLOBAL FINANCIAL CRISIS AND

FISCAL POLICY
The global financial crisis that erupted around September 2008 saw Indian fiscal
policy being tested to its limits. The policymakers had to grapple with the impact
of the crisis that was affecting the Indian economy through three channels: (i)
contagion risks to the financial sector, (ii) the negative impact on exports and
(iii) the effect on exchange rates. One could also add to this list the dampening of
domestic business sentiments as a result of the deterioration in the economic
prospectsin developed countriesin the wake of the global financial crisis.
Somewhat serendipitously, the government already had an expansionary fiscal
stance in view of a rural farm loan waiver scheme, the expansion of social security
schemes under the National Rural Employment Guarantee Act (NREGA) and
the implementation of revised salaries and pensions for the central public servants
as per the recommendations of the Sixth Pay Commission. Furthermore, the
parliamentary elections of 2008 also resulted in further increase in government
expenditures.
As the crisis unfolded, the government initiated a series of stimulus packages on

7th December 2008, 2nd January 2009 and 24th February 2009. Actions included
an overall central excise duty cut of 4 per cent, ramping up additional plan
expenditure of about Rs. 200 billion, further state government borrowings for
planned expenditure amounting to around Rs. 300 billion, interest subsidies for
export finance to support certain export-oriented industries, a further 2 per cent
reduction of central excise duties and service tax for export industries (in all a
total of 6 per cent central excise reduction). The impact of these measures is
estimated to be around 1.8 per cent of GDP in 2008-09. If the increase in public
expenditure across the budgets of 2007-08 and 2008-09 is taken together it
amounted to over 3 per cent of GDP.
In 2008-09, there was a reversal of the steady fiscal consolidation being pursued.
The budgeted fiscal deficit for 2008-09 was 2.5 per cent of GDP, while the revised
estimates shown in the interim budget presented in February 2009 was 6 per cent
of GDP. However, the Centre’s actual fiscal deficit in 2008-09, inclusive of the
off-budget expenditures of oil and fertilizer bonds was in fact 7.8 per cent despite
significant under-reporting through deferment of expenditure liabilities. Thus,
the total deterioration in the fiscal deficit in 2008-09 was a dramatic 5.3 per cent
of GDP. The revenue deficit also ballooned considerably in 2008-09, from the
budgeted 1 per cent to the revised 4.4 per cent of GDP. Accounting for the off-
budget bonds brought the number to an unprecedented 6.3 per cent of GDP (Buiter
and Patel, 2010).
Unlike international best practices, neither the escape clause (first proviso to
Section 4) of the FRBM Act nor the associated FRBM Rules mandate a clearly
defined correction path that would facilitate a return to fiscal consolidation
following a breach in adherence to the fiscal rules.The Finance Minister in his
65
Monetary and Fiscal Policies 2011-12 Budget Speech announced that amendments would be made to the
FRBMA along with “laying down the fiscal map for the next five years.” In the
succeeding year’s Budget Speech, the FM yet again announced that amendments
to FRBMA would be introduced through the Finance Bill of 2012. The Finance
Bill proposed that the new target for the reduction of GFD and RD, and elimination
of effective revenue deficit be set as March 31, 2015. These proposals resulted
in amendment of FRBMA in May 2013. The term ‘effective revenue deficit’ was
also introduced into FRBMA through Finance Bill of 2012. The government
then revised the FRBMA further in the Finance Bill of 2015 by amending Section
4 to change deadline of March 31, 2015 to March 31, 2018, to grant the newly
formed Government in May 2014, some more fiscal space to achieve deficit
targets.
The need for review of the FRBMA is in sync with the need for enhancing
credibility, discipline, transparency and accountability in the conduct of
macroeconomic policy. The 13th Finance Commission recommended that the
Centre should institute a process of independent review and monitoring of the
implementation of the FRBMA. Accordingly, the Act was amended in 2012 to
provide for the government entrusting a periodical review of compliance with
the provisions of the Act to the Comptroller and Auditor-General (CAG).
The NK Singh Committee (FRBM Review Committee): In May 2016,

Government of India constituted a five-member committee to review the working
and functioning of FRBMA. On January 23, 2017, the committee submitted a
report to the Finance Minister. Its main policy recommendations are summarised
below:
1) Adopt a prudent medium-term ceiling for general government debt of 60
per cent of GDP, to be achieved by the fiscal year 2022-23.
2) Within the overall ceiling specified above, adopt a ceiling of 40 per cent for
the centre, and the balance 20 per cent for the states.
3) Adopt fiscal deficit as the key operational target consistent with achieving
the medium-term debt ceiling.
4) A path of fiscal deficit with fixed operational targets rather than a range.
Table 11.1: The recommended debt-deficit paths by the FRBM review committee
Debt-GDP Fiscal Deficit Revenue Deficit
ratio (per cent) ( per cent of GDP) ( per cent of GDP)
2016-17 49.4 3.5 2.30
2017-18 47.3 3.0 2.05
2018-19 45.5 3.0 1.80
2019-20 43.7 3.0 1.55
2020-21 42.0 2.8 1.30
2021-22 40.3 2.6 1.05
2022-23 38.7 2.5 0.80
Source: NK Singh Committee Report, 2017
66
5) A path of fiscal deficit to GDP ratio of 3.0 per cent during 2017-18 and Fiscal Policy and Fiscal
2019-20, 2.8 per cent in 2020-21, 2.6 per cent in 2021-22, and 2.5 per cent Management (FRBM) Act
in 2022-23.
6) Reduce revenue deficit to GDP ratio steadily by roughly 0.25 percentage
points each year, to reach 0.8 per cent by 2022-23.
7) The Inter-State allocation for State Governments for the achievement of the
overall debt and fiscal targets be assigned to the 15th FC through a specific
Terms of reference (ToR).
The timeline of FRBM Act and relevant developments are present in the table
below:
Table 11.2:Timeline of the FRBMA and relevant developments
Month,Year Event
Jan, 2000 Sarma Committee on Fiscal Responsibility Legislation constituted
by Finance Minister
Dec, 2000 FRBM Bill tabled in Parliament
Aug, 2002 Karnataka FRBM Act enacted by State Government
Aug, 2003 FRBM Act receives assent of President
July, 2004 FRBM Rules were notified by government under FRBMA and were
brought into force. Task Force (Chairman: Dr Vijay Kelkar) on
implementation of FRBMA set up
March, 2006 Date recommended for revenue deficit elimination and reduction of
fiscal deficit to 3 per cent by Sarma Committee
March, 2008 First target date by which revenue deficit had to be eliminated and
fiscal deficit reduced to 2 per cent of GDP (set by FRBMA)
Sep, 2008 Lehman Brothers files for bankruptcy, Global Financial Crisis
March, 2009 First target date by which revenue deficit had to be eliminated and
fiscal deficit reduced to 3 per cent of GDP (set by FRBM Rules)
July, 2009 FRBM targets suspended and Act put on hold till negative effects of
Global Financial Crisis are overcome
Feb, 2011 Revised fiscal road map for 5 succeeding years and amendments to
FRBMA
May, 2013 Amendments to FRBM Rules
March, 2015 Fiscal and revenue deficit target set in Budget Speech of 2011-12;
Fiscal target date set for elimination of revenue deficit (set by FRBM
Rules 2013)
May, 2015 FRBM target of March 31, 2015 revised to March 31, 2018
June, 2015 Amendments to FRBM Act
May, 2016 FRBM Review Committee headed by N.K. Singh constituted
Jan, 2017 FRBM Review Committee submits its Report
March, 2017 Fiscal target date by which gross fiscal deficit to be reduced to 3 per
cent of GDP (set by FRBM Rules 2013)
April, 2017 FRBM Review Committee Report released to public
March, 2018 First target date by which revenue deficit has to be reduced to 2 per
cent and fiscal deficit to 3 per cent of GDP (set by FRBMA 2015)
Source: Charan Singh et. al. 67
11.7 GOODS AND SERVICES TAX (GST)
India adopted the value added tax (VAT) both at the Central and State level in
2005 with most states and union territories implementing the VAT. However,
both central VAT (i.e., CENVAT) and the State VAT had certain incompleteness.
The incompleteness in the CENVAT was that it had not been extended to include
chain of value addition in the distributive trade below the stage of production.
Similarly, in the State-level VAT, CENVAT load on the goods had not yet been
removed and the cascading effect of that part of tax burden had remained
unrelieved. Moreover, there were several taxes in the States, such as, Luxury
Tax, Entertainment Tax, etc. which were still not been subsumed in the VAT.
Also there had not been any integration of VAT on goods with tax on services at
the state level in order to remove cascading effect of service tax. CST was another
source of distortion in terms of its cascading nature. It was also against one of
the basic principles of consumption taxes that tax should accrue to the jurisdiction
where consumption takes place. Despite remarkable harmonisation in VAT, the
national market was fragmented with too many obstacles in free movement of
goods necessitated by procedural requirement under VAT and CST.
Integration of Central VAT and State VAT therefore was nothing but an inevitable
consequence of the tax reform process. As a natural corollary of this, any
unification of the taxation system required a dual GST, levied and collected both
by the Union and the States.Power of taxation is assigned to both the Union and
States under Schedule VII of the Constitution. While the Centre is empowered to
tax goods up to the production or manufacturing stage, the States have the power
to tax goods at distribution stage. The Union can tax services using residuary
powers but States could not. Under a unified Goods and Services Tax scheme,
both should have power to tax the complete supply chain from production to
distribution, and both goods and services. The Constitution (115th Amendment)
Bill, 2011, in relation to the introduction of GST, was introduced in the Lok
Sabha on 11.03.2011. The Bill was referred to the Standing Committee on Finance
on 29.03.2011 which submitted its report on the Bill in August, 2013. However,
the Bill was lapsed with the devolution of the 15th Lok Sabha. The Constitution
(122nd Amendment) Bill, 2014 was introduced in the 16thLok Sabha on 19.12.2014.
The Constitution Amendment Bill was passed by the Lok Sabha in May, 2015.
The Bill with certain amendments was finally passed in the Rajya Sabha and
thereafter by Lok Sabha in August, 2016. Further the bill was ratified by required
number of States and received assent of the President on 8th September, 2016
and has since been enacted as Constitution (101st Amendment) Act, 2016 w.e.f.
16.09.2016.
The Goods and Services Tax (GST) was rolled out across the country on July 1,
2017. It replaced several existing multiple taxes levied by the central and state
governments.The central and states taxes subsumed in GST is shown in Table
11.3.
India adopted the dual GST model because of its unique federal nature. Under
this model, tax is levied concurrently by the Centre as well as the States on a
common base, i.e. supply of goods or services or both. GST levied by the Centre
would be called Central GST (CGST) and that levied by the States would be
called State GST (SGST) and that levied by union territories without legislature
will be called UGST. For inter-state transactions and imported goods or services,
68
an Integrated GST (IGST) is levied by the Central Government. GST is a Fiscal Policy and Fiscal
consumption-based tax/destination-based tax, therefore, taxes are paid to the Management (FRBM) Act
state where the goods or services are consumed not the state in which they were
produced.
Goods and services are divided into five different tax slabs for collection of tax–
0 per cent, 5 per cent, 12 per cent, 18 per cent and 28 per cent. However, petroleum
products, alcoholic drinks, and electricity are not taxed under GST and instead
are taxed separately by the individual state governments, as per the previous tax
system8.
Table 11.3: Central and States Taxes Subsumed under GST

Central Taxes State Taxes
1. Central Excise duty (CENVAT) 1. State VAT /Sales Tax
2. Service Tax 2. Central Sales Tax
3. Additional Excise Duties 3. Purchase Tax
4. Excise duty (Medicinal & 4. Entertainment Tax (not levied by local
Toiletries Preparation Act) bodies)
5. Additional duties of Customs - 5. Luxury Tax
Countervailing Duty (CVD)- 6. Entry Tax (All forms)
Special Additional Duty (SAD)
7. Taxes on lottery, betting & gambling
6. Central Surcharges & Cess
8. State Surcharges & Cess
As provided for in Article 279A of the Constitution, the GST Council (the
Council9) was notified with effect from 12.09.2016 which is responsible for
conducting regular meeting and taking majority of GST related decisions. One
half of the total number of Members of the Goods and Services Tax Council
shall constitute the quorum at its meetings. Every decision of the Goods and
Services Tax Council shall be taken at a meeting, by a majority of not less than
three-fourths of the weighted votes of the members present and voting, in
accordance with the following principles, namely: – a) the vote of the Central
Government shall have a weightage of one-third of the total votes cast, and b)
the votes of all the State Governments taken together shall have a weightage of
two-thirds of the total votes cast, in that meeting.
Since its implementation there has been a feeling among states that they have
ceded more ground to the union government and that their freedom with regard
to changing the rates of value-added tax (VAT), their main source of revenue
was entirely lost. In order to protect any revenue loss to states on account of
switching to GST, the Goods and Services Tax (Compensation to States) Act,
2017 was enacted in 2017. Compensation will be provided to states for a period
8
Besides, some goods and services are exempt also. Rate for precious metals and affordable
housing are an exception to ‘four-tax slab-rule’ and the same has been fixed at 3 per cent and
1 per cent respectively. In addition, unworked diamonds, precious stones, etc. attracts a rate of
0.25 per cent. A cess over the peak rate of 28 per cent on certain specified luxury and demerit
goods, like tobacco and tobacco products, pan masala, aerated water, motor vehicles is imposed
to compensate States for any revenue loss on account of implementation of GST. The list of
goods and services in case of which reverse charge would be applicable has also been notified.
9
The Council is comprised of the Union Finance Minister (who is the Chairman of the Council),
the Minister of State (Revenue) and the State Finance/Taxation Ministers as members. 69
Monetary and Fiscal Policies of five years– July 2017-June 2022. For the purpose of calculating the
compensation amount to be paid to states in any financial year, their revenues in
2015-16 from taxes subsumed in GST will be considered as the base year. A
growth of 14 per cent over the base subsumed revenue would be guaranteed to
the states. If a state’s GST revenue fall short of the of the 14 per cent protected
revenue, its revenue loss will be compensated up to the level of assured protection.
Table 11.4 shows the trend in GST collections since its implementation from 1
July 2017. The overall Y-o-Y growth in the collection in 2019-20 over 2018-19
was 3.8 per cent.
Table 11.4: Trend in GST collection (Rs. Crore)
Month 2017-18 2018-19 2019-20 Y-o-Y change

in 2019-20
(per cent)
April – 1,03,459.0 1,13,865.0 10.06
May – 94,016.0 1,00,289.0 6.67
June – 95,610.0 99,939.0 4.53
July 21,572.0 96,483.0 1,02,083.0 5.80
August 95,633.0 93,960.0 98,202.0 4.51
September 94,064.0 94,442.0 91,916.0 -2.67
October 93,333.0 1,00,710.0 95,380.0 -5.29
November 83,780.0 97,637.0 1,03,492.0 6.00
December 84,314.0 94,726.0 1,03,184.0 8.93
January 89,825.0 1,02,503.0 1,10,828.0 8.12
February 85,962.0 97,247.0 1,05,366.0 8.35
March 92,167.0 1,06,577.0 97,597.0 -8.43
Total 7,40,650.0 11,77,370.0 12,22,141.0 3.80
Source: GST Council

1) State the objectives of FRBM Act, 2003.
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
2) What was the targeted fiscal deficit to GDP ratio by the 12th Finance
Commission?
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
70 .......................................................................................................................
3) Explain the channels through which the global financial crises affected Indian Fiscal Policy and Fiscal
economy. Management (FRBM) Act
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
4) State the important recommendations of FRBM Review Committee.
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
5) Which commodities are out of purview of GST?
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
11.8 LET US SUM UP

Fiscal Policy refers to the policy under which government uses its expenditure
and revenue programme to produce desirable effects and avoid undesirable effects
on the national income, production and employment. For understanding how
changes in government spending and taxation effects equilibrium level of income
and interest rate in the economy it is desirable to know the IS-LM framework.
Hence Section 11.2 throws light on theoretical analysis of the IS-LM framework.
Fiscal Policy during 1970s focussed on achieving greater equity and social justice
and both taxation and expenditure were employed towards this direction. During
1980s, the fiscal deterioration took place and eventually became unsustainable.
Rising deficits and debt raised the price of serving the debt in terms of mounting
interest payments. This in turn reduced the quality of the expenditure at the cost
of social and developmental expenditure.
In the post-reforms period the direct tax structure was simplified and rationalised.
As a result, the share of indirect tax declined to 45 per cent and share of direct
tax increased to 35 per cent by 2005-06.
On the expenditure side, the strategy was focused to reduce the subsidies and
cutting down on non-capital expenditure. By 2005-06, the interest component
came down to 30 per cent and defence and subsidies each took up 11 per cent.
71
Monetary and Fiscal Policies Despite these measures, the rising trend of fiscal revenue deficits since 1997-
1990 reflected signs of distress. By 2003-04, the combined liabilities of the Centre
and the States were up at 81.09 per cent of GDP from 70.59 per cent in 2000-01.
This necessitated having a new fiscal discipline frame work and consequently
the Fiscal Responsibility and Budgetary Management Act, 2003 was adopted in
2004.
The good and services tax which replaced the layers of multiple taxes levied by
the Central and State Governments has been introduced across the country since
July 1, 2017. Under the dual GST model, the tax is levied concurrently by the
Centre as well as the States on a common base i.e. supply of goods or services or
both.

1) Explain how IS-LM framework is useful to examine the impact of
government spending and taxation on aggregate income, saving and interest
rate.
2) Elaborate the broad trends in the pattern of public revenue and public
expenditure during last 30 years.
3) What do you mean by fiscal imbalance? What are the measures of fiscal
imbalance? How far FRBMA has been effective to correct fiscal imbalances?
4) State the channels through which global financial crises had affected Indian
economy. How far the fiscal policy in India been effective to mitigate the ill
effects of global financial crises?
5) State the salient features of Goods and Services Tax. Do you think it was a
right step to raise the State’s resources and in bringing transparency in tax
compliance?
6) What measures will you suggest to improve the working of fiscal policy in
India?
11.10 KEY WORDS

Balance of Payments (BOP) : Statement of the country’s trade and financial
transactions with the rest of the world during
the year.
Capital Budget : This consists of capital receipts and payments.
It also incorporates transactions in the Public
Account.
Capital Receipts : The main items of capital receipts are loans
raised by government from public which are
called market loans, borrowings by government
from Reserve Bank and other parties through
sale of treasury bills, loans received from
foreign bodies and governments, and recoveries
of loans granted by the Union government to
state and Union territory and other parties.
Direct Tax : Tax levied by government on the income and
72 wealth received by households and businesses.
Fiscal Deficit : The difference between revenue receipts plus Fiscal Policy and Fiscal
non-debt capital receipts on one side and total Management (FRBM) Act
expenditure including loans, net of repayments
on the other side.
Fiscal Policy : An instrument of demand management which
seeks to influence the level of economic activity
in an economy through the control of taxation
and government expenditure.
Indirect Tax : A tax levied by government on goods and
services.
Monetary Policy : The tool of macro-economic policy which
involves the regulation of money supply, credit
and interest rates in order to control the level
of spending in the economy.
Non-Tax Revenue : These receipts of government mainly consist
of interest and dividend on investments made
by government; fees and receipts for other
services rendered by government.
Primary Deficit : The fiscal deficit minus interest payments.
Public Debt : National debt and other miscellaneous debt for
which the government is ultimately
responsible. This would include the
accumulated debt of nationalised industries and
local authorities.
Revenue Budget : This consists of the revenue receipts of the
government (tax revenues and other revenues)
and the expenditure met from these revenues.
Tax Revenues : These comprise proceeds of taxes and other
duties levied by the concerned authority.
Tax Avoidance : Efforts to avoid paying tax by legal means.
Tax Evasion : Efforts to evade the payment of tax by illegal
means.
Tax Base : The total pool which tax authorities can tap
when levying a tax.
Value Added Tax (VAT) : A general tax applied at each point of exchange
of goods or services from primary production
to final consumption. It is levied on the
difference between the sale price of output and
the cost incurred on its production.
11.11 REFERENCES
1) Froyen R.T., “Macroeconomics: Theories and Policies”, 10th edition, Pearson
Education Ltd.
73
Monetary and Fiscal Policies 2) Dornbusch R., Fischer S. and Startz R., “Macroeconomics”, 11th edition,
McGraw-Hill Irwin
3) De S. (2012). “Fiscal Policy in India: Trends and Trajectory”, Department

of Economic Affairs Paper Series.
4) Rao M.G. and Rao. K.R. (2006).“Trends and Issues in Tax Policy and Reform
in India” India Policy Forum, NCAER.
5) Singh C., Prasad D., Sharma K.K., and Reddy S. (2017). “A Review of the
FRBM Act”, Working paper no. 550, Indian Institute of Management,
Bangalore.
6) Reddy Y.V. and Reddy G.R. (2019). Indian Fiscal Federalism, Oxford
University Press.
7) Department of Revenue (2019). “Goods and Services Tax (GST): Concept

and Status” Ministry of Finance, Government of India, August.
8) Ministry of Finance (2017). “FRBM Review Committee Report”, New Delhi,

January.

PROGRESS EXERCISES
1) i) Household
ii) Good market
iii) Crowding-out effect of public investment
2) See Sub-Section 11.2.1

1) See Section 11.5
2) 3 per cent of GDP
3) See Section 11.6
4) See Section 11.6
5) See Section 11.7
74
Fiscal Policy and Fiscal
UNIT 12 MAJOR DEVELOPMENT ON UNION Responsibility and Budget
STATE RELATIONS
Structure
12.0 Objectives
12.1 Meaning of and Rationale for Federal Structure
12.2 Pillars of Federal Finance
12.2.1 Assignments
12.2.1.1 Assignment of Public Expenditure
12.2.1.2 Assignment of Revenue Sources
12.2.2 Vertical and Horizontal Imbalances
12.2.3 Correcting the Imbalances – Inter-governmental Transfers
12.2.4 Sub-national Borrowing
12.3 Institutions of Federalism in India
12.3.1 Finance Commission
12.3.2 Planning Commission/NITI Aayog
12.3.3 GST Council
12.4 The 14th and 15th Finance Commissions
12.5 Trends and Issues in Fiscal Federalism in India
12.5.1 Centralisation and Vertical Imbalance
12.5.2 Regional Equity and Horizontal Imbalance
12.6 Let Us Sum Up
12.8 Key Words
12.9 References
Appendix 12.1
Appendix 12.2
12.0 OBJECTIVES
This unit is concerned with Union-States financial relations. After going through
this unit, you should be able to:
spell out the principles governing fiscal federalism;
state the provisions enshrined in Indian Constitution relating to division of
financial powers between Union and States;
discuss the role of various elements of the institutional structure underpinning
the Union and State relations;
appreciate the role of Finance Commission as an institution, and the
importance of major recommendations of various Finance Commissions over
the years;
critically examine the major recommendations of 14th Finance Commission,
the Terms of Reference and the interim Report of the 15 th Finance
Commission; and
evaluate the dimension and nature of issues involved in contemporary Centre-
State fiscal situation in the country. 75
12.1 MEANING OF AND RATIONALE FOR
FEDERAL STRUCTURE
Federalism refers to a system with more than one level of governance, each with
some autonomy and decision-making powers. A political definition would be
more rigorous and would require some specific conditions to be fulfilled, but an
economist’s definition is not so stringent. As long as all levels (two or more)
have the authority to take some key decisions regarding revenue raising and
spending public resources, basic conditions for fiscal federalism are satisfied,
even if political federalism may not exist. When characterised in this fashion,
only the degree of fiscal federalism differs among nations– even the formally
unitary countries have aspects of it. This is because economic administration
requires a minimum level of decentralisation and some delegation of fiscal powers
in the interest of efficiency.
The primary reason for the widespread implementation of the principles of

federalism, apart from the political aspects, is its suitability for realising the
economic benefits of both small and large size in the same administrative structure.
The primary economic benefit of large size is a large common market that allows
scaled-up production with economies of scale as also specialisation, making
production more efficient. The formation of the European Common Market has
been cited as a good example of these benefits of larger size. At the same time,
smaller jurisdictions also have the benefit of better information availability, less
divergence in tastes and preferences, and easier administration in general. A formal
statement of such benefits is given by the decentralisation theorem, which
essentially states that a decentralised system of governance better caters to local
tastes and preferences, and is therefore more efficient than a centralised system1.
These theoretical and a priori insights are well-supported in the case of India, as
a nation of its size and diversity appears to be well-suited for a federal system.
12.2 PILLARS OF FEDERAL FINANCE

12.2.1 Assignments
Assignments refer to the distribution of powers and responsibilities of the
government between the existing tiers. This is generally formalised in the
Constitution of the nation, but often history and conventions play a significant
role in the determination of the actual practices. In Canada, the Provinces that
came together to form the federation preceded the federal government;
accordingly, all powers and functions that were not specifically assigned to the
federal government remained with the Provinces. In contrast, the Indian States
as we see now were carved out from the whole after independence by the National
Legislature. The nation preceded the constituent units, and correspondingly, the
States were given specific powers and functions by the Constitution. The exclusive
domains of the Union and State governments, in the case of India, are specified
in their respective lists in the Constitution, along with a Concurrent list that
specifies the functions common to the jurisdictions of both the Union and the
States. However, the Union’s powers prevail over that of the States in case of
any conflict with respect to matters in the Concurrent list. This centralisation
1
See Oates (1972).
76
bias is further strengthened with all residuary powers remaining with the Union Major Development on Union
State Relations
(also called Central) government2.
The overall responsibilities of the government can be broadly classified following
Musgrave (1959) into three groups– resource allocation, distribution of wealth
and income, and stabilisation of the economy. Of these, the first type of
interventions that seek to reallocate resources to various economic activities
through fiscal tools are usually thought and actually found in practice to be suitable
for all levels of government, depending on the exact nature of the intervention.
The other two are conceptually better suited to the national level government as
regional or local level policy initiatives can be defeated by inter-jurisdictional
mobility of citizens or resources. For example, an aggressive redistributive policy
of a sub-national jurisdiction can cause out-migration of the rich from that
jurisdiction into other less aggressive jurisdictions.This can continue in principle
as long as the policy differential exists till all the rich taxpayers have shifted out
and there is no one left to redistribute from. Similarly, stabilisation policy adopted
by a sub-national jurisdiction can be neutralised by contrary policies adopted by
other jurisdictions. In general, when economic policies require uniformity across
the nation to be effective in a federal system, it is better administered by the
national government. These considerations apply to both sides of the fiscal
operations of the government– revenue raising and public expenditures.
12.2.1.1 Assignment of Public Expenditure
The assignment of expenditure responsibilities and of revenue handles are, in

principle, governed by different considerations. The expenditure responsibilities
are ideally assigned in such a way that the nature of the function maps closely to
the size of the jurisdiction. For example, defense is a national public good (i.e.,
its benefit area covers the entire nation) that maps best at the central level, and
hence best assigned to the Union government. In contrast, public lighting is very
much a local public good in nature, and hence best allotted to the local government
units. Regional level public goods can be assigned to State governments, and if
a particular public good does not map well into the pre-defined jurisdictions,
even special purpose sub-national special agencies can be created (e.g., school
districts in the USA or river valley project authorities in several countries including
Sri Lanka).
Apart from the economic efficiency argument of the ‘decentralisation theorem’

relating to greater cognizance of local variations in demand for public services,
the correspondence of benefit area with decision-making jurisdiction internalises
costs and benefits of public services and avoids distortions and sub-optimal
decisions. This is often termed as the subsidiarity principle, although strictly
speaking, the general principle essentially requires all decision-making at the
most decentralised level by default, and these powers and functions moved up to
progressively less decentralised levels only when there are clear and substantive
reasons for it. However, considerations of scale economies may sometimes
2
This has had significant impact on fiscal federalism, not foreseen by the Constitution makers.
The best example is that of no mention of the services sector anywhere in the three lists of the
Constitution, except a few specific services. This sector grew faster than all other sectors to
become the largest one in terms of share in GDP. The centre claimed the right to tax services
sector under the residuary powers clause, and this in fact upset the balance of revenue raising
powers between the Centre and the states irrevocably, with strong implications for subnational
autonomy. 77
Monetary and Fiscal Policies outweigh the subsidiarity principle in functional assignment. Also, the second-
generation theory of fiscal federalism (Qian and Weingast, 1997) asserts that the
main consideration in determining assignments should be the ability of any level
of government to carry out the function most efficiently, irrespective of the nature
of the public service one is considering. This contention is the main argument of
the modern theory of competitive federalism as well (Breton, 1987).
12.2.1.2 Assignment of Revenue Sources
As far as revenue-raising is concerned, primarily redistributive taxes like the

personal income tax are generally assigned to the national level. Modern
corporations are large entities with business operations across a nation, and to
prevent tax-induced distortions in location and other business decisions causing
inefficiencies, corporate taxation is also usually assigned to national governments.
Taxes on foreign trade are also assigned to the national government, as uniformity
is required across the nation. As per the original scheme of constitutional
assignment in most large federal systems including India, indirect or commodity
taxes were distributed among different levels. In India, the Union government
levied the Union Excise duty on production, the states levied sales tax (later
converted to a variant of Value Added Tax or VAT), and the local bodies could
levy Octroi duty. All three taxes were actually taxing consumption, which caused
a significant extent of tax overlapping, making it difficult to even assess the
effect of various taxes on the prices, leave alone the economic impact of this
complex system of indirect taxation. Further, competition among states to attract
business into their jurisdiction using the incentive of lower tax rates caused
revenue losses for all of them. This system badly needed rationalisation, with an
additional issue of the increasing share of the services sector in the GDP and the
appropriation of its taxation by the Union government using the residuary powers
clause of the Constitution. The rationalisation process was a long drawn-out
affair, beginning with efforts to lower the degree of tax competition in stages,
and culminating in the introduction of a Goods and Services Tax (GST) in 2017,
levied jointly by the Union and the state governments. While indirect tax reform
based on introduction of some variant of nationwide VAT has been a recurring
phenomenon across the globe for the last fifty years, its structure and
administration has neither been uniform, nor free from controversy in large
federations. Brazil, Canada and India, three large federations, each have different
versions of VAT/GST being levied, and in all three nations the extant system
faces some criticism.
In contrast to the broad-based taxes like income tax or VAT, there are some
revenue sources the base of which are less mobile and are therefore suited for
sub-national governments. For example, property tax or road/bridge tolls are
ideal for local bodies, and usually assigned to them. In India, Octroi was a major
source of revenue for local bodies in some of the states like Maharashtra, but
being a checkpost-based levy hampering smooth flow of traffic and an
anachronism in present times, had to be abolished. To be sure, an appropriate
substitute for Octroi was not found, and the concerned local bodies had to make
do with less productive and less regular source of income in terms of cash flow.
Local bodies also raise revenues from several non-tax revenue sources like fees/
rental from markets built/provided by them, and charges for water supply.
Middle-level (regional) governments in principle are assigned taxes that do not

78
require nationwide uniformity, and do not give rise to externalities outside their Major Development on Union
State Relations
boundaries, while internalising externalities that may arise if levied by local
governments. States in India typically raise most of their revenues from taxes
comprising motor vehicle taxes, state excise, stamp duty and registrations fees
apart from GST as the major taxes; a few other smaller sources of revenue like
land revenue, profession tax, and electricity duty are also allotted to the states by
the Constitution. Significant consolidation of several smaller constitutionally
allocated state taxes like entertainment tax, passenger and goods tax, entry tax,
and luxury tax levied on goods and services took place while introducing the
GST, which subsumed all these taxes. This certainly simplified the tax system of
the states. However, the introduction of GST with its legislation dominated by
the Union, despite granting states access to the services sector as tax base, has
reduced both revenue flow and revenue flexibility/autonomy for several states.
Important non-tax revenue sources for some of the states include royalty from
minerals including onshore petroleum crude extracted, and income from forests
(with some regulation of the use of forest resources)3.
12.2.2 Vertical and Horizontal Imbalances

As the principles governing assignment of government expenditures and revenue
sources are different, the two sides would be balanced for any level of government
only by accident. In general, because of the bias towards decentralisation of
functional responsibilities and government expenditures, the latter are incurred
at the sub-national level to a greater extent while, the collection of broad-based
taxes and those with substantial economies of scale imparts a bias towards greater
centralisation of tax collection. Together, these biases imply that the expenditure
responsibilities at the sub-national levels are not adequately supported by the
revenue assignments. This is termed as vertical imbalance, which is present in
varying degrees in practically all federations of the world. There is another type
of imbalance that relates to the varying ability of different constituent units at
the same level (sub-national), to meet their expenditure needs with their own
revenues. This is known as the horizontal imbalance, the degree of which is
often linked to the level of economic development of the concerned unit. For
example, Bihar is likely to have a much higher degree of horizontal imbalance
compared to Haryana. Expenditure responsibilities of a poor state like Bihar
would be higher because of the inability of the majority of its citizens to pay and
access private supply of the services they need, while their low incomes would
permit the state government to raise only relatively low amounts of revenues.
Both the problems are likely to be less severe in the relatively better-off state of
Haryana.
12.2.3 Correcting the Imbalances – Inter-governmental

Transfers
The vertical and horizontal imbalances inherent in most of the federal fiscal
systems have to be resolved (called the process of equalisation) in the interest of
the stability of the system. Equalisation is a constitutional requirement in some
countries, and in some others, a legal obligation. It can also be motivated by a
tradition/convention or an implicit general agreement or ‘common will’ as
expressed by the legislature. This mechanism for resolution should be a part of
3
For the Union government in India, sale of spectrum has been a lucrative non-tax revenue
source. 79
Monetary and Fiscal Policies the system to obviate the need for repeated consideration and policy initiatives
for such resolution. In general, this requirement being met by inter-governmental
transfers is a common feature in all systems of fiscal federalism, including India.
Apart from resolving the vertical and horizontal imbalances, inter governmental
transfers can also serve other purposes. These include:
a) compensating for benefit spillovers across jurisdictions to maintain
efficiency4,
b) to pay for agency functions performed by sub-national governments on behalf
of the national government,
c) to help sub-national governments maintain a minimum level of basic services,
and
d) to incentivise the sub-national governments to fall in line with central
planning or development objectives.
Each of these motives for intergovernmental transfers has been explicitly
considered and catered to, in the Indian system at some point. For example, the
14th and now the 15th Finance Commissions have linked a State’s tax share
positively to its area under forests, keeping in mind the environmental and
ecological benefit spillovers of forests. Erstwhile Planning Commission and the
Plan transfers under its aegis exemplified (d) above.
Inter governmental transfers can be formula-driven (amounts for each recipient

determined objectively using a set of pre-determined, quantifiable criteria) or
discretionary (determined on a case-by-case basis). While some amount of
discretionary transfer is present in almost all federal systems, too much of it can
result in undesirable consequences like loss of sub-national autonomy, inefficient
lobbying by recipient governments, and strategic behaviour. Inter governmental
transfers generally take one of the two forms: revenue-sharing and grants. Both
forms are widely prevalent in various countries of the world including India.
Revenue– sharing is usually through a scheme of specified percentage of the
total for individual units of sub-national governments, implying varying amounts
with variations in the total. In India, the aggregate tax revenue of the Union is
shared with States, while other countries may share revenues from individual
taxes (Brazil, for example)5. Non-tax revenues can also be shared; royalty from
various minerals including petroleum crude is shared among different levels of
government in several countries.
Grants can be of different types, and their designs are often influenced by the
objective of the grants. They can be conditional (specific purpose) or
unconditional (also called general purpose or block grants). The latter are
generally preferred for correcting horizontal or vertical imbalances. But grants
to maintain a minimum level of basic services would obviously be conditional,
4
When sub-national governments optimise their public spending by equating benefits with
costs, there may be under-provision in the presence of benefit spillovers (positive externalities)
– a part of the benefits accruing outside the jurisdiction of the government incurring the
expenditure, as the decision may be based on benefits accruing within the jurisdiction only.
5
Revenue sharing should be distinguished from revenue base sharing. Base sharing does not
require intergovernmental transfers unless collection is centralised by common agreement.
Income tax base is shared between the States/Provinces and the Federal (central) government
in both the USA and Canada, but that does not entail inter governmental transfers. GST base
80 is shared between the Union and the States in India.
to be spent on specified (basic) services only. Conditional grants can be matching Major Development on Union
State Relations
(linked to the recipient units’ performance in revenue collection or expenditure)
or non-matching. Matching grants are used when the grantor government wants
to modify the grantee government’s preferences in favour of the activity supported
by the grant. Most of the central grants provided to states under the Centrally
Sponsored Schemes are of this type. Further, grants can be closed-ended (pre-
defined maximum) or open-ended.
In the budget documents, grants are reported broadly according to their

institutional channel. The first classification is between Plan grants and non-
Plan grants. With the discontinuation of central planning, the first category is
currently void except for grants relating to Centrally Sponsored Schemes. The
second category of non-Plan grants comprises statutory grants (those
recommended by the Finance Commission) and other grants (the composition of
which can change from time to time).
12.2.4 Sub-national Borrowing

In India, sub-national governments– states and local bodies are permitted by the
Constitution to borrow from various sources. These sources include (a) a higher
level of government, (b) market borrowings, (c) negotiated loans from various
financial institutions including commercial banks, and (d) the central bank of
the country and bankers to most of the states– the Reserve Bank of India (RBI).
Apart from these, there are other liabilities in the nature of debt that the sub-
national governments incur, like Provident Fund contributions collected from
their employees. While most of the borrowings are made at their discretion, market
borrowings are subject to direct central government control, as per a constitutional
provision (Art. 268). Typically, negotiated loans, market borrowings and
borrowings from the Union government are long-term loans while loans from
commercial banks and those from the RBI are short-term. Loans from the Union
government may include some amounts that are simply pass-through debt, actually
borrowed from bilateral/multilateral institutions such as the World Bank or Asian
Development Bank. Although these loans are negotiated by the lender organisation
directly with the beneficiary sub-national government6, the actual flow of funds
is through the Government of India as the other levels of government are not
permitted by the Constitution to borrow from any non-domestic source7.
All the state governments in India are subject to their own fiscal responsibility
legislations, introduced around the middle of the first decade of this millennium
in most of the states. These have the common features, prompted by the Finance
Commission, of limitations on revenue deficit, fiscal deficit and the ratio of total
debt to Gross State Domestic Product (GSDP). In general, states in India cannot
finance their deficit without incurring some kind of debt; thus, the statutory
limitation on fiscal deficit automatically implies a restriction on debt. This is
important from the point of view of fiscal sustainability of the state finances in
6
This is the position after the year 2000. Before that, foreign lenders could not negotiate with
the sub-national governments directly as the constitutional restriction was strictly enforced.
Also, irrespective of the terms of lending agreed with the original lender, the Union government
on-lent the amounts at the same standard terms as the usual lending to the sub-national
governments.
7
The extent to which sub-national units can access debt from foreign lenders varies between
different countries. In Sri Lanka, sub-national governments cannot borrow at all from foreign
sources, while Canadian Provinces freely do so. 81
Monetary and Fiscal Policies India, which went through serious stress during the period 1990-2005 leading to
the introduction of the fiscal responsibility legislations (FRBMA) in the first
place.

1) What do you understand by the term ‘fiscal federalism’?
.......................................................................................................................
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2) List the overall responsibilities of a government. How are these
responsibilities suited or assigned to different layers of the Government?
.......................................................................................................................
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.......................................................................................................................
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.......................................................................................................................
.......................................................................................................................
3) To what extent do inter-governmental transfers help to correct the vertical
and horizontal imbalances?
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
4) What are the different sources of sub-national borrowings?
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.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
82
Major Development on Union
12.3 INSTITUTIONS OF FEDERALISM IN INDIA State Relations
Apart from the different tiers of the government, the institutional structure relating
to fiscal federalism in India primarily involves the Finance Commissions at the
central and state levels, and to a lesser extent the NITI Aayog8. An agency that
should have been playing a major role is the Inter-State Council, but it does not
in practice. In the present fiscal context, another agency that has assumed
importance is the GST Council, empowered by the relevant legislation to
deliberate upon and take decisions relating to key issues within the ambit of
GST structure in the country and administration.
12.3.1 Finance Commission

Article 280 of the Indian Constitution provides for the apex (and originally the
only) Finance Commission empowered to advise the Union Government of the
day in matters relating to Centre-State financial relations. The Constitution
provides for appointment of a Finance Commission by the President of India
(the Chairman and Members, on the advice of the Union Government) every
five years or earlier. The Commission is provided with a set of Terms of Reference
(ToR) that may include, apart from the constitutionally mandated tasks, any other
matter involving centre-State financial relations. The constitutionally mandated
tasks at present include, inter alia, tax devolution or sharing of central tax revenue
with the States (Art. 270 as amended), as also recommending grants-in aid to
individual States to cover revenue deficits, for onwards transmission to local
bodies, for meeting natural calamities, and for any other reason at its discretion
(Art. 275 and 282). The Commission also considers the indebtedness of the Union
and the States, and makes recommendations deemed appropriate (Art. 293). It is
expected to submit its recommendations in a Report some time before its award
implementation period is to begin, to give enough time to the Union government
to consider the recommendations and table it in the Parliament along with an
Action Taken Report (ATR). Each Commission is disbanded after submitting its
report, unless an additional issue is entrusted to it for consideration and
recommendations. There have been only rare instances when the Union
government has not accepted Finance Commission recommendations; this has
been a healthy tradition in the working of Indian fiscal federalism.
State Finance Commissions came into being as a result of 73rd and 74th amendments
of the Constitution in 1992 conferring constitutional status to the third tier of
government, the urban and rural local bodies. Each State government has its
own legislation in this respect, and is expected to appoint the State Finance
Commissions at regular intervals as provided in their concerned legislation. The
scope of the recommendations covers State-local financial relations, mainly fiscal
transfers from the State government to the local bodies.
12.3.2 Planning Commission/Niti Aayog

The erstwhile Planning Commission played a significant role in the area of fiscal
federalism in India. It oversaw the State level Five Year Plans– both physical
and financial, provided financial assistance for State Plans in terms of both debt
and grants, and possibly most importantly, provided a forum for the States to
8
Its predecessor, the Planning Commission, played a much more important role– as important
as the Finance Commission. Some details are provided in following paragraphs. 83
Monetary and Fiscal Policies come together and discuss issues important to them in the form of National
Development Committee (NDC), chaired by the Prime Minister of India. The
Planning Commission was set up by an executive order of the Union Government
when India adopted the mixed economy model of economic system with central
planning. While the system of central planning was preferred one, the Planning
Commission was a key institution for economic policy; with the economic policy
liberalisation of 1991, its pre-eminence started dwindling, and in 2014, its
discontinuation was announced. It was replaced by NITI Aayog, which has so
far been a purely advisory body with some amount of responsibilities for
monitoring and research. It does not play any direct role in fiscal federalism in
India.
Various Ministries of the Government of India including the Ministry of Finance

play an important role in the system of fiscal federalism in India. While the
Ministry of Finance plays an important role in implementing the Finance
Commission recommendations, monitoring FRBM Act implementation, and
several other tasks of monitoring and control of States’ financial measures, several
individual line Ministries are responsible for implementing Centrally Sponsored
Schemes relating to their mandate and provide associated transfers to States/
local bodies.
12.3.3 GST Council

As you have learnt in Unit 11, indirect tax structure has undergone a revolutionary
change through introduction of a single Tax– Goods and Services Tax (GST) by
way of constitutional amendment (Article 279A of the Constitution) made in
2016. Prior to GST, the Central taxes include central excise duty, additional duties
of excise, additional duties of customs service tax, surcharges and cesses. Similarly
the state taxes were State VAT/ sales tax, central sales tax, purchase tax,
entertainment tax, luxury tax, entry tax, taxes on lottery, betting and gambling
surcharges and cesses, etc.
This multiplicity of indirect tax structure has been replaced by a single tax i.e.
GST structure through the Constitutional Amendment in 2016 providing
concurrent powers to both Centre and States to levy GST (Centre to tax sale of
goods and States to tax provision of services). The key features of GST are:
Single Tax (GST)
Single Tax Administration
Uniform Law
Computerised Uniform Procedures
In brief GST Structure in India can be summed up as under:
GST
C-GST S-GST/UT-GST I-GST
Fig. 12.1: GST Structure in India

84
Alcohol for human consumption, five petroleum products, Tobacco and Major Development on Union
State Relations
entertainment tax have been left outside the purview of GST.
This tax is a major contributor to the tax revenue of both levels of the Government,
particularly the States.
The GST Council comprising both State and Union representatives has assumed
significance because it is entrusted with the responsibility of providing/ amending/
updating the details with respect to the structure and administration of GST, a
tax jointly levied by the centre and the States.
As on 14-5-2019, 94.5 per cent of the total decisions (1064) of the GST Council
have already been implemented, which is a significant achievement given the
complicated nature and wide area of subjects/issues involved on the fact that
most decisions were taken unanimously.
12.4 THE 14TH AND 15TH FINANCE COMMISSIONS

The primary responsibility of the Finance Commission, as mentioned above in
the preceding section, relates to recommending fiscal transfers from the Union
to sub-national governments. As the transfers to local bodies are also routed
through the State governments, it could be taken as Centre-State transfers. The
two types of transfers, tax devolution and grants, are different in nature in that
grants are recommended in money terms or fixed amounts (for each State), while
tax devolution is recommended as the percentage shares of each State in the total
tax revenue of the Union net of :
a) Cost of collection of taxes
b) Revenues collected in the Union Territories
c) Exclusions like cess and surcharges as specified in the Constitution.
Usually, Finance Commissions estimate individual States’ revenue receipts and
current expenditure first, yielding estimates of revenue deficit/surplus9. Next,
tax devolution is recommended in terms of (i) the share of States as a whole in
the distributable tax revenue of the Union and (ii) applicable shares of each
State. The Commission itself estimates distributable Union tax revenues for the
award period, and applying the shares recommended, it estimates the amount of
tax devolution for each State. Selecting the States with pre-devolution revenue
deficits, these deficits are reduced by the estimated tax devolution. For only
those States which end up with post-devolution revenue deficits, a revenue deficit
grant to cover the same is recommended. Other grants are usually recommended
independent of this process, based on considerations specific to the nature of the
grant recommended. By far, tax devolution outweighs other transfers (grants) in
terms of the amounts concerned.
The ToR of the 14th Finance Commission, the last one to have submitted its
report at this point, is reproduced in Appendix 12.1. As can be seen, it was asked
to consider a large number of issues other than the basic ones enshrined in the
9
By choice, Finance Commissions in India have confined themselves to the current account
(internationally the term ‘current’ or ‘recurrent’ is used to denote receipts or expenditure without
any associated future financial flows, but the roughly equivalent term ‘revenue’ is used in the
Indian budgetary parlance) of the budget only. The capital account is not considered by them
except when considering indebtedness. 85
Monetary and Fiscal Policies Constitution. It, however, did not make specific recommendations affecting the
Centre-State financial flows on all of them. The highlights of its recommendations
were as follows.
Its first major recommendation was to raise the share of States as a whole in the
net tax revenues substantially. This can be seen with reference to the earlier
Finance Commissions’ recommendations provided in Table 12.2.
Table 12.2: States’ Share in Divisible Pool of Central taxes
States Share in the Net Proceeds of
Finance Commission Income Union Excise All Shareable
Tax (%) Duties (%) Union Taxes (%)
FC-1 (1952-57) 55 40
FC-2 (1957-62) 60 25
FC-3 (1962-66) 66.66 20
FC-4 (1966-69) 75 20
FC-5 (1969-74) 75 20
FC-6 (1974-79) 80 20
FC-7 (1979-84) 85 40
FC-8 (1984-89) 85 45
FC-9-I (1989-90) 85 40
FC-9-II (1990-95) 85 45
FC-10 (1995-00) 77.5 47.5
FC-11 (2000-05) 29.5
FC-12 (2005-10) 30.5
FC-13 (2010-15) 32
FC-14 (2015-20) 42
Before the 11th Finance Commission, Finance Commissions could recommend

devolution with respect to two taxes only: income tax (after 1961, personal income
tax only) was shareable as per the Constitution while Union excise duty was
shareable if the Parliament so desired (it passed a resolution to share the tax).
The 10th Finance Commission recommended a change in the system to sharing
of all taxes, which was then made feasible with the necessary constitutional
amendment; this was implemented with the awards of the 11 th Finance
Commission onwards. It may be noticed that there is a significant jump in the
States’ share recommended by the 14th Finance Commission. While this was
extensively analysed by commentators, it actually signified a much smaller
increase, the rest of it being a compensatory one for the discontinuation of Plan
grants and the 14th Finance Commission consciously avoiding certain types of
grants awarded by several previous Finance Commissions. This latter observation
actually constitutes the second highlight of the14th Finance Commission awards.
All the recent Finance Commissions had recommended conditional or specific-

purpose grants, apart from the constitutionally ordained revenue deficit grants,
those for local bodies, and for disaster relief/preparedness. In contrast, the 14th
86
Finance Commission took the position that other agencies with adequate domain Major Development on Union
State Relations
expertise should be tasked with the responsibility of recommending specific
purpose, or scheme specific grants. In the process, the transfers recommended
by it were overwhelmingly unconditional, enhancing the autonomy of the States
to decide the uses of the funds received.
The third highlight related to the use of population data. Several Finance
Commissions preceding the 14th had used population data for the year 1971 for
scaling purposes as also when population was directly used as a determinant of
the transfers, as required by their ToR. This in turn was the result of a resolution
of the Parliament. The basic idea was to provide an implicit incentive to States
with lower growth of population as compared to the others, or rewarding
successful control of population growth. However, its ToR marked a departure
from the past several Finance Commissions; while the 14th Finance Commission
was asked to continue with the 1971 population as the basic number, the ToR
specified that it may consider ‘demographic changes’ post-1971 also. Accordingly,
the 14th Commission used a variable termed ‘demographic changes’ (post-1971)
in their suggested formula to determine tax devolution. Table 12.3 provides the
determinants used by a few recent Finance Commissions to provide a context
and comparison.
Table 12.3: Components and Weights used in Tax Devolution Formulae
Component FC 11 FC 12 FC 13 FC 14
Income Distance/Fiscal Capacity 62.5% 50.0% 47.5% 50.0%
Population-1971 10.0% 25.0% 25.0% 17.5%
Area 7.5% 10.0% 10.0% 15.0%
Index of infrastructure 7.5% - - -
Tax Effort 5.0% 7.5% * -
Fiscal Discipline 7.5% 7.5% 17.5% -
Demographic Change (2011 population) - - - 10.0%
Forest Cover - - - 7.5%
* Included in fiscal discipline
It can be seen that the formula for determination of the shares of individual
States in tax devolution recommended by the 14th Finance Commission was
different in two other respects. One, it did not include a traditional fiscal discipline/
tax effort variable – justified as providing the appropriate fiscal incentive – in its
list of determinants on the ground that the already operational Fiscal
Responsibility and Budget Management (FRBM) Acts of different States, and
the incentives provided to the States to stay within the parameters defined by the
Acts obviated the need for any further incentive. Two, it introduced a new
determinant for the first time – the share of a State in total forest cover – in
response to one clause of the ToR that stressed “the need to balance management
of ecology, environment and climate change consistent with sustainable economic
development”.
The fourth and final highlight related to a small variation permitted in the
normative fiscal deficit level recommended for compliance with FRBM Act.
87
Monetary and Fiscal Policies The two primary targets of FRBM legislations as recommended by preceding
Finance Commissions were zero revenue deficit or a revenue surplus, and a
maximum fiscal deficit of 3 per cent of Gross State Domestic Product (GSDP).
The 14th Finance Commission allowed a maximum of 0.5 per cent of GSDP as
additional fiscal deficit provided the concerned State had:
a) Revenue deficit = 0;
b) Debt-GSDP ratio = 25%;
c) Interest payments = 10% of revenue receipts.
To avail of any additional fiscal deficit limit, a State had to fulfil the condition
(a). Fulfilling conditions (b) and (c) entitled a State to 0.25 per cent additional
fiscal deficit limit for each, available separately and simultaneously (if both the
conditions were fulfilled). Thus, instead of a uniform prescription of 3 per cent
fiscal deficit, States had three possible levels of fiscal deficit– 3 per cent, 3.25
per cent and 3.5 per cent, depending on their fulfilling conditions (a), (b), and
(c). This partially met the critique of the uniform 3 per cent ceiling as a ‘one size
fits all’ approach unsuitable for a large and diverse nation like India, where
individual States had different investment needs and their financing requirements
through borrowing.
The 15th Finance Commission was appointed in November 2017, and initially
asked to submit its report by October 2019, as its award period was to begin
from the fiscal year 2020-21. As has become customary, its ToR (see Appendix
12.2) contains several issues over and above the basic constitutionally mandated
tasks. Of course, it is not necessary for the Commission to make recommendations
on every item of the ToR– it was determined long ago by the Sixth Finance
Commission that Finance Commissions were not bound by the ToR. However,
they must give due consideration to each item of the ToR, and build in whatever
considerations they feel appropriate into their recommendations. Also, an
important change in the ToR that generated some controversy was a shift to the
2011 population (as opposed to the 1971 population) as the basic population
data for each State. States with relatively greater success in controlling their
population felt it to be a disincentive for containing population growth.
First because of the additional ToR to consider and suggest a dedicated financing
mechanism for defence and internal security, and then because of the change in
the status of the State of Jammu and Kashmir into two Union Territories, the
Commission needed and was given a one-year extension. It provided a small
first report in 2019, applicable to the fiscal year 2020-21 only. The first report
marginally modified the share of the States in the net tax revenue of the Union to
41 per cent (Jammu & Kashmir was not covered any more), and also made some
small changes in the tax devolution formula (the main one being the reintroduction
of tax effort as a determinant with a small weight, and use of a variable
representing Total fertility rate of a State as per 2011 Census data along with
population as per 2011 Census). Its full report is expected in October 2020, but
the outbreak of the COVID-19 pandemic, and its impact on the finances of the
States and the Union, would require reconsideration of its entire approach and
resultant computations. Moreover, the Commission has been asked to provide
its recommendations for five more years till 2025-26, making it the only Finance
Commission so far with its award period covering a total of six years instead of
the customary five.
88
Check Your Progress 2 Major Development on Union
State Relations
1) What is the (Union) Finance Commission? How is it distinct from State
Finance Commission?
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2) What is the basis for the recommendation of the tax devolution and grants
made by the Finance Commission?
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3) Discuss the role of GST Council in management and administration of GST
jointly levied by the Centre and States.
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4) State the highlights of the recommendations of 14th Finance Commission.
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12.5 TRENDS AND ISSUES IN FISCAL

FEDERALISM IN INDIA
12.5.1 Centralisation and Vertical Imbalance
Federalism in India has been evolving over time, with the broad structure given
by the Constitution proving to be durable. However, the fiscal aspect of it has
struggled to align with the political evolution of India. After independence, the
country saw a politically dominant central government, with the State
89
Monetary and Fiscal Policies governments basically playing the role of followers, primarily a result of most
State governments dominated by the same political party that was in power at
the Union level. This political landscape started changing gradually by the ‘sixties,
and by the mid-seventies, regional parties and others not in power at the centre
were challenging the political monopoly, often successfully. The political non-
conformity among the Union and States has now become the norm, and this has
had implications for fiscal federalism, mainly expressed as the demand from the
States for financial independence and autonomy. There were, to be sure,
institutional responses to this development. The Planning Commission, for
example, shifted from a system of scheme-based discretionary financial support
system for State Plans, to a substantively formula-driven, block-grant based
system in 1969 with the introduction of the well-known ‘Gadgil formula’ (later
modified a little) designed to reduce micro-management of State Plans and
enhance States’ autonomy. Similarly, several Finance Commissions have also
tried to reduce vertical imbalance as best as they could. But in general, the Union
government has not been particularly supportive of greater fiscal – particularly
revenue – decentralisation, although there have been a few instances of moving
in the direction of greater State level financial autonomy.
Independent analysts have branded the system in India as ‘quasi-federalism’
because of certain centralising features– the primary one being the power of the
national legislature to redefining State boundaries and change the political status
of a State. This power has already been exercised a few times. Some other features
like residuary powers resting with the Union, and the introduction of central
planning through the creation of Planning Commission by the executive, have
contributed to this view of a centralised federation. The vertical imbalance in
revenue raising powers has also been quoted in this context, although most large
federations are characterised by this feature in varying degrees. Because of the
persisting need for resources to finance public interventions in a developing India,
both the central and the State governments are always trying to garner resources
for themselves, and this takes several forms, one of which is to get (or keep, as
the case may be) as much as feasible for themselves. It should be noted here that
the Union has access to additional sources of funds including deficit financing
that the States do not have, and hence the position of the two levels of governments
are not symmetrical. The Finance Commissions have generally been sympathetic
to the plight of the States and have tried to allocate a fair share of resources to
them. But the Union has tried to thwart these efforts often, as can be deduced
from the following examples.
In the early years of independent India, there was only one income tax
covering both personal and corporate income tax. In 1961, the relevant Act
was overhauled, and the accounts of the Union split the two income taxes
into different major heads. This was followed by the position that corporate
income tax was now a separate tax, and since the Constitution did not ask
for sharing this and only income tax (interpreted to mean just the personal
income tax), corporate income tax was not shareable. De facto additional
resource mobilisation through personal income tax also decreased following
this episode until the 10th Finance Commission recommended sharing of all
taxes of the Union.
A recent example of this tug-of-war for resources is provided by the Union

government’s reaction to the increased tax devolution recommended by the
90 14th Finance Commission. While a large part of this increase was actually
compensatory in nature consequent to abolition of the Plan transfers and Major Development on Union
State Relations
eschewing sector-specific and scheme-based grants, only the increase was
highlighted, and was followed by a restructuring of the financing of Centrally
Sponsored Schemes such that, the additional financing required from the
States practically wiped off whatever little net benefit the 14th Finance
Commission had provided to the States.
A third example relates to the rather liberal use of cess and surcharges by
the Union government in recent years, a trend that is still continuing. Suffice
it to point out that cess and surcharges are excluded from shareable taxes
and have increased from about 10 per cent of gross tax revenues of the
Union to 18.55 per cent between 2011-12 and 2019-20.
A fourth and final example is about mineral royalties payable to States on

major minerals10 extracted from within their jurisdiction. Royalty rates are
statutorily required to be reassessed at given intervals, usually to raise them
to allow States to share the benefits of rising prices. This feature was really
important when royalty rates were specific (i.e., fixed amounts per unit of
output), and the central government delayed revisions in the face of fast-
rising prices of minerals like iron ore; now that these rates have been changed
to ad valorem (percentage of value per unit of output), theoretically rate
revisions should be less of a problem. However, there are still complaints
from States that because major minerals are largely extracted by central
public enterprises, the Union government often uses price data for
determining value of minerals that underestimate true market value.
As against the above examples, there are some examples of the central government
accommodating States’ interests too. For instance, in the year 2000, the Union
changed its usual practice of lending all foreign assistance in the form of debt or
combination of debt and grants under its common terms for lending to States (at
that point of time, the rates of interest charged were substantially higher than
market rates, and an administrative charge was payable in addition) to ‘back-to-
back’ passing on of such assistance (meaning on the same terms as received
from the foreign source). This essentially meant that States could take advantage
of the soft terms attached to such assistance, while they also had to bear the
exchange risk of foreign-currency denominated loans.
The centralising tendency is visible on the expenditure side also, but more
qualitative than quantitative. First, the constitutional provision of the Union
dominance in the subjects included in the Concurrent List (decisions by the
Parliament overrule any State legislations in these areas) facilitates centralisation
by design. This has been expanded with a few cases of constitutional amendment
moving subjects from State List to the Concurrent List. Centrally Sponsored
Schemes have been, however, a greater irritant in the context of centre-State
10
Minerals are divided into three categories from the point of view of financial flows relating to
them. Crude petroleum is a category by itself; the Union has full jurisdiction on its exploitation
with only a royalty payable to the concerned State on onshore production (royalty on offshore
production, as in the case of Bombay High oilfields, is collected by the centre). For major
minerals like coal, iron ore, bauxite, copper and gypsum, the States have a say in the actual
exploitation of mines, and also receive a royalty on the value of minerals extracted. In the case
of minor minerals like earth, stones and sand, the States are given full control over their
exploitation and royalty collections. The rates of royalty are determined by the Union
government for petroleum crude and major minerals. 91
Monetary and Fiscal Policies financial relations. These are centrally initiated and designed schemes relating
to subjects in the State domain, funded fully or partially by the Union, the latter
usually with matching requirements. Resource-starved State governments cannot
afford refusal to participate, but matching grants distort State priorities by pulling
in more State resources for the activity supported by the Scheme than would
otherwise be the case (see Cullis and Jones, 1992, pp. 307-311 for a theoretical
discussion of the effect of different types of grants on recipient governments’
expenditure). Administered by central ministries relevant to the coverage of the
scheme, in the last two decades, grants under these schemes have outweighed
other types of grants. Apart from limiting State autonomy in practice, these grants
also modify the regional pattern of equity and the incentive structure built into
the Finance Commission transfers. To be sure, there is a place for such conditional
matching grants in a federal system; but it is the quantum of these grants that
really generate skepticism about their legitimacy in India. These grants have a
tendency of proliferating and attempts to limit their number and financial flows
in the past have been defeated by the internal dynamics of the governmental
processes within the Union government.
12.5.2 Regional Equity and Horizontal Imbalance

India is one of the countries with fairly high levels of regional inequality. Though
regional inequality and horizontal imbalance are not exactly the same as the
latter refers to the limited context of public finances, there would be a presumption
that these two would be highly correlated. This is because the poorer regions
would have a smaller revenue base to exploit and greater need for public
interventions on account of lower ability of its residents to spend on private
goods and services. This is certainly the case in India, if we consider expenditure
needs and revenue potentials of the States rather than the actual receipts and
expenditures (Sen, 2011). A major objective of the inter-governmental transfers
is to reduce vertical imbalances, which can then contribute to reduction in regional
inequalities. Admittedly, the latter is determined by several interrelated factors
other than the State’s public finances, some of which are within the public policy
domain. However, the link between development and public policy
(implementation of most of which requires financial resources) is summarised
in Figure 12.1.
Poor Initial Conditions
Low Public Investment

to Improve Initial Low Levels of
Conditions Development
Low Availability of
Public Resources
Fig. 12.1: Vicious Cycle of Public Interventions for Development

Source: Reproduced from Sen (2011)
92
It is this vicious cycle that the system of fiscal federalism is expected to disrupt; Major Development on Union
State Relations
unfortunately that has not happened to any appreciable extent. The salient causes
may be summarised as follows:
Various elements of public policy have worked at cross purposes. Empirical

studies have shown that among different channels of fiscal transfers, only
Finance Commission transfers have been somewhat equalising (inversely
related to per capita income of individual States). Earlier Plan assistance,
transfers under Centrally Sponsored and Central Plan Schemes and other
transfers have no significant relationship with per capita income. Central
investments in public sector undertakings also have not been progressive,
nor the major budgetary subsidies of the central government or credit flows
from the financial institutions (Rao and Sen, 1996). The lack of coordinated
public policy aiming to reduce regional disparities has thus witnessed a
widening of the disparities over the years.
Even the Finance Commission transfers have been less equalising than they
could have been. Their refusal to consider investment requirements of various
States – particularly important for low-income States – even after the
discontinuation of the Planning Commission that was expected to attend to
this aspect has pushed this consideration out of the agenda for Centre-State
financial flows, to the detriment of prospects of dynamic equalisation. Even
when considering revenue deficit grants, the receipts and expenditures are
estimated using projections on the basis of actual values for a base year and
not normative estimates (i.e., revenue potential and expenditure need). Since
actual values of expenditure of low-income States are strongly revenue-
constrained, this results in underestimating expenditure requirements of these
States. In contrast, even a high-income high-spending State can qualify for
grants-in-aid if it does not raise adequate revenues in fact. Even the latest
report – the First Report of the 15th Finance Commission – uses a similar
methodology, building in perverse incentives and negating equalisation.
The FRBM Act also constrains developmental effort of low-income States.

The absolute limit on fiscal deficit (implying a limit on borrowings), makes
it difficult for low-income States to borrow and invest beyond the prescribed
limit, even if such a course of action is financially viable and required for
development purposes.
Thus, with the design of fiscal federalism not providing resources for accelerating
the developmental process to the low-income States, they are left to do so with
the resources they can raise themselves, which are constrained by the smaller
base compared to other States. Widening disparities is a logical outcome of this
framework.

1) In what sense India’s fiscal federalism is branded as ‘quasi-fiscal federalism’?
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93
Monetary and Fiscal Policies 2) Which aspects of public policy have been operating at a cross-purpose?
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3) Identify the critical issues in fiscal federalism in India.
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12.6 LET US SUM UP

Federalism refers to a system having more than one level of governance, each
with some autonomy and decision-making power. Under such a system, the
powers and responsibilities are distributed among the different layers of the
Government. The overall responsibilities of the Government are classified into
three groups– resource allocation, distribution of wealth and income, and
stabilisation of the economy. The fiscal operations of the Government i.e., revenue
raising and public expenditures at different levels play a significant role in
discharging the above responsibilities.
Apart from the tiers of the Government, the institutional structure relating to
fiscal federalism in India involves primarily the Finance Commission and GST
Council at the Central and State level and to a lesser extent the NITI Aayog. The
Constitution provides for appointment of a Finance Commission every five years
or earlier with a set of terms of reference. The constitutionally mandated tasks at
present include inter-alia, sharing of Central tax revenue with States,
recommending grants-in-aid to individual States to cover revenue deficits for
onward transmission of local bodies, for meeting natural calamities and for any
other reason at its discretion. State Finance Commissions are appointed by the
State Governments to deal with State local Financial relations, mainly fiscal
transfers from State Governments to the local bodies.
The 15th Finance Commission was appointed in November 2017 and its full report
is expected by the end of 2020. The commission has been asked to provide its
recommendation for five more years till 2025-26.
Centralisation and vertical imbalance, regional inequality and horizontal

imbalance difficulties being faced by low-income states in borrowing and
investing beyond the prescribed limits due to FRBM set, widening disparities,
etc. are issues of concerns with the present design of fiscal federalism.
94
12.7 TERM-END EXERCISES State Relations
1) State in brief the principles of Federal finance. How far these principles
have been adhered to the Centre-State financial relations in India?
2) What is Finance Commission? How is it different from NITI Aayog and
GST Council? Evaluate the recommendations of 14th Finance Commission.
3) “The question of Centre-State relations has become the focal point of
discussion for a number of reasons”. Comment on this statement and point
out the reasons for conflict between Center and State.
12.8 KEY WORDS

Gadgil Formula : A formula of plan assistance to States adopted
since the Fourth Plan (1969-74) which
provided that distribution of plan assistance to
the States should take five elements into
account. This is named after Professor D.R.
Gadgil, the then Vice-Chairman of the Planning
Commission.
Gap-filling Approach : Assistance to States for rectifying imbalances
—vertical or horizontal— is essentially in the
nature of a device to bridge a budgetary gap.
However, the phrase ‘gap-filling approach’
epitomises the practice of Finance
Commissions of recommending grants-in-aid
to States on the basis of estimated gap between
forecasted expenditure and receipts (inclusive
of tax shares) on revenue account.
Horizontal Imbalance, i.e., : The imbalance between the expenditure
Horizontal Federal Fiscal requirements and own revenues of different
Imbalance constituents units of a federation mainly on
account of differences in fiscal capacities
arising out of regional economic disparities.
Rectifying horizontal imbalance means
promoting regional equalisation.
Inter-State Council : In 1990, the Government took the step of
invoking the constitutional provision (Article
263) and forming an Inter-State Council
charged with the duty of: “(a) inquiring into
and advising upon disputes which may have
arisen between States; (b) investigating and
discussing subjects in which some or all of the
States or the Union and one or more of the
States, have a common interest; or (c) making
recommendations upon any such subject”.
Statutory Transfer : Transfer of resources form Centre to States
under tax devolution and Article 275 grants-
in-aid at the recommendations of the Finance
Commission.
95
Monetary and Fiscal Policies Tax Effort : Judged from ratio of tax revenue to State
income.
Vertical Imbalance, i.e., : Th e n o n -co rres p o n d en ce b et ween t h e
Vertical Federal Fiscal expenditure requirements of the functions and
Imbalance the extent of revenue raised from the sources
assigned to the unit governments as compared
to the national government in a federation.
12.9 REFERENCES
1) Breton, Albert (1987). “Towards the theory of competitive federalism”,
European Journal of Political Economy, Special issue, Vol. 3, No. 1+2, pp.
263-328.
2) Cullis, John and Philip Jones (1992).Public Finance and Public Choice:
Analytical Perspectives, London: McGraw-Hill.
3) Fourteenth Finance Commission (2014)., Report, Volume-I, New Delhi:
Government of India.
4) Fifteenth Finance Commission (2019). First Report, New Delhi: Government
of India.
5) Lessmann, Christian (2012). “Regional Inequality and Decentralization: An
Empirical Analysis”, Environment and Planning A: Economy and Space,
Vol.44, issue 6.
6) Rao, M. Govinda and Tapas K. Sen (1996).Fiscal Federalism in India:
Theory and Practice, Delhi: Macmillan India.
7) Reddy, Y. V. and G.V. Reddy (2019).The Rules of the Game: Indian Fiscal
Federalism, New Delhi: Oxford University Press.
8) Sen, Tapas K. (2011). “Horizontal Imbalances in Indian Federalism”, in
Praveen Jha (ed.), Progressive Fiscal Policy in India, New Delhi: Sage
Publications, pp. 246-263.
9) Twelfth Finance Commission (2003), Fifty Years of Fiscal Federalism:
Finance Commissions of India, New Delhi: Government of India [This
publication contains ToR, composition, summarized approach, main
recommendations and action taken report of first 11 Finance Commissions
– excellent source for a history of Finance Commissions].
10) Source-GST Council.gov.om/sites/default/files/gst.update010719

PROGRESS EXERCISES
1) See Section 12.1
2) See Section 12.2
3) See Sub-Section 12.2.2 and 12.2.3
96
Check Your Progress 2 Major Development on Union
State Relations
2) See Section 12.4
4) See Section 12.4
3) See Section 12.5
97
APPENDIX 12.1: TOR OF THE 14TH FINANCE
COMMISSION
“4) The Commission shall make recommendations as to the following matters:
i) the distribution between the Union and the States of the net proceeds of
taxes which are to be, or may be, divided between them under Chapter
I, Part XII of the Constitution and the allocation between the States of
the respective shares of such proceeds;
ii) the principles which should govern the grants-in-aid of the revenues of
the States out of the Consolidated Fund of India and the sums to be paid
to the States which are in need of assistance by way of grants-in-aid of
their revenues under article 275 of the Constitution for purposes other
than those specified in the provisos to clause (1) of that article; and(iii)
the measures needed to augment the Consolidated Fund of a State to
supplement the resources of the Panchayat and Municipalities in the
State on the basis of the recommendations made by the Finance
Commission of the State.
5) The Commission shall review the state of the finances, deficit and debt levels
of the Union and the States, keeping in view, in particular, the fiscal
consolidation road map recommended by the Thirteenth Finance
Commission, and suggest measures for maintaining a stable and sustainable
fiscal environment consistent with equitable growth including suggestions
to amend the Fiscal Responsibility and Budget Management Acts currently
in force and while doing so, the Commission may consider the effect of the
receipts and expenditure in the form of grants for creation of capital assets
on the deficits; and the Commission shall also consider and recommend
incentives and disincentives for States for observing the obligations laid
down in the Fiscal Responsibility and Budget Management Acts.
6) In making its recommendations, the Commission shall have regard, among
other considerations, to:
i) the resources of the Central Government, for five years commencing
on 1 April 2015, on the basis of levels of taxation and non-tax revenues
likely to be reached during 2014-15;
ii) the demands on the resources of the Central Government, in particular,
on account of the expenditure on civil administration, defence, internal
and border security, debt-servicing and other committed expenditure
and liabilities;
iii) the resources of the State Governments and the demands on such
resources under different heads, including the impact of debt levels on
resource availability in debt stressed states, for the five years
commencing on 1 April 2015, on the basis of levels of taxation and
non-tax revenues likely to be reached during 2014-15;
iv) the objective of not only balancing the receipts and expenditure on
revenue account of all the States and the Union, but also generating
surpluses for capital investment;
v) the taxation efforts of the Central Government and each State
98 Government and the potential for additional resource mobilisation to
improve the tax-Gross Domestic Product ratio in the case of the Union Major Development on Union
State Relations
and tax-Gross State Domestic Product ratio in the case of the States;
vi) the level of subsidies that are required, having regard to the need for
sustainable and inclusive growth, and equitable sharing of subsidies
between the Central Government and State Governments;
vii) the expenditure on the non-salary component of maintenance and upkeep
of capital assets and the non-wage related maintenance expenditure on
plan schemes to be completed by 31 March, 2015 and the norms on the
basis of which specific amounts are recommended for the maintenance
of the capital assets and the manner of monitoring such expenditure;
viii) the need for insulating the pricing of public utility services like drinking
water, irrigation, power and public transport from policy fluctuations
through statutory provisions;
ix) the need for making the public sector enterprises competitive and market
oriented; listing and disinvestment; and the relinquishing of non-priority
enterprises;
x) the need to balance management of ecology, environment and climate
change consistent with sustainable economic development; and
xi) the impact of the proposed Goods and Services Tax on the finances of
Centre and States and the mechanism for compensation in case of any
revenue loss.
7) In making its recommendations on various matters, the Commission shall
generally take the base of population figures as of 1971 in all cases where
population is a factor for determination of devolution of taxes and duties
and grants-in-aid; however, the Commission may also take into account the
demographic changes that have taken place subsequent to 1971.
8) The Commission may review the present Public Expenditure Management
systems in place including the budgeting and accounting standards and
practices; the existing system of classification of receipts and expenditure;
linking outlays to outputs and outcomes; best practices within the country
and internationally, and make appropriate recommendations thereon.
9) The Commission may review the present arrangements as regards financing
of Disaster Management with reference to the funds constituted under the
Disaster Management Act,2005 (53 of 2005), and make appropriate
recommendations thereon.
10) The Commission shall indicate the basis on which it has arrived at its findings
and make available the State-wise estimates of receipts and expenditure.”
The following additional item was added to the ToR of the Commission vide
President’s Order published under S.O. No. 1424(E) dated 2 June 2014 (Annex
1.2):
“Para 5 A. The Commission shall also take into account the resources available
to the successor or re-organised States on re-organisation of the State of Andhra
Pradesh in accordance with the Andhra Pradesh Re-organisation Act, 2014 (6 of
2014) and the Ministry of Home Affairs notification number S.O. 655 (E) dated
4 March, 2014 and make recommendations, for successor or re-organised States,
on the matters under reference in this notification”.
99
APPENDIX 12.2: TOR OF THE 15TH FINANCE
COMMISSION
“4) The Commission shall make recommendations as to the following matters,
namely:—
i) The distribution between the Union and the States of the net proceeds
of taxes which are to be, or may be, divided between them under Chapter
I, Part XII of the Constitution and the allocation between the States of
the respective shares of such proceeds;
ii) The principles which should govern the grants-in-aid of the revenues
of the States out of the Consolidated Fund of India and the sums to be
paid to the States by way of grants-in-aid of their revenues under Article
275 of the Constitution for purposes other than those specified in the
provisos to clause (1) of that article; and
iii) The measures needed to augment the Consolidated Fund of a State to
supplement there sources of the Panchayats and Municipalities in the
State on the basis of the recommendations made by the Finance
Commission of the State.
5) The Commission shall review the current status of the finance, deficit, debt
levels, cash balances and fiscal discipline efforts of the Union and the States,
and recommend a fiscal consolidation roadmap for sound fiscal management,
taking into account the responsibility of the Central Government and State
Governments to adhere to appropriate levels of general and consolidated
government debt and deficit levels, while fostering higher inclusive growth
in the country, guided by the principles of equity, efficiency and transparency.
The Commission may also examine whether revenue deficit grants be
provided at all.
6) While making its recommendations, the Commission shall have regard,
among other considerations, to:
i) The resources of the Central Government and the State Governments
for the five years commencing on 1st April 2020 on the basis of the
levels of tax and the non-tax revenues likely to be reached by 2024-25.
In the context of both tax and non-tax revenues, the Commission will
also take into consideration their potential and fiscal capacity;
ii) The demand on the resources of the Central Government particularly
on account of defence, internal security, infrastructure, railways, climate
change, commitments towards administration of UTs without legislature,
and other committed expenditure and liabilities;
iii) The demand on the resources of the State Governments, particularly on
account of financing socioeconomic development and critical
infrastructure, assets maintenance expenditure, balanced regional
development and impact of the debt and liabilities of their public utilities;
iv) The impact on the fiscal situation of the Union Government of
substantially enhanced tax devolution to States following
recommendations of the 14th Finance Commission, coupled with the
100
continuing imperative of the national development programme including Major Development on Union
State Relations
New India – 2022;
v) The impact of the GST, including payment of compensation for possible
loss of revenues for 5 years, and abolition of a number of cesses,
earmarking thereof for compensation and other structural reforms
programme, on the finances of Centre and States; and
vi) The conditions that GoI may impose on the States while providing
consent under Article 293(3) of the Constitution.
7) The Commission may consider proposing measurable performance-based
incentives for States, at the appropriate level of government, in following
areas:
i) Efforts made by the States in expansion and deepening of tax net under
GST;
ii) Efforts and Progress made in moving towards replacement rate of
population growth;
iii) Achievements in implementation of flagship schemes of Government
of India, disaster resilient infrastructure, sustainable development goals,
and quality of expenditure;
iv) Progress made in increasing capital expenditure, eliminating losses of
power sector, and improving the quality of such expenditure in
generating future income streams;
v) Progress made in increasing tax/non-tax revenues, promoting savings
by adoption of Direct Benefit Transfers and Public Finance Management
System, promoting digital economy and removing layers between the
government and the beneficiaries;
vi) Progress made in promoting ease of doing business by effecting related
policy and regulatory changes and promoting labour intensive growth;
vii) Provision of grants in aid to local bodies for basic services, including
quality human resources, and implementation of performance grant
system in improving delivery of services;
viii) Control or lack of it in incurring expenditure on populist measures; and
ix) Progress made in sanitation, solid waste management and bringing in
behavioural change to end open defecation.
8) The Commission shall use the population data of 2011 while making its
recommendations.
9) The Commission may review the present arrangements on financing Disaster
Management initiatives, with reference to the funds constituted under the
Disaster Management Act, 2005 (53 of 2005), and make appropriate
recommendations thereon.
10) The Commission shall indicate the basis on which it has arrived at its findings
and make available the Statewise estimates of receipts and expenditure.”
101
Monetary and Fiscal Policies Subsequent to the publication of these ToR, a fresh Term of Reference was added
for the consideration of the Commission. The Commission was asked “to examine
whether a separate mechanism for funding of defence and internal security ought
to be set up and if so, how such a mechanism could be operationalised.” Also,
the change in the status of Jammu and Kashmir from a State to a Union Territory
necessitated changes in the 15th FC methodology, since Union Territories are
outside the purview of the Finance Commission.
102
State Relations
BLOCK 4
SECTOR SPECIFIC ISSUES
AND POLICIES
103
Sector Specific Issues and
Policies BLOCK 4 SECTOR SPECIFIC ISSUES AND
POLICIES
This block focuses on Sector-specific (Agriculture, Industries and Services) issues,

concerns and associated policies addressing those issues and concerns. The block
comprises 5 Units.
Unit 13 entitled ‘Agriculture: Issues, Concerns, Policy and Programmatic

Initiatives deals with role and relevance of agricultural sector in the Indian
economy, trends of agricultural production, causes of deceleration of agricultural
growth in India, shifting of agriculture from traditional to modern dynamic sector,
impact of green revolution and the various policy initiatives taken by the
government in this regard.
Unit 14 on Large Scale Industries in India: Issues and Policy covers the issues
and policy related to large scale Industries. The unit examines growth strategy of
heavy industries in terms of their features, legislative support, industrial policy
support, critical issues before industrial sector and the framework for a new
industrial policy.
Unit 15 on ‘Micro, Small and Medium Enterprises: Issues and Policy’ covers
issues and challenges being encountered by MSME sector, the impact of
demonetization and GST on the MSME sector, and the various policy initiatives
taken by the Government.
Unit 16 entitled ‘Services Sector I: Organised Sector— Issues and Policy’

identifies the various issues and concerns of organised services sector. Sector-
specific policy initiatives and issues in selected organised sectors have been
provided in this unit.
Unit 17 entitled ‘Services Sector-II: Informal Sector— Issues and Policy’

sheds light on salient characteristics of informal service sector. Factors responsible
for its exponential growth, the issues and challenges being faced by the informal
sector, policy implications of informality, and the role of government at various
levels in this regard have also been covered in this Unit.
104
Agriculture: Issues,
UNIT13 AGRICULTURE: ISSUES, Concerns, Policy and
Programmatic Initiatives
CONCERNS, POLICY AND
PROGRAMMATIC INITIATIVES
Structure
13.0 Objectives
13.1 Intoduction: Role and Relevance of Agriculture in the Indian Economy
13.2 Agriculture Production and Productivity after Independence
13.2.1 Trends in Production
13.2.2 Trends in Productivity
13.3 Causes for Stagnation in Agriculture Growth in India
13.3.1 Deceleration in Agriculture Investment
13.3.2 Inadequate Irrigation Coverage and Falling Productivity of Irrigation in Food
grains
13.3.3 Failure to Evolve and Adopt New Technologies
13.3.4 Shrinking Farm Size
13.3.5 Non-availability or Inadequate Credit from Formal Sources
13.3.6 Imbalance in the Use of Fertilizers
13.3.7 Effectiveness of Minimum Support Prices (MSPs)
13.3.8 Inadequate Availability and Access to Quality Seeds
13.3.9 Farm Mechanisation: Major Challenges
13.3.10 Post-harvest Activities-Inadequate Storage Facilities
13.4 Transformation of Indian Agriculture: Strategies for Development (1951-
2002)
13.4.1 Phase I: Traditional Agriculture (1951-1966)
13.4.2 Phase II: Technologically Dynamic Agriculture with New Agriculture Strategy
(NAS):1966 – 2002
13.4.3 Impact of Green Revolution on Production and Yield of Major Crops During
the Entire Planning Period
13.5 Transformation of Indian Agriculture: Strategies for Development (2002-
2014)
13.5.1 Rashtriya Krishi Vikas Yojana (RKVY)
13.5.2 Second Green Resolution
13.6 Transformation of Indian Agriculture through an Umbrella Programme
of Doubling of Farmers’ Income (DFI) from 2015 to 2022
13.6.1 Prime Minister’s Multi-dimensional Seven Points Strategy
13.6.2 Policy Initiatives for Enhancing the Farmers’ Output per Hectare: Improving
Cropping Intensity
13.6.3 Policy Initiatives for Crop Diversification and Enhancing Value Realisation
13.6.4 Policy Initiatives to Ensure Remunerative Price to Farmers for their Produce:
MSP Policy and Procurement
13.6.5 Policy Initiatives to Improve Resource Efficiency/ Reduction in Cost
13.7 Relevance of Non-Agricultural Activities in Doubling of Farmers’ Income
13.8 Let Us Sum Up
13.9 Term-end Exercises 105
Sector Specific Issues and 13.10 Key Words
Policies
13.11 References
13.0 OBJECTIVES
After reading and studying this unit, you will be able to explain:
role and relevance of agriculture sector in the Indian Economy;
trends in agriculture production and productivity both in major food grains
and non-food grains since independence especially after the adoption of
New Agriculture Strategy in mid-1960s;
causes for Stagnation in Agriculture Growth in India especially during
economic reforms regime;
shift in agricultural sector in India from a traditional agriculture in the 1950s
to the modern technologically dynamic high capital-intensive agriculture;
various programmes implemented during the first decade after independence
for increasing the food grains production;
impact of green revolution in terms of attaining self-sufficiency in food grains
and in terms of shrinking incomes of the farmers as well as widespread
environmental implications; and
various policy and strategic initiatives by the Government for doubling of
farmers’ income.
13.1 INTRODUCTION: ROLE AND RELEVANCE OF

AGRICULTURE IN INDIAN ECONOMY
Agriculture as a sector has contributed significantly in the process of India’s
development in number of ways, some of which are listed below:
Contribution to National Income:In 1950-51 contribution of agricultural
sector to national income was 59 per cent and in 2004-05 it came down to
24.4 per cent and further to about 15 per cent in 2017-18. Economic
contribution of agriculture to India’s GDP is steadily declining with the
country’s broad-based economic growth, yet, nearly 43 per cent of the
population continues to be dependent on it for livelihood.
Largest Employment Provider Sector:In 1972-73, 73.9 per cent of the
working population was engaged in agriculture/allied activities, which fell
to 64.8 per cent in 1993-94, to 48.9 per cent in 2011-12 and to 43 per cent in
2017-18. With rapid increase in population, the absolute number of people
engaged in agriculture has become exceedingly large. As development of
other sectors has not been sufficient, dependence of increasing population
on agriculture has increased with marginal productivity of labour being less
than or equal to zero– a scenario which gives rise to the familiar problem of
disguised unemployment in agriculture.
Provision of Food Surplus to the Expanding Population: Agriculture is the
basic source of food supply and if agriculture fails to meet the rising demand
of food products (due to increase in population), it is bound to affect adversely
106 the growth rate of the economy. In India, food consumption still constitutes
on an average 60 per cent of household income thereby generating adequate Agriculture: Issues,
Concerns, Policy and
demand for food products. Programmatic Initiatives
Providing Raw Materials to Industries: It provides essential raw materials

to many industries like cotton textiles, jute, sugar, vegetables, oil, tinned
food, Cigarettes and rubber, etc. The entire range of food processing industries
is also dependent on agriculture. Therefore, unless agriculture develops, these
industries will not be able meet their demand for raw materials.
Market for Industrial Products: As majority of the population live in rural

areas, increased rural purchasing power is a valuable stimulus to industrial
development, as propounded by Ragner Nurkse and Arthur Lewis in their
theories on financing industrial development through agriculture
Commercial Importance: For a number of years after independence, the

three agriculture-based exports of India – cotton textiles, jute and tea –
accounted for more than 50 per cent of export earnings of the country. On
adding the exports of other agricultural products such as cashew kernels,
tobacco, coffee, Vanaspati, oil, and sugar, etc. the share of agriculture in
total exports rose to around 70 to 75 per cent. Such a heavy dependence on
agriculture reflected the underdeveloped nature of economy. With economic
progress and consequent diversification of production base, share of
agriculture goods in total exports fell to 44.2 per cent in 1960-61 which
considerably fell to 30.7 per cent in 1980-81 and 12.3 per cent in 2016-17.
As India is still home to the largest number of poor and malnourished people in
the world with it being at the 101th position among 119 countries in Global Hunger
Index, 2018, a higher priority to agriculture will achieve the goals of reducing
poverty and malnutrition as well as achieving inclusive growth. ‘Growth with
inclusiveness’ can be achieved only when agriculture growth accelerates and is
widely shared among the people and regions of the country.
Given the role and relevance of agriculture in India’s economy, this unit intends
to discuss in detail (a) the performance of agriculture sector in terms of trends in
production and productivity focusing upon the period since independence; (b)
Issues and concerns being faced by the sector; and (c) Strategic, policy and
schematic initiatives taken by the government for transformation of agriculture
and how far these measures have benefited in de-facto sense the farmers/
cultivators.
13.2 AGRICULTURE PRODUCTION AND

PRODUCTIVITY AFTER INDEPENDENCE
The two major crop groups are Food grains (Food crops) and Non-food grains
(Non-food crops). Food crops include rice, wheat, jowar, bajra, small millets,
cereals, gram, pulses, vegetables and fruits, while Non-food crops include
Oilseeds (groundnut, linseed, rapeseed and mustard, niger seed), Fibre crops
(cotton, jute and mesta), sugarcane, tobacco, Plantation crops (tea, coffee and
rubber), Condiments and Spices.
The food crops contribute about 2/3rd of total agricultural production. The most
important component in the food grains category is wheat followed by rice. In
107
Sector Specific Issues and non-food grains category, oilseeds constitute the most important group followed
Policies
by Sugarcane and cotton.
13.2.1 Trends in Production

Table 13.1 reveals the following trends:
Consistent increase in food grains production with considerable annual
fluctuations.
The production of two major crops – Wheat and Rice – has consistently
increased since 1950-51 and increase was significant, especially in case of
wheat after the adoption of New Agricultural Strategy since mid-1960s and
in rice it followed subsequently in early 1980s. These two crops benefitted
the most from the development of ‘miracle seeds’.
Jowar and bajra exhibited erratic trends over the planning period. Introduction
of HYV maize has pushed up its production and productivity. As a result,
area under maize has risen significantly at the cost of other cereals like
jowar, bajra, etc.
Table 13.1: Trends in Agricultural Production 1950-51 to 2018-19 (Units in Million Tones)
Decadal Trends from 1950-51 to 2010-11 and Annual Trends thereafter up to 2018-19
Crop 1950- 1960- 1970- 1980- 1990- 2000- 2010- 2011- 2012- 2013- 2014- 2015- 2016- 2017- 2018-
51 61 71 81 91 01 11 12 13 14 15 16 17 18 19
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Rice 20.6 34.6 42.2 53.6 74.3 85.0 96.0 105.3 105.2 106.6 105.5 104.4 109.7 112.8 116.4
Wheat 6.4 11.0 23.8 36.3 55.1 69.7 86.9 93.5 93.5 95.8 86.5 92.3 98.5 99.9 102.6
Jowar 5.5 9.8 8.1 10.4 11.7 7.5 7.0 6.0 5.3 5.5 5.5 4.2 4.6 4.8 3.8
Bajra 2.6 3.3 8.0 5.3 6.9 6.8 10.4 10.3 8.7 9.3 9.2 8.1 9.7 9.2 8.6
Maize 1.7 4.1 7.5 7.0 9.0 12.0 21.7 21.8 22.3 24.3 24.2 22.6 25.9 28.8 27.2
Other Cereals 4.1 6.5 7.0 6.4 4.1 4.5 4.3 5.3 3.6 4.2 3.9 3.6 3.4 6.4 3.0
Pulses 8.4 12.7 11.2 10.6 14.3 11.0 18.2 17.1 18.3 19.3 17.2 16.4 23.1 25.4 23.4
Total FGs 50.8 82.0 108.4 129.6 175.4 196.8 244.5 259.3 257.1 265.0 252.0 251.6 275.1 285.0 285.0
Oilseeds# 6.2 7.0 9.6 9.4 18.6 18.4 32.5 29.8 30.9 32.7 27.5 25.3 31.3 31.5 32.3
Sugarcane 57.1 110.0 126.4 154.2 241.0 296 342.4 361.0 341.2 352.1 362.3 348.4 306.1 379.9 400.2
Cotton@ 3.0 5.6 4.8 7.0 9.8 9.5 33.0 35.2 34.2 35.9 34.8 30.0 32.6 32.8 27.8
Jute$ 3.3 4.1 4.9 6.5 7.9 9.3 10.0 10.7 10.3 11.7 10.6 9.9 10.4 9.6 9.4
@Million Bales (bale=170kg), $ Million Bales (bale=180kg),
#Includes groundnut, rapeseed & mustard, sesamum, linseed, castorseed, nigerseed, safflower, sunflower and soyabean;
Source: Source: Indian Economy, Mishra and Puri, 36th Edition, 2018 and Col 3-6 from Economic Survey, 2000-01 (Statistical Tables,
Table 1.12), Col 7 to 16 from Economic Survey, 2019-20 (Volume II), Statistical Appendices, Table 1.15, page number A 34.
Pulses requirement in India is estimated at about 17 million tons; but actual

production has been considerably less than this level during most of the
period. However, production of pulses shot up from 16.4 million tons in
2015-16 to 23 million tons in 2016-17. The supply of pulses lagged behind
for most of the planning era; India has had to import a large quantity of
pulses over the period which constituted 15-20 per cent of our total demand
in the country. Recently India has achieved nearly self-sufficiency in pulses
108
and therefore imports are confined to international agreements negotiated Agriculture: Issues,
earlier Programmatic Initiatives
As far non food grains group is concerned, the production of oilseeds rose
sharply in the latter half of 1980s and the first decade of the present century
with minor fluctuations. Just like pulses, there has been a large gap between
demand and supply for a considerable period forcing the countryto import
large quantities of edible oils. In fact, even at present 60 per cent of demand
for edible oils is met out of imports, Which is likely to be untenable in the
long run.
century with minor fluctuations. Just like pulses, there has been a large gap
between demand and supply for a considerable period forcing the country
to import large quantities of edible oils. In fact, even at present 60 per cent
of demand for edible oils is met out of imports, which is likely to be untenable
in the long run.
Production of cotton which averaged 8 to 9 million bales per annum till
2000-01 rose significantly thereafter due to widespread use of Bt Cotton (a
genetically modified pest resistant plant cotton variety) in 2002. From annual
production of about 9 million bales in 2000-01, the production rose to 33
million bales in 2010-11 but thereafter it almost stagnated at the same level.
Now almost 90 per cent of cotton area is covered under Bt cotton.
Jute saw a slow and halting progress during the entire period of planning.
The sugarcane exhibited a consistent increase in production during the four
decades period 1952-53 to 2002-03 but thereafter it rose considerably with
annual fluctuations.
13.2.2 Trends in Productivity

The agricultural production depends not only on the area but also on the
productivity of land. It shows the relationship between inputs and output. The
agricultural productivity can be classified into two categories viz. agricultural
productivity per hectare and agricultural productivity per worker. Trends in
productivity per hectare of major food grains and Non-food grains crops after
independence are analysed in Table 13.2.
The Table 13.2 reveals the following trends:
The yield per hectare of all food grains has increased by about four times
from 552 kg per hectare in 1950-51 to 2299 kg per hectare in 2018-19.
The most significant increase has been recorded by wheat with its yield
increasing from 655 kg per hectare to 3507 kg per hectare in 2018-19.
Productivity of rice also increased significantly from 1123 kg per hectare in
1970-71 to 2659 kg per hectare in 2018-19.
Jowar and Bajra recorded much lower rates of growth in productivity.
Most disappointing has been the performance of pulses with stagnant
productivity at around 532 kg per hectare during the period from 1960-61
to 1999-00, thereafter it increased at snail pace to 806 in 2018-19.
The productivity of maize and cotton has increased in recent years due to
adoption of hybrid maize varieties and Bt cotton since 2002 in most areas of
the country.
109
Sector Specific Issues and Table-13.2: Yield Per Hectare of Major Crops (Kg per Hectare)
Policies
Crop 1950- 1960- 1970- 1980- 1990- 2000- 2010- 2011- 2012- 2013- 2014- 2015- 2016- 2017- 2018-
51 61 71 81 91 01 11 12 13 14 15 16 17 18 19
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Rice 668 1013 1123 1336 1740 1901 2239 2393 2462 2416 2391 2400 2416 2576 2659
Wheat 655 851 1307 1630 2281 2708 2989 3178 3117 3145 2750 3034 3145 3368 3507
Jowar 353 533 466 660 814 764 949 957 850 957 884 697 957 960 979
Bajra 288 286 622 458 658 688 1079 1171 1198 1184 1255 1132 1184 1231 1242
Maize 547 926 1269 1159 1518 1822 2540 2478 2566 2676 2632 2563 2676 3065 2986
Pulses 441 539 524 473 578 544 691 699 789 764 728 656 764 853 806
Total FGs 552 710 872 1023 1380 1626 1930 2078 2079 2120 2028 2042 2120 2235 2299
Oilseeds* 481 507 579 532 771 810 1193 1133 1168 1168 1075 968 1168 1284 1265
Cotton 88 125 106 152 225 190 499 491 486 510 462 415 510 443 386
Jute 1043 1049 1186 1245 1833 2026 2329 2389 2396 2639 2549 2457 2639 2517 2467
*Include groundnut, rapeseed & mustard, sesamum, linseed, castorseed, nigerseed, safflower, sunflower and soyabean.
Source: Indian Economy, Mishra and Puri, 36th Edition, 2018 and Col 3-7 from Economic Survey, 2000-01 (Statistical Tables,
Table 1.14), Col 7 to 16 from Economic Survey, 2019-20 (Volume II), Statistical Appendices, Table 1.17, and page number A
36.
Even if we focus on trends in agricultural growth in post-1991 economic reforms

regime, it is observed that new economic policy seems to have bypassed the
agriculture sector completely. The comparison in aggregate GDP growth vis-à-
vis Agri-GDP growth is reflected in Table 13.3.
Table 13.3: Rates of Growth (in per cent) since 1991
Years Overall GDP Agri-GDP
1991-92 to 1995-96 5.2 2.4
1999-00 to 2003-04 6.0 2.9
2004-05 to 2013-14 8.0 3.7
2014-15 to 2018-19 7.2 1.9

1) Trace out the trends in production and productivity of major crops in India
after independence.
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
110
2) Do you agree with the statement that ‘Agriculture has significantly Agriculture: Issues,
contributed to development of India’? Programmatic Initiatives
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
3) Do you agree with the view that agriculture growth continued to stagnate
even after economic reforms were launched in 1991? Does it imply that
economic reforms have by-passed agriculture?
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
13.3 CAUSES FOR STAGNATION IN

AGRICULTURE GROWTH IN INDIA
13.3.1 Deceleration in Agriculture Investment
Capital formation is necessary for improving long-term growth potential in
agriculture. The share of agriculture and allied activities in gross capital formation
in the economy increased in the mid-1960s and this trend continued till the late
1970s. Higher growth rates of agriculture witnessed in the 1980s were due to the
lagged impact of increases in the share of agriculture and allied sector in gross
capital formation during the late 1960s and 1970s (Figure 13.1)
20
15
10
0
1990-91
2010-11
2006-07
1974-75
1970-71
1994-95
2002-03
1978-79
1998-99
1986-87
1966-67
1982-83
Figure 13.1: Share of Agriculture and Allied Sectors (per cent) in Gross Capital
Formation since 1966-67
Source: Planning commission of India and Agricultural Statistics at a Glance (2015)
However, since the 1980s, the share has shown a declining trend. There was a
mild recovery during the late 1990s till 2001- 02, and then the share declined
again. Total investment in agriculture as proportion of GDP declined from 9.9
per cent in 1990-91 to just 3.5 per cent in 1999-2000. The share of public
111
Sector Specific Issues and investment in gross capital formation in agriculture has also declined over the
Policies
years, as shown in Table 13.4.
Table 13.4: Share of Public & Private Sector in Capital Formation in Agriculture
and Allied Activities
Sector 1970s 1980s 1990s 2000s 2011-12 2015-16
Private 66.5 58.3 761 81.1 84.9 81.98
Public 33.5 41.7 23.9 18.9 15.1 18.02
Source: National Accounts Statistics and National Accounts Statistics, 2017.
There is a difference in the nature of public and private capital formation and
contribution in the production processes. The former is mainly in the nature of
public goods such as irrigation projects and road networks. These will not be
provided by private capital. Decline in public capital formation is not adequately
compensated by an increase in private investment in agriculture. The most
important cause of decline in public investment in agriculture is the diversion of
resources from investment to current expenditure in the form of subsidies.
13.3.2 Inadequate Irrigation Coverage and Falling Productivity

of Irrigation in Foodgrains
Inadequate irrigation cover for most of the crops is an important constraining
factor in speedy adoption of improved technology. Various Economic Surveys
released by Ministry of Finance have highlighted the following issues: (a) only
40 per cent of Gross Cropped Area (GCA) was under irrigation in 2002-03,
which increased only to around 49 per cent in 2016-17, and (b) share of public
expenditure on irrigation and flood control to total public expenditure has declined
over the years, (c) Irrigation coverage across the states is quite skewed (e.g. in
Punjab 98.5 per cent of total area under all crops is irrigated, while in Maharashtra
it was only 19.5 per cent in 2013-14) and (d) distribution of irrigation facilities
across crops is equally skewed (e.g. 93.6 per cent of area under wheat, 60 per
cent of area under rice has been under irrigation while for pulses and oilseeds it
was only 20 per cent and 27 per cent, respectively).
Jha and Acharya (2011) examined trends in policies that govern public expenditure
on agricultural and rural development, including expenditure on irrigation and
flood control, in the post-Independence period. Their study classifies this period
into three phases. The first phase, which lasted from the early years after
independence to the late 1960s, saw the Central and State governments paying
greater attention to the development of irrigation. This period was characterised
by large outlays on medium and minor irrigation schemes. In the second phase,
from the early 1970s to the late 1980s, substantial expenditure was incurred on
new water technologies to promote the Green Revolution. The third phase, which
begins with liberalisation of the economy in the 1990s, is characterised by a
substantial reduction in the expenditure on agricultural and rural development.
Table 13.5 shows the decline in the share of outlays on irrigation in GDP over
time from the already low levels of the 1980s.
112
Table 13.5: Allocation to Irrigation Projects as percentage to GDP Agriculture: Issues,
Year 1981-82 1990-91 1995-96 2000-01 2005-06 2011-12 2013-14 Programmatic Initiatives
Share 1.4 0.7 0.7 0.7 0.8 0.6 0.5
Source: Shantanu De Roy(2017), “Economic Reforms and Agricultural Growth in India”,

Economic and Political Weekly, vol LII no 9, March 4, 2017, p.70 (Table 6).
The low irrigation cover for various crops has led to severe rainfall dependency.
One finds a high correlation between production and rainfall for pulses and
oilseeds.
13.3.3 Failure to Evolve and Adopt New Technologies

India was able to avail of the potential of seed-fertilizer technology because of
favourable international research collaborations. However, the country has failed
to make a major breakthrough in frontal areas like biotechnological research. In
India, public funding for agriculture Research and Education (R&E) is contributed
by both Centre and States with around 55.4 per cent of the total allocation
contributed by the Centre and 44.6 per cent by states. Lack of investment in
research and technology in agriculture has resulted in the non-availability of any
new cost– reducing technology in agriculture and has led to declining input
efficiency. One of the main reasons for the low levels of yields in Indian agriculture
has been the unsatisfactory spread of new technological practices including HYVs
of seeds and usage of fertilizers and pesticides and inadequate spread of farm
management techniques and other practices such as soil conservation and crop
rotation.
Between 2000-01 and 2014-15, India’s total R & E expenditure for agriculture
and allied activities in real terms (2004-05 prices) has increased from Rs. 31.1
billion to Rs. 61.6 billion (a compound annual growth rate of 5 per cent). However,
as a percentage of GDP from agriculture (GDPA), it amount to about 0.54 per
cent in 2014-15.
13.3.4 Shrinking Farm Size

The shrinking size of average land holding of an Indian farmer has held back
agricultural productivity and there is not much that can be done about this. Due
to smaller holding size majority of Indian farms find it difficult to access
institutional credit, access new technology, adopt more efficient form of farm
practices and undertake more capital-intensive investment for land improvement.
The average landholding size of a household has shrunk marginally to 1.1 hectare
(ha) in 2015-16 from 1.16 ha three years ago, according to a rural survey carried
out by the National Bank for Agriculture and Rural Development (NABARD).
The said survey shows that nearly one-thirds of farmers have land parcels smaller
than 1 ha, while 37 per cent of farm households owned land parcels of smaller
than 0.4 ha, another 30 per cent had holdings which fall between 0.41 and 1.0 ha.
Only 16 per cent agricultural households owned landholdings in between 1 to 2
ha and only 13 per cent of farmers have holdings bigger than 2 ha.
113
Sector Specific Issues and Table 13.6: Trends in Farm Size Holdings in India (Unit in Million)
Policies
Holding 1970-71 1980-81 1990-91 2000-01 2010-11
Marginal 36 50 83 75 93
Small 13 16 20 23 25
Medium 19 21 22 21 20
Large 3 2 2 1 1
Note: Marginal: up to 1 hectare, Small: 1-2 hectares, Medium: 2-10 hectares, Large: over 10
hectares. Sources: Agriculture Census 2011
13.3.5 Non-availability or Inadequate Credit from Formal

Sources
Shantanu De Roy (2017) using the data from RBI’s Handbook of Statistics for
Indian Economy computed the trends in (a) opening of new rural branches, (b)
credit-deposit ratio in rural areas and (c) shares of priority sector and agriculture
in total outstanding credit of Commercial Banks which are presented in Figures
(Figure 13.2A to 13.2C). It may be observed that reduction in bank branches in
rural areas and declining credit–deposit ratios led to increased dependence of
smaller cultivators on private moneylenders at exploitative conditions.
Reduced emphasis on priority sector lending with financial liberalisation had

led to reduction in the availability of credit to small and marginal cultivators and
made cultivation more expensive. Trends in credit–deposit ratio and shares of
priority sector and agriculture in total outstanding credit of commercial banks
indicate that both declined in the 1990s as compared to the 1980s. Since 2001,
however, there has been a turnaround, whereby there were steep increases in
these ratios. Increase in rural credit since 2001 was largely due to an increase in
indirect finance in agriculture and definitional changes that incorporated export-
oriented and capital-intensive agriculture under priority sector lending. Main
beneficiaries of this change were large agribusiness companies and big cultivators.
The share of the latter in total credit outstanding and loan per account increased
substantially between the mid-1990s and 2004–05.
Share of Rural branches in total branches of
80
commercial banks (%)
60
40
20
0
1991
1995
1989
2001
2005
1981
1983
2007
1993
2003
2015
1985
1997
1987
2011
2013
1999
2009
Fig. 13.2A: Trends in the declining Rural Branches in India
Source: Computed from the Handbook of Statistics, Reserve Bank of India, various years.
114
120 Concerns, Policy and
100
80
60
40
20
0
1986
1990
2014
2010
2002
2006
1998
1994
Fig. 13.2B: Trends in the declining Credit-Deposit Ratio

Source: Computed from the Handbook of Statistics, Reserve Bank of India, various years.
50
Priority Sector
40
30
20
Agriculture
10
0
2014
2002
2012
2010
1991
1986
2008
2004
1996
2000
2006
1981
1998
Fig. 13.2C: Shares of Priority Sector and Agriculture in Total Outstanding Credit of
Commercial Banks
13.3.6 Imbalance in the use of Fertilizer

In general, the nitrogenous (N), phosphate (P) and potash (K) Fertilizers’ ratio of
4:2:1 is considered to be optimum for India. The total fertilizer-use in India
increased at 6 per cent per annum from 2.65 million tons of NPK in 1971-72 to
28.12 million tons in 2010-11. In the early 1970s Indian farmers applied N, P
and K in the ratio of 6.0:1.9:1.0, which increased to 9.5:3.2:1 in 1992. The ratio
worsened further to 10:2.9:1 in 1996. In 2012–13, the ratio of NPK use in India
reached 8.2:3.2:1, which is more imbalanced compared to the early 1970s.
Imbalance in the use of fertilizers in soil may also result in a loss of fertility.
13.3.7 Effectiveness of Minimum Support Prices (MSPs)

MSPs are declared prior to each sowing season (in June and October) so that
farmers are aware of the minimum price the government will offer for their
produce. As per a report by the NITI Aayog, a low proportion of farmers (10 per
cent) were aware of MSPs before the sowing season. 62 per cent of the farmers
were informed of MSPs after sowing their crops. The pricing policy of MSPs
would be effective only if farmers are aware of it at the time of deciding what
crops to grow. The NITI Aayog recommended that the awareness level of farmers
regarding MSPs must be increased and the mediums of dissemination of this
information must be strengthened.
115
Sector Specific Issues and Other issues with the implementation of the MSP regime include long distances
Policies
to the procurement centres, increasing cost of transportation for farmers, irregular
hours of the procurement centres, lack of covered storage godowns and inadequate
storage capacity, and delays in the payment of MSPs to farmers.
13.3.8 Inadequate Availability and Access to Quality Seeds

Quality seeds are another input necessary for agricultural productivity, and good
quality seeds account for 20 per cent-25 per cent of increased crop productivity.
Agricultural seeds are produced by various agencies such as Indian Council of
Agricultural Research and its research institutions, state agricultural universities,
and national and state seeds corporations. The private sector has also started
playing a role in supplying some seeds such as hybrid maize, bajra, cotton and
sunflower. About 30 per cent-35 per cent of the total seeds available are produced
by private and public sector companies, and farm bred seeds account for the
remaining seeds. The cost of HYV varieties is too high for marginal and small
farmers to afford, thus disincentivising them from purchasing these varieties.
The Economic Survey 2015-16 recommended bringing in more players into the
production of seeds, to improve their availability in the market and also reduce
their prices.
13.3.9 Farm Mechanisation: Major Challenges

Mechanisation is another aspect with a significant impact on agricultural
productivity. It makes activities such as tilling, spreading of seeds and fertilizers
and harvesting more efficient, so that the cost of inputs is offset. It can also make
the use of labour in agriculture more cost-effective. The status of mechanisation
in agriculture varies for different activities, although the overall level of
mechanisation is still less than 50 per cent, as compared to 90 per cent in developed
countries.
Some challenges faced by farm mechanisation include different soil and climatic
zones which require customised farm machinery, and small land holdings with
lack of access to resources. To increase productivity, farm equipment which is
durable, lightweight and low cost and also specific to different crops and regions
should be made available for small and marginal farmers.
13.3.10 Post-harvest Activities-Inadequate Storage Facilities

After agricultural produce is harvested, it requires a robust storage infrastructure
in order to minimise any losses due to adverse weather conditions or in the process
of transportation. Owing to the inadequate capacity and poor conditions of storage,
the quantity of food which is wasted during the harvest and post-harvest processes
in the country has increased over the years. The highest losses are observed in
the case of fruits and vegetables (up to 40 per cent of production), pulses (6.4 per
cent-8.4 per cent) and oilseeds (5.3 per cent-9.9 per cent).
In sum, Indian agriculture continues to face challenges, some new and some old,
such as: (i) declining availability/quality of soil, water and other natural resources;
(ii) decreasing size of farm holdings; (iii) inefficient use of inputs and their
increasing costs; (iv) scarce and more costly agriculture labour; (v) drudgery in
farming operations; (vi) growing risks in farming at all its stages from pre-
production to production to marketing; (vii) increasing information gap,
116
knowledge gap and skill gap; (viii) poor access to credit and investments; (ix) Agriculture: Issues,
slow diffusion of relevant technologies; (x) competitiveness of quality and prices Programmatic Initiatives
in domestic and export markets; (xi) inadequate focus on processing and value
addition; (xii) inadequate rural infrastructure; (xiii) regional imbalances; (xiv)
problems in retaining rural youth in agriculture; (xv) poor access to resources
and services for women in agriculture; (xvi) weak institutional/sub-system
linkages and convergence; and (xvii) extreme events of climate change.

1) Discuss the factors responsible for slow growth in agriculture in recent years.
.......................................................................................................................
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2) How does public investment in agriculture affects the productivity growth
of the sector in India? Give reasons.
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3) Give a critical appraisal of the flow of institutional credit for agriculture in
India.
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4) Do you agree with the view that shrinking farm size in India is a major
factor of sluggish growth and rural poverty in India?
.......................................................................................................................
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.......................................................................................................................
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13.4 TRANSFORMATION OF INDIAN

AGRICULTURE: STRATEGIES FOR
DEVELOPMENT (1951-2002)
Agricultural sector in India has moved from a traditional agriculture in the 1950s
to the modern, technologically dynamic high capital-intensive agriculture, in 117
Sector Specific Issues and which along with food and non-food crops, horticulture and other allied activities
Policies
have also expanded. In the context of Indian agriculture, three distinct phases of
growth can be distinguished as follows:
Phase I: Traditional Agriculture (1951-1966)
— First sub-period (1951-61)
— Second sub-period (1961-66)
Phase II: Technologically Dynamic Agriculture with New Agriculture
Strategy (NAS) (1966 - 2002)
Phase III: Post Green Revolution (GR) Policy/Schematic Initiatives
13.4.1 Phase I: Traditional Agriculture (1951-1966)

This is a technologically stagnant phase in which a larger farm production becomes
generally possible only through increased application of all three traditional inputs,
viz. land, labour and capital. The rate of increase of output is normally smaller
than the rate of increase in inputs-revealing diminishing productivity of inputs,
even at a low yield. Till mid-1960s, the Indian agriculture was typically embodied
within the characteristics of traditional agriculture.
The primary feature of this period was that production of agricultural crops
consistently maintained an upward trend, except for small dips in two years,
1957-58 and 1959-60. Independent India implemented various programmes, listed
below, as part of the effort to increase production and to ensure food security.
Grow More Food Campaign,
Intensive Agricultural Development Programme (1950-51),
Community Development Programme (1952),
National Extension Service (1953), and
Intensive Agricultural District Programme (1960-61)
Neglect of the agricultural sector during the Second Plan, the short war with
China in 1962 and with Pakistan in 1966, the widespread drought in the east
India culminated in a food crisis. In 1965-66, foodgrain production in the country
fell from 83 million tons in 1960-61 to 72 million tons. This led to a serious
crisis in the Indian economy, as the growth in foodgrains production was
inadequate to meet the consumption needs of the growing population and food
imports became essential.
13.4.2 Phase II: Technologically Dynamic Agriculture with New

Agriculture Strategy (NAS):1966 - 2002
This is the beginning of the process of transformation from traditional agriculture
to modern agriculture. The distinguishing feature of phase II is the application of
science and technology, evolved by research institutions, in a progressively large
scale. The ‘New Agricultural Strategy’ was India’s response to the grave and
long - standing food crisis that culminated in the 1960s.
The salient features of the Green Revolution Strategy are briefly listed below:
Revolution in Biotechnology: Biotechnology - a hybrid of genetics and
118 chemistry determines the maximum biological performance of plants and
animals and also influences the scope and effectiveness of other forms of Agriculture: Issues,
technology as well. Programmatic Initiatives
Green Revolution as Package Programme: consisting of improved seeds,

inorganic fertilizer, irrigation, and plant protection code (PPC) combined
with agricultural R&D
Central Role of High Yielding Varieties or ‘Miracle seeds’: The response of
the traditional varieties to fertilizer was said to be negative. When they are
fertilized with chemicals, they would shoot up even faster, grow dense, stoop
and lodge on the ground reducing the photosynthetic work, and in the end
would yield even less.
An important characteristic of modern varieties is their ability to utilise
nutrients and water efficiently, and to trans-locate more of them to grain
formation than to other parts such as leaf. The unique feature of these seeds
is that it can grow and work uninterruptedly even under cloudy skies, which
drastically cuts down the time needed to produce a crop. This results in a
quantum jump in yield.
Spread of Green Revolution limited to irrigated areas.
Confined to Wheat Revolution: Presently 90 per cent of lands engaged in
wheat cultivation have benefitted from this new agricultural strategy. Most
of the HYV seeds are related to wheat crop and major portion of chemical
fertilizers are also used in wheat cultivation.
13.4.3 Impact of Green Revolution on Production and Yield of

Major Crops During the Entire Planning Period
The rate of growth of wheat production which was 4 per cent per annum in
the pre-green revolution period (1949-50 to1964-65) shot up to 5.7 per cent
per annum. During the sub-Phase I, i.e. initial phase of green revolution
(1967-68 to1980-81) the rate of productivity doubled over the period from
1.3 per cent per annum to 2.6 per cent per annum. It was due to the adoption
of new HYVs of seeds in the irrigated areas in certain regions of the country.
Other crops picked up in the decade of 1980s, for instance, rice and oilseeds
did considerably better in 1980s as compared with 1967-68 to 1980-81 and
green revolution started spreading to more crops and this period is termed
as the maturing of green revolution.
During pre-green revolution phase, the contribution of area growth to output
growth was 50.1 per cent while that of yield growth was only 38.4 per cent.
During the green revolution or post green revolution phase, yield growth
became the dominant source of growth of output, i.e. 85.2 per cent of growth
was accounted for by yield growth while area expansion only contributed
only 14.4 per cent.
Deceleration in agricultural growth rates in the reform period commencing
in 1991: Rate of growth of food grains production fell from 2.9 per cent in
1980s to 2 per cent in 1990s and remains stagnant thereafter at around 1.2
per cent during 1999-2019.Similarly rate of growth of productivity fell from
2.7 per cent in 1980s to 1.51 per cent in 1990s and further decreases to 1.3
per cent during the period 2000-19.
119
Sector Specific Issues and Thus in the reform period, the resurgent growth in agriculture from mid-1960s
Policies
was arrested.
Green revolution generated employment opportunities in diverse activities which

were created as a result of multiple cropping and mechanisation of farming. It
helped to stimulate non-farm economy that generated newer employment in
various services such as milling, marketing, warehousing, etc. Another positive
effect of Green Revolution is the ploughing back of increased profits in agriculture.
Increased production and productivity of foodgrains in post green revolution
period not only helped in maintaining the price stability in food grains but also
strengthened the forward and backward linkages with industry.
Negative socio-economic impacts of Green Revolution
The new agriculture strategy has resulted in increased productivity and returns
for farmers. However, the revolution resulted into increased income with wide
interpersonal and regional inequality and inequitable asset distribution:
Being costly, NAS was adopted by large farmers resulting in interpersonal
inequalities.
NAS was confined to only irrigated areas, resulting in an increase in regional
disparities.
Restrictive Crop Coverage: The new agriculture strategy involving use of

HYV seeds was initially limited to wheat and other major crop rice responded
much later. The progress of developing and application of HYV seeds in
other crops especially commercial crops like oilseeds, jute, etc. has been
very slow. In fact, in a certain period, a decline in the output of commercial
crops is witnessed because of diversion of area under commercial crop to
food crop production.

1) Give an account of major programmes implemented during first one and a
half decade of planning era for enhancing the foodgrains production in India.
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2) Enhancing the productivity of agriculture is the key to inclusive growth
which is possible only with ‘strategic management’ and ‘technological
upgradation’ in the sector. Discuss.
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120
3) What are the unique characteristics of the New Agriculture Strategy (also Agriculture: Issues,
called Green Revolution)? Do you think India needed such strategy to address Programmatic Initiatives
its food shortage? Narrate the positive and negative impacts of the Green
Revolution.
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4) The Green Revolution and consequent increase in agriculture produce has
worked to the disadvantage of farmers. Critically analyse the statement.
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AGRICULTURE: STRATEGIES FOR
DEVELOPMENT 2002-2014
The analysis of growth dynamics of agriculture after adoption of NAS reveals
that agricultural development strategies must be reoriented to meet the needs of
farmers and called upon the Central and State governments to evolve a strategy
to rejuvenate agriculture. The new strategy requires extending the first Green
Revolution to the second Green Revolution in Eastern Part of the country or to
Evergreen Revolution throughout the country to ensure that growth in agriculture
is sustainable in future. This called for giving more autonomy and degree of
freedom to states in formulating agricultural policies.
13.5.1 Rashtriya Krishi Vikas Yojana (RKVY)

Given the fact that by the end of 1990s, rates of growth of both production and
the yield plateaued or rather declined, National Development Council (NDC)
resolved on 29.5.2007 that agricultural development strategies must be reoriented
to meet the needs of farmers and called upon the Central and State governments
to evolve a strategy to rejuvenate agriculture. In compliance of the NDC resolution
Ministry of Agriculture and Farmers Welfare launched a new Scheme named
Rashtriya Krishi Vikas Yojana (RKVY) in 2007 with the following objectives:
To incentivise the states that increase their investment in agriculture and
allied sectors;
To provide flexibility and autonomy to the States in planning and executing
programmes for agriculture;
To ensure the preparation of agriculture plans for the districts and states; 121
Sector Specific Issues and To achieve the goal of reducing the yield gaps in important crops;
Policies
To maximise returns to the farmers;
To address the agriculture and allied sectors in an integrated manner.
The macro-level impact of RKVY at both the national and state level has been
measured using three growth indicators. These indicators are: (i) growth in GDP,
overall GSDP and agricultural GSDP (ii) growth in agricultural area and
production and (iii) percentage of agriculture expenditure out of states’ budget
and agriculture GSDP. The growth in agricultural GDP of the country was 2.4
per cent per annum in the 10th Plan that increased to 3.7 per cent per annum in the
11th Plan. The overall growth rate of GSDP of 28 states (excluding the UTs) also
went-up from 7.61 per cent in 10th FYP to 8.63 per cent in the 11th FYP. Similarly,
the overall agriculture GSDP of 28 states grew from 2.38 per cent in 10th FYP to
3.66 per cent in 11th FYP.
13.5.2 Second Green Resolution

Green Revolution accelerated the yields of major food crops such as paddy, wheat,
millets and oil seeds, particularly in the states of Punjab, Haryana, parts of Uttar
Pradesh and Rajasthan. Green Revolution in India created a huge impact in terms
of crop production but it had several negative impacts like gradual loss of soil
fertility, increasing alkalinity and salinity, water-logging, depletion of ground-
water resources, decreasing bio– diversity, chemical poisoning of soils, surface
water and food. The first Green Revolution was launched to ensure food security
as there was severe scarcity of food in the country. Now our food supply is well
secure and meeting the growing needs is within reach. Therefore, the second
Green Revolution should aim at promoting sustainable livelihood, enabling the
poor to come out of poverty by generating gainful self-employment. There is a
need for a second green revolution which could potentially address the negative
impacts of the climate change through some kinds of farming like:
Agro-forestry on Degraded Lands: The focus should be on sustainable use
of degraded and low fertility lands deprived of irrigation. Such lands can be
profitably used for establishment of drought tolerant fruit crops and
agriculture-horticulture pastures.
Farming on Wastelands: Apart from un-irrigated lands, there are large
stretches of wastelands in India. Among the estimated 40-50 million ha of
wastelands, more than 9 million ha are sodic wastelands (Fertile irrigated
fields which turned sodic due to excessive use of water for irrigation and
poor drainage facilities). With reclamation of sodic lands, it is possible to
enhance food production while creating employment for 8-10 million people.
Organic Agriculture: cultivation without any use of chemical inputs like
mineral fertilizers and chemical pesticides.
Green Agriculture: cultivation with the help of integrated pest management,
integrated nutrient supply and integrated natural resource management
systems.
Eco-agriculture: Based on conservation of soil, water and biodiversity and
the application of traditional knowledge and ecological prudence.
EM Agriculture: system of farming using effective microorganisms (EM).
122
White agriculture: system of agriculture based on substantial use of Agriculture: Issues,
microorganisms, particularly fungi. Programmatic Initiatives
One-straw Revolution: system of natural farming without ploughing,
chemical fertilizers, weeding and chemical pesticides and herbicides.
Promotion for animal husbandry.
Efficient management of water resources.
This could help address the issues of climate change and agriculture and would
further increase the productivity in perpetuity without ecological harm.
Consequently, new agriculture policy of India aims at sustainable agriculture,
which is popularly called ‘second green revolution’ or ‘Evergreen Revolution’.

1) Do you agree with the view that green revolution lost its stream and India
needs another green revolution or evergreen revolution? Give adequate
justification in support of your answer.
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AGRICULTURE THROUGH AN UMBRELLA
PROGRAMME OF DOUBLING OF FARMERS’
INCOME (DFI) FROM 2015 TO 2022
Past strategy for development of the agriculture sector in India focused primarily
on raising agricultural output and improving food security. This strategy involved:
(a) an increase in productivity through better technology and varieties, and
increased use of quality seed, fertilizer, irrigation and agro-chemicals, (b) incentive
structure in the form of remunerative prices for some crops and subsidies on
farm product, (c) public investments in and for agriculture, and developing
facilitating institutions. This strategy paid dividends as the country was able to
address severe food shortage that emerged during 1960s:
During the period 1965-2015, since the adoption of green revolution, India’s
food production multiplied 3.7 times while the population multiplied by
2.55 times.
The net result has been a 45 per cent increase in per person food production,
which has made India not only self-sufficient in foodgrains at aggregate
level but also a net food exporting country.
This strategy did not recognise the need to raise farmers’ income and thus no
direct action for farmers’ welfare. NSSO data on Household Consumption Survey,
2011-12 reveal that more than 1/5th of rural households with self-employment in
agriculture have income below the rural poverty line. During 1980s, farm income
123
Sector Specific Issues and per cultivator was just 34 per cent of the income of non-agricultural worker,
Policies
which further worsened to 25 per cent in 1993-94. Low level of absolute income
of farmers and rising disparity between the farmers’ income and non-farm workers
resulted in widespread emergence of farmers’ distress during 1990s. Low and
highly fluctuating farm income has been detrimental to farmers and farm
investment, and thus forcing young people leaving agriculture. Realising the
need to pay special attention to the plight of farmers, the goal to double the
farmer’s income by 2022-23 has been set by the government.
13.6.1 Prime Minister’s Multi-dimensional Seven Points

Strategy
Prime Minister’s multi-dimensional seven-point strategy includes:
1) Emphasis on irrigation along with end-to-end solution on creation of
resources for ‘More crop per drop’.
2) Provision of quality seeds and nutrients according to the soil quality of each
farm.
3) Large investments in warehouses and cold chains to prevent post-harvest
losses.
4) Promotion of value addition through food processing.
5) Implementation of National Agricultural Markets and e-platforms (e-NAM)
to eliminate shortcomings of all the 585 centres.
6) To mitigate the risk, introduction of crop insurance scheme at a lower cost
to the farmers.
7) Promotion of allied activities such as dairy, animal husbandry, poultry, bee-
keeping, horticulture, and fisheries.
13.6.2 Policy Initiatives for Enhancing the Farmers’ Output per

Hectare: Improving Cropping Intensity
In consonance with crucial sources for raising the cropping intensity, two major
flagship schemes launched immediately after announcement of DFI include (a)
Pradhan Mantri Krishi Sinchayee Yojana (PMKSY) and (b) Pradhan Mantri Fasal
Bima Yojana (PMFBY)
Pradhan Mantri Krishi Sinchayee Yojana (PMKSY)
With almost 54 per cent of the net sown area in the country rain-fed, availability
of irrigation facility will ensure access to some means of protective irrigation for
all agricultural farms in the country. To this effect Pradhan Mantri Krishi
Sinchayee Yojana (PMKSY) has been approved (in July 2015) and formulated
with the vision of extending the coverage of irrigation ‘Har Khet Ko Pani’ and
improving water use efficiency ‘More crop per drop’.
Pradhan Mantri Fasal Bima Yojana (PMFBY)
Small and marginal farmers holding (86.3 per cent) with 47.3 per cent cropped
area dominates India’s agriculture. India’s primary failure has been its inability
to capitalise on technology and efficient agricultural practices, which can ensure
surpluses despite small landholdings. Another reason for India’s farmers needing
insurance is that commercialisation of agriculture requires an increase in credit
124
needs, but most small and marginal farmers cannot avail credit from formal Agriculture: Issues,
institutions due to the massive defaults caused by repeated crop failure. Besides, Programmatic Initiatives
due to climate change higher incidence of extreme weather events aggravates
agrarian distress and if this risk is mitigated, farmers will be motivated to make
investment in agriculture.
In April, 2016, the government of India had launched PMFBY after rolling back
the earlier insurance schemes viz. National Agriculture Insurance Scheme (NAIS),
Weather-based Crop Insurance scheme and Modified National Agricultural
Insurance Scheme (MNAIS). The PMFBY was created to target 50 per cent of
all farmers, with the promise of compensation in case of crop loss.
13.6.3 Policy Initiatives for Crop Diversification and Enhancing

Value Realisation
To enhance the farmers’ income one of the alternatives is that farmers may be
motivated to diversify the cropping pattern from cultivation of cereals such as
wheat and rice to high value crops such as fruits and vegetables, commercial
crops, spices etc. The idea behind Operation Green is to double the income of
farmers by end of 2022 through changing the cropping pattern.
Basic Principles of Operation Green Strategy

Principle I:To establish the link between farmers and major organised
retailers to begin with and thereafter allow them to access the retail markets.
The real challenge is to find the right markets that can give them remunerative
prices on a sustainable basis. Farmers can be organised in Farmers Producers
Organisations (FPOs). NABARD and Small Farmers’ Agri-Business
Consortium (SFAC) together have about 3,000 FPOs, which could be the
starting points for the aggregation of commodities, assaying, sorting, grading,
and even packing with bar codes, reflecting their traceability. It is targeted
to form at least 10,000 FPOs by 2022.
Principle 2: The existing Agricultural Produce Market Committee (APMC)
system of marketing does not allow FPOs to sell their produce directly to
the private traders. APMC Act needs to be replaced by the New Agriculture
Produce and Livestock Marketing, (Promotion and Facilitation) (APLM)
Act, 2017.
Principle 3:Reducing post-harvest losses (PHL) in fruits and vegetables,
which are approx. 40 per cent in India. Agri-logistics can help generate
post-harvest specialised infrastructure needed for complete integration of
cold-chain facilities. In order to increase the income gains to farmers, they
should be involved in post-harvest logistics as partners through the Farmer
Producer Organisation (FPO)/Village Producer Organisation (VPO)/
cooperative society. This would directly benefit the farmers by providing
them access to bigger markets (beyond the local market) and more
remunerative prices.
Principle 4: Linking the processing industry with farmers and FPOs. The
processing of perishable agricultural products is low (around 2 per cent). In
fact, farmers do not have access to the food processing markets and most of
their produce they sell directly to APMC markets and private traders and
thus get less than 1/14th of the price consumer pays to the chain of middlemen
125
Sector Specific Issues and operating between farmers and retail and food processors. The Operation
Policies
Green focuses on direct access of food processing market by FPOs. To
facilitate this linkage, Agricultural Produce and Livestock Contract Farming
and Services (Promotion & Facilitation) Act, 2018 has been drafted and
circulated to all states for replacing it with existing APMC Acts.
Agricultural markets despite some changes continue to face many challenges
like licensing barriers, lack of integration of various markets, lack of marketing
infrastructure, high incidence of marketing charges, high wastages in supply
chain, etc. Market dynamics continued with the protectionist perspectives. The
best protection to farmers is in promoting long– term market linkages, such that
markets are connected across place, time and form with farms. The necessary
condition for transferring remunerative prices to the farmers is a competitive
environment that facilitates fair and transparent price discovery.
E-National Agriculture Market (e-NAM)

The government introduced a Central Sector Scheme for promotion of a NAM
to bring about a transformation in agriculture marketing environment. A unified
market can be best realised through a pan-India electronic platform which can
facilitate the participation of buyers and sellers from all over the country. The e-
NAM network was inaugurated on 14-April-2016. As of July 2019, all 585
markets have been integrated into the scheme and 42.18 lakh farmers and 89,199
traders have been registered on e-NAM portal with a turnover of Rs. 16, 163.1
crore from the trading of 63.17 lakh tons produce. The government intends to
link 22,000 mandis across the country with e-NAM, by 2021-22.The vision of a
full-fledged e-NAM is where all types of markets have inter-operability in
communication, standards, systems, operating under a common regulatory
framework.
13.6.4 Policy Initiatives to Ensure Remunerative Price to

Farmers for their Produce: MSP Policy and Procurement
The success of green revolution journey predicated upon, inter-alia, market
support in terms of Minimum Support Price (MSP) and Procurement Policies.
MSP was intended to serve as a floor price and an assurance against risks that
could arise from sharp falls in the market price. The Government notifies MSPs
based on the recommendations of an independent body, called Commission for
Agricultural Costs and Prices (CACP).CACP recommendation is based on A-2
concept of cultivation which comprises of input costs in cash +Imputed value of
family labour.
Minimum support prices acquire value only when they are supplemented by a
robust mechanism of procurement, whenever they are breached in the market on
the negative side. It is opined that the farmers would gain better from a more
robust system of procurement rather than increase in MSPs. The existing
procurement mechanisms by the government are implemented under:
Food Corporation of India (FCI) operations for Central Pool Procurement is
made to meet buffer norms and for meeting targets of the public distribution
system.
Price Support Scheme (PSS) applicable in case of MSP notified crops.
Intervention by GoI whenever market prices fall below MSP.
126
Market Intervention Scheme (MIS): To support commodities, for which Agriculture: Issues,
MSPs are not notified - fruits/vegetables/other horticulture products. Programmatic Initiatives
Price Stabilisation Fund (PSF): A scheme to protect consumers from rising
prices.
Enhanced MSP (= 1.5 times of Cost of Cultivation-A-2) in Union Budget,
2018 followed by announcement of PM-AASHA for Enforcement
Giving a major boost to the pro-farmer initiatives of the Government and in

keeping with its commitment and dedication for the Annadata, the government
launched a Scheme “Pradhan Mantri Annadata Aay Sanrakshan Abhiyan’ (PM-
AASHA) which aimed at ensuring remunerative prices to the farmers for their
produce as announced in the Union Budget for 2018. The new Umbrella Scheme
PM-AASHA comprises of Price Support Scheme (PSS) (for Pulses, Oilseeds
and Copra), Price Deficiency Payment Scheme (PDPS) (Oilseeds and Pulses)
and Pilot of Private Procurement and Stockiest Scheme (PPPS) (only for Oilseeds
in 15 districts).
Warehousing
An efficient marketing system alone is not sufficient and cannot guarantee desired
benefits to farmers unless it is supported by an efficient storage system for post-
harvest crops. Warehousing allows farmers to balance their supply to markets
and in the interim, enables them to avail finance to meet their immediate financial
requirements. Warehousing availability, of suitable type and quality, thus makes
it an important component of the agricultural marketing system. Three main
agencies in the public sector engaged in building large scale storage/warehousing
capacity viz., Food Corporation of India (FCI), Central warehousing Corporation
(CWC) and State Warehousing Corporation (SWCs). The government also
supports the private sector and Cooperatives in creating warehousing capacity
under the ‘Agricultural Marketing Infrastructure sub scheme’ (erstwhile rural
godown scheme).
13.6.5 Policy Initiatives to Improve Resource Efficiency/

Reduction in Cost
The inputs (seed, fertilizers and pesticides, farm machinery, credit and labour)
account for major component of cost in case of all selected crops. The effective
management of these inputs and their efficient use would help in reducing the
cost and in turn in enhancing the productivity and income of the farmers.
Soil Health Management – Soil Health Card (SHC) Scheme

Diagnostic surveys in the Indo-Gangetic Plains (IGP) indicate that in several
high productivity areas of irrigated ecosystems, farmers use excessive fertilizer
N to maintain the yield levels attained previously with relatively less fertilizer.
Indiscriminate use of N fertilizers aggravates soil fertility depletion, and proves
detrimental in terms of low nutrient use efficiency, poor quality of produce,
enhanced susceptibility of crops to biotic and a biotic stresses, and a potential
threat of groundwater pollution due to excessive leaching of nitrates beyond
effective root zone.
Enhancing nutrient use efficiency will be the key for sustained agricultural
production, lowering of unit cost of cultivation and for raising farm income in
127
Sector Specific Issues and the years to come. SHC Scheme, launched on 19 February, 2015 aims at issuing
Policies
SHC to each one of the 140 million farm holdings at 2-3-year interval on a
continuing basis. The SHC would include analysis of 12 soil parameters viz.,
potential for hydrogen (pH), Emulsifiable Concentrate (EC), Soil Organic (SOC),
available primary nutrients (N, P, K), available secondary nutrient (S), and
available micro-nutrients (Zn, Fe, Cu, Mn, Boron). Based on analyses for these
values, fertilizer and soil amendment recommendations are to be formulated for
three prominent crops each of kharif (monsoon) and rabi (dry) seasons.
Issue of subsidised fertilizers to farmers was linked to the recommendations

made in soil health card. SHC involves assessment of soil fertility variation and
suggesting nutrient prescriptions following the principle of 4R (right rate, right
source, right time and right method). As on 31st March 2019, around 130 million
SHCs issued.
To rationalise the use of fertilizers, government announced Direct Benefit Transfer

(DBT) scheme under which subsidies will be released for those fertilizers issued
against the SHCs. The SHC-based fertilizer recommendation is expected to
enhance productivity and income. But timely availability of all fertilizers
recommended in the SHC is a pre-requisite for adoption of SHCs.
Seed – A critical Input
Seed is a critical input for enhancing productivity of all agricultural and

horticultural crops and plays a vital role in improving the income status of farmers.
Use of quality seeds alone can increase productivity by 15-20 per cent, showcasing
its importance in agriculture. Sustained increase in agricultural production and
productivity necessarily requires continuous development of new and improved
varieties as well as hybrids, suitable for 128 agro-climatic zones of the country.
This also necessitates an efficient seed multiplication system, integrating plant
breeding, trade and distribution, and finally the farmer using the seeds. One of
the serious factors responsible for low use of quality seed is sale of spurious seed
in the market.
In order to improve the quality of farm saved seeds (60-65 per cent), Seed Village
Programme being implemented from year 2005-06 onwards needs to be upgraded
for better monitoring. The targeted 500 number of Seed Processing and Godown
at the Gram Panchayat level by 2022 will strengthen seed production system.
Pest Management
In India, the farmer’s crop yield losses range from 15 to 25 per cent owing to the
presence of weeds, pests, diseases and rodents. The Government enacted
Insecticides Act (I.A.), 1968 regulates import, manufacture, sale, transport,
distribution and use of pesticides so as to prevent risks to human beings, animals
and matters connected therewith. Challenges such as Quality of pesticide,
Optimum application of pesticide, Popularising Integrated Pest Management
(IPM) techniques, Price of generic pesticides and monopolistic practices still
need to be addressed. The problem of excessive pesticide usage can be addressed
through multi-stakeholder participation. In addition to farmers, pesticide producers
and sellers, middleman of vegetable trade and consumers should also be involved
in diagnosis of the problems and designing of approaches.
128
Agriculture Mechanisation Agriculture: Issues,
Agricultural Mechanisation speeds up tasks, and helps bring judicious use of
inputs like seeds, fertilizer and water, contributing to farm productivity, and is,
therefore aid in enhancing farmers’ income. Estimates indicate that agricultural
mechanisation can contribute a cut in cultivation cost by 25 per cent and rise in
productivity by 20 per cent, thereby affecting an increase in farm income, to the
extent of 25-30 per cent.
The Government of India is promoting agricultural mechanisation on farms

through a Sub Mission on Agricultural Mechanisation (SMAM) of Rs. 2000
crore, which started from April 2014 under the umbrella of National Mission on
Agricultural Extension and Technology (NMAET). The objectives of this Mission
are: increasing the reach of farm mechanisation to small and marginal farmers
and regions with low farm power; promoting ‘Custom Hiring Centres’; creating
hubs for hi-tech and high value farm equipment; awareness through demonstration
and capacity building and ensuring performance testing and certification of
machines.

1) ‘Crop diversification is the key for raising the farmers Income’. Do you
agree with the statement? Critically examine the strategy envisaged by the
Government for promoting crop diversification in India.
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2) In the context of the stated aim of doubling farmer’s income, discuss the
challenges involved in realising the same.
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3) What is MSP? Explain its importance to Indian agriculture and to consumers.
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129
Sector Specific Issues and 4) Examine the problems associated with food grains procurement and their
Policies
storage by the government in India.
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13.7 RELEVANCE OF NON-AGRICULTURAL

ACTIVITIES IN DOUBLING OF FARMERS’
INCOME
The agrarian structure of India has been experiencing a reduction in farm size
and increase in marginalisation of holdings for the past several decades. The
small land base of the Indian farmer is one of the major factors contributing to
rural poverty. If agriculture were to the sole source of income for small
landholders, the majority of them would live much below the poverty line. A
number of studies from developing countries have suggested that diversification
of rural economy towards non-farm activities has considerable potential to
augment farmers’ income and reduce rural poverty. Diversification towards
nonfarm activities overcomes the land constraint to income growth, enables the
farmers to cope up with the shocks of crop failure and enhances their capacity to
invest in productivity-enhancing agricultural inputs and technologies.
NABARD Survey shows that 35 per cent income of agricultural households is

from cultivation, 34 per cent from wage labour, 16 per cent from salaries and 8
per cent from livestock and remaining 7 per cent from non-farm sectors. NABARD
survey also provides that:
• Only 13 per cent of agricultural households have one single source of income.
• Around 50 per cent of these households have two sources,
• 29 per cent three sources and
• 9 per cent four sources.
It shows that agricultural households do not depend only on farm income but
they depend on multiple sources for their livelihoods. Thus, both agriculture and
non-agriculture are important for raising income of agricultural households.
According to NSSO SAS Surveys and NABARD Survey, the income of
households was classified according to four sources, viz. agriculture, agricultural
wages, livestock and non-farm income. Further discussion on income of the
farmers earned through sources other than cultivation is beyond the scope of this
unit and therefore needs to be covered separately in the different unit.
130
Check Your Progress 6 Agriculture: Issues,
1) Briefly discuss the role and relevance of non-agricultural activities in raising Programmatic Initiatives
the farmers income in India.

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13.8 LET US SUM UP

In India, agriculture is a key sector in terms of its contribution to both employment
and GDP.
The green revolution in cereal production, white revolution in milk production,

green revolution in cotton production and the more recent diversification of
production towards pulses, fruit and vegetables as well as meat and meat products,
have been largely in response to evolving demand patterns driven by rising
incomes and urbanisation. As a result, India has transformed from a food deficit
country to a major exporter of agriculture and allied products. The strong growth
in production has been sustained by an improved access to inputs such as fertilizers
and seeds, increased irrigation coverage (including micro irrigation), greater reach
of institutional credit, introduction of the Kisan Credit Card scheme – enabling a
more timely access to credit – and the designation of agriculture for priority
lending. The beginning of structural change is underway due to the involvement
of the private sector, going beyond the mainly traditional or unorganised private
players (including mandi traders, private mills, village brokers, traditional
retailers) to organised private entities, such as agribusiness and large food–
processing companies or supermarkets.
Despite these successes, challenges remain. Among them, the notable being,
slow pace of structural transformation and low labour productivity, continuing
fragmentation of operational holding, inefficient agro-food supply chains and
retail sector, prevalence of informal channels of credit and the climate change.
Although, Indian agriculture has increasingly become integrated with world
markets, its trade share is still low compared to the share of India’s total
merchandise exports and imports as a per cent of India’s GDP. Environmental
pressures are also starting to loom large. To address these concerns, agricultural
policies in India are designed and implemented by a complex system of
institutions. States have Constitutional responsibility for many aspects of
agriculture, but the Central government plays an important role by developing
national approaches to policy and providing the necessary funds for
implementation at the state level. Throughout the last decades, agricultural policies
have sought to achieve food security, often interpreted in India as self-sufficiency,
while ensuring remunerative prices to producers and safeguarding the interest of
consumers by making supplies available at affordable prices.
131
Policies 13.9 TERM-END EXERCISES
1) The need for a Second Green Revolution is being experienced more than
ever before. Do you agree? What are your views with respect to bringing
revolution in the production of nutrition-rich crops like pulses, fruits and
vegetables — which remained untouched in the first Green Revolution?
2) Discuss any two steps taken by the government in the direction of improving
agricultural marketing system in India since independence.
3) “Agriculture sector appears to be adversely affected by the economic reform

process.” Elucidate.
4) Discuss the impact of the Climate change on the Indian Agriculture. What
are the initiatives taken by the Government to mitigate this impact?
5) How farming system play important role in doubling the farmers income?
Also, explain the role of Non-farm income in doubling farmers’ income.
6) What are the Policy Initiatives taken by the government to ensure

Remunerative Price to farmers for their Produce?
13.10 KEYWORDS
Crop Diversification : Crop diversification refers to the addition of new
crops or cropping systems to agricultural
production on a particular farm taking into
account the different returns from value-added
crops.
HYV Seeds : High Yielding Variety Seeds (HYV seeds) are

seeds of better quality than normal quality seeds.
They are resistant and have a high yielding
potential against insects and diseases.
Institutional Credit : Agriculture credits provided by government

institutions are called institutional credit.
Marginalising of : A general feature of the size distribution of

Landholdings operational holdings is that the percentage of
holdings decreases as the holding size increases.
Minimum Support Prices : The minimum support price (MSP) is an

agricultural product price, set by the Government
of India to purchase directly from the farmer.
13.11 REFERENCES
1) Acharya, S.S. (2016). “Agricultural Price Policy and Development: Some
Facts and Emerging Issues”, in Indian Society of Agricultural Economics
(ed., 2016)
132
2) Aggarwal, N. , S. Jain and Sudha Narayanan (2017). The Long Road to Agriculture: Issues,
Transformation of Agricultural Markets in India” Economic and Political Programmatic Initiatives
Weekly, Vol.52, No.41
3) Chand, Ramesh (2016). “Doubling Farmers’ Income: Rationale, Strategy,
Prospects and Action Plan”, NITI Policy Paper No.1/2017, NITI Ayog, New
Delhi
4) Gulati, Ashok and Bathla, Seema (2002). Capital formation in Indian
agriculture: Trends, composition and implications for growth. NABARD
Occasional Paper No. 24. Also published in Economic and Political Weekly,
36: 1697-1708.
5) Indian Society of Agricultural Economics (ISAE) (edited 2016), “Indian
Agricultural Economy under Liberalised Regime: 1991 to 2015”, Academic
Foundation, Delhi
6) Mishra SK and Puri VN, Indian Economy, 36th Edition, 2018, Himalayan
Publishing House, New Delhi
7) Shantanu De Roy(2017). “Economic Reforms and Agricultural Growth in
India”, Economic and Political Weekly, Vol LII no 9, March 4, 2017.

PROGRESS EXERCISES
1) Read Section 13.2 and answer
2) Read Sections 13.1 and 13.2 and answer
3) Read Sections 13.1 and 13.2 and answer

2) Read Sub-section 13.3.1 and answer


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Sector Specific Issues and Check Your Progress 5
Policies
134
UNIT 14 LARGE SCALE INDUSTRIES IN Concerns, Policy and
INDIA: ISSUES AND POLICY
Structure
14.0 Objectives
14.1 Introduction
14.2 Industrialisation and Economic Development
14.2.1 What is Industrialisation?
14.2.2 Case for Industrialisation
14.3 Growth Strategy in India
14.3.1 Evolution of Strategy in India’s Plans
14.3.2 Essential Features of Heavy Industries
14.3.3 Policy Support to Strategy
14.3.4 Industrial Policy in India
14.3.5 Legislative Support to Strategy
14.4 Review of Industrial Licensing in India
14.4.1 Phase of Liberalisation
14.4.2 Recent Policy Initiatives Impacting Industrial Growth
14.5 Critical Issues before Industrial Sector
14.5.1 Industiral Sickness
14.5.2 Technological Obsolescence and Modernisation
14.5.3 Productivity in Indian Industry
14.6 Approach to a New Industrial Policy
14.7 Let Us Sum Up
14.9 Key Words
14.10 References
14.0 OBJECTIVES
After studying this unit, you will be able to:
discuss the relevance of industrialisation in the process of growth and
development of an economy;
appreciate the basic contours of growth strategy pursued in India in the
context of Heavy industrialisation;
identify the role of the state in formulating and operating the industrial policy
in India;
review the relevance of industrial licensing in India and the subsequent phase
of liberalisation;
outline the critical issues facing the industrial sector in India; and
get insights into the approach to the new industrial policy in India.
135
Policies 14.1 INTRODUCTION
As stated elsewhere in this unit, “fast economic development everywhere has
been made possible essentially due to rapid industrialisation.” Industrialisation,
indeed, holds the key to rapid economic growth, as productivity levels in industry
are much higher than in agriculture. Moreover, industrialisation is regarded as
an important policy to affect fundamental economic and social changes in under-
developed countries which are considered as necessary conditions to raise their
growth potentials. No wonder, fast industrialisation as the developmental goal
has a universal appeal, notwithstanding the fact that industrialisation may give
rise to problems like pollution, premature exhaustion of raw materials,
unemployment, and inequalities in income distribution. India has been no
exception to this universal urge. The present unit involves discussion about the
Indian industrial sector with respect to its relevance for the Indian economy’s
growth and development; the strategies and policies initiated to serve this sector;
the issues faced by this sector; and the approach that could be adopted for setting
up the new industrial policy.
14.2 INDUSTRIALISATION AND ECONOMIC

DEVELOPMENT
Industrialisation has come to be regarded as synonymous with economic
development. There is hardly any country in the world (with the possible exception
of New Zealand) that could reach the level of per capita income of industrially
developed countries of the West, on the back of its agriculture and processing of
its products (petroleum producing countries, like Saudi Arabia, Kuwait and UAE
represent a special case or exception to the positive relationship between per
capita income and the share of manufacturing sector). The main criteria that are
generally being used to distinguish a developed economy from a developing one
relate to the proportion of workforce engaged in industrial activity and the
proportion of national output originating in the industrial sector.
14.2.1 What is Industrialisation?

Industrialisation is a process by which the centre of economic gravity of an
economy shifts from agriculture to industry.
Industrialisation involves two things:
i) Adoption of technologically superior techniques of production that help to
transform basic raw materials and intermediate goods into manufactured
goods;
ii) Application of modern techniques of management and organisation like
economic calculations, accountancy and management techniques.
Large vs. Small Industry
For policy purposes, industrial units are generally classified as (i) micro, small
and medium enterperises (MSMEs) and (ii) large enterprises. For this
categorisation, indicators like capital investment, output capacity, labour
employed are used. Units within the laid down maximum limits of these indicators
are classified as MSMEs. Beyond these limits, all enterprises are treated as large
enterprises.
136
Consumer vs. Capital Goods Large Scale Industries in
India: Issues and Policy
Production units that produce consumer goods are classified as consumer goods
industries, whereas, capital goods are produced in capital goods industries.
Public vs. Private Ownership

Production units set up and managed by a government are classified as units
with public ownership. Privately owned units are the ones owned and managed
by private capital and enterprise.
14.2.2 Case for Industrialisation

The following factors favour rapid industrialisation as a means to accelerate
economic development:
1) Labour Productivity
The productivity in the industrial sector is generally higher due to one or
more of the following reasons:
i) existence of greater capital intensity,
ii) continuity of production,
iii) greater specialisation and division of labour,
iv) less dependence on natural factors,
v) a greater possibility of internal-external economies in the manufacturing
sector.
2) Employment Generation
Industrial activity expansion create more employment opportunities, thus
attracting labour from less productive occupations. This process adds to the
national output as also to the purchasing power and aggregate consumption
expenditure which in turn pulls the aggregate demand upwards and is
instrumental in creating more employment opportunities.
3) Mobilisation of Surplus
A major constraint on development in a developing economy is the lack of
adequate resources to finance the process of capital accumulation.
Inadequacy of resources is the result of two inter-related factors: (a) the
absolute size of resources, national output and saving in a developing
economy is low, and (b) it is not possible to mobilise the surpluses. The
problem of inadequacy of resources is common to all the sectors of the
economy, while the problem of mobilisation of resources is peculiar in the
agricultural sector. The task of mobilisation of surplus savings in this sector
is rendered difficult by the fact that there is no suitable institutional set-up
for this purpose. Such a set-up can more easily be provided in the industrial
sector of the economy. Thus, by concentrating resources on industrialisation
the pace of economic development can be quickened.
14.3 GROWTH STRATEGY IN INDIA

The primary problem to be identified in developmental planning in an
underdeveloped mixed economy is to establish a set of ends or goals that could
137
Sector Specific Issues and be pursued with a specific choice of technique deemed appropriate for that context.
Policies
This refers to the strategy of planning. Any strategy for development consists of
three components: resource mobilisation, priorities for the allocation of resources
mobilised, and a policy framework to ensure an efficient deployment of resources
into the priority sectors.
14.3.1 Evolution of Strategy in India’s Plans

It was during the First Five Year Plan (FYP-1) period itself that the Planning
Commission had started doing ‘home work’ relating to the formulation of the
FYP-2. A series of studies, under the general guidance of Prof. P.C. Mahalanobis,
were prepared by a group of both Indian and foreign economists and statisticians.
These contributed to the writing of the Mahalanobis’ Plan Frame (hailed as the
most radical Plan outside Communist countries) which became the foundation
of the FYP-2, and for that matter, all long-term planning subsequently. The strategy
aimed at building a self-sufficient economy.
The two basic features of the strategy were: (i) Explicit emphasis on

industrialisation, and (ii) Within the industrial sector, emphasis on the growth of
heavy/capital goods industries.
The essential feature of the strategy was to allocate a given volume of investible
resources in the capital goods producing industries which would yield a relatively
large volume of investment goods and therefore support growth with
transformation of the economy, in comparison to allocation tilted in favour of
consumer goods industries. Hence, the strategy to be driven by the increased
production of heavy engineering or capital goods in the short run required a
higher allocation of investible resources to the capital goods sector. Such a strategy
would lead to lower levels of consumption in the short run, but would yield a
relatively high growth and consumption in the medium to long run. In contrast to
this, an alternative model of development was developed by Vakil and
Brahmananda which laid stress on wage goods or what they called liquid capital
in determining the growth of employment and income. Their model propounded
a strategy of development which accorded the highest priority to wage goods
industries, especially agriculture in allocation of investment resources. However,
policy choice was exercised in favour of the former model.
14.3.2 Essential Features of Heavy Industries

Three essential features of the heavy industries are as follows:
One, capital investment to set up and run such units involves huge sums of money.
Two, the time lag between capital accumulation (investment) and flow of output
(gestation gap) could be fairly large, which could deter private enterprise from
entering such industries. Three, these production units by nature are natural
monopolies, (i.e., these are subject to law of increasing returns to scale). Given
these features, it is no wonder that strategies pertaining to heavy industrialisation
devolves almost exclusively on the State, which is required to set up and operate
such production units. This is precisely what the State in India chose to do.
14.3.3 Policy Support to Strategy

There are several aspects of industrial policy which affect industrial investment
138 and production.
a) Industrial licensing policy which regulates the setting up of new (large and Large Scale Industries in
medium) industrial undertakings and their expansion.
b) Policy concerning the control of monopolies and economic concentration—
and the reservation of certain lines of production for the decentralised, small-
scale sector– which in a way forms an integral part of industrial licensing
policy.
c) Policy regarding technology import. Closely allied to technology import
policy is the policy regarding the import of capital goods, components, and
raw materials.
d) A whole range of financial and fiscal policies which pertain to the provision
of industrial finance, development of the capital market, as well as fiscal
incentives/disincentives to investment and production.
The goal of industrial policy is to influence sectoral development in an economy.
14.3.4 Industrial Policy in India

Till July 24, 1991, when the New Industrial Policy was announced by the
Government, the industrial policy had been chalked out within the framework of
the Industrial Policy Resolution, 1956 (IPR, 1956). The roots of the IPR, 1956,
can be traced back at least to a decade earlier. Immediately after Independence,
it was considered desirable by the Government to announce its attitude towards
private capital and to define the scope of State participation in economic activity.
This aimed at removing all uncertainties that would have worked as constraints
on industrial growth in the economy. This announcement took the form of the
Industrial Policy Resolution, 1948 (IPR, 1948).
IPR 1956
A number of important developments had taken place in India since adoption of
the IPR, 1948. These necessitated a fresh statement on industrial policy. Among
these developments the more important were as follows:
i) New Constitution of India which guaranteed certain Fundamental Rights
and provided for Directive Principles of State Policy.
ii) Completion of the First Five-Year Plan and the commencement of the Second
Plan; and
iii) Acceptance by Parliament of the socialist pattern of society as the objective
of social and economic policy.
The industrial policy, as other policies, was, therefore, to be governed by these
principles and directions. The IPR, 1956, has been known as the ‘Economic
Constitution’ of India. The Resolution put emphasis on:
i) The development of heavy and machine-building industries;
ii) the expansion of the public sector;
iii) the establishment of a large and growing co-operative sector; and
iv) encouragement to the diffusion of ownership and management in the private
sector.
139
Policies
14.3.5 Legislative Support to Strategy
The system of industrial licensing was adopted in India to give effect to the IPR,
1948. The legislative framework of industrial licensing is embodied in three
different Acts passed at different times.
A) Industries (Development and Regulation) Act, 1951

The Industries (Development and Regulation) Act (in short, known as the IDRA)
was passed in October, 1951. It came into force on May 8, 1952.
1) Objectives The chief objective of the Act, as its title suggests, is the
development and regulation of Indian industries in a manner befitting a
socialistic society, and other related social, economic or political
considerations.
2) Provisions The Act made the registration of all industrial units in the
scheduled industries compulsory and enjoin upon the owners thereof to obtain
a certificate of registration within a prescribed period. It also required the
new industrial units to be established only after obtaining a licence from the
Central Government. A licence from the Government was required for any
of the following purposes:
a) starting of a new industrial unit,
b) a substantial expansion of the existing unit,
c) the manufacture of a new ‘article’, and
d) shifting the location of an industrial unit.
3) Scope The Act in its original form applied to industries included in the first
schedule to the Act. This schedule covered a number of industries like
metallurgical, industrial machinery, transportation, fertilizers, textiles,
cement, defence, etc.
B) Monopolies and Restrictive Trade Practices Act, 1969
The Mahalanobis Committee, in 1960, brought out the issue of growing

inequalities in the post-independence period. The Monopoly Inquiry Commission
(MIC) in its Report submitted in 1965 recognised the ill effects of concentration
of economic power. The findings of MIC prompted the Government of India to
enact the Monopolies and Restrictive Trade Practices Act (MRTPA), 1969 which
came into force on June 1, 1970, with the objective of prevention of concentration
of economic power to the common detriment, control of monopolies and
prohibition of monopolistic/restrictive trade practices. The Act covered
monopolistic trade practices and restrictive trade practices. Unfair trade practice
was added through amendment in 1984.
The issue of concentration of economic power was addressed by the government

by making it obligatory for undertakings with assets of the total value of Rs. 20
crore or more (later raised to Rs. 100 crore or more in 1985 and removed altogether
in 1991) and for dominant undertakings which enjoy 1/4th of the market share of
the total market (which was initially 1/3rd) with assets of Rs. one crore or more,
to seek prior approval before effecting expansion of the undertaking.
140
C) Foreign Exchange Regulation Large Scale Industries in
The Foreign Exchange Regulation Act, 1973 (FERA, 1973)– often described as
the economic canvas of the country– had its origin in the Foreign Exchange
Regulation Act, 1947 (FERA, 1947).
The FERA, 1973 was formulated in the background of a highly restrictive and
centrally controlled industrial policy regime. The subsequent amendment to the
FERA in 1993 substantially diluted its regulatory provisions and brought it in
line with the new liberalised industrial, trade and exchange rate policies. The
FERA has since been repealed and replaced by FEMA.
D) Other Controls
1) The Companies Act, 2011

The Companies Act, 2011 was enacted to comprehensively amend the 55-
year old Companies Act, 1956. The Act was aimed at the modernisation of
corporate regulation.
2) The Securities Contracts (Regulation) Act, 1956

The Act provides for, apart from regulation of stock exchanges, a general
system and apparatus of control to ensure fair dealing in securities and
investors protection. In terms of recent amendment to this Act, companies
cannot reject, except on technical grounds, share transfer without appropriate
reference to the Company Law Board.
3) Import and Export Control

Import and export control in India is exercised under the provisions of the
Foreign Trade (Regulation and Development) Act, 1992, which succeeds
the Imports and Exports (Control) Act, 1947. The principal objective of the
Act is ‘to provide for the development and regulation of foreign trade by
facilitating imports into, and augmenting exports from, India.
4) Commodity Control
Commodity control in India is exercised under the provisions of various
Acts enacted by the Government. The first in the list is the Essential
Commodities Act, 1955, which empowers the Central Government to control,
regulate or prohibit the production, distribution, transport, trade,
consumption, or storage of a large number of commodities, to prescribe
their prices and even to take over stocks on conditions that it set. Besides,
there are several enactments to control various specific commodities like
coffee, coir, tea, rubber, sugar, etc.
5) Financial and Credit Controls

Allocation of credit is subject to guidelines or policy announced by the
government from time to time. Since a large part of the financial sector is in
the public sector, the government exercises formal and informal control
over the allocation of financial resources.
6) Location, Environment and Labour Legislation

The location of industries is banned in the municipal areas of all towns and
cities, as well as in specific areas around the largest twenty cities.
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Sector Specific Issues and Environmental and pollution control clearance for all projects above a certain
Policies
size is also mandatory. The rules regarding closure of units, retrenchment of
labour, compensation, and sale of assets of a sick unit are governed by a
comprehensive set of labour laws.
To top all these controls is the Companies Act, which, in its present
incarnation, has 658 sections and hundreds of sub-sections, clauses, sub-
clauses and amendments governing every aspect of the running of a company,
from audits and printing of annual reports, to remuneration of directors, and
investments and mergers.

1) What do you understand by the term ‘Industrialisation’? How does
industrialisation contribute to economic development?
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2) How does the strategy for the industrial sector evolved during the planning
era in India?
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14.4 REVIEW OF INDUSTRIAL LICENSING IN

INDIA
Industrial licensing was introduced in India with the enactment of the IDRA,
1951, in pursuance of the IPR, 1948. The system worked to provide protection to
the Indian industry. It could be argued that protection, both against potential
domestic competition and foreign competition, was the right approach in the
initial stage of industrialisation in a developing economy which was struggling
to come out of the stranglehold posed by two-centuries old colonial domination.
The industrial landscape underwent a dramatic change within a period of about
four decades. But the major failure of the policy of protection was that it did not
have a built-in mechanism that could prompt the industry to adapt itself to the
fast-changing technological scene to which a large part of the underdeveloped
world was responding with zeal and enthusiasm. The industrial structure of India,
under the burden of protection, turned out to be high-cost and low-quality that
lacked the basic ingredients of international competitiveness. Instead of fortifying
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the economy (where domestic economy will be protected against outright Large Scale Industries in
incursions), we made a ‘jail’ out of it. The tiger was ‘caged’ and remained so for
long, its muscles became frigid and lacked in flexibility.
It was becoming increasingly clear that the industrial policy would have to be
taken out of the “convoluted cobweb” in which it had got landed, system of
controls would have to be gradually given up and the industrial economy
liberalised, so as to enable it to breathe some fresh air.
14.4.1 Phase of Liberalisation

New Industrial Policy, 1991
Experiments with domestic liberalisation began in the mid-1970s. In 1975, a
scheme was introduced which provided for an increase in licensed capacity up
to a maximum of 25 per cent in a five-year period. Other measures included
regularisation of capacities in excess of authorised capacities for select industries,
some liberalisation from controls for units which exported 100 per cent of their
production, and a more general scheme of re-endorsement of capacities introduced
in 1982. The exemption limit for industrial licensing was also raised from Rs. 1
crore as set in 1970 to Rs. 3 crore in 1978 and to Rs. 5 crore in 1983, and further
since June 1988 to Rs. 25 crores for those units that were set up in the non-
backward areas and to Rs. 75 crores for those units that were set up in the backward
areas. The main emphasis during the 1970s was on reducing the restrictive and
complex features of the licensing policy.
The process of liberalisation got a fillip with the announcement of the New
Industrial Policy (NIP) in July 1991, and entered a new phase of what has been
described as ‘reform by storm’ that supplants ‘reform by stealth’ of the last half
of the 1970s, and ‘reform with reluctance’ during the second half of the 1980s.
As already stated earlier the NIP has made a bonfire of the industrial licensing
system by throwing out various provisions. There has also been some move
away from extensive physical controls and an increase in the role of financial
incentives in channelling investments in the desired areas. This, plus the lowering
of the tax rates combined with better administration of the revenue-collecting
system, helped in attracting investments and boosting economic activity which
had strayed away from the mainstream. The role of the financial institutions for
their intermediation functions become very important in the new regime.
1) Foreign Investment
i) Automatic approval is available to FDI in almost all sectors except a few

sensitive ones. Automatic approval is available for 50 per cent, 51 per cent,
74 per cent and even 100 per cent in specified industry groups.
ii) To provide access to international markets, majority foreign equity holding

up to 51 per cent equity will be allowed for trading companies primarily
engaged in export activities.
iii) The Foreign Investment Promotion Board has been constituted to negotiate
with a number of large international firms and approve direct foreign
investment in select areas.
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Sector Specific Issues and 2) Foreign Technology Agreements
Policies
i) Automatic permission is to be given for foreign technology agreements in
identified high priority industries up to a lumpsum payment of $ 2 million,
5 per cent royalty for domestic sales and 8 per cent for exports, subject to
total payments of 8 per cent of sales over a 10-year period from date of
agreement or 7 years from commencement of production.
ii) In respect of industries other than those included above, automatic permission
is to be given subject to the same guidelines as if no foreign exchange is
required for any payments.
3) Public Sector
a) Portfolio of public sector investments is to be reviewed with a view to focus

the public sector on strategic, high-tech and essential infrastructure. Whereas
some reservation for the public sector is being retained, there is no bar for
areas of exclusivity to be opened up to the private sector selectively. Similarly,
the public sector is also to be allowed entry in areas not reserved for it.
b) Public enterprises which are chronically sick and which are unlikely to be
turned around will, for the formulation of revival/rehabilitation schemes,
are to be referred to the Board of Industrial and Financial Reconstruction.
c) In order to raise resources and encourage wider public participation, a part

of the government’s shareholding in the public sector would be offered to
mutual funds, financial institutions, general public and workers.
4) MRTP Act
a) The MRTP Act has been amended to remove the threshold limits of assets in
respect of MRTP Companies and dominant undertakings.
b) Provisions relating to concentration of economic power, pre-entry restrictions

with regard to prior approval of the Central government for establishing a
new undertaking, expanding an existing undertaking, amalgamations,
mergers etc., have been deleted.
c) Emphasis has been placed on controlling and regulating monopolistic,

restrictive and unfair trade practices.
5) There is considerable internal deregulation aimed at strengthening the more

efficient domestic firms and encouraging them to invest and expand. This is
expected to inject much more competition into the system, creating incentives
for reducing costs. Scientists tell us that the diamond sparkles because of a
phenomenon called total internal reflection. If our economy is to sparkle,
total internal liberalisation is the key.
6) Measures have also been taken to improve the legal framework.
The Securitisation, Reconstruction of Financial Assets and Enforcement of

Security Interest Act, 2002 gives powers to banks and financial institutions
to enforce their claims on collateral for delinquent secured credit, without
going through a long and cumbersome judicial process.
144
Companies (Amendment) Act, 2002 is expected to enhance the Large Scale Industries in
competitiveness of cooperatives, and enable them to compete and operate
in today’s liberalised, globalised market.
In Companies (Second Amendment) Act, 2002 industrial sickness has been

redefined; a revival and rehabilitation fund has been set up; protection from
creditors has been withdrawn.
The Competition Act, 2002 aims at promoting competition through

prohibition of anti-competitive practices, abuse of dominance and through
regulation of companies beyond a particular size.
DIN (Director Identification Number) has been issued to all the directors of
all the companies under a surveillance system. The system will give the
government instant access to the details and nature of employment relevant
to company law requirements and antecedents which are crucial to investor
protection.
The internal liberalisation has been accompanied by a policy of maintaining an

open access to imports to permit modernisation and technological upgradation
in Indian industry which is expected to reduce costs and promote international
competition.
The aim of sweeping policy changes is to evolve an integrated economic package

that can be implemented in stages to create an appropriate environment so as to
encourage and promote greater efficiency, higher productivity and faster industrial
growth in desired directions through a well-coordinated system of incentives.
Accelerated growth of manufacturing, accompanied by radical restructuring and
induction of ‘sunrise’ industries within a suitably modified policy frame would
bring about a significant transformation of India’s industrial economy.
Positive Effects
India has woken up to the liberating influence of what Joseph Schumpeter called
“creative destruction”– the death of the outdated at the hands of the modern. The
following can be identified as some of the positive effects:
1) The post-liberalisation era has propelled companies into a restructuring spree;

companies are doing away with their not-so-profitable businesses. Corporate
sell offs are moving at a pace never seen before.
2) More ambitious players have been consolidating themselves by way of

mergers and acquisitions. Entrepreneurs have come to believe: “In business,
big is always beautiful.”
3) Over the last two decades, Indian manufacturing companies have emerged
on a par with the best in the world from the quality perspective. This has
happened because Indian manufacturing has adopted world-class practices
in manufacturing management by educating their employees, both managers
and shop-floor staff with the help of global teachers, mainly Japanese, who
have brought in the best manufacturing management techniques.
4) India’s share in world market capitalisation is now more aligned with its
share in global GDP.
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Sector Specific Issues and 5) Economic reforms have created an environment conducive for low-cost
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innovation. This, combined with increasing pressures for inclusiveness, will
contribute to creating an income-pyramid that will develop a bulge in the
middle– faster than earlier forecast. That is creating a huge mass market for
goods and services at a price that is affordable for this segment.
6) Indian business has emerged leaner, more efficient in terms of process, quality
and financing, and becoming competitive on a global scale. Indian companies
today are expanding operations in overseas markets through both organic
and inorganic means. There is a sense of optimism, and the ability to think
big and execute large plans. In addition, companies have developed the
ability to quickly respond to changes in market conditions. For example, in
response to the recent global economic slowdown, they aggressively reduced
their inventories, realigned production levels, and cut costs to rebase to the
new cost price-demand equation.
7) Companies are increasingly going in for coopetition, i.e., getting together to

become more competitive.
8) Trade unions and workers have responded positively to the economic reforms.
Their open-minded approach towards adoption of new technologies and
productivity linked wage agreements would go a long way in consolidating
the future of Indian industry.
9) Liberalisation has altered the investment behaviour of Indian entrepreneurs.

Industrialists have fast realised the role of scale economies, rapid
technological growth and increased productivity. Indian companies are now
going in for world-size plants. This will enable them to meet the competitive
challenge of MNCs. Many Indian companies, for the first time, have crossed
the billion-dollar mark in annual turnover.
10) The restructuring process of the corporate sector has gained momentum
with foreign collaborators seeking to enhance equity in the Indian ventures,
to gain a foothold in the management. The money comes in with strings
attached: board membership, due diligence and even some operational
oversight.
In short, liberalisation has opened up a new era which stresses the importance of
both economies of scale and quality of products; these hold the embryo of higher
productivity and competitiveness both in the home market and the export markets,
only if the Indian industry responds positively to the challenge thrown to it.
Negative Effects
From a force that unleashed India’s creative energies, markets are increasingly
seen as an institution that seems emblematic of homo homini lupus – man is
wolf to another man - and capitalism’s genius of “creative destruction” appears
in popular discourse as a force that is more destructive and less creative.
The current phase of investment following liberalisation also need to be given a

second look. While substantial investments might have been flowing into a few
industries the Government has reportedly expressed its concern over slow pace
of investments in a few basic and strategic industries such as engineering, power,
machine tools, etc. It has often been pointed out that the rate of return in these
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sectors is not more than the expectations in the newer or ‘Sunrise’ areas. Thus, Large Scale Industries in
the rate of growth of the industries wherein sufficient investment is not coming
could slacken. Such distortions in the investment pattern need to be rectified for
the sake of balanced growth of industrial economy.
Need for Strengthening Interlinkages between New and Old Sectors

New sectors should have strong linkages with the old ones and should push up
the latter towards modernisation and new product development. Unless
interlinkages are strengthened, a part of impetus given by the new sectors could
be lost through leakages abroad.
New Game-Changers
Indian investors tracking basic industries had a relatively easier task till now.
They had to keep one eye on the macroeconomy and assess the interplay of
factors such as demand-supply, raw material cost and availability, and the landed
cost of imports. These factors can be tracked since they are tangible and
measurable.
Government Policy has now emerged as a new and significant factor on the
horizon, one which is intangible and, hence, not easily measured. Environmental
policy and regulations at the central and state levels are affecting business. The
key players are the government itself, regulators (such as pollution control boards)
and courts.
14.4.2 Recent Policy Initiatives Impacting Industrial Growth

Implementation of GST
The GST is a game changing reform introduced by the government. It is expected
that implementation of GST will facilitate the creation of one common market in
the country by removing tax barriers; eliminate cascading of taxes thereby
reducing cost of production of manufacturing goods; and enhance ease of doing
business by cutting down transaction costs associated with the complex tax
regime. The implementation of GST is also going to cover the unorganised sector
industries.
Make in India
The ‘Make in India’ programme has been launched globally on 25th September
2014 which aims at making India a global hub for manufacturing, research and
innovation and integral part of the global supply chain. This initiative is based
on four pillars of New Processes, New Infrastructure, New Sectors and New
Mindset.
Start-up India
Start-up India is a flagship initiative of the Government of India, intended to
build a strong eco-system for nurturing innovation and Start-ups in the country
that will drive sustainable economic growth and generate large scale employment
opportunities. The Government through this initiative aims to empower Start-
ups to grow through innovation and design.
Ease of Doing Business

The Government has taken up a series of measures to improve Ease of Doing
Business. The emphasis has been on simplification and rationalisation of the 147
Sector Specific Issues and existing rules and introduction of information technology to make governance
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more efficient and effective. States too have been brought on board in the process
to expand the coverage of these efforts.
Intellectual Property Rights (IPR) Policy

In May, 2016, Government for the first time adopted a comprehensive National
Intellectual Property Rights (IPR) policy to lay future roadmap for intellectual
property. This aims to improve Indian intellectual property ecosystem, hopes to
create an innovation movement in the country and aspires towards “Creative
India; Innovative India”.

1) Outline the main features of strategy for the industrial sector pursued post
1991 reforms.
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2) Compare and contrast the positive and the negative effects of liberalisation
on the Indian industrial sector post 1991 reforms.
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3) Outline the recent policy initiatives impacting the Indian industrial sector.
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14.5 CRITICAL ISSUES BEFORE INDUSTRIAL

SECTOR
14.5.1 Industrial Sickness
India is probably unique among market economies in having policies which
override the normal processes of adjustment and which effectively prevent firms
from closing down their operations. The result has been a widespread and growing
incidence of the special Indian phenomenon of ‘Industrial sickness’.
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Definition of Sickness Large Scale Industries in
The definition of sickness has undergone changes over the years. The latest
definition of sick units is such that the related default of the loan amount is
enough to categorise it as a sick unit. Technically speaking, the loan account of
the unit has to become a non-performing asset (NPA).
Causes of Sickness
The important causes of industrial sickness can be classified as: (1) external
causes, and (2) internal causes.
External Causes
i) High costs of manufacture coupled with a low realisation of sales revenue.
High costs may be due to inflated prices of inputs. A low sales revenue may
be accounted for by lack of control over prices of output.
ii) Non-availability of raw materials, regularly and smoothly, or availability at
high prices.
iii) A lack of regular supply of inputs such as power and transport bottlenecks.
iv) A general recessionary trend in the economy affecting the overall
performance of industrial units. This will be reflected in a downward sloping
demand curve or lack of demand altogether, particularly for industries which
have a derived demand.
v) Fiscal imposts such as excise duties, import duties, etc. These more generally
undermine the profit margins.
Internal Causes
i) An improper demand estimation for the products to be sold. Normally, only
industry-wise demand estimations are made without ascertaining the
particular factors which account for a specific demand for a particular unit’s
production.
ii) An improper choice of technology, unsuitability of product mix, or single
product technology, wrong location of industry, non-flexibility of fixed assets,
mainly machinery, for possible use in the diversified manufacturing set-up.
iii) A defective capital structure specially on account of delayed constructions
and operations, resulting in cost overruns and larger borrowings. Moreover,
an inability to raise adequate financial resources to with-stand operational
losses and bear their impact, in the initial stages, due to a poor equity base,
will appear to be a severe constraint.
iv) A growing shortage of working capital, as the units go into operation, due to
a shortage of raw materials, and high prices, poor debtors’ collection,
inadequate inventory management, etc. are serious constraints.
v) Managerial ineffectiveness, poor control and absence of control on such
key areas of operations as finance, inventory and marketing.
Of all the factors mentioned above, it is the mismanagement1 that has been the
most important cause of sickness.
1
Until recently, under what Raj Krishna called the dharmshala model (a shelter for the pious
poor), government guaranteed capital against failure by taking over sick industries. 149
Sector Specific Issues and Government Policy
Policies
The Government in co-operation with the RBI have instituted arrangements for
monitoring sickness of industrial units so that corrective action is taken in time.
The legislative and institutional framework for dealing with industrial sickness
is contained in the Sick Industrial Companies Act, (SICA) 1985 that provided
for the setting up of the Board for Industrial and Financial Reconstruction (BIFR).
Rehabilitation
The rehabilitation programme involves the following major issues which have
to be sorted out after it is decided that a sick unit is viable and should be
rehabilitated: (a) Change of management, (b) Development of a suitable
management information system, (c) A settlement with the creditors for payment
of their dues in a phased manner, taking into account the expected cash generation
as per viability study, (d) Determination of the sources of additional funds needed
to refinance, (e) Modernisation of plant and equipment or expansion of an existing
programme or even diversification of the products being manufactured, (f)
Concession or reliefs or assistance to be allowed by the state level corporation,
financial institutions and Central Government.
14.5.2 Technological Obsolescence and Modernisation

Another related problem Indian industry is faced with is that of technological
obsolescence a large segment of industry. As a result, input intensity has increased,
productivity is low, costs high and quality poor. All this means losing out in the
world market and cutting into the rate of growth of income. Indian industry needs
modernisation, which is a multidimensional concept. It may cover replacement
of an obsolete machinery by a new machinery. A basic test of modernisation is
that it should lead to a substantial reduction in the unit cost of production
Causes of Slow Pace of Modernisation

The basic cause has been the paucity of finance resulting from the following
major handicaps:
1) Licensing Policy. Sometimes, modernisation of a unit may bring about
expansion of capacity. In the past restrictive industrial policy was followed,
whereby expansion and modernisation proposals, specially from the large
houses, were rejected because these led to capacity addition.
2) Price Controls. Price controls tend to depress the rate of return. This prevents
industry from retaining adequate profits which can be deployed to replace
machines in time. From experience, it is found that even when costs of
production rise sharply, the adjustment in prices follow invariably with a
time lag, resulting in substantial erosion of funds for replacement and
modernisation.
3) Depreciation Provisions. Depreciation provisions based on historical cost
of acquisition of machinery are inadequate to replace machinery in a period
of rising costs and prices. Industry is forced to borrow just to keep the
production capacity intact. Modernisation, consequently, is delayed.
4) High Rate of Corporate Taxation. This leaves industry with too little
earnings for modernisation. Although recently (2019) this has been brought
down to regionally competitive levels.
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The combined effect of the above factors has been the erosion of funds available Large Scale Industries in
for replacement or modernisation.
Suggested Measures
To put the modernisation programme through, certain policy modifications will
be required. These can be classified in two categories: (a) those required to meet
immediate needs, and (b) those over time.
Among the first is the need to make available more and cheaper funds through
the financial institutions. Viability of an enterprise has a be the primary and the
most important criterion for lending these funds. There should not be insistence
on any specific debt-equity ratio or promoter’s contribution. Similarly, investment
allowance and excise rebate on production could be granted.
For future needs, following steps can be suggested:
i) Units may be allowed to set aside a percentage of profits and depreciation
towards modernisation reserves. This presumes that units have adequate
profits.
ii) In computing the cost of production for fixing prices, modernisation
requirement must be taken into account.
iii) For purposes of taxation, units may be allowed to carry back losses against
profits of the previous three years.
iv) The import policy for capital goods may be modified. The possibility of
tying up modernisation with export production can also be considered.
v) Developments in technology are taking place across the globe. Government
and industry must work together to complete the programme within the
shortest possible time.
14.5.3 Productivity in Indian Industry

Productivity is a measure of performance of the production activity and refers to
the amount of output produced per unit of input. It is possible to express this in
the following equation:
Here, output stands for a weighted sum of various products, whereas input stands
for a weighted sum of various inputs. So defined, the concept of productivity
refers to the total factor productivity, rather than the partial measures of
productivity like labour productivity (i.e., output per unit of labour); and capital
productivity (i.e., output per unit of capital). The partial productivity indices are
dominantly influenced by the process of capital deepening (or increasing capital-
labour ratio) which is normally associated with the process of capital
accumulation. It is, therefore, necessary to go beyond the partial factor
productivities to analyse the total factor productivity growth (TFPG).
Importance of Productivity
For a country like India, with a multiplicity of socio-economic demands on its
capital, how the limited resources are utilised assumes importance. While
substantial improvements in production process can be a precondition for
economic transformation, it is only the productivity of investments undertaken
which yields further re-investible resources. These generate surpluses, which
then motivate entrepreneurs toward undertaking further industrial activity. 151
Sector Specific Issues and Secondly, productivity growth also comes in handy in an attempt to enhance the
Policies
competitiveness of a country’s exports. Productivity growth lowers labour costs
and thus, ceteris paribus, the international price of the good concerned.
Thirdly, TFP is now accepted as the main contributing factor of economic growth.
The central idea is that due to the law of diminishing returns, increased use of
inputs simply fails to yield increased output in the long run. Sustained output
growth requires not so much the dollops of capital as technological sophistication,
managerial innovativeness and shop floor acumen.
Fourthly, productivity growth can have a positive impact on poverty reduction

through two channels. One, an increase in productivity potentially raises wages
and incomes, and hence reduces poverty. Higher productivity-led wages and
incomes can have a second-round impact on domestic demand, and in turn, on
employment and in further gains in poverty reduction. Two, productivity gains
help to moderate the rate of increase in prices. Lower inflation is equivalent to
an increase in the purchasing power of current incomes. This indirect effect,
operating through lower inflation, can also have a mitigating effect on poverty
levels.
Liberalisation and Productivity

Productivity gains are the most immediate targets of the policy reforms that have
centred around liberalisation and deregulation. Liberalisation can contribute to
productivity gains in at least four different ways:
1) Liberalisation could result in reduction of X-inefficiency. This can happen
in two ways: (a) a ‘challenge-response’ mechanism induced by a more
competitive environment helps reduce the managerial slack; and (b) the
existence of excess capacity can deter entry.
2) Liberalisation makes better exploitation of scale economies. These economies
are possible through larger export markets.
3) Relaxation of import restrictions, or an increased ability to import due to
increased exports, could then lead to better productivity performance due to
the import of superior embodied technology and/or lower cost inputs.
4) Liberalisation makes possible faster rates of technological ‘Catch up’ in
expanding sectors of comparative advantages.
Total factor productivity in Indian manufacturing was 0.61 per cent per annum
during the period 1981-82 to 1990-91, dipped to 0.25 per cent per annum during
1991-92 to 1997-98, went down further to -0.09 per cent per year during 1998-
99 to 2001-02 and then expanded sharply to 1.41 per cent per year between
2002-03 and 2007-08. The growth of productivity in manufacturing, therefore,
follows a J-curve pattern, slowing down in the initial years after liberalisation,
but picking up steam later.
Why is the curve J-shaped? Total factor productivity growth was slow during the
early and mid-1990s because of the dramatic import liberalisation, the balance
of payments deterioration and the exchange rate reform, all of which came as a
shock to industry. Moreover, with the removal of import restrictions on consumer
goods, certain types of capital goods were rendered obsolescent, which led to
lower capacity utilisation in the late 1990s and early 2000s, and even lower
152
productivity. As firms learned to cope and the benefit of new technologies and Large Scale Industries in
products became widespread, productivity improved dramatically from the mid-
2000s.
Although other general measures on labour, land and infrastructure could improve
total factor productivity somewhat, sector-specific factors are required to be
analysed for taking necessary policy measures to take productivity growth in
manufacturing to a higher level.
14.6 APPROACH TO A NEW INDUSTRIAL POLICY

The Government had released in recent past a ‘Discussion Paper’ outlining the
basic contours of industrial policy suitable for rapid industrial growth. It presents
vision, strategic objectives, and intent of the policy. These objectives and
instruments to achieve the same are summarised below.
Clear Vision, Strategic Objectives and Intent

The policy aims to set a clear vision for the role of industry and industrial growth
in the growth and development of the economy. A shared vision to develop a
globally competitive Indian industry with skill and scale, which leverages
technology will be developed through engagement with stakeholders. Strategic
objectives have to be delineated with measurable outcomes. The policy has to
also ensure that it embeds into itself sectoral objectives and provides an
overarching umbrella policy framework. The timeframe for implementation of
the policy needs to be decided taking into consideration the changing economic
and business cycles of the world and the Indian economy, geopolitical trends
and broad policy directions of the country. To begin with, the following strategic
objectives are set forth for the policy, to enable commencement of work.
A) Establishing Global Linkages

1) India needs to strengthen global strategic linkages by– creating global brands
out of India, strengthening linkages between Indian and global inductivity
and intensifying FDI.
2) Brand building must gain importance alongside achieving quality and scale.
The quantum of value addition must be increased at all levels. Larger the
value addition, greater the positive externalities from economic activity.
3) FDI policy is largely aimed at attracting investment. Benefits of retaining
investments and accessing technology in industrial sector have not been
harnessed to the extent possible. FDI policy requires a review to ensure that
it facilitates greater technology transfer, leverages strategic linkages and
innovation
B) Enhancing Industrial Competitiveness
1) Competitiveness can be improved by reducing the cost of infrastructure
such as power logistics causing regulatory compliance burden reducing the
cost of capital and improving labour productivity.
2) Industrial infrastructure in India suffers from lack of funds and inefficiencies.
Infrastructure financing relies heavily on banks due to the lack of developed
debt and bond markets. Increased pressure on infrastructure from rapid
urbanisation exacerbates inefficiencies leading to high cost of logistics. 153
Sector Specific Issues and 3) Advances in technology are leading to emergence of new activities, major
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changes in existing systems and obsolescence at a rate faster than ever before.
The central role of technology in next generation business has to be
acknowledged and appropriated to ensure greater productivity and
competitiveness.
4) In an open world, domestic tax structure and duty rates are an important
factor in deciding the direction of flow of raw materials and final products.
High direct tax rates and a duty structure that favours import of final products
can act as disincentives for domestic manufacturers.
C) Employing Gainfully a Growing Workforce
India is now in the mid-point of the demographic dividend phenomenon which
is expected to continue for another 15- 20 years. Demographic dividend has
been a part of mainstream planning and policy making process in the last decades.
There are several related concerns to name a few include the following:
Some states would move out of the phenomenon earlier than others adding
yet another dimension to existing inequalities
Projected upward trends in automation and Artificial Intelligence (AI)
leading to job losses
Disproportionately slower growth in creation of jobs as compared to growth
in output – the phenomenon of ‘job-less’ or ‘ruth- less growth’.
Poor outcomes in education, skill and health leading to an inability to harness
the demographic dividend.
D) Ensuring Sustainability and Responsible Industrialisation
Industry is a major contributor to carbon emission and also has substantial resource
footprint. It is also irrefutable that energy is a significant contributor to industrial
growth as well as industrial emissions. Policies on utilisation of natural resources,
including energy sources have to be aligned to support industrial growth.
Sustainability has to be treated as integral to growth in all sectors and industry as
a whole. A balance between industrial growth and improvement in environment
and sustainability has to be achieved. Sectors that contribute to the latter should
be given equal or more attention given that they also contribute to the former
E) Enabling Ecosystem for Technology Adoption and Innovation
1) India has the potential to diversify its strengths in the field of information
technology. It is not just the largest software service provider, but can provide
products and solutions and also become the ‘Digital factory of the world’,
by becoming the vanguard of digital revolution. Despite foreign investments
being received in the country over the last three decades, transfer of
technology has largely remained at assembly level. Component
manufacturing design and R&D activities have to be strengthened.
2) Right models of technology transfer need to be adopted to ensure that the

transferred technology is enhanced and customised for Indian conditions.
The issue of academia– research institutions industry linkages needs to be
addressed. Across the board innovation should be promoted helping Indian
firms increase their R&D spends and file high-quality patents that can be
commercialised. Start-up ecosystem that plays a key role in this effort needs
154 to be encouraged.
To sum up, there is a need to formulate an outcome-oriented actionable industrial Large Scale Industries in
policy that provides direction and charts a course of action for a globally
competitive Indian industry which leverages skill scale and technology.
Consultations will be held with industry bodies, industry captains, central
government departments, state governments, think tanks, academia, and R&D
institutes to understand perspectives of all stakeholders.

1) What was the critical issues facing the Indian industrial sector?
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
2) What are the strategic objectives set forth for the new Indian industrial policy?
.......................................................................................................................
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.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
14.7 LET US SUM UP

Industrialisation is the process by which an economy moves from primarily
agrarian production to mass-produced and technologically advanced goods and
services. This phase brings with itself an era of higher productivity, shifts from
rural to urban labour, and increased standards of living. In India, post-
independence, the national consensus was in favour of the rapid industrialisation
of the economy as the key to economic growth and development. The Industrial
Policy Resolution of 1948 marked the beginning of the evolution of the Indian
Industrial Policy. The Resolution emphasised the importance to the economy of
securing a continuous increase in production and its equitable distribution, and
pointed out that the State must play a progressively active role in the development
of Industries. In the subsequent years, India’s Industrial Policy developed through
successive Industrial Policy Resolutions and Industrial Policy Statements. The
key role in industrial development programme was in the public sector. The aim
was to make the economy self-sustaining in producers’ goods industries such as
steel, machine building, etc., so that the quantum of external assistance needed
could be curtailed to a very low level. Later in the mid-eighties, the trend towards
liberalisation became more pronounced. Industrial policies took a shift from
predominantly Socialistic pattern in 1956 to Capitalistic since 1991. Industrial
policy 1991 onwards dealt with liberalising licensing and measures to encourage
foreign investments. However, the major challenges that have restricted industrial
growth inter-alia include– inadequate infrastructure, restrictive labour laws,
complicated business environment, slow technology adoption, low productivity,
155
Sector Specific Issues and etc. This calls for adopting a comprehensive, actionable, outcome oriented
Policies
industrial policy which will enable Industry to deliver a larger role in the economy;
to fulfil its role as the engine of growth and to shoulder the responsibility of
adding more value and jobs.

1) Outline the factors that justifies the basic premise of the Industrial Policy
Resolution 1956.
2) What do you mean by ‘industrial sickness’? How is it treated in India?
3) How does improved technology contribute to industrial development in an
economy?
14.9 KEY WORDS

Capital Goods : Capital goods are fixed assets such as machinery,
equipment, buildings, vehicles , computers, etc.
which are used in the productive process in order
to produce a finished ‘consumer’ good.
Creative Destruction : Creative destruction refers to the incessant product
and process innovation mechanism by which new
production units replace outdated ones.
Heavy Industries : Industry that manufactures large pieces of
equipment or machinery, or that uses large pieces
of equipment or machinery to manufacture
products.
Industrialisation : Industrialisation is the process by which an
economy is transformed from a primarily
agricultural one to one based on the manufacturing
of goods.
Industrial Sickness : Industrial sickness usually refers to a situation
when an industrial firm performs poorly, incurs
losses for several years and often defaults in its
debt repayment obligations.
Liberalisation : It is the lessening of government regulations and
restrictions in an economy in exchange for greater
participation by private entities.
14.10 REFERENCES
1) I.C. Dhingra, (2021) The Indian Economy, Environment and Policy, Sultan
Chand & Sons, New Delhi.
2) Vijay Kelkar and Ajay Shah, (2019) In Service of the Republic, Penguin
India.
3) Industrial Policy – 2017, A Discussion Paper. Department of Industrial Policy

and Promotion, Ministry of Commerce and Industry.
156
4) Chapter 3: Industrial Policy and Indian Economy. Retrieved from http:// Large Scale Industries in
lib.unipune.ac.in:8080/xmlui/bitstream/handle/123456789/3051/
11_chapter%203.pdf?sequence=11&isAllowed=y

PROGRESS EXERCISES
1) See Section 14.2 and answer.

2) See Sub-section 14.4.1 and answer.

157
Policies UNIT 15 MICRO, SMALL AND MEDIUM
ENTERPRISES (MSMEs): ISSUES
AND POLICY
Structure
15.0 Objectives
15.1 Introduction
15.2 What are Micro, Small and Medium Enterprises (MSMEs)?
15.3 Significance of MSMEs in the Indian Economy
15.3.1 Contribution of MSMEs in the Gross Domestic Product (GDP)
15.3.2 Employment in the MSME Sector
15.3.3 Comparison of MSME Export to Total Exports
15.4 Comparison of the MSME Sector with the Overall Industrial Sector
15.5 Issues and Challenges Faced by the MSME Sector
15.5.1 Impact of Demonetisation and GST on the MSME Sector
15.5.2 Impact of the COVID-19 Pandemic on the MSME Sector
15.6 Policy Initiatives by the Government
15.6.1 Legislation and Institutional Support System
15.6.2 Formalisation of MSMEs
15.7 Let Us Sum Up
15.8 Key Words
15.9 References
15.0 OBJECTIVES
After reading and studying this unit, you will be able to:
define Micro Small and Medium Enterprises (MSMEs);
discuss the significance of MSMEs in the Indian Economy;
evaluate the performance of the Indian MSME sector in terms of contribution
to GDP and employment share;
compare the performance of the MSME sector with that of the overall
industrial sector;
identify the issues and challenges faced by this sector; and
outline the policy framework for the MSME sector.
15.1 INTRODUCTION
Micro, Small and Medium Enterprise (MSME) sector has emerged as a significant
sector of the Indian economy, contributing remarkably to employment generation,
entrepreneurship, innovation, exports, and inclusive growth of the economy.
158
Likewise, the sector has been regarded as the engine of growth worldwide, in Micro, Small and Medium
Enterprises (MSMEs): Issues
both, the developing as well as the developed countries. and Policy
As per the WTO, Micro, small and medium-sized enterprises (MSMEs) are the
backbone of many economies, representing 95 per cent of all companies
worldwide and accounting for 60 per cent of employment. Many MSMEs depend
on international trade for their activities, either because they export their products
through direct or indirect channels, or because they import inputs to manufacture
the products that they sell domestically. They are major employers of women
and young people, and a key driver of innovation. Nevertheless, the sector is not
able to contribute to its potential due to some issues faced by MSMEs.
These issues can be classified as being external and internal. External issues are
caused due to macro environmental factors– economic and political– that are
beyond the control of the enterprises, for example regulatory barriers, access to
finance, corruption, competition, lack of skilled labour, changing global economic
scenario, etc. Internal issues are related to factors that are within the enterprise
domain, for example, lack of managerial competence and appropriate technology,
ineffective marketing and distribution techniques, etc. In response to these issues,
from time to time, government has been coming up with various policies to assist
the MSME sector in various ways including, enterprise and skill development,
technological up gradation, access to finance, cluster development, marketing
assistance, etc.
However, several issues continue to persist, more in some areas than others. It is
imperative to realise the importance of MSMEs, recognise the factors hindering
their growth and address through appropriate policies. This unit seeks to do just
that. It begins with defining the MSME sector, which is followed by a discussion
on the significance of the MSME sector in the Indian Economy. Subsequent
sections will involve evaluating the performance of the Indian MSME sector in
terms of its contribution to GDP and employment and comparing the performance
of the MSME sector with that of the overall industrial sector. The unit also carries
a section identifying the issues and challenges faced by the MSME sector,
followed by a section outlining the policy framework for the sector.
15.2 WHAT ARE MICRO, SMALL AND MEDIUM

ENTERPRISES (MSMEs)?
The term ‘MSME’ is normally used to describe small industrial or business units
in private sector. Considering the global trend of classifying the MSME sector,
the definition differs widely across jurisdictions and depends upon the government
policies of the country. As per International Finance Corporation (2014) report,
among the 267 definitions used by different institutions in 155 economies, the
most widely used variable for defining an MSME is the number of employees.
Other variables commonly found in MSME definitions are turnover as well as
value of assets, with few other variables being the loan size, formality, years of
experience, type of technology, size of the manufacturing space, and initial
investment amount, among others. The definition according to the World Bank
is that a business is classified as MSMEs when it meets two of the three criteria
– employee strength, size of assets or annual sales (refer Table 15.1).
159
Sector Specific Issues and Table 15.1:Definition of the MSME sector as per the World Bank
Policies
Medium <300 <USD 15 Million <USD 15 Million
<INR 750 Million <INR 750 Million
Small <50 <USD 3 Million <USD 3 Million
<INR 150 Million <INR 150 Million
Macro <10 <USD 10, 000 <USD 10,000
<INR 500, 000 <INR 500,000
However, in India, MSMEs are presently defined based on investment in plant

and machinery/equipment. The enactment of Micro, Small & Medium Enterprises
Development (MSMED) Act, in 2006 by the Government of India (GOI) gave a
legal basis and framework to the micro, small and medium enterprises by defining
and classifying these enterprises on a uniform basis. This classification covers
industries both under manufacturing and service sector and the said limits (refer
Table 15.2) are excluding the cost of land, building and other specified items.
Table 15.2: Defining MSME for Manufacturing and Service sector
Manufacturing Sector
Enterprise Category Investment in Plant & Machinery
Micro Enterprises Does not exceed twenty five lakh rupees
Small Enterprises More than twenty five lakh rupees but does not exceed
five crore rupees
Medium Enterprises More than five crore rupees but does not exceed ten crore
rupees
Service Sector
Enterprise Category Investment in Equipment
Micro Enterprises Does not exceed ten lakh rupees
Small Enterprises More than ten lakh rupees but does not exceed two crore
rupees
Medium Enterprises More than two crore rupees but does not exceed five crore
rupees
Thus, an enterprise, engaged in the manufacture or production of goods pertaining

to any industry specified in the first schedule to the Industries (Development and
Regulation) Act,1951, is defined as– (i) a micro enterprise, where the investment
in plant and machinery does not exceed twenty– five lakh rupees;(ii) a small
enterprise, where the investment in plant and machinery is more than twenty-
five lakh rupees but does not exceed five crore rupees; or(iii) a medium enterprise,
where the investment in plant and machinery is more than five crore rupees but
does not exceed ten crore rupees. Similarly, an enterprise engaged in providing
or rendering of services is defined as– (i) a micro enterprise, where the investment
in equipment does not exceed ten lakh rupees;(ii) a small enterprise, where the
investment in equipment is more than ten lakh rupees but does not exceed two
crore rupees; or (iii) a medium enterprise, where the investment in equipment is
more than two crore rupees but does not exceed five crore rupees.
The definition based on investment in plant and machinery/equipment is often

criticised for not reflecting the current increase in price index of plant and
160
machinery/equipment. Furthermore, MSMEs due to their informal and small Micro, Small and Medium
scale of operations often do not maintain proper books of accounts and hence and Policy
find it difficult to get classified as MSMEs as per the current definition. In response
to this and to facilitate ease of doing business, the Government has proposed
turnover-based definition by replacing the current investment-based definition
of MSMEs. The proposed definition is found to be rational, transparent,
progressive and easier to implement with the introduction and operationalisation
of Goods and Services Tax(GST).
Proposed Definition
Government of India has proposed to classify MSMEs based on turnover as
mentioned below:
i) A micro enterprise will be defined as a unit where the annual turnover does
not exceed five crore rupees;
ii) A small enterprise will be defined as a unit where the annual turnover is
more than five crore rupees but does not exceed seventy-five crore rupees;
iii) A medium enterprise will be defined as a unit where the annual turnover is
more than seventy-five crore rupees but does not exceed two hundred and
fifty crore rupees.

1) What are Micro, Small and Medium Enterprises (MSMEs)? Also state the
criticism involved in defining these enterprises on the basis of investment
in Plant and machinery/equipment.
.......................................................................................................................
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.......................................................................................................................
.......................................................................................................................
2) Briefly explain how MSME (Manufacturing) are different from MSME
(Services)?
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.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
15.3 SIGNIFICANCE OF MSMES IN THE INDIAN

ECONOMY
India is currently among the fast growing economies of the world. The MSME
sector in the country occupies the second position next only to agriculture in
terms of employment generation. It has been contributing significantly to the
161
Sector Specific Issues and expansion of entrepreneurial base through business innovations. The sector
Policies
consistently feeds the domestic and the international value chains as
manufacturers, suppliers, distributors, retailers, contractors and service provider
by accounting for a substantial segment of the economy’s industrial and service
units. Besides this, MSMEs are widening their domain across sectors of the
economy, producing diverse range of products and services to meet demands of
domestic as well as global markets.
15.3.1 Contribution of MSMEs in the Country’s Economy

As per the Central Statistics Office (CSO), Ministry of Statistics and Programme
Implementation, the contribution of MSME Sector in country’s Gross Value Added
(GVA) and Gross Domestic Product (GDP), at current prices for a 5-year period
is as below (Table 15.3):
Table 15.3: Contribution of MSMEs in the Indian Economy (at Current prices)
(Figures in Rs. Crores adjusted for FISIM1 at current prices)

Year MSME Growth Total Share of Total Share of
GVA (%) GVA MSME in in MSME
GVA (%) GDP GDP (in %)
2011-12 2622574 - 8106946 32.35 8736329 30.00
2012-13 3020528 15.17 9202692 32.82 9944013 30.40
2013-14 3389922 12.23 10363153 32.71 11233522 30.20
2014-15 3704956 9.29 11504279 32.21 12467959 39.70
2015-16 4025595 8.65 12566646 32.03 13764037 29.20
2016-17 4405753 9.44 13841591 31.83 15253714 28.90
Source: Central Statistics Office (CSO), Ministry of Statistics and Programme Implementation
The MSME sector accounts for about 95 per cent of the industrial units, 45 per
cent of manufacturing output, and 40 per cent of total exports of the country. The
sector has shown impressive growth in terms of parameters like number of units,
production, employment, exports in the economy. The sector has been performing
appreciably better than the overall rate of GDP(average 8 per cent growth per
annum) and the overall industrial output (measured by Index of Industrial
Production-IIP). As per a press release by Press Information Bureau of a
“Roadmap for Growth of MSMEs” in August 2019, currently MSME contributes
29 per cent to the country’s GDP and the government intends to take this to 50
per cent in the next 5 years. The sector gives employment to about 11 crore
people currently, which the Ministry of MSME intends to take to 15 crore in the
next 5 years. To achieve this, the Ministry has underlined the need to create new
channels for funding, making the sector investor-friendly, bringing in
technological innovations, and reducing logistics cost to make MSME products
competitive, providing adequate skilling and market support. There is scope for
diversification in the MSME sector. Honey production, bamboo, bio-fuel
production, fisheries, dairy, Agarbatti making, hydroponics, water transport like
Ro-Ro, Ro-Pax, e-transport, mechanised fishing trawlers etc. are some of the
new areas for ventures. Also, since MSMEs are less capital intensive, more
employment-friendly, have easier access to raw materials, subsidies and other
incentives under cluster programmes, there is huge potential for the sector to
162 Financial Intermediation Services Indirectly Measured
1
grow as ancillary industries to unleash greater industrial growth. Development Micro, Small and Medium
of the sector is therefore extremely important as it holds the key to inclusive and Policy
growth and plays a pivotal role in holistic development of the country.
As per the MSME Annual report 2019-20, the state of Uttar Pradesh had the
largest estimated number of MSMEs with a share of 14.20 per cent of MSMEs in
the country. West Bengal comes a close second with a share of 14 per cent The
top ten States together accounted for a share of 74 per cent of the total estimated
number of MSMEs in the country.
The MSME sector has the potential to emerge as the backbone of Indian economy
and to continue as an engine of growth provided policy environment– that
addresses issues in the areas like entrepreneurial skill development, financial
resources, human resources, technology and innovations, international market
linkages and bilateral trade agreements, and infrastructural support..
15.3.2 Employment in the MSME Sector

MSME sector in India creates largest employment opportunities, both in terms
of self-employment and wage-employment, for the Indian labour force, next only
to agriculture. MSMEs are thought to have lower capital-output and capital-
labour ratios than large-scale industries, and therefore, better serve growth and
employment objectives. The sector in India has grown significantly since 1960 –
with an average annual growth rate of 4.4 per cent in the number of units and
4.62 per cent in employment (currently employing 110 million). Not only do
MSMEs generate the highest employment per capita investment, they also go a
long way in checking rural-urban migration by providing people living in isolated
areas with a sustainable source of employment. Apart from this, MSMEs also
help in industrialisation of rural and backward areas, thereby, reducing regional
imbalances, assuring more equitable distribution of national income and wealth.
As per the National Sample Survey (NSS) 73rd round conducted during the period
2015-16, MSME sector has been creating 111 million jobs in the rural and the
urban areas across the country. Micro sector enterprises provided employment
to 107.7 million persons that in turn accounts for around 97 per cent of total
employment in the sector. For the Small and the Medium sectors, the employment
shares were around 2.88 per cent and 0.16 per cent, respectively. As far as the
employment in the MSME sector based on broad activity category-wise is
concerned, the respective sharesare given in the following Table 15.4:
Table 15.4: Estimated Employment in MSME sector
(Broad Activity Category Wise)
Broad Activity Employment (in Lakh) Share (%)
Category Rural Urban Total
Manufacturing 186.56 173.86 360.41 32
Trade 160.64 226.54 387.18 35
Other Services 150.53 211.69 362.22 33
Electricity* 0.06 0.02 0.07 0
All 497.78 612.10 1109.89 100
Source: National Sample Survey (NSS) 73rd round 2015-16

163
Policies
15.3.3 Comparison of MSME Export to Total Exports
The MSME sector in India is contributing more than 40 per cent to exports. The
share of MSME exports has increased from 43 per cent in 2012-13 to 49 per cent
in 2017-18. Further, the trend growth of MSME exports is in line with the total
exports of the country. (Refer Table 15.5)
Table 15.5: Share of MSME Exports in Total Exports (in US $)
Year Total Exports Exports by MSME Share of MSME
Exports *(%)
2012-13 300400 127992 43
2013-14 314415 133313 42
2014-15 310352 138896 45
2015-16 262291 130768 50
2016-17 275852 137068 50
2017-18 303376 147390 49
Source: Central Statistics Office (CSO), Ministry of Statistics and programme Implementation
As can be seen from Figure 15.1, MSME exports grew by 4.19 per cent in 2014-
15, which declined to –5.85 per cent in 2015-16. During the same period total
exports also declined from –1.29 per cent to –15.49 per cent. During 2016-17
and 2017-18 there was positive growth in case of both MSME exports and total
exports.
Fig. 15.1: Growth of Exports by MSME in Total Exports
Source: RBI & Press Information Bureau/Directorate General of Commercial Intelligence

and Statistics. (DGCIS)
15.4 COMPARISON OF THE MSME SECTOR WITH

THE OVERALL INDUSTRIAL SECTOR
MSMEs provide employment opportunities at comparatively lower capital cost
and act as ancillary units for large enterprises. Figure 15.2 depicts the growth
rate of MSME sector in comparison with the overall industrial sector during last
164 sixteen years.
Micro, Small and Medium
and Policy
Fig. 15.2: Comparison of MSME sector vis-à-vis Overall Industry

Source: Annual Reports of Ministry of MSME
The MSME sector has in many years registered a higher growth rate than the
overall growth of industrial sector. During, the period 2000 to 2006, India
witnessed industrial growth in the range of 5-8 per cent annually. Subsequently,
it recorded double digit growth for 4-5 years, before slowing down to around 6
per cent growth during 2015-2016. The MSME sector improved its growth
performance during 2003 –2009 and recorded a growth of over 10 per cent during
2008-09. Introduction of MSMED Act, 2006 apparently played a role here.
However, post 2008 global financial crisis, MSME growth fell sharply and
hovered around 4-7 per cent.

1) Discuss the contribution of the MSME sector to the India economy.
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
2) MSME sector has been performing better than the overall industrial sector.
Do you agree? Give the possible reasons for your agreement or disagreement
with the statement.
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
3) Briefly discuss the reasons behind the MSME sector becoming the largest
employer next only to the agriculture in the Indian economy.
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
165
Policies 15.5 ISSUES AND CHALLENGES FACED BY THE
MSME SECTOR
Despite the pivotal role and strategic importance in the context of industrial
development and economic growth of the country, the MSME sector experiences
several constraints and challenges. The Committee on financial architecture of
MSME sector in their Report submitted in the February, 2015 has identified
some key issues. These include; i) Equity as a source of financing is underutilised
and the prevalence of investment by venture capital and angel investors is low,
ii) MSMEs face the problem of delayed payments from their buyers which
adversely impacts their working capital as well as their next cycle of production,
iii) MSMEs lack adequate information about various schemes and benefits
available by the government, iv) Financial institutions/Banks face challenges in
credit risk assessment of MSMEs, v) The utilisation of the available credit
guarantee and insurance schemes by banks has been low. In general, the sector is
inflicted by some of the major challenges including:
i) Lack of Adequate Capital and Credit

This is one of the greatest challenges which constrains the growth of MSMEs
in our country. Easy and timely access to credit is crucial factor for
development and growth of enterprises. The Report of the Working Group
on Rehabilitation of sick MSMEs by the RBI has identified this situation as
a crucial reason for industrial sickness of this sector. This is further worsened
by the complex collaterals instead by the banks, cumbersome sanction
procedures and delay in disbursement and high rate of interest on term loans.
ii) Poor and Inadequate Infrastructural Facilities

Lack of adequate infrastructure facilities and poor support facilities marked
by inadequate access to basic facilities like water, power supply, road/rail
connectivity, etc. adversely affect this sector and contribute to enhance their
operational costs. This renders the MSMEs less competitive in a challenging
market situations.
iii) Inadequate Access and Marketing Linkages

Weak marketing linkages characterised by inadequate Government support
and patronage, lack of adequate marketing infrastructure/ network facilities
continue to be a greater challenge for marketing and sale of MSME products.
iv) Lack of Skilled Human Resources

Unavailability of the skilled workforce and descent managerial/entrepreneurial
expertise at affordable cost in the proximity of the enterprises is another
such big challenge for the MSMEs in our country.
v) Lack of Access to New Technology

Continuance of low technology base in the MSME sector results in low
productivity by making these enterprises uncompetitive in the ever-widening
industry with most of the industries today requiring application of advanced
technology in their operations.
166
vi) Dilatory and Cumbersome Regulatory Practices Micro, Small and Medium
The MSME sector suffers from the cumbersome and dilatory regulatory and Policy
practices relating to sanction and disbursement of loans from banks, collateral
securities/guarantees, for construction permits, resolving insolvency and
taxation, etc. Absence of a common regulatory body and inadequate
provisions for start-ups affect the growth of such enterprises. Non-adherence
to RBI guidelines regarding revival/rehabilitation of seek enterprises by the
Banks is another such constraint that needs to be addressed.
This calls for the need for strategic intervention to improve coordination
and linkages between various stakeholders including the Government,
industries and other agencies/associations working in this field.
15.5.1 Impact of Demonetisation and GST on the MSME Sector

Micro, small and medium enterprises (MSMEs) in India and abroad have
demonstrated considerable strength and resilience in maintaining a consistent
rate of growth and employment generation during the global recession and
economics lowdown. However, at times, the sector faces operational problems
due to its size and nature of business, and is, therefore, relatively more vulnerable
in the face of shocks to the economy. MSMEs largely operate in the informal
sector and comprise a large number of micro enterprises and daily wage earners.
As a result, the sector could not escape the consequences of two major shocks,
viz., demonetisation and introduction of goods and services tax (GST). For
instance, as per on RBI report (2017), contractual labour in both the wearing
apparel and gems and jewellery sectors reportedly suffered as payments from
employers became constrained after demonetisation. Similarly, the introduction
of GST led to increase in compliance costs and other operating costs for MSMEs
as most of them were brought into the tax net.
The structural reforms might have disrupted the performance of MSMEs in the
short run. Nevertheless, Demonetisation and GST are expected to be positive in
the long run with growth in digitisation, enhanced ease of doing business and
creation of database of transactions which would facilitate better access to finance
and improve the medium- and long-term growth prospects of the sector.
15.5.2 Impact of the Covid-19 Pandemic on the MSME Sector

COVID-19 pandemic brought in country-wide lockdown and impacted the MSME
sector severely mainly due to liquidity crunch. Extended lockdown had negative
impact on supply of finished goods, procurement of raw material, cash flow and
availability of employees to work in production and supply processes. During
April to June 2020, sector faced challenges related to debt repayments, wages/
salaries, statutory dues, etc. As per some survey reports, disruptions caused by
the Covid-19 pandemic have impacted MSMEs earnings by 20-50 per cent.
Furthermore, the sudden collapse of trade during the lockdown time affected the
MSME sector. India’s top exports including labour intensive products starting
from gems and jewellery to garments/apparel or sea food are mainly supplied by
MSME sector. Similarly, the lockdown affected the imports of raw materials and
intermediates which disrupted the supply chain of MSME sector. MSMEs
presence in remote areas also faced lots of difficulties due to interrupted supply
167
Sector Specific Issues and chain systems and intrastate lockdown provisions. However, enterprises working
Policies
in essential commodity business were better off in terms of interrupted but
predictable cash flows. Some enterprises innovated their ways by shifting focus
from non-essential commodities towards essential commodities; like production
of hand sanitizer and toiletries, PPE kits, reusable masks, etc. and were able to
survive in tough times. The pandemic time has also enhanced digitisation of the
MSME sector, with most businesses going digital by either starting a website or
expanding their offering on to e-commerce.

1) Discuss the issues and the challenges faced by the MSME sector in India.
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
2) Briefly discuss the impact of policy shocks on the Indian MSME sector and
how do you see the sector coping in the medium term?
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
3) MSMEs suffered during the lockdown period resulting from the COVID-19
pandemic. Does this hold true for all the MSMEs equally?
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
15.6 POLICY INITIATIVES BY THE GOVERNMENT

15.6.1 Legislation and Institutional Support System
Government and regulators through various legislations and directives have
attempted to create a conducive environment for the development of MSME
sector. One of the major steps in this direction was enactment of the MSMED
Act, 2006. The Act facilitates MSMEs in terms of public procurement, delayed
payment, marketing support, issues that have been constraining the sector. It
also empowers Central and State Government to establish institutions for
promotion of MSMEs.
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The MSMED Act has the following key provisions: Micro, Small and Medium
Establishment of a National Board for Micro, Small and Medium Enterprises and Policy
headed by the Minister for MSME. The role of the Board is to examine the
factors affecting the promotion and development of MSMEs, review the
policies and programmes of the Central Government and make
recommendations to facilitate their promotion and development and enhance
their competitiveness.
It provides the legal framework for recognition of the concept of “enterprise”
which comprises both manufacturing and service entities. It defines medium
enterprises for the first time and seeks to integrate the three tiers of these
enterprises, namely, Micro, Small and Medium.
It empowers the Central Government to undertake programmes and issue
guidelines and instructions to develop and enhance the competitiveness of
MSMEs.
On 9 May 2007, the erstwhile Ministry of Small Scale Industries and the Ministry
of Agro and Rural Industries were merged to form the Ministry of Micro, Small
and Medium Enterprises (M/o MSME). This Ministry is responsible for designing
policies, promoting/ facilitating programmes/ projects/schemes and monitoring
their implementation, with a view to assist MSMEs and helping them to scale
up. The Ministry runs various schemes aimed at financial assistance, technology
assistance and up-gradation, infrastructure development, skill development and
training, enhancing competitiveness and market assistance of MSMEs.
A number of statutory and non-statutory bodies work under the aegis of the
Ministry of MSME. These include the Khadi and Village Industries Commission
(KVIC) and the Coir Board besides National Small Industries Corporation (NSIC),
National Institute for Micro, Small and Medium Enterprises (NIMSME) and
Mahatma Gandhi Institute for Rural Industrialisation (MGIRI). The M/o MSME
envisions a progressive MSME sector by promoting growth and development of
the sector, including Khadi, Village and Coir Industries, in cooperation with
concerned Ministries/Departments, State Governments and other Stakeholders,
through providing support to existing enterprises, adopting cutting-edge
technologies and encouraging creation of new enterprises.
The primary responsibility of promotion and development of MSMEs is of the

State Governments. However, the Government of India, supplements efforts of
the State Governments through various initiatives. The role of the Ministry of
MSME and its organisations is to assist the States in their efforts to encourage
entrepreneurship, employment and livelihood opportunities and enhance the
competitiveness of MSMEs in the changed economic scenario.
Some of the major policy initiatives introduced by the Government of India for
support and promotion of micro, small and medium enterprises in the country
include; establishment of Small Industries Development Bank of India (SIDBI)
in 1990 for promotion and financing of the MSME sector, Credit Guarantee
Fund Trust of Micro and Small Enterprises (CGTMSE) was launched in 2000 to
offer credit facilities to eligible borrowers and the Prime Minister’s Employment
Generation Programme (PMEGP) in 2008 to generate employment opportunities
in rural and urban areas through new self-employment ventures / projects / micro
enterprises.
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Policies
15.6.2 Formalisation of MSMEs
As per 73rd round of National Sample Survey (NSS), there are 63.39 million
MSMEs in the country. However, a large number of MSMEs exist in the informal
sector and are not registered with any statutory authority. Reasons for lack of
registration are many and varied. For nano/household type of enterprises, not
obtaining registration is an escape from official machinery, paperwork, costs
and rent seeking. For them, it is perhaps “the art of not being governed”.
Registration offers them little by way of tangible benefits. There are other MSMEs
who, upon reaching a minimum size seek legitimacy and acknowledgement of
their existence to seek benefits or credit for instance, but they too struggle.
Lack of formalisation impacts the sector in terms of development and in availing

credit from financial institutions like banks and in terms of policymaking as well
as development interventions. Registration provides information on nature of
business, location, segmentation, etc. In the absence of a robust system of
registration for capturing information on operational units, new and existing units,
reliance has to be placed on surrogate data or on national census/ surveys, which
are infrequent.
Although the registration of MSMEs engaged in services activities is discretionary,

nevertheless, over a period of time, registration has been an intrinsic part of the
development of MSMEs itself. Having a registration certificate entitles an MSME
for numerous benefits. Particularly after the MSMED Act, 2006, which came
into effect from October 2, 2006, availability of registration certificate has
assumed greater importance. Some of the direct incentives provided by the
Government are:
Collateral Free loans from banks
Ease of getting Licenses, approvals and registrations
Reservation policies to manufacturing / production sector
Special consideration on international trade fairs
Octroi benefits
Waiver of Stamp Duty and Registration Fees
Exemption under Direct Tax Laws
Bar Code registration subsidy
Subsidy on National Small Industries Corporation Limited (NSIC)
Performance and
Credit ratings
Eligibility for Industrial Promotion Subsidy (IPS) subsidy
Counter Guarantee from Government of India through Guaranteed by Credit
Guarantee Fund Trust for Small Industries (CGSTI)
Protection against delay in payment
Reduction in rate of Interest from banks
15% Credit Linked Capital Subsidy Scheme (CLCSS) subsidy to purchase
fully
Waiver in Security Deposit in Government
170
Concession in electricity bills Micro, Small and Medium
Reimbursement of International Organisation for Standardisation (ISO) and Policy
Certification
Excise Exemption Scheme
Preference in procuring from Government
P15% weightage in price Preference
1% exemption on interest rate on Overdraft(OD)
50% subsidy for patent registration.
Source: Ministry of MSME
The registration process of MSMEs was radically simplified with the introduction
of Udyog Aadhaar, with effect from September 18, 2015. It is an Aadhaar based
electronic platform and requires a few basic entries including PAN details.
Registration certificate is also issued electronically. In terms of coverage, 68.89
lakh MSMEs (as on June 12, 2019) have registered through this system. Udyog
Aadhaar has facilitated registration of MSMEs in a user-friendly way. While
Udyog Aadhaar offers a simple mode of registration, it is usually not enough.
Often, more is needed e.g., Shops and Establishments, PAN, GST, etc.
The Government and RBI have taken several initiatives and measures to address
the issues faced by MSMEs. However, the sector remains informal and vulnerable
to structural and cyclical shocks, at times with persistent outcomes. Further, an
increasingly globalised world, marked by competition and innovation is posing
newer and varied challenges to the MSMEs. The increasing stress in the sector is
a matter of concern and therefore, it was felt imperative that a comprehensive
review should be undertaken of the entire MSME ecosystem along with global
best practices for suggesting measures for a holistic development of the sector.
For this, an all-inclusive approach is necessary to be adopted with special focus
on appropriate policy and institutional interventions, accelerating incubation and
enabling formalisation.

1) What are the policy initiatives or measures taken by the government to
provide an enabling environment to the MSME sector?
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2) ‘The policy framework to help the MSME sector grow and develop has not
been adequate enough’. Comment on the statement with suitable examples.
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171
Sector Specific Issues and 3) What is the need for formalisation the MSME sector? Do you agree with the
Policies
view that formalisation of the MSME sector will be equally advantageous
for the MSMEs as it will be for the Government? Justify adequately.
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4) What are the incentives provided by the Government of India to incentivise
MSMEs to come under the purview of organised sector?
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15.7 LET US SUM UP

The Micro, Small and Medium Enterprises (MSMEs) sector constitute the
backbone of the Indian economy. There are several ways of defining the term
MSME. The definition varies country-wise depending upon variables like
turnover, value of assets, loan size, formality, years of experience, type of
technology, size of the manufacturing space, and initial investment amount, among
others. In India, MSMEs are presently defined based on investment in plant and
machinery/equipment. However, a definition based on the turnover is being
proposed by the Government. This sector contributes significantly in the economic
and social development of the country by fostering entrepreneurship and
generating large employment opportunities at comparatively lower capital cost,
next only to agriculture. Complementary to large industries as ancillary units,
MSMEs contributes significantly in the inclusive industrial development of the
country.
Besides this, the sector has been registering a higher growth rate than the overall
growth of industrial sector in most of the years. Despite the significant
contributions of the MSME sector, the sector continues to face certain constraints
including financial/credit crunch, non-availability of suitable technology,
ineffective marketing strategy, non-availability of skilled labour, etc. Over the
years, the government has been taking initiatives to create an enabling ecosystem
where these enterprises are able to access the benefits meant for themselves
under a formal and friendly ecosystem and are further capable of meeting the
emerging challenges of a globally competitive order. A few among them are:
enactment of the MSMED Act, 2006, creating the Ministry of MSME, providing
incentives to formalise the MSME sector, etc.
Nevertheless, considering the extent to which the prevalent issues impact the
MSME sector, it is essential that an all-inclusive approach is adopted with special
172
focus on appropriate policy and institutional interventions, accelerating incubation Micro, Small and Medium
and enabling formalisation, addressing infrastructural bottlenecks, facilitating and Policy
capacity building, enabling access to risk capital, credit and technological
interventions for improving underwriting standards and delivery, supporting
market linkage and tie-up with public procurement platforms, etc.
15.8 KEY WORDS

COVID-19 : Coronavirus disease 2019 is a mild to severe
respiratory illness that is caused by
a Coronavirus.
Demonetisation : The act of stripping a currency unit of its status
as legal tender.
Formalisation : The act of making formal aiming at bringing
more of the unorganised sector into the formal
fold.
Gross Domestic Product : A monetary measure of the market value of all
(GDP) the final goods and services produced in a country
during a specific time period.
Gross Value Added (GVA): A measure of the value of goods and services
produced in an area, industry or sector of an
economy.
Goods and Services Tax : An indirect tax (or consumption tax) used in India
(GST) on the supply of goods and services. It is a
comprehensive, multi-stage, destination-based
tax that is levied on every value addition made
along the supply chain.
Informal Sector : According to National Commission for
Enterprises in the Unorganised Sector (NCEUS)
informal sector consists of all unincorporated
private enterprises owned by individuals or
households engaged in the sale and production
of goods and services operated on a proprietary
or partnership basis and with less than ten total
workers.
Lockdown : A lockdown is a restriction policy for people or
community to stay where they are, usually due
to specific risks to themselves or to others if they
can move and interact freely.
Rehabilitation : The action of restoring something that has been
damaged to its former condition.
Service Sector : The service sector is the third of the three
economic sectors of the three-sector theory. The
others are the secondary sector, and the primary
sector. The service sector consists of the
production of services instead of end products.
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Policies 15.9 REFERENCES
1) The World Trade Organisation. (September, 2020).Helping MSMEs Navigate
the Covid-19 Crisis. Available at https://www.wto.org/english/tratop_e/
covid19_e/msmes_report_e.pdf
2) The RBI. (June, 2019). Report of the Expert Committee on Micro, Small
and Medium Enterprises. Available at https://rbidocs.rbi.org.in/rdocs/
PublicationReport/Pdfs/MSMES24062019465CF8CB30594
AC29A7A010E8A2A034C.PDF
3) Das, P. (March, 2017). Micro, Small and Medium Enterprises(MSME) in
India: Opportunities, Issues & Challenges. Great Lake Herald, Vol 11, Issue
no. 1. Available at https://www.greatlakes.edu.in/herald/pdfs/march-2017/
article-5.pdf
4) Annual Report 2019-20. Government of India Ministry of Micro, Small and
Medium Enterprises, New Delhi. Available at https://msme.gov.in/sites/
default/files/FINAL_MSME_ENGLISH_AR_2019-20.pdf
5) Annual Report 2017-18. Government of India Ministry of Micro, Small and
Medium Enterprises, New Delhi. Available at https://msme.gov.in/sites/
default/files/MSME-AR-2017-18-Eng.pdf

PROGRESS EXERCISES
2) The Manufacturing Enterprise are engaged in the manufacture or production
of goods pertaining to any industry specified in the first schedule to the
industries (Development and regulation) Act, 1951) or employing plant and
machinery in the process of value addition to the final product having a
distinct name or character or use, and they are defined in terms of investment
in Plant & Machinery; while the Service Enterprises are engaged in providing
or rendering of services and are defined in terms of investment in equipment.
3) See Section 15.2 & 15.3 and answer.
2) See Section 15.5 & 15.6 and answer.
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Micro, Small and Medium
UNIT 16 SERVICES SECTOR I: ORGANISED Enterprises (MSMEs): Issues
and Policy
SECTOR - ISSUES AND POLICY
Structure
16.0 Objectives
16.1 Introduction
16.2 What Constitutes the Services Sector?
16.3 Service Sector Measurement Issues
16.4 Pattern of Growth in Services in India
16.4.1 Structural Change in Indian Economy
16.4.2 Relative Shares of Sub-Sectors of Service GDP
16.4.3 Share of Services in Trade
16.4.4 Share of Services in FDI
16.5 Factors behind Service Sector Growth
16.5.1 Demand Side Factors
16.5.2 Supply Side Factors: Trade Liberalisation and Reforms
16.6 Organised Service Sectors – Cross Cutting Policy Initiatives and Issues
16.6.1 Impact of Demonetisation on Service Sector in India
16.6.2 Goods and Services Tax (GST): Impact on Services
16.6.3 Domestic Regulations and Barriers to Trade in Services
16.6.4 Low Employment Elasticity in Organised Service Sectors
16.7 Sector-specific Policy Initiatives and Issues in Selected Organised Sectors
16.7.1 IT-BPM / Software Sector
16.7.2 Challenges and Prospects of Indian Tourism
16.7.3 Shipping and Port Services: Initiatives and Challenges
16.7.4 Real Estate Sector in India: Policy Initiatives and Challenges
16.7.5 Policy Initiatives and Challenges being Faced by Banking and Financial Services
16.8 Policy Implications
16.9 Let Us Sum Up
16.10 Key Words
16.11 References
16.0 OBJECTIVES
After studying this unit, you will be able to explain:
role of the services sector in the process of development and how the relative
share of various sector changes as the economy grows;
what constitutes the services sector in general and especially in case of Indian
economy;
the pattern of growth of services sector in Indian Economy and changes in
relative shares of various sub-sectors within the service GDP;
175
Sector Specific Issues and the factors which led to the spurt in services sector growth especially in
Policies
post-reform regime;
policy initiatives and measures taken by the government for the promotion
and growth of certain major services; and
constrains and bottlenecks being faced in selected service sectors.
16.1 INTRODUCTION
The service or tertiary sector is the third piece of a three-part economy. The first
economic sector, the primary sector, covers the farming, mining, and agricultural
business activities in the economy. The secondary sector covers manufacturing
and business activities that facilitate the production of tangible goods from the
raw materials produced by the primary sector. The service sector, though classified
as the third economic sector, is responsible for the largest portion of the global
economy’s business activity.The sector currently accounts for more than half of
India’s GDP. This process of tertiarisation (dominance of the tertiary or services
sector) of the economy has been accompanied by a decline in the share of the
primary sector (agriculture) and a more or less constant share of the secondary
(industry) sector over the years.
However, though the growth of service sector in India is in line with the global
trends, there are unique characteristics of India’s service sector growth.
First, the entire decline in the share of agriculture sector in GDP has been
picked up by the service sector while manufacturing sector’s share has
remained more or less the same.
Second, in spite of its growing share in the GDP, there has been a serious
mismatch between the share of services in GDP and the corresponding share
of services in total employment.
Further, it is found that growth pattern in the service sector has not been
uniform across all services in India.
This unit, especially focusing on the organised service sector, is designed to

respond the following questions: (a) what constitutes the service sector (b) what
is the pattern of growth in India’s service-sector? (c) what are issues – major
cross-cutting issues as well as sector-specific issues being faced by the organised
service sector in India? (d) what are the important external and internal barriers
to trade in different services in India? (e) what policy initiatives have been taken
by the government to sustain the growth of service sector in the long run?
16.2 WHAT CONSTITUTES THE SERVICES

SECTOR?
The term services sector refers to, at the most aggregate level, a large group of
activities that include trade, hospitality (hotels, restaurants), transportation,
communication, entertainment, health, education, public services and so on. Even
at the aggregate level, the services sector is more heterogeneous than the other
two sectors, agriculture (primary sector) and industry (secondary sector). Thus,
if the primary sector involves producing goods directly from natural resources
(agriculture, fishing, hunting, mining and so on) and secondary sector involves
176
modifying material goods into other more useful products and commodities, then Services Sector I: Organised
Sector - Issues and Policy
the tertiary sector or the services sector includes all activities that do not produce
or modify material goods.
In other words, unlike the output of agriculture, mining or manufacturing which

are material and tangible, the output of the services sector such as teaching,
cleaning, selling, curing and entertaining have no physical form and therefore
are immaterial or intangible. Given its nature and heterogeneity, the precise
definition and identification of the services sector is being debated even today.
T. P. Hill (1977) provided what constitutes the production of goods and what
would be services, and thus provides a positive definition of the services sector.
Hill makes a distinction between ‘services affecting goods’ and ‘services affecting
persons’ and thus proposes a definition of the services sector “as a change in the
condition of a person, or of a good belonging to some economic unit, which is
brought about as the result of the activity of some other economic unit, with the
prior agreement of the former person or economic unit”. Alternatively, many
studies adopt a broader and simpler definition of services on non-transferability
and non-storability. Other associated characteristics of services that need to be
noted are that services are heterogeneous and flexible in production and imperfect
competition is highly relevant for services.
According to the United Nations System of National Accounts (UNSNA) (1993),

“Services are not separate entities over which ownership rights can be established.
They cannot be traded separately from their production. Services are
heterogeneous outputs produced to order and typically consist of changes in the
conditions of the consuming units realised by the activities of producers at the
demand of the consumers. By the time their production is completed they must
have been provided to the consumers.”
In India, the National Industrial Classification provides classifications for services.

At present, the National Industrial Classification 2008 is used (Box 16.1) though
there are differences between it and the United Nations International Standard
Industrial Classification (UNISIC), e.g., construction is not a part of the sector
in India while it is in the UNISIC.
Box 16.1: Services Included in the Service Sector in the National

Industrial Classification, 2008
Wholesale and retail trade; repair of motor vehicles and motorcycles
Transportation and storage
Accommodation and food service activities
Information and communication
Financial and insurance activities
Real estate activities
Professional, scientific, and technical activities
Administrative and support services
Public administration and defense; compulsory social security
Education
Human health and social work activities
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Policies Arts, entertainment, and recreation
Other service activities
Activities of households as employers; undifferentiated goods and services
producing activities of households for own use
Activities of extraterritorial organisations and bodies
Source: Extracted from National Industrial Classification, 2008
Disaggregated data for many services are not available. Services such as retailing
and construction are largely in the non-corporate (informal or unorganised) sector,
there is both misreporting and under-reporting.
India has a quasi-federal governance structure; some services are under the
jurisdiction of the central government (Union List), some are under the state
governments (State List) and the remaining are under the joint administration of
central and state governments (Concurrent List) (Box 16.2).
Box 16.2: Jurisdictions in the Service Sector

Union List
Telecommunications, postal, broadcasting, financial services (including
insurance and banking), national highways, mining services
State List
Healthcare and related services, real estate services, retail, services
incidental to agriculture, hunting, and forestry
Concurrent List
Professional services, education, printing and publishing, electricity
Multiple ministries and central government departments regulate services such

as energy and transport while others like construction and retail do not have
nodal ministries. Services like telecommunications have one independent
regulator while others like electricity have state regulators as well. Professional
bodies regulate professions such as doctors, architects, and accountants.
16.3 SERVICE SECTOR MEASUREMENT ISSUES

The main sets of problems with regard to measurement of services sector value
added are:
The first set of problems relates to the inability to measure the value of
output itself. For example, there are services that are not marketed or do not
have an explicit ‘market value’ such as services that are provided by public
administration, ownership dwellings, banking and financial services and so
on. A part of this problem is also the difficulty in obtaining the actual ‘quantity
of service’ provided.The general method adopted for measuring value added
in case of such services is the value of wages given to workers in the sector.
Thus, an increase in either employment or in wages both lead to a
corresponding increase in value added.
The second set of problems relate to obtaining the real value of services as
178 opposed to the nominal value of services. The absence of appropriate price
deflators for many different types of services makes it difficult to arrive at Services Sector I: Organised
the value added in services in real terms. The most popular method used to
overcome this problem is the method of double deflation, where in the value
of output and value of inputs are deflated separately by their appropriate
price indices and the value added for the service is then estimated as the
difference between the output and inputs.
The third set of issues is to do with the inability to actually make

measurements on the ground and hence the use of indicators as proxies for
the existence and growth of some services.
Having discussed the three problem areas of services sector measurement in

general, we now turn to discuss issues specific to India. The main problem with
regard to estimating services GDP in India emanates from the fact that the
estimates for GDP are arrived at in seven main categories, each being subdivided
into subcategories and each of the subcategories in turn being classified further
into three institutional sectors viz., private sector, public corporate sector and
the unorganised sector. Each of these three institutional sectors has its own
characteristics, making collection of data and estimates complicated and complex.
On the challenges in measurement of services sector in India, Economic Survey

of 2010- 11 observed that “One of the important challenges faced by the country
is collection of data on the services sector. The challenge of data collection leads
to difficulties in compilation of an index for services sector production, non
representation of many services sectors in the calculation of the wholesale price
index, limited availability of published data on pricing of services, and limited
data on trade in services. Even where data are available, they suffer from 14
deficiencies related to definition, method of collection, suitability for pricing,
and construction of indices”.

1) Briefly explain the process of tertiarisation in case of Indian Economy.
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2) Briefly discuss the unique characteristics of growth of service sector in India.
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Sector Specific Issues and 3) Briefly explain the issues involved in measuring the value added in some of
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the services sectors in India.
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16.4 PATTERN OF GROWTH IN SERVICES IN

INDIA
16.4.1 Structural Change in Indian Economy
The process of development requires structural change. The structural change of
an economy takes place mainly along two dimensions: one is the changing sector-
wise shares in GDP and the second is the changing share of the labour force,
engaged in each sector. Over a span of past 60 years (1950-51 to 2011-12), the
share of primary sector in GVA at factor cost measured at constant prices (2004-
05 prices), in general, and the agriculture, in particular, has come down to one-
third of what it was initially (i.e., 53.7 per cent in 1950-51 to 16.48 per cent in
2011-12). Even during 2011-12 to 2019-20 (shares measured with new data
sources and new methodology for estimation), although the share of commodity
sectors were slightly inflated but the share of primary sector continued to fall
from 21.8 per cent in 2011-12 to 16.9 per cent in 2019-20 (1st AE) (Economic
Survey, 2020).The secondary sector of the economy has shown a change at the
snail’s pace. The share of secondary sector that was 14.35 per cent of GVA in the
year 1950-51 took a long span of 60 years to grow to 26.11 per cent. The
percentage share of tertiary sector in the GVA has grown to 57.41 per cent in
2011-12 as compared to mere 29.43 per cent in 1950-51. This implies that the
tertiary sector has been the major beneficiary of the economic reforms.
16.4.2 Relative Shares of Sub-Sectors of Service GDP

Major trends in the change in structure of service sector during the entire period
from 1950-51 to 2011-12 and thereafter are summarised as below:
Two important service sub-sectors, Trade and Public administration appear
to remain stable with regard to their contribution to services sector GDP.
The share of Trade changed from 25 per cent to about 26 per cent. Similarly,
the share of Public administration changed from 9 per cent to 10 per cent.
A closer look at trends over the period reveals that trade shows a U-shaped
pattern with regard to its share in total services GDP; its share first declined
to about 20 per cent in 1991- 92 before increasing to 27 per cent in 2011-12.
Similarly, Public administration displays an inverse U-shaped pattern with
regard to its share in total services GDP. Public administration peaked with
a share in services GDP of about 14.7 per cent before declining to 10 per
cent in 2011-12.
180
The services that have notable increases in shares through the period are Services Sector I: Organised
Banks (whose GDP increase from about 1.2 per centin 1950 51 to 8.3 per
cent in 2009 10), Road transport (from 4.5 per centto 8 per cent), Business
services (from 0.8 per cent to 7.4 per cent) and Insurance (0.8 to 2.7 per
cent). Of these, the share of Business services increased sharply starting
from the mid 1990s. Services that experienced a secular decline are Dwellings
(23.8 per cent to 7.6 per cent), Domestic services (8.4 per cent to 1per cent)
Recreation and entertainment services (5.4 per cent to 0.8 per cent)
Services that exhibited an inverse U-pattern in their shares in GDP are Public
administration, Education and Health. Their respective shares in services
GDP increased till about the 1980s before beginning to decline.
Finally, there are two services that stand out prominently in terms of high
growth. The first is Business services and the second is Private sector
communications. Private sector communications which did not exist in any
significant way till 1990 - 91 (0.1 per cent) grew to account for about 3.5
per cent of services GDP in 2011- 12. Similarly, business services of which
computer related services is a major component accounted for only about
1.3 per cent of the services GDP in 1989- 90 and this share increased to 7.4
per cent in 2011-12.
16.4.3 Share of Services in Trade
The growth in services sector worldwide has also been accompanied by the rising
share of services in world transactions. In India also, growth in the services
sector has also been accompanied by a substantial growth in international
transactions in services. In fact, India’s exports of services displayed one of the
fastest growth rates in the world, i.e., over 17 per cent per annum in the 1990s
(the world average being 5.6 per cent). Thereafter it declined but still remains
higher than the merchandise share in world trade. India’s Services share in world
services exports is given in Table 16.1.
Table 16.1: India’s Share in World Services Exports (Unit in USD Billion)
Year Exports of India’s Imports of India’s India’s Share in

Services Services World Exports of
Services
1998-99 13.20 11.02 0.99
1999-00 17.60 11.64 1.20
2000-01 20.40 16.39 1.40
2001-02 20.70 16.08 1.30
2017-18 205.11 179.58 3.50
Source: Handbook of Statistics on The Indian Economy (https://dbie.rbi.org.in), Reserve Bank
of India, Mumbai.
16.4.4 Share of Services in FDI

Along with trade, there has been a large inflow of FDI into India since 1990s
onwards. However, this increase in FDI inflows has been accompanied by a
change in the structure of FDI. Following the international trend, FDI inflows
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Sector Specific Issues and into India are also shifting increasingly away from manufacturing sector, towards
Policies
services sector. The average share of services in total FDI increased from 10.5
per cent in the period 1990-94 to 28.3 per cent in the period 1995-1999 (World
Investment Report, 2004).But the inflow of FDI into services sector has been
biased towards few of the services sectors e.g. telecommunications (69 per cent),
financial services (15 per cent) and Hotels and Restaurants (6 per cent). Relative
share of FDI inflows in India from 2006-07 to 2010-11indicates that the share of
services although remains dominant but declined in total FDI inflows and largely
moved into the manufacturing sector.

1) Briefly discuss the trends in the relative shares of sub-sectors of Service
GDP since independence.
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2) Discuss the trends in the share of services in trade and FDI inflows in India
and comment on the dominance of services both in trade and FDI inflows.
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16.5 FACTORS BEHIND SERVICE SECTOR

GROWTH
The literature on growth in service sector primarily argues that when an economy
grows, both demand side and supply side factors operate that lead to higher
growth in the service sector as compared to the other sectors. This also results in
a larger share of service sector in total employment.
16.5.1 Demand-Side Factors

Although the emphasis laid on different factors by different economists has varied,
the broad line of reasoning advanced by pioneers like Fisher and Clark and
followed with some elaborations and modifications by later analysts has been as
follows: Income elasticity of demand for agricultural products is low; that for
industrial, particularly manufacturing goods is high; and, for services, it is still
higher. As a result, with rising levels of income, the demand for agricultural
products relatively declines and that for industrial goods increases and, after
reaching a reasonably high level of income, demand for services increases sharply.
182
Bhagwati (1984) has put forward different ways in which technical and structural Services Sector I: Organised
changes define a continuous process during which services splinter-off-goods
and goods-splinter-off services. He argues that services that splinter off from
goods are technically progressive and possibly capital-intensive, but services
that are left behind after goods-from-services splintering process are mostly
technically unprogressive and labour intensive. The reason for expecting these
services to be technically progressive is the fact that these services arise due to
specialisation, which reflects economies of scale. But in case the goods that
splinter-off from services, for example records being produced, the musical
services left behind are unprogressive and technically stagnant.
16.5.2 Supply Side Factors: Trade Liberalisation and Reforms

Three supply side factors that lead to higher supply of services are increased
trade, higher FDI and improved technology. With respect to the Indian
economy,Gordon and Gupta (2004) show that on the demand side high growth
of services output in the 1990s was mostly due to factors such as, increasing
input usage of services by other sectors i.e., higher domestic demand, higher
foreign demand for services and higher income elasticity for final demand for
services. The study also found that the growing use of services has a significant
favourable effect on growth of output in Indian manufacturing in the 1990s. The
contribution of service input to output growth in manufacturing was about one
per cent in the 1980s, and it increased to about 25 per cent in the 1990s.
Trade reforms carried out in the 1990s explain to a large extent the rapid growth
of use of services in manufacturing. Lower tariff and lower non-tariff barriers
were also found to have led to an increase in the usage of services in manufacturing
sector. Thus, the studies show that growth of India’s services sector can be
attributed to:
Structural Changes that have led to increase in usage of services by other
sectors;
Lower tariff and non-tariff barriers to trade; and
Other reforms carried out in the 1990s.
1) Discuss the factors that have led to the spurt in service sector growth in
India.
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183
Policies 16.6 ORGANISED SERVICE SECTORS– CROSS
CUTTING POLICY INITIATIVES AND ISSUES
Various policy initiatives have been taken by the Government to promote the
services sector:
In the Foreign Trade Policy (2015-20), to provide an impetus to the services
trade, the SEIS (Service Export from India Scheme) incentives were
increased by 2 per cent for notified services such as Business, Legal,
Accounting, Architectural, Engineering, Educational, Hospitals, Hotels and
Restaurants amounting to Rs. 1140 crore.
The validity period of the Duty Credit Scrips was increased from 18 months
to 24 months to enhance their utility in the GST framework. GST rate for
transfer/sale of scrips has been reduced to zero from the earlier rate of 12
per cent. This will also help services sector.
New Logistics Division created in the Commerce Department to develop
and coordinate implementation of an Action Plan for the integrated
development of the logistics sector.
New Services division is being set up in Directorate General of Foreign
Trade (DGFT) to examine EXIM policies and procedures from the point of
view of “Services”.
Despite these cross-cutting promotional measures, service sectors are facing

variety of issues. The issues can be divided into two broad categories– Major
Cross Cutting Issues and Sector-specific Issues. In this section, focus is on the
major issues concerning all the service sectors.
16.6.1 Impact of Demonetisation on Service Sector in India

Demonetisation has offered both challenges and opportunities in the digitisation
of the Indian economy. There was positive impact on services due to greater
digitisation with measures like launch of Unified Payments Interface (UPI), Bharat
Interface for Money (BHIM) app, and BHIM-Aadhaar Pay, etc. It has been
empirically justified in many studies (R. Seranmadevia and A. Senthil Kumar,
2019) that the impact of demonetisation based on adoptability, implementation,
readiness and acceptance of new payment methods and digital cash by the services
providers and the customers has been significant.
16.6.2 Goods and Services Tax (GST): Impact on Services

You have already learned about the GST in detail in Unit 11. As you are aware,
Goods and Services Tax Law, introduced since 1st July 2017, is a comprehensive,
multi-stage, destination based tax that is levied on every value addition.
Positive Effects of GST on Service Sector
No double taxation:In the previous regime there were disputes whether a

particular supply is a supply of good or service. In such scenario, assesses
were required to pay taxes (both VAT and Service Tax) multiple times. In GST
regime, both goods and services are treated equally and this double taxation
is removed.
184
Seamless flow of Input Tax Credit (ITC): Under GST regime, service Services Sector I: Organised
providers are allowed to avail ITC paid on inputs and capital goods.
Therefore, now the cost of inputs and capital goods is reduced for service
providers.
Access to inputs held in stock: The service providers will access CENVAT

credit of inputs that is held in stocks. This is best applicable when a person
is moving from one category of taxation to the next like the exemption
category to the taxable one. For example, earlier, service providers used to
charge Service Tax to the clients and used to pay VAT on the goods purchased,
like computers. It was not possible to take set off VAT against Service Tax.
But in GST regime, you pay GST on both sales and purchases and hence it
is easy to claim ITC on that.
More Clarity for Software Industry: For companies that sell online software,
it was not clear whether to apply VAT or Service Tax on the product. In GST
regime, there is a clear distinction between products and services which
will remove the confusion for service industry.
Fewer costs to service providers: In the previous system of taxation, the

credit of VAT and CST that were paid to the input were billed to the service
provider. With the GST system, the CENVAT credit of SGST/CGST, as
well as the IGST that are to be paid on inputs and capital goods are all taken
care of which is a relief to the service provider.
Negative Impacts of GST on Service Sector
Lack of a centralised registration: With the previous taxation system, many

service providers rejoiced over being able to register all their businesses in
different areas from a central place. However, this privilege has been taken
away. Most of the service providers with operations in multiple states will
now have to register in different states to be assessed separately in each
state.
More burden of Compliance: Service Tax return was required to be filled

half yearly but in GST regime, 3 returns are required to be filled per month.
Annual return is also required to be filled in addition to monthly return. In
crux, now service providers are required to file 37 returns per state in
comparison with 2 returns on PAN India basis.
Services becoming Costlier: In previous tax regime, service tax was

applicable at the rate of 15 per cent on Services rendered which included
0.5 per cent for Swachh Bharat Cess and 0.5 per cent for Krishi Kalyan
Cess but in the Goods and Service tax regime, it has been increased up to 18
per cent making the services and works contracts costlier. Some services
are put in 28 per cent slab.
16.6.3 Domestic Regulations and Barriers to Trade in Services

Since services trade often requires (temporary) movement of provider or
consumer, restrictions on services mostly arises from regulations and
discriminating requirements regarding this movement. Most service industries
are highly regulated by national governments so that non-tariff barriers may be
185
Sector Specific Issues and inadvertent and also specifically designed to exclude foreign competition. Trade
Policies
in services thus can be restricted by external constraints as well as domestic
constraints.
External trade barriers are mainly in the form of quantity and price-based
barriers, limits on foreign equity participation, recognition and licensing of
provisions, immigration and labour market regulations and discriminatory
treatment with respect to taxes, subsidies, and other policies.
While domestic constraints may result from infrastructure inadequacies, poor
quality and standards, lack of clear-cut responsibilities between centre and
state governments and other policy-related disincentives.
Services that face high trade barriers have mostly experienced low growth rates,
especially professional services and rail transport that are still restricted services.
Not all services that have low external trade barriers and high growth rates have
high share in exports. In particular, it is observed that health and education services
have low external trade barriers and experience high growth rates but have low
share in exports. This reflects high domestic constraints in these services. Further,
there are services that are less than moderately liberalised or are restricted with
high external trade barriers and low growth e.g., professional services like legal,
accountancy and rail transport. These services also have low share in exports,
which reflect both domestic as well as external constraints to their
trade.Construction services are also found to have low growth and low share in
exports though external trade barriers have been somewhat lowered for them.
Modes of Trade in Organised Services

The definition of services trade used in the General Agreement on Trade in
Services (GATS) includes four modes of delivery.
The first mode is cross-border supply, with neither the consumer moving
nor the supplier establishing it abroad. The supplier mails, electronically
transmits, or otherwise transports a service across a national border. For
example, architectural services may be provided in the form of design
drawings sent via mail to a consumer in a foreign country.
The second mode of supply is consumption abroad, where consumers, such

as a tourists or students, travel across national borders to avail themselves
of a service.
In the third mode, commercial presence, a service supplier establishes a

foreign-based corporation, joint venture, partnership, or other establishment,
to supply services to persons in the host country.
Presence of natural persons is the fourth mode of delivery and involves an

individual, functioning alone or in the employment of a service provider,
temporarily travelling abroad to deliver a service.
Reflecting the diverse economic and technical characteristics of services, the

relative importance of different modes of supply varies widely across services.
The principal method by which foreign firms establish a commercial presence is
through foreign direct investment (FDI). FDI involves a foreign firm or individual
acquiring a controlling interest in a firm in a host country or establishing a new
186 firm or subsidiary in the host country.
16.6.4 Low Employment Elasticity in Organised Service Sectors Services Sector I: Organised
India’s services sector has witnessed tremendous growth since the reform period,
nevertheless, this growth has not been accompanied by a corresponding growth
in employment in this sector. The share of manufacturing sector in GDP has also
remained stagnant since 1990s.The biggest employing sector in India is the
Agriculture sector, employing 45 per cent of the population but contributing 15
per cent to the GDP, whereas Service sector is the biggest contributor to the GDP
but employs about 30 per cent. This has led to a policy dilemma and doubts have
been cast on the sustainability of service-led growth.
It is observed that growth in service sector has been lopsided and jobless. Some
sub-sectors have witnessed a double-digit growth rate in the last decade, e.g.,
communication and business services, while some have experienced a fall in
their growth rates, e.g., railways, real estate and dwellings. The sub-sectors that
have witnessed negative growth rates and those that have experienced slow growth
rates are also the ones that have large potential for generating employment, e.g.,
construction, transport and professional services. Rising labour productivity in
the faster growing sub-sectors has further reduced the scope for increasing
employment in these sub-sectors. For example, IT, ITeS, business and financial
services are drivers of service sector growth however these sub-sectors are not
employment intensive. The average labour productivity in this sector is 5-10
times that of the overall Indian economy, while its share in overall employment
is only about 1.7 per cent. Thus, the knowledge-intensive services sector which
along with some segments of capital-intensive manufacturing were the engines
of growth in India. But these sectors by their nature are not employment-intensive.
Thus, they have contributed to growth, but not necessarily to employment. It is
also observed in number of empirical studies that stringent employment protection
legislations (e.g. Industrial Dispute Resolution Act, Trade Union Act, and Work
Compensation Act, etc.) have pushed employers towards more capital-intensive
modes of production, than warranted by existing costs of labour relative to capital.
For example, a World Bank Study reveals that Industrial Disputes Act has lowered
employment in organised manufacturing by about 25 per cent.

1) Analyse the positive impact of demonetisation in driving the growth in IT/
Telecom services in India.
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2) Do you agree with the view that GST has retarded the growth of services in
India? What improvements could be done in GST regime so that it becomes
a stimulator for services growth in India?
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187
Sector Specific Issues and 3) Do you think that domestic regulations and barriers are more constraining
Policies
to trade in services rather than the external barriers? Elucidate your reply
with suitable examples and justifications.
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4) How far the GATS have been successful in promoting the trade in services
across the world? Give adequate justifications in support to your reply.
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16.7 SECTOR-SPECIFIC POLICY INITIATIVES

AND ISSUES IN SELECTED ORGANISED
SECTORS
16.7.1 IT-BPM / Software Sector
Government Initiatives in IT-BPM/Software Sector
The Government of India’s rapid adoption of technologies as a platform to delivery
of government-to-government and government-to-citizen services is a tremendous
push factor for the domestic IT-BPM (Business Process Management) market. It
has developed its own cloud platform – MeghRaj – that offers Platform-as-a
Service (PaaS), Infrastructure as a Service (IaaS), Software as a Service (SaaS)
and Storage as a Service (STaaS). The focus of this initiative is to accelerate
delivery of e-services in the country while optimising Information Communication
and Technology (ICT) spending of the Government. It also intends to make India
a hub for cyber security solutions for the world. Some of the initiatives under
Digital India programme include Universal Digital Identity (Aadhaar); Common
Services Centres (CSCs); Digital Locker; eSign; UMANG(Unified Mobile App
for New Age Governance); Jeevan Pramaan scheme for Digital Life Certificate
for Pensioners; National Scholarship Portal; National Centre of Geo-informatics
(NCoG) project, etc.
With these initiatives, India’s IT industry has thrived globally with exports around
$70 billion. There are over 2.8 million employees working in the IT sector. India’s
IT industry is an emerging market for the economy which requires more IT
services as we move further. The major reason behind the rapid development of
the IT industry is the vast reservoir of technically skilled manpower which has
transformed India into a IT superpower. However, India’s Software exports which
188 were growing robustly at 27 to 38 per cent during 2002- 03 to 2007-08 have
slowed down in recent years with exports even falling. In FY 2019, growth will Services Sector I: Organised
settle just about 7.5 per cent to 8 per cent while in FY 2020, IT services export
growth is pegged at 6 per cent to 8 per cent.
The major issues and challenges in the IT-BPM sector are listed below:
Visa Issues : This is a major issues for the IT sector. Immigration and visa
issues, which have long plagued the information technology sector seem to
have hurt Indian IT services companies with the US Government’s stance
on the H-1B visa issue.
Goods and Services Tax payable (‘IGST/CGST/SGST’) on import or domestic
procurement of services by Software Technology Parks of India (STPIs):
GST laws treat any service provided to a SEZ unit as ‘Zero Rated Supply’.
Accordingly, a SEZ unit can import services or procure domestically those
services required for authorised operations without payment of GST.
However, STPI units, which are also into the activity of export of IT/ITES
are required to pay GST both on import and domestic procurement of services
required for authorised operations and subsequently claim refund of the
same. Payment of GST on procurement of services by an STPI unit would
increase the working capital requirement. While relief has been provided
till March 2018, upfront exemption from payment of GST on import and
domestic procurement of services by STPIs could be considered in the GST
regime on par with SEZ units.
Further on the Goods and Service Tax (GST) front, the industry has been
adversely impacted and faced with ambiguity due to divergent advance
rulings by tax authorities. Delay in granting refund of accumulated GST
credits continues to pose a working capital challenge to the industry, despite
government’s initiatives such as special refund drives.
SEIS benefit to units covered under STP scheme and export of IT/ITES(IT
enabled services): Under the Service Exports from India scheme (SEIS) of
FTP (2015-20), certain services including professional services have been
notified as eligible services. Under these scheme exports of notified services
by SEZ units are made eligible to claim the SEIS scrips. However, exports
of similar notified services by units registered under STPI scheme are not
eligible to claim the SEIS scrips.
Globally, India has continued to perform well in the computer software and ITES
sphere since the post-reforms period. However, this achievement has been dwarfed
by the neglect of high-end IT services. Too much dependence on a few external
markets for IT exports could prove to be a risky business model, and there is a
serious need to explore possibilities of broadbasing the market by looking at the
African, Asian and Latin American markets. Also, the IT/ITES sector in the
country faces a scarcity of professionals and venture capital. The increased threat
to cyber security due to cloud computing, e-commerce, and digital payments is
another concern which the industry has to deal with without delay.
16.7.2 Challenges and Prospects of Indian Tourism

Important initiatives taken by the Government to promote tourism in the country
include the following:
For creation of tourism infrastructure, Central Financial Assistance to States/
UTs under the schemes of Swadesh Darshan, National Mission on Pilgrimage 189
Sector Specific Issues and Rejuvenation and Spiritual Heritage Augmentation Drive (PRASHAD). Besides,
Policies
some initiatives taken by Ministry of Tourism include the following:
Extension of e-visa facility to citizens of 167 countries.

Launch of the Incredible India 2.0 campaign with market specific promotional
plans and content creation.
Revamping of Incredible India website with the aim to provide more
information about India as a tourist destination.
Launch of 24x7 toll free multi-lingual tourist helpline in 12 International
languages including Hindi and English.
Organisation of annual Global Tourism Mart for India in line with major
international travel marts being held in countries across the world. It provides
a platform for all stakeholders in tourism and hospitality industries to interact
and transact business opportunities.
Organisation of Annual International Tourism Mart for promotion of tourism
in North Eastern States.
Promotional activities in tourist generating markets overseas through the
India Tourism Offices abroad with active participation in travel fairs and
exhibitions; organising Road Shows, “Know India” seminars and workshops.
Ministry launched a mobile application called Swatch Paryatan which will
let citizens report any hygiene issues at various tourist destinations across
the country.
The Archaeological Survey of India (ASI) has identified 100 monuments to
be developed as Model Monuments under Adarsh Smarak scheme.
The Government has initiated many policies to make India a Medical Value Travel
destination which include constituting the National Medical and Wellness Tourism
Promotion Board in 2015 and launching e-tourist visa and m-visa facilities. The
board has taken many initiatives which inter alia include: a) Stressing on easing
entry formalities for those arriving for Medical Visits. On the recommendations
of the Board, Government has done away with the procedure for reporting of
those coming on medical visas to Foreigner Regional Registration Offices (FRRO)
and accepts hospital’s reporting. b) Giving emphasis on accreditation of
institutions and organisations dealing with Medical and Wellness Tourism at all
levels. c) Encouraging the Medical and Wellness Tourism stakeholders to work
in a transparent and fair manner by listing out indicative cost of procedures.
The ‘Adopt a Heritage Scheme’ invited Private Sector Companies, Public Sector
Companies and Corporate individuals to adopt the sites and to take up the
responsibility developing 8 monuments, heritage and tourist sites across India
and making them tourist friendly to enhance their tourism potential and cultural
importance, in a planned and phased manner.
As a result of these initiatives, Indian travel and tourism industry is prospering

enormously with number of tourists increasing from 17000 in 1951 to over 10
million by 2017. It contributed 9.4 per cent to India’s total GDP (Gross Domestic
Product) in 2017 and provided 41.622 million jobs to the people. Yet, we are
relatively far behind several other small countries like Singapore and Hong Kong.
190
Some of the challenges being faced by the tourism sector are listed below: Services Sector I: Organised
Lack of proper infrastructure
GST related Issues: Ministry of Finance in its Working Paper (Prasad and
Sathish, 2017) highlighted the following GST related issues in tourism sector:
o Need to treat foreign exchange earnings in tourism services as exports
or deemed exports: While goods and services exported from India are
exempt from GST, for tourism services this is not the case as they are
governed by a special provision of being served in India.
o GST rates in India are very high:With GST for hotels at around 18 per
cent and tour operators at 28 per cent, India is among the highly taxed
tourism countries.
Social and Political Concerns: These relate to the developmental, cultural
and environmental effects liberalisation of tourism can have on local
communities and sensitive locales. New parameters at the macro, and micro
levels have to be identified for developing tourism keeping in view the
incidents of communalism, terrorism, natural disasters, climate change,
global warming, deforestation, pollution etc.
Alternatives: This includes health tourism, village tourism (in the vintage of
global village!), sports and games tourism, etc. Kerala has done innovative
thinking in “monsoon tourism” which reduces seasonality of tourism.
16.7.3 Shipping and Port Services: Initiatives and Challenges

As far as the Indian subcontinent is concerned, shipping plays an important role
in the transport sector of India’s economy. Approximately, 95 per cent of the
country’s trade by volume (70 per cent in terms of value) is moved by sea. The
geographical factor that puts the Indian maritime sector at an advantageous
position is its vast coastline of 7,500 km.
In order to improve India’s ranking in terms of ‘Trading across Borders’, the

Ministry of Shipping has initiated the following measures:
From manual to e-forms
Implementation of Direct Port Delivery Scheme
Reduction in fee and charges for non-peak hours
Container scanners at major ports
Delivery orders are automated
RFID Scheme for gate automation: All the major ports are in process of
implementing radio-frequency identification (RFID) gate automation system.
Integration of major ports filing system with Customs software: This
process has cut down dwell time significantly.
Remove congestion at ports: To remove bottlenecks in rail or road
connectivity for faster evacuation of cargo, all major ports have been directed
to take the measures such as development of parking areas, widening roads
and inter-terminal movement trailers.
191
Sector Specific Issues and The important issues in this sector are listed below:
Policies
The costs of operating a shipping company in India are higher than overseas
and therefore foreign shipping companies do not prefer to flag their ships in
India.
Onerous Tax Regime: The shipping industry is facing significant tax burden
such as minimum alternate tax, dividend distribution tax, withholding tax
liability on interest paid to foreign lenders and on charter hire charges paid
to foreign ship owners, and so on which is ultimately squeezing the bottom
line/profit margin further.
GST related issues:Ministry of Finance in its Working Paper (Prasad and

Sathish, 2017) highlighted the following GST related issues in shipping
sector
o GST applicability on sale of ships located abroad: GST is applicable
on the sale of a ship by an Indian shipping company which has a ship
located abroad. Earlier, such a sale was outside the purview of the Indian
VAT laws and hence was not liable to VAT.
o Need for parity in GST treatment for services of international
transportation of goods by sea by Indian shipping companies vs. foreign
shipping companies:If a foreign charterer desires to engage a shipping
line for transportation of cargo from abroad to India, he would prefer
to engage a foreign shipping line over an Indian shipping line since the
latter would charge 5 per cent GST on its freight invoice while the
former would not charge any tax.
o GST input tax credit on any goods purchased in various States: Goods
such as furnace oil, lubes, spares, ship stores, etc. are purchased by
shipping companies at various ports/States. Such purchase of goods
would attract CGST and SGST of the respective State where goods are
procured. Shipping companies may not have any place of business in
the States where the purchases are made and hence may not be able to
utilise the input tax credit in respect of goods procured at various States.
This could result in significant blockage of input tax credit in various
States and needs to be addressed.
The multiplicity of Regulations – costly affair: The shipping industry is
regulated by International Maritime Organisation (IMO). There are also
international regulations on operations of ships and for seafarers. Even though
such regulatory framework makes stricter entry barriers into the industry, it
adds cost to the compliance of such regulations.
The challenges facing in development of a world class port infrastructure
include the following:
o Issues with PPP Model- Most port PPPs impose strict limits on what
private operators are allowed to do, usually in terms of the types of
cargo they are allowed to handle.
o Limited Hinterland Linkages
o Sub-optimal Transport Modal Mix – Lack of requisite infrastructure
for evacuation from major and non-major ports leads to sub-optimal
192 transport modal mix.
o Processes and operations across India’s ports are not standardised or Services Sector I: Organised
uniform, costs and time for key processes are unpredictable and there
is an unacceptable level of variation across ports as well as within ports.
o Financial constraints – continued underinvestment have left the port
infrastructure in dismal condition especially with regards to the non-
major ports.
o Deficient dredging capacity – Draft is also a major limitation in India
as terminals and ports are unable to cater to vessels beyond Panamax
(Draft over 13 meters) size that are increasingly dominating global trade.
o Land acquisition and environmental clearances are some specific
challenges for port infrastructure.
16.7.4 Real Estate Sector in India: Policy Initiatives and

Challenges
The real estate sector in India is growing at a rate of about 20 per cent per annum
and this sector has been contributing to about 6-7 per cent to India’s GDP but it
is not able to balance the supply-demand continuum.
Some of the policy initiatives that have had a lasting impact on the Indian real
estate industry include Pradhan Mantri Awas Yojana, Smart Cities Mission,Real
Estate Regulation and Development Act (RERA) in 2016, Amendment to Benami
Transactions (Prohibition) Act, Real Estate Investment Trust (REITs)– approved
by the Securities and Exchange Board of India (SEBI) – is a platform to pool
money from investors all across the country, Service Tax Exemption on
Construction of Affordable Housing, Interest Subsidy for the first-time
homebuyers, Permanent Residency Status for Foreign Investors for a period of
10 years, subject to fulfillment of certain conditions, Infrastructure Status to
Affordable Housing; Foreign Direct Investment in Real Estate (except real estate
farms) and Home loan moratorium for real estate due to the COVID-19-led
lockdown and the nationwide restrictions aiming at helping borrowers and
developers who are reeling under monetary pressure since long.
The demonetisation in November 2016 severely impacted the growth of the real
estate sector and reduced the flow of investments. The implementation of the
Real Estate Regulation Act (RERA) in 2016 and GST in 2017 has resulted in a
variety of projects arriving at a standstill. Similarly, there are other such policy
and regulation challenges that have plagued the real estate sector in India:
Delayed Infrastructure Projects:In addition to the complications faced to

acquire funding for the project, a real estate developer has to navigate through
numerous government regulations before commencing construction. Thus,
the sector calls for a single-window clearance system to streamline and fasten
the approval mechanism.
Funding problems for land acquisition: Currently, funding is only available

for construction purpose, but not for land acquisition. Land acquisition alone
constitutes 60 per cent of the entire cost in a particular project. After funding
for the acquisition of a land, developer needs to wait for 12 to 18 months,
during which the developer does not get any money, but gets burdened with
interest charges. These issues need to be examined and addressed.
193
Sector Specific Issues and Land availability: Another challenge that has affected the growth of the
Policies
real estate sector and the developers is litigated land. According to a survey
conducted by the MahaRERA, around 16 per cent of projects and 31 per
cent of built-up spaces are, or have been, in legal disputes.These challenges
call for a serious revision of the Land Acquisition Resettlement and
Rehabilitation Act, 2013 which grants compensation, rehabilitation, and
resettlement to the affected persons in India.
Outdated building byelaws: Over 50 per cent of the world’s population lives

in cities, and the number is expected to rise by 2.5 billion by the year 2050.
However, the current Floor Space Index (FSI) norms in the cities are not on
par with the growing demands of the consumers. Reports state that the
permitted FSI in Indian cities is currently at an all-time industry low, within
the range of 1 to 1.5. These challenges call for state governments to revisit
the FSI norms.
Rising non-performing assets (NPA), higher risk provisioning assigned

to real estate sector by the RBI and dwindling profits in the real estate
sector: These have affected bank lending to the sector. Among the major
funding sources to real estate sector, bank lending to the real estate sector
has significantly dropped from over 57 per cent in 2010, to less than 24 per
cent in 2016, while private equity investments have increased. The real estate
sector has also been grappling with liquidity issues and piling debt.
Tax shifts and demand shifts: Prior to GST implementation, there was a
service tax of 4.5 per cent that was payable in case of under-construction
property. Post GST, that rate has gone up sharply to 12 per cent making it
almost unattractive to buyers. Property buyers were already paying
registration charges and stamp duty on properties. With the addition of 12
per cent GST, the total statutory cost has gone up by 20 per cent of the cost
of property for the buyer. The bigger problem is a fundamental shift in
demand patterns. During the days of the property boom, many real estate
companies invested heavily in developing middle range and premium
properties. When the cycle turned, most of these properties could not find
buyers. Shortage of working capital has led to many builders defaulting on
their delivery commitments to customers.
GST Issues: While construction sector is the worst hit sector due to economic
slowdown and demonetisation, all components of construction except bricks
are charged at 28 per cent GST.
16.7.5 Policy Initiatives and Challenges being Faced by Banking

and Financial Services
Initiatives to improve the conditions of Government Banks and Financial Services
Government of India has taken comprehensive steps to strengthen the Public
Sector Banks (PSBs), under Government’s 4R’s strategy of– recognising NPAs
transparently, resolving and recovering value from Stressed Accounts through
clean and effective laws and processes, recapitalising banks, and reforming banks
through the PSB Reforms Agenda.Other steps taken by the Government to
improve the condition of banks include, inter alia, the following:
194
Change in credit culture with institution of Insolvency and Bankruptcy Code Services Sector I: Organised
(IBC) fundamentally changing the creditor-borrower relationship, taking
away control of the defaulting company from promoters/owners and
debarring wilful defaulters from the resolution process and debarring them
from raising funds from the market.
Fugitive Economic Offenders Act, 2018 has been enacted to enable
confiscation of fugitive economic offenders’ property.
National Financial Reporting Authority has been established as an
independent regulator for enforcing auditing standards and ensuring audit
quality.
Key reforms instituted in PSBs include, the following:
o To ensure proper due diligence in project financing, Board-approved
Loan Policies of PSBs now mandate tying up necessary clearances/
approvals and linkages before disbursement, scrutiny of group balance-
sheet and ring-fencing of cash flows, and appraised of non-fund and
tail risk.
o For mitigating risk on account of misrepresentation and fraud, use of
third-party data sources for comprehensive due diligence across data
sources has been instituted.
o For clean and effective monitoring, monitoring roles have been strictly
segregated from sanctioning roles in high-value loans, and specialised
monitoring agencies combining financial and domain knowledge have
been deployed for effective monitoring of loans above Rs. 250 crore.
o To ensure timely and better realisation in One-Time Settlements (OTSs),
online end-to-end OTS platforms have been set up.
o For faster processing of loan proposals, Loan Management Systems
have been put in place for personal segment and MSME loans.
To strengthen governance at the Board level, the position of Chairman and
Managing Director (CMD) has been bifurcated into separate positions of a
Non-executive Chairman and a Managing Director (MD) and Chief
Executive Officer (CEO).
A professional Banks Board Bureau (BBB) has been created for arm’s length
selection of non-executive Chairmen and whole-time directors.
The banking industry is undergoing a radical shift, one driven by new competition
from FinTechs, changing business models, mounting regulation and compliance
pressures, and disruptive technologies. The emergence of FinTech/non-bank Start-
ups is changing the competitive landscape in financial services, forcing traditional
institutions to rethink the way they do business.
A Cultural Shift:In the digital world, there is no room for manual processes and
systems. Therefore, it’s important that financial institutions promote a culture of
innovation for maximum efficiency.
Regulatory Compliance:Regulatory compliance has become one of the most

significant banking industry challenges as a direct result of the dramatic increase
195
Sector Specific Issues and in regulatory fees relative to earnings and credit losses since the 2008 financial
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crisis. Beginning from Basel’s III Risk-weighted capital adequacy norms to a
growing number of RBI regulations that banks must comply with; compliance
can significantly strain resources.
Security Breaches: With a series of breaches and frauds over the past few years,
security is one of the leading banking industry challenges, as well as a major
concern for bank and credit union customers.
Continuous Innovation:Sustainable success in business requires insight, agility,

rich client relationships, and continuous innovation. Innovation stems from
insights, and insights are discovered through customer interactions and continuous
organisational analysis.

1) ‘The policy initiatives or measures taken by the government to provide a
boost in service sectors are not adequate enough instead big-bang reforms
are required to provide impetus to growth of sectors’. Comment on the
statement with suitable examples.
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
2) Do you think that GST law launched in July 2017 has put the break on the
growth and development of certain major service sectors in India? Give
adequate justifications with suitable citations in your answer.
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
3) Do you agree with the view that infrastructure constraint is the biggest
bottleneck in growth and development of major service sectors in India?
Justify adequately.
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
196
4) ‘Service sectors which are contributing significantly to service GDP requires Services Sector I: Organised
more reforms to improve their competitiveness and exploit their unleashed
potential’ Comment on the statement with suitable examples and
justifications.
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
16.8 POLICY IMPLICATIONS

One of the probable reasons for lopsided growth in services is the fact that reforms
in India at the sectoral level have evolved in an ad-hoc way. There has been no
coherent overall policy for services in line with the industrial policy and
agricultural policy. Consequently, the depth and pace of reforms lack uniformity
across sectors.
Given the large positive externalities of services, it is important for an economy

to provide services as efficiently as possible. Keeping in view the backward and
forward linkage for activities in different sectors it is observed that the services
that have maximum forward as well as backward linkages are trade, transport,
and construction. These sectors are found to have high domestic constraints and
therefore require immediate policy reforms.
It is observed that health and education sectors have high potential for trade
since they have low external barriers and high growth rates. This indicates
substantial domestic constraints in these services. Given the low-cost quality
treatment available in India, there is a large scope for health tourism in India.
India also has a competitive advantage in the practice of alternative medicine.
These areas should be developed and exploited for trade opportunities.An
important domestic constraint identified in the health sector is that since health
sector is on the concurrent list, i.e., both state and central governments have
jurisdiction over this sector; a number of regulations are imposed by the state
governments. There are also state-specific regulations of the town and planning
departments on the design and construction of healthcare infrastructure, which
form important domestic constraints to trade in health services. Thus, even though
there is no cap on FDI in health services, there is still a low share of health
services in total trade and FDI. There is therefore a need to have a clear-cut
demarcation of responsibilities of Centre and the State in this respect. Regarding
trade in education services, there is a need to study the system of regulation and
accreditation of educational institutions in foreign countries and accordingly
develop own accreditation system.
With respect to slow growing services, which have low share in exports, e.g.,
professional services, like legal, postal, accountancy, etc. we find that these
services have restricted liberalisation. Both external and domestic constraints
restricting growth in these services need to be identified and addressed by taking
relevant policy initiatives.
197
Sector Specific Issues and The full gains of trade liberalisation in services can however be acquired by an
Policies
economy only if certain economy-wide efforts are made to make general
environment more conducive to trade and investments in services. Macro-
economic policies like high tariff rates, large fiscal deficits and rigid labour laws
may have as adverse effect on competitiveness of services as on goods. Excessive
regulations, discretion in the allocation of licenses and permits, corruption and
poor quality of infrastructure could adversely affect the growth of services sector.
16.9 LET US SUM UP

The services sector accounts for more than half of India’s GDP. This process of
tertiarisation (dominance of the tertiary or services sector) of the economy has
been accompanied by a decline in the share of the primary sector (agriculture)
and a more or less constant share of the secondary (industry) sector over the
years. However, though the growth of service sector in India is in line with the
global trends, there are unique characteristics of India’s service sector growth.
Within the service sector, the fastest growing services in the 1990s have been
trade, communications, financial services, business services and community
services like health and education. However, out of these services, only
communication services have witnessed growth in their share in exports and
FDI during this period.
In India the share of services sector was already notable in the 1950s, and there
has been steady growth of the sector since then. During the entire planning era,
Trade and Public administration appear to remain stable with regard to their
contribution to services sector GDP. Similar to the world trend, in the Indian
economy, growth in the services sector has been accompanied by a substantial
growth in international transactions in services. Along with trade, there has been
a large inflow of FDI into India since 1990s onwards. But, the inflow of FDI into
services sector has been biased towards few of the services sectors.
The analysis of the Services Sector in general and selected sectors, in particular,
indicates not only the potential of the services sector, but also the major issues
and problems areas. While only few services are analysed, there are many other
services. Telecom is one area where India has already made a mark. Some other
services are Super Specialty healthcare, Satellite Mapping and Professional
services where prospects are bright and India has the necessary competence to
provide them. Many of the issues highlighted in various sectors if addressed can
help in further growth of the services sector. This can make the services sector
which is already the dominant growth contributor to become a high growth
propeller, along with foreign exchange earner and employment provider for India.
16.10 KEY WORDS

Duty Credit Scrips : A Duty Credit Scrip is a scrip which can be
used for the payment of Customs Duty.
Employment Elasticity : It is a measure of how employment varies with
economic output.
Trade Barrier : A trade barrier is a government-imposed
restrictions on international trade.
198
General Agreement on : The General Agreement on Trade in Services, Services Sector I: Organised
Trade in Services (GATS) abbreviated as GATS, is a treaty of the World
Trade Organisation (WTO) that entered into
force in 1995 following the Uruguay Round
negotiations. It envisages the objective of
establishing a sound multilateral framework
or principles and rules for trade in services.
Information Technology : Information Technology and Business Process
Business Process Management (IT-BPM) refers to engagement
Management (IT-BPM) of services of a third-party vendor to manage
certain aspects of work operations by an
enterprise.
Public Private Partnership : Public-private partnership (PPP), partnership
(PPP) between an agency of the government and the
private sector in the delivery of goods or
services to the public
Quasi-federal : Quasi-federalism means an intermediate form
of state between a unitary state and a
federation. It combines the features of a federal
government and the features of a unitary
government.
Special Economic Zone : Special Economic Zone (SEZ) is an area in a
(SEZ) country that is subject to different economic
regulations than other regions within the same
country.
16.11 REFERENCES
1) H.A.C. Prasad and R. Sathish, (2017). ‘Services Sector: Challenges, Issues
and Policy Suggestions’, Working Paper No. 2/2017—DEA, Ministry of
Finance, Department of Economic Affairs (economic Division), Government
of India.
2) Rashmi Banga, (2005).‘Critical Issues in India’s Service-led Growth’,
Working Paper No. 171, Indian Council for Research on International
Economic Relations, Lodi Road, New Delhi.
3) Hill T.P. (1977). “On goods and services”, Review of Income and Wealth,
Vol. 23, No 4, pp 315-338.
4) World Economic Forum, The Travel & Tourism Competitiveness Report
2017, published within the framework of the Economic Growth and Social
Inclusion System Initiative and the Future of Mobility System Initiative.
5) Kaldor, Nicholas (1966). ‘Marginal Productivity and the Macro-economic
Theories of Distribution: Comment on Samuelson and Modigliani’, Panico,-
Carlo; Salvadori,-Neri, eds. Post Keynesian Theory of Growth and
Distribution. Elgar Reference Collection series. International Library of
Critical Writings in Economics, vol. 21. Aldershot, U.K
6) Baumol, W. (1967). ‘The Macroeconomics of Unbalanced Growth: The
Anatomy of Urban Crisis’, The American Economic Review 57 (3): 415–
26.
199
Sector Specific Issues and 7) Bhagwati, Jagdish, N (1984). ‘Splintering and Disembodiment of Services
Policies
and Developing Nations’,World-Economy,7(2), June, 133-43.
8) Gordon, J. & Poonam Gupta (2004). ‘Understanding India’s Services
Revolution’,IMFWorkingPaper WP/04/171.
9) R. Seranmadevia and A. Senthil Kumar, ‘Experiencing the effect of
demonetization on service sectors in India’, a School of Commerce Studies,
Jain (Deemed-to-be) University, Bengaluru, Karnataka, India.
10) Hansda, S.K. (2001). ‘Sustainability of Services-led Growth: An Input-Output
Analysis of Indian Economy’, RBI Occasional Working Paper, Vol 22, No.
1,2 and 3.
11) JesimPais, ‘Growth and Structure of the Services Sector in India’ Working
Paper No. 160, Institute for Studies in Industrial Development (ISID) 4,
Institutional Area, Vasant Kunj Phase II, New Delhi 110 070.
12) Bhattacharya B.B. and Arup Mitra (1997) Changing Composition of
Employment in Tertiary Sector: A Cross Country Analysis”, Economic and
Political Weekly, Vol. 32, No. 11, pp. 529 534.
13) Mitra Ashok (1988). Disproportionality and the Services Sector: A Note,
Social Scientist, Vol. 16, No. 4, Four Decades of Economic Development
II, pp. 3 8.
14) Nagaraj R. (1991). “Excess Growth of Tertiary Sector?”, Economic and
Political Weekly, Vol. 26, No. 5, pp. 247 248.
15) Shetty S.L. (2007). “Status Paper on Database Issues of the Services Sector”,
Economic and Political Weekly, Vol. 42, No. 37, pp 3723 3726
16) Singh Nirvikar (2006). “Services Led Industrialization in India: Assessment
and Lessons”, Working Paper No. 290, Stanford Center for International
Development, Stanford University.
17) Tendulkar Suresh (2007). “India’s Growing Services Sector: Database
Problems and Issues”, Economic and Political Weekly, Vol. 42, No. 37, pp
3721 3722
18) UN SNA (1993). System of National Accounts 1993, United Nations, New
York.
19) World Investment Report (2004). ‘The Shift Towards Services’, United
Nations, New York and Geneva.

PROGRESS EXERCISES
1) See Section 16.1 to 16.3 and answer
2) See Section 16.2 and answer

200
Check Your Progress 3 Services Sector I: Organised

1) See Sub-section 16.6.1 and answer

201
Policies UNIT 17 SERVICES SECTOR II: INFORMAL
SECTOR-ISSUES AND POLICY
Structure
17.0 Objectives
17.1 Introduction
17.2 Informal Service Sector in India: Definition and Characteristics
17.2.1 Characteristics of an Informal Service Sector
17.3 Size of Informal Service Sector in India
17.3.1 Factors behind Growth of the Informal Sector
17.4 Legal and Regulatory Framework
17.5 Informal Service Sector: Issues and Challenges
17.5.1 Costs Associated with a Formal Enterprise
17.5.2 Risks associated with being an Informal Enterprise
17.5.3 Challenges for their Growth and Scalability
17.5.4 Impact of Demonetisation on the Informal Sector
17.5.5 Impact of GST on the Informal Sector
17.5.6 Impact of Coronavirus and Lockdown on the Informal Sector
17.6 Policy Implications
17.6.1 Role and Responsibility of the Governments
17.6.2 Access to Credit
17.6.3 Tax Reforms
17.6.4 Social Security Contributions
17.6.5 Inspection and Compliance
17.6.6 Awareness and Promotional Campaigns
17.7 Let Us Sum Up
17.8 Key Words
17.9 References
Appendix 17.1 Why Informal India cannot be ‘Atmanirbhar’ India?
17.0 OBJECTIVES
After studying this unit, you will be able to
explain the informal service sector;
discuss the salient characteristics of the informal service sector in India;
shed light on the size of informal service sector in India and main factors
responsible for its exponential growth;
analyse legal and regulatory framework for commercial enterprises and their
implications for the informal sector with special reference to the service
sector;
point out issues and challenges being faced by the informal service sector in
202 India; and
highlight the policy implications of informality particularly focusing on the Services Sector II: Informal
role of governments at various levels.
17.1 INTRODUCTION
In some countries, the term “informal sector” refers to the private sector while in
others the term is considered synonymous with the “underground”, “shadow” or
“grey” economy. However, the majority of workers and enterprises in the informal
sector produce legal goods and services, albeit sometimes not in conformity with
procedural legal requirements, for example, where there is non-compliance with
registration requirements, labour and or tax and commercial laws. It is important
to note that the informal sector absorbs workers who would otherwise be without
work or income, especially in developing countries like India that have a large
and rapidly growing labour force, and where workers are made redundant
following structural adjustment programmes. Most people enter the informal
economy not by choice but out of a need to survive. Given the circumstances of
high unemployment, underemployment and poverty, the informal sector has the
potential for creation of jobs by providing ease of entry with low requirements
for education, skills, technology, and capital. The jobs created falls under ‘low
productivity low wage’ syndrome and thus often fail to meet the criteria of decent
work. The informal sectors also meet the needs of poor consumers by providing
accessible and low-priced goods and services.It supplies labour-intensive exports.
This sector thus drives growth and livelihoods.
Considering the significant role played by the informal sector, the present unit
while focusing on the informal service sector, is designed to respond to the
following questions: (a) how the informal sector is defined in India and what
constitutes the informal service sector? (b) what explains growth in India’s
informal service sector? (c) what are the issues being faced by the informal service
sector in India? (d) what policy initiatives are taken so far to address the concerns
of the informal sector in general and informal service sector in particular?
17.2 INFORMAL SERVICE SECTOR IN INDIA:

DEFINITION AND CHARACTERISTICS
There is no standard definition of informal sector as such. A formal sector is
generally referred to as that part of the economy which operates under the
regulatory framework, is taxed by the government, and is monitored for inclusion
in the gross national product. The term “informal sector” refers to all economic
activities by workers and economic units that are – in law or in practice – not
covered or insufficiently covered by formal arrangements. According to National
Commission for Enterprises in the Unorganised Sector (NCEUS) unorganised
or informal sector consists of all unincorporated private enterprises owned by
individuals or households engaged in the sale and production of goods and services
operated on a proprietary or partnership basis and with less than ten total workers.
As per International Labour Organisation (ILO), the informal sector consists of

units that are unincorporated (i.e., not constituted as separate legal entities of
their owners), produce goods or services for sale or barter, and satisfy a number
of criteria, for example, they are unregistered, small, have unregistered employees
and/or they do not maintain a complete set of accounts. Here, enterprises/ units
include not only those that employ hired labour but also self-employed persons 203
Sector Specific Issues and such as street vendors, taxi-drivers, home based workers, etc. A wider concept of
Policies
informal sector includes informal employment, which as per NCEUS consist of
those working in the unorganised sector or households, excluding regular workers
with social security benefits provided by the employers and the workers in the
formal sector without any employment and social security benefits provided by
the employers.
17.2.1 Characteristics of an Informal Service Sector

Informal enterprises are often characterised by ease of entry; the use of local
resources; family ownership; small scale; labour-intensive adapted technology;
informally acquired skills; and relatively unregulated, competitive markets. The
informal sector is mainly located outside of (or antagonistic to) government
regulation although this may not be always true. Some firms do act in accordance
with government regulations. Some may evade them and in some cases the
government may actually try to enforce regulations on small firms. Firms may
comply with some but not other regulations. Perhaps the most useful, and
common, distinction between the two sectors (formal or informal) seems to be
with the number of employees in a firm. But this yardstick loses its relevance in
case of professional services such as doctors and lawyers.
Activities Included:
A good way to envision the informal service sector is through some of its activities.
Typical activities included in the informal service sector are:
General Services: tailoring, hair dressing, machinery repair, etc.
Commerce: retail sector, hotels, restaurants, lodging, etc.
Finance: Informal financial services including money lending, etc.
Real Estate: Construction and repair of public physical infrastructure projects,
houses, and dwelling units, etc.
Transportation: taxis, buses, etc.
Social and community services.
Miscellaneous: recycling, various illegal, immoral activities, etc.
Because informal firms operate outside some government regulation, often
employing family workers, wages are low. Because they may have a harder time
getting loans, and rely on informal financing, capital costs are higher. The lower
wage-rental ratio, combined with smaller scale, explains why more firms are
relatively labour-intensive in nature and operate with simpler technology.
The Informal Service Sector and Micro or Small-Scale Industries

Firms in the informal sector are usually of micro or small size. There are a number
of reasons for this, including small, fragmented markets, high transportation costs,
little access to capital and the prominence of labour-intensive industry such as
food processing and apparel tend to keep down the size of firms. Once these
barriers are overcome, firms can become quite large. In addition, a high degree
of government regulation is also a factor. The cost of regulations frequently
discourages the firms from crossing the invisible line that separates informal
from formal while the large firms are better able to withstand those costs; thus,
there are few mid-range firms.
204
Usefulness and Importance Services Sector II: Informal
Informal firms provide some services that are otherwise not available at all
or are available to only a small part of the population through the formal
sector.
They provide ancillary services (such as transportation and, repair work)
that permit the formal sector to provide a variety of services to individuals
who work in the formal sector.
Informal firms are an extremely important source of inexpensively acquired
skills including managerial and organisational skills for the poor workers in
the country.
Informal firms may compete with some formal firms, especially in services,
transportation and insurance, but they also provide strong backward linkages
to the formal sector by purchasing their machinery and raw materials.
The informal economy absorbs workers who would otherwise be without
work or income, especially in developing countries that have a large and
rapidly growing labour force or where workers are made redundant following
structural adjustment programmes.
The informal economy also helps to meet the needs of poor consumers by
providing accessible and low-priced goods and services.
Mode of Finance
Informal finance through moneylenders and co-operative organisations formed
by poor people are crucial. In both rural and urban areas, there are informal
rotating credit organisations in which funds are contributed by members and are
available to them either on a regular basis or as needed.
Outside the Coverage of Tax Laws

Unregistered and unregulated enterprises often do not pay taxes, and benefits
and entitlements to workers, which results in undervaluation of national income,
accumulation of black money and unfair competition to other enterprises. These
situations may deprive the government of public revenue thereby limiting
government’s ability to extend social services.
Informality is a Governance Issue

Informality is principally a governance issue. The growth of the informal economy
can often be traced to inappropriate, ineffective, misguided or badly implemented
macroeconomic and social policies, often developed without tripartite
consultation; the lack of conducive legal and institutional frameworks; and the
lack of good governance for proper and effective implementation of policies and
laws.
Informality can also be traced to a number of other socio-economic factors. These

include:
Poverty prevents real opportunities and choices for decent and protected work.
Low and irregular incomes and often the absence of public policies prevent people
from investing in their education and skills needed to boost their own
employability and productivity. Lack of education (primary and secondary) to
205
Sector Specific Issues and function effectively in the formal economy, in addition to a lack of recognition
Policies
of skills garnered in the informal economy, act as another barrier to entering the
formal economy. The lack of livelihood opportunities in rural areas drives migrants
into informal activities in urban areas or other countries.
The feminisation of poverty and discrimination by gender, age, ethnicity, or

disability also mean that the most vulnerable and marginalised groups tend to
end up in the informal sector. The informal sector also provides an environment
that allows child labour to thrive. The eradication of child labour requires the
programme to transfer jobs from the informal to the economic mainstream. Key
to the success of abolishing child labour is the creation of more quality jobs for
adults.

1) How is the informal sector usually defined in general and particularly in
India?
.......................................................................................................................
.......................................................................................................................
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2) What are the characteristics of informal sector and especially the informal
service sector in India?
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.......................................................................................................................
3) Do you agree with the view that informality is a governance issue?
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17.3 SIZE OF INFORMAL SECTOR IN INDIA

Table17.1 presents the contribution of formal/informal sectors to total GVA. The
share of informal sector is highest in agriculture as the holdings are small and
fragmented which is followed by trade, construction, real estate, and other
services.While the unorganised/informal sector now accounts for roughly half
of India’s GDP – and is shrinking relative to the share of the private and public
206
corporate sector – it accounts for 80-90 per cent of the workforce. The informal Services Sector II: Informal
service sector includes most of the rural non-farm economy and the vast services
sector, from high-end to low-end, the manufacturing labour force, workshop
industry and trade.
Table 17.1: Share of formal/informal sectors across broad sectors to GVA
Industry 2011-12 2017-18
Organised / Unorganised/ Organised/ Unorganised/
formal Informal Formal informal
Agriculture, forestry 3.2 96.8 2.9 97.1
and fishing
Mining and quarrying 77.4 22.6 77.5 22.5
Manufacturing 74.5 25.5 77.3 22.7
Electricity, gas, water 95.7 4.3 94.7 5.3
supply & other utility
services
Construction 23.6 76.4 25.5 74.5
Trade, repair, 13.4 86.6 13.4 86.6
Accommodation and
food services
Transport, storage, 53.0 47.0 52.3 47.7
communication & services
related to broadcasting
Financial services 90.7 9.3 88.1 11.9
Real estate, ownership 36.9 63.1 47.2 52.8
of dwelling & professional
services
Public administration and 100.0 0.0 100.0 0.0
defence
Other services 58.8 41.2 52.1 47.9
Total GVA at basic prices 46.1 53.9 47.6 52.4
Source: Computed from National Accounts Statistics, 2019
17.3.1 Factors behind Growth of the Informal Sector

i) Growth Strategy
India’s growth strategy adopted during the planning period has played a
significant role in impacting the growth of the informal sector in the country.
For instance, the Second Five Year Plan (1955-6 to 1959-60) involved
adopting an import-substituting industrialisation strategy, with a focus on
heavy-industry. This could not be, by definition, a strategy for rapid
absorption of surplus labour in agriculture. The result was as surplus workers
migrated away from agriculture in search of non-agricultural work, they
were inevitably absorbed in traditional services in both rural and urban areas.
If not, they were absorbed in unorganised manufacturing in micro-enterprises
employing less than 10 workers, where no social insurance was available,
in other words, in the informal sector of the economy.
207
Sector Specific Issues and ii) Reservation for Manufacturing by the Small-scale Units
Policies
Post-independence, in addition to the import-substituting industrialisation
strategy, Government decided to reserve manufacture of consumer products
of a non-durable nature for the small-scale sector, which began with a few
products and reached 836 in 1990. Since medium-sized firms or large
corporates were disallowed from entering this sector, the small enterprises
had no incentive to grow and absorb more workers in their manufacturing
units, thus exacerbating the problem of expanding informal sector resulting
from the heavy industry first strategy.
iii) Central and State Governments Labour Laws

Another factor which led to growth of tiny, micro, small informal sectors is
the plethora of central and state government labour laws. On the one hand,
hardly any labour laws were applicable to the small enterprises. On the
other hand, the larger enterprises, whether medium or large, became gradually
subject to a number of laws passed by state or central governments, which
protected the workers in the organised sector. While social insurance (in the
form of employee provident fund and health insurance) was mandatory, the
growing number of laws covering organised workers meant that employers
tended to adopt technologies that often limited the number of workers. The
number of central government laws related to labour alone amounted to 45
(in 2014, though after repeal of some the number fell to 35 by 2018), which
are often inconsistent with each other, and tend to grow in their coverage as
the size of enterprises increases. On top of these 35, there are state-specific
labour laws that organised segment firms in industry or services had to
comply with. The reaction of employers was inevitable: the fewer the
workers, the better it is from their perspective. Organised sector jobs grew
slowly, and most non-agricultural employment continued to grow in the
always unorganised sector in micro-enterprises, with workers employed
without any hope of social insurance.
iv) The Quality of Labour Supply

Another significant factor that resulted in the growth and persistence of
informality in India is the education and skill levels of the workforce. It is
pertinent to note that 146 million (or 30 per cent) of the workforce of 485
million in 2012 were illiterate. An additional 52 per cent (or 253 million) of
the labour force are those only with education upto secondary level (class
10). Barely 3 per cent of the workforce has technical education at tertiary
level, and another 7.2 per cent has general academic education at tertiary
level. As recently as 2017-18, only 2.4 per cent of the workforce has formally
acquired any vocational education or training.
NSS data allows an analysis of the workforce by three types of employment:

self-employed, casual wage labour, or regular salaried work. It is not surprising
that hardly any illiterates have regular salaried jobs. Most illiterate are either
casual workers or in self-employment usually engaged in low productivity work.
Over half of the self-employed are own-account workers, as opposed to being
employed in micro-enterprises which might have 2-9 workers. Firms that employ
less than 10 workers are defined in Indian official parlance as being in the
unorganised or informal sector. Just over half the workforce has education up to
secondary level. Well over half of those who have education upto secondary
208
level are self-employed. However, what is more worrying is that as many as 75 Services Sector II: Informal
million of those with secondary education actually are in casual work. Given
that nearly half of all those in the work force have secondary education the fact
that nearly a third of all those with secondary education are in casual work (without
any social insurance) is a challenge to policy makers.
The total number of those with higher secondary education (34.4 million) and
those who have graduate level education and above (35.6 million) is roughly
similar in the workforce. What is notable, however, is that half of those with
only higher secondary education are self-employed. Under a third of those with
higher secondary education are in regular salaried employment (while only 15
per cent of those with secondary education have regular salaried jobs). However,
half of those with graduate level education or above are in regular salaried
employment. What is worrying is that nearly four million of those with higher
secondary level of education are engaged in casual wage work.
Both the labour market as well as tertiary education outcomes for men and women
are rather different. It is well known that the labour force participation rate of
women in India is well below that for men and in fact is one of the lowest in the
world (at 23 per cent in 2011-12). Even more worrying is the fact that it has been
declining. Nearly half of the women in the workforce are illiterate but less than
one-third of men in the workforce are illiterate. Clearly, with a labour force that
has relatively poor levels of education, it is not surprising that most of them have
been absorbed, in informal services, or in informal construction sector. In none
of these areas does employment come with social insurance.
Thus, as per economic literature, growth in unorganised/informal sector is

generally due to either of the following reasons:
High monetary costs associated with a formal set-up acts as a barrier to
entry for informal enterprises (Exclusion view)
Benefits of formalisation are not high enough to compensate for the costs of
formalising and the survival of such enterprises will be difficult (Exit view)
People resort to start an informal business due to lack of wage jobs in the
formal economy (Dual economy view)
All these reasons can be attributed to the growth of informal enterprises in India.
As revealed in FICCI’s survey of industrial clusters, it is quite evident that
unorganised enterprises do not want to get registered as it entails huge barriers,
in terms of both monetary cost and time. In fact, one of the key reasons why
unorganised players do not register business is to avoid tax net as they operate at
marginal levels and cannot afford to pay taxes. Survival is a bigger concern for
such enterprises. They believe that post registration, they will be rendered
uncompetitive against not only the organised large players but also against the
unorganised players who continue to remain in the informal sector. Businesses
also view registration as unnecessary because they believe that it would lead to
harassment, compliance and legal binding. Moreover, various studies conducted
to study the issues involved with informal enterprises also indicate that weak
enforcement encourages informal entrepreneurs to refrain from legal processes
and rather incur slight cost of detection (in form of bribes to local authorities).
Such payoffs enable these enterprises to get away with fines and penalties.
209
Sector Specific Issues and Table 17.2 gives a sense of the formalisation of the workforce over the period
Policies
2011-12 to 2017-18.
Table 17.2: Distribution of Total Employment (per cent)

Worker 2011-12 2017-18
Unorganised Organised Total Unorganised Organised Total
Informal 82.6 9.8 92.4 85.5 5.2 90.7
Formal 0.4 7.2 7.6 1.3 7.9 9.3
Total 83.0 17.0 100.0 86.8 13.2 100.0
In 2011-12, in terms of employment share, the unorganised sector employs 83

per cent of the work force and while the share is 17 per cent in the organised
sector. There are 92.4 per cent informal workers (with no written contract, paid
leave and other benefits) in the economy. There are also 9.8 per cent informal
workers in the organised sectors indicating the level of outsourcing. These are
possibly the contract workers. In 2017-18 the share of unorganised sector
employment has increased by 3.6 percentage points while on the other hand the
share of formal employment has increased by 0.9 percentage points. There has
been an increase in the share of formal employment. This also indicates the efforts
of the government to provide social security to workers in the unorganised sector.
The Census of Micro, Small and Medium Enterprises (MSME) (2006-07) also
shows (Table 17.3) that of nearly 361 lakh MSMEs in India, about 95.7 per cent
are unregistered, with a large number operating in the unorganised/ informal
sector.
Table 17.3: Distribution of Working MSMEs by type of Organisation (in lakh)

Enterprises Registered Unregistered Total Per cent of
Unregistered
Proprietary 14.09 327.45 341.54 95.9
Partnership 0.63 3.65 4.28 85.3
Private Company 0.43 0.06 0.49 12.2
Co-operatives 0.05 1.16 1.21 95.9
Others 0.44 7.65 8.09 94.6
Not recorded 0.0 6.15 6.15 100.0
Total 15.64 346.12 361.76 95.7
Source: Fourth All India Census of MSME, 2006-2007.

1) What is the role and significance of informal sector in India?
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210
2) What according to you are the factors leading to exponentially increasing Services Sector II: Informal
size of informal sector?
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3) Do you think that the quality of labour supply has been a factor in the rise
and persistence of informal sectors?
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17.4 LEGAL AND REGULATORY FRAMEWORK

With more than half of the economic activities in India operating outside the
legal and regulatory framework, it becomes essential to understand as to why do
informal enterprises hesitate from becoming a legal entity. One of the reasons as
pointed out is the complexities and difficulties associated with the overall
regulatory framework.
According to the survey of selected industrial clusters undertaken by Federation

of Indian Chambers of Commerce and Industry and Konrad-Adenauer-Stiftung
(2017), the legal framework applicable for enterprises in India can be broadly
categorised into following:
Registration: To get registered, a business owner first needs to identify his/
her business as a particular entity namely sole proprietorship, partnership,
company, or a co-operative society. Each type of business entity has a
governing act which defines the entity.
Indirect Taxation: A registered business entity is required to collect tax on
all sales made and to deposit it with the government. Before 1st July 2017, a
business in the manufacture or trade of goods was bound to collect and pay
Excise Duty and Value Added Tax (VAT) respectively to the relevant
Government(s). Similarly, a service providing entity needs to collect and
pay Service Tax to the Government. There are several other indirect taxes
that a business passes on to the final consumer. From 1st July, 2017 onwards,
all indirect taxes for most goods and services have been subsumed under
one single indirect tax called the Goods and Services Tax. All existing and
new businesses have to register under the GST and will receive a GSTIN
for the same.
Direct Taxation: Profits earned by a business are taxable under the laws of
the Income Tax Act, 1961. In order to file Income Tax returns and deposit
211
Sector Specific Issues and the tax, the business entity is required to register for a Permanent Account
Policies
Number (PAN).
Besides these, there are certain regulatory procedures that need to be

complied by a legal entity. All businesses in the formal sector must comply
with the prescribed regulations. These include:
Security and Safety Regulations: To formally start a business, an enterprise

also needs to abide by various other regulatory procedures related to safety
and security that may be governed by specific Acts. For instance, a business
enterprise is required to obtain No Objection Certificates from Fire
department, Pollution Control Board, Health department, Licensing
Commissioner, etc.
Labour regulations: Various labour laws apply to a business entity,
depending on the number of employees that work there
– 1-9 employees: Workmen’s Compensation Act, 1923; Minimum Wages
Act, 1948; The Industrial Disputes Act 1947, etc.
– 10-19 workers: The payment of gratuity Act, 1972; Maternity Benefits
Act1961, etc.
– 20-49 workers: The Payment of Bonus Act, 1965; The Employees
Provident Fund and Miscellaneous Provisions Act, 1952, etc.
Vast numbers of business regulations at different levels of government are
contradictory as well as overlapping on account of these being administered by
the different tiers as well as layers of government. According to National
Manufacturing Policy, 2011 as amended thereafter, on an average, a unit in India
has to comply with 70 odd legislations. In another study undertaken by Industrial
Finance Corporation in Rajasthan on improving its business environment pointed
that businesses in Rajasthan are required to obtain 136 licenses of which 40
licenses relate to Union government, 66 licenses relate to State government and
24 licenses relate to Local government. The study also found that an average
medium sized business enterprise will require at least 28 licenses to start operating
its business in the state.
1) What is the legal and regulatory framework for Commercial Enterprises in
India?
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2) Do you think that legal and regulatory framework put in place for Commercial Services Sector II: Informal
Enterprises in India has contributed to exponential growth of informal service
sector in India?
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.......................................................................................................................
.......................................................................................................................
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17.5 INFORMAL SERVICE SECTOR: ISSUES AND

CHALLENGES
Informal enterprises are peculiar for working with small profit margins and a
business model which is vulnerable to sudden change. They face many challenges
that threaten their survival in a highly competitive and aggressive market. They
also lack awareness of the benefits derived from formalisation and organisation.
Key issues and challenges being faced by the informal enterprises especially in
the service sector in India are:
17.5.1 Costs Associated with a Formal Enterprise

The costs associated with formalisation are broadly of two types:
Entry costs: Besides the compulsory procedures in vogue to get registered
in the formal set up, which includes the licence or registration fees which
varies from state to state, the major deterrents during entry include:
– Complicated paperwork for firm registration
– Subsequent permissions, clearances, and licenses from multiple
departments of the Government
– One-time fees to be paid
– Time involved in getting registered.
Recurring costs: The recurring costs associated with working in the formal
economy include:
– Monetary costs like taxes, fees, social security contributions
– Compliance costs with respect to labour and other regulations, and
– Harassment by Government officials following any discrepancy in
compliance.
After registration, there are numerous rules and regulations that have to be abided
by the small firms that hold them back from growing in size. For example, a
large number of small firms feel that income tax and EPF payment obligations as
hurdles and therefore they ensure themselves to be below the threshold size in
order to avoid compliance. Labour regulations, especially stringent hiring and
firing rules also keep the entrepreneur’s hands tied. A lot of the firms’ finances
during their growing phase are diverted towards employees’ compensation and
social security contributions. Also, registered firms cannot pay their employees
below the minimum wage level or else it would attract heavy fines and penalties.
213
Sector Specific Issues and As against this, small firms find it beneficial to operate in the informal sector.
Policies
They are free from bearing the entry costs and the formal operating costs as
faced by formal organisations. They do not have to comply with stringent rules
and regulations, nor are they forced to compensate their employees in a particular
way. They can thus retain all their earnings with minimal costs and hence have a
huge incentive to remain undetected.
17.5.2 Risks Associated with being an Informal Enterprise

Contrary to the benefits of staying informal, there are also several costs associated
with informality. To remain undetected, informal businesses are required to use
less-visible work places (often residential), keep a smaller number of employees
and that too dispersed, avoid certain market places and keep the scale of business
low. These phenomena directly affect the firms’ business, forcing them to operate
at thin margins. Additionally, if detected, the firm has to bribe authorities to
avoid penalties and fines.
Informality deprives a small firm of external funds, restricting it from investing

in new fixed assets which would help the firm grow. It cannot use its existing
assets as collateral for fresh credit. An unregistered firm does not enjoy the benefits
of the country’s legal system. Thus, informal enterprises are unable to reap benefits
associated with being in the formal set up, namely ease of permanent location,
access to formal credit, insurance, access to business development services, and
access to larger geographical market as well as benefit of utilising online
marketplaces.
17.5.3 Challenges for their Growth and Scalability

The small units operating in an informal environment face severe survival
challenges, especially due to competition from big manufacturers. In a FICCI
Survey of informal enterprises conducted in 2017, almost 80 per cent of the
small informal businesses that were surveyed indicated that their business has
been declining and will continue to do so in future. Most of these enterprises
operate on thin margins and have been impacted by cheaper imports as well as
shift in consumer purchases towards organised retail market. Since most of them
are unsure of their future growth or even survival, there is high resistance to
undergoing the formalities for formal registration. Major challenges posed by
these firms are corruption, availability of regular electricity, and access to easy
credit. In order to ease these issues, they expect the Government to rationalise
tax rates, invest in skill development, ban predatory pricing by large firms and
promote competitive business practices.
17.5.4 Impact of Demonetisation on the Informal Sector

Demonetisation in November, 2016 ceased the legal tender status of Rs. 500 and
Rs. 1000 Indian currency notes in an attempt to counter a host of factors affecting
the economy adversely, including, black money, hoarding, counterfeit notes, terror
financing, among others. With 98 per cent of transactions made in cash before
demonetisation, the removal of currency notes dealt a massive shock to the
informal sectors. Unfamiliar with e-tech, unwilling to pay hefty commissions on
e-transactions, or to depend on mobile bankers the informal sector did not trust
or to face physical discrimination in banks, the informal workforce reverted to
old forms of exchange: barter, payments in kind, long-term credit promises, gifts,
214
reciprocal social support. Some informal enterprises especially the family firms Services Sector II: Informal
began to rely on credit lines of big corporations by becoming their retail agents,
as a result of which casual wage workers replaced the family workers in such
enterprises.
In the period that followed, India’s real economy took a beating. Production and
consumption contracted. Agricultural activities were delayed. Starved of cash,
supply lines in all sectors without exception were disrupted: prices went haywire,
job losses and chaotic flows of migrant workers grew to unprecedented levels.
In the black economy there was temporary stop, after which it was business as
usual. Growth in the tax base also has been mediocre. Investment in registered
MSMEs has shrunk. Despite some re-employment, the unemployment rate rose
and unemployment of more educated workers is at levels not seen for over four
decades.
17.5.5 Impact of GST on the Informal Sector

The Goods and Services Tax reform (July 1, 2017) was sought to bring the
informal sector under the regulatory framework. In other words, it was widely
predicted that GST will formalise the informal sector and this in turn will reduce
the economic share of unregistered/informal firms. The costs of compliance of
GST were expected to put these firms out of competition. The necessary ‘paper
trail’ and document-matching for purchases and sales (in fact regular e-returns)
would force them to make hefty investments in IT and increase their skilled
labour and materials costs. However, the research studies have been revealing
that the formalisation of the informal sector is not happening to the extent
predicted. Disregarding the reports of chaos in implementation caused by many
fought-over amendments, GST further penalised small firms through delays in
refunds. It generated a perverse redistribution from small to large firms, just as it
has penalised states in relation to the Centre.
GST had the outcome as feared, in terms of sharp hits in profits in firms with
recorded turnovers above the threshold of Rs. 20 lakhs, especially in trading
firms, service-providers and micro enterprises (general stores, tailors, cobblers,
barbers, plumbers, masons, electricians, etc.), resulting in reports of job losses
in the informal economy of between 35 and 45 per cent. The household savings
trends reveal that the informal economy has indeed been battered to the point
where growth is depressed and that capital formation in the corporate sector has
finally started to exceed that in the informal sector.
17.5.6 Impact of Coronavirus and Lockdown on the Informal

Sector
The COVID-19 pandemic has caused a global multidimensional crisis, one of its
impacts being the crisis on the informal economy. Even in the pre-COVID-19
period, the informal sector was reeling under shocks from economic slowdown,
demonetisation and a poorly rolled out GST. As per the Periodic Labour Force
Survey (2017-18), about 57 per cent of rural households derived their major
income from self-employment activities, and 25 per cent had a major source of
income from casual labour. The proportions of regular/wage salaried earners
accounted for 12.81per cent of rural households. In urban India, the corresponding
figures were 37.57 per cent, 12.68 per cent and 41.66 per cent. Many of these
rural self-employed households are marginal cultivators and petty artisans, while 215
Sector Specific Issues and in urban areas they are engaged in small shops, low-scale businesses or
Policies
intermediation activities. Larger share of the self-employed and casual labour
households indicates the extent of hardships millions of households must have
undergone due to the suspension of economic activities amid the COVID-19
outbreak. The closure of businesses results in lost wages for workers in many
cases, especially in the informal economy where there is no paid leave. The
results of many surveys reveal that workers in the informal sector experienced
decline in their incomes or loss of income altogether. This in turn has pushed the
masses into deeper poverty.

1) List out the major challenges being faced by the informal sector and
particularly the informal service sector in India.
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2) Do you agree that demonetisation of currency of high denominations in
November 2016 which was followed by introduction of GST in July 2017
have further worsened the situation of informal sector in India?
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17.6 POLICY IMPLICATIONS

Unit 16 highlighted the fact that reforms in India at the sectoral level have evolved
in an ad-hoc way which is probably one of the most important reasons for lopsided
growth in services. There has been no coherent overall policy for services in line
with the industrial policy and agricultural policy. Consequently, the depth and
pace of reforms lack uniformity across sectors. In that unit, role and significance
of some services sub-sectors was highlighted. As the size of informal service
sector is quite large and provides the livelihood to those needed it most, i.e.,
vulnerable groups (unskilled, semi-skilled, illiterate persons, women, etc.) of
the society, under this section, the role of government at various levels is
highlighted so that informal sector can also grow with high productivity and
those employed in this sector can enjoy the benefits of social security, high rates
wages/remuneration and security of jobs.
17.6.1 Role and Responsibility of the Governments

Since decent work deficits are often traceable to good governance deficits, the
216 government has a primary role to play in improving the quality of work
opportunities. Governments should adopt a dynamic approach to place decent Services Sector II: Informal
employment at the centre of economic and social development policies. It must
promote well-functioning labour markets and labour market institutions, including
labour market information systems and credit institutions. To increase job quantity
and quality, emphasis should be placed on investing in people, especially the
most vulnerable – in their education, skills training, lifelong learning, health and
safety – and encouraging their entrepreneurial initiative. Poverty reduction
strategies, in particular, should specifically address the problems in the informal
economy. The creation of decent jobs should be a measure of success for these
strategies.
Governments should have a lead responsibility to extend the coverage of social
security to groups in the informal economy which are currently excluded. Micro
insurance and other community-based schemes are important but should be
developed in ways that are consistent with the extension of national social security
schemes. The government has launched several policies and programmes for the
development of the small and informal sector markets, but the perks of such
initiatives do not seem to be reaching the actual targets. When enquired, it seems
that they are unaware of these policies and programmes. For example, while the
Central Government has passed the Street Vendors Act, 2014, which aims to
protect the livelihood of street vendors, the same has not been implemented at
the municipal level in many districts of the country. Granting legitimacy to street
vendors is one of the strongest tools for formalisation, and while the provisions
exist in law, the same need to be strictly implemented and enforced at the states
and municipal levels.
Thus, making the administrative procedures simpler and less costly, introducing
special and lower tax rates for small firms, providing them proper access to
credit and financing for their better management, taking care of their social
security contributions and replacing inspections and fines with training to improve
awareness and knowledge of the entrepreneurs so that they are not harassed by
the public officials are some of the measures which can help in promoting
formalisation among the micro, small and medium firms.
Policies should also aim at developing greater understanding of the relationship
between the informal economy and the feminisation of work and identify and
implement strategies to ensure that women have equal opportunities to enter and
enjoy decent work.
17.6.2 Access to Credit

The informal business owners cannot use their assets as collateral when requesting
for formal credit. Thus, obtaining adequate financing is difficult and costly for
informal firms, making it hard to run and expand their business. Thus, policies
providing them access to finance and credit acts as incentives to formalise. For
instance, Colombia promoted young entrepreneurs and provided them easy access
to credit. “Colombia goes formal” helped firms who wished to formalise, through
credit lines and grants.
All these measures if implemented by the governments at various levels with

utmost sincerity and transparency will improve the image of informal sectors
within a reasonable period of time. Particularly, if the state initiates efforts as
early as possible to provide social insurance coverage to the poor among the
217
Sector Specific Issues and unorganised segment, informal workers, this process will constitute a huge gain
Policies
for the realisation of the rights of workers.
17.6.3 Tax Reforms

The tax laws and regulations that come along with formalisation are something
that the small business owners take into account while making the decision to
formalise. Not only the rates, but the complexity of procedures, multiplicity of
taxes and the lack of information and support also disincentivises the entrepreneurs
from formalising their business.
In order to promote formalisation, the steps that could be taken in the field of
taxation include special tax regimes for MSMEs, convenient payment
mechanisms, proper information and assistance and measures to check tax
evasion. Special tax regimes for MSMEs include lower tax rates, certain
exemptions, and integration of different taxes into a single payment. For instance,
in Costa Rica, small companies faced preferential tax rates and were exempted
from a corporate tax. Only the MSMEs registered with the Ministry of Economy
could take benefit of this exemption, thus reinforcing formalisation.
17.6.4 Social Security Contributions

Informal businesses often fail to comply with their obligation related to the social
security coverage of the workers in the firm. The costs related to declaring and
paying to different social security administrators acts as obstacles to formalisation.
Another disincentive to formalisation is the lack of continuity in social security
payments, caused by seasonal or intermittent employment in micro and small
enterprises. Limited knowledge among employers and employees about the real
benefits of social security constitutes another obstacle.
Given these difficulties, the benefits from complying with social security payment
schedules should be such that the stakeholders consider them to be valuable. The
services that these schemes provide should be of good quality, in areas such as
health, maternity and unemployment. Schemes like accidental insurance coverage
at work act as incentives to labour formalisation. Social security schemes should
be designed with the following characteristics to favour formalisation: (a)
progressive social security contributions, (a) subsidies for social security
contributions on low-income wages, (c) reduction of the administration costs of
social security schemes.
17.6.5 Inspection and Compliance

The limited control of the tax and labour authorities over the informal firms acts
as an obstacle to their formalisation. Regulation concerns not only labour law,
but also health and safety, taxation, accounting rules, technical standards,
consumer rights, bureaucratic procedures, and more. There is need for better
regulatory environment. Complying with the law must become easier and law
enforcement should be more effective. It is important that the small firm owners
are not harassed by the public authorities.
Measures that involve capacity building are more effective than punitive sanctions
for lack of compliance. For example, in Chile and Peru, inspectorates provide
training for micro and small enterprises (MSEs) to comply with the law,
218
particularly on safety and health issues, instead of imposing a fine on them for Services Sector II: Informal
defaulting. In order, to be able to impart better knowledge and information about
the rules and regulations, it is necessary to train the officials to interact with the
employers and at the same time, it is necessary to organise training programmes
and information campaigns for employers and employees of micro and small
enterprises.
17.6.6 Awareness and Promotional Campaigns

Very often, micro and small entrepreneurs lack awareness of not just rules and
regulations but also of various policies and schemes being run by the authorities
to support registered enterprises. Industry and trade Chambers such as FICCI,
CII and ASSOCHAM, in collaboration with or through other relevant
organisations could assist economic units operating in the informal economy in
a number of important ways, including access to information which they would
otherwise find difficult to obtain. They could extend business support and basic
services for productivity improvement, entrepreneurship development, personnel
management, accounting, and the like. They could help develop a lobbying agenda
specially geared to the needs of micro and small enterprises.
Trade unions can sensitise workers in the informal economy to the importance
of having collective representation through education and outreach programmes.
They can also make efforts to include workers in the informal economy in
collective agreements. With women accounting for a majority in the informal
economy, trade unions should create or adapt internal structures to promote the
participation and representation of women and also to accommodate their specific
needs. Trade unions can provide special services to workers in the informal
economy, including information on their legal rights, educational and advocacy
projects, legal aid, provision of medical insurance, credit and loan schemes and
the establishment of cooperatives.
17.7 LET US SUM UP

The Service sector in India has been the fastest growing sector in the last decade.
Within the service sector, we find that the fastest growing services in the 1990s
have been trade, communications, financial services, business services and
community services like health and education. The literature on growth in service
sector primarily argues that when an economy grows, both demand side and
supply side factors operate that lead to higher growth in the service sector as
compared to the other sectors and also lead to a larger share of service sector in
total employment.
However, the unfortunate part of growth of the service sector over time has led
to informalisation of its growth process thereby creating a dualism in the sector
wherein one component is growing very fast with high productivity while other
component, quite large in size, has become laggard growing in size but not in
terms of growth in productivity and profitability. As a result, those employed in
the laggard informal service sector remain vulnerable in terms of low level of
income and wages, insecurity of jobs, lack of social security and other benefits
associated with the job if it had been in the formal service sector. The dynamic
analysis presented in this unit highlights the factors responsible for such a growth
of the sector and policy initiatives needed at comprehensive scale to improve the
219
Sector Specific Issues and image and status of informal sector. Many of the issues highlighted above if
Policies
addressed can help in further growth of the services sector. This can make the
services sector which is already the dominant growth contributor to become a
high growth propeller, along with foreign exchange earner and employment
provider for India.
17.8 KEY WORDS

Covid-19 : Coronavirus disease 2019 is a mild to severe
respiratory illness that is caused by
a Coronavirus.
Demonetisation : The act of stripping a currency unit of its
status as legal tender.
Goods and Services Tax : An indirect tax (or consumption tax) used in
(GST) India on the supply of goods and services. It
is a comprehensive, multi-stage, destination-
based tax that is levied on every value
addition made along the supply chain.
Import-substituting Strategy : A trade strategy or policy that advocates
replacing foreign imports with domestic
production.
Informal Sector : Informal sector refers to all economic
activities by workers and economic units that
are – in law or in practice – not covered or
insufficiently covered by formal
arrangements.
17.9 REFERENCES
In addition to the readings listed under Unit-16, some additional readings are
listed below:
1) Federation of Indian Chambers of Commerce and Industry and Konrad-
Adenauer- Stiftung (2017).‘Informal Economy in India: Setting the
framework for formalization’, published by FICCI, Tansen Marg, New Delhi.
2) Kundu, A., & Sharma, A. N. (Eds). (2001). Informal sector in India:
Perspectives and policies. New Delhi: Institute for Human Development
and Institute of Applied Manpower Research.
3) Ministry of Finance (2018). “Economic Survey of India 2017-18”
Government of India, New Delhi.
4) Ministry of Lavor and Employment (2013-14). “Report on Employment in
Informal Sector and Conditions of Informal Employment (2013-14), Volume
IV”, Government of India, New Delhi.
5) NSO (2019). 2017-18-unit level data, Periodic Labour Force Survey, NSSO
Ministry of Statistics and Program Implementation. Government of India.
New Delhi.
220
6) NSSO (2013). 2010-11-unit level data, 67th round, Unincorporated Non- Services Sector II: Informal
agricultural (excluding Construction) enterprise survey in India, Ministry
of Statistics and Program Implementation. Government of India. New Delhi.
7) NSSO (2014). 2011-12-unit level data, 68th round, Employment
Unemployment survey, NSSO Ministry of Statistics and Programme
Implementation. Government of India. New Delhi.
8) National Statistical office (2015). Report of the Sub Committee on
Unorganized Manufacturing & Services Sectors for Compilation of National
Accounts Statistics with Base Year 2011-12.
9) Rangarajan C., Padma I. K. and Seema (2011). “Where Is the Missing Labour
Force?”, Economic and Political Weekly, Vol. 46, No. 39.
10) Report of the Working Group on Business Regulatory Framework 2011,
“Towards Optimal Business Regulatory Governance in India”, Steering
Committee on Industry, Planning Commission, Government of India.

PROGRESS EXERCISES



2) See Sub-section 17.5.4 and 17.5.5 and answer.
221
Policies APPENDIX 17.1
Why Informal India cannot be ‘Atmanirbhar’ India?
Atmanirbharta, or self-reliance, has been a holy grail for the Indian economy. In
its present avatar, the idea hovers around increasing competitiveness and growth
of the manufacturing sector which will in turn is expected to further expand the
service sector. Competitiveness arises from productivity differentials, which, in
turn, are a function of firm size. Larger firms are more productive with higher
value added per capita, and higher levels of sales and output per employee. Formal
status is another empirically established characteristic of productive firms across
countries. World Bank’s micro and informal enterprise surveys show that for
India the wedge between value added per employee in a registered and
unregistered firm is 35 per cent, that between a small registered firm and a large
firm is 68 per cent, and that between a large registered firm and an unregistered
firm is 212 per cent.This differential is due to large, formal firms’ access to
external finance, and use of more capital per labour. These firms with economies
of scale are often run by better educated managers, and employ specialised staff
for specific functions, resulting in better internal processes, and customer outreach,
allowing these firms to generate sustainable productivity differentials to achieve
competitiveness.
There are 19.67 million micro, small and medium enterprises (MSMEs)
employing 36.04 million people. The share of micro enterprises, among MSMEs
is almost 99 per cent.The antimonopoly regulations and stringent labour laws
practised over years have ensured that the average Indian manufacturing firm
remained small in size. The employment-generating and cost-cutting
characteristics of these informal firms have made us believe that informality is
forced by excessive cost of regulation. It is important to start acknowledging
that these firms may be unproductive, run by lowly qualified managers, unable
to function efficiently and, therefore, out of formal structure. The notion that
economic growth will generate returns for these firms, bringing them into
formality has not worked so far. Nor is there much empirical support for the
hypothesis of registration alone increasing their productivity.
Shift to a formal status would typically mean additional costs of paying taxes,
adhering to safety norms, and providing additional employment benefits to
workers. All these are genuine costs. Any estimation of loss of revenue to the
exchequer due to tax evasion, loss of lives and project assets due to non-
compliance with safety norms, and loss of productivity due to non-provision of
social security to employees, is sure to bypass the loss of profitability to informal
enterprises.
However, thrust of the self-reliance movement undoubtedly has to be on designing

regulatory systems conducive to creating large firms with a clear competitive
edge. Ample macroeconomic evidence suggests that limited access to capital
constrains productivity growth in developing countries. Ownership of banks by
the government has resulted in hampered credit allocation as there is a conflict
of interest between social objectives and the running of an efficient financial
system. Implicit government guarantee weakens their incentives to pursue
operational efficiency. They are prone to evergreen non-performing loans and
keep insolvent borrowers afloat. Slow in adopting new technologies to improve
222
the efficiency of financial intermediation, public banks are more susceptible to Services Sector II: Informal
distress than private banks. Their investment in government securities reduces
availability of loans to the private sector. Designing regulations to prune these
hydra-headed institutions is vital in pursuance of self-reliance.
‘Atmarnirbhar’ development requires organisations that can benefit from scale

economies, entrepreneurs who take risks and grow those organisations,
independent professionals who have the skills that can support technological
progress and productivity growth, and banks that understand the hazards of
providing credit and that diversify their risks while financing growth. It requires
regulating and unleashing the power of markets and holding back the temptation
to use the state to direct scarce resources towards centrally-handed-down goals.
The informal sectoreffectively constitutes 90 per cent of the workforce and about
50 per cent of the national product. As per Government of India statistics, the
unorganised sector contributes almost 50 per cent of the total GDP. The Economic
Survey of 2018-19, released on 4 July, 2019, said “almost 93 per cent” of the
total workforce is “informal”. Around 86per cent of those working in the informal
sector are not covered under labour legislation and they have absolutely no
protection in terms of employment as they do not have an appointment letter,
contract, guarantee for wages, health facilities, insurance, etc. They are at the
mercy of the employer.
If the Centre realises the importance of the informal sector and its contribution
to the economic growth of the country, it will need to define the sector effectively,
provide labour legislation to protect employment, wages and treat them on par
with the formal sector. As long as these measures are not put in place, it is difficult
for informal India to become Atmanirbhar India.
223
MEC-205
Indian Economic
Policy
VOLUME-III
(Block 5 and 6)

EXPERT COMMITTEE
Prof. Atul Sarma Prof. R. Nagraj Prof. Pravakar Sahoo
Former Director, Indira Gandhi Institute of Institute of Economic
Indian Statistical Institute Development Research, Mumbai Growth, New Delhi
Prof. S.K.Singh Prof. K. Barik
Former Professor of Economics Professor of Economics
New Delhi
IGNOU, New Delhi IGNOU, New Delhi
Prof. N.R. Bhanumurthi
Prof. Vijay Katti Shri Saugato Sen
Professor and Head, Economics and Associate Professor of
Trade Policy, IIFT, New Delhi Economics
Prof. Prem S.Vashistha IGNOU, New Delhi
Shri I.C.Dhingra
Rtd. Director, Agro Economic
Rtd. Associate Professor Prof. Narayan Prasad
Research Centre,
Shaheed Bhagat Singh College Professor Economics
(University of Delhi), Delhi IGNOU, New Delhi
COURSE EDITOR : Prof. Rajeev Malhotra, Former Economic Advisor to the Union
Finance Minister, Govt. of India

BLOCK 5 EXTERNAL SECTOR AND TRADE POLICY
Unit 18 Trade Policy Deepika Shrivastava Prof. Narayan Prasad

Dy. Director, Ministry of Ms. Chetali Arora
Agriculture, New Delhi
Unit 19 Foreign Trade and Balance of Dr. Shyam Sunder Prof. Narayan Prasad
Payment Mahindra and Mahindra Ltd. Ms. Chetali Arora
New Delhi
Unit 20 Foreign Capital Dr. Shyam Sunder Prof. Narayan Prasad
Mahindra and Mahindra Ltd. Ms. Chetali Arora
New Delhi
BLOCK 6 MAJOR ISSUES CONFRONTING INDIAN ECONOMY
Unit 21 Poverty, Malnutrition and Inclusive Dr. S K Mishra, Fellow Prof. Narayan Prasad
Growth: Policy Implications IHD, New Delhi Ms. Chetali Arora
Unit 22 Employment and Unemployment: Prof. Narayan Prasad Ms. Chetali Arora
Policy Challenges Professor of Economics
IGNOU
Unit 23 Social Security Measures in India Dr. Sant Lal, Visiting Prof. Narayan Prasad
Professor, IHD, New Delhi
Unit 24 Regional Disparity in India: Dr. S K Mishra, Fellow Ms. Chetali Arora
Policy Implications IHD, New Delhi
Unit 25 Ingredients of Good Governance Prof. PK Chaubey Prof. Narayan Prasad
Rtd. Professor Ms. Chetali Arora
IIPA, New Delhi
Ms. Kamini Dogra
Personal Assistant
PRINT PRODUCTION
Mr. Yashpal
Assistant Registrar (Publication)
IGNOU, New Delhi
May, 2021
ISBN :
Printed at:
4
Contents
BLOCK 5 EXTERNAL SECTOR AND TRADE POLICY 7

UNIT 18 Trade Policy 9
UNIT 19 Foreign Trade and Balance of Payment 27
UNIT 20 Foreign Capital 55
BLOCK 6 MAJOR ISSUES CONFRONTING INDIAN 97

ECONOMY
UNIT 21 Poverty, Malnutrition and Inclusive Growth: Policy 99
Implications
UNIT 22 Employment and Unemployment: Policy Challenges 131
UNIT 23 Social Security Measures in India 154
UNIT 24 Regional Disparity in India: Policy Implications 173
UNIT 25 Ingredients of Good Governance 202
5
BLOCK 5
EXTERNAL SECTOR AND TRADE POLICY
BLOCK 5 EXTERNAL SECTOR AND TRADE
POLICY
In the post economic reforms period, external sector in the economy has gained
prime importance. Foreign trade contributes to economic development in number
of ways. Hence, the external sector and trade policy constitutes the subject matter
of this block. The block comprises of three units.
Unit 18 entitled Trade Policy throws light on the characteristics of international

trade and status of the Indian trade prior to and post 1991 reforms. Various
instruments of Trade policy with special reference to the developing nations
have been highlighted. Emerging trade issues, along with the policy response to
them in the form of FDI policy have also been spelt out in this unit.
Unit 19 entitled Foreign Trade and Balance of Payment discusses the role of
foreign trade in economic development of a country. The Unit also examines
India’s foreign trade and the changes in its direction and composition. The
country’s Balance of Payment position, and the policy framework adopted for
restoring the balance of payments have also been discussed.
Unit 20 on Foreign Capital analyses the role of foreign capital in the growth
process of a developing economy. It discusses the types, the sources of foreign
capital and the evolution of India’s policy with respect to the foreign capital. The
composition, trend, sources and destinations of overseas foreign direct investment
in the context of Indian economy have also been examined.
8
UNIT 18 TRADE POLICY Trade Policy
Structure
18.0 Objectives
18.1 Introduction
18.2 International Trade Policy
18.3 Instruments of a Trade Policy
18.4 International Trade Agreements: A Brief History
18.5 Trade Policy of Developing Economies
18.6 Trade Policy of India
18.6.1 Prior to 1991
18.6.2 Post 1991
18.6.3 FDI Policy in India
18.7 India and the Changing Nature of World Trade
18.7.1 Trade in Services
18.7.2 Trade in Intellectual Property
18.7.3 Trade in Agriculture
18.8 Regional Agreements relevant for India
18.8.1 Regional Comprehensive Economic Partnership (RCEP)
18.9 Recent Scenario in Indian Trade
18.10 Trade Policy of India 2015-2020
18.11 Let Us Sum Up
18.13 Key Words
18.14 References
18.0 OBJECTIVES
● discuss the characteristics of International trade and in particular about
the Indian trade prior and post 1991;
● identify the instruments of a trade policy;
● appreciate the trade policy of developing economies;
● point out the emerging foreign trade issues in the changing nature of
world trade;
● explain the role of the FDI policy in India; and
● evaluate the Foreign Trade Policy 2015-20.
9
External Sector and
Trade Policy 18.1 INTRODUCTION
In this unit we shall discuss the Indian trade policy, its features in pre-
economic reforms and post- economic reforms periods. We shall highlight
the trade related important issues like trade in services, trade and intellectual
property rights, and agriculture and regional trade agreements. The features
of the trade policy 2015-2020 and its evaluation will also be discussed. To
begin with, let us discuss the concept of international trade policy.
18.2 INTERNATIONAL TRADE POLICY

International trade policies from a country’s point of view are those policies
which the government adopts towards international trade. These are the
policies that involve a number of actions like taxes on international
transactions of goods and services, subsidies for other transactions, legal
limits on the value and volume of imports and exports and many other
measures. Trade policy involves a number of instruments described in the
section that follow.
Additionally, there are various international organisations ensuring smooth
trade flows between the nations. For instance, the World Trade Organisation
(WTO) is a major international organisation that deals with the rules of trade
between nations. WTO operates a global system of trade rules, acts as a
forum for negotiating trade agreements, settles trade disputes between its
members and supports the trade related needs of developing countries. Thus,
the goal is to ensure that trade flows are as smooth, predictable and free as
possible.
18.3 INSTRUMENTS OF A TRADE POLICY

1) Tariffs
Tariffs are among the oldest forms of trade policy instruments and have
traditionally been used as a source of government income. Tariffs can be
classified as:
● Specific tariffs– taxes that are levied as a fixed charge for each unit of
goods imported.
● Ad-valorem tariffs– Taxes that are levied as a fraction of the value of the
imported goods.
A compound duty (tariff) is a combination of an ad-valorem and a specific

tariff.
In analysing trade policy in practice, it is important to know how much

protection a trade policy actually provides. Protection can be categorised as
nominal rate or effective rate of protection. The nominal rate of protection
(NRP) on any good is the proportional difference between its domestic and
international (or world) price arising from the trade policies in question.
10
These policies can include import tariffs, export taxes, quantitative Trade Policy
restrictions, etc. Thus, NRP is
NRP = (Pd – Pw)/ Pw × 100
Where Pd and Pw are the domestic and world price, respectively.
Since trade involves both inputs and outputs, it is important to measure

effective rate of protection i.e. one must consider both the effects of tariffs on
the final price of a good, and the effects of tariffs on the costs of inputs used
in production.
The effective rate of protection is a commonly used measure of net effect of
trade policies on the incentives facing domestic producers. In case of a
garment producer, for instance, taxes or other restrictions on clothing imports
raise domestic clothing prices and are beneficial to domestic producers
selling in the local market. On the other hand, a tariff-induced increase in the
domestic price of fabric raises garment producers’ costs and so is harmful to
them. The net impact of trade policies on the producers of any good depends
on their effects on prices of both their outputs and their inputs.
One can express the amount of effective protection as a percentage of the

price that would prevail under free trade. The actual protection provided by a
tariff will not equal the tariff rate if imported intermediate goods are used in
the production of the protected good.
Thus, Rate of Effective Protection = [VT – VW] / VW where V is value

added at world prices (W) and in presence of trade policies (T).
For example: Suppose a 10 per cent tariff is applied to motorcycles, so that a
totally India made motorcycle which originally sold for Rs. 25000 (under free
trade) can now sell for Rs 27500 because of the protection from foreign
imports. In this calculation, effective protection equals nominal, i.e., 10 per
cent. However, suppose imported inputs used in motorcycles were Rs.15000.
Then the effective rate of protection is 25 per cent {= [(27500 –
15000)/10000)] – 1}.
2) Export Subsidies
It is a payment by the government to a firm or individual that ships a good
abroad. When the government offers an export subsidy, shippers will export
the good up to the point where the domestic price exceeds the foreign price
by the amount of the subsidy. It can be either specific or ad valorem. An
export subsidy raises prices in the exporting country while it lowers them in
the importing country.
3) Import Quotas
An import quota is a direct restriction on the quantity of a good that is
imported. The restriction is usually enforced by issuing licenses to some
group of individuals or firms i.e. the right to sell in India is given directly to
the governments of exporting countries. License holders are able to buy
imports and resell them at a higher price in the domestic market. The profits
received by the holders of import licenses are known as quota rents. 11
External Sector and 4) Voluntary Export Restraints
Trade Policy
A voluntary export restraint (VER) is an export quota administered by the
exporting country. It is also known as a voluntary restraint agreement (VRA).
VERs are imposed at the request of the importer and are agreed to by the
exporter to forestall other trade restrictions. A VER is exactly like an import
quota where the licenses are assigned to foreign governments and is therefore
very costly to the importing country. A VER is always more costly to the
importing country than a tariff that limits imports by the same amount. The
tariff equivalent revenue becomes rents earned by foreigners under the VER.
5) Local Content Requirements

A local content requirement is a regulation that requires that some specified
fraction of a final good be produced domestically. This fraction can be
specified in physical units or in value terms. Local content laws have been
widely used by developing countries trying to shift their manufacturing base
from assembly back into intermediate goods. Local content laws do not
produce either government revenue or quota rents. Instead, the difference
between the prices of imports and domestic goods gets averaged in the final
price and is passed on to consumers. Firms are allowed to satisfy their local
content requirement by exporting instead of using parts domestically.
Other restrictions are like Export Credit Subsidies (form of a subsidised loan
to the buyer of exports, resulting in the same effect as regular export
subsidies), National Procurement [purchases by the government (or public
firms) can be directed towards domestic goods, even if they are more
expensive than imports], Red Tape Barriers (barriers put by the governments
based on health, safety and customs procedures).
18.4 INTERNATIONAL TRADE AGREEMENTS:

A BRIEF HISTORY
Post-World War II, in order to take full advantage of bilateral and multilateral
coordination, a group of 23 countries began trade negotiations under a
provisional set of rules that became to be known as the General Agreement
on Tariffs and Trade, or GATT. Officially, the GATT was an agreement, not
an organisation-the countries participating in the agreement were officially
designated as “contracting parties,” not members. In practice, the GATT did
maintain a permanent “secretariat” in Geneva, which everyone referred to as
“the GATT”. In 1995, the World Trade Organisation (WTO) was established-
finally creating the formal organisation envisaged 50 years earlier. However,
the GATT rules remain in force, and the basic logic of the system remains the
same. Tariffs were the main point of contention among countries. Thus,
various trade rounds (wherein, large groups of countries get together to
negotiate a set of tariff reductions and other measures to liberalise trade) were
conducted to reach a consensus on the tariff issues. The first five trade rounds
under the GATT took the form of “parallel” bilateral negotiations, where
each country negotiates pair-wise with a number of countries at once. The
sixth multilateral trade agreement, known as the Kennedy Round, was
12
completed in 1967. This agreement involved an across-the-board 50 per cent Trade Policy
reduction in tariffs by the major industrial countries, except for specified
industries whose tariffs were left unchanged. The so-called Tokyo Round of
trade negotiations (completed in 1979) reduced tariffs employing a formula
more complex than that used under the Kennedy Round. Finally, in 1994 an
eighth round of negotiations, the so-called Uruguay Round was completed.
The Uruguay Round, like previous GATT negotiations, cut tariff rates around
the world. The average tariff imposed by advanced countries fell almost 40
per cent as a result of the round. More important than this overall tariff
reduction were the moves to liberalise trade in two important sectors,
agriculture and clothing.
The ninth major round of world trade negotiations, known as the Doha round,
began in 2001. Its aim was to achieve major reform of the international
trading system, with the fundamental objective to improve the trading
prospects of developing countries through the introduction of lower trade
barriers and revised trade rules. It ended without the negotiations being
completed, resulting in a spurt in bilateral trade agreements.

1) What is the difference between nominal rate of protection and effective
rate of protection?
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
2) What is the idea behind the formation of WTO?
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
18.5 TRADE POLICY OF DEVELOPING

ECONOMIES
Trade policy in developing countries is concerned with two objectives:
promoting industrialisation and coping with the uneven development of the
domestic economy. Government policy to promote industrialisation has often
been justified by the infant industry argument, which says that new industries
need a temporary period of protection against competition from established
industries in other countries. Using the infant industry argument as
justification, many less-developed countries have pursued policies of import-
substituting industrialisation in which domestic industries are created under 13
External Sector and the protection of tariffs or import quotas. Beginning from about 1985, many
Trade Policy
developing countries, dissatisfied with the results of import-substitution
policies, greatly reduced rates of protection for manufacturing. As a result,
developing-country trade grew rapidly, and the share of manufactured goods
in exports rose. The results of this policy change in terms of economic
development, however, have been, at best, mixed. This idea had been mainly
confounded by the Asian Economies including India.
18.6 TRADE POLICY OF INDIA

18.6.1 Prior to 1991
In the post-independence period, prior to 1991, India followed a protectionist
approach. The principle objectives of this protectionist policy were to:
a) stabilise balance of payments,

b) encourage industrialisation,
c) fulfil the objectives of self-reliance and self-efficiency,
d) help in reallocation of resources,
e) increase employment, and
f) provide revenue for the government.
The selection of instruments, adopted for achieving the objectives of the
protectionist policy, can be classified in two broad groups: (a) tariff and (b)
non-tariff measures. These instruments were basically used to bring about
changes in price, volume or other parameters relating to tradable
commodities and services. In the pre-reform period, India’s import and
export policy was guided by the Import and Export Control Act of 1947. In
1977, two additional orders, viz. the Import Control Order and Export
Control Order, were introduced and the subsequent annual policy of imports
and exports was based on these legislations. A long-term trade policy, for
three years, was announced in 1985 by the government and some concrete
steps towards liberalisation were taken within the framework of economic
reforms.
In the pre-reform period, India’s trade policy regime was complex and
cumbersome. There were different categories of importers, different types of
import licences, alternate ways of importing, etc. Different types of licenses,
that used to be issued in the pre-reform period, can be categorised as: (a)
Open General License, (b) Automatic License, (c) Supplementary Import
License and (d) Imports through government-owned canalised agencies. The
trade policy was geared towards developing a self-reliant production
structure. There were high tariffs on imports. The intention of high tariffs was
to promote domestic production, by making imported goods more expensive
than those produced at home. This is what is called import substitution. Apart
from import duties, there were various permissions required before importing
something. Importing a computer, for instance, required many licenses and
permissions. The central government would decide on imports, depending on
its assessment of its importance for the national economy.
14
Import substitution had its other side - that of discouraging exports. There Trade Policy
was no active policy of discouraging exports. But import tariffs meant that
the profits from investing in import substituting production were higher from
investing in production for export. Assuming that costs of production were
not substantially higher in India, the profits would also be greater. In exports,
on the other hand, Indian producers would have to compete with producers
from other countries and there would be no excess profits for them. Thus, the
policy of high import tariffs served to discourage investment in exports. In a
way, high import tariffs distorted market price signals away from exports
towards import substitution.
Economic policies are not just manufactured out of thin air. They are
inevitably based on some theory of how the economy functions. What was
the theory behind such a control on imports? The theory goes back right to
the beginnings of plan development in India and was part of the formulation
of the Second Five Year Plan (1961-65). The theory goes by the name of
‘export pessimism’.
Export Pessimism
In the post-colonial situation of the 1950s, it was held that the export earnings
of underdeveloped countries were subject to severe constraints. World
manufacturing was concentrated in the industrialised or developed countries,
while the underdeveloped countries were largely agrarian in nature. The
structure of world trade reflected this division of the world economy. Under-
developed countries exported raw materials and primary goods, such as
coffee, tea, raw cotton, or minerals. Developed countries exported
manufactured products. World trade was an exchange of the manufacturer of
industrialised countries with the agricultural and primary goods of agrarian
and primary commodities producing countries.
Manufactured goods are produced by companies, often large companies.
With monopolistic market positions, these companies could determine the
prices of their outputs, i.e. they were price-makers. Agricultural commodities
are produced by large numbers of small producers. These small producers do
not have market power and cannot set prices for their products, i.e. they are
price-takers. On the other hand, the buyers of agricultural commodities from
the developed countries are few in number. This is called a monopsony
position, where there are just one or a few buyers along with a large number
of sellers for a product. The buyer or buyers can then be price-makers for that
primary commodity. The price of, say, coffee could be kept low and thus the
returns to the millions of primary commodity producers would also be low.
We need to add a third dimension to the structure of world trade to complete

this picture. That is the control of key mineral resources by the Multinational
Corporations (or MNCs), sometimes also called Trans-national Corporations
(TNCs) of the industrialised economies. The MNCs had operations in more
than one country, and they controlled much of the mineral and raw material
resources of the developing countries. The classic example of this control
was that of crude oil, mainly produced in West Asia, but controlled by the
Anglo-American oil majors. The result of this control of crude oil was that
15
External Sector and the oil majors could keep the price of crude oil low and give a small royalty
Trade Policy
to the governments of the supplying countries.
The role of under-developed countries in world trade was then to export

agricultural commodities or minerals, non-manufactured goods of various
kinds. In a competitive market, with a relatively fixed demand for agricultural
commodities, an increase in production is likely to result in a fall in the price.
Thus, even with an increase in production of the agricultural commodity,
there may not be an increase in export earnings since prices may fall.
Suppose there was a productivity increase by the farmers of coffee adopting
more productive methods. Would the benefits of increased productivity not
accrue to the producers? This would happen only if a few producers
(progressive farmers) alone adopted the improved technology while the bulk
of the farmers did not. Then, the progressive farmers would get the benefit of
higher productivity. Their costs of production would go down. With a
constant price, the higher productivity of the progressive farmers would give
them higher export earnings. But productivity improvements by farmers can
easily spread beyond a group or even country. If all the producers of coffee
adopt the improved practice, then the monopsony buyer could use
competition among sellers to bring the price down. The premium for
increased productivity would then go to the buyers from the developed
countries, who may or may not pass on the benefits to consumers in their
own countries. On the other hand, the MNC producers of industrialised
countries did not have to pass on the benefits of increased productivity. Their
monopoly positions allowed them to set prices of manufactures.
The implication of the above two propositions is that the terms of trade (i.e.
ratio of prices of what a country sells to the prices of what it buys, or of
primary goods’ prices to manufactured goods’ prices) for under-developed
countries’ would deteriorate. This, in brief, was the powerful analysis on
what is known as the Prebish-Singer hypothesis. This was the understanding
of export pessimism - that there was a strict limit to what an under-developed
country could earn in the export market.
The other side of export pessimism was import rationing. Since India needed
to develop its own industries, it needed scarce foreign exchange to be used
mainly for importing equipment and machinery for industries. In times of
food scarcity, food may also need to be imported. In this situation the limited
foreign exchange earnings needed to be rationed, with the government and
not players on the market deciding on what to import and what not to import
on the basis of relative prices. Among all commodities that it was
economically profitable to import, the government would decide on the most
important uses of the limited foreign exchange.
Export pessimism and import controls thus characterised Indian trade policy
in the early decades after Independence. It began to change in the mid-1980s
and was abandoned with the 1991 liberalisation.
16
18.6.2 Post 1991 Trade Policy
The 1991 trade policy reforms were precipitated by the external debt crisis
the government faced. At that time, the Indian government did not have
sufficient foreign exchange to cover the external debt payments that were
due. In order to avoid defaulting on its international debt obligations, the
government was forced to approach the International Monetary Fund (IMF)
for a loan.
Trade policy reform, focusing on tariffs and quantitative restrictions, was an
important part of the economic reform initiated in 1991. Supplemented by
recommendations of an Expert Committee, India’s trade policy reform paved
the road for a major reduction of average tariffs, tariff peaks, simplification
of the tariff and quota regimes, and removal of several import restrictions.
These changes reflected a larger vision of reform to enhance the efficiency of
domestic industry, together with a number of other objectives such as
promoting infant industry, exports, technological upgradation and food
security.
The 1991 Union Budget recognised the significance of trade policy reform as
part of the overall reform programme, stating for instance that: “The policies
for industrial development are intimately related to policies for trade” (Para
11 of Union Budget speech). Several steps were taken to reform trade policy:
a more outward oriented regime was put in place, tariffs were reduced in a
phased manner, import duties were streamlined or simplified, and a process
transforming quantitative border restrictions to price-based measures was
begun.
Likewise, export incentives were continued, or new ones provided for a
number of products, and institutional changes were made to bring
transparency and to facilitate transactions involving domestic and foreign
markets. This included the establishment of certain institutions or revised
mandates for existing institutions that would help implement the new focus
areas (e.g., the Tariff Commission).
Further, 1991 trade policy reform was an exercise that balanced several
objectives. For instance, loss of revenue was a major concern, and this was
mentioned as a reason for not reducing the import duty more than what was
being announced. In a number of instances, import tariffs were kept high to
encourage infant industry. The need for protecting Indian industry against
foreign competition, and to save foreign exchange, was explicitly recognised.
This was balanced with a reduction in tariffs to lower input costs and to
encourage export activities. Another important feature of the 1991 reform
was that it began opening up the regime for FDI. While FDI was not linked at
that time with trade policy, it created a base for increasing economic linkages
with global markets.
Average tariff levels prior to 1991 were in triple digits. The 1991 tariff
reform reduced these very significantly, but the new levels too were very
high at the end of the 1990s. A noteworthy feature of India’s tariff peaks and
averages in the early 1990s was that though they were reduced from high
17
External Sector and levels, they were high (particularly for non-agriculture) compared with most
Trade Policy
tariffs prevailing in economies with low tariffs, e.g. the United States. Before
1991, India imposed high auxiliary duties on imports. These were merged
with basic tariffs and the overall combined tariff level.
18.6.3 FDI Policy in India

At the time of independence, policy towards FDI was largely conditioned by
two factors: the Industrial Policy Resolution of 1948 and 1956, and the
foreign exchange crisis, especially in the late fifties. However, in 1969 a
more precise policy towards FDI was evolved. This consisted of setting out
three groups of industries where (i) there would be FDI without technical
collaboration (ii) only technical collaboration and (iii) no foreign
participation. Second, the foreign exchange crisis precipitated the Foreign
Exchange Regulation Act (FERA) particularly Article 29 which specified that
any foreign owned firm with more than 40 per cent of equity held abroad had
to apply to the Reserve Bank of India for approval in cases relating to
expansion, mergers, purchase of shares in other firms, etc. FERA came into
force in 1974 and all applications had been dealt with by 1979.
A more liberal attitude towards foreign investment emerged after about 1980
or so. This phase begins with the Industrial Policy statements of 1980 and
1982 and, more importantly the Technology Policy Statement of 1983. For
one, the policy statements began the process of delicensing. The New
Industrial Policy of 1991 was the starting point of a new phase in FDI in
India. Thus, with the new FDI policy up to 51 per cent foreign equity was
permitted with automatic approval in specified industries producing
intermediate and capital goods. Economic reforms post 1991 had encouraged
foreign investment as well as foreign collaborations. The dominant policy at
that time was export oriented FDI and restrictions on large volume of FDI in
the form of equity.
In 1995, India had reoriented its FDI policy. This is because India signed the
Uruguay Agreement in 1995 which made it a member of the World Trade
Organisation (WTO) and hence an automatic signatory to the agreement on
trade related investment measures (TRIMS). A series of measures that were
directed towards liberalising foreign investment included: (i) introduction of
dual route of approval of FDI – RBI’s automatic route and Government’s
approval [Secretariat of Industrial Assistance (SIA)/ Foreign Investment
Promotion Board (FIPB)] route, (ii) automatic permission for technology
agreements in high priority industries and removal of restriction of FDI in
low technology areas as well as liberalisation of technology imports, (iii)
permission to Non-resident Indians (NRIs) and Overseas Corporate Bodies
(OCBs) to invest up to 100 per cent in high priorities sectors, (iv) hike in the
foreign equity participation limits to 51 per cent for existing companies and
liberalisation of the use of foreign ‘brands name’ and (v) signing the
Convention of Multilateral Investment Guarantee Agency (MIGA) for
protection of foreign investments. In order to give a fillip to combat decline
in FDI post Asian Crisis in 1997, several measures were taken by the
government to further liberalise FDI policies. Measures included were
18
increasing the ceiling for FDI under the automatic route in oil refining from Trade Policy
49 per cent to 100 per cent. Further, in order to standardise India’s FDI
definition, a Committee was constituted by the Department of Industrial
Policy and Promotion (DIPP) in May 2002 to bring the reporting system of
FDI in India with international best practices. According to Economic survey
2003-04, the revised definition included three categories of capital flows
under FDI: equity capital, reinvested earnings and other direct capital.
Previously, the data on FDI reported in the balance of payments statistics
used to include only equity capital.
This change in definition was called for in order to bring the reporting system
of FDI data in India into alignment with best international practices. Thus,
with increasing liberalisation India has become an important destination for
FDI. At present 100 per cent FDI is provided in most of the sectors except in
defence sector which is open to FDI subject to 26 per cent cap. Sectors where
FDI is completely banned are Retail Trading (except single brand wholesale
retailing), atomic energy, lottery, business including Government / private
lottery, online lotteries, gambling and betting including casinos, business of
Chit fund and Nidhi company, real estate business, or construction of farm
houses, manufacturing of cigars, cheroots, cigarillos and cigarettes, of
tobacco or of tobacco or of tobacco substitutes and trading in transferable
development rights. Thus, with increased FDI there is an increased
prevalence of multinational corporations as it is the companies that trade.

1) What do you mean by export pessimism? State the implications of export
pessimism and import control prior to 1991 period.
……………………………………………………………………………
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2) Identify the measures taken by the government to liberalise FDI policy
post 1995.
……………………………………………………………………………
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3) State the categories of FDI as identified in Economic Survey 2003-04.
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19
External Sector and
Trade Policy 18.7 INDIA AND THE CHANGING NATURE OF
WORLD TRADE
There has been a change in the nature of trade. During the Eighth WTO
Ministerial Conference held in Geneva in 2011, some Ministers said that the
WTO needed to pay more attention to global value chains (GVCs). A global
value chain (GVC) is a chain of separate but inter-linked and coordinated
activities, which can be undertaken within a single firm or be divided among
multiple firms in different geographical locations to bring out a product or a
service from conception to complete production and delivery to final
consumers.
India participates strongly in manufacturing GVCs for chemicals, electrical
instruments and other manufactures (for example, jewellery). India’s
participation in manufacturing GVCs is due to sourcing of intermediates from
abroad. India also shows a high participation rate in services as well,
especially business activities.
18.7.1 Trade in Services

Trade traditionally meant trade in goods. However, with several services
becoming tradable and due to increased globalisation and integration of the
economies, trade in services have become a common parlance among
countries. The WTO under the General Agreement on Trade in Services
(GATS) recognises three modes of trade in services. Mode 1 is by foreign
companies investing in the country where the services are to be provided.
Mode 2 is by off-shoring of the service to a foreign location. A good example
of this are the call centres that have come up in many cities of India providing
services such as answering consumer inquiries, taking orders, etc. Mode 3 is
the movement of what in legal terminology is called ‘natural persons’,
another term for migration.
Indian firms have established a strong presence in the world trade in services.
Indian firms carry out a multitude of off-shoring tasks– from simple
consumer service centres, to accounting services and the various business
tasks called Business Process Outsourcing (BPO). These are also called IT
Enabled Services (ITES), since they depend crucially on IT and
communication technology.
18.7.2 Trade in Intellectual Property

In the WTO regime, trade issues have been somewhat broadened to include
matters of Intellectual Property (IP) Rights (TRIPS or Trade Related
Intellectual Property Rights). Under TRIPS, all member countries are
required to have a similar IP protection law. Patent rights must be allowed for
products and not only processes. Before the WTO requirement, Indian IT law
protected only processes and not products. As a result, Indian pharmaceutical
companies could develop different processes to ‘reverse engineer’ products
initially made in the industrialised countries.
20
18.7.3 Trade in Agriculture Trade Policy
Another area of contention in trade policy is that towards agriculture.

Agreements in this area have been stalled by the collapse of the Doha Round
of WTO negotiations. The USA and European Union (EU) both provide large
subsidies to their farmers. These are categorised in WTO terms under
different colours– Red as trade distorting, such as an export duty or export
subsidies, or Green for general support to the sector. But such general support
also helps the subsidy-receiving farmers to export at lower prices. This brings
down the price of agricultural commodities and could enable the developed
countries to increase their agricultural exports. The developed countries have
been pressing for an agreement to reduce or, even eliminate controls on
agricultural imports.
India has insisted on maintaining controls on agricultural imports, even

exports for that matter. The argument is basically that agriculture is not the
production of a commodity but is also the means of livelihood of crores of
small and medium farmers in the country. Particularly where new jobs in
low-skill manufacturing are not growing so fast, India wants to protect its
agriculture from cheap exports promoted by subsidies from the developed
economies.
18.8 REGIONAL AGREEMENTS RELEVANT

FOR INDIA
India has bilateral trade arrangements with all major regional groupings. In
Europe, it is a part of European Free Trade Association (EFTA), consisting of
Switzerland, Norway, Iceland and Liechtenstein. In 2018-19, India exports to
and imports from EFTA stood at US$ 1,534.00 million and US$ 18,076.88
million, respectively. Among SAARC countries, India and Bangladesh have
a bilateral trade agreement and both countries are exploring the possibility of
entering into a bilateral Comprehensive Economic Partnership Agreement
(CEPA). Negotiations for India and Iran entering into a Preferential Trading
Agreement (PTA) are under way. Review meetings for India-Nepal Treaty of
Trade are going on. With Sri Lanka, India has India-Sri Lanka Free Trade
Agreement (ISLFTA), under which duty-free access for almost all the
products except a few is provided. India is also negotiating a new Economic
and Technology Cooperation Agreement (ETCA) with Sri Lanka. India and
ASEAN have agreed to start examining the preliminary proposals related to
the scope of the review of ASEAN India Trade in Goods Agreement
(AITIGA). Within ASEAN, India has a Comprehensive Economic
Cooperation Agreement (CECA) with Singapore, Thailand and Malaysia.
Among Latin American countries, India has Preferential Trade Agreements
(PTA) with MERCOSUR (Argentina, Brazil, Paraguay and Uruguay) and
Chile. India has signed 28 bilateral / multilateral trade agreements with
various country/group of countries. However, few agreements as discussed
below seem relevant for India.
21
External Sector and 18.8.1 Regional Comprehensive Economic Partnership
Trade Policy
(RCEP)
Launched in Cambodia on December 20, 2012, the RCEP is an FTA between
ASEAN and its FTA partners (Australia, Brunei, China, Cambodia, India,
Indonesia, Japan, the Republic of Korea, Laos, Malaysia, Myanmar, New
Zealand, the Philippines, Singapore, Thailand, and Vietnam). The sixteen
participating countries account for almost half the world’s population, 30 per
cent of global GDP, and 25 per cent of world exports. RCEP seeks to achieve
a modern, comprehensive, high-quality, and mutually beneficial economic
partnership agreement that will cover trade in goods, services, investment,
economic and technical cooperation, intellectual property, competition, and
dispute settlement. India is participating in the RCEP negotiations but
appears to be doing so with extreme caution.
18.9 RECENT SCENARIO IN INDIAN TRADE

In 2018-19, petroleum products were the largest exported commodity, in
value terms, with a share of 14.1 per cent in the country’s export basket.
Other major exports included pearls, precious, semi-precious stones as also
gold and other precious metal jewellery besides drug formulations,
biological. However, exports of organic chemicals grew at the highest rate at
30.6 per cent in 2018-19. In the import basket of 2018-19, petroleum crude,
at 22.2 per cent had the largest share followed by gold and other precious
metals (Jewellery at 6.4 per cent and pearls precious/semi-precious stones at
5.3 per cent).
India’s major trading partners are the United States of America (USA), which
accounted for 16 per cent of India’s exports (in value terms) in 2018-19,
followed by the United Arab Emirates (UAE), China and Hong Kong.
However, in 2018-19, growth of India’s exports to the Netherlands was the
highest (40.7 per cent), followed by China (25.6 per cent) and Nepal (17.4
per cent). China continues to be the largest source of imports of India
accounting for 13.7 per cent of the total imported value in 2018-19. The other
important sources from which India imports are the USA, UAE and Saudi
Arabia.
In 2018-19, India’s exports to countries with which it has a trade agreement

stood at US$ 121.7 billion accounting for 36.9 per cent of India’s export to
all the countries. Similarly, in the same year, India’s imports from countries
with which it has a trade agreement stood at US$ 266.9 billion accounting for
52.0 per cent of India’s imports from all the countries.
18.10 TRADE POLICY OF INDIA 2015-2020

The Government of India announced a Foreign Trade Policy for the period
2015-2020 on 1st April, 2015. The important measures taken by the
Government in the Foreign Trade Policy 2015-2020 to include ‘Make in
India’ and ‘Digital India’ programmes and to ease the trade are:
22
i) Specific Export Obligation under Export Promotion Capital Goods Trade Policy
(EPCG) scheme, in case capital goods are procured from indigenous
manufacturers, has been reduced to 75 per cent of the normal export
obligation, in order to promote domestic capital goods manufacturing
industry.
ii) Under Merchandise Exports from India Scheme (MEIS), export items
with high domestic content and value addition have generally been
provided higher level of rewards.
iii) For reward schemes and duty exemption schemes, hard copies of
applications and specified documents which were required to be
submitted earlier have now been dispensed with.
iv) Landing documents of export consignment as proof for notified market
can now be digitally uploaded.
v) There will be no need to submit copies of permanent records / documents
repeatedly with each application, once the same are uploaded in
Exporter/Importer Profile.
vi) For faster and paperless communication with various Committees of
Directorate General of Foreign Trade (DGFT), dedicated e-mail
addresses have been provided for various Committees, e.g. Norms
Committees, Exim Facilitation Committee, etc.
The Foreign Trade Policy 2015-2020 introduced two new schemes, namely,
‘Merchandise Exports from India Scheme’ (MEIS) for incentivising export of
specified goods to specified markets and ‘Services Exports from India
Scheme’ (SEIS) for increasing exports of notified services from India. The
scrips can be used for payment of customs duty, excise duty and service tax.
All duty credit scrips issued under both the schemes and the goods imported
against these scrips are fully transferable. Further, e-Commerce exports of
certain specified employment creating sectors, made through courier or
foreign post offices, have been supported under MEIS.

1) State the features of changing nature of world trade.
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2) Discuss the relevance of trade with respect to intellectual property and
agriculture issues.
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23
External Sector and 3) Identify the major features of Exim policy 2015-20 aiming to the export
Trade Policy
of goods and services.
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18.11 LET US SUM UP

Trade policy refers to all the policies related to both exports and imports.
Countries use different instruments of trade policy while framing their own
trade policy. For example, most developing countries believed in import
pessimism. In the case of India, prior to 1991, Indian trade policy was
characterised by export pessimism and import controls. This situation began
to change in the 1980’s and the control regime was abandoned after 1991
economic reforms. In the changed situation of world trade, firms in the
developing economies have managed to get entry into developed economy
markets. India also accounts for a larger share of FDI inflows and its FDI
policy is being liberalised regularly. India accounts for a substantial share of
world trade in the services sector. Agricultural products due to subsidy to its
farmers by developed countries are another area of controversy in trade
policy. India has bilateral trade arrangements with all major regional
groupings and the most controversial one is the RCEP. The long-term export-
import policy 2015-20 aimed at doubling India’s share in global trade by
2020 and accelerating the country’s contribution to the global vibrant
economy to derive maximum benefits from expanding global market
opportunities. The country is on track to achieve the $1-trillion export
target by 2025 with the government and industry deliberating on measures to
boost exports, manufacturing and the new foreign trade policy.

1) India’s trade policy prior to 1991 was derived from the policy of self-
reliance. In the light of this statement critically evaluate India’s trade
policy.
2) Explain the important issues which are crucial and hence need to be
addressed in India’s trade policy.
3) Critically evaluate trade policy of India 2015-20.
4) Discuss India’s position in changing the nature of world trade.
5) Highlight the features of FDI policy in India since 1985.
24
18.13 KEY WORDS Trade Policy
General Agreement : This is the agreement on trade in services, which

on Trade in forms part of the WTO agreements. The preceding
Services (GATS) GATT did not have any agreement dealing with
services. At that time, until the 1990s, there was not
much trade in services.
Multi-National : An MNC, sometimes also called a TNC or Trans-
Corporation national Corporation, refers to a corporation that
(MNC) has subsidiaries or branches in more than one
country. The branches may often be 100 per cent
owned by the parent corporation, but they may also
be with minority investment.
Regional Trade : Refers to trade within a region, such as Europe, or
Asia or parts of Asia. Regional trade has often led
to Regional Free Trade Agreements (RFTAs).
WTO - World : Set up as the successor to the General Agreement
Trade Organisation on Trade and Tariffs (GATT). Its headquarters is in
Geneva, Switzerland. The WTO is a membership-
based organisation. A member, on being accepted,
agrees to all the instruments of the organisation.
Unlike GATT, the WTO has a dispute resolution
mechanism. Any member is free to take up a case
against any other member. This allows for formal
equality, but it is often difficult, because of the cost
of engaging lawyers in Geneva. But India, for
instance, has filed and won cases against the US.
Voting in the WTO, as in the UN General
Assembly, is ‘one country, one vote’. But decisions
are usually arrived at through informal consultation
mechanisms.
18.14 REFERENCES
1) International Economics: Theory and Policy (10th Edition) (Pearson
Series in Economics) 10th Edition by Paul R. Krugman (Author),
Maurice Obstfeld (Author), Marc Melitz (Author)
2) India: Trade Policy Review by V. N. Balasubramanyam.
3) Annual Report of the RBI.
4) Ministry of Finance, Economic Survey.
5) FDI in India: History Policy and the Asian Perspectives by Manoj Pant
and Deepika Srivastava.
25
External Sector and
Trade Policy 18.15 ANSWERS OR HINTS TO CHECK YOUR
PROGRESS EXERCISES
1) See Section 18.3
2) See Section 18.4
3) Equity Capital, reinvested earnings, direct capital
1) See Section 18.7
3) See Section 18.10
26
Foreign Trade and
UNIT 19 FOREIGN TRADE AND BALANCE Balance of Payment
OF PAYMENT
Structure
19.0 Objectives
19.1 Introduction
19.2 Trade and Economic Development
19.2.1 Trade Policy Analysis Tools
19.2.2 Composition of Trade
19.2.3 Direction of Trade
19.3 India’s Foreign Trade
19.3.1 Volume of India’s Merchandise Trade
19.3.2 Volume of India’s Trade in Services
19.3.3 Composition of India’s Merchandise Trade
19.3.3.1 Composition of India’s Merchandise Exports
19.3.3.2 Composition of India’s Merchandise Imports
19.3.4 Composition of India’s Trade in Services
19.3.5 Direction of India’s Foreign Trade
19.4 India’s Balance of Payments
19.4.1 The Current Account
19.4.2 The Capital Account
19.4.3 The Financial Account
19.4.4 Net Errors and Omissions
19.5 India’s Balance of Payments – Recent Trends
19.5.1 The Salient Features of India’s BOP
19.6 External Debt
19.7 Let Us Sum Up
19.8 Key Words
19.9 References
19.0 OBJECTIVES
After going through this unit, you will be able to :
● discuss the role of foreign trade in economic development of a country;
● evaluate India’s foreign trade and the changes in its direction and
composition;
● assess India’s position of balance of payment;
● outline the policy framework for restoring equilibrium in balance of
payments. 27
External Sector and
Trade Policy 19.1 INTRODUCTION
India is globalising rapidly. Inter-dependence between the economies inthe
world has increased multi-fold. External sector in the economy has gained
prime importance. Both exports and imports contribute to the production
process. Both of these are effective instruments in raising the income levels
of the people in a developing economy. Apart from flow of goods, increasing
flows of services and capital between nations give rise to payments and
receipts in foreign exchange which, in turn, influences the balance of
payments (BoP)position. In this unit, we shall examine the various issues
related to foreign trade and BoP. Let us begin with explaining the relationship
between foreign trade and economic growth.
19.2 TRADE AND ECONOMIC DEVELOPMENT

External trade is important for sustained economic growth. Many of the
fastest growing economies of the past few decades have always recorded high
trade growth. Trade has many positive spillovereffects on a domestic
economy. Apart from increasing foreign exchange reserves, exports boost
competitiveness, promote investments, generate linkage with the global
economy, increase employment, and can also help in upgradation of skills.
Foreign trade has worked as an ‘engine of growth’ in the past (witness Great
Britain in the 19th century and Japan in the 20th, besides others), and even in
more recent times the “outward-oriented growth strategy” adopted by the
newly industrialising Economies of Asia, viz., Hong Kong, (now a special
administered area of China), Singapore, Taiwan, Malaysia, Thailand, and
South Korea, has enabled them to overcome the constraints of small
resource-poor under-developed economies.
Contribution of Foreign Trade to Economic Development

Foreign trade contributes to economic development in several ways.
• It provides flow of technology which allows for increases in total factor

productivity, and some short-run multiplier effects for countries with
unemployed labour.
• It generates pressure for dynamic change through: (i) competitive
pressure from imports, (ii) pressure of competing for export markets, and
(iii) a better allocation of resources.
• Exports allow increased exploitation of economies of scale, separation of
production pattern from domestic demand, and increasing familiarity
with absorption of new technologies.
These, in turn, help increase the profitability of the domestic business without
any corresponding increase in price.
Foreign trade increases most workers’ welfare. It does so at least in four

ways: (i) larger exports translate into higher wages; (ii) as workers are also
consumers, trade brings them immediate gains through cheaper imports;(iii)
28
Foreign Trade and
it enables most workers to become more productive as the goods they Balance of Payment
produce increase in value; and (iv) trade increases technology transfers from
industrial to under-developed countries (UDCs) and the transferred
technology is biased in favour of skilled labour.
Increased openness to trade has been strongly associated with the reduction
of poverty in most developing countries, as the historian Arnold Toynbee
said ‘civilisation’ has been spread through ‘mimesis’: simple copying.
19.2.1 Trade Policy Analysis Tools1

A proper analysis of a country’s foreign trade can be attempted by analysing
(i) Volume of trade, (ii) Share of exports/imports in GDP, (iii) Share of
exports/imports in world trade, (iv)Degree of Openness, (v) Composition of
trade, (vi) Sectoral and Geographical Orientation of Trade, (vii) Terms of
trade, and (viii) Direction of trade.
Volume of Trade
It relates to the size of international transactions. Since a large number of
capital, goods and services enter in international transactions and their
aggregate can be found only by finding their money value, therefore, the
volume of trade can be measured only in terms of money value. The trends in
the value of trade help to identify the basic forces that may be operating at
different periods in the economy.
However, mere absolute changes in the value of trade may not be satisfactory
guide, hence it is necessary to find the changes in the value of trade by
relating them to two variables, viz.i) Share of exports/imports in GDP, andii)
Share of exports/imports in world trade.
Share of exports/imports in GDP

The share of exports/imports in GDP indicates the degree of outward
orientation or openness of the economy to trade. This share reflects ina broad
way the nature of trade strategies adopted in the country. The ratio ofexports
to GDP could alsobe interpreted to mean supply capability of the
economyregarding exports. It can be called as average propensity to export.
The similarratio between imports and GDP gives the average propensity to
import. Clearly,however, the appropriate share of exports in output under an
efficient allocationof resources will be less in bigger economies than in
smaller economies.
Share of exports/imports in world trade

The share of exports in the world trade indicates the importance of the
country as a nation in the world economy. It reflects the market thrust that the
country is able to realise in presence of the various competitors in the world
market. Changes in this ratio, thus, indicate the shift in the position of the
comparative advantage of the country.
1
Based upon A Practical Guide to Trade Policy Analysis, co-published by the World Trade
Organisation and the United Nations Conference on Trade and Development, 2012. 29
External Sector and Degree of Openness
Trade Policy
The most natural measure of a country’s integration in the world trade is its
degree of openness. One might suppose that measuring a country’s openness
is a relatively straightforward endeavour. Let Xi, Mi and Yi be respectively
country i’s total exports, total imports and GDP. Country i ’s openness ratio
is defined as:
�
� � + ��
� =
��
Higher the Oi, the more open is the country. For small open economies like
Singapore, it may even be substantially above one. The index can be traced
over time.
19.2.2 Composition of Trade

It is indicative of the structure and level of development of an economy. For
instance, most of the UDCs depend for their export earnings on a few
primary commodities (PCs); these countries export raw materials of
agricultural origin and import manufactured industrial products, thus,
denying themselves the benefits of value addition in their goods. As an
economy develops, its trade gets diversified. It no more remains dependent
on a few PCs. It begins to export more of manufactured industrial goods and
import industrial raw materials, capital equipment and technical know-how.
Manufactured exports create greater value addition than PCs as they go
through more stages of processing. The manufacturing sector has greater
linkages with the rest of the economy and, hence, the downstream effect on
exports from these sectors islikely to be greater than primary exports.
The commodities entering trade could also be classified by various other

criteria such as value added per unit of output, productivity of labour, capital
intensity in production, strength of backward and forward linkages, etc.The
shifts in the commodity composition of trade in these categories would bring
out the nature of structural changes in regard to income generation,
employment effect and overall industrialisation through linkages effects, etc.
Sectoral and Geographical Orientation of Trade

The sectoral composition of a country’s trade matters for a variety of reasons.
For instance, it may matter for growth if some sectors are drivers of
technological improvement and subsequent economic growth, although
whether this is true or not is controversial. Moreover, constraints to growth
may be more easily identified at the sectoral level.
Geographical composition highlights linkages to dynamic regions of the
world (or the absence thereof) and helps to think about export-promotion
strategies. It is also a useful input in the analysis of regional integration, an
item of rising importance in national trade policies.
Simple indexes for the share of each sector in a country’s total imports or
exports can be constructed using a dataset with sector-level trade data.
30
Foreign Trade and
Likewise, one can construct indexes of the share of each partner in a Balance of Payment
country’s total imports or exports using bilateral trade data. One can go a step
further and assess to what extent a country’s export orientation is favourable,
i.e. to what extent the country exports in sectors and toward partners that
have experienced faster import growth.
Terms of trade (TT)

Changes in the value of exports may be compared to the changes in the value
of imports. The relationship between these two variables is known as the
terms of trade (TT), i.e., the terms at which exports exchange for imports; if
the exports value in terms of imports value shows an increase, the TT are said
to be favourable. Favourable TT implies that for a given value of exports, the
country can produce more of imports. Conversely, if the TT is unfavourable a
country has to give up more exports to produce a given volume of imports. In
short, Terms of trade (TOT) are the relative price, on world markets, of a
country’s exports compared to its imports. If the price of a country’s exports
rises relative to that of its imports, the country improves its purchasing power
on world markets. The two most common indicators are barter terms of trade
and income terms of trade.
19.2.3 Direction of Trade

It is indicative of the structure and level of economic development. As a
country develops and its trade gets diversified, it has to seek new outlets for
its exports. Its horizon of choice in terms of imports also gets widened. The
country begins to trade with an increasingly large number of countries. In this
regard, one could ask whether there has been a concentration or dispersion of
the markets for exports and sources of supply for imports.

1) What role does foreign trade play in economic development of a nation?
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2) How does growth of an economy affect the volume of its foreign trade?
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31
External Sector and 3) What types of changes are observed in the direction of trade as an
Trade Policy
economy experience growth?
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4) How can you measure the openness of Indian Economy?
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19.3 INDIA’S FOREIGN TRADE

Foreign trade has always been important for the sustained economic growth
of an economy. Many Asian economies such as Japan, South Korea,
Singapore, and China, have achieved high levels of economic growth with
resulting positive spillover in productivity, investments, technology
upgradation, and job growth, on the back of export-led growth. Foreign trade
will also play a crucial part in India’s goal to become a US$ 5 trillion
economy.
19.3.1 Volume of India’s Merchandise Trade

India is not a major player in global trade. Its share in world’s merchandise
exports and imports was below one percent level up to the year 2000.
Thereafter, on account of various policy measures, India’s share in world’s
merchandise exports and imports started growing and it reached the level of
1.7 per cent and 2.5 per cent respectively in 2019 (Table 19.1). This reflects
India’s increasing integration with the global value chain.
Table 19.1: India’s Share in World's Merchandise Exports & Imports

(share in per cent)
Year Exports Imports
1980 0.4 0.7
1990 0.5 0.7
2000 0.7 0.8
2010 1.5 2.3
2019 1.7 2.5
Source: UNCTAD Statistics
32
Foreign Trade and
Table 19.2 shows the growth story of India’s external trade in merchandise, Balance of Payment
exports and imports. India’s total merchandise trade increased from US$ 24.4
billion in the year 1980-81 to US$ 844.2 billion in 2018-19 in absolute terms.
In the same period, merchandise exports increased from US$ 8.8 billion to
US$330.1 billion, while imports grew from US$15.9 billion to US$514.1
billion. It is interesting to see that the value of India’s merchandise exports
has been stagnant or declining over a relatively long period starting from
2011-12. Growth in India’s merchandise exports over 2015-16 was minus
15.5 per cent, as compared with minus 1.3 per cent in 2014-15 and a positive
4.7 per cent in 2013-14. In fact, in 2018-19, growth of India’s exports and
imports has reduced as compared to the growth in previous year. There are
several factors contributing to this situation. Slowdown in the world output,
trade tensions and protectionism and less diversification of India’s exports
basket are few of the reasons for contraction in India’s exports. As per
opinion expressed by many experts, contraction in India’s imports bill in
recent years was partially because of decline in oil prices.
Table 19.2: India’s Merchandise Trade
Value in US $ Million (Rate of change over previous period

in per cent)
Year
Total External
Exports Imports
Trade
1980-81 8484.7 (-) 15866.5 (-) 24351.2 (-)
1990-91 18145.2 (113.9) 24072.5 (51.7) 42217.7 (73.4)
2000-01 44560.3 (145.6) 50536.5 (109.9) 95096.8 (125.3)
2010-11 251136.2 (463.6) 369769.1 (631.7) 620905.3 (552.9)
2011-12 305963.9 (21.8) 489319.5 (32.3) 795283.4 (28.1)
2012-13 300400.6 (−1.8) 490736.6 (0.3) 791137.2 (−0.5)
2013-14 314415.7 (4.7) 450213.6 (−8.3) 764629.4 (−3.4)
2014-15 310352.0 (−1.3) 448033.4 (−0.5) 758385.4 (−0.8)
2015-16 262291.1 (−15.5) 381007.8 (−15.0) 643298.8 (−15.2)
2016-17 275852.4 (5.2) 384357.0 (0.9) 660209.5 (2.6)
2017-18 303526.2 (10.0) 465581.0 (21.1) 769107.2 (16.5)
2018-19 330078.1 (8.7) 514078.4 (10.4) 844156.5 (9.8)
Source: Reserve Bank of India
Table 19.3 summarises the contribution of merchandise exports and imports

in India’s GDP during the years from 1970-81 to 2018-19. Share of
merchandise exports in India’s GDP has increased from 4.5 per cent in 1980-
81 to 12.4 per cent in 2018-19 while share of merchandise imports increased
from 8.8 per cent to 19.0 percent during the same period. Total merchandise
trade (exports + imports) contributed 31.4 per cent in India’s GDP during
33
External Sector and 2018-19. From 2015-16 onwards, the ratio of the merchandise imports to
Trade Policy
GDP has been declining for India entailing a net positive impact on the
Balance of Payment position. At the same time, merchandise exports to GDP
ratio for India has almost been stagnant from 2015-16 onwards.
Table 19.3: Share of Merchandise Exports & Imports in India’s GDP

(share in per cent)
Total External
Trade
1980-81 4.5 8.8 13.3
1990-91 5.8 8.7 14.4
2000-01 9.7 12.4 22.1
2010-11 15.3 22.9 38.2
2015-16 12.7 18.8 31.5
2018-19 12.4 19.0 31.4
Trade Deficit
India has a large deficit in the classical trade in goods. Because of growing
difference between India’s merchandise imports and exports bills, we have
been witnessing a huge deficit in our merchandise trade. In fact, India’s
merchandise trade deficit has increased from US$ 7.4 billion in 1980-81 to
US$ 184.0 billion in 2018-19, Growing deficit in merchandise trade is a
matter of concerns for the Indian policy makers and the government has
come with many measures under Foreign Trade Policy 2015-20 to increase
exports and reduce the trade deficit. The Government of India is currently
discussing New WTO compliant Foreign Trade Policy to address various
trade related issues.
19.3.2 Volume of India’s Trade in Services

India’s services trade has been a major driver of its exports over the past two
decades. The country has emerged among the fastest growing nations in
global services trade. This sector has not only attracted significant foreign
investment flows but also contributed significantly to exports as well as
provided large-scale employment. India’s services sector covers a wide
variety of activities such as software, hotels and restaurants, transport, storage
and communication, financing, insurance, real estate, business services,
community, social and personal services, and services associated with
construction.In 2005, India contributed 1.9per cent of world’s service exports
which increased to 3.5per cent in the year 2019 while its shares in service
imports increased from 2.3 per cent to 3.1 per cent in the same period.
The broad trend in India’s Services trade in the last ten years is indicated in
Table 19.4. It shows that India’s export of services has shown an increasing
trend from 2011-12 to 2018-19, except for a small dip in 2015-16, whereas
imports have also shown an increase from US$ 78.2 billion in 2011-12 to
34
Foreign Trade and
US$ 126.0 billion in 2018-19 with a net services trade surplus in the above Balance of Payment
period. The net service trade has shown fluctuations in the recent years.
Table 19.4: India’s Service Trade
Growth Over Previous

Value in US $ Million
Period (per cent)
Year
Net Net
Exports Imports Exports Imports
Services Services
2009-10 96040 60030 36020 - - -
2010-11 124640 80550 44080 29.8 34.2 22.4
2011-12 142325 78227 64098 14.2 -2.9 45.4
2012-13 145678 80763 64915 2.4 3.2 1.3
2013-14 151813 78747 73066 4.2 -2.5 12.6
2014-15 158107 81578 76529 4.1 3.6 4.7
2015-16 154311 84635 69676 -2.4 3.7 -9.0
2016-17 164197 95852 68345 6.4 13.3 -1.9
2017-18 195089 117527 77562 18.8 22.6 13.5
2018-19 208000 126060 81941 6.6 7.3 5.6%
19.3.3 Composition of India’s Merchandise Trade

The composition of India’s merchandise trade has been changing. In the early
decades after Independence, exports were mainly of primary goods, viz.
agricultural commodities, and raw materials, such as minerals. Over time, the
role of manufactures including engineering goods has been increasing.
Overall manufactured goods are as much as 66 per cent of total exports, of
which engineering goods contribute as much as 27 per cent of the value of
goods exported. These engineering goods include automobiles and parts,
agricultural machinery, and electrical machinery.
19.3.3.1 Composition of India’s Merchandise Exports

Exports of India are broadly classified into four categories:
Agricultural and allied products-This mainly include tea, coffee, cereals,
unmanufactured tobacco, spices, cashew nuts, oil meals, fruits and vegetables
and pulses, marine products, raw cotton, etc.
Ores and minerals (excluding coal)- include iron ore, mica, processed
minerals, and other ores and minerals.
Manufactured goods- include textile fabrics and manufactures, cotton yarn,
fabrics, made-ups, etc., readymade garments of all textile materials, Coir yarn
and manufactures, Jute manufactures (including twist and yarn), leather and
leather manufactures (including leather footwear, leather travel goods
35
External Sector and andleather garments), handicrafts (including hand-made carpets), gems and
Trade Policy
jewellery, chemicals and allied products, machinery, transport and metal
manufactures (including iron and steel), etc.
Mineral fuels and Lubricants (including Coal)

The composition of India’s merchandise trade has been changing. In the early
decades after Independence, exports were mainly of primary goods, viz.
agricultural commodities, and raw materials, such as minerals. Over time, the
role of manufactures including engineering goods has been increasing.
Agriculture and allied products accounted for 30.07 per cent of India’s total
merchandise exports in 1980-81, this has however, declined to 11.8 percent
in 2018-19. At the same time, the share of manufactured goods has witnessed
a mixed trend. In fact, share of manufactured goods has gone up from 55.8
percent in 1980-81 to 79.0 per cent in 2000-01 but again declined to 70.3 per
cent in 2018-19.
Turning to India’s exports by principal products of India, in 2018-19, India’s
top 3 merchandise exports included engineering goods, petroleum products,
and gems and jewellery. In fact, in recent years, petroleum products, precious
stones, drug formulations, gold and other precious metals continue to be
India’s top export items. In 2018-19, engineering goods was the largest
exported commodity, in value terms. However, its growth was only 6.3 per
cent as compared to 2017-18. Top 5 exported products accounted for more
than 60percentshare in India’s total merchandise exports in 2018-19. The
exports that have not grown as much as would be expected, given India’s
status as a labour abundant economy, are textiles and textile products, which
include garments and leather products. They still account for just a little more
than 10 per cent of India’s exports.Overall, composition of India’s
merchandise exports has undergone a positive change. The remarkable
achievement is that India has transformed itself from a predominantly
primary goods exporting country into a non-primary goods exporting
country.
19.3.3.2 Composition of India’s Merchandise Imports

Crude oil imports have a large presence in the import basket with the value of
India’s total imports being influenced bycrude prices. Similarly, gold imports
also have a significant presence in the import basket and gold prices
influence the value of India’s total imports. In the import basket of 2018-19,
top 5 products include i) Petroleum, Crude and products at 27.4 percent
share, ii) Electronic goods at 10.8 percent share, iii) Machinery, electrical and
non-electrical at 7.7 per cent share, iv) Gold at 6.4 per cent share and v)
Pearls, precious and Semi-precious stones at 5.3 per cent share. These
products together accounted for more than 55 percent of India’s imports in
2018-19. Crude oil has been the largest item in India’s imports basket which
increased from US$ 87.1 billion in 2009-10 to US$ 141.0 billion in 2018-19
which a growth of 29.7 percent over previous year. Growth rates of gold and
pearls (including precious and semi-precious stones) however declined in
2018-19.
36
Foreign Trade and
India’s POL(petroleum, oil, and lubricants)imports increased from US$5.8 Balance of Payment
billion in 1981-82 to US$ 141 billion in 2018-19. Its share in India’s total
imports basket however declined from 38.1 percent to 27.4 per cent in same
time period. As far as imports of Non-POL products are concerned, its shares
in India’s imports basket increased from 61.9per cent in 1981-82 to 72.6per
cent in 2018-19 whereas in terms of absolute value it increased from, US$ 9.4
billion to US$ 373.2 billion in the same period. POL imports witnessed sharp
rise in growth rate from 4.8 per cent in 2016-17 to 29.7 per cent in 2018-19.
The non-POL imports also increased from − 0.2 per cent in 2016-17 to 4.5
per cent in 2018-19. This is mainly because of a downturn in the Indian
economy. Further, rise in growth of POL imports from 2016-17 to 2018-19
was mainly on account of both price increase in the international market and
volume consumed by India.
19.3.4 Composition of India’s Trade in Services

The composition of service exports has remained largely unchanged over the
years. Telecommunications, computer, and information services constitute
the bulk of it at around 41-46 per cent between 2016-17 to 2018-19, followed
by other business services at about 18-20 per cent, travel at 13-14 per cent
and transportation at 9-10 per cent during the same period.The relative shares
of the various constituents of service imports have also not varied much with
business services constituting about a third of service imports, which is in
consonance with the rising level of economic activity in the country. The
component of travel and transport services together constitutes another third
of total service imports.
Although India’s services exports have seen a general increase in growth, a

large part of this growth is confined to two categories– telecommunications,
computer, and information services and other business services. Given the
increasingly large role services trade is playing in the global economy along
with a rise in automation and new forms of services, there is an urgent need
for diversification of India’s services trade to limit the impact of data
localisation on services exports.
19.3.5 Direction of India’s Foreign Trade

Within the world geographic region, Asia is the largest destination of Indian
exports which accounted for 48.8 per cent of India’s exports (in value terms)
in 2018-19 followed by America and Europe with 20.9 percent and 19.9
percent share, respectively in the same period (Table 19.5). In 2018-19,
India’s exports (in terms of value) over previous year i.e. 2017-18, grew at a
faster rate in CIS & Baltics and Africa region as compared to Asia, America,
and Europe. Though, absolute value of merchandise exports was much less in
CIS & Baltics and Africa.
In case of merchandise imports, India sourced 62.0 percent of its requirement

within Asia in 2018-19. Whereas Europe and America accounted for 15.4 per
cent and 12.7 per cent respectively of India’s imports in the same time
period(Table 19.6). In terms of absolute value, India’s imports from America
grew at a faster rate of 16.4% in 2018-19 over the previous year. Whereas
37
External Sector and imports from Baltics & CIS region actually declined by 26.7 percent over the
Trade Policy
same time period.
Table 19.5: Direction of India’s Merchandise Exports by Geography

Value in US$ million
% Growth Share in
Regions 2017-18 2018-19 Over Previous %
Year 2018-19
Asia 1,49,635 1,61,216 7.7 48.8
America 62,783 68,861 9.7 20.9
Europe 60,346 64,375 6.7 19.5
Africa 24,904 28,541 14.6 8.7
CIS & Baltics 3,007 3,467 15.3 1.1

Unspecified
2,851 3,617 26.9 1.1
Region
Total Exports 3,03,526 3,30,078 8.8 100
Table 19.6: Direction of India's Merchandise Imports by Geography

Value in US$ million
% Growth
Share in %
Regions 2017-18 2018-19 Over Previous
2018-19
Year
Asia 2,79,667 3,18,762 14.0 62.0
Europe 69,898 79,357 13.5 15.4
America 55,993 65,190 16.4 12.7
Africa 37,789 41,128 8.8 8.0
CIS & Baltics 12,876 9,443 -26.7 1.8
Unspecified Region 9,358 199 -97.9 0
Total Imports 4,65,581 5,14,078 10.4 100

India’s largest export destination country is the United States of America

(USA), which accounted for 15.9 per cent of India’s exports (in value terms)
in 2018-19, followed by United Arab Emirates (UAE), China and Hong
Kong. India’s merchandise exports to China accounted for 3.8 per centin
2014-15 but it increased to 5.1 per cent in 2018-18 whereas, share of India’s
total exports to UAE has actually declined from 10.6 per centin the same time
38
Foreign Trade and
period. India’s top 10 exporting destination during 2018-19 jointly accounted Balance of Payment
for more than 50 per cent of India’s total merchandise exports to world.
China has been the largest source of imports forIndia, accounting for 13.7 per
cent of the total merchandised imports in terms of value in the year 2018-19.
In fact, share of Chinese imports into India’s overall merchandise imports
have witnessed a mixed trend from 2014-15 to 2018-19. Other main countries
from which India significantly imports are the USA, UAE, and Saudi Arabia.
India’s top 10 sourcing destination during 2018-19 jointly accounted for
more than 52.8 per cent of India’s total merchandise imports from world.
Economic Survey 2019-20 has done a very interesting analysis of India’s

bilateral trade position with respect to its top trading partners over a five
years period from 2014-15 to 2018-19 (Table 19.7). India mostly has trade
surplus since 2014-15 with its top two trading countries i.e. USA and United
Arab Emirates. On the other hand, India has trade deficit continuously since
2014-15 with respect to other major trading partners i.e. China PRP, Saudi
Arabia, Iraq, Germany, Korea RP, Indonesia, and Switzerland. India had
trade surplus with Hong Kong and Singapore till 2017-18, before it changed
to trade deficit in 2018-19. The bilateral imbalances, however, have remained
stable in most cases. India’s deficit in merchandise trade with China reached
up to US$ 63.05 in 2017-18 which marginally improved to US$ 53.37 in the
subsequent year.
Table 19.7: Bilateral Trade Surplus/Deficit (Sorted on Year: 2018-19)

US $ Billion
Country 2014-15 2015-16 2016-17 2017-18 2018-19
Trade USA 20.63 18.55 19.90 21.27 16.86

Surplus United Arab
Countries Emirates 6.89 10.87 9.67 6.41 0.34
China PRP -48.48 -52.70 -51.11 -63.05 -53.57

Saudi Arabia -16.95 -13.94 -14.86 -16.66 -22.92
Iraq -13.42 -9.83 -10.60 -16.15 -20.58
Germany -5.25 -5.00 -4.40 -4.61 -6.26
Trade
Deficit Korea RP -8.93 -9.52 -8.34 -11.90 -12.05
Countries
Indonesia -10.96 -10.31 -9.94 -12.48 -10.57
Switzerland -21.06 -18.32 -16.27 -17.84 -16.90
Hong Kong 8.03 6.04 5.84 4.01 -4.99
Singapore 2.68 0.41 2.48 2.74 -4.71
39
External Sector and Check Your Progress 2
Trade Policy
1) State the important changes being observed in the composition of India’s
external trade since 2007-08.
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
2) Do you think that direction of India’s exports has been changing with
BRICS Countries over time?
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
3) Give the emerging features of changes in the volume and direction of
India’s foreign trade.
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
19.4 INDIA’S BALANCE OF PAYMENTS

The sixth edition of the Balance of Payments and International Investment
Position Manual (BPM6) of the International Monetary Fund (IMF) defines
BoP as a statistical statement that summarises economic transactions between
residents and non-residents during a specific time period. It consists of the
goods and services account, the primary income account, the secondary
income account, the capital account, and the financial account. The different
accounts within the BoP are distinguished according to the nature of the
economic values provided and received, under the double-entry system of
accounting in the BoP.
The BoP, thus, includes all transactions showing2:

transactions in goods, services and income between an economy and the rest
of the world changes of ownership and other changes in that economy’s
monetary gold, special drawing rights (SDRs), and financial claims on and
liabilities to the rest of the world, and unrequited transfers.
These transactions are categorised into:
the “current account” including “goods and services”, the “primary income”,
and the “secondary income”, the “capital account”, and the “financial
account”.
40 2
Balance of Payments Manual for India, Sept. 2010, RBI
Foreign Trade and
19.4.1 The Current Account Balance of Payment
The current account includes flows of goods, services, primary income, and
secondary income between residents and non-residents and thus constitutes
an important segment of BoP.
Under current account of the BoP, transactions are classified into i)

merchandise (exports and imports) and ii) invisibles. Invisible transactions
are further classified into three categories, namely (a) Services-travel,
transportation, insurance, Government not included elsewhere (GNIE) and
miscellaneous (such as, communication, construction, financial, software,
news agency, royalties, management and business services); (b) Income; and
(c) Transfers (grants, gifts, remittances, etc.) which do not have any quid pro
quo.
Exports of goods and services and the receipt of transfers are entered in the
current account as credits (+) because they lead to the receipt of payments
from foreigners. On the other hand, imports of goods and services and the
granting of transfers entered as debits (–) because they lead to payment to
foreigners.
The Balance of Trade (BoT) deals only with exports and imports of
merchandise (or visible items). The Balance of Invisibles (BoI) shows net
receipts on account of invisibles. It is not necessary that BoT should always
balance; more often than not, it will show either a surplus or a deficit on BoI.
If the surplus on BoI equals the deficit on BoT, the current account will show
a net balance. But then there is no reason why these two balances should
always be equal, again, always in opposite directions. As a matter of fact, the
balance on current account can always show a deficit or a surplus. A surplus
on current account leads to an acquisition of assets or repayment of debts
previously contracted, and a deficit involves withdrawal of previously
accumulated assets or is met by borrowings.
While the “goods and services (invisibles) account” generally forms a major
part of the current account, the primary income account reflects amounts
payable and receivable in return for providing temporary use of labour,
financial resources, or non-produced non-financial assets (natural resources).
The net effect of all the transactions under the above accounts is known as
the “current account balance”. In other words, the current account balance
shows the difference between the sum of exports of goods and services as
well as income receivable, on the one hand, and the sum of imports and
income payable on the other. From a macroeconomic perspective, the value
of the current account balance reflects the inflow/outflow of foreign
resources bridging the savings-investment gap.
19.4.2 The Capital Account

The capital account3 shows credit and debit entries for non-produced non-
financial assets and capital transfers between residents and non-residents. It
3
As Defined in Balance of Payments and International Investment Position Manual Sixth
Edition (BPM6), IMF 41
External Sector and records acquisitions and disposals of non-produced non-financial assets, such
Trade Policy
as land sold to embassies and sales of leases and licenses, as well as capital
transfers, that is, the provision of resources for capital purposes by one party
without anything of economic value being supplied as a direct return to that
party.
To be more precise, the capital account shows the change in the nation’s
assets abroad and the foreign assets in the nation, other than official reserve
assets. It includes direct investments (e.g. building of a foreign plant), the
purchase or sale of foreign securities (stocks, bonds, and treasury bills), and
the change in the nation’s non-bank and bank claims on and liabilities to
foreigners during the year. Increases in the nation’s assets abroad and
reductions in the foreign assets in the nation (other than official reserve
assets) are capital outflows or debits (–) in the nation’s capital account
because they lead to payment to foreigners. On the other hand, decreases in
the nation’s assets abroad and increases in foreign assets in the nation are
capital inflows or credits (+) because they lead to the receipt of payments
from foreigners.
19.4.3 The Financial Account

The financial account reflects net acquisition and disposal of financial assets
and liabilities during a period. The transactions under financial account
appear both in the BoP and in the integrated international investment position
(IIP) statement owing to their effect on the stock of assets and liabilities. The
sum total of net transactions under the current and capital account represents
net lending (surplus) or net borrowing (deficit) by the economy from the rest
of the world, which is reflected in the financial account as net outflow or
inflow of capital. Thus, the financial account shows how the net lending to or
borrowing from the rest of the world has occurred. Conversely, it shows how
the current account surplus is used or the current account deficit is financed.
The financial account together with the “other changes account” explains the
change in the IIP between the beginning and end-periods.
The sum of the balances on the current and capital accounts represents the net
lending (surplus) or net borrowing (deficit) by the economy with the rest of
the world. This is conceptually equal to the net balance of the financial
account. In other words, the financial account measures how the net lending
to or borrowing from non-residents is financed. The financial account plus
the other changes account explain the change in the IIP between beginning-
and end-periods.
19.4.4 Net Errors and Omissions

While BoP accounts are, in principle, balanced, imbalances may occur in
practice on account of imperfect compilation procedures and different data
sources. This imbalance, a usual feature of BoP statistics, is termed “net
errors and omissions” and is identified explicitly in the BoP statement. Net
errors and omissions in simple terms are derived residually as the difference
between total of receipts and payments (both current and capital together with
42
Foreign Trade and
the financial account). Therefore, a positive value of net errors and omissions Balance of Payment
indicates any or all of the following:
• the credit transactions (current or capital or both) are understated;
• the debit transactions (current or capital or both) are overstated;
• the net increase in assets in the financial account is overstated;
• the net increase in liabilities in the financial account is understated.
In the case of a negative value of net errors and omissions, the opposites of
the above would hold.
19.5 INDIA’S BALANCE OF PAYMENTS –

RECENT TRENDS
In India, Reserve Bank of India publishes the quarterly and annual BoP
statistics in two formats, an old format and a BPM6 format as recommended
by the IMF. Table 19.8 presents the summary of the India’s BoP account
from 2014-15 to 2018-19. Table 19.9 exhibits the overall situation of India’s
BoP whereas Table 19.10 demonstrates the key indicators of India’s BoP as a
percentage of GDP. Figure. 19.1 exhibit Current Account Deficit (CAD) as
per cent of GDP over the period of time which has been further captured for
the period of 2009-14 and 2014-19 in the Table 19.11.
Table 19.8: Balance of Payments(in US $ million)
S.
Item 2014-15 2015-16 2016-17 2017-18 2018-19
No.
1 2 3 4 5 6 7
I Current Account
1 Exports 3,16,545 2,66,365 2,80,138 3,08,970 3,37,237
2 Imports 4,61,484 3,96,444 3,92,580 4,69,006 5,17,519
3 Trade Balance (1-2) -1,44,940 -1,30,079 -1,12,442 -1,60,036 -1,80,283
4 Invisibles (net) 1,18,081 1,07,928 98,026 1,11,319 1,23,026
A. Services 76,529 69,676 68,345 77,562 81,941
B. Income -24,140 -24,375 -26,302 -28,681 -28,861
C. Transfers 65,692 62,627 55,983 62,438 69,946
Goods and Services
5 -68,411 -60,402 -44,098 -82,474 -98,342
Balance
Current Account
6 Balance -26,859 -22,151 -14,417 -48,717 -57,256
(3+4)
43
External Sector and
Trade Policy
II Capital Account
Capital Account
89,286 41,128 36,447 91,390 54,403
Balance
External Assistance
i. 1,725 1,505 2,013 2,944 3,413
(net)
External
Commercial
ii. 1,570 -4,529 -6,102 -183 10,416
Borrowings
(net)
iii. Short-term credit -111 -1,610 6,467 13,900 2,021
Banking Capital(net)
iv. of 11,618 10,630 -16,616 16,190 7,433
which:
Non-Resident
14,057 16,052 -12,367 9,676 10,387
Deposits (net)
Foreign
v. Investment(net) of 73,456 31,891 43,224 52,401 30,094
which:
A. FDI (net) 31,251 36,021 35,612 30,286 30,712
B. Portfolio (net) 42,205 -4,130 7,612 22,115 -618
vi. Other Flows (net) 1,028 3,242 7,460 6,138 1,026
III Errors and Omission -1,021 -1,073 -480 902 -486
IV Overall Balance 61,406 17,905 21,550 43,574 -3,339
Reserves change
V [increase (–) / -61,406 -17,905 -21,550 -43,574 3,339
Decrease (+)]
Table 19.9: India's Balance of Payments (BoP)Situation

(in US $ million)
Year/ Item Current Account Capital Account Overall Balance
1981-82 -3179 657 -2523
1991-92 -1178 3777 2599
2001-02 3400 8357 11757
2011-12 -78155 65324 -12831
2018-19 -57256 53917 -3339

Source: Database on Indian Economy, Reserve Bank of India
44
Foreign Trade and
Table 19.10: Key indicators of India’s Balance of Payments Balance of Payment
(As per centof GDP)
Import
Net Trade Cover
Invisibles Balance of Reserves
(In months)
1981-82 4.5 8.3 2.1 -3.8 3.3
1991-92 6.8 7.8 0.6 -1.0 5.3
2001-02 9.2 11.6 3.1 -2.4 11.5
2011-12 17.0 27.4 6.1 -10.4 7.1
2018-19 12.4 19.0 4.5 -6.6 9.6
Source: Database on Indian Economy, Reserve Bank of India
1 0.7
0
−0.6
−0.4
−1
−1.7 −1.1
−1.7 −1.3 −2.1
−2
−1.8
% of GDP
−3
−4 −4.3
−5 −4.8
−6
1981-82 1991-92 2001-02 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19
Financial Year
Fig. 19.1: Current Account Deficit (CAD) as per cent of GDP

Source: Computed from database on Indian Economy, Reserve Bank of India
Table 19.11: Current Account Deficit (CAD) as per cent of GDP
CAD as per cent of 2009-14 2014-19 2018-19

GDP -3.3 -1.4 -2.1
19.5.1 The SalientFeatures of India’s BOP

For an emerging and aspiring market economy like India which need access
of foreign savings and capital to meet the investment requirement for a US$ 5
trillion-economy, improvement in BoP position is critical. It ensures
financing of essential imports like crude oil and other such inputs that drive
the major sectors of the economy to ensure livelihood to crores of people in
the country.
45
External Sector and Before 1991
Trade Policy
The entire period was very challenging for India’s BoP, partly because of
slow growth of exports in relation to import requirements and partly because
of adverse external factors. Foreign exchange reserves were at a low level,
generally less than necessary to cover three months’ exports. Almost the
entire CAD (92 per cent) was financed by inflows of external assistance.
Recent Developments
The prominent features of the BoP situation as it has emerged over the last
two decades can be briefly summarised as follows:
 Widening Deficit on Balance of Trade Account – Goods: Deficit
towards merchandise trade has been the biggest component of India’s
current account deficit which is adversely impacting the BoP position.
India’s exports and imports have multiplied fast, but imports have risen
at a faster rate than exports. In the recent years, the escalation of global
trade tensions and global slowdown have worsened India’s trade deficit.
As imports grew faster than exports, the deficit in Balance of Trade
(goods) widened to 10.7 per cent of GDP in 2012-13 which narrowed
down to 4.9 per cent of GDP in 2016-17, but again increased to 6.6 per
cent of GDP in 2018-19. The improvement in the deficit of BoT in 2016-
17 was on mainly on account of more than fifty per cent decline in crude
prices.
 Role of Invisibles –There has been a phenomenal increase in net surplus
on account of invisibles principally, due to a) buoyancy in private
transfers (i.e. inward remittances), and fast expansion in exports of
services, especially software. India is unique among emerging economies
to have a sizable invisible surplus that substantially offsets the
merchandise trade deficit. Net Private transfer receipts, mainly
representing remittances by Indians employed overseas, increased
marginally from USD 65.7 billion in 2014-15 to around USD 70.0
billion in 2018-19. According to the Economic Survey 2018-19, India
remained a top remittance recipient country in 2018, followed by China,
Mexico, Philippines, and Egypt, with remittance inflows peaking at all-
time high. Of three main components of net invisibles, net services grew
from USD 76.5 billion in 2015-16 to USD 81.9 billion in 2018-19.
Economic Survey 2019-20 points out that the surplus on net services has
been significantly financing the merchandise trade deficit which reached
its peak to about two-thirds of merchandise deficit in 2016-17 before
declining to less than half in the last couple of years. Overall, net
invisibles as a proportion of GDP reflects the net impact of service
exports and imports and unilateral transfers on BoP. In recent times, net
invisibles have grown from USD 118.1 billion in 2015-16 to USD 123.0
billion in 2018-19. However, India’s net surplus on account of invisibles
has been steadily declining in relation to GDP. As a matter of fact,
India’s net invisibles were 6.2 percent of GDP in the year 2013-14 which
continuously declined and reached to 4.2 percent of GDP in 2018-19 and
thereafter marginally improved to 4.5 per cent of GDP in 2019-20.
46
Foreign Trade and
 Current Account - Slowdown in global demand, higher global crude oil Balance of Payment
prices, subdued global trade activity and geo-political uncertainties took
a toll on India’s external sector as the CAD widened to its highest level
since 2012-13. (RBI Bulletin November 2019) India’s external sector
faced persistent global headwinds in 2018-19. As a result, CAD which
averaged 1.3 per cent of GDP during 2013-14 to 2017-18 rose to 2.1 per
cent of GDP. (RBI Bulletin November 2019). India’s Current Account
Deficit (CAD) as a percentage of GDP has shown variable trend. The
CAD for the year as a whole widened to –4.8 per cent of GDP in 2012-
13. Thereafter, it started narrowing down to –0.6 per cent in 2016-17.
CAD again increased to –2.1 per cent in 2018-19, primarily on the back
of higher trade deficit. Economic Survey 2019-20 has pointed out that
India’s CAD to GDP ratio significantly improving from 2009-14 to
2014-19.
 Developments in Capital Account – Major components in the capital
account are foreign investment (including foreign direct investment and
portfolio investment) and borrowings.On the capital account, India has
been running a significant surplus. As a result, India has been rapidly
building up its foreign exchange reserves. However, during 2018-19,
foreign investment declined to US$30.1 billion as compared to US$ 73.5
billion in period of 2014-15. Economic Survey 2018-19 states that robust
foreign direct investment (FDI) inflows, were more than outweighed by
withdrawals under portfolio investment reflecting an escalation of global
risk aversion. Among other forms of capital flows, banking capital
recorded a net inflow ofUS$ 7.4 billion in 2018-19, a 36 per cent decline
over US$11.6 billion in 2014-15. Among debt creating capital flows, net
external assistance increased by 97.9 per cent to US$3.4 billion in 2018-
19 as against US$1.7 billion in 2014-15. External Commercial
Borrowings (ECBs) experienced a significant increase in net inflow of
US$10.4 billion during 2018-19 which is a massive increase of more
than five times as against a net inflow of US$1.6 billion in 2014-15,
reflecting in part a possible credit crunch in the country. Net NRI deposit
declined by 26.1 percent to US$1.0 billion in 2018-19 as against
US$14.0 billion in 2014-15. Net short-term trade credit has shown a
mixed trend and after recording a sharp decline during 2014-15 and
2015-16 due to import contraction, it has increased to US$ 13.9 billion in
2017-18 and thereafter declined to US$2.0 billion in 2018-19. Overall, in
2018-19, net capital flows fell short of financing current account deficit
resulting in depletion of foreign exchange reserves. The capital account
demonstrates following features: (a) Both inflows and outflows of capital
have increased. (b) The composition of capital flows is undergoing a
change: (1) Official external assistance has been gradually losing out its
significance; (2) FDI and portfolio investment have surged, and among
the two, the inflows on account of FDI have been more than on account
of portfolio investment (except 2010-11 when the trend got reversed). (3)
With easing of controls, external commercial borrowings have been
coming back into prominence.
47
External Sector and On account of average GDP growth of 7.5 per cent during the period 2014-
Trade Policy
19, the Balance of Payments (BoP) position of India improved from an
accumulated foreign reserve of US$ 304.2 billion at end of 2013-14 to US$
412.9 billion at end of 2018-19. In recent period, financing of the current
account has become less vulnerable to capital flight as compared to the
previous period. At the same time, it has been observed that growth of forex
reserves in India bears no correlation with movements in net Foreign
Portfolio Investment (FPI). The widening of the current account deficit over
the period has been largely on account of a higher trade deficit driven by rise
in international crude oil prices (Indian basket). Net remittances from Indians
employed overseas has been constantly increasing over the years helping
stabilising the BoP situation. India’s balance of payments position in 2018-19
came under pressure from higher current account deficit (CAD) as well as
lower net capital inflows. Nevertheless, continuous improvement in BoP
position of India shows sentiments and confidence being reflected by global
economy which increasingly believes in India’s growth story.
19.6 EXTERNAL DEBT

External debt is the component of total debt held by creditors of the foreign
nations. Debt can be in the form of money owed to banks (Asian
Development Bank (ADB), International Bank for Restructuring and
Development (IBRD) outside the domestic nation or borrowings from the
global financial institutions like the World Bank and International Monetary
Fund (IMF).
In a developing country like India, external borrowing is important to
increase the volume of funds available for investment. However, it is
important that borrowed money be used for investment (other than in a
situation of a dire emergency) so that economy grows and is able to repay the
debt. Along with growth there is a need for foreign earning too to increase so
that the debt can be repaid.
Classification of External Debt

The external debt in India is classified as:
(i) long-term debt and(ii) short-term debt.
The long-term debt consists of external commercial borrowings, borrowings
from global financial institutions like IMF (Multilateral Debt), borrowings
from private banks (Bilateral Debt), trade credit, NRI deposits, etc. On the
other hand, short-term debt comprises of FII investments in government T-
bills, investment in T-bills by foreign central banks, external debt liabilities
of commercial banks and RBI.
External Debt Indicators

Key indicators such as debt to GDP ratio, debt service ratio, short-term debt
to total debt, short-term and total debt to foreign exchange reserves,
concessional debt to total debt and debt expressed in terms of present value
48
Foreign Trade and
are commonly used to assess the stability and sustainability of a country’s Balance of Payment
stock of external debt relative to the absolute level of the debt.
Evolution and Characteristics of India’s External Debt

As per Ministry of Finance report4, external debt is largely used for financing
specific projects at the Central and State levels. States are not permitted to
contract external debt directly and therefore in the existing system all external
debt (even those not used for financing Central Govt. projects) are first
contracted in the Consolidated Fund of India and then on-lent to States. Most
of the external debt is from Multilateral agencies such as IDA, IBRD, ADB,
etc. A small proportion of existing external debt comes from bilateral
agencies. All these loans are generally long-term variable rate loans linked to
LIBOR. While calculating effective rate of interest for these loans, impact of
exchange rate variation needs to be considered.
Prior to 1991, the bulk of short-term debt was borrowed by public sector
canalising agencies for financing the import of petroleum, petroleum
products and fertilisers. Such short-term debt constituted around 10 per cent
of total external debt during the 1980s. The experience with the balance of
payments crisis of 1991 led to the adoption of policies for prudent external
debt management with less dependence on short-term foreign capital.
India’s external debt has undergone significant level and compositional
changes since the early 1990s. Drawing on the lessons from the external
payment crisis of 1991 and the recommendations of the High-level
Committee on Balance of Payments, 1993 (Chairman: Dr C. Rangarajan), the
policy approach has been guided by5 :
● restrictions on size, maturity and end-use of External Commercial
Borrowings (ECBs);
● LIBOR-based interest ceiling on non-resident deposits to discourage the
volatile component of such deposits;
● pre-payment and refinancing of high cost external debt; and
● measures to encourage non-debt creating financial flows such as foreign
direct investment (FDI) and foreign portfolio investment (FPI).
Highlights of India’s External Debt6

At end-March 2020, India’s external debt was placed at US$ 558.5 billion,
recording an increase of US$ 15.4 billion over its level at end-March
2019.Commercial borrowings remained the largest component of external
debt, with a share of 39.4 per cent, followed by non-resident deposits (23.4
per cent) and short-term trade credit (18.2 per cent).
At end-March 2020, long-term debt (with original maturity of above one

year) was placed at US$ 451.7 billion, recording an increase of US$ 17.0
4
Government Debt, Status Report, March 2012, Department of Economic Affairs, Ministry
of Finance
5
RBI Bulletin December 2017
6
RBI release on 30th Jun 2020 49
External Sector and billion over its level at end-March 2019. Whereas, the share of short-term
Trade Policy
debt (with original maturity of up to one year) in total external debt declined
to 19.1 per cent from 20.0 per cent, the ratio of short-term debt (original
maturity) to foreign exchange reserves declined to 22.4 per cent from 26.3
per cent in the same period.
US dollar denominated debt continued to be the largest component of India’s

external debt, with a share of 53.7 per cent at end-March 2020, followed by
the Indian rupee (31.9 per cent), Yen (5.6 per cent), SDR (4.5 per cent) and
the Euro (3.5 per cent).
The external debt to GDP ratio – a summary measure of a country’s

potential to service external debt by switching production to exports –
declined sharply from 28.3 per cent at end-March 1991 to 19.8 per cent by
end-March 2019.
An increase in external debt to GDP ratio increases debt servicing and draws
down on forex reserves, worsening BoP position. After a significant
reduction in 2014-19 relative to 2009-14, India’s external debt to GDP ratio
slightly increased by 0.3 per cent at the end of first half of 2020 over its level
at end-March 2019, primarily on account of an increase in commercial
borrowings, non-resident deposits and short-term trade credit. Even though
the increase in external debt – on average – exceeded the pace of expansion
of the domestic economy in nominal terms since the second half of the 2000s,
the ratio remained modest relative to its level during the 1990s and stood at
20.6 per cent of GDP at end-March 2020.
A rising share of short-term debt makes the BoP position more vulnerable
because of relatively higher rates of interest on such borrowings. However, a
contraction of short-term debt has been experienced in the falling share of
short-term debt (with original maturity of up to one year) in total external
debt since 2012-13. At a time when exports are not growing rapidly, loans at
high interest rates can create pressure on BoP in the future.
Table 19.12: India's External Debt (Per cent of GDP)
2009-14 2014-19 2018-19
23.90 19.70 19.80
Table 19.13 summarises the key external debt indicators of India reflecting
that India’s external debt is not unsustainable.
Debt Service Ratio indicates the claim that servicing of external debt makes
on current receipts and is, therefore, a measure of strain on BoP due to
servicing of debt service obligations. Debt Service ratio was badly hight at
35.3per cent in 1991 which increased till 2016 and then declined
continuously since 2016 from 8.8 per cent to 6.5 per cent in 2020 (end-
March).Total External Debt to Exports Ratio, another measure of debt
sustainability, increased since 2014 till 2016 and then reduced to 107.1 per
50 cent.
Foreign Trade and
Table 19.13: India’s Key External Debt Indicators Balance of Payment
End- Ratio of Debt Ratio of Ratio of Ratio of Ratio of

March External Service Foreign Concessional Short-term Short-term
Debt to Ratio Exchange Debt to Total Debt to Debt (original
GDP Reserves Debt Foreign maturity) to
to Total Exchange Total Debt
Debt Reserves
1991 28.3 35.3 7.0 45.9 146.5 10.2
2001 22.1 16.6 41.7 35.4 8.6 3.6
2011 18.6 4.4 95.9 14.9 21.3 20.4
2014 23.9 5.9 68.2 10.4 30.1 20.5
2015 23.8 7.6 72.0 8.8 25.0 18.0
2016 23.4 8.8 74.3 9.0 23.2 17.2
2017 19.8 8.3 78.5 9.4 23.8 18.7
2018 20.1 7.5 80.2 9.1 24.1 19.3
2019 19.8 6.4 76.0 8.7 26.3 20.0
2020 20.6 6.5 85.5 8.6 22.4 19.1
As per the report published in the Economic Survey 2018-19, international

comparison of external debt based on World Bank data shows that among the
top twenty developing debtor countries in 2017, India’s external debt to
Gross National Income (GNI) ratio at 19.8 per centwas fourth lowest, while
China continues to have the lowest ratio of 14 per cent. In terms of the
foreign exchange reserves cover to external debt, India’s position was fifth
highest at 75.9 per cent, whereas India has fifth lowest short-term debt to
foreign exchange reserves at 25.1 per cent among the top twenty developing
debtor countries. Again as per the World Bank data, though India is the third
largest debtor country (in absolute amounts) among developing countries
(after China and Brazil), its average-age of debt is much higher given that its
ratio of short-term debt to total debt is only about 19.0 per centwhile that of
China is 69 per cent. Higher age of debt reduces the rollover risk.
Overall, external debt of India continues to be dominated by long-term

borrowings. India continues to be among the less vulnerable nations with its
external debt indicators. India’s external debt remains low as compared to the
average external debt to GDP ratio of all developing countries (25.6 per cent)
according to World Bank’s International Debt Statistics, 2020. The prudent
external debt policy pursued by the government has helped in maintaining
foreign debt within manageable limits.

1) Examine recent scenario of current account deficit in India.
…………………………………………………………………………….
51
External Sector and …………………………………………………………………………….
Trade Policy
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
2) Why did India face the adverse balance of payment prior to 1991?
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
3) What are the trends and challenges of India’s Balance of Payments?
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
19.7 LET US SUM UP

Trade has long been considered, and accurately so, as one of the most
preferred indicators ofa country’s capacity to sustain economic growth. That
is because trade is a reflector of competitiveness.Currently, global trade is
going through a challenging phase due to a variety of factors.Perhaps the
chiefamong them is the trade wars between some of the major nations
seeking to capture a large proportion of trade flows.Thesetradewars between
the economies in the world result in negative repercussions across the
globaleconomy through their impact on the value chains and the creation of
policy uncertainty. Other factors contributing to uncertainty which is
affectingglobal economic growth (and thus global trade) include BREXIT.
This, and the slowdown ofgrowth in the EU, (including its major exporter,
Germany) has led to subdued demand in one of the largesttrading blocs in the
world. Multilateralism has also not made much headway with the lack of
progress of theDoha Development Round.
The composition of India’sexternal trade has been changing from primary
goods to manufacturing andengineering goods. Similarly, direction of India’s
exports is shifting away fromthe traditional markets (EU, USA, and Japan) to
Asia. India’s merchandise trade balance has improved from 2009-14 to 2014-
19 althoughmost of the improvement in the latter period was on account of
more than fifty percentdecline in crude prices in 2016-17.Engineering goods,
petroleum products, precious stones, drug formulations andbiologicals,
goldand other precious metals continue to be top-exported commodities.
Crudepetroleum, electronic goods, machinery, gold, precious stones, and coal
52
Foreign Trade and
constitutetop import items. India’s top five trading partners continue to be Balance of Payment
USA,China, UAE, Saudi Arabia, and Hong Kong.India’s balance of
paymenthas been in surplus resulting in rapid build-up of foreign exchange
reserves largelydue to massive inflows of foreign capital. Indian economy has
been steadilybecoming more open and hence international consequences need
to be kept inmind by the policy makers.
19.8 KEYWORDS
Balance of : The balance of payments is the record of all

Payments international trade and financial transactions made
by a country’s residents.
External Debt : External debt is the portion of a country’s debt that is
borrowed from foreign lenders, including
commercial banks, governments, or international
financial institutions
Degree of : The degree of openness is an economic metric
Openness calculated as the ratio of country’s total trade, the
sum of exports plus imports, to the country’s gross
domestic product.
Terms of Trade : Terms of trade are the relative price of exports in
terms of imports.
Trade Deficit : Also called a negative balance of trade, a trade
deficit is an amount by which the cost of a country’s
imports exceeds its exports.
Trade Policy : Trade policy refers to the regulations and agreements
that control imports and exports to foreign countries.
In other words, it defines standards, goals, rules, and
regulations that pertain to trade relations between
countries.
19.9 REFERENCES
1) Balance of Payments andInternationalInvestmentPosition Manual, Sixth
Edition (BPM6), International Monetary Fund.
2) Basu, Kaushik and AnnemieMaertens, (ed.), (2011).The New Oxford
Companion to Economics in India, Oxford University Press, New
Delhi
3) Bhagwati, Jagdish, (2004).In Defence of Globalisation, Oxford
University Press, New Delhi
4) EXIM Bank of India, Annual Reports.
5) RBI, Annual Reports.
6) Ministry of Finance, Economic Survey, 2017-18, 2018-19, 2019-20
53
External Sector and 7) Reddy, Y.V.: India and the Global Financial Crisis: Managing Money
Trade Policy
and Finance,Orient Blackswan, Hyderabad.

PROGRESS EXERCISES
54
UNIT 20 FOREIGN CAPITAL Foreign Capital
Structure
20.0 Objectives
20.1 Introduction
20.2 Types of Foreign Capital
20.3 Foreign Investment in India
20.3.1 Trends and Magnitude of FDI
20.3.2 Sectoral Distribution of FDI
20.3.3 Countries of Origin of FDI in India
20.3.4 Evolution of Inward Foreign Capital Policy
20.3.5 Key Measures Taken by India to Attract FDI
20.3.6 Consolidated FDI Policy, 2020
20.4 Capital Outflows- Overseas Foreign Direct Investment
20.4.1 Drivers of India’s OFDI
20.4.2 Evolution of OFDI Policy in India
20.4.3 Trends and Magnitude of OFDI flows from India
20.4.4 Sectoral Composition of OFDI flows from India
20.4.5 Destination-wise OFDI flows from India
20.5 Let Us Sum Up
20.6 Key Words
Appendix 20.1
Appendix 20.2
20.0 OBJECTIVES
● analyse the role of foreign capital in the growth process of a developing
economy;
● know the types and sources of foreign capital;
● explain evolution and various phases of India’s policy towards foreign
capital;
● discuss composition, trend, and sources of origin of inward Foreign
Direct Investment to India;
● examine composition, trend, and destinations of Overseas Foreign Direct
Investment (OFDI) of India; and
● evaluate the Government of India’s Policy towards Foreign Capital.
55
External Sector and
Trade Policy
20.1 INTRODUCTION
The term Foreign Capital is primarily associated with inflow of foreign
capital into home country from foreign countries. Spread of globalisation and
opening of the economies along with recent technological advances have led
to movement of firms from one geography to another, thereby contributing to
the economic integration of the world. For any economy, particularly for the
developing economy, foreign capital plays acritical role including by (i)
bridging investment-saving gap (ii) bridging management, entrepreneurship,
technology and skilling gap (iii) bridging foreign exchange gap, (iv)
undertaking initial business risks, (v) contributing to development of basic
economic infrastructure, (vi) supporting stability of foreign exchange and
reducing balance of payment deficit, (vii) facilitating integration with other
economies of the world for trade of goods and services and (vii) eventually
supporting higher development. Because of these collateral benefits
associated with foreign capital, greater use of foreign capital is associated
with improved prospects for economic growth.
Foreign capital helps to improve the competitiveness of the domestic
economy by breaking domestic monopolies. A healthy competitive
environment always pushes firms to continuously enhance their processes
and product offerings, thereby fostering innovation. Consumers also gain
access to a wider range of competitively priced products.
From the perspective of both governments and businesses, foreign capital has
become an important factor in driving economic growth and development. By
acquiring a controlling interest in foreign assets, businesses can quickly
explore new products, technologies, and markets. Leveraging the foreign
capital, governments can create jobs and improve economic growth. Various
studies have shown that the growth of developing and emerging economies is
being driven by leveraging incoming foreign capital in the form of direct
investments. At the same time, firms investing abroad can realise higher
growth rates and diversify their income, which creates opportunities for
investors.
In this unit we shall discuss these various issues related to the foreign capital.
20.2 TYPES OF FOREIGN CAPITAL

In the broader term, foreign capital can be classified in the following
categories:
1) Foreign Investment:
i) Foreign Direct Investment (FDI)
ii) Foreign Portfolio Investment (FPI)
2) External Commercial Borrowings (ECB)
3) Commercial Deposits by Non-Resident Citizens / NRI Deposits
4) External Assistance
i) Loans
56
ii) Grants Foreign Capital
iii) Debt Service Payment

iv) Foreign Aid
According to Reserve Bank of India (RBI), foreign investment means any
investment made by a person resident outside India on a repatriable basis in
capital instruments of an Indian company or to the capital of a limited
liability partnership (LLP).
Similarly, Foreign Direct Investment (FDI) is the investment through capital
instruments by a person resident outside India (a) in an unlisted Indian
company; or (b) in 10 per cent or more of the post issue paid-up equity
capital on a fully diluted basis of a listed Indian company. In a broader sense,
FDI pertains to international investment in which the investor obtains a
lasting interest in an enterprise in another country. More precisely, it may
take the form of buying or constructing a factory in a foreign country or
adding improvements to such a facility, in the form of property, plants, or
equipment. FDI is calculated to include all kinds of capital contributions,
such as the purchases of stocks, as well as the reinvestment of earnings by a
wholly owned company incorporated abroad (subsidiary), and the lending of
funds to a foreign subsidiary or branch. The reinvestment of earnings and
transfer of assets between a parent company and its subsidiary often
constitutes a significant part of FDI calculations.
RBI describes Foreign Portfolio Investment (FPI) as any investment made by

a person resident outside India in capital instruments where such investment
is (a) less than 10 per cent of the post issue paid-up equity capital on a fully
diluted basis of a listed Indian company or (b) less than 10 per cent of the
paid-up value of each series of capital instruments of a listed Indian
company. Broadly speaking, FPI is a category of investment instruments that
is more easily traded, may be less permanent, and do not represent a
controlling stake in an enterprise. These include investments via equity
instruments (stocks) or debt (bonds) of a foreign enterprise e.g. Foreign
Institutional Investors, which does not necessarily represent a long-term
interest.
While FDI tends to be commonly undertaken by multinational corporations,

FPI comes from many diverse sources such as a small company’s pension or
through mutual funds held by individuals. The returns that an investor
acquires on FPI usually take the form of interest payments or dividends.
Investments in FPI that are made for less than one year are distinguished as
short-term portfolio flows.
Calculations of FDI and FPI are typically measured as either a “flow”,

referring to the amount of investment made in one year, or as “stock”,
measuring the total accumulated investment at the end of that year.
As per framework introduced by RBI, External Commercial Borrowings

(ECBs)1 are commercial loans raised by eligible resident entities from
1
Master Direction - External Commercial Borrowings, Trade Credits and Structured
Obligations, FED Master Direction No.5/2018-19, Reserve Bank of India 57
External Sector and recognised non-resident entities and should conform to parameters such as
Trade Policy minimum maturity, permitted and non-permitted end-uses, maximum all-in-
cost ceiling, etc. The parameters apply in totality and not on a stand alone
basis. RBI further prescribes the framework for raising loans through ECB.
The ECB Framework enables permitted resident entities to borrow from
recognised non-resident entities in the following forms:
i) Loans including bank loans;
ii) Securitised instruments (e.g. floating rate notes and fixed rate bonds,
non-convertible, optionally convertible or partially convertible
preference shares / debentures);
iii) Buyers’ credit;
iv) Suppliers’ credit;
v) Foreign Currency Convertible Bonds (FCCBs);
vi) Financial Lease; and
vii) Foreign Currency Exchangeable Bonds (FCEBs)
However, ECB framework is not applicable in respect of the investment in

Non-convertible Debentures (NCDs) in India made by Registered Foreign
Portfolio Investors (RFPIs).
Commercial loans, which primarily take the form of bank loans issued to
foreign businesses or governments. External Assistance to India denotes
multilateral and bilateral loans received under the agreements between
Government of India and other Governments/International institutions and
repayments of such loans by India, except loan repayment to erstwhile
“Rupee area” countries that are covered under the Rupee Debt Service. This
also include Official Development Assistance (ODA), received by the
country from donor countries and International organisations e.g. UNO,
World Bank etc. The main objective of such aid is to promote the economic
development of the recipient countries.
20.3 FOREIGN INVESTMENT IN INDIA

20.3.1 Trends and Magnitude of FDI
At the time of opening of the Indian economy in 1991, foreign investment,
was small, a total of just $103 million. With the opening up of the economy,
it grew substantially and in 2006-07 reached $29.2 billion. In recent years,
FDI trend in Indian Economy is moving in upward direction that too rapidly.
FDI has emerged as the predominant source of external financing. The
attractiveness of India as a preferred investment destination could be
ascertained from the large increase in gross and net FDI inflows to India.
Gross inflow of foreign investment in India grew from $4.03 billion in 2000-
01 to $74.39 billion in 2019-20. In terms of net inflow of FDI to India
(inflow less outflow from India), this figure has grown from $3.27 billion in
2000-01 to $43.01 billion in 2019-20. FDI inflows have continued to be
buoyant in 2019-20. In both gross and net terms, FDI flows in 2019-20 were
58
$74.4 billion and 43.0 billion respectively, well above their respective levels Foreign Capital
in 2018-19. The significant increase in FDI inflows to India reflected the
impact of liberalisation of the economy since the early 1990s as well as
gradual opening up of the capital account. As part of the capital account
liberalisation, FDI was gradually allowed in almost all sectors, except a few
on grounds of strategic considerations, subject to compliance of sector
specific rules and regulations.
During the global financial crisis, when there was a significant deceleration
in global FDI flows the decline in FDI flows in 2009-10 to India was
relatively moderate on the back of strong rebound in domestic growth.
However, in subsequent year of 2010-11, gross FDI equity inflows to India
witnessed significant moderation. After the launch of Make in India in
September 2014, the trends in FDI have improved, showing a positive impact
on the foreign investors due to investor friendly signals from India. India has
jumped from 15th position in 2014 to 10th position in 2015 in the most trusted
nations for FDI. According to World Investment Report 2020, published by
UNCTAD, despite a slowdown in the global economy and growing global
investment concerns due to disruptions in supply chains, India was able to
sustain the pace of FDI in 2019-20 and was the 9th largest recipient country
globally in 2019. Economic Survey 2019-20 pointed out that continuous
liberalisation of FDI guidelines has been responsible for rising in flows of
foreign investment into the country.
Trends in Foreign Portfolio Investment (FPI)

Foreign Portfolio Investment (FPI) is the entry of funds into a country where
foreigners deposit money in a country's bank or make purchases in the
country’s stock and bond markets, sometimes for speculation. Portfolio
investments mainly include investment by foreign institutional investors
(FIIs), funds raised through of American Depository Receipts (ADRs) or
Global Depository Receipts (GDRs) by Indian companies and through
offshore funds. An increase innet FPI flows improves the Balance of
Payment (BoP) position and arises on account of cross-border transactions
involving debt or equity securities, other than those included in direct
investment or reserve assets. However, FPI is often referred to as “hot
money” because of its tendency to flee at the first signs of trouble in an
economy or improvement in investment attractiveness elsewhere in the
world, particularly in the US, at the hands of the Federal Reserve.
The Indian rules for foreign portfolio investments (FPIs) have undergone
several regulatory changes designed to ease investment in the last few years.
FPIs primarily consist of securities and other financial assets passively held
by foreign investors, generally for short-term speculation. Foreign portfolio
investment differs from foreign direct investment in that it does not give the
invest or direct ownership of financial assets.
FPIs in India have been volatile over the years. In 2008-09, 2015-16 and
2018-19, there was a net portfolio outflow from the country that was seen as
weakening of confidence of investors in India’s economy.
59
External Sector and The net portfolio out flow in 2008-09 was $14.03 billion. This is when the
Trade Policy financial crisis hit the developed economies, and many financial institutions
would have withdrawn investments from India and other developing
countries, in order to strengthen their balance sheets at home. In 2015-16
foreign portfolio flows, remain vulnerable to bouts of global risk aversion
which resulted in outflow to the tune of $4.13 billion. Similarly, in 2018-19,
there was a net portfolio outflow of $0.62 billion from the country that was
seen as weakening of confidence of investors in India’s economy.
Trends in External Assistance to India

External assistance is composed of loans and grants. External assistance by
India - denotes aid extended by India to other foreign Governments under
various agreements and repayment of such loans. External Assistance to India
denotes multilateral and bilateral loans received under the agreements
between Government of India and other Governments/International
institutions and repayments of such loans by India, except loan repayment to
erstwhile Rupee area countries that are covered under the Rupee Debt
Service. However, most of the assistance in the initial periods of planning
were in the form of interest-bearing loans, while only a fraction was in the
form of outright grants. According to a position paper published by
Department of Economic Affairs, Ministry of Finance, Government of India
in March 2008.
“As per the extant policy, Government of India does not accept aid in areas
where it has substantial control. While bilateral aid is accepted only from G-
8 countries, the Russian Federation, and the EC, tied aid is not accepted at
all. Channelisation of external assistance from smaller partners (other than
those mentioned above), is only through multilateral organisations to
promote greater aid harmonisation. Further, all countries can provide
bilateral development assistance directly to autonomous institutions,
universities, NGOs, etc through a simplified procedure. Directing of external
assistance of smaller size towards the non-government sector allows this
sector to remain an effective channel for implementation of development
programmes and strengthens the civil society”.
Net Inflow of external assistance reached an all-time high of $4.72 billion in

2010-11 and a record low of $-3.33 billion in 2003-04 (Table 20.3 in
Appendix 20.2).
Trends in NRI Deposits / Outstanding

NRI deposits were first introduced in February 1970. The initial scheme was
a rupee denominated account, the Non-resident (External) Rupee Account
(NRE), with repatriable principal and interest. In November 1975, a foreign
currency denominated deposit facility, the Foreign Currency Non-resident
Account (FCNRA) was added. This deposit was also repatriable and was
made attractive to the banks through the RBI assuming the exchange rate
risk. Currently, there are three kinds of deposit accounts of Indian banks
where NRIs or PIOs (persons of Indian origin) can park their funds - NRE
(non-resident external-rupee account), NRO (non-resident ordinary rupee
60 account) and FCNR(B) (foreign currency non-resident bank account).
Deposits in NRE accounts are freely repatriable unlike NRO accounts. Both Foreign Capital
NRE and NRO accounts are rupee denominated. FCNR(B) are foreign
currency accounts - dollar, euro, and pound sterling accounts.
Notwithstanding positive accretions of deposits under Non-Resident

(External) Rupee (NRE) accounts; and Non-Resident Ordinary (NRO)
accounts, there was a net outflow of US$12.4 billion from non-resident
deposits during 2016-17, following a lumpy redemption of FCNR(B)
deposits raised by banks under the Reserve Bank’s special swap window
during September to November 2013.
Net flows into non-resident deposit account declined by 17 per cent in 2019-
20 as deposits under the Non-Resident (External) Rupee (NRE) accounts,
which accounted for the bulk of the inflows declined sharply. Softening of
term deposit rates and expectations of further depreciation of rupee amidst
global uncertainties partly moderated flows into this account. Among the
other two accounts, deposits in Non-Resident Ordinary Rupee (NRO)
accounts and the Foreign Currency Non-Resident (Banks) [FCNR (B)]
accounts remained at the previous year’s level
20.3.2 Sectoral Distribution of FDI

Sectoral Distribution of Equity FDI Inflows to India
From a sectoral perspective, FDI2 in India mainly flowed into services sector
(with a cumulative total of $132.8 billion — 69.5 per cent of total equity FDI
flow in the past five years from 2015-16 to 2019-20) followed by
manufacturing, $43.5 billion (around 22.83 per cent during) the same period.
Share of service in total equity FDI inflow to India increased from 62.6
percent ($22.6 billion) in 2015-16 to 77.8 per cent (28.3 billion) in 2017-18
and then declined to 74.2 per cent in 2019-20 ($31.6 billion). Within
manufacturing sector, automobile, chemicals (other than fertilizers) and drugs
& pharmaceuticals are the main sectors responsible for significant FDI.
The Service sector in India includes Financial, Banking, Insurance, Non-

Financial/Business, Outsourcing, Research and Development (R&D),
Courier, Tech, Testing and Analysis services. Within services, the top three
sectors which witnessed highest cumulative inflows of FDI during past five
years from 2015-16 to 2019-20 include communication services ($29.5
billion), financial services ($22.0 billion) and retail and wholesale trade
($20.5 billion).
The rise in FDI flows to India has been accompanied by strong regional
concentration. As per the data released by Department for Promotion of
Industry and Internal Trade (DPIIT)3, the top six states, viz., Maharashtra
(30.35 per cent), Karnataka (17.92 per cent), Delhi (16.6 per cent) Gujarat
2
in equity through SIA/FIPB and RBI routes only and excluding acquisition of
shares and equity capital of unincorporated bodies, as per Reserve Bank of India.
3
https://dipp.gov.in/sites/default/files/FDI_Factsheet_March20_28May_2020.pdf 61
External Sector and (11.05 per cent), Jharkhand (7.7 per cent) and Tamil Nadu (4.21 per cent)
Trade Policy
accounted for over 80 per cent of the FDI equity flows to India between
October 2019 to March 2020. The top two states, i.e., Maharashtra and
Karnataka accounted for over 45 per cent of FDI flows during this period.
Maharashtra alone accounted for over 30 per cent of FDI flows to India
during the same period.
Despite impressive growth rates achieved by most of the Indian states as well
as aggressive investment promotion policies pursued by various state
governments, the concentration of FDI flows across a few Indian states
continues to exist.
20.3.3 Countries of Origin of FDI in India

Countries of Origin of FDI Equity Inflows to India
Singapore and Mauritius remained the major source countries, accounting for
about 50 per cent of cumulative equity FDI flows during past five years from
2015-16 to 2019-20, followed by the Netherlands (8.4%), the US (7.6%),
Japan (6.5%) and the Cayman Islands (3.1%).
During 2019-20, India received the maximum FDI equity inflow from
Singapore (US$ 12.6 billion), followed by Mauritius (US$ 7.5 billion),
Netherlands (US$ 5.3 billion), Cayman Islands (US $3.5 billion), USA (US$
3.4 billion) and Japan (US$ 2.3 billion).
20.3.4 Evolution of Inward Foreign Capital Policy

The Indian growth story in the last three decades is a story of constant
renewal and finding new purpose to meet the goals and aspirations of a
billion people. The Indian economy has evolved and made significant
progress from a closed economy until the 1990s to a vibrant economy of
today. India’s policy on investment by foreign capital can also be divided into
two phases, pre- and post-1991. There has been a sea change in India’s
approach to foreign investment from the early 1990s when it began structural
economic reforms encompassing almost all the sectors of the economy.
Pre-Liberalisation Period (Pre-1991 Period)
Historically, an extremely cautious and selective approach was followed by

India while formulating Foreign Capital Policy. Import-substitution strategy
was preferred in implementing industrialisation framework. Protecting and
nurturing domestic industries was the primary goal. FDI through foreign
collaboration was welcomed in the areas of high technology and high
priorities to build national capability and discouraged in low technology
areas. The regulatory framework was driven by the enactment of Foreign
Exchange Regulation Act (FERA), 1973. Foreign equity holding in a joint
venture was allowed only up to 40 per cent. Subsequently, various
exemptions were extended to foreign companies engaged in export-oriented
businesses and high technology and high priority areas including allowing
equity holdings of over 40 per cent. As India continued to be highly
62
protective, these measures did not add substantially to export Foreign Capital
competitiveness. Recognising these limitations, partial liberalisation in the
trade and investment policy was introduced in the 1980s with the objective of
enhancing export competitiveness, modernisation, and marketing of exports
through Trans-national Corporations (TNCs). The announcements of
Industrial Policy (1980 and 1982) and Technology Policy (1983) attempted
for a liberal attitude towards foreign investments in terms of changes in
policy directions. The policy was characterised by de-licensing of some of
the industrial rules and promotion of Indian manufacturing exports as well as
emphasising on modernisation of industries through liberalised imports of
capital goods and technology. This was supported by trade liberalisation
measures in the form of tariff reduction and shifting of large number of items
from import licensing to Open General Licensing (OGL).
Post-Liberalisation Period (Post 1991 Period)
Major shift occurred when India embarked upon economic liberalisation and
reforms programme in 1991 aiming to raise its growth potential and
integrating with the world economy. Industrial policy reforms gradually
removed restrictions on investment projects and business expansion on the
one hand and allowed increased access to foreign technology and funding on
the other. A series of measures that were directed towards liberalising foreign
investment included: (i) introduction of dual route of approval of FDI– RBI’s
automatic route and Government’s approval (SIA/FIPB) route, (ii) automatic
permission for technology agreements in high priority industries and removal
of restriction of FDI in low technology areas as well as liberalisation of
technology imports, (iii) permission to Non-resident Indians (NRIs) and
Overseas Corporate Bodies (OCBs) to invest up to 100 per cent in high
priorities sectors, (iv) hike in the foreign equity participation limits to 51 per
cent for existing companies and liberalisation of the use of foreign ‟brands
name’’ and (v) signing the Convention of Multilateral Investment Guarantee
Agency (MIGA) for protection of foreign investments. These efforts were
boosted by the enactment of Foreign Exchange Management Act (FEMA),
1999 [that replaced the Foreign Exchange Regulation Act (FERA), 1973]
which was less stringent. This along with the sequential financial sector
reforms paved way for greater capital account liberalisation in India. Table
20.1 summarises the evolutionary phases of India’s inward FDI policy
regime.
63
External Sector and Table 20.1: Evolution of India’s Inward FDI Policy
Trade Policy
Policy Phase / Salient Features of Inward FDI Policy
Period
After • India’s policy with regard to foreign capital was
Independence formulated, for the first time, in the Industrial Policy
Resolution of April 1948.
• The government recognised participation of foreign
capital and enterprise, particularly as regards to
industrial technique and knowledge for rapid
industrialisation of the economy.
• There were no restrictions on the 100 per cent
ownership of Indian subsidiaries, but the authorities
exerted informed pressure on foreign companies to
sell part of their equity to local investors.
• The policy environment was sufficiently
unpredictable to discourage new entrants into India.
During 1960- • FDI policy of India was more restrictive due to the
1980s need to develop local industries.
• No FDI was allowed without transfer of technology.
• Renewals of foreign collaborations were restricted.
• Foreign Exchange Regulation Act, 1973 was
restricted to FDI in certain core or high priority
industries.
• Equity participation was restricted to 40 per cent.
• FDI regime was characterised by a cautious welcome
to foreign investments meaning retaining majority
domestic ownership and effective control in foreign
enterprises.
• Inward-looking, import substitution strategy of
economic development began, quota, permit, and
license regime prevailed all the way and was guided
and controlled by the bureaucracy.
• Development pattern was characterised by strong
centralised pharming, government ownership of
basic and key industries, excessive regulation and
control of private enterprise, trade protectionism
through tariff and non-tariff barriers.
1980s to 1990s • Attitude towards FDI was liberalised as a part of the
industrial policy resolutions.
• Inward looking regulatory regime continued until the
early 1980s.
• Government of India introduced a series of measures
through 1985-industrial policy, to reduce control on
industries, particularly large ones.
Since 1991 • Government started the process of liberalisation of
FDI policy in July 1991; the first-generation reforms
created conducive environment for foreign
investment in India. Foreign investment and
64
technology collaboration was welcomed to obtain Foreign Capital
higher technology, to increase exports and to expand
the production base.
• Foreign Exchange Regulation Act (FERA), 1973
was replaced with Foreign Exchange Management
Act, 1999 (FEMA).
• Licensing and permit quota regime were eliminated,
and firms in all but a few sectors were allowed to
start operations without government approval.
• Automatic route for FDI is permitted.
• Except for certain specified activities, no prior
approval from exchange control authorities i.e.,
Reserve Bank of India is required.
• Many new sectors were thrown open for FDI.
• Eventually, FDI was permitted in virtually every
sector, except those of strategic concern such as
defence and transport.
• Approval mechanism for FDI was made simpler and
transparent.
• Two approval routes i.e., automatic route and
Foreign Investment Promotion Board (FIPB) route
was introduced.
• Capital account restrictions were eased to allow
Indian companies to raise capital abroad, by way of
Eurobonds and GDR/ADRs.
• Foreign companies were permitted to set up 100 per
cent subsidiaries in India.
• Focus shifted to opening of infrastructure, insurance
and service sector, liberalising royalty payment
regime and permitting royalty on trademarks and
brand names.
• Foreign equity was permitted up to 100 per cent in
roads, ports, harbours, bridges, and highways in
1999.
• In the year 2000, a paradigm shift occurred, wherein,
except for a negative list, all the remaining activities
were placed under the automatic route.
• From 2014 onwards, FDI regime was further
liberalised in the sectors like defence, mining,
insurance, pensions e-commerce, retail, and media
etc.
Source: Compiled from various reports published by RBI, Ministry of Finance
20.3.5 Key Measures Taken by India to Attract FDI

Advantage India: Key Facts
i) India has the world’s most liberal FDI rules with sectors like insurance,
defence, single brand retail, food processing, smart cities and space
technology opening up for foreign investment.
65
External Sector and ii) India ranked 63rd out of 190 countries in World Bank’s Ease of Doing
Trade Policy business 2020 report, a significant improvement from the previous year’s
spot, when it ranked 77th.As such, India joined the list of 10 most
improved economies for the third year in a row.
iii) This has been possible as the government has continued to regularly
review FDI norms, basis the changing economic landscape and
geopolitical environment. All these proactive steps have borne fruit, as is
evident from the ever-increasing volumes of FDI inflows and first five
months of fiscal 2021 witnessed highest ever inflow of US$35.7 billion,
a 13 per cent increase from last year.
iv) Given India’s growing demographics, and huge e-commerce and
technological markets, activity in both areas are expected to grow in the
following years.
Over the years, systematic reforms have helped the Indian economy
withstand many a crisis. India is taking a holistic approach to address other
historical issues: for instance, it has already announced labour reforms to
allow more flexible labour related practices; power reforms (addressing high
industrial power tariffs) and port-linked industrial cluster policy (to resolve
the issue of scarcity of industrial land). Structural reforms within the
Agricultural sector, along with US$13 billion Agri-infra fund will be enablers
to attract FDI.
According to the survey conducted by Confederation of Indian Industry (CII)

and Ernst & Young (EY) on “FDI in India– Now, Next and Beyond, Reforms
and opportunities” India can expect to attract US$120 billion to US$160
billion of FDI annually by 2025 if it manages to increase the FDI to GDP
ratio between 3 per cent to 4 per cent range by 2025. This can aid in bringing
back India’s GDP growth rate to 7-8 per cent range. The above growth will
be stimulated by the recent structural reforms, raising of the FDI limits in
multiple sectors and the Atmanirbhar Bharat strategy of the Government of
India.
The Government has undertaken several structural reforms with a focus on

land, labour, liquidity, and law that will globally position India as an
attractive investment destination. Since the onset of the pandemic, it has
injected over Rs. 20 lakh crores stimulus for the economy. The sectors
covered include power, manufacturing, defence, land, education, mining, and
minerals.
Some of the important reforms that have been put in motion are:
i) Corporate tax rate for new manufacturing facilities at 15 per cent to
make it competitive vis-à-vis ASEAN countries.
ii) Abolition of Dividend Distribution tax on companies.

iii) Phased and graded duty structure to incentivise indigenous
manufacturing of intermediate and final goods e.g., Electric Vehicles.
iv) Production linked incentives of Rs. 197 thousand crores for 13 sectors.
66
v) Monetary incentives on incremental sales for a period of five years to Foreign Capital
offset disability manufacturing in India. Initial focus on high import
items (cell phones) and healthcare related products.
vi) Increase in FDI limit for defence production under automatic route from
49 per cent to 74 per cent.
vii) Expanded the definition (turnover and investment thresh holds) of

MSMEs to encourage MSMEs to grow.
viii) Consolidating over 100 labour laws into 4 codes with higher exemptions
for retrenchment and fewer registrations.
ix) Implementing a GIS system to provide information on industrial land

include plot-level information.
x) Enabling ease of doing business through faceless e-assessment for
taxation, decriminalisation of companies’ law and allowing for netting of
qualified Financial Contracts.
xi) Opening of commercial mining of coal and integrated licensing regime
for minerals mining.
xii) Airport Authority of India (AAI) has awarded 3 airports out of 6 bids for
Operation and Maintenance on Public Private Partnership (PPP) Basis.
xiii) Power Departments/ Utilities in Union Territories to be privatised. This

will improve operations and financial efficiency in Distribution and
provide a model for emulation by other utilities across the country.
xiv) New Public Sector and Enterprises Policy where all sectors are open to
private sector while public sector enterprises will play a role in defined
areas.
xv) “Atmanirbhar Bharat Rozgar Yojana” launched to incentivise creation of

new employment opportunities during the COVID recovery phase.
The reforms related to corporate tax cuts, labour, agriculture, Production

Linked Incentives (PLI) & Phased Manufacturing Plan (PMP), Micro Small
& Medium Enterprises (MSME), coal and mining etc. were the long-pending
demands of the industry and multilateral agencies. These reforms will help in
increasing not just the productive capacity of the economy, they will also
make the economy more efficient in use of the resources available.
20.3.6 Consolidated FDI Policy, 2020

India announced its latest consolidated foreign direct investment (FDI)
policy, which is in effect from October 15, 2020 (as per the official circular
released by the government). The Consolidated FDI Policy, 2020
incorporates restrictions notified earlier in the year on FDI coming in from
overseas entities or citizens belonging to neighbouring countries that share a
land border with India, including China, to prevent opportunistic takeovers of
firms.
67
External Sector and Key changes
Trade Policy
i) This Revised Policy supersedes all the press notes, press releases,
clarifications and/or circulars issued by the DPIIT, which were in force
as on 15 October 2020.
ii) The Revised Policy is aligned with the Implementation of the Foreign
Exchange Management (Non-debt Instruments) Rules, 2019 (NDI Rules)
and Foreign Exchange Management (Mode of Payment and Reporting of
Non-Debt Instruments) Regulations, 2019 by incorporating all necessary
changes, including procedural instructions on payment of inward
remittance and reporting requirements.
iii) Government scrutiny of investments from India’s neighbouring countries
- An entity of a country, which shares a land border with India or where
the beneficial owner of an investment into India is situated in or is a
citizen of any such country– can invest only under the Government
approval route. The Revised Policy also included the scenario with
respect to transfer of ownership of an Indian entity, directly or indirectly,
resulting in the beneficial ownership falling within the
restriction/purview stated above. Therefore, any transfer of ownership
resulting into transfer of beneficial ownership to entities or citizens of
neighbouring countries sharing land borders will require government
approval.
iv) Revisions of sectoral caps: Annexure of this unit provides details of

various caps and entry route applicable for specific sectors.

1) State how foreign capital contributes to economic growth?
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
2) What do you mean competitiveness of the economy? How does foreign
capital help to create healthy competitive environment in the economy?
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
68
3) State the nature of technology gap faced by a developing economy. Foreign Capital
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
4) State various types of Foreign Capital.
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
5) Distinguish between Foreign Direct Investment (FDI) and Foreign
Portfolio Investment.
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
6) List the top sectors and country of origin responsible for FDI into India.
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
7) State three important reforms introduced to attract FDI in India.
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
20.4 CAPITAL OUTFLOW- OVERSEAS

FOREIGN DIRECT INVESTMENT
Here, we describe outflow of capital as the movement of assets out of a
country in terms of Overseas Foreign Direct Investment (OFDI). Reserve
69
External Sector and Bank of India (RBI) defines OFDI outside India as investments, either under
Trade Policy the Automatic Route or the Approval Route by way of contribution to the
capital or subscription to the Memorandum of a foreign entity or by way of
purchase of existing shares of a foreign entity either by market purchase or
private placement or through stock exchange. This signifies a long-term
interest in the foreign entity [Joint Venture (JV)/ Wholly Owned Subsidiary
(WOS)], but it does not include portfolio investment.
As per RBI, "JV / WOS" means a foreign entity formed, registered or

incorporated in accordance with the laws and regulations of the host country
in which the Indian party/Resident Indian makes a direct investment. A
foreign entity is termed as JV of the Indian Party/Resident Indian when there
are other foreign promoters holding the stake along with the Indian Party. In
case of WOS entire capital is held by the one or more Indian Party/Resident
Indian.
Overseas Foreign Direct Investment (OFDI) is divided into three categories

i.e. equity, loans and guarantee issued.
20.4.1 Drivers of India’s OFDI

One of the essential motives of Indian firms’ overseas direct investment has
been essentially to tap the host country markets, i.e. such investments have
been market-seeking. A detailed survey conducted by the Export-Import
Bank of India (Exim Bank)4 identifies number of factors that are responsible
for Indian businesses expedition abroad. Some of these include:
i) Regulatory changes in the FDI investment.

ii) Expending of existing market and increasing appetite to take risk by
Indian companies.
iii) Value addition through enhanced technical knowhow.
iv) Low factor cost advantages in the host country (as in natural resources).
v) If the interest rate in a foreign country is low as compare to India, there
would be greater incentive to borrow abroad and make direct
investments abroad.
vi) Depreciation of Indian currency will make it more attractive for Indian
companies to invest overseas in another currency.
vii) Saturation of the Indian market lead to the need to enhance their export-
competitiveness in third country markets.
viii) To exploit the domestic market potential in other countries.

However, a clear outcome that emerges from the Exim Bank survey is that
the overseas investment activities of Indian companies are essentially
motivated by a set of firm-specific objectives. It can be just a market entry
4
Outward Direct Investment from India: Trends, Objectives and Policy Perspectives,
70 Export-Import Bank of India, May 2014.
strategy or market entry plus strategy (e.g. accessing strategic asset)implying Foreign Capital
a multi-purpose intention of making an overseas investment.
20.4.2 Evolution of OFDI Policy in India

After independence and before the process of liberalisation and globalisation
of the economy in 1991-92, India followed a very restrictive and inward
looking OFDI policy regime. No cash remittance was allowed and
repatriation of dividend from the profits from overseas projects was
mandatory. To some extent, policy regime supported promoting OFDI
amongst developing countries under the overall objective of enhancing south-
south cooperation. During the period of 1960s to 1980s, Indian businesses
also preferred inward looking approach which is characterised by seeking
protection from foreign direct investment (FDI) and imports. During this
period, Indian businesses were highly dependent upon domestic markets and
operated with low technological capabilities, inadequate product quality and
low productivity.
With the gradual opening of the economy since 1991-92, regulatory regime
guiding India’s OFDI was witnessed gradual changes over the period of time.
Current OFDI policy orientation is now more or less region/country neutral.
This has encouraged large number of Indian firms to establish their foothold
in international markets, through acquisitions and investments in businesses.
Table 20.2 summarises the evolution of Indian policy regime towards OFDI.
Table 20.2: Overview of Evolution of India’s OFDI Policy Regime
Policy
Phase / Salient Features of OFDI Policy
Period
• The period of Economic Liberalisation in India
• “Guidelines Governing Indian Joint Ventures / Wholly
owned Subsidiaries Abroad” was introduced.
• ‘Automatic Route’ for overseas investments by Indian
entrepreneurs was introduced in 1992.
• Cash remittances were allowed for the first time.
However, the total value was restricted to US$ 2 million
Phase I with a cash component not exceeding US$ 0.5 million in
(1992-94) block of 3 years.
• Provided more operational freedom to investors, subject
to the condition that no additional financial transfers from
India was required.
• Removed the requirement of only minority equity
shareholding in JVs.
• Financial sector was excluded from the purview of
automatic approvals.
71
External Sector and • Aimed at providing a transparent policy framework for
Trade Policy
Indian investors to plan their business.
• Guidelines for Indian Direct Investment in Joint Ventures
and Wholly-owned Subsidiaries Abroad was suitably
amended to support the overseas investment by the Indian
businesses.
• Conception of Fast Track Route work relating to
approvals for overseas investment was transferred from
Ministry of Commerce to the Reserve Bank of India to
provide a single window clearance mechanism.
• Limits were raised from US$ 2 million to US$ 4 million
and linked to average export earnings of the preceding
three years.
• Above US$ 4 million, approvals were considered under
the normal route approved by a Special Committee.
• In 1997, limit of automatic approval was increased up to
US$15 Million.
Phase II • Investment proposals in excess of US$ 15 million were
(1995- considered by the Ministry of Finance with
1999) recommendations of the Special Committee and were
generally approved if the required resources were raised
through the global depository receipts (GDR) route.
• The exchange earners, other than exporters, were brought
under the fast track route in 1997.
• Permitted acquisitions of foreign companies.
• The condition that the amount of outward investment
should be repatriated in full by way of dividend, royalty,
etc. within a period of five years was done away.
• Investments in Nepal and Bhutan, in Indian currency,
increased up to INR. 120 crores.
• In 1999, annual ceiling of OFDI under fast track mode
was further increased to US$ 30 Million in SAARC
countries and Myanmar. For other countries, the ceiling
remained at $15 million.
• A series of measures to encourage software industry in
India to expand capacity: reduce costs, improve quality,
and invest abroad, were introduced.
• Implementation of the Foreign Exchange Management
Act (FEMA) in June 2000.
• Liberalisation under FEMA and thereafter scope of
Phase III outward FDI expanded significantly.
(2000 • 2002-Annual limit of investment under automatic
onwards) approval increased to US$ 100 Million to Indian corporate
with a proven track record for investment in overseas joint
ventures or wholly owned subsidiaries, even where the
investment is not in the same core activity as they are
72 engaged. They were also allowed to invest in such
ventures up to 100% of their net worth. Foreign Capital
• 2005: Automatic route for investment abroad was raised

to 200% of net worth.
• 2006:Done away with the requirement that only promoter
corporates could issue guarantee on behalf of JV/WOS.
Any Indian entity was permitted to issue guarantees.
• 2007: Automatic approval was made up to 300% of net
worth in June’ 07 and this limit was increased to 400% in
September’ 07.
• 2008: Permitted Indian private entities in the oil sector to
invest in unincorporated entities in oil sector up to 400%
of their net worth under the automatic route.
• 2013: Brought down the ceiling of automatic approval to
100% of net worth. However, provisions in the oil sector
remain unchanged.
Source: Compiled from Joseph (2019)5 and Reserve Bank of India
Currently, Overseas Foreign Direct Investment (OFDI) outside India is

governed by Foreign Exchange Management (Transfer or Issue of any
Foreign Security) (Amendment) Regulations, 2004 (‘FEMA Regulations’), as
amended from time to time.
Over the last two decades, overseas investment has become one of the key
mechanisms of Indian companies to establish their global operations. Indian
businesses are more open to the idea that their future growth would be
influenced not only through exports but also by establishing physical
presence overseas.
Permissible Sources for Funding Overseas Foreign Direct Investment

RBI allow funding for overseas direct investment can be made by one or
more of the following sources:
i) Withdrawal of foreign exchange from an AD bank (Authorised dealer

Category) in India.
ii) Swap of shares (refers to the acquisition of the shares of an overseas JV /
WOS by way of exchange of the shares of the Indian party).
iii) Capitalisation of exports and other dues and entitlements.
iv) Proceeds of External Commercial Borrowings / Foreign Currency
Convertible Bonds.
v) In exchange of ADRs / GDRs issued in accordance with the Scheme for
issue of Foreign Currency Convertible Bonds and Ordinary Shares
(Through Depository Receipt Mechanism) Scheme, 1993 and the
guidelines issued by Government of India in the matter.
vi) Balances held in Exchange Earners Foreign Currency account of the
Indian Party maintained with an Authorised Dealer.
5
Joseph, Reji K.: Outward FDI from India: Review of Policy and Emerging Trends. 73
External Sector and vii) Proceeds of foreign currency funds raised through ADR / GDR issues.
Trade Policy
20.4.3 Trends and Magnitude of OFDI flows from India
In terms of flow of overseas investment, equity and loans would be relevant
as a very small proportion of guarantees are invoked which require the flow
of money. Table 20.7 (in appendix 20.2) shows that outward foreign direct
investment flows rose from US $ 677.7 million in 2000-01 to US$ 12.9
billion in 2019-20.
Cumulative OFDI for the period of 2000-01 to 2019-20 in the form of equity
and loans constitute 66.7 per cent and 30.6 per cent share respectively of the
total OFDI from India. Only 2.7 per cent of guarantee was actually invoked
during this period. Annual OFDI flows exhibited a growing trend till 2007-
08.The global financial crisis affected the flow of outward FDI from India in
2009-10. Thereafter, it shows mixed trend. The share of financing OFDI
through equities declined from 88.8 per cent in 2000-01 to 48.4 per cent in
2019-20, while share of loans in financing outward OFDI from India rose
from 10.4 per cent to 45.9 per cent during the corresponding period.
20.4.4 Sectoral Composition of OFDI flows from India

The sectoral pattern of cumulative outward FDI shows that during past five
years from 2015-16 to 2019-20, it has been mainly invested in financial,
insurance and business services (34.8 per cent) followed by manufacturing
sector (22.1 per cent), wholesale, retail trade, restaurants and hotels (12.5 per
cent) and agriculture and mining (12.0 per cent).
20.4.5 Destination-Wise OFDI flows from India

Table 20.9 (in Appendix 20.2) depicts destination-wise distribution of OFDI
from India during past five-year period from 2015-16 to 2019-20. Top ten
destination countries accounted for 79.6% share of India’s cumulative OFDI
during 2015-16 to 2019-20. Singapore (19.2%) has emerged as the top
destination of India’s cumulative OFDI during the same period followed by
Mauritius (16.3%), United States of America (13.1%), United Kingdom
(7.7%) and the Netherlands (7.6%).
The recent trend is showing that outward FDI form India is increasingly
flowing to developed countries. This reflects growing confidence of the
Indian corporate to expand their global footprints. Indian firms invest in
foreign shores primarily through mergers and acquisition (M&A). With rising
M&A activity, companies will get direct access to newer and more extensive
markets and better technologies, which would enable them to increase their
customer base and achieve a global reach.
According to the RBI Annual report 2019-20, outward direct investment by
Indian entities also remained robust as Indian entities continued to expand
their overseas business operations. Outward FDI was mainly in the form of
equity and loans to subsidiaries/ affiliated enterprises, primarily to Singapore,
the US, the UK, Mauritius, Switzerland, and the Netherlands, which
accounted for 75 per cent of total overseas investments during the period.
74
Most of these investments were made in the business services, manufacturing Foreign Capital
and restaurants and hotels sector.
According to the information published by India Brand Equity Foundation

(IBEF)6, some of the facts and figures with respect to major overseas
investments by Indian companies during 2019-20 were:
i) In 2019-20, India invested in 120 projects and created 5,429 new jobs in
the UK to become the second-largest source of foreign direct investment
(FDI).
ii) In 2020, Zerodha announced to introduce an option to invest in US

stocks on its platform.
iii) In August 2020, Axis Securities launched new platform to invest in US

stocks to meet the increasing interest of the Indian retail investors in the
US stock markets.
iv) In February 2020, Bharti Airtel invested US$ 978.92 million in its
wholly owned subsidiary in Mauritius.
v) In January 2020, Calleis Infrastructure invested US$ 81.12 million in its

wholly owned subsidiary in the UK.
vi) In December 2019, Indian Oil Corporation Limited’s (IOCL’s)
INDMAX refining technology was licensed to Naftna Industrija Srbije
(NIS) of Serbia for production of higher value products.
vii) In December 2019, memorandum of understanding (MoU) was signed
between National Small Industries Corporation (NSIC) and Aramco Asia
for developing the MSME Ecosystem in India in the Oil and Gas sector.
viii) In December 2019, Panacea Biotec bagged orders worth nearly Rs 1.7
billion (US$ 24.32 million) from UN agencies, including UNICEF, for
supply of Pentavalent vaccine.
ix) In December 2019, supply chain focused fintech firm, LivFin, raised
US$ 5 million of equity capital from German development finance
institution DEG.
x) In November 2019, PVR Cinemas, a leading multiplex chain, launched

its first property in Sri Lanka, marking its first international venture.
xi) In September 2019, Liquefied Natural Gas (LNG) importer Petronet

entered into an agreement with US LNG developer Tellurian Inc. and
invested US$ 2.5 billion.
xii) In September 2019, Reliance Power announced joint venture (JV) with
Japanese energy major JERA to jointly set up a 750-Megawatt (MW)
gas-based combined cycle power project (phase-1) at Meghnaghat in
Bangladesh.
6
https://www.ibef.org/economy/indian-investments-abroad seen on 28th Dec 2020. 75
External Sector and xiii) In September 2019, OYO acquired Copenhagen-based data science
Trade Policy firm Danamica. This marked the fast-growing lodging start-up to
expand its business in Europe.

1) State the important factors responsible for Capital Outflows.
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
2) State the composition and destination of India’s Overseas Foreign Direct
Investment.
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
3) What is the distinction between Joint Ventures (JVs) and Wholly Owned
Subsidiary (WOS)?
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
4) State the important points of India’s OFDI Policy since 2000 onwards.
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
20.5 LET US SUM UP

Foreign capital contributes to the economic growth of a developing economy
by bridging various gaps i.e. saving gap, foreign exchange gap, technological
gap, skilling gap etc. Foreign capital can be public through participation of
government agencies and through multilateral organisations (the World Bank,
ADB) or private. Again, foreign private capital is of two types — Foreign
direct investment and portfolio investment. Foreign capital has grown
substantially with opening-up of the economy. However, the total foreign
investment has become volatile due to portfolio investment. Several new
forms of investment (i.e. setting up of research centres by MNCs securing
access of raw materials, etc.) have emerged. Since 1991, Government of
India has taken various steps to liberalise the Indian economy. Thereafter,
India has been witnessing significant inflows of foreign direct investment
from various countries and across the sectors. In recent years, India’s global
ranking on “Ease of Doing Business” has been significantly improved on
account of various measures initiated by Government of India to facilitate
76
foreign investment in India. All these measures have helped India in Foreign Capital
becoming one of the attractive destinations for FDI.
Overseas investment is one of the foremost steps to enter the global

marketplace. The policy regime governing India’s outward FDI (OFDI) has
undergone significant change since 1991-92. In recent years, India has taken
necessary steps to make its presence felt in the global arena. Key motivations
of Indian firms for considering OFDI are to maximise gains in ways such as
promotion of exports, securing of energy resources, acquisition of
technology, strategically securing supply-chain and sourcing of raw materials
and intermediary goods. Investment outlook in some of the overseas market
looks positive. In recent years, outward FDI are mainly financed through
equity and loans. Overseas investment from India have undergone a
considerable change, not only in terms of magnitude but also in terms of
geographical spread and sectorial composition. Overseas investment by
Indian companies is expected to increase, backed by the growing appetite of
the Indian corporates to establish their footprints abroad and the liberal
regulatory regime, stable market conditions and considerable impact of the
investment on local economies.
Various studies have established that for Indian economy, foreign capital,
particularly FDI has had a positive impact. FDI inflow has helped
supplementing domestic capital, as well as bridging technology and skills
gaps of existing companies. It also helped to establish new companies. All of
these have contributed to economic growth of the Indian Economy.
20.6 KEY WORDS

Saving Gap : The difference between the required rate of
investment and the actual rate of saving
available in an economy.
Trade Gap : The difference between the expenditure of
foreign exchange and receipts of foreign
exchange in transactions of goods and services.
Multinational : A business organisation which owns or controls
Corporations income generation assets in more than one
country, and in so doing produces goods or
services outside its country of origin.
Foreign Direct : More generally refers to the value of the MNC’s
Investment investment in equity shares of an enterprise in a
foreign country.
Portfolio : Refers to equity holdings by a non-resident in
Investment the recipient country’s joint stock companies.
Overseas Foreign : Refers to the investments made in the overseas
Direct Investment entities by way of contribution to their capital or
subscription to the Memorandum of Association
of a foreign entity or by way of purchase of
existing shares of a foreign entity either by
77
External Sector and market purchase or private placement or through
Trade Policy stock exchange, but it does not include portfolio
investment.

PROGRESS EXERCISES
1) See Section 20.1
2) See Section 20.1
3) See Section 20.1
4) See Section 20.2
3) See Section 20.4
78
APPENDIX 20.1 Foreign Capital
Consolidated FDI Policy 2020 effective from 15th October 20207
PROHIBITED SECTORS
Inward FDI to India is prohibited in:
a) Lottery Business including Government/private lottery, online lotteries,
etc.
b) Gambling and Betting including casinos etc.
c) Chit funds
d) Nidhi company
e) Trading in Transferable Development Rights (TDRs)
f) Real Estate Business or Construction of Farmhouses
g) ‘Real estate businesses shall not include development of townships,
construction of residential /commercial premises, roads or bridges and
Real Estate Investment Trusts (REITs) registered and regulated under the
SEBI (REITs) Regulations 2014.
h) Manufacturing of cigars, cheroots, cigarillos, and cigarettes, of tobacco
or of tobacco substitutes.
i) Activities/sectors not open to private sector investment e.g.(I) Atomic
Energy and (II) Railway operations (other than permitted activities
mentioned under the consolidated FDI policy).
Foreign technology collaboration in any form including licensing for
franchise, trademark, brand name, management contract is also prohibited for
Lottery Business, Gambling and Betting activities.
Permitted Sectors
Table: Sector Specific Limits of Foreign Investment in India
Sector FDI Entry

Cap/Equity Route
AGRICULTURE
AGRICULTURE & ANIMAL HUSBANDRY
• Floriculture, Horticulture, and Cultivation of 100% Automatic
Vegetables & Mushrooms under controlled
conditions;
• Development and Production of seeds and
planting material;
• Animal Husbandry (including breeding of
dogs), Pisciculture, Aquaculture, Apiculture;
and
7
Department for Promotion of Industry and Internal Trade (FDI Division), Ministry of
Commerce & Industry, Government of India. 79
External Sector and • Services related to agro and allied sectors
Trade Policy
Note: Besides the above, FDI is not allowed in
any other agricultural sector/activity
PLANTATION SECTOR
• Tea sector including tea plantations 100% Automatic
• Coffee plantations
• Rubber plantations
• Cardamom plantations
• Palm oil tree plantations
• Olive oil tree plantations
Note: Besides the above, FDI is not allowed in

any other plantation sector/activity
Other condition:- Prior approval of the State
Government is required in case of any future
land use change.
MINING AND PETROLEUM & NATURAL GAS
MINING
Mining and Exploration of metal and non-metal 100% Automatic
ores including diamond, gold, silver, and precious
ores but excluding titanium bearing minerals and
its ores; subject to the Mines and Minerals
(Development & Regulation) Act, 1957.
Coal & Lignite 100% Automatic
• Coal and Lignite mining for captive
consumption by power projects, iron & steel
and cement units and other eligible activities
permitted under and subject to the provisions
of Coal Mines (Special Provisions) Act, 2015
and the Mines and Minerals (Development and
Regulation) Act, 1957.
• Setting up coal processing plants like
washeries subject to the condition that the
company shall not do coal mining and shall not
sell washed coal or sized coal from its coal
processing plants in the open market and shall
supply the washed or sized coal to those
parties who are supplying raw coal to coal
processing plants for washing or sizing.
• For sale of coal, coal mining activities
including associated processing infrastructure
subject to the provisions of Coal Mines
(Special Provisions) Act, 2015 and the Mines
and Minerals (Development and Regulation)
Act, 1957 as amended from time to time and
other relevant Acts on the subject.
80
Mining and mineral separation of titanium bearing 100% Government Foreign Capital
minerals and ores, its value addition, and
integrated activities.
• Mining and mineral separation of titanium

bearing minerals & ores, its value addition, and
integrated activities subject to sectoral
regulations and the Mines and Minerals
(Development and Regulation Act, 1957).
Petroleum & Natural Gas
• Exploration activities of oil and natural gas 100% Automatic
fields, infrastructure related to marketing of
petroleum products and natural gas, marketing
of natural gas and petroleum products,
petroleum product pipelines, natural
gas/pipelines, LNG Regasification
infrastructure, market study and formulation
and Petroleum refining in the private sector,
subject to the existing sectoral policy and
regulatory framework in the oil marketing
sector and the policy of the Government on
private participation in exploration of oil and
the discovered fields of national oil companies.
• Petroleum refining by the Public Sector 49% Automatic
Undertakings (PSU), without any
disinvestment or dilution of domestic equity in
the existing PSUs.
MANUFACTURING
• Subject to the provisions of the FDI policy, 100% Automatic
foreign investment in ‘manufacturing’ sector is
under automatic route. Manufacturing
activities may be either self-manufacturing by
the investee entity or contract manufacturing in
India through a legally tenable contract,
whether on Principal to Principal or Principal
to Agent basis. Further, a manufacturer is
permitted to sell its products manufactured in
India through wholesale and/or retail,
including through e-commerce, without
Government approval.
• Notwithstanding the FDI policy provisions on 100% Government

trading sector, 100% FDI under Government
approval route is allowed for retail trading,
including through e-commerce, in respect of
food products manufactured and/or produced
in India.
DEFENCE
81
External Sector and • Defence Industry subject to Industrial license 100% Automatic
Trade Policy up to 74%
under the Industries (Development and
Regulation) Act, 1951 and Manufacturing of Government
small arms and ammunition under the Arms route
Act, 1959 beyond
Note: Other Conditions Applicable as notified 74%
by the Govt of India wherever it
is likely to
result in
access to
modern
technology
or for other
reasons to
be recorded.
SERVICES SECTOR
BROADCASTING
Broadcasting Carriage Services 100% Automatic
• Teleports (setting up of up-linking HUBs/
Teleports);
• Direct to Home (DTH);
• Cable Networks (Multi-System operators
(MSOs) operating at National or State or
District level and undertaking upgradation of
networks towards digitalisation and
addressability);
• Mobile TV;
• Headend-in-the Sky Broadcasting Service
(HITS)
Cable Networks 100% Automatic
• (Other MSOs not undertaking upgradation of
networks towards digitalisation and
addressability and Local Cable Operators
(LCOs))
Note: Infusion of fresh foreign investment, beyond 49% in a company not
seeking license/permission from sectoral Ministry, resulting in change in
the ownership pattern or transfer of stake by existing investor to new
foreign investor, will require Government approval.
BROADCASTING CONTENT SERVICES
• Terrestrial Broadcasting FM (FM Radio), 49% Government
subject to such terms and conditions, as
specified from time to time, by Ministry of
Information & Broadcasting, for grant of
permission for setting up of FM Radio stations.
• Up-linking of ‘News & Current Affairs’ TV 49% Government
Channels
82
• Uploading/Streaming of News & Current 26% Government Foreign Capital
Affairs through Digital Media
• Up-linking of Non- ‘News & Current 100% Automatic
Affairs’ TV Channels/ Down-linking of TV
Channels
PRINT MEDIA
• Publishing of newspaper and periodicals 26% Government
dealing with news and current affairs
• Publication of Indian editions of foreign 26% Government
magazines dealing with news and current
affairs
• Publishing/printing of scientific and technical 100% Government
magazines/specialty journals/ periodicals,
subject to compliance with the legal
framework as applicable and guidelines issued
in this regard from time to time by Ministry of
Information and Broadcasting.
• Publication of facsimile edition of foreign 100% Government
newspapers
CIVIL AVIATION
AIRPORTS
• Greenfield projects 100% Automatic
• Existing projects 100% Automatic
AIR TRANSPORT SERVICES

(1) (a) Scheduled Air Transport Service*/ 100% Automatic
Domestic Scheduled Passenger Airline up to 49%
(Automatic
(b) Regional Air Transport Service up to 100%
for NRIs)
Government
route be 49%
(2) Non-Scheduled Air Transport Services 100% Automatic
(3) Helicopter services/seaplane services requiring 100% Automatic

DGCA approval
OTHER SERVICES UNDER CIVIL AVIATION SECTOR
(1) Ground Handling Services subject to sectoral 100% Automatic
regulations and security clearance
(2) Maintenance and Repair organisations; flying 100% Automatic
training institutes; and technical training
institutions.
CONSTRUCTION DEVELOPMENT: TOWNSHIPS, HOUSING,
BUILT-UP INFRASTRUCTURE
83
External Sector and • Construction-development projects (which 100% Automatic
Trade Policy
would include development of townships,
construction of residential/commercial
premises, roads or bridges, hotels, resorts,
hospitals, educational institutions, recreational
facilities, city and regional level infrastructure,
townships)
INDUSTRIAL PARKS
• Industrial Parks- new and existing 100% 100%
Automatic
SATELLITES- ESTABLISHMENT AND OPERATION
• Satellites- establishment and operation, subject 100% Government
to the sectoral guidelines of Department of
Space/ISRO
PRIVATE SECURITY AGENCIES
• Private Security Agencies 74% Automatic
up to 49%
Government
route beyond
49% and up
to 74%
TELECOM SERVICES
• Telecom Services (including Telecom 100% Automatic
Infrastructure Providers Category-I) All up to 49%
telecom services including Telecom
Infrastructure Providers Category-I, viz. Basic, Government
Cellular, United Access Services, Unified route
License (Access Services), Unified License, beyond 49%
National/International Long Distance,
Commercial V-Sat, Public Mobile Radio
Trunked Services (PMRTS), Global Mobile
Personal Communications Services (GMPCS),
All types of ISP licenses, Voice Mail/
Audiotex/UMS, Resale of IPLC, Mobile
Number Portability Services, Infrastructure
Provider Category-I (providing dark fibre,
right of way, duct space, tower) except Other
Service Providers
TRADING
• Cash & Carry Wholesale Trading/Wholesale 100% Automatic
Trading (including sourcing from MSEs)
E-COMMERCE ACTIVITIES
• E-commerce activities 100% Automatic
SINGLE BRAND PRODUCT RETAIL

TRADING
• Single Brand Product Retail Trading 100% Automatic
84
MULTI BRAND RETAIL TRADING Foreign Capital
• Multi Brand Retail Trading 51% Government
DUTY FREE SHOPS

Duty Free Shops 100% Automatic
• Note: Duty Free Shops would mean shops

set up in custom bonded area at
International Airports/International
Seaports and Land Custom Stations where
there is transit of international passengers.
• Foreign investment in Duty Free Shops is
subject to compliance of conditions stipulated
under the Customs Act, 1962 and other laws,
rules, and regulations.
• Duty Free Shop entity shall not engage into
any retail trading activity in the Domestic
Tariff Area of the country.
RAILWAY INFRASTRUCTURE
Railway Infrastructure 100% Automatic
• Construction, operation and maintenance of

the following:
(i) Suburban corridor projects through PPP,
(ii) High speed train projects, (iii) Dedicated
freight lines, (iv) Rolling stock including train
sets, and locomotives/coaches manufacturing
and maintenance facilities, (v) Railway
Electrification, (vi) Signalling systems, (vii)
Freight terminals, (viii) Passenger terminals,
(ix) Infrastructure in industrial park pertaining
to railway line/sidings including electrified
railway lines and connectivity to main railway
line and (x) Mass Rapid Transport Systems.
Note:
i) Foreign Direct Investment in the above mentioned activities open to private
sector participation including FDI is subject to sectoral guidelines of
Ministry of Railways.
ii) Proposals involving FDI beyond 49% in sensitive areas from security point
of view, will be brought by the Ministry of Railways before the Cabinet
Committee on Security (CCS) for consideration on a case to case basis.
FINANCIAL SERVICES
• Foreign investment in other financial services, other than those indicated
below, would require prior approval of the Government.
ASSET RECONSTRUCTION COMPANIES
85
External Sector and • Asset Reconstruction Company’ (ARC) 100% Automatic
Trade Policy
means a company registered with the Reserve
Bank of India under Section 3 of the
Securitisation and Reconstruction of Financial
Assets and Enforcement of Security Interest
Act, 2002 (SARFAESI Act).
BANKING- PRIVATE SECTOR
• Banking- Private Sector 74% Automatic
up to 49%
Government
route beyond
49% and
up to 74%.
BANKING- PUBLIC SECTOR
• Banking- Public Sector subject to Banking 20% Government
Companies (Acquisition and Transfer of
Undertakings) Acts 1970/80. This ceiling
(20%) is also applicable to the State Bank of
India and its associate Banks.
CREDIT INFORMATION COMPANIES (CIC)
• Credit Information Companies 100% Automatic
INFRASTRUCTURE COMPANY IN THE SECURITIES MARKET

• Infrastructure companies in Securities Markets, 49% Automatic
namely, stock exchanges, commodity
exchanges, depositories and clearing
corporations, in compliance with SEBI
Regulations
INSURANCE
• Insurance Company 49% Automatic
• Intermediaries or Insurance Intermediaries 100% Automatic

including: Insurance brokers, re-insurance
brokers, insurance consultants, corporate
agents, third party administrator, Surveyors
and Loss Assessors and such other entities, as
may be notified by the Insurance Regulatory
and Development Authority of India from time
to time.
PENSION SECTOR
• Pension Sector 49% Automatic
POWER EXCHANGES
• Power Exchanges registered under the Central 49% Automatic
Electricity Regulatory Commission (Power
Market) Regulations, 2010.
WHITE LABEL ATM OPERATIONS
86
• White Label ATM Operations 100% Automatic Foreign Capital
OTHER FINANCIAL SERVICES

• Financial Services activities regulated by 100% Automatic
financial sector regulators, viz., RBI, SEBI,
IRDA, PFRDA, NHB or any other financial
sector regulator as may be notified by the
Government of India.
PHARMACEUTICALS
• Greenfield 100% Automatic
• Brownfield 100% Automatic

up to 74%
Government
route
beyond 74%
87
External Sector and
Trade Policy
APPENDIX 20.2
Table 20.1: Foreign Investment Flows
Amount in US $ Million
Year Gross Repatriation/ Direct FDI by Net % growth

inflows/ Disinvestment Investment India FDI to over
Gross to India (Overseas India previous
Investments (2-3) Investment (4-5) year
to India by India)
1 2 3 4 5 6
2000-01 4031 0 4031 759 3272
2001-02 6130 5 6125 1391 4734 44.7%
2002-03 5095 59 5036 1819 3217 -32.0%
2003-04 4322 0 4322 1934 2388 -25.8%
2004-05 6052 65 5987 2274 3713 55.5%
2005-06 8962 61 8901 5867 3034 -18.3%
2006-07 22826 87 22739 15046 7693 153.6%
2007-08 34844 116 34729 18835 15893 106.6%
2008-09 41903 166 41738 19365 22372 40.8%
2009-10 37746 4637 33109 15143 17966 -19.7%
2010-11 36047 7018 29029 17195 11834 -34.1%
2011-12 46552 13599 32952 10892 22061 86.4%
2012-13 34298 7345 26953 7134 19819 -10.2%
2013-14 36047 5284 30763 9199 21564 8.8%
2014-15 45147 9864 35283 4031 31251 44.9%
2015-16 55559 10652 44907 8886 36021 15.3%
2016-17 60220 18005 42215 6603 35612 -1.1%
2017-18 60974 21544 39431 9144 30286 -15.0%
2018-19 62001 18699 43302 12590 30712 1.4%
2019-20 74390 18384 56006 12993 43013 40.1%
Notes:
1. Data on FDI have been revised since 2000-01 with expanded coverage to
approach international best practices.
2. Negative (-) sign indicates outflow.
3. Direct Investment data for 2006-07 include swap of shares of 310 Crore.
Source: Reserve Bank of India.
88
Table 20.2: Net Inflow of Portfolio Investment Foreign Capital
(Amount in US $ Million )
Offshore Portfolio % Growth

Net Portfolio
GDRs/ADRs FIIs Funds and Investment over
Year Investment
Others by India Previous
1 2 3 4 (1+2+3-4) Year
2004-05 613 8,686 16 24 9,291
2005-06 2,552 9,926 14 0 12,492 34.5%
2006-07 3,776 3,225 2 56 6,947 -44.4%
2007-08 6,645 20,328 298 -163 27,434 294.9%
2008-09 1,162 -15,017 0 177 -14,032 -151.1%
2009-10 3,328 29,048 0 -20 32,396 330.9%
2010-11 2,049 29,422 0 1,179 30,292 -6.5%
2011-12 597 16,813 0 238 17,171 -43.3%
2012-13 187 27,582 0 878 26,891 56.6%
2013-14 20 5,009 0 207 4,822 -82.1%
2014-15 1,271 40,923 0 -11 42,205 775.3%
2015-16 373 -4,016 0 487 -4,130 -109.8%
2016-17 0 7,766 0 154 7,612 284.3%
2017-18 0 22,165 0 50 22,115 190.5%
2018-19 1,820 -2,225 0 213 -618 -102.8%
2019-20 0 552 0 -851 1,403 327.1%
Table 20.3: Net Inflow of External Assistance to India
(US $ million)
Net Inflow of Foreign % Growth over Previous
Year
Aid Year
2000-01 -537
2001-02 332 161.8%
2002-03 -3912 -1278.3%
2003-04 -3225 -17.6%
89
External Sector and 2004-05 952 129.5%
Trade Policy
2005-06 1545 62.3%
2006-07 1290 -16.5%
2007-08 1655 28.3%
2008-09 2179 31.7%
2009-10 3129 43.6%
2010-11 4720 50.8%
2011-12 2612 -44.7%
2012-13 910 -65.2%
2013-14 1500 64.8%
2014-15 1261 -15.9%
2015-16 1715 36.0%
2016-17 1734 1.1%
2017-18 2197 26.7%
2018-19 2337 6.4%
2019-20 2475 5.9%
Table 20.4: NRI Deposits Outstanding
(Value in US $ million, Growth in %)

Year % Growth over
Total
(end-March) Previous Year
2002 25174
2003 28529 13.3%
2004 33266 16.6%
2005 32975 -0.9%
2006 36282 10.0%
2007 41240 13.7%
2008 43672 5.9%
2009 41554 -4.8%
2010 47890 15.2%
2011 51682 7.9%
2012 58608 13.4%
2013 70822 20.8%
2014 103844 46.6%
90
Foreign Capital
2015 115163 10.9%
2016 126929 10.2%
2017 116867 -7.9%
2018 126182 8.0%
2019 130423 3.4%
2020 130581 0.1%
Notes: 1. The figures are outstanding as on last Friday of March.
2. The figures on NRI deposits are as reported by scheduled commercial
banks in India.
Source: Reserve Bank of India.
Table 20.5: Foreign Direct Investment Flows in Equity to India:

Industry-wise
(US$ million, Share in %)

Cumulative
Inflows
Sector/Industry 2015-16 2016-17 2017-18 2018-19 2019-20
(Apr 2015 to
March 2020)
Total FDI in
S. Equity (SIA/FIPB 36068 36317 37366 38744 42629 191124
No. & RBI Routes (100.0%) (100.0%) (100.0%) (100.0%) (100.0%) (100.0%)
only)
Sector-wise Inflows
8439 11972 7066 7919 8153 43549
1 Manufacturing
(23.4%) (33.0%) (18.9%) (20.4%) (19.1%) (22.8%)
22565 22064 28306 28255 31622 132812

2 Services
(62.6%) (60.8%) (77.8%) (72.9%) (74.2%) (69.5%)
Communication 2638 5876 8809 5365 6838 29526

2.1
Services (11.7%) (26.6%) (31.1%) (19.0%) (21.6%) (22.2%)
Retail & 3998 2771 4478 4311 4914 20472

2.2
Wholesale Trade (17.7%) (12.6%) (15.8%) (15.3%) (15.5%) (15.4%)
3547 3732 4070 6372 4326 22047

2.3 Financial Services
(15.7%) (16.9%) (14.4%) (22.6%) (13.7%) (16.6%)
4319 1937 3173 3453 4104 16986

2.4 Computer Services
(19.1%) (8.8%) (11.2%) (12.2%) (13.0%) (12.8%)
3031 2684 3005 2597 3684 15001

2.5 Business services
(13.4%) (12.2%) (10.6%) (9.2%) (11.7%) (11.3%)
Restaurants and 889 430 452 749 2546 5066

2.6
Hotels (3.9%) (1.9%) (1.6%) (2.7%) (8.1%) (3.8%)
1363 891 1267 1019 2333 6873

2.7 Transport
(6.0%) (4.0%) (4.5%) (3.6%) (7.4%) (5.2%)
91
External Sector and
Trade Policy
Electricity and
other energy
1364 1722 1870 2427 1906 9289
2.8 Generation,
(6.0%) (7.8%) (6.6%) (8.6%) (6.0%) (7.0%)
Distribution &
Transmission
Education,
394 205 347 736 528 2210
2.9 Research &
(1.7%) (0.9%) (1.2%) (2.6%) (1.7%) (1.7%)
Development
Miscellaneous 1022 1816 835 1226 443 5342

2.10
Services (4.5%) (8.2%) (2.9%) (4.3%) (1.4%) (4.0%)
4141 1564 1281 2009 1937 10932

3 Construction
(11.5%) (4.3%) (3.4%) (5.2%) (4.5%) (5.7%)
Real Estate 112 105 405 213 564 1399

4
Activities (0.3%) (0.3%) (1.1%) (0.5%) (1.3%) (0.7%)
596 141 82 247 217 1283

5 Mining
(1.7%) (0.4%) (0.2%) (0.6%) (0.5%) (0.7%)
215 470 226 102 137 1150

6 Others
(0.6%) (1.3%) (0.6%) (0.3%) (0.3%) (0.6%)
Figures in parenthesis represent share in percentage

Note: Includes FDI in Equity through SIA/FIPB and RBI routes only (excluding acquisition of shares
and equity capital of unincorporated bodies)
Table 20.6: Foreign Direct Investment Flows in Equity to India:

Country-wise
(Value in US$ million, Share in %)
Cumulative
Inflows
Source/Industry 2015-16 2016-17 2017-18 2018-19 2019-20
(Apr 2015 to
March 2020)
Total FDI in
Equity
36,068 36,317 37,366 38,744 42,629 1,91,124
(SIA/FIPB &
RBI routes only)
Country-wise Inflows
12479 6529 9273 14632 12612 55525

Singapore
(34.6%) (18.0%) (24.8%) (37.8%) (29.6%) (29.1%)
7452 13383 13415 6570 7498 48318

Mauritius
(20.7%) (36.9%) (35.9%) (17.0%) (17.6%) (25.3%)
2330 3234 2677 2519 5295 16055

Netherlands
(6.5%) (8.9%) (7.2%) (6.5%) (12.4%) (8.4%)
92
440 49 1140 863 3496 5988 Foreign Capital
Cayman Islands
(1.2%) (0.1%) (3.1%) (2.2%) (8.2%) (3.1%)
4124 2138 1973 2823 3401 14459

U.S.A.
(11.4%) (5.9%) (5.3%) (7.3%) (8.0%) (7.6%)
1818 4237 1313 2745 2308 12421

Japan
(5.0%) (11.7%) (3.5%) (7.1%) (5.4%) (6.5%)
392 487 403 375 1167 2824

France
(1.1%) (1.3%) (1.1%) (1.0%) (2.7%) (1.5%)
842 1301 716 1211 1125 5195

United Kingdom
(2.3%) (3.6%) (1.9%) (3.1%) (2.6%) (2.7%)
241 466 293 982 777 2759

South Korea
(0.7%) (1.3%) (0.8%) (2.5%) (1.8%) (1.4%)
344 134 1044 598 678 2798

Hongkong
(1.0%) (0.4%) (2.8%) (1.5%) (1.6%) (1.5%)
488 282 290 161 657 1878

Cyprus
(1.4%) (0.8%) (0.8%) (0.4%) (1.5%) (1.0%)
927 845 1095 817 443 4127

Germany
(2.6%) (2.3%) (2.9%) (2.1%) (1.0%) (2.2%)
57 172 213 56 388 886

Belgium
(0.2%) (0.5%) (0.6%) (0.1%) (0.9%) (0.5%)
961 645 408 853 323 3190

U.A.E.
(2.7%) (1.8%) (1.1%) (2.2%) (0.8%) (1.7%)
784 99 243 251 252 1629

Luxembourg
(2.2%) (0.3%) (0.7%) (0.6%) (0.6%) (0.9%)
203 212 21 290 250 976

UK Virgin Islands
(0.6%) (0.6%) (0.1%) (0.7%) (0.6%) (0.5%)
461 198 350 229 162 1400

China
(1.3%) (05%) (0.9%) (0.6%) (0.4%) (0.7%)
1725 1905 2498 2768 1796 10692

Others
(4.8%) (5.2%) (6.7%) (7.1%) (4.2%) (5.6%)
Figures in parenthesis represent share in percentage

Note: Includes FDI in Equity through SIA/FIPB and RBI routes only (excluding
acquisition of shares and equity capital of unincorporated bodies)
Table 20.7: Component-wise Break-up of OFDI
Value in $ Million, Share in %

Year Equity Loan Guarantee Actual OFDI Guarantee
(1) (2) Invoked Outflow Issued
(3) (1+2+3)
602.1 70.6 5.0 677.7

2000-01 112.6
(88.8%) (10.4%) (0.7%) (100.0%) 93
External Sector and 878.8 120.8 0.4 1000.0
Trade Policy 2001-02 155.9
(87.9%) (12.1%) (0.0%) (100.0%)
1746.3 102.1 0 1848.4
2002-03 139.6
(94.5%) (5.5%) (0.0%) (100.0%)
1250 316.6 0.0 1566.6
2003-04 440.5
(79.8%) (20.2%) (0.0%) (100.0%)
1482 513.2 0.0 1995.2
2004-05 316
(74.3%) (25.7%) (0.0%) (100.0%)
6657.8 1195.3 3.3 7856.4
2005-06 546.8
(84.7%) (15.2%) (0.0%) (100.0%)
12062.9 1247 0.0 13309.9
2006-07 2261
(90.6%) (9.4%) (0.0%) (100.0%)
15431.5 3075 0.0 18506.5
2007-08 6553.5
(83.4%) (16.6%) (0.0%) (100.0%)
10732.3 3333.2 0.0 14065.5
2008-09 3104.9
(76.3%) (23.7%) (0.0%) (100.0%)
6761.7 3602.8 24.2 10388.7
2009-10 7600.8
(65.1%) (34.7%) (0.2%) (100.0%)
9351.8 7346.9 52.5 16751.2
2010-11 27230.5
(55.8%) (43.9%) (0.3%) (100.0%)
6288.4 8325.2 0.0 14613.6
2011-12 16249.4
(43.0%) (57.0%) (0.0%) (100.0%)
5856.2 4351 0.0 10207.2
2012-13 16665.2
(57.4%) (42.6%) (0.0%) (100.0%)
10194.50 3725.50 64.90 13984.90
2013-14 22980.5
(72.9%) (26.6%) (0.5%) (100.0%)
3985.70 2852.90 35.70 6874.30
2014-15 24080.9
(58.0%) (41.5%) (0.5%) (100.0%)
8192.38 4096.99 74.19 12363.56
2015-16 22,914.61
(66.3%) (33.1%) (0.6%) (100.0%)
10480.23 4509.80 321.53 15311.56
2016-17 25,226.45
(68.4%) (29.5%) (2.1%) (100.0%)
10018.61 3529.43 3015.49 16563.53
2017-18 20,856.24
(60.5%) (21.3%) (18.2%) (100.0%)
8092.30 4221.43 1195.82 13509.55
2018-19 24,159.00
(59.9%) (31.2%) (8.9%) (100.0%)
6236.95 5907.25 736.07 12880.27
2019-20 22,252.48
(48.4%) (45.9%) (5.7%) (100.0%)
Cumulative
OFDI from 136302.47 62443.00 5529.10 204274.57
243846.88
2000-01 to (66.7%) (30.6%) (2.7%) (100.0%)
2019-20
Figures in parenthesis represent share percentage
Source: Compiled from Khan (2012), Joseph (2009), RBI-ODI and Department of
Economic Affairs
94
Table: 20.8: Sector-wise Composition of OFDI Outflow Foreign Capital
Value in US $ Million, Share in %
Cumulative
S. OFDI
Sectors 2015-16 2016-17 2017-18 2018-19 2019-20
No. (2015-16 to
2019-20)
Financial,
4245.69 4563.03 6743.56 5345.48 3687.43 24585.19
1 Insurance and
(34.3%) (29.8%) (40.7%) (39.6%) (28.6%) (34.8%)
Business Services
2457.4 3721.62 2993.95 3015.30 3430.14 15618.41

2 Manufacturing
(19.9%) (24.3%) (18.1%) (22.3%) (26.6%) (22.1%)
Wholesale, Retail
1441.09 2023.37 1270.78 1780.40 2322.85 8838.49
3 Trade, Restaurants
(11.7%) (13.2%) (7.7%) (13.2%) (18.0%) (12.5%)
and Hotels
Agriculture and 401.13 1751.31 3695.41 1998.87 641.58 8488.3

4
Mining (3.2%) (11.4%) (22.3%) (14.8%) (5.0%) (12.0%)
242.07 339.28 445.97 763.09 864.73 2655.14

5 Construction
(2.0%) (2.2%) (2.7%) (5.6%) (6.7%) (3.8%)
Electricity, Gas and 574.37 618.98 59.6 140.45 797.31 2190.71
6
Water (4.6%) (4.0%) (0.4%) (1.0%) (6.2%) (3.1%)
Community, Social
575.42 655.02 367.46 309.31 199.21 2106.42
7 and Personal
(4.7%) (4.3%) (2.2%) (2.3%) (1.5%) (3.0%)
Services
Transport, Storage
and 2372.02 1515.68 913.44 113.77 901.33 5816.24
8
Communication (19.2%) (9.9%) (5.5%) (0.8%) (7.0%) (8.2%)
Services
54.37 123.27 73.36 42.88 35.69 329.57

9 Miscellaneous
(0.4%) (0.8%) (0.4%) (0.3%) (0.3%) (0.5%)
12363.56 15311.56 16563.53 13509.55 12880.27 70628.47

Total
(100.0%) (100.0%) (100.0%) (100.0%) (100.0%) (100.0%)
Figures in parenthesis represent percentage
Source: Compiled from RBI-ODI and Department of Economic Affairs
95
External Sector and
Trade Policy
Table 20.9: Top Ten OFDI Destination Countries
Value in US $ Million, Share in %
Cumulative
S.
Country 2015-16 2016-17 2017-2018 2018-19 2019-20 OFDI (2015-
No.
16 to 2019-20)
1439.21 2892.72 2665.53 2846.06 3717.03 13560.55
1 Singapore
(11.6%) (18.9%) (16.1%) (21.1%) (28.9%) (19.2%)
3362.68 5091.96 1440.84 535.24 1052.05 11482.77

2 Mauritius
(27.2%) (33.3%) (8.7%) (4.0%) (8.2%) (16.3%)
United States 1648.36 1892.64 1256 2478.02 1976.33 9251.35

3
of America (13.3%) (12.4%) (7.6%) (18.3%) (15.3%) (13.1%)
United 642.13 1378.78 837.07 1442.27 1141.2 5441.45

4
Kingdom (5.2%) (9.0%) (5.1%) (10.7%) (8.9%) (7.7%)
1146.46 743.71 1143.34 1105.06 1232.56 5371.13

5 Netherlands
(9.3%) (4.9%) (6.9%) (8.2%) (9.6%) (7.6%)
United Arab 1750.29 888.01 644.33 734.86 439.54 4457.03

6
Emirates (14.2%) (5.8%) (3.9%) (5.4%) (3.4%) (6.3%)
677.91 491.71 484.06 498.86 636.46 2789

7 Switzerland
(5.5%) (3.2%) (2.9%) (3.7%) (4.9%) (3.9%)
222.64 311.57 409.83 525.06 590.46 2059.56

8 Russia
(1.8%) (2.0%) (2.5%) (3.9%) (4.6%) (2.9%)
Cayman 9.87 90.18 591.75 419.22 60 1171.02

9
Island (0.1%) (0.6%) (3.6%) (3.1%) (0.5%) (1.7%)
British
128.8 102.32 130.79 85.12 181.69 628.72
10 Virgin
(1.0%) (0.7%) (0.8%) (0.6%) (1.4%) (0.9%)
Islands
Total OFDI
11028.35 13883.6 9603.54 10669.77 11027.32 56212.58
to Top 10
(89.2%) (90.7%) (58.0%) (79.0%) (85.6%) (79.6%)
Countries
Total OFDI
12363.56 15311.56 16563.53 13509.55 12880.27 70628.47
(to All
(100.0%) (100.0%) (100.0%) (100.0%) (100.0%) (100.0%)
Countries)
Source: Compiled from RBI and Department of Economic Affairs
96
Foreign Capital
BLOCK 6
MAJOR ISSUES CONFRONTING
INDIAN ECONOMY
97
External Sector and
Trade Policy
BLOCK 6 MAJOR ISSUES CONFRONTING
INDIAN ECONOMY
The major issues confronting Indian economy, i.e., Poverty, Malnutrition and
Inclusive Growth, Employment and Unemployment, Social Security,
Regional Disparities, and Good Governance constitute the subject matter of
Block 6. The block comprises of five units.
Unit 21 entitled Poverty, Malnutrition and Inclusive Growth: Policy
Implications throws light on the concept of Poverty, different income and
non-income indicators of poverty, concept of Malnutrition and the factors
conditioning the nutritional status of children and adults in India. It also
covers the concept of inclusive growth along with the policy implications.
Unit 22 entitled Employment and Unemployment: Policy Challenges
covers various dimensions of unemployment in India, the concepts used in
measuring employment and unemployment by NSSO and PLFS. The unit
examines growth and the quality of employment in the post-reform period,
and suggests various measures towards the employment policy framework.
Unit 23 entitled Social Security Measures in India discusses the meaning
of social security, the approaches towards social security, different acts and
programmes launched by the government on Social Security. It also analyses
social security code and its benefits along with the policy measures.
Unit 24 entitled Regional Disparity in India: Policy Implications sheds
light on the meaning of regional disparity, analyses regional disparity in
terms of macroeconomic aggregates including growth rate, per capita GDP,
etc. Special focus has been given to the regional disparity in agriculture and
infrastructural development, and on review of regional disparity in human
development.
Unit 25 entitled Ingredients of Good Governance explains the meaning and
the importance of governance, narrates the evolution of the definition of good
governance along with the features of good governance. It also presents an
overview of the state of governance in India.
98
UNIT 21 POVERTY, MALNUTRITION AND Poverty, Malnutrition
and Inclusive Growth:
INCLUSIVE GROWTH: POLICY Policy Implications
IMPLICATIONS
Structure
21.0 Objectives
21.1 Introduction
21.2 The Concept of Poverty
21.3 Measurement of Poverty
21.3.1 Income Indicators of Poverty
21.3.2 Non-income Indicators of Poverty
21.4 Dimensions of Poverty in India: The Income and Non-Income Dimension
21.5 The Concept of Malnutrition
21.6 Malnutrition Type and Measurement
21.6.1 Malnutrition Type and Measurement among Children
21.6.2 Malnutrition Type and Measurement among Women
21.7 Malnutrition and Poverty: A Comparative Analysis
21.8 Inclusive Growth
21.9 Inclusive Growth – Policy Implications
21.10 Let Us Sum Up
21.12 Key Words
21.13 References
Appendix 21.1
21.0 OBJECTIVES
● define the concept of poverty;
● know different income and non-income indicators of poverty;
● identify the income and non-income dimensions of poverty in India;
● explain the Concept of Malnutrition;
● discuss the factors that condition the nutritional status of children and
adults in India;
● analyse the persistence of nutrition problem in India in spite of the
progress made in poverty reduction; and
● examine the concept of inclusive growth and the policy implications.
99
Major Issues
Confronting Indian 21.1 INTRODUCTION
Economy
Poverty, inequality (and hence need for inclusive growth) and unemployment
are inter-related issues. One cannot be appreciated without knowing the
dimensions of the other. We need to distinguish between the concept of
absolute poverty and the concept of relative poverty. Simple increase in the
GDP may not be a sufficient condition (although a necessary condition) to
enable all sections of the society to share the fruits of growth. Empirical
evidence shows that the benefits of growth are unevenly distributed
(especially when an economy is in transition from a low-income category to a
high-income category).
Absolute poverty explains a situation in which some persons, small or large

in number, live in a state of destitution, such that these persons (or groups of
persons) fail to meet their basic needs. They may live at bare subsistence, or
even below subsistence levels. This situation could well arise irrespective of
the size of the cake available for distribution. Here, again, two situations can
be visualised. One, the size of the national cake may be so small, that it is
not adequate to meet the minimum needs of all sections of the society;two,
the size may be fairly large.The existing institutions and practices do not
result in equitable distribution, so that a large part of national product goes to
enrich the pockets of a few, and a large mass of people is left to take care of
themselves with very little resources. Whatever the situation may be, a
meaningful effort is required to lift the poor to a respectable level of living,
Importantly, the growth process needs to be made inclusive to keep poverty
in check. In this unit, we discuss these issues.
21.2 THE CONCEPT OF POVERTY

In the development literature, poverty is defined as ‘multi-dimensional’
phenomenon which is assessed not just with respect to lack of income, but
also directly with respect to basic needs such as those related to health,
education, nutrition and shelter. In a broader conceptualisation, poverty
includes a lack of social security and empowerment, as well. All the income
and non-income aspects of poverty help us to understand whether an
individual is living decently and with dignity or not. This broader
conceptualisation of poverty has been popularised by UNDP in ‘Human
Development Report’ and World Bank in ‘World Development Report’. It
defines poverty as ‘a human condition characterised by the sustained or
chronic deprivation of the resources, capabilities, choices, security and power
necessary for the enjoyment of an adequate standard of living and other civil,
cultural, economic, political and social rights’ (UN, 2001).
The Noble laureate Prof.AmartyaSen has contributed to broadening the

understanding of human wellbeing,and therefore poverty, in the importance
he attaches to the concept of capability of a person to function in a society.
Poverty arises in the society where people lack capability, for example, to
earn a livelihood, maintain an adequate living standard or health, possess low
self-confidence or powerlessness. The state of poverty is sometimes
100 visualised in terms of a ‘human rights approach’ that defines poverty as the
denial or violation of economic, political, social and civil rights. The rights Poverty, Malnutrition
may be right to education, right to minimum health, right to decent living and Policy Implications
right to employment. These rights if guaranteed would ensure that an
individual is able to livean adequate and dignified life above the minimum
threshold.
21.3 MEASUREMENT OF POVERTY

Before analysing the measurement of poverty, it is necessary to know why
we need to measure poverty or in other words what is the objective of
measuring poverty. Poverty measurement is a powerful instrument to focus
the attention of policymaker or government on the living condition of poor.
The second reason for measuring or identifying the poor is to be able to target
poverty eradication meaningfully. The different measures of poverty help us
analyse the incidence and the extent of poverty among different geography
(rural, urban, hilly, tribal dominated), different social categories of population
(Scheduled caste, Scheduled tribe, Muslims, women headed households,
households without earning members), etc. For example, if the incidence of
poverty among agricultural labourers is high, government can take some
measure so that this section of population can bridge the poverty gap, such as
by providing cheap credit facility, housing facility, different type of skill
training, etc. Poverty measurement also helps many international agencies to
easily target the extremely poor region for intervention (within their limited
resources). The measurement of poverty also helps the government to
evaluate the policies and programmes that is specifically implemented to
eradicate poverty. For example, if the KBK (Kalahandi-Korapur-Bolangir)
region in Odisha is most poverty ridden, then government can implement
some focused programmes in the same region.
21.3.1 Income Indicators of Poverty

At the outset, in estimating the incidence of poverty, we need an income
threshold or poverty line to identify the poor. Income cut-offs used to identify
the poor are often viewed as arbitrary. The poverty line can be defined as the
minimum requirement of an individual for a healthy living. The minimum
requirement can include both food and non-food items. There are many
income poverty measures. Some of the important poverty measures
frequently used are:
a) Head Count Index (HCR)

The most widely used poverty measure is the headcount index, which simply
measures the proportion of the population that is counted as poor. In other
words, the incidence of poverty is defined as the proportion of poor to the
total population.
�� (��)
�� = × 100
�� (�)
101
Major Issues
Confronting Indian For example, if 120 people out of 600 total population are poor, then the
Economy proportion of population below poverty line is calculated as 20 per cent
(120/600 × 100=20per cent). This is expressed in percentage. The greatest
virtues of the headcount index is that it is simple to construct and easy to
understand and helps to compare among different subgroup/areas (like
rural/urban or social category such as SC/ST/OBC or different states) at a
point of time or over a period of time. From this we can know whether
poverty rate is reducing or not and if reducing what is the pace of reduction.
However, the HCR method is not free from limitations. Firstly, the head-
count index does not indicate how much poor the poor are, and hence does
not change if people below the poverty line become poorer. Moreover, the
easiest way to reduce the headcount index is to target benefits to people just
below the poverty line, because they are the ones who are easiest to move
across the line. But by most normative standards, people just below the
poverty line are the least deserving of the poor. This can be explained by way
of an example. Let us take two countries i.e. country ‘A’ and country ‘B’ and
each having four persons.
If the poverty line is 450, then in both the countries 50 per cent of people are
below poverty line, but country A shows the high intensity of poverty as
compared to country B. Hence the proportion of people just below poverty
line are less deserved poor as compared to the people lying far from poverty
line. Secondly the HCR calculate poverty level by household. Hence if for a
community or area where the family size is high the percentage of poor is
higher as compared to low family size area.
HCR of Country A and B assuming Poverty Line 450

Expenditure Expenditure Expenditure Expenditure HCR
1stIndividual 2ndIndividua 3rdIndividua th
4 Individu (%)
l l al
Country 250 275 500 500 50
A
Country 448 449 500 500 50
B
Again, the intra-household issue of poverty is not captured by this method

and we assume that the level of well-being is same for all the household
members. But in many cases, it is found that poverty level among girl child
or senior people are higher than the adult member within the same household.
The depth and severity of poverty cannot be found out by the HCR method.
This is captured by poverty gap index.
b) Poverty Gap Index (PGI) and Squared Poverty Index (SPI)

PGI is another measure that is derived from income or expenditure
distribution. This measure shows how far below is the income/consumption
of people/households from poverty line. The PGI shows the shortfall of
expenditure of the poor relative to poverty line. It adds up the extent to which
individuals on average fall below the poverty line and expresses it as a
102
percentage of the poverty line. More specifically, the poverty gap (Gi) is the Poverty, Malnutrition
poverty line (Z) less actual income (Yi) for poor individuals; the gap is Policy Implications
considered to be zero for everyone else.
� ��
PGI = � ∑�
��
� (1)
Where N is the total population or sample and Yi<Z.

On the other hand, the Squared Poverty Index (SPI) is simply a weighted sum
of poverty gaps (as a proportion of the poverty line), where the weights are
the proportionate poverty gaps themselves; a poverty gap of (say) 20 per cent
of the poverty line is given a weight of 20 per cent while one of 50 per cent is
given a weight of 50 per cent; this is in contrast with the poverty gap index,
where they are weighted equally.
The SPI can be defined as

� ��
SPI = � ∑�
��
� (2)
Where, N=total population or sample size, Z=Poverty line,

Yi=Income/consumption expenditure of poor and Yi<Z.
The PGI and SPI can be explained with the help of a numerical example
given below.
Calculating the Poverty Gap Index (PGI) and Squared Poverty Index (SPI),
assuming poverty line of 130
Expenditure of each Individual
Expenditure in country 110 115 150 160
A
Poverty gap (Gi) (130−110)=20 (130−115)=15 0 0
Gi/z 20/130=0.15 15/130=0.12 0 0
(Gi/z)2 (0.15)2=0.024 (0.12)2=0.013 0 0
Poverty Gap Index = (0.15+0.12)/4 = 0.07
Square Poverty Index = (.024+.013)/4 =.009
You can check the above example when expenditure of first and second
individual is 120 and 125 respectively (that is, poverty gap is low) and for
other two person the expenditure remains same at 150 and 160 respectively,
the PGI=0.03 and SPI= 0.002; whereas if the expenditure of first and second
individual is 75 and 80 respectively while for the other two person the
expenditure remains the same at 150 and 160, respectively, then the PGI =
0.20 and SPI = 0.082.
C) Sen Index (PS).

Prof. Sen developed this index which combine the effect of number of poor,
the depth of their poverty, and the distribution of poverty within the group.
This can be summerisedin the equation as
103
Major Issues
Confronting Indian
Economy
whereP0is the headcount index, μPis the mean income (or expenditure) of the
poor, and GPis the Gini coefficient of inequality among the poor. There are
two other measures the ‘Sen-Shorrocks-Thon index’ and the ‘Watts Index’
which we shall not go into detail.
21.3.2 Non-Income Indicators of Poverty

As discussed earlier, the poor are identified by setting a poverty line on the
basis of household consumption expenditure or income. The well-being of a
person defined on the basis of income or consumption expenditure is a
unidimensional approach and this does not provide the complete picture of
the extent of deprivation. In most situation it may be desirable to look atother
aspects of poverty which includes several non-income indicators like housing
status, sanitation status, health status (child mortality, maternal mortality rate,
morbidity), educational status, etc.
Since 1990, UNDP has been preparing the Human Development Index by
using three most important attainments that are valued by people:
i) Longevity: The choice to lead a healthy life
ii) Educational attainment: The choice to acquire knowledge
iii) Economic attainment: To have access to the resources needed for a

decent level of living
The countries are ranked on the basis of composite indicators on these three
aspects of well-being or the three choices that are critical for people to live a
decent life. The HDR also estimates the Human Poverty Indices by taking
three deprivations which include
i) Proportion of population not expected to survive beyond 40 years
ii) Adult literacy rate
iii) Percentage of population without sustainable access to an improved
water source and percentage of children aged 5 or below who are
underweight for their ages.
Following the UNDP framework, the Planning Commission has also

prepared India’s human development report. The selection of indicator in
planning commission’s HDI is to some extent different from that of UNDP
report. In general, different countries and researchers have experimented with
the framework popularised by UNDP in its Human Development Reports by
focusing more on certain aspects of well-being and poverty, given their
specific objectives. This has led to different measures and policy guidance for
addressing improvement in well-being or alleviating poverty at the national
and sub-national level.
104
Gender Related Development Index (GDI) or Gender Equality Index Poverty, Malnutrition
(GEI) Policy Implications
The human development index devised by the Planning Commission or

UNDP are explained by the overall development or well-being of a person.
But this attainment does not reflect gender-based disparity in such attainment.
In many of the indicators, the gender-based disparity is there which directly
or indirectly affects the poverty level of female population as compared to its
male counterpart. The GEI has been estimated to measure the inequality in
attainments on human development indicators between females and males.
This approach helps the policy maker to reflect more on the gender related
programmes and policies. The same three indicators are used for males and
females separately and the gap of males and females in these attainments are
found. The index has been presented as a ratio of attainments for females to
that of males.
Capability Poverty Measure (CPM)

UNDP has also developed a new multi-dimensional measure of human
deprivation called the capability poverty measure (CPM). The CPM focuses
on human capabilities. The capability poverty measure reflects percentage of
people who lack basic essential human capability. This helps them to have a
strong human development.
The CPM considers the lack of three basic capabilities:

• The first is the lack of being well nourished and healthy, represented in
this case by the proportion of children under five years who are
underweight.
• The second is the lack of capability for healthy reproduction, shown by
the proportion of births unattended by trained personnel.
• The third is the lack of capability to be educated and knowledgeable,

represented by female illiteracy.
Hence, multi-dimensional indicators have become important instruments in

measuring “outcomes” (in the form of social attainments at individual or at a
group level) as opposed to inputs (income and consumption), thereby
enabling assessmentof the level of well-being/ poverty as well as of the
impact of the social welfare policies on humanwelfare.
21.4 DIMENSIONS OF POVERTY IN INDIA:

INCOME AND NON-INCOME DIMENSION
The first step to estimate poverty rate is to define and quantify poverty line.
The Task Force on ‘Projection of Minimum Needs and Effective
Consumption Demand’ constituted by the Planning Commission in 1979
defined the poverty line as per capita consumption expenditure level based on
meeting the nutritional requirement of 2400 calories per capita per day in
rural areas and 2100 calories per capita per day in urban areas along with
some non-food expenditure (not anchored in any norms). It used the age-sex-
105
Major Issues
Confronting Indian activity specific calorie allowances recommended by the Nutrition Expert
Economy Group (1968) to estimate the average daily per capita requirement for rural
and urban areas using the age-sex-occupational structure of their respective
population. Then they find out the monetary convert for the said kilocalorie
(kcal) for both rural and urban areas. The poverty line is hence partly
normative and partly behavioural as it takes the value of minimum calories
requirement by a person along with some non-food requirement like clothing,
shelter, transport, etc. By taking 28th round NSS data, the Task Force
estimated that on an average, consumer expenditure of Rs. 49.09 per capita
per month meet the requirement of 2400 calories in rural area and Rs. 56.64
per capita per month with an intake of 2100 calories per capita per day in
urban areas. The poverty line defined at national level (separately for rural
and urban areas) was used in all the States/Union Territories (UTs). The
expert group constituted by the Planning Commission (Lakdawala
Committee) in September 1989 on Estimation of Proportion and Number of
Poor realised that due to inter-state variation in prices, the all India poverty
line cannot be used for all the states and union territories. Hence the expert
group disaggregated these national level poverty lines of the Task Force into
state-specific poverty lines using state-specific price indices and inter-state
price differential. The expert group took the state-specific cost of living for
estimating and updating the poverty line separately for rural and urban areas.
The poverty line is inflated from time to time depending on the cost of living
as estimated for different states. The poverty line as calculated in various
rounds of NSS survey is given in Table 21.1.
Table 21.1: Poverty Line (Rs. Monthly Per Capita)
Year Rural Urban
1973-1974 49.63 56.76

1977-1978 56.84 70.33
1983 89.50 115.65
1987-1988 115.20 162.16
1993-1994 205.84 281.35
1999-2000 327.56 454.11
2004-2005 356.30 538.60
2011-2012 972.00 1407.0
Source: Planning Commission (1997), Press Information Bureau (2001), Press

InformationBureau, (2007).
The Planning Commission set up an expert group under the chairmanship of

Prof. Suresh Tendulkar to examine the issue relating to new poverty line and
estimates. The expert group submitted their report in the year 2009. The
committee has used the Mixed Reference Period (MRP) based estimates of
the relevant NSSO quinquennial household consumption expenditure survey
for their recommendations. The committee has taken the basket of household
106 goods and services consumed by households corresponding to the poverty
line consumption expenditure class, at the borderline separating the poor Poverty, Malnutrition
from non-poor. The Expert Committee’s proposed price indices are based on Policy Implications
the household level unit value obtained from 61st round NSS household
consumption expenditure survey for different food and non-food items for
both rural and urban areas. As Tendulkar Committee adopted new reference
basket and new price indices, it is not comparable with the official head count
ratio released for the earlier years. Table 21.2 explains the poverty line and
percentage of population below poverty line. The percentage of population
below poverty line declined to 21.9per cent in 2011-12 from 37.2 per cent in
2004-05 in India. In rural India the proportion is comparatively higher as
compared to urban areas. A 12 percentage point difference in poverty head
count ratio is found between rural and urban areas in the year 2011-12.
Between the year 2004-05 to 2011-12 a 16 percentage point reduction is
visible in rural areas whereas the same for urban area is 12 percentage point.
Table 21.2: Poverty Line (Rs. Monthly Per Capita)
Poverty Line (Rs) Poverty Head Count

Ratio ( per cent)
Year Rural Urban Rural Urban Total
2004-05 446.7 578.8 41.8 25.7 37.2
2009-10 672.8 859.6 33.8 20.9 29.8
2011-12 816.0 1000.0 25.7 13.7 21.9
Source: Calculated from different NSS consumption expenditure data.
a) Income Poverty Indicators

Over the time, India has shown considerable reduction in poverty which is
well documented. During the period between 1973-74 and 2011-12, the
incidence of poverty declined continuously from 37.2 per cent to 21.9 percent
or the absolute number of poor decreased from 321.3 million in 1973-74 to
269.8million in 2011-12. In rural areas the poverty level reduced from 56.4
percent to 25.7 percent and in urban areas the same has reduced from 49
percent to 13.7 percent.
However, one thing should be kept in mind that the pace of reduction in
poverty varies considerably during this period with a large decline in 2011-12
and a very small decline in 1987-88. The number of people below the poverty
line increased by 7.6 million during the 1973-74 to 1977-78; decreased by
21.8 million during the 1983 to 1987-88 and by 6.4 million during 1987-88 to
2004-05 (see Table 21.3). A decline of 137 million was registered between
2004-05 and 2011-12. The annual average decline (per cent) from 1993-94 to
2004-05 is 0.74 per cent, whereas the decline between 2004-05 to 2011-12 is
2.18 percent.
107
Major Issues
Confronting Indian Table 21.3: HCR Poverty in India, 1973-74 — 2011-12
Economy
Year Head Count Absolute Number of
Ratio (per cent) Poor belowPoverty
Line(in million)
Rural Urban Total Rural Urban Total

1973-74 56.4 49.0 54.9 261.3 60.1 321.3
1977-78 53.1 45.2 51.3 263.3 64.6 328.9
1983 45.7 40.8 44.5 252.0 70.9 322.9
1987-88 39.1 38.2 38.9 231.9 75.2 307.1
1993-94 37.3 32.3 35.97 244.0 76.3 320.4
2004-05 41.8 25.7 37.2 326.3 80.8 407.1
2011-12 25.7 13.7 21.9 216.7 53.1 269.8
Source: Planning Commission
Considering the trend in povertyincidence, rural share of total poverty

reduced from 81 per cent during 1973-74 to 80 percent (1 percentage point
reduction) in 2011-12. The number of urban poor increased by 10.6 million
during 1973-74 to 1987-88.Between 2004-05 to 2011-12 it decreased by 28
million in urban areas whereas in rural areas it declined by 109 million during
the same period.
The poverty head count ratio by social category provides an insight of the
inequality in prevalence of poverty. Highest levels of HCR among SCs and
STs go with the highest depth as well severity of poverty.
The head count poverty by social category from the year 1993 to 2011-12is
provided in Table 21.4. The poverty rate among STs reduced by 17.0
percentage points (from 2004-05 to2011-12), whereas for SCs the percentage
point reduction is 21.5. The percentage point reduction for other caste
population (other than SC/ST/OBC) is 10.5 percentage points. A large
difference in poverty incidence is found between rural and urban areas. In
2011-12 the poverty rate of ST was 45.3 percent in rural areas whereas in
urban area it was 24.1 percent (21 percentage point difference).
Poverty rates by some religion in the year 2011-12 shows that poverty rate is
highest among Muslims(25.4per cent) followed by Hindu (21.9per cent). The
rate is lowest among Jains (3.3per cent) followed by Sikhs (5.9per cent).It is
interesting to find that the percentage point reduction in poverty head count
between 2004-05 to 2011-12 shows that the reduction is highest among
Muslims (43.6 per cent in 2004-05 to 25.4 per cent in 2011-12) followed by
Hindu (from 37.5 per cent in 2004-05 to 2011-12 in 2011-12). The lowest
reduction is registered among Sikhs.
108
Table 21.4: Poverty Rates among Social Category (1993-94 and 2011-12) Poverty, Malnutrition
Policy Implications
Area Social Percentage Population below the Percentage point
Category Tendulkar line poverty reduction
2004-05 to 2011-12
1993- 2004- 2009- 2011-
94 05 10 12
ST 65.9 62.3 47.4 45.3 16.9
Rural SC 62.4 53.5 42.3 31.5 22.0
OBC 39.8 31.9 22.7 17.1
FC 44.0 27.1 21.0 15.5 11.6
All 50.3 41.8 33.3 25.4 16.4
ST 41.1 35.5 30.4 24.1 11.4
Urban SC 51.7 40.6 34.1 21.7 18.8
OBC 30.6 24.3 15.4 15.2
FC 28.2 16.1 12.4 8.1 8.0
All 31.9 25.7 20.9 13.7 12.0
ST 63.7 60.0 45.6 43.0 17.0
Total SC 60.5 50.9 10.6 29.4 21.5
OBC 37.8 30.0 20.7 17.1
FC 39.5 23.0 17.6 12.5 10.5
All 45.7 37.7 29.9 22.0 15.7
Source:ArvindPanagariya and Vishal More, ‘Poverty by Social, Religious and Economic
Considering the State-wise poverty head count data from the NSS 61st and
68th rounds, it can be said that poverty is getting concentrated in few states
and social groups. A group of four states comprising Chhattisgarh,
Jharkhand, Arunachal Pradesh, Bihar, and Odisha had a highest proportion of
poor in 2011-12. On the other hand, the states like Kerala, Himachal Pradesh,
Punjab, Andhra Pradesh and Delhi shows the lowest rate of poverty.
The reduction in poverty rate between 2004-05 and 2011-12 is highest in
Odisha (24.6 percentage points) followed by the states Uttarakhand (21.4
percentage point) and Maharashtra (21 percentage points). On the other hand,
Assam, Jammu and Kashmir and Delhi registered the lowest reduction. The
state Arunachal Pradesh registered an increase in rate of poverty from 31.4
percent in 2004-05 to 34.7 percent in 2011-12.
The poverty gap ratios have been incorporated in Table 21.5separately for
rural and urban areas. About 16.56 percent of the total consumption in the
109
Major Issues
Confronting Indian rural areas in 1973-1974 was required to increase by 16.56 per cent to bring
Economy the poor to the poverty line whereas this came down to 9.63 percent in 2004-
05 and further to 5.05 percent in 2011-12. The trend was the same in the
urban areas where 13.64 percent of the total consumption was needed to
bring the poor to the poverty line in 1973-74, 6.12 percent in 2004-05 and 2.7
percent in the year 2011-12 (Table 21.5).
Table 21.5: Poverty Gap Ratio (Percentage)

(MRP Consumption Distribution)
Year Rural Urban

1973-1974 16.56 13.64
1977-1978 15.73 13.13
1983 12.32 10.61
1987-1988 9.11 9.94
1993-1994 8.45 7.88
1999-2000 5.11 4.84
2004-2005 9.63 6.12
2011-12 5.05 2.7
Source: Estimated from the household consumer expenditure data of the NSSO,
various Rounds.
b) Income and Non-income Indicators of Poverty

So far, we have discussed poverty expressed by way of poverty ratio. No
doubt it is an important aspect of the living standard, but this does not reflect
certain aspects of non-income poverty expressed by way of the measures like
health, education, nutrition deficiencies, human development outcomes,
gender inequality status,etc. Studies show the headcount ratio as discussed in
this section as a static measure and there are chances that people may fall
back into poverty. Again, other studies highlighted education, health and
nutrition are other dimensions that need to be taken into account. Let us
discuss the Indian situation in terms of non-income measure of poverty.
The multidimensional poverty index as developed by Oxford Poverty and

Human Development Initiative (OPHI) is a multidimensional poverty
measure (MPI) which takes into account three dimensions i.e., health,
education and living standard. Within health they have taken two indicators
such as nutrition and child mortality, in education two indicators i.e., year of
schooling and school attendance and in living standard six indicators such
ascooking fuel, sanitation, drinking water, electricity, housing and asset. All
the dimensionsare given equal weight and within the dimension all the
variables areequally weighted.
As per the finding of OPHI multidimension poverty indicators (using NFHS

database) in India, poverty declined over the decade from 2005/6 to 2015/16
– from 635 million to 364 millionpoor persons. Again, it is interesting to find
that out of 364 million MPI poor in India about 35 per cent are children. The
110
Multi-dimensional poverty indicators show that 27.9 percent of population Poverty, Malnutrition
are MPI poor. As compared to the income poor of 21.9 percent, the MPI poor Policy Implications
shows a 6-percentage point higher poor. This method also calculates the
contribution of 10 indicators in overall poverty. For the year 2015-16 the
contribution of different dimensions to overall poverty is given in Figure
21.1.
Nutrition
3.0 2.8
3.9 Years of
4.3 schooling
Cooking
fuel
28.8 Sanitation
7.5
Housing
School
10.7 attendance
Assets
Electricity
11.2 15.9
Child mortality
11.8
Drinking water
Source: OPHI (2020)

Fig. 21.1: Indicator Contribution to Overall Poverty by Area
The figure clearly indicates that nutrition contributes 29 percent to the total
poverty followed by the years of schooling (16per cent) and cooking fuel and
sanitation (each 11per cent). The variables contributingleast to overall
poverty are drinking water and child mortality (each 3per cent).
The state-level MPI poor indicate a large inequality in MPI poor among
different states. The states like Bihar (52per cent), Jharkhand (47per cent),
Madhya Pradesh (41per cent), Uttar Pradesh (41per cent) have the highest
poverty head count in terms of MPI poor. On the other hand, the state
registering the lowest proportion of MPI poor people are Kerala (1per cent),
Delhi (4per cent), Punjab (6per cent) and Tamil Nadu (7per cent). In 2015-
16, the four poorest states – Bihar, Jharkhand, Uttar Pradesh, and Madhya
Pradesh – were still home to 196 million MPI poor people – over half of all
the MPI poor people in India. Of the total MPI poor in India, 8.6per cent still
live in severe poverty.
The HDR published in the year 2019 considered fourindicators in the index,
viz.expectancy at birth,expected years of schooling,mean years of schooling,
GNI per capita. As per the methodology if the HDI is approaching towards 1
the higher the status and if it approaching towards 0 the lower the progress of
the country. In 2019 the Human Development index for India increased from
0.431 in 1990 to 0.647 in 2018 (Table 21.6)
111
Major Issues
Confronting Indian Table 21.6: HDI Value in India 1990-2018
Economy
Year HDI Value
1990 0.431
1995 0.463
2000 0.497
2005 0.539
2010 0.581
2015 0.627
2016 0.637
2017 0.643
2018 0.647
Source: UNDP HDR 2019 downloaded from
http://hdr.undp.org/sites/all/themes/hdr_theme/country-notes/IND.pdf
It is clear from the non-income poverty analysis that the nutrition constitutes
an important dimension to the overall non-income poverty. In the next
section, we will analyse malnutrition as a non-income poverty measure and
its comparison to the income poverty measure.

1) How is the PG index more useful vis-à-vis poverty head count measure
in assessing poverty?
…………………………………………………………………………….
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2) Identify the measures that take note of income as well as non-income
aspects of poverty.
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112
3) What are the indicators used in capability poverty measure or a human Poverty, Malnutrition
development measure such as HDI? Policy Implications
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
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4) What do you mean by MPI? What are the advantages of MPI poverty
measure over income poverty measure?
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21.5 THE CONCEPT OF MALNUTRITION

In this section, we shall analyse the concept of malnutrition and the status of
India in terms of malnutrition measures. We discuss the type of malnutrition
and different measures of malnutrition for both adult and children. First, we
define the most common measures of nutrition to identify the nutrition
outcome variables. Second, we discuss the direction of influence between
different socio-economic indicators like wealth, social category, religious
category, education on malnutrition both by reviewing relevant literature and
the database. Third, we identify the main determinant variables from the
literature and from other studies that are responsible for high malnutrition in
India.These three aspectswill be analysed and is compared with income
poverty. Here the malnutrition indicators that we have used are
malnutritionamong children below 5 years comprising anthropometric
measurement (stunting, wasting and underweight) and anaemia, whereas
among adult we analyse prevalence of anaemia and Body Mass Index (BMI)
status for women in the age group 15 to 49 years.The reason behind taking
the malnutrition among children and women is because in developing
countries like India, children and adults are vulnerable to malnutrition
because of low dietary intakes, infectious diseases, lack of appropriate care
and inequitable distribution of food within the household. Also, during early
childhood under-nutrition of children can cause low cognitive outcomes and
low productivity during adulthood. Also, children respond faster to changes
in food intakes and food shortages. Hence, the anthropometric measures of
children are considered to be a good proxy of nutrition situation of the
country.
113
Major Issues
Confronting Indian 21.6 MALNUTRITION TYPEAND
Economy
MEASUREMENT
This section is divided into two parts– the first part analysed the malnutrition
among children and the second part analysed the malnutrition among women.
21.6.1 Malnutrition Type and Measurement among

Children
In India, the percentage of stunted children in the age group of 0 to 5 years
was 38.4 per cent in 2015-16 whereas in 2005-06 it was 48.0 percent which
shows a decline by about 9.6 percent. The wasting in 2015-16 was 21 percent
whereas in 2005-06 it was slightly lower at 19.8 percent. Again, the
proportion of underweight which was 36 percent in 2015-16 declined by
about 7 percent over one decade (2005-2015). Higher proportion of children
was found malnourished in rural areas as compared to urban areas. In
stunting and underweight the rural urban differential in the year 2015-16 was
about 10 percentage point whereas in wasting it was only 1.5 percentage
point difference.
Assessing in terms of wealth index, in general, stunting among children

declines, as a household moves up the income/wealth ladder (from poorest to
richest). Over the last decade, percentage of stunted children has declined
across every wealth quintile. In 2015-16, the proportion of stunted children
belonging to the richest household declined to 22 percent from 26 percent in
2005-06. On the other hand, among poorest classes about half of the total
children were stunted (52 percent) which decreased from 60 percent in 2005-
06 (Figure 21.2).
60
50.7
48
50 45.7
42.5 41.2
39.9 38.4 38.3
40 35.7
32.8 31 29.2
30
20.8 19.8 21.420 21
20 16.8
10
0
Stunting Wasting Underweight Stunting Wasting Underweight
NFHS 3 (2005-06) NFHS 4 (2015-16)
Rural Urban Total
Source: Calculated from NFHS 2005-06 and 2015-16.
Fig. 21.2: Trend Analysis of Malnutrition over a Decade (2005-06 to 2015-16)
114
As shown in Figure 21.3, in 2015-16, stunting among children has been Poverty, Malnutrition
found to be the highest among scheduled tribe households (44 percent) and Policy Implications
lowest among the children belonged to other than SC/ST/OBC households.
On the other hand, in the year 2005-06, a 13percentage point difference was
found between children belong to SC category and other than SC/ST/ OBC
category. In terms of wasting, in 2015-16 again ST children have the highest
proportion of wasted children whereas it is lowest among children belonged
to other than SC/ST/OBC category.The proportion of children underweight in
2015-16 is highest among STs (45per cent) and lowest among the children
belonged to other than SC/ST/OBCs (29 per cent). Over the one-decade
period the stunted among STs declined from 54 percent in 2005-06 to 44
percent in 2015-16. Whereas stunted children belonged to general caste
declined from 41 percent in 2005-06 to 29 percent in 2015-16.In terms of
underweight, in 2005-06the highest proportion was found among children
belonged to STs (55 per cent) whereas it was lowest among general caste
children (other than SC/ST/OBCs). The percentage point difference in
underweight between ST and general children in 2005-06 was 21 percent
whereas it was reduced to 16 percentage point change in 2015-16.
60 5454 55
49 49 48
50 45
41 43 42 43 44
39 37 39
40 36 35
33 31
28 27 29
30
21 20 21 21 20
1614 19
20
10
1.3 1.7 1.7 1.4 1.4 1.6
0
Stunting Wasting Underweight Stunting Wasting Underweight
NFHS-3 (2005-06) NFHS-4 (2015-16)
Schedule Caste Schedule Tribe
OBC None of them
Don't Know Ration ST and Other than SC/ST/OBC
Source: Calculated from NFHS 2005-06 and 2015-16.

Fig. 21.3: Percentage of Children Stunted, Wasted and Underweight, by Social
Category 2005-06 and 2015-16
Anaemia is a condition that is marked by low levels of haemoglobin in the

blood. Iron is a key component of haemoglobin, and iron deficiency is
estimated to be responsible for half of all anaemia globally (NFHS report
2015-16). Anaemia is a serious concern for children because it can impair
cognitive development, stunt growth, and increase morbidity from infectious
diseases.
As per NFHS data, the anaemia is a major concern and in 2015-16 the
proportion of children anaemic is about 59 percent which is reduced by 11
percentage points as compared to 2005-06.
115
Major Issues
Confronting Indian Table 21.7: Anaemia among Children 6-59 Months in India, 2005-06 and
Economy 2015-16
NFHS- NFHS 3-
NFHS-3 4 NFHS 4
Urban 63.1 56.1 7.0
Area Rural 71.6 59.6 12.0
Poorest 76.6 64.1 12.5
Poorer 73.7 59.9 13.8
Middle 69.4 59.1 10.3
Richer 64.7 54.5 10.2
Wealth Richest 56.6 51.9 4.7
Schedule caste 72.5 60.8 11.7
Schedule tribe 77.1 63.8 13.3
OBC 70.2 58.7 11.5
None of them 64.0 54.7 9.3
Social group Don’t know 69.0 62.0 7.0
Hindu 69.8 58.8 11.0
Muslim 69.7 59.3 10.4
Christian 60.4 45.8 14.6
Sikh 63.9 56.6 7.3
Buddhist/Neo-
Religious Buddhist 66.7 56.7 10.0
group Other 73.7 65.0 8.7
Total 69.5 58.7 10.8
Source: Calculated from NFHS 2005-06 and 2015-16
A large disparity was also visible. In 2015-16 the rural-urban differential

reduced as compared to 2005-06. The anaemia among children by wealth
quintile shows that among poorest the proportion was 64 percent as compared
to the richest quintile of 52 percent.Again anaemia among children belonging
to ST category is the highest among the social categories whereas the
children belonged to the general caste population (other than SC/ST/OBCs) is
the lowest. Among religious category, the highest proportion of anaemic
children were Hindu and Muslims.
An analysis of anaemia among children 6-59 months across the major states
of India shows that in 2015-16, anaemia was higher in the state of Haryana
(72 per cent). This is peculiar as the state has low poverty incidence in terms
of income poverty. The other states registering higher proportion of anaemic
children are Jharkhand, Madhya Pradesh, Bihar and Uttar Pradesh. On the
other hands in states of Assam (36per cent), Kerala (36per cent), Chattisgarh
and Odisha it is the lowest.
116
Poverty, Malnutrition
72 70 69
64 63 62 61 61 Policy Implications
60 60 60 59 59
57 54 54 54
54 51
45 42
36 36
Source: Calculated from NFHS 2005-06 and 2015-16
Fig. 21.4: Percentage of Children Anaemic by States, 2015-16
21.6.2 Malnutrition Type and Measurement among Women

As discussed earlier, BMI is one of the indicators to measure the nutrition
status of women. As per the WHO standard, the BMI is calculated for women
in the age group of 15-49 years. The proportion of thin women declined from
36 percent in 2005-06 to 23 percent in 2015-16 and at the same time the
proportion of overweight or obese women increased from 13 percent to 21
percent. Overall, there has been an increase in the mean BMI from 20.5 in
2005-06 to 21.9 in 2015-16.
The proportion of thin women in rural and urban India are respectively
15.5per cent and 26.8per cent showing a 11 percentage point difference. As
expected, the thin women by social category shows that STs and SCs bear the
highest percentage (ST 31.7per cent and SC 25.3per cent) and it is lowest
among general caste population (other than SC/ST/ OBC).
The other important indicator measuring the nutritional status of women is

the anaemia. As per the NFHS statistics, the proportion of women anaemic
was 53 percent in 2015-16 as compared to 55.3 percent in 2005-06. The
anaemia among women by wealth quintile shows a variation with about 59
percent of women in the lowest wealth quintile are anaemic as compared to
48.2 percent in the highest wealth quintile. The anaemia of women by
schooling status shows that among illiterate women, the proportion of women
anaemic was 56.4 percent as compared to 48.7 percent for women having
education at intermediate level.
21.7 MALNUTRITION AND POVERTY: A

COMPARATIVE ANALYSIS
Hunger, malnutrition, hidden hunger and poverty all are related to each other.
Poverty is considered to be the main cause of malnutrition and hunger,
117
Major Issues
Confronting Indian however rich people are found to be malnourished as well. In this section we
Economy analyse the interaction between income poverty and malnutrition.
Table 21.8: A Comparative Analysis of Income Poverty and Non-Income

Poverty by State
Income Per MPI Anaemia Stunted Thin

Poverty capita Poor Children Children Women
2011-12 NSDP 2015-16 2015-16 2015-16 2015-16
2017-18
at
constant
price
Kerala 7.1 138368 1 36.0 20 9.7
Himachal Pradesh 8.1 130644 8 53.7 26 16.2
Punjab 8.3 110802 6 56.7 26 11.7
Andhra Pradesh 9.2 103214 16 58.5 31 17.6
Delhi 9.9 255431 4 59.9 32 14.8
Jammu & Kashmir 10.4 62984 15 54.2 27 12.1
Haryana 11.2 159892 11 71.8 34 15.8
Uttarakhand 11.3 147204 17 60.2 34 18.4
Tamil Nadu 11.3 133029 7 50.8 27 14.6
Rajasthan 14.7 74441 32 60.4 39 27
Gujarat 16.6 142068 22 62.4 39 27.2
Maharashtra 17.4 140724 17 54.0 34 23.5
West Bengal 20.0 64007 26 54.5 33 21.3
Karnataka 20.9 143827 17 61.3 36 20.8
Uttar Pradesh 29.4 42798 41 63.3 46 25.3
Madhya Pradesh 31.7 54264 41 69.0 42 28.4
Assam 32.0 57835 36 35.9 36 25.7
Odisha 32.6 72760 36 44.6 34 26.5
Bihar 33.7 26699 52 63.5 48 30.5
Jharkhand 37.0 52277 47 70.1 45 31.6
Chhattisgarh 39.9 66122 37 41.7 38 26.7
All-India 21.9 87828 28 56.9 38 22.9
Table 21.8presents the income and non-income poverty indicators. When we

compare the income poverty and anaemia among children it shows that
Andhra Pradesh and Delhi registered low-income poverty and high anaemia
among children. On the other hand,Chhattisgarh, Odisha and Assam
registered high proportion of income poverty but comparatively low
proportion of anaemic children. Again, when we compare the income poverty
and stunted children, Andhra Pradesh and Delhi which have lower poverty
rate registered high proportion of stunted children. In terms of comparison of
118
income poverty and Low BMI among women (thin) shows that the states Poverty, Malnutrition
Himachal Pradesh and Andhra Pradesh which registered low-income poverty Policy Implications
shows high proportion of thin women. Hence, we can conclude that the non-
income poverty indicators are important to analyse poverty status of the state.
21.8 INCLUSIVE GROWTH

Inclusive growth is the growth that not only creates new economic
opportunities, but also ensures equal access to the opportunities created for
all segments of society, particularly for the poor. The OECD defines
inclusive growth as economic growth that creates opportunity for all
segments of the population and distributes the dividends of increased
prosperity, both in monetary and non-monetary terms, fairly across
society.Thus, Inclusive growth is the process that focuses on both creating
opportunities rapidly and making them accessible to all including the
disadvantaged.
The traditional view suggests that inequality is inherent in the process of

growth. During structural transformation of the growth process certain
sectors benefit more from the process than other sectors that lag behind. So,
in the initial period growth leads to rise in inequality. But subsequently, the
benefits of growth percolates down to the lagging sectors leading to a more
equitable growth outcome. This process is visible in ‘Kuznet curve’ where
inequality first rise and then fall. However, this process was not found to be
true in India as increase in growth rate did not result in a decrease in
inequality.
The country has grown strongly since the economic reforms of the early
1990s, with growth averaging around 7 percent during 1993-94 and 2009-10
and 6.7 per cent during the period 2010 to 2016.Compared with other
countries at similar level of development, in India, inequality is not only very
high, but has also shown a rising trend over time, particularly since the early
1990s. While the rate of rise in inequality seems to have slowed down after
2004-05, it continues to show a rising trend. Inequality in India is about
education, health, nutrition, sanitation, and opportunities as much as it is
about rising income inequality. Some of the plausible reasons could be rapid
growth in GDP, liberal and expansionary fiscal policy, large public debt,
rapid improvement in technology and the changes in the nature of production
using more capital, increasing share of services in GDP, unfavourable
policies and institutions, etc. Besides this, the country has a high level of
horizontal inequalities based on caste, class, religion, race, gender, and
location. A commonly used indicator of inequality is the Gini index, which
varies from zero (in a context of perfect equality) to one (perfect
inequality).By this measure, inequality declined between 1983 and 1993–94
but rose appreciably in thefollowing decade after the onset of reforms in
1991.
Considering the widening disparities in the form of surging income

inequality, inequality in opportunities (including on access to education,
health and financial services/inclusion), unemployment, poverty and other
119
Major Issues
Confronting Indian forms of social deprivations– policies aiming towards inclusive growth
Economy becomes imperative. Universal access to education and health services,
access to financial services, new technologies, gender equality and more
equal distribution of resources can all support inclusive economic
development. The inclusive growth has been extensively reflected in different
plan period in India. The 11th Plan defines inclusive growth to be “a growth
process which yields broad-based benefits and ensures equality of
opportunity for all”. Likewise, the basic objective as stated in the 12th five-
year plan was “Faster, More Inclusive and Sustainable Growth”.We have
seen progress on inclusiveness:Agricultural Growth, Poverty Reduction,
Education, Health, Upliftment of SCs /STs etc. However, progress on
inclusiveness is less than expected. It can be apprehended from different
aspects. India missed achieving many indicators of Millennium Development
Goals (MDG). In the literacy front the goal of increasing literacy among
backward classes and other weaker sections has not been achieved.
Agriculture growth is still in vulnerable conditions. The employment
schemes like MGNREGS are not upto the mark. There are many plans,
policies, schemes but their implementation is not according to their expected
level.
21.9 INCLUSIVE GROWTH – POLICY

IMPLICATIONS
Agricultural Development
Agriculture development should be given priority. The recent trend shows
that the contribution of agricultural sector to total GDP has reduced from 44.6
per cent to 17.2 per cent from the year 1958-59 to 2008-09 and to 16.5per
cent in 2019-20.On the other hand the absorption of labour in the agricultural
sector has not reduced much during the same period. This emphasises show
that the pace of reduction of contribution to GDP by agricultural sector is
extremely high as compared to pace of reduction of workforce in agricultural
sector. Hence there is a need to develop the agricultural sector by way of
irrigation and water management, credit, research and extension, marketing
etc.Land and water management (including watershed development) are
crucial for agriculture development. Development of agro-based industries in
rural areas has not only expanded the scope of employment but also reduced
the heavy dependence on agricultural sector.
Rural Non-farm Employment opportunities

The Rural Non-Farm Sector (RNFS) encompasses all non-agriculture
activities: mining and quarrying, household and non-household
manufacturing, processing, etc. Rural non-farm economy, is considered as an
effectual strategy for decentralisation of economic activities to rural India in
order to check for unregulated migration, bridge rural-urban divide, generate
employment, reduce inequalities, etc. According to different international
studies on India’s labour market, between 2011 and 2015, thenumber of
agriculture jobs fell by 26 million while non-farm ones rose by 33
million.However, the sector has been contending with a number of factors
120
like inadequate rural infrastructure, particularly roads, electricity and Poverty, Malnutrition
communication facilities, lack of sufficient skilled labour and adequate Policy Implications
access to credit, information and training facilities, etc. Thus, heavy
investments are needed for inclusive, sustainable and diversified rural
development along with the right governance system.
Financial Inclusion
Financial Inclusion is the availability of financial services and timely and
adequate credit at an affordable cost to the disadvantaged and low-income
groups. Financial inclusion can help in achieving development goals such as
poverty eradicationand income equality, food security and sustainable
agriculture, supporting infrastructure and industries, better healthcare,
encouraging increased consumption and savings, reduction in unemployment
and sustainable economic growth. Financial inclusion has been ensured by
the government and the central bank by way of – no frills accounts with low
or zero minimum balances and minimum charges to expand outreach of such
accounts to low-income groups, easier credit facilities, simpler KYC norms,
use of information and technology, expansion of electronic benefit transfer
system, business correspondence model, bank branch and ATM expansion,
financial literacy and credit counselling, etc. Yet a large part of the Indian
population remains excluded from the formal banking sector. Rapid
urbanisation is increasing the rate of urban poor who are devoid of the most
basic banking facilities. Also, people working in the informal sector still
remain outside the rings of the formal financial system. Thus, much needs to
be done in the financial inclusion space in order to ensure inclusive growth.
Public Investment
High investment in infrastructure is important for inclusive growth. In many
developing countries it is visible that public expenditure as percentage of
GDP is low and declining. Public investment in rural development has
declined sharply. Consequently, agricultural growth slowed down in India.
Priority to public investment in physical (irrigation, roads, communications,
transport, electricity, etc.) and human infrastructure (health, education, etc.) is
considered as one of the important factors resulting in inclusive growth.
Public Finance and Tax Policies

Taxes provide the primary source of financing for public expenditure in
public education, healthcare, job creation and the overall social welfare.
Taxes are also the financial backbone for social security networks and basic
welfare, providing essential support to poor people against unexpected risks
and preventing them from falling back into poverty during difficult times.
Hence, progressive tax policies are central to fostering a fairer distribution of
income and wealth.
Development of Institutions
Development of new institutions and strengthening the present institutions of
service delivery are important. Several institutions seemed to have failed in
delivering better services particularly in health and education in rural areas.
121
Major Issues
Confronting Indian Institutions seem to be responsive when women are empowered.
Economy Decentralisation in terms of strengthening Panchayati Raj Institutions (PRIs)
has to be improved in order to have better delivery systems.
Social Protection
The social protection system can play an important role in mitigating poverty
and inequality through redistribution. This also helps to give the platform to
the excluded section of the society. India has implemented a plethora of
poverty alleviation programmes to address the issue of poverty and
inequality. Most important programme is Public Distribution System (direct
food subsidy), Indira AwasYojana (Housing for poor) and direct cash transfer
through the programmes like old age pension scheme, widow pension
scheme, disability pension scheme, national family benefit schemes, etc.
Some other programmes are also incentive based for example, incentives for
institutional delivery, incentives for family planning, etc. For some of the
educational development programmes like scholarship, free distribution of
books, cycle, dresses, midday meal, etc. are implemented.
From time to time the central and state governments implement different
employment generation programmes which provides the minimum livelihood
for rural and urban poor. The National Rural Employment Guarantee Act
(NREGA) 2005, passed by the Government of India in August 2005, is a
unique programme implemented by central government which guaranteed
one hundred days of unskilled work per year on public works programmes to
each rural Indian providing guaranteed employment entitled by law. Now,
within fifteen days of a valid application, the government must provide work
or unemployment allowance.

1) What is the concept of inclusive growth?
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
2) State how social protection can play an important role in mitigating
poverty and inequality.
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
122
21.10 LET US SUM UP Poverty, Malnutrition
Policy Implications
The unit deals with the nature and dimension of poverty and inequality, and
how the inclusive growth addresses these two issues. In general sense,
poverty implies the lack of income/expenditure and the access to basic needs
like food, shelter, drinking water, health, etc.
Poverty is measured by the methods like head count ratio, poverty gap index,
squared poverty gap index by taking into consideration the
income/expenditure. Several other non-income dimensions also play a major
role in determining the level of poverty. The rate of poverty in India shows a
declining trend from 1973-74 to 2011-12. High growth with inequality is a
common phenomenon in developing countries. How to tackle this lopsided
growth with inequality is the major challenge. The inequality is measured by
different methods like range, range ratio, coefficient of variation, and most
importantly Lorenz curve. In India high inequality is found both in the
income and expenditure and also in other non-income variables like IMR,
underweight of child, literacy rate, etc. Even geographical inequality also
exists.
Malnutrition which is measured by the anthropometric indicator for children

below 5 years and anaemia are the important indicators to show the poverty
level of a state. It was found that a state having low proportion of head count
poverty does not necessarily guarantee low prevalence of malnutrition among
children and women. Hence for any policy analysis the malnutrition
indicators need be taken into account.
Inclusive growth not only creates new economic opportunities, but also
ensures equal access to the opportunities created for all segments of society,
particularly for the poor. Creating opportunity, equalising opportunity and
providing the safety net are the main pillars of inclusive growth.

1) What do you mean by poverty? Explain the indicators that cover income
and non-income dimensions of poverty.
2) What do you mean by inequality? How are the inequalities of income
measured in an economy? Also state the different indicators that cover
inequality in non-income aspects of life.
3) Examine the policy implications of widespread poverty and inequality in
the Indian economy.
4) “The quality of life in India is far from satisfactory.” Comment.
5) What is multidimensional poverty and how is it calculated?
123
Major Issues
Confronting Indian 21.12 KEYWORDS
Economy
Poverty Line : Poverty line is the income/expenditure cut-offs used to

identify the poor from non-poor. This is the minimum
requirement of an individual for a healthy living. The
minimum requirement can include both food and non-
food items.
Head Count : This is the simplest measures of calculating the
Ratio incidence of poverty. This is the proportion of the
population that is counted as poor. In other words the
incidence of poverty is defined as the proportion of
poor to the total population.
��
�� (��)
= × 100
�� (�)
Poverty Gap : This is a measure to identify the incidence as well as
Index severity of poverty which derived from income or
expenditure distribution. This measure shows how
below the income/consumption from poverty line.
Capability : This is a multi-dimensional measure of human
poverty deprivation developed by UNDP. The indicator of this
measures measure is the lack of being well nourished and
healthy, the lack of capability for healthy
reproduction, and the lack of capability to be
educated.
Lorenz Curve : This is a graphical representation of the
proportionality of a distribution. This is often
associated with income distribution calculations and
commonly used in the analysis of inequality.
21.13 REFERENCES
1) Dev, S.Mahendra and C.Ravi. (2007). “Poverty and Inequality: All India
and States, 1983-2005”, Economic and Political Weekly, Vol.42, No.6.
2) The World Bank. (2006). “India Inclusive Growth and Service Delivery:
Building on India’s Success” Development Policy Review, Report No.
34580-IN.
3) Ifzal Ali and Hyun Hwa Son. (2007). “Measuring Inclusive Growth”,
Asian Development Review, vol. 24, no. 1, pp.11-31.
4) World Bank Institute. (August 2005).“Introduction to Poverty Analysis.”
5) Amitabh Kundu and K. Varghese. (September 2010).“Regional

Inequality and ‘Inclusive Growth’ in India under Globalization:
Identification of Lagging States for Strategic Intervention”,Oxfam India
working papers series, OIWPS – VI.
124
6) Planning Commission. (2002).“National Human Development Report”, Poverty, Malnutrition
Government of India. Policy Implications
7) Government of India. (1993).Report of the Expart Group on Estimation

of Proportion and Number of Poor”, Perspective Planning Division,
Planning Commission, New Delhi.
8) Government of India. (2009).“Report of the Expert Group toReview the

Methodology forEstimation of Poverty,Planning Commission.
9) Ian MacAuslan. (2008).“India’s National Rural Employment Guarantee

Act: A Case Study for How Change Happens” From poverty to Power
background paper, Oxfam International.
10) Catherine Barber. (2008). “Notes on Poverty and Inequality” From

poverty to Power background paper, Oxfam International.
11) Stephen P. Jenkins and Philippe Van Kerm. (2008). “The Measurement
of Economic Inequality” Oxford Handbook on Economic Inequality
edited by Brian Nolan, WiermerSalverda and Tim Smeeding.
12) Savita Sharma. (2004).“Poverty Estimates in India: Some Key
Issues”,ERD Working Paper No. 51, Asian Development Bank.
13) SandipSarkar, Sunil Mishra, HarishwarDayal and Dev Nathan (2006).
‘Development and Deprivation of Scheduled Tribes’, Economic and
Political Weekly’.
14) United Nations Development Programme (2010). Human Development
Report 2010’, UNDP, New York, USA.
15) Sainath, P, “Everybody Loves a Good Drought: Stories from India’s

Poorest Districts”, Penguin Books India (P) Ltc., New Delhi-17.
16) Joseph Gastwirth, Reza Modarres, EfstathiaBura (2005). “The use of the
Lorenz curve, Gini index and related measures of relative inequality and
uniformity in securities law”METRON - International Journal of
Statisticsvol. LXIII, n. 3, pp. 451-469.
17) Klasen, S., and H. Waibel (Eds). (2012). Vulnerability to Poverty-

Theory, Measurement, and Determinants. Palgrave Macmillan.
18) Clark, D., and D. Hulme. (2010). Poverty, Time and Vagueness:
Integrating the Core Poverty and Chronic Poverty Frameworks.
Cambridge Journal of Economics, 34(2): 347–366.
doi:10.1093/cje/ben046.
19) OPHI (2020). ‘Global MPI Country Briefing 2020: India (South Asia)’,
Oxford Poverty and Human Development Initiative (OPHI), University
of Oxford downloaded from https://ophi.org.uk/wp-
content/uploads/CB_IND_2020.pdf.
125
Major Issues
Confronting Indian 21.14 ANSWERS OR HINTS TO CHECK YOUR
Economy
PROGRESS EXERCISES
1) The PG index is helpful in working out the shortfall of consumption
below the poverty line. It will indicate the magnitude of the effort that
would be required to raise the consumption level of all the persons below
the poverty line to the consumption level of the poverty line.
2) Human Development Index and Human Poverty Index.
4) See Section 21.4
1) See Section 21.8
2) See Section 21.9
126
Poverty, Malnutrition
APPENDIX 21.1 and Inclusive Growth:
Policy Implications
Table 1: Proportion of Population below Poverty Line in Major
States(2004-05 and 2011–12)
2004–05 2011–12 Difference

States
Rural Urban Total Rural Urban Total Rural Urban Total
Andhra Pradesh 32.3 23.4 29.6 11.0 5.8 9.2 21.3 17.6 20.4
Arunachal
Pradesh 33.6 23.5 31.4 38.9 20.3 34.7 -5.3 3.2 -3.3
Assam 36.4 21.8 34.4 33.9 20.5 32.0 2.5 1.3 2.4
Bihar 55.7 43.7 54.4 34.1 31.2 33.7 21.6 12.5 20.7
Chhattisgarh 55.1 28.4 49.4 44.6 24.8 39.9 10.5 3.7 9.5
Delhi 15.6 12.9 13.0 12.9 9.8 9.9 2.7 3.1 3.1
Gujarat 39.1 20.1 31.6 21.5 10.1 16.6 17.6 10.0 15.0
Haryana 24.8 22.4 24.1 11.6 10.3 11.2 13.2 12.1 12.9
Himachal Pradesh 25.0 4.6 22.9 8.5 4.3 8.1 16.5 0.3 14.8
Jammu &
Kashmir 14.1 10.4 13.1 11.5 7.2 10.4 2.6 3.2 2.8
Jharkhand 51.6 23.8 45.3 40.8 24.8 37.0 10.8 -1.0 8.3
Karnataka 37.5 25.9 33.3 24.5 15.3 20.9 13.0 10.7 12.4
Kerala 20.2 18.4 19.6 9.1 5.0 7.1 11.1 13.4 12.6
Madhya Pradesh 53.6 35.1 48.6 35.7 21.0 31.7 17.9 14.1 17.0
Maharashtra 47.9 25.6 38.2 24.2 9.1 17.4 23.7 16.5 20.9
Odisha 60.8 37.6 57.2 35.7 17.3 32.6 25.1 20.3 24.6
Punjab 22.1 18.7 20.9 7.7 9.2 8.3 14.4 9.5 12.6
Rajasthan 35.8 29.7 34.4 16.1 10.7 14.7 19.8 19.0 19.7
Tamil Nadu 37.5 19.7 29.4 15.8 6.5 11.3 21.7 13.2 18.1
Uttar Pradesh 42.7 34.1 40.9 30.4 26.1 29.4 12.3 8.0 11.5
Uttarakhand 35.1 26.2 32.7 11.6 10.5 11.3 23.5 15.7 21.4
West Bengal 38.2 24.4 34.2 22.5 14.7 20.0 15.7 9.7 14.2
All-India 41.8 25.7 37.2 25.7 13.7 21.9 16.1 12.0 15.3
Note:Figures are based on Tendulkar Methodology; All-India includes figures for rest of the UTs.
Sources: Press Note on Poverty Estimates, 2009–10, Planning Commission, Government of India
website (http://planningcommission.nic.in/news/press_pov1903.pdf,accessed on 4 April 2013);
Press Note on Povery Estimates, 2011–12, Planning Commission, Government of India website
(http://planningcommission.nic.in/news/pre_pov2307.pdf, accessed on 26 August 2013). 127
Major Issues
Confronting Indian Table 2: Percentage of children under age five years classified as
Economy malnourished according to three anthropometric indices of nutritional
status: height-for-age, weight-for-height, and weight-for-age, according
to state, India, 2005-06
Height-for-age Weight-for- Weight-for-age

(Stunting) height (Underweight)
State (Wasting )
Andhra Pradesh 42.7 12.2 32.5
Assam 46.5 13.7 36.4
Bihar 55.6 27.1 55.9
Chhattisgarh 52.9 19.5 47.1
Gujarat 51.7 18.7 44.6
Haryana 45.7 19.1 39.6
Himachal Pradesh 38.6 19.3 36.5
Jammu & Kashmir 35 14.8 25.6
Jharkhand 49.8 32.3 56.5
Karnataka 43.7 17.6 37.6
Kerala 24.5 15.9 22.9
Madhya Pradesh 50 35 60
Maharashtra 46.3 16.5 37
Odisha 45 19.5 40.7
Punjab 36.7 9.2 24.9
Rajasthan 43.7 20.4 39.9
Tamil Nadu 30.9 22.2 29.8
Uttar Pradesh 56.8 14.8 42.4
Uttarakhand 44.4 18.8 38
West Bengal 44.6 16.9 38.7
India 48 19.8 42.5
128
Table 3 :Statewise IMR, 2006 and 2010 Poverty, Malnutrition
Policy Implications
2006 2010
State
Male Female Person Male Female Person

Delhi 36 39 37 30 37 29
Haryana 57 58 57 48 51 38
Himachal Pradesh 45 55 50 40 41 29
Jammu & Kashmir 51 53 52 43 45 32
Punjab 39 50 44 34 37 28
Rajasthan 65 69 67 55 61 31
Uttarakhand 42 44 43 38 41 25
Chhattisgarh 59 62 61 51 52 44
Madhya Pradesh 72 77 74 62 67 42
Uttar Pradesh 70 73 71 61 64 44
Bihar 58 63 60 48 49 38
Jharkhand 46 52 49 42 44 30
Odisha 73 74 73 61 63 43
West Bengal 37 40 38 31 32 25
Assam 67 68 67 58 60 36
Gujarat 52 54 53 44 51 30
Maharashtra 35 36 35 28 34 20
Andhra Pradesh 55 58 56 46 51 33
Karnataka 46 50 48 38 43 28
Kerala 14 16 15 13 14 13
Tamil Nadu 36 37 37 24 25 22
India 56 59 57 46 49 47
Source: Economic Survey 2011-12; Sample Registration System 46; Dec. 011, Office of Registrar
General, Ministry of Home Affairs
129
Major Issues
Confronting Indian Table4: Percentage of births delivered in a health facility five years preceding
Economy the survey by state, India, 2005-06
States Mothers’ Education

Total No < 8 years 8-9 years 10 years NFHS-2
NFHS 3 Education Complete Complete Complete
and
above
Andhra Pradesh 64.4 46.9 76.8 85 90.8 49.8
Assam 22.4 9.8 16.7 32.5 71.2 17.6
Bihar 19.9 12.6 28.3 45.6 64.6 14.8
Chhattisgarh 14.3 5.5 12 26 67.2 13.8
Gujarat 52.7 38.4 53.5 68.6 83 46.3
Haryana 35.7 14.6 38 43.6 69.6 22.4
Himachal
Pradesh 43 19 28.4 37.5 61.2 28.9
Jammu &
Kashmir 50.2 40.7 52.1 65.5 81.7 35.7
Jharkhand 18.3 8.2 18.5 46.7 68.8 13.9
Karnataka 64.7 36.7 68.5 82.3 89.5 51.1
Kerala 99.3 * 98.8 99.5 99.7 92.9
Madhya
Pradesh 26.2 37.7 58.4 71.8 89.6 52.6
Maharashtra 64.6 17.3 33.6 39.3 79.9 22
Odisha 35.6 14.8 48.8 61.6 74.1 22.6
Punjab 51.3 30.8 41.5 54.2 78.1 37.5
Rajasthan 29.6 20.6 45.8 60.2 78.9 21.5
Tamil Nadu 87.8 79.3 90.1 88.6 96.7 79.3
Uttar Pradesh 20.6 13.6 23.2 29.1 59.2 15.2
Uttarakhand 32.6 15.6 30.8 25.3 71.2 20.6
West Bengal 42 22.9 45.8 64.2 89.5 40.1
India 38.7 19.8 45.7 57.8 80.6 33.6
130
UNIT 22 EMPLOYMENT AND Employment and
Unemployment: Policy
UNEMPLOYMENT: POLICY Challenges
CHALLENGES
Structure
22.0 Objectives
22.1 Introduction
22.2 Enumeration of Workers
22.2.1 Conceptual Framework of Key Employment and Unemployment Indicators
22.3 Labour Force and Work Force Participation Rates
22.4 Dimensions of Unemployment
22.5 Growth of Employment
22.6 Quality of Employment
22.6.1 Proportion of Workers in Organised and Unorganised Sectors
22.6.2 Proportion of Workers Engaged in Regular and Casual Labour
22.7 Employment Policy Framework
22.7.1 Report to the People on Employment
22.7.2 Issues of Concerns
22.8 Let Us Sum Up
22.10 Key Words
22.11 References
22.0 OBJECTIVES
● know the various concepts used in the measurement of employment and
unemployment by NSSO and PLFS;
● explain the various dimensions of unemployment in India;
● examine the growth of employment in the post-reform period;
● assess the quality of employment; and
● suggest various measures towards employment policy framework.
22.1 INTRODUCTION
Engagement of a person in any economic activity is central to the concept of
identifying a worker. A worker is one who participates in any economic
activity. His or her human capital endowment is utilised by the society (or
131
Major Issues
Confronting
the economy) and in the process, he or she earns a living. All workers
U
Indian Economy constitute the workforce or the employed.
Those who are not workers are called non-workers. Some among the non-
workers may be seeking or looking for work or are available for work. Such
persons constitute the unemployed. The workforce and the unemployment
together make up the labour force. The entire population of any area, region
or country is, thus, made up of three components; the workforce (the
employed), the unemployed and the non-workers. The third component is
also referred to, for obvious reasons, as the population which is not a part of
the labour force. The first is engaged in economic activity and produces the
national product, the second is available for being engaged in such activity
but the economy is unable to utilise it and the third is not available for
utilisation in economic activity. Schematically, workforce can be illustrated
as follows:
Population
Labour Force Out of Labour

Foce
They are not available for utilisation
in Economic activity
Work Force The Unemployed
(The Employed)
Economy is unable to
utilise them
Utilised by the economy

for generating national
product
Fig. 22.1: Labour Force, Work Force and the Unemployed
How are the workers or the employed and the other two categories of people
in a given area – a region or a country, say India – identified and
enumerated? How are the workforce and the labour force measured? We
shall answer these questions in the next section.
22.2 ENUMERATION OF WORKERS

Now, let us discuss about the sources of data in India on workers. In India,
two main organisations which generate and compile data on workers are the
National Sample Survey Organisation (NSSO) and Office of the Registrar
General of Census. These two organisations generate quite a substantial data
on the workers, employment and unemployment, etc. on regular intervals for
the entire country. Among these two sources, NSSO provides more data on
employment and unemployment. For understanding and studying the data
132 given in National Sample Survey (NSS) Rounds, it is important to be well
aware of the concepts that were used in these data collection exercises. NSSO Employment and
used the concept of ‘Usual Principal Status’ (UPS) as a time reference period Challenges
for identifying workers. In more general terms, NSSO used three reference
periods to describe the activity status of a worker. These reference periods
are– a year, a week and a day.
Starting from 27th round during Oct, 1972-Sep, 1973, the quinquennial
employment-unemployment surveys (EUs) of the NSSO provided relevant
data on key features of the labour force as well as the status of the decent
work. These surveys continued till 68th round conducted during 2011-12.
Towards improving the existing system (quinquennial surveys– EUs) of
collecting data, the Periodic Labour Force Survey (PLFS) has been designed
to replace its previous quinquennial rounds on the employment-
unemployment situation and gather the annual estimates of the labour force
on employment and unemployment along with quarterly estimates for the
urban areas. These annual PLFS provide quarterly statistics for urban areas
on current weekly status (CWS) and annual estimates of employment
indicators both for rural and urban areas on CWS and usual status basis.
Since there has been a significant re-structuring of the previously existing

questionnaire, survey methodology and inquiry schedule, labour market
estimates by PLFS is not strictly comparable with NSSO-EUs. For
comparability, the results of PLFS with earlier rounds of NSSO surveys need
to be understood in the context with which the survey methodology has been
designed.
22.2.1 Conceptual Framework of Key Employment and

Unemployment Indicators
The Periodic Labour Force Survey (PLFS) gives estimates of key
employment and unemployment indicators like the Labour Force
Participation Rates (LFPR), Worker Populations Ratio (WPR),
Unemployment Rate (UR), etc. These indicators are defined as follows:
a) Labour Force Participation Rate (LFPR): LFPR is defined as the

percentage of persons in labour force (i.e., working or seeking or
available for work) in the population. Generally, by population we refer
people in the age group 15-60 years, the segment of the population which
can potentially work, the rest (children below 15 years and elderly above
60 years) are considered as the dependent population. Sometimes the
working-age population may be differently specified.
b) Worker Population Ratio (WPR): WPR is defined as the percentage of
employed among the persons in the labour force.
c) Unemployment Rate (UR): UR is defined as the percentage of person

unemployed among the persons in the labour force.
d) Usual Principal Status Unemployment (UPS): this is measured as the

number of persons who remained unemployed for a major part of the
year. The persons covered by the survey may be classified into those
working and/or available for work in their principal activity, and those
133
Major Issues
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working and/ or available for work in a subsidiary activity, that is, a
U
Indian Economy sector other than their principal activity. Hence, within the usual status
concept, the estimates are derived on the usual principal status as well as
the usual principal and subsidiary status basis. The usual status
unemployment rate indicates chronic unemployment, because all those
who are found usually unemployed in the reference year are counted as
unemployed. This measure is more appropriate to those in search of
regular employment, e.g., educated and skilled persons who may not
accept casual work. This is also referred to as ‘open unemployment’.
e) Usual Principal and Subsidiary Status Unemployment (UPSS): Here

person is considered unemployed, if besides UPS, those available but
unable to find work on a subsidiary basis during a year.
f) Activity Status-Usual Status: The activity status of a person is

determined on the basis of the activities pursued by the person during the
specified reference period. When the activity status is determined on the
basis of the reference period of last 365 days preceding the date of
survey, it is known as the usual activity status of the person.
g) Activity Status-Current Weekly Status (CWS): The activity status

determined on the basis of a reference period of last 7 days preceding the
date of survey is known as the current weekly status (CWS) of the
person.
h) Activity Status-Current Daily Status (CDS): The activity status
determined on the basis of a reference period of each day of the 7 days
preceding the date of survey is known as the current daily status (CDS)
of the person.
Creation of employment opportunities depends on the volume and
composition of economic activity in the economy, that is, the total output of
goods and services in the economy and its structure. The total output of
goods and services is called the Gross Domestic Product (GDP). Thus, levels
of employment in an economy depend on the size and composition of its
GDP. Factors that affect this basic relationship are: (i) the availability of
capital, (ii) the availability of skills and expertise among the employed
persons and (iii) the manner in which capital and labour (the number of
employed persons) combine to produce the output of goods and services. In
other words, a number of inter-dependent factors like material, financial and
human capital, knowledge and technology utilised, productivity of labour and
capital, and Government policies shape this relationship.
22.3 LABOUR FORCE AND WORK FORCE

PARTICIPATION RATES
As stated in the previous section, labour force refers to that segment of
population which supplies or offers to supply labour for production and
therefore includes both employed and unemployed persons.
134
Labour Force Participation Rate (LFPR) is a measure of the proportion of the Employment and
country’s population that is engaged actively in the labour market, either by Challenges
working or seeking work. It provides an indication of the size of the supply
of labour available to engage in the production of goods and services. The
gap between average annual growth of labour force and employment growth
provides hints towards increase/ decrease in the existing stock of unemployed
people. Work Participation Rate (WPR) is a measure of the proportion of the
country’s labour force who are engaged in work. It provides information on
the ability of the economy to generate employment.
Throughout the period between 1983 and 2018-19, male participation

remained higher both in labour and workforce. Using the usual principal and
subsidiary status (UPSS) criterion, labour force participation rate, recorded at
42.9 per cent in 1983, declined to 42.3 per cent in 1993-94, and again
declined to 37.5 per cent in 2018-19. Among women, rates were found to be
29.8, 29.0 and 18.6 per cent in the three years respectively. Female
participation per se in rural areas was much higher than in urban areas. Urban
male participation rates (both labour force and workforce) were higher than
rural male participation in 1999-2000, 2004-05, 2009-10 and 2018-19. (Table
12.1)
LFPR for rural males increased marginally in 2009-10 compared to 2004-05

while for urban males it actually declined. The most striking revelation of
NSSO’s 66th round survey is the significant fall in female work participation
rates (FWPR) between 2004-05 and 2009-10. Rural FWPR dropped to reach
20 per cent in principal status work (UPS) and 26 per cent in usual (principal
+ subsidiary) status work (UPSS) in 2009-10. However, it marginally
increased to 19.1 per cent in 2018-19. In urban areas too, FWPR has fallen
substantially from 13.5 per cent in 2004-05 to below 12 per cent in 2009-10
in the case of UPS employment and from close to 17 per cent to below 14 per
cent in UPSS during the same period (Mazumdar, 2011). With principal
status or main work/employment as well as subsidiary status or marginal
work having both lost ground, it appears that relatively more durable work as
well as shorter bursts of temporary employment have become less available
to women. Two possible explanations may be offered for this decline: firstly,
women have simply withdrawn from the labour market in India due to social
conservatism. Secondly, more women are pursuing higher education
resulting decline in women LFPR. However, decline in women LFPR across
all age groups indicates that there must be some other factors inhibiting
women from participating in the labour market. The decline in the LFPR for
women irrespective of age is possibly due to decline of overall employment
opportunities compelling the women for withdrawal from the labour market.
Thus, labour force participation rate as percentage of population has not

remained fixed over a period of time. There has been specific participation
rate changes overtime in response to economic, social and cultural factors.
This is particularly true for women and children. Most women from poor
households participate in the labour force, but they may withdraw from it
with increase in household income and then join again at much higher level
of income and also when they have acquired a certain level of education. So
135
Major Issues
Confronting
female labour force participation rate is observed to have a U-shaped
U
Indian Economy relationship with the per capital income level (India Labour and Employment
Report, 2012).
Table 22.1: Labour Force and Work Force Participation Rates (CDS
basis) (per cent)
1983 1993-94 1999-00 2004-05 2009-10 2017-18 2018-19

Labour force participation rates (LFPR)
Rural Male 52.7 53.4 51.5 53.1 53.6 54.9 55.1
Rural Female 21.9 23.2 22.0 23.7 19.7 18.2 19.7
Urban Male 52.7 53.2 52.8 56.1 55.6 57.0 56.7
Urban Female 12.1 13.2 12.3 15.0 14.1 15.9 16.1
Work Force participation rates (WFPR)
Rural Male 48.2 50.4 47.8 48.8 50.1 54.9 52.1
Rural Female 19.8 21.9 20.4 21.6 18.2 18.2 19.1
Urban Male 47.3 49.6 49.0 51.9 52.2 57.0 52.1
Urban Female 10.6 12.0 11.1 13.3 11.7 15.9 14.5
Source:
1) Various rounds of NSSO survey on employment and unemployment.
2) PLFS Report 2018-19 for 2017-18 and 2018-19.4

1) What are various measures of employment and unemployment?
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
2) Do you think that CDS criterion is the most inclusive measure of
unemployment? Why?
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
3) Differentiate between worker, non-worker and unemployed.
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
136
22.4 DIMENSIONS OF UNEMPLOYEMNT Employment and
Challenges
The unemployment rate is the ratio of the number of unemployed persons in
the labour force per thousand.
Based on the Periodic Labour Force Survey (PLFS)- Annual Report (July,
2018 – June, 2019), the data relating to unemployment situation has been
incorporated in Table 22.2.
1) As per the latest Annual report (by the Periodic Labour Force Survey
2018-19) on the employment situation, the unemployment rate in India
was 5.8 per cent at the all-India level following the usual states criterion.
It was 5.6 per cent among males and 3.5 per cent among females in rural
areas while the rates were 7.1 per cent among males and 9.9 per cent
among females in urban areas.
2) Among the educated persons falling within the age group of 15 years and
above, unemployment rate was 11.2 per cent in rural areas and 10.8 per
cent in urban areas.
3) In 2018-19, the unemployment rate among rural male youth and rural
female youth (persons of age 15-29) was 16.6 per cent and 13.8 per cent
respectively. Unemployment rate among urban male youth and female
youth was much higher to the extent of 18.7 per cent and 25.7 per cent
respectively.
Thus, it is clear that unemployment rate is not only on the rise in the country
but is at an all-time high. It has been the highest since 1977-78 among the
males and highest since 1983 among the females in the rural as well as in the
urban areas. The unemployed persons in 2017-18 have more than doubled to
28.5 million from 10.8 million in 2011-12.
The key features of the unemployment situation in India (as given by the
PLFS 2018-19) are:
1) The rise in the unemployment rate has occurred across states. The states
which crossed 5 per cent unemployment rate are Goa, Manipur, Kerala,
Mizoram, Nagaland, Odisha, Uttar Pradesh, Arunachal Pradesh,
Himachal Pradesh, Jammu and Kashmir, and Rajasthan. Some of these
states namely Goa, Manipur, Kerala, Mizoram and Nagaland crossed
double digits rate of unemployment.
2) Regional variation in unemployment has declined since 2009-10

indicating convergence of unemployment rate across states.
3) The possible reason for high unemployment rate in the urban sector are
migration of surplus labour from the rural areas, which accelerates with
increase in connectivity between the two sectors. This leads to inference
that higher level of urbanisation correspondence to higher unemployment.
Further, availability of the consumption support schemes particularly in the

rural areas, rising opportunities for young educated and school dropout young
adults, higher wages due to MNREGA effect– have eased the situation of 137
Major Issues
Confronting
large-scale underemployment visible in terms of residual absorption of labour
U
Indian Economy in low productivity activities. This has resulted in higher rate of open
unemployment. Also, due to rise in the demand for education and skills,
many young boys and girls prefer to remain unemployed and keep searching
for suitable jobs. The rising urbanisation reflected in large scale emergence of
census towns in 2011 has made the unemployment rate more visible.
Table 22.2:Unemployment Rates (as percentage of Labour Force)
Year UPS UPSS CWS CDS

1972-73 3.80 1.61 4.32 8.35
1977-78 4.23 2.47 4.48 8.18
1983 2.77 1.90 4.51 8.28
1987-88 3.77 2.62 4.80 6.09
1993-94 2.56 1.90 3.63 6.03
1999-2000 2.81 2.23 4.41 7.32
2004-05 3.18 2.33 4.53 8.34
2009-10 2.50 2.00 3.60 6.60
Source: India Labour and Employment Report, 2012
Table 22.3: Unemployment Rate (as percentage of Labour Force)
2017-18 2018-19
Rural Urban Total Rural Urban Total
Male 5.8 7.1 6.2 5.6 7.1 6.0
Female 3.8 10.8 5.7 3.5 9.9 5.2
Person 5.3 7.8 6.1 5.0 7.7 5.8
Source: Periodic Labour Force Survey – Annual Report (July, 2018 – June, 2019)
The high incidence of unemployment among the educated in general and

women in particular reflects that the pace of creation of diversified
employment opportunities is lagging behind the pace of expansion of
education. The educational and training courses offered by the educational
and training system and their curricular content is becoming increasingly
irrelevant to the kind of employment opportunities being generated by the
economy. Gender discrimination in the labour market and at the workplace
also seems to be adding to the problem. These features of the unemployment
situation call for steps like: (i) expansion and diversification of the economy,
especially the rural economy, (ii) restructuring of the education and skill
development system to make it responsive to the world of work and (iii)
focus on removal of gender bias in the labour market, the workplace and in
skill development.
138
22.5 GROWTH OF EMPLOYMENT Employment and
Challenges
The available information relating to the growth of employment in India
during the last three decades is comprehensively summarised in Table 22.4
and 22.5 below:
Table 22.4: Average Annual Rate of Growth of Employment
Year Growth Rate

1983-1994 2.06
1994-2000 0.98
2000-2005 2.95
2004/05-2009-10 0.95
Source: Based on respective rounds of employment and unemployment survey reports
Table 22.5: Addition to Working Age Population (15 years and above)
and its Distribution
Period Addition Additions to LF, WF and EF as

to WAP Percentages to Additions in WAP
(mn)
LF WF EF Out of WF
and EF
Men & Women
1983-94 140.68 58.2 56.9 13.0 30.1
1994-2005 152.05 60.2 57.9 12.4 29.7
2005-12 137.63 14.5 14.7 30.3 55.0
2012-18 128.34 10.3 -4.8 22.1 82.7
Only Men
1983-94 72.82 80.8 79.4 15.2 5.4
1994-2005 78.65 77.7 75.7 12.2 12.1
2005-12 65.66 56.3 55.7 35.5 8.8
2012-18 64.97 48.8 24.1 23.0 52.9
Only Women
1983-94 67.85 34.0 32.8 10.6 56.6
1994-2005 73.40 41.4 38.8 12.6 48.6
2005-12 71.96 -23.7 -22.7 25.7 97.0
2012-18 63.36 -29.1 -34.4 21.2 113.2
WAP = working age population, LF = labour force, WF= workforce, EF= educational force
Source: Article From Jobless to Job-loss Growth Gainers and Losers during 2012-18
published in EPW, Vol. 4, No. 44, November, 9 2019.
1) The ability of Indian economy to absorb the incremental working age

population into workforce has been declining since 2004-05. The period 139
Major Issues
Confronting
between 2012 and 2018 has shown a negative trend. During this period,
U
Indian Economy existing workers equivalent to close to 5 per cent of the incremental
working age population lost their jobs. During two decades (i.e., 1983-84
- 2004-05) 57 per cent to 58 per cent of those coming to working age
population were absorbed into the workforce. This proportion fell close
to 15 per cent during the next seven year period (2004-05 – 2001-12) and
during the period (2011-12 – 2017-18) it turned out negative.
2) During the first two decades (1983-2005) only 12 per cent to 13 per cent
of the addition to the working age population (15 years and above) found
themselves in educational force. This proportion increased to 30 per cent
by 2012. However, during last 6 years’ period (2012-18) this share came
down to 22 per cent. Putting together those in workforce and those in
education, we find that 70 per cent of the incremental working age
population during 1983-94 as well as 2004-05 but this decreased to 45
per cent during 2005-12 and then 17 per cent during 2012-18. This
shows that ability of the economy to absorb addition to the working age
population either in employment or in education has practically declined
since 2005 but more sharply since 2011-12. This also indicates that
potential demographic dividend by way of an increasing share of
working age population in the total population has not been translated
into actual demographic dividend (Kamnan and Ravindran, 2019).
3) During 2005 to 2012 and 2012-2018, there has been a net loss of
women’s labour force as well as workforce. The process appears to have
accelerated during the latter period as compared to the former one.
4) Despite a higher share of young women from additional working age

population taking to education, the share of those outside the workforce
and educational workforce has been increasing so alarmingly that it has
now reached 113 per cent of the addition to their working age
population.
5) Those with higher education have gained in employment significantly

among all social groups. Women from the ST group are the biggest
gainer followed by both men and women from the SC group.
6) There has been a sharp decline in the growth rate of employment (UPSS)
from 2.06 per cent per year in the period 1983 to 1993-94 to only 0.98
per cent in the period 1993-94 to 1999-2000. Although this deceleration
in employment is accompanied by an equally sharp decline in the rate of
growth of labour force from 2.29 per cent in the period 1987-88 to 1993-
94 to only 1.03 per cent in the period 1993-94 to 1999-2000, yet the
growth rate of employment has been less than the growth rate of the
labour force. This indicates an increase in the unemployment rate.
7) Employment growth during 1999-2000 to 2004-05 has accelerated
significantly as compared to the growth witnessed during 1994-2000.
During 1990-2000 about 47 million work (CDS basis) opportunities
were created compared to only 24 million in the period between1993-94
and 1999-00. Employment growth accelerated from 0.98 per cent per
140 annum to 2.95 per cent per annum. However, since the labour force grew
at a faster rate of 2.84 per cent than the workforce, unemployment rate Employment and
also rose. The incidence of unemployment on CDS basis increased from Challenges
7.31 per cent in 1999-00 to 8.28 per cent in 2004-05.
8) The employment growth during 2004-05 to 2009-10 was significantly

lower than during 1999-00 to 2004-05. The pattern of employment
growth reveals absolute decline in rural female’s employment. In this
period, both in rural and urban areas slowdown in employment growth
for male has occurred. The sharp absolute decline for rural females and
slight absolute increase for urban females is observed.
9) There have been significant changes in the sectoral pattern of
employment. The proportion of the work force engaged in the primary
sector declined by 12 per cent between 1983 and 2004-05 and it showed
faster decline between 2004-05 and 2009-10. Between 2009-10 and
2017-18, the share of employment in primary sector further declined to
44.6 per cent. Similarly, in the Secondary sector also, the share of
employment increased from 21 per cent in 2009-10 to 24.4 per cent in
2017-18. However, the Tertiary sector has performed very well in
employment as its share jumped from 25 per cent (2009-10) to 31.0 per
cent (2017-18). This marks an important phase of structural
transformation for the Indian economy, in which, the share and number
of workers in agriculture has been declining with corresponding rise in
employment in non-farm sectors. Among the non-firm sectors, service
sector is primarily driving the employment growth during 2009-10 and
2017-18.
Table 22.6: Changes in Sectoral Shares of Employment (UPSS)

(Percentages)
Primary Secondary Tertiary All

Rural 1983 81.80 8.60 9.50 100.00
2004-05 73.00 13.20 13.80 100.00
2009-10 68.60 16.70 14.70 100.00
Urban 1983 15.60 32.60 51.80 100.00
2004-05 9.40 33.30 57.30 100.00
2009-10 8.10 33.80 58.10 100.00
Total 1983 68.90 13.30 17.80 100.00
2004-05 57.00 18.20 24.80 100.00
2009-10 53.80 20.90 25.39 100.00
2017-18 44.6 24.4 31.0 100.00

1) What are the implications of decline in women LFPR?
…………………………………………………………………………….
…………………………………………………………………………….
……………………………………………………………………………. 141
Major Issues
Confronting
2) Do you think that higher growth necessarily helps in expanding
U
Indian Economy employment growth?
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
3) State the various dimensions of deterioration in the quality of
employment in India.
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
4) Give an account of changing sectoral shares of employment in the Indian
economy.
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
22.6 QUALITY OF EMPLOYMENT

Broadly, quality of employment can be judged on the following basis:
• Proportion of workers in organised and unorganised sectors
• Proportion of workers engaged in regular and casual labour
22.6.1 Proportion of Workers in Organised and Unorganised

Sectors
Increasing share of employment in unorganised sector reflect deterioration in
the quality of employment because workers’ earnings, regularity of
employment, work environment and social security vastly differ between
organised and unorganised sectors. Workers in organised sector have better
wages and salaries, job security, reasonably decent working conditions and
social protection against risks such as sickness, injuries, disability and death
arising out of hazards, accident at works, separations and old age. Those in
the unorganised sector apart from insecurity of job generally have no
protection against these risks, have low earning, often lower than the modest
statutory minimum wages and have no regularity. An increase in the share of
142
unorganised employment obviously means an overall deterioration in the Employment and
quality of employment. Challenges
An important aspect related to quality of employment is the large size of

unorganised sector as against organised sector in the total employment. The
size of the organised sector characterised by higher earnings and job security
has declined from 17 per cent in 2011-12 to 13.2 per cent on 2017-18.
Corresponding share of workers in unorganised sector increased from 83 per
cent in 2011-12 to 87 per cent in 2017-18.There are 92.4 per cent informal
workers (with no written contract, paid leave and other benefits) in the
economy. There are also 9.8 per cent informal workers in the organised
sectors indicating the level of outsourcing. These are possibly the contract
workers.
Even the organised sector is increasingly moving towards informal

employment. The entire employment in the unorganised sector is informal as
is clear from the following table.
Table 22.7: Distribution of workers by types of employment and sector
2011-12 2017-18
Worker Unorganised Organised Total Unorganised Organised Total
Informal 82.6 9.8 92.4 85.5 5.2 90.7
Formal 0.4 7.2 7.6 1.3 7.9 9.3
Total 83.0 17.0 100.0 86.8 13.2 100.0
Source: Computed from NSS 68th unit level data on employment unemployment,
2011-12 and Periodic Labour Force Survey, 2017-18
It is significant to note that the informality is generally linked to economic

activity with low productivity and low-income generating prospectus. Given
the heterogeneity of informal employment, there is a need to formulate
specific policy sets to find solution to informality traps.
Further it is relevant to mention that quality of life and formal employment
are positively correlated with each other. The countries with very high HDI
are having more than 80 per cent of their workers in formal employment.
Most of the countries, with high HDI, are also having 60 to 80 per cent of
their workers in formal employment. This proportion ranges between 40 to
60 per cent in most of the medium HDI countries. Compared to it, less than
20 per cent of the workers are in formal employment in almost all the
countries with low HDI. Thus, social security and quality of life are closely
related with each other, higher the social security coverage higher is the
quality of life, as reflected by HDI.
22.6.2 Proportion of Workers Engaged in Regular and

Casual Labour
Another dimension of deterioration in the quality of employment can be
examined in terms of low earning, irregularity and uncertainty of work
availability, poor condition of work and lack of social protection and
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Major Issues
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vulnerability to the risks and hazards. This in turn is seen in the increase in
U
Indian Economy the casualisation of the work force.
The Indian employment market is moving from regular towards casual

employment. From 1983 to 2017-18, people have moved from self-
employment to regular salaried employment and casual employment. The
proportion of casual workers in total workers increased from 24.03 per cent
in 1983 to 25 per cent in 2017-18, while the proportion of self-employed
declined from 58.84 per cent to 52.2 per cent and the proportion of regular
salaried employees increased from 17.14 per cent to 22.8 per cent during the
same period.
Casualisation of employment does not assure adequate days of employment
and income to meet the basic necessities of labour households. This along
with low wage rates adversely affects growth rate of average daily wage
earnings of the casual labour depriving them of fulfilling the basic needs.
Table 22.8: Distribution of Workers by Category of Employment
Year Nature of Employment

Self employed Regular/Salaries Casual
1983 58.84 17.14 24.03
1993-94 57.31 16.35 26.34
1999-2000 55.19 17.52 27.29
2011-12 52.00 18.00 30.00
2017-18 52.20 22.80 25.00
Source: 1) Different Quinquennial survey reports of NSSO till 2011-12
2) Periodic Labour Force Survey (PLFS): Annual Report (July 2018-June 2019).
22.7 EMPLOYMENT POLICY FRAMEWORK

India’s growth strategy adopted during the planning period has played a
significant role in impacting the employment situation in the country. For
instance, the Second Five Year Plan (1955-6 to 1959-60) involved adopting
an import-substituting industrialisation strategy, with a focus on heavy-
industry. This could not be, by definition, a strategy for rapid absorption of
surplus labour in agriculture. The result was as surplus workers migrated
away from agriculture in search of non-agricultural work, they were
inevitably absorbed intraditional services in both rural and urban areas. If not,
they were absorbed in unorganised manufacturing in micro-enterprises
employing less than 10 workers, where no social insurance was available. In
addition to this, government reserved manufacture of consumer products of a
non-durable nature for the small-scale sector, which began with a few
products and reached 836 in 1990. Since medium-sized firms or large
corporates were disallowed from entering this sector, the small enterprises
had no incentive to grow and absorb more workers in their manufacturing
units, thus exacerbating a problem resulting from the heavy industry first
strategy.
144
The employment situation is also impacted by the plethora of central and Employment and
state government labour laws. On the one hand, hardly any labour laws were Challenges
applicable to the small enterprises. On the other hand, the larger enterprises,
whether medium or large, became gradually subject to a number of laws
passed by state or central governments, which protected the workers in the
organised sector. While social insurance (in the form of employee provident
fund and health insurance) was mandatory, the growing number of laws
covering organised workers meant that employers tended to adopt
technologies that often limited the number of workers. The number of central
government laws related to labour alone amounted to 45 (in 2014, though
after repeal of some the number fell to 35 by 2018), which are often
inconsistent with each other, and tend to grow in their coverage as the size of
enterprises increases. On top of these 35, there are state-specific labour laws
that organised segment firms in industry or services have to comply with. The
reaction of employers was inevitable: the fewer the workers, the better it is
from their perspective. Organised sector jobs grew slowly, and most non-
agricultural employment continued to grow in the always unorganised sector
in micro-enterprises, with workers employed without any hope of social
insurance.
Consequently, in the earlier plan documents, calculations were made as to

how much additional employment was needed to absorb the unemployed and
under-employed and the growth in the labour force. In the draft of the Fourth
Year Plan 1969-1974 (Govt. of India, 1969), the employment issue just
occupied 3 pages in a Forth Year Plan document of 350. However, it was
clear that even rapid growth of the small modern sector could not create
enough jobs for a large and growing population. Without large scale creation
of employment, the benefits of economic growth would not reach the
population as a whole.
Suggestion of Dandekar and Rath in 1971 that high rates of poverty in India
need to be addressed through a massive programme of public works which
would create employment and public assets, essentially in rural areas, gave
rise to the Maharashtra Employment Guarantee Programmes in 1970 and
later on a much larger scale to NREGA in 2005. Since that time the need to
address the employment deficit has been constantly present in economic
analysis in India. During 1970s and 1980s, a variety of special programmes
to promote employment were introduced. These include Indira Gandhi’s 20-
point programme– Integrated Development Programme (IRDP), which was
applied across the country in 1980s. Due to rise in demand for labour on
account of spread of the green revolution, efforts were made by the Planning
Commission to reinforce employment intensive agriculture through strategic
investment. However, the main focus was on growth and not on employment.
Raj Krishna, a renowned economist argued that 6.5 per cent growth rate
would be enough to absorb the backlog of unemployment and similar
arguments were put forwarded to support the economic reforms of early
1990s.
Economic acceleration of the 1990s failed to deliver the expected increase in

employment and jobless growth became the common talking point. Overall
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Major Issues
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job creation was slow after the economic reforms except during a short
U
Indian Economy period between 1999 and 2004. This trend continues right upto the present,
since the most recent data show negative employment elasticity for the
economy as a whole in the period from 2011-2012 to 2017-2018 and for
several key sectors including agriculture and manufacturing.
In view of the above, employment continues to be high on the policy agenda

reflected from labour law reforms and the various policy initiatives by the
Government like Skill India, Start Up India, reorientation policies for
MSMEs growth, Pradhanmantri Kaushal Yojna for skill formation, Mudra
Yojana, Pradhan Mantri Rojgar Protsahan Yojana (PMRPY), SAMADHAN
(Software Application for Monitoring and Disposal, Handling of
Apprehended/Existing Industrial Dispute), Shram Suvidha Portal to bring
transparency and accountability in enforcement of labour laws and easecompl
exity of compliance, Pradhan Mantri Shram Yogi Maandhan Yojana (PM-
SYM) for old age protection and social security of unorganised workers and
so on.
Besides, the Ministry of Labour and Employment, one of the oldest and
important Ministries of the Government of India, is functioning to ensure
improving life and dignity of labour force of the country by protecting and
safeguarding the interest of workers, promotion of their welfare and
providing social security to the labour force both in Organised and
Unorganised Sector by enactment and implementation of various Labour
Laws, which regulate the terms and conditions of service and employment of
workers. The State Governments are also competent to enact legislation, as
labour is a subject in the Concurrent List under the Constitution of India.
22.7.1 Report to the People on Employment

The annual reports provide a framework to understand the contemporary
employment scenario. They focus on key issues of generation of quality
employment for the people seeking work. The issue of providing decent
work, particularly to those who are excluded and marginalised in the labour
market is a central concern of these reports. The reports highlight that
employment growth along with equity and distributive justice can be a
powerful instrument for achieving faster, inclusive and sustainable growth.
Report to the People on Employment (2010)
The 2010 report views employment as a primary means through which

citizenship is made real for the people, the way in which the people acquire a
stake in society, overcome the insecurities of old age and ill health and ensure
a better future for children. One of the central ideas of the report is– high
economic growth and growth of quality employment reinforce each other.
Recognising low level of earnings and poor working conditions of casual
labourers and a part of self-employed workers, the report argues for
increasing the share of organised sector employment in total employment of
the country, particularly in the manufacturing and service sectors.
The report firmly puts on the agenda to best utilise the ‘demographic
146 dividend’ by focusing on generating gainful employment for youth, in
general, and young women, in particular. The report notes that given very Employment and
low proportion of skilled workers at present, a suitable and workable Challenges
framework to enhance the employability of workers is essential. The same
can be achieved by providing training to workers at various levels with
emphasis on recognising local skills and certifying informally acquired skills
along with the expansion of skill development institutions. The report also
argues for rationalisation of labour laws and broadening the ambit of labour
reforms for achieving equitable employment growth. It sets out short-term
and medium-term strategies to ensure gainful employment opportunities for
all the working people with particular emphasis on the disadvantaged
sections.
Report to the People on Employment (2011)
The report notes that the unemployment rate in India has declined during the
period 2004-05 to 2009-10.There has been a positive change in the quality of
employment during the period 2004-05 to 2009-10 as most of the
employment growth has been contributed by growth in principal status
workers. There also has been an increase in proportion of regular wage
workers in the total workforce. Analysis of the sectoral distribution of
workers shows a declining trend incase of the primary sector, nearly stagnant
in manufacturing sector and an increase in the share of service sector.
The report highlights the vital role that the service sector can play in
generating productive employment in future. The report, however, notes the
dualistic nature of service sector employment with high income and better-
quality jobs limited to a small section of the workforce while the vast
majority remains trapped in low-wage income and relatively insecure
occupations. Hence, the report stresses the vital role of skill upgradation and
targeted social security provisions to reduce this dualism.
The report analyses the structural inequality in the labour market and access
to quality employment. One of the key inequalities is the high concentration
of socially disadvantaged groups (SC, ST and OBC) among casual workers.
Access to quality employment being highly correlated with educational status
and skill endowment, socially disadvantaged groups with high rates of
illiteracy and lack of industry relevant skills face greater barriers to access
productive employment.
Key medium-term strategies and targets include: Focus on self-employed and
casual workers for improving livelihood; Enhance the scope of employment
in the organised sector; Enhance regular employment for less advantaged
groups and in poorer states; Comprehensive coverage of unorganised sector
workers under social security schemes; Rationalisation and simplification of
labour regulations and broadening the ambit of labour reforms, Promote
diversification of rural workforce to off-farm and non-farm activities; Target
regions with concentration of vulnerable social groups such as ST, SC,
minorities, women, illiterate and less skilled for active labour market
policies; Detailed skill mapping mechanism to be evolved, Credible and
independent accreditation and certification process to be created; Up-
gradation of all training providing institutions and strengthening delivery
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Major Issues
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through public private partnership (PPP) mode; Creating large number of
U
Indian Economy skill development institutions and pool of trainers to expand the outreach of
skill development initiative; Setting up of Sector Skills Council;
Development of National Vocational Qualification Framework; and Creating
a credible Labour Market Information System.
22.7.2 Issues of Concern

There are several issues of concern which need to be addressed:
1) Until recently the overall unemployment rate remained fairly low and
showed no long-term trend. The quality of employment in terms of
higher daily unemployment rate among casual workers and higher level
of unemployment among educated youth, especially among young
women was the major problem. The lack of productive, regular jobs has
emerged as deterioration in the quality of employment. There has been a
substantial increase in real wages and incomes in the informal activities
since 1980s indicating rise in productivity with persistence of dualism.
However, for 2017-18 Periodic Labour Force Survey shows a sharp rise
in open unemployment reflecting slow employment creation since 2012.
This high unemployment appears to be associated with deficiencies in
both the level and the pattern of demand in the economy.
2) Employment is not homogenous. There is a whole spectrum of jobs of
different types some much more productive or desirable than others.
There is a need of high productivity jobs in modern economic sectors.
The policy of promotion of entrepreneurship through Mudra Yojana and
focus on MSMEs need to be strengthened. In other words, employment
problem is a problem of composition of employment at overall level.
3) Employment deficits are not easy to measure, even conceptually. The

classical definition of open unemployment captures only apart of the
problem. Whether our concept of employment is well adapted to analysis
of today’s economy? Whether it captures gender differences, primary
and secondary activities, desirable and undesirable work or new types of
employment in the economy. For having clear understanding of these
issues, broader notion of work is needed (Gerry Rodgers, 2020).
4) Even within the narrow concept, employment creation is the result of

complex economic and social process and overall employment
elasticities are inadequate to reveal these processes of employment
generation. A negative employment elasticity means little at its own
(Gerry Rodgers, 2020).
5) A new strategy focussing change in economic policy framework from a

supply side one to a demand side one is required. This would call for a
focus on the rural economy, strengthening the productive capacity of
small enterprises in both rural and urban areas and strengthening the
education, health and related sectors especially in the rural economy. The
various schemes launched under the programme Atama Nirbhar Bharat
appears to be right initiative in this direction.
148
It is, therefore, imperative that the growth strategy gets appropriately tuned to Employment and
the third policy option i.e., altering the pace and composition of industrial Challenges
growth and create greater space for agriculture not only as a traditional
reservoir of labour for industrialisation, but also as a sector with greater
flexibility to absorb labour and generate broad based or extensive growth
(Bhaduri, 2006; p.85). This of course, is not the same as ‘agriculture first’
strategy advocated earlier by a number of scholars (Johnston and Maler,
1961; Maler, 1976). Here, the emphasis is not on sectoral priority. The idea
is ‘to combine the advantages of industrialisation and inclusive growth with
extensive growth in agriculture achieved through better labour absorption and
a higher participation ratio’ (Bhaduri, 2006; p.85). The central thrust here is
that ‘besides the issue of sectoral balance in any developmental strategy, the
scope for increasing labour periodicity through reorganising agriculture, as
different from shifting a part of the labour to other sectors, should be
thoroughly assessed and explored. This substantiated by and a renewed
recognition of the potential for surplus labour absorption and increase in
labour productivity in agriculture and rural sector, quite apart from the
strategy for inter-secoral shift of workforce (Bhaduri, 2006; p.84). The
Green Growth perspective may further enhance the potential of the primary
sector to absorb productive labour by reversing the process of factor
substitution that was mentioned above.
It is, therefore, argued that a balanced approach such as this may open up a
number of avenues for reorganising production and consumption, essentially
by harping on the demand side dynamics that leads to significant increase in
effective demand in the domestic market. It is at this juncture, one may find
a substantial space for convergence between the perspectives on employment,
environment and social dimensions as suggested by the sustainable
development framework (Shah, 2011).

1) Discuss different policy measures undertaken by the government to deal
with the issue of unemployment in the Indian economy.
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
2) Which measures would you like to suggest to generate employment
opportunities for those already unemployed?
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
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Major Issues
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3) State the central ideas of the Report to the People on Employment 2010.
U
Indian Economy
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
22.8 LET US SUM UP

The population of any area, region or country is made up of three
components: employed, unemployed and non-workers. Employed and
unemployed together make up of labour force. Three reference periods (i.e. a
year, a week and a day) identify the nature and extent of employment and
unemployment in the economy. Based on these three reference periods, three
approaches are adopted in estimating the status of employment and
unemployment – Current Daily Status (CDS), Current Weekly Status (CWS)
and Usual Principal Status (UPS). Several key employment and
unemployment indicators include Labour Force Participation Rates (LFPR),
Worker Populations Ratio (WPR), Unemployment Rate (UR), etc. Labour
force participation rate as percentage of population has been fluctuating over
a period of time. From 1983 till 2018-19, the LFPR for male (urban as well
as rural) and urban female has increased while the rate has declined for rural
female. While in terms of WFPR, the rate has increased for male (both urban
and rural) and urban female, while it has decreased for rural female.
As per the Periodic Labour Force Survey 2018-19, the unemployment rate for
both males and females is not only on the rise in the country but is at an all-
time high. Besides this, the ability of the economy to absorb addition to the
working age population either in employment or in education has practically
declined since 2005. Also, the economy is suffering from the loss of
women’s labour force and work force. As regards the sectorial pattern of
employment, the proportion of workforce engaged in primary sector has been
falling, whereas, there has been rise in the share of workforce engaged in the
secondary and the tertiary sector. An increase in the share of unorganised
employment is another issue the Indian economy is facing. In addition to this,
there has been increase in the casualisation of the work force as reflected by
the rise in the proportion of the workers moving towards casual employment.
Employment continues to be high on the policy agenda reflected from labour

law reforms and the various policy initiatives by the Government. Also,
Ministry of Labour and Employment is functioning to ensure improving life
and dignity of labour force of the country. Nevertheless, the complexity
associated with the issue of employment need to considered while framing
the employment policy framework.
150
22.9 TERM-END EXERCISES Employment and
Challenges
1) Distinguish between labour force and work force. How are the
employed workers identified and enumerated in India? Also examine the
dimensions of unemployment in India.
2) State the various dimensions of deterioration in the quality of

employment in India. Also examine the policy implications of slowdown
in women’s workforce participation rate.
3) Critically evaluate the employment policy embodied in the eleventh Five

Year Plan. Also state the conditions necessary for the success of this
policy.
22.10 KEY WORDS
Underemployment : Underemployment means people who are

employed for only part of a day or part of the
week and unemployed for the remainder of the
day or the week. This is underemployment that
is visible.
Incidence of : It is the share of the total unemployed persons
Unemployment in total labour force, expressed in percentage
terms.
Human Capital : Human Capital Endowment is the capability,
Endowment innate and acquired, of a person to earn income
for living, which is over and above the costs
involved in carrying out that effort.
Own-account Worker : Own-account worker is another name for self-
employed workers.
Usual Principal Status : An activity on which, a worker is engage for a
Activity (UPS) relatively longer period during one year,
preceding the date of survey.
Employment Elasticity : The ratio of employment growth to the growth
of National Income.
22.11 REFERENCES
1) Annual Report to the People on Employment (2010). Ministry of Labour
and Employment. Government of India, Retrieved from
https://vvgnli.gov.in/ sites/default/ files/First%20 Annual%20
Report_to_People%20 Employment. pdf
2) Second Annual Report to the People on Employment (2011). Ministry of

Labour and Employment. Government of India, Retrieved from https://
vvgnli.gov.in/sites/default/files/Second%20Emp%20Report%
20FINALFG_0.pdf
151
Major Issues
Confronting
3) Arup Mitra and Jitender Singh. (2019). Rising Unemployment in India:
U
Indian Economy A Statewise Analysis from 1993-94 to 2017-18. Economic and Political
Weekly, Vol LIV No 50, December 21, 2019.
4) Gerry Rodgers. (2020). Labour and Employment in India: A 50-year

Perspective. Indian Journal of Labour Economics, 63, pp 1-19.
https://doi.org/10.1007/s41027-020-00204-x
5) Ghosh, Ajit K. (2011). ‘The Growth-Employment Interaction in a

Developing Economy,’ V.B. Singh Memorial Lecture delivered in the
53rd Annual Conference of The Indian Society of Labour Economics
held in Udaipur.
6) Ghuman, R.S. (2011). ‘Development Paradigm and Need for Social

Protection for Workers; Global and Indian Scenario, Keynote paper on
the Theme Social Protection for Workers in India presented in the 53rd
Annual Conference of The Indian Society of Labour Economics held in
Udaipur.
7) Himanshu, (2011). ‘Employment Trends in India: A Re-examination’,

Economic and Political Weekly, Vol. XLVI, No. 37, pp.43-59
8) IHD (2012). India Labour and Employment Report, Oxford University

Press, New Delhi
9) K P Kannan and G Raveendran. (2019). From Jobless to Jobloss Growth:

Gainers and Losers during 2012-18. Economic and Political Weekly, Vol
LIV No 44, November 9, 2019.
10) MazumdarIndrani, Neetha N. (2011). ‘Gender Dimensions: Employment

Trends in India, 1993-94 to 2009-10, Occasional Paper No. 56, CWDS,
New Delhi
11) NCEUS (2010). ‘Report on Conditions of Work and Promotion of

Livelihoods in Unorganised Sector’, Academic Foundation, New Delhi.
12) NSSO, (2011). Key indicators of Employment and Unemployment in
India, 2009-10, Government of India, New Delhi
13) Periodic Labour Force Survey (PLFS): Annual Report (July 2018-June
2019). Ministry of Statistics and Programme Implementation, National
Statistical Office, Government of India, New Delhi.
14) Shah Amita, (2011). ‘Environment, Employment and Labour: Pathways

to Sustainable Development’, Keynote Paper on the Theme of “Labour
and Environment” presented in the 53rd Annual Conference of The
Indian Society of Labour Economics held in Udaipur.
15) S V Ramana Murthy (2019). Measuring Informal Economy in India-

Indian Experience. Retrieved from
https://www.imf.org/~/media/Files/Conferences/2019/7th-statistics-
forum/session-ii-murthy.ashx
152
22.12 ANSWERS OR HINTS TO CHECK YOUR Employment and
PROGRESS EXERCISES Challenges

1) Employment and unemployment are measured by several criteria viz, (i)
Usual Principal Status, (ii) Usual Principal and Subsidiary Status, (iii)
Current Weekly Status (CWS), (iv) Current Daily Status
2) Yes, because it gives the estimate of the extent of under-utilisation of the

labour force in terms of number of days. It is, therefore, made up of both
open unemployment and visible under-employment.
3) One who participates in any economic activity is a worker. One who is

not available for any worker is a non-worker. Unemployed is a worker
who seeks or looks for work or is available for work.

1) See Section 22.4 and 22.5
2) No, the decade of 1990s and 2000s have witnessed high growth without
corresponding growth of employment.
3) Increasing share of unorganised sector in employment, higher proportion
of casual workers in employment, rising number of workers, etc.
4) See Section 22.5

1) See Section 22.7
2) See Section 22.7
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Major Issues
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UNIT 23 SOCIAL SECURITY MEASURES
Economy
IN INDIA
Structure
23.0 Objectives
23.1 Introduction
23.2 Social Security, Social Protection, and Social Protection Floor
23.3 Objectives of Social Security
23.4 Approaches to Social Security
23.4.1 Social Insurance
23.4.2 Social Assistance
23.5 Social Security Schemes in India
23.6 Existing Provisions: Problems and Issues
23.7 The Code on Social Security, 2019
23.8 Let Us Sum Up
23.10 References
23.11 Key Words
23.12 Answers or Hint to Check Your Progress Exercises
23.0 OBJECTIVES
● examine the meaning of social security, social protection, and social
protection floor;
● discuss the approaches to Social Security;
● analyse the different acts and programmes launched by the Government
on Social Security;
● follow the functioning of the different programmes related to social
security;
● assess the Social Security Code and its benefits; and
● discuss the policy measures in perspective and recognise the gaps.
23.1 INTRODUCTION
Uncertainties on account of unemployment, illness, disability, death and old
age are experienced by all the people across the world. These inevitable
154
facets of life are said to be threats to one’s economic security. In a society, Social Security
Measures in India
the livelihood of an individual is made up of very diverse elements which
taken together constitute the physical, social, cultural and political universe
where he lives. Whenever an individual who lives in a society and faces the
uncertainties threatening the bare necessity to sustain a minimum livelihood,
he needs some help from the society, may it be the family, or any government
or private institutions. The term ‟social security” refers to any programme
that aims to help individuals faced with such situations. Such people include
the poor, the elderly, anybody who is physically disabled, and the mentally
challenged. The International Labour Organisation (ILO) defines Social
Security as ‟the security that society provides through appropriate
organisation against certain risks to which its members are perennially
exposed”. These risks are essentially contingencies against which an
individual cannot effectively provide by his own ability or foresight alone or
even in private combination with his fellows.
23.2 SOCIAL SECURITY, SOCIAL

PROTECTION, AND SOCIAL
PROTECTION FLOOR
In common parlance, the terms social protection and social security are used
interchangeably. However, in development literature the two terms are
defined differently, although with some common characteristics.
Social protection is a broader concept and includes both protective and

promotional measures. Protective measures are those measures which are
directed towards providing safety against risk and vulnerability. Promotional
measures are those measures which are aimed at increasing well-being and
livelihood conditions of the people. The policies and procedures included in
social protection involve five major kinds of activities:
i) labour market policies and programmes,

ii) social insurance programmes,
iii) social assistance,
iv) micro and area-based schemes, and
v) child protection.
In a nutshell, the social protection hovers around the promotion of economic
strength, protection of the deprived sections, prevention from external shocks
and diminution of people’s exposure to risks, and enhancement of their
capacity to protect themselves against hazards and interruption/loss of
income. On the other hand, Social security is a traditional concept and
includes measures aimed at providing safety protection during risk and
vulnerability against poverty, old age, disability, sickness, orphanage, etc.
The International Labour Organisation (ILO), a specialised agency of the UN

though it pre-dates the UN, has been working for the welfare of labour since
1919 through its Member-States. It holds certain conventions whereby
signatory member-states implement agreed-upon agenda. It can also make
155
Major Issues recommendations which do not bind member-states which however, consider
Confronting Indian the merit of a recommendation vis-à-vis its capacity. Two flagship
Economy
conventions / recommendations set by ILO for the extension of social
security are: (i) Social security (minimum standards) convention, 1952 (No.
102), and (ii) Social protection floors recommendation, 2012 (No. 202).
The Social Security (Minimum Standards) Convention, 1952 (No. 102),
establishes minimum standards for all nine branches of social security. These
branches are:
• medical care;
• sickness benefit;
• unemployment benefit;
• old-age benefit;
• employment injury benefit;
• family benefit;
• maternity benefit;
• invalidity benefit; and
• survivors’ benefit.
The minimum standards of the Convention for all the nine branches relate to
the percentage of the population protected by social security schemes, the
level of the minimum benefit to be secured to protected persons, as well as to
the conditions for entitlement and period of entitlement to benefits. It also
lays down that social security schemes be administered on a tripartite basis,
which guarantees and strengthens social dialogue between Governments,
employers, and workers.
ILO Convention 102 does not include the principle of universality and does
not prescribe how to reach these objectives but leaves certain flexibility to the
member state. As per this convention social security grows and evolves over
time. Social security policies should reflect countries’ social and cultural
values, their history, their institutions and their level of economic
development.
By the year 2012, the majority of countries had social security schemes
established by law covering all or most areas, albeit in many cases including
India only for a minority of their populations. After the economic crisis of
2008, UN recognised the fact that billions of people who have no social
protection were hit harder. It shows that extension of legal coverage does not
in itself ensure either the effective coverage of the population or
improvements in the quality and level of benefits. Realising the importance
of human right to social security across the board, ILO has made certain floor
recommendations in 2012. Called as social protection floors
recommendation, 2012 (No. 202) is the first international instrument that
explicitly recognises the triple role of social security as a universal human
right, an economic necessity and social necessity. It calls upon the States to
achieve universal coverage with at least minimum levels of protection
through the implementation of Social Protection Floors as a matter of
156 priority; and to progressively ensure higher levels of protection.
National Social Protection Floors comprise four basic social security Social Security
Measures in India
guarantees (BSSGs) that ensure effective access to essential health care and
basic income security (BIS) at a level that allows people to live in dignity
throughout the life cycle. The four BSSGs are:
i) Access to essential health care, including maternity care;
ii) BIS for children;
iii) BIS for persons of working age who are unable to earn sufficient income,
in particular in cases of sickness, unemployment, maternity and
disability;
iv) BIS for older persons.
Government, employer and worker delegates of the ILO’s 185 member States
adopted this social protection floors recommendation, 2012 (No. 202) nearly
unanimously. India was part of the agreement and an Indian expert was part
of ILO Expert group.

1) What do you mean by the term ‘Social Security’?
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2) What is the distinction between social protection and social security?
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3) Which activities are covered under social protection and social security?
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4) Which activities are covered under social protection?
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157
Major Issues 5) Name the instrument which add human rights to social security.
Confronting Indian
Economy …………………………………………………………………………….
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23.3 OBJECTIVES OF SOCIAL SECURITY

The primary objectives of social security are to:
1) Generate confidence among individuals and families that their level of

living and quality of life will not erode by social or economic
uncertainties.
2) Provide medical care and income security against consequences of

defined contingencies.
3) Facilitate the victims’ physical and vocational rehabilitation.
4) Prevent or reduce ill health and accidents in the occupation.

5) Protect against unemployment by maintenance and promotion of job
creation.
6) Provide benefit for the maintenance of children.
23.4 APPROACHES TO SOCIAL SECURITY

Social security is a very comprehensive term. The two important means of
providing social security are social insurance and social assistance.

It is a method to provide benefits to persons of small earnings, which
combine the contributions of the beneficiaries with subsidies from the
employer and the state. In this case the beneficiaries, employers and the
Government make contributions towards the creation of a common pool, out
of which benefits are paid to the members in the event of any contingency.
Thus, social insurance is a co-operative device which aims at granting
adequate benefits to the insured on the compulsory basis in time of
unemployment, sickness and other emergencies.

Social assistance refers to the assistance rendered by the society to the poor
and needy persons without placing any obligation on them to make any
contribution to be entitled to relief as in the case of workmen’s compensation,
maternity benefit and old age pension etc. Thus, one may say that a social
assistance scheme provides benefits to persons of small means granted as of
158
right in amount sufficient to meet a minimum standard of need and financed Social Security
Measures in India
from taxation.
Social assistance represents the unilateral obligations of the community

towards its dependent group. It is provided by the society or the government
to the poor and needy individual. The important features of social assistance
are: (i) the whole cost of the programme is met by the State and local units of
Government (ii) benefits are paid as of legal right in prescribed categories of
need (iii) in assessing need, a person’s other income and resources are taken
into account, certain resources such as a reasonable level of personal savings
are disregarded.
23.5 SOCIAL SECURITY SCHEMES IN INDIA

Legislation provides the general welfare by establishing a clear-cut system.
It extends the rights and obligations of its own nationals. Social security
schemes are dependent on social security legislations. Each country made its
own law/advisory to protect its citizen through legislative enactments.
The social security legislation in India derives its strength and spirit from the
Directive Principles of the State Policy (DPSP) and the subjects enlisted in
the Concurrent List. Two important social issues mentioned in the
Concurrent List (List III in the Seventh Schedule of the Constitution of India)
are;
Item No. 23: Social Security and insurance, employment and unemployment.
Item No. 24: Welfare of Labour including conditions of work, provident

funds, employers’ liability, workmen’s compensation, invalidity and old age
pension and maternity benefits.
Besides this, there are a few articles in the constitution which distinctly relate
to social security issues. They are:
Article 38: State to secure a social order for the promotion of welfare of the
people.
Article 39 (a): The state to direct its policy towards securing the citizens,
men and women equally, the right to an adequate means of livelihood.
Article 41: Right to work, to education and to public assistance in certain

cases.
Article 42: Provision for just and humane conditions of work and maternity
relief.
Article 43: Work Living wage, good conditions of work, full enjoyment of
leisure, for all kinds of workers.
Drawing from ILO Conventions on Social Security, and some of the

legislations made by Government of India for social security along with the
schemes are as follows:
159
Major Issues 23.5.1 Social Insurance
Confronting Indian
Economy 1½ The Employees’ State Insurance Act, 1948
It provides benefit to workers, in the event of sickness, maternity and
employment injury, in the form of payment of sick leave, hospitalisation, etc.
The scheme provides two types of social security cover namely - (a) Medical
Care and (b) Cash Benefits. Medical care is provided to the insured persons
and their family members through a vast network of panel clinics, ESI
dispensaries and hospitals generally within the vicinity of their residential
areas. The cash benefits on the other hand include Sickness benefits,
Maternity benefits, Disablement benefit, Benefits after retirement,
Dependents’ benefits, Funeral Expenses, Rehabilitation allowance, and
Standard benefits.
Employees State Insurance Corporation administers this Act. It covers every
establishment in which 10 or more employees are employed or were
employed on any day during the preceding twelve months, other than a
seasonal factory
2½ The Employees’ Provident Funds and Miscellaneous Provisions Act,

1952
An important scheme under this Act is Employees’ Provident Fund Scheme,
1952. But beneficiaries of this scheme are also entitled to get benefit under
two more schemes namely (a) Employees’ Pension Scheme, 1995, and (b)
Employees’ Deposit Linked Insurance Scheme, 1976. The schemes are
administered by a tripartite body headed by Labour Minister. Employees
Provident Fund Organisation functions under the overall superintendence of
Central Board of Trustees (CBT).
i) Employees’ Provident Funds Scheme (EPFS), 1952

The Act extends to whole of India, and is applicable to every establishment,
specified in Schedule-I to the Act in which twenty or more persons are
employed or any other establishment employing twenty or more persons or
class of such establishment, the Central Government notifies in the Official
Gazette. At present, 190 classes of establishments have been notified in
Schedule-I of the Act. In case of Cine-Workers, the required employee’s
strength for the purpose of coverage is five.
The Act is not applied to any other establishment belonging to or under the
control of the Central Government or a State Government or set up under any
Central, Provincial or State Act and whose employees are entitled to the
benefit of contributory provident fund or old age pension in accordance with
any scheme or rule framed by the Central Government or the State
Government governing such benefits. These establishments are called the
exempted establishments. Though the functioning of these establishments is
the responsibility of the Trusts of the respective establishments, the EPFO
carries out regular inspections to ensure the compliance of conditions of
exemption.
160
Number of exempted establishments was 3109 in the year 1994 which Social Security
Measures in India
increased to 4365 in the year 2016. Growth of Un-exempted establishments
was much higher than exempted establishments, during this period and their
number increased from 233772 in the year 1994 to 926297 in the year 2016.
There are two main benefits admissible under the provident fund scheme.
First, the beneficiary gets accumulated amount along with interest at the time
of retirement or resignation. Second, he can get partial withdrawals for some
specific purposes viz. house construction, higher education, marriage, illness
etc.
ii) Employees' Pension Scheme (EPS), 1995
The Employees’ Pension Scheme, 1995 came into effect on 16th November,
1995. With the introduction of this scheme the erstwhile Employees’ Family
Pension Scheme, 1971 (EFPS) ceased to operate, and all the assets and
liabilities of EFPS were transferred and merged with the Employees’ Pension
Fund. The benefits and entitlements of the beneficiaries under the old scheme
(EFPS) were protected and continued under the new EPS, 1995.
The EPS has been designed on the principles of a ‟Defined Contribution -
Defined Benefit” and adopts ‟actuarial principles” for ensuring long- term
financial viability. It aims to provide economic sustenance during old age and
survivorship coverage to members and his families.
iii) Employees’ Deposit Linked Insurance Scheme (EDLIS), 1976
Employees’ Deposit Linked Insurance Scheme came into force on 1st August,
1976. It is supported by a nominal contribution by the employers and no
contribution is payable by the employees. The scheme covers all the
employees of the establishments to which EPFMP Act, 1952 applies.
Insurance benefit is provided in case of death of an employee who was
member of the scheme at the time of death. Under the revised benefit under
the scheme the family will get an amount linked to either the average balance
in PF Account during preceding 12 months or 20 times of the average wages
on which contributions were made during the last 12 months of the member
subject to a maximum of Rs 6 lakhs, whichever is higher.
3½ The Payment of Gratuity Act, 1972

It applies to every factory, mine, oilfield, plantation, port and railway
company and every shops or establishments having a minimum of 10
employees, and provides for gratuity of payments at the end of service. To be
eligible for gratuity the employees should have a minimum continuous
service of 5 years. This Act provides for payment of a lump sum gratuity to
the employees. Under the Scheme, Gratuity is payable @ 15 days wages for
every completed year of service subject to monetary ceiling of Rs. 10.0 lakh.
In the event of the death or disablement of the employee, the gratuity must
still be paid to the nominee or the heir of the employee.
Gratuity is exempted from taxation provided that the amount does not exceed
15 days’ salary for every completed year of service calculated on the last
161
Major Issues drawn salary (subject to a maximum of Rs. 10 lakh). It is important to note
Confronting Indian that an employer can choose to pay more gratuities to an employee, which is
Economy
known as ex-gratia and is a voluntary contribution. Ex-gratia is subject to tax.
4) Enactment of the two Legislations relating to the Welfare of

Construction Workers in the Year 1996
In July 1996 two bills on construction workers were introduced in the
Parliament which were approved by the Parliament resulting in the enactment
of the Building and Construction Workers (Regulation of Employment and
Condition of Service) Act, 1996 and the Building and Other Welfare Cess
Act, 1996.
The Building and Construction Workers Act is applicable to the

establishments which employ 10 or more workers in any building or other
construction work and their project cost is more than Rs. 10 lakhs. There is a
provision to constitute Central and the State Advisory Committees to advise
the appropriate Governments in the matters arising out of the administration
of the Act. Various items for which these committees can advise are:
Constitution of Welfare Boards by the State Governments, registration of
beneficiaries under the Fund, provision for regulating the employment and
conditions of service, welfare measures for the construction workers. Further
as per the Building and other welfare cess act, Central and the State Advisory
Committees may advice for setting up a Welfare Fund at the State level to be
financed by contribution from beneficiaries, levy of cess on all construction
works at rates of 1 to 2 per cent of construction cost incurred by an employer
and non-mandatory grants/loans from the State/Central Governments.
With the efforts of Ministry of labour and employment, Government of India,
States/UTs carried out the notification of Rules and formation of the Boards.
As per the Act, these Boards have the authority to provide various social
security schemes to their members. These may relate to health, education and
old age protection.
5) The Mahatma Gandhi National Rural Employment Guarantee Act

(MGNREGA) 2005*
Objectives of the Act
i) providing a rights based 100 days employment in a year to strengthen the

subsistence livelihood support, enhancing the rural households
purchasing power and capacity to alleviate hunger; and
ii) directing the colossus amount of wages towards creating productive and
durable assets of irrigation, drought proofing, land and water
conservation, horticulture and connectivity to general prosperous
livelihood support system. The ultimate objective was to benefit the
entire community by providing employment; raising agricultural
productivity and increasing natural resource base, particularly water. The
process envisaged to attain the objectives would result in strengthening
*By virtue of being MGNREGA as job guarantee scheme. It is also mentioned as
MGNREG Scheme (MGNREGS)
162
the grassroots processes of democracy and infusing transparency and Social Security
Measures in India
accountability in governance.
Features of the Programme
i) The adult members of the rural households apply to the local

panchayats seeking registration for employment;
ii) issue of job cards by the panchayat within 15 days from the date of
application;
iii) written application by the job card holders to the panchayat seeking
employment;
iv) issue of dated receipt of written application for employment;
v) provision of employment within 15 days of application for work failing
which payment of unemployment allowance;
vi) provision of work within a radius of 5 km from the village (payment of
extra wages of 10 per cent, if the work provided is beyond 5 km);
vii) payment of wages as per the minimum wages act;
viii) provision of equal wages for men and women;
ix) disbursement of wages on a weekly basis;
x) women should constitute one-third of the workers;
xi) provision of facilities at the work site;
xii) shelf of project as recommended by the Gram Panchayat and approved
by zilla Parishad;
xiii) permissible works are predominantly soil and water conservation,
forestation and land development;
xiv) wage material cost ratio should be 60:40 (no room for machine and
contractors);
xv) social audit has to be undertaken by the Gram Sabha;
xvi) institution of grievances redressal mechanism for ensuring responsive
implementation process; and
xvii) all accounts are subject to public scrutiny resulting in accountability
and transparency of the scheme.
Working of the Programme

MGNREGA is the first tangible commitment to the poor that they can expect
to earn a living wage without loss of dignity and demand this as a right.
MGNREGA has benefited the people especially the marginalised and the
poor on several counts. Evidences from the field and the analysis of the
macro data have brought to light the various merits of the scheme and its
impact on the target beneficiaries.
163
Major Issues 6) Unorganised Workers’ Social Security Act, 2008
Confronting Indian
Economy The law aims at extending benefits to workers in informal sector/unorganised
sector similar to that of formal sector/organised sector workers. The Act
broadly covers life and disability, health and maternity benefits, old age
protection, and any other benefit as may be determined by the Central
Government.
7) Domestic Workers Act, 2008

It aims at regulating payment and working conditions of domestic workers
and entitles every registered domestic worker to receive pension, maternity
benefits and a paid weekly leave.
8) Food Security
Food security means the easy availability and access of food at all times in
sufficient quantity in a safe and nutritious form to meet the dietary
requirements and food preferences for an active, healthy and productive life.
This should also be adequate in terms of quantity, quality and variety and is
acceptable to culture. Food security is one of the pre-requisite for economic
and social stability of a nation. The availability, access and stability are three
important indicators which should be analysed in the context of food security.
The National and State government’s implement different food security

schemes to tackle food insecurity and malnutrition. These are related to
various government sectors, since they seek to support agricultural
production, distribution, purchase and use, as well as to ensure the provision
of health and nutritional services, sanitation and others. Initiatives include
subsidised food sales, school meals for targeted vulnerable citizens. They
include longstanding schemes such as the Integrated Child Development
Service (ICDS), which has been in place since 1975 and seeks to provide
education, nutrition and health services to women and children; and recent
initiatives such as the National Food Security Mission, launched in 2007,
which aims to increase crop productivity.
The most widely implemented food security scheme is the Public

Distribution System (which later formed as Targeted Public Distribution
System with some modification in its content, scope and objectives). Under
the scheme, the government provides distribution of cereals, as well as sugar
and Kerosine oil through fair price shops at subsidised price. The other
important scheme on food security is the Antodaya Anna Yojana (AAY)
which caters to the poorest of the poor section of population. Under these
schemes, all the households are divided into Above Poverty Line (APL) and
Below Poverty Line (BPL) based on the planning commission cut off
income. These two groups are treated separately in terms of price and
quantity of food grain.
9) Pension Fund Regulatory Development Authority Act, 2014

In late nineties there was a critical challenge before India due to the
enormous strain on revenue being provided due to government employees on
164 the basis of defined pension benefits. Keeping this in view Government of
India decided to introduce a National Pension Scheme (NPS) based on Social Security
Measures in India
defined contribution pension scheme for new entrants to Central Government
service, except to Armed Forces, in the first stage, with effect from January 1,
2004, replacing the existing defined benefit scheme. At the same time for old
employees, existing defined benefits were not disturbed.
Although an Ordinance was issued in the year 2004 to set up a statutory

Pension Fund Regulatory and Development Authority (PFRDA) to
administer National Pension Scheme, the Act became effective from
February 1, 2014 after receiving the assent of the President. Under the Act
PFRDA was set up to promote old age income security by establishing,
developing and regulating pension funds and protecting the interests of
subscribers to various schemes of pension funds. The ongoing schemes
administered by PFRDA are:
i) National Pension Scheme (NPS) for Central and State Government

Employees
Initially National Pension System was introduced on mandatory basis only

for the new entrants to central government service (other than armed forces)
who joined on or after 01.01.2004. After that it has been extended to state
government employees also. At present all the states except West Bengal and
Tripura have adopted NPS for their employees from the notified dates. Tamil
Nadu has adopted contributory pension scheme under National Pension
System (NPS), but it maintains the employees’ pension accounts itself.
Beside this as on 31st March, 2017, 528 central autonomous bodies and 806
state autonomous bodies are registered under NPS.
After joining the services, all the new employees who joined after January 1,
2004 are to be registered under NPS on mandatory basis.
ii) National Pension Scheme for Corporate Sector
Companies can enroll their employees as members of NPS and provide

retirement benefits to their employees. Instead of taking of their own, ‘the
work of setting up and managing trusts, investing the funds and providing
annuity’, they can use the NPS architecture. Companies decide about amount
of contribution to be paid in the retirement account. All the contribution can
be from the employer or from the employee or it can be shared by both in a
decided proportion. The choice of fund manager as well as investment pattern
can be either decided by the employer or the employer can give this choice to
the employee. The periodic contributions can be either directly made by the
employer to NPS or it can be routed through Point of Presence with which
the company has tied up to provide the services. Subscribers have the
portability facility in which they can transfer their retirement account across
locations and between sectors. The subscriber can move the account from one
employer to another employer or from the Corporate Sector to the All
Citizens model, as the case may be.
Until now individuals between the ages of 18 to 60 years could join NPS. In a
significant move to expand pension coverage in the country, the maximum
age for joining the NPS has been raised from 60 years to 65 years for the
165
Major Issues employees of corporate sector and self-employed. The move by PFRDA will
Confronting Indian enable people aged between 60 and 65 years to join NPS and make
Economy
contributions to it until the age of 70 years.
iii) All Citizen – Unorganised Sector Workers
In May 2009, NPS was opened on voluntary basis for all Indian Citizens
which includes the private sector and informal sector (unorganised sector)
workers. Objective of extension of the NPS was to provide a low-cost
retirement savings system to India’s informal sector workers. Alterations in
the scheme were made to ensure that it is scalable, low cost, simple, portable
and flexible. PFRDA allowed the enlisted Post offices, public sector banks
and NGOs with local standing to open the accounts of these workers.
The unorganised sector (All Citizens) Model of the NPS was available to all
citizens of India, whether resident or non-resident. However, the applicant
should be between 18–60 years of age as on the date of submission of his/her
application. Recently the maximum age of self-employed has been raised
from 60 years to 65 years.
iv) Atal Pension Yojana
Eligibility and Benefit of APY

The scheme is open to all bank account holders who are between the age of
18 years and 40 years. Under APY there is a provision for fixed pension for
the subscribers ranging between Rs. 1000 to Rs. 5000. The contribution rate
is low if subscriber joins early and increases if he joins late.
Government co-contributes 50 per cent of the total contribution of the
subscriber or Rs. 1000 per annum, whichever is lower, to eligible subscribers
who have joined before 31st March 2016; and also reimburses expenditure for
the promotional and development activities including incentive to the
contribution collection agencies to encourage people to join the APY.

1½ The Employee’s Compensation Act, 1923 also known as The
Workmen’s Compensation Act, 1923
The Workmen’s Compensation Act is the oldest of the social security
legislations intended for the welfare of workers. This Act makes it obligatory
for the employers to provide compensation to workmen or their survivors in
case of injuries and occupational diseases sustained during the course of
employment and resulting in disablement or death. Compensation calculation
is done as given below:
a) Death: 50 per cent of the monthly wage multiplied by the relevant factor
(age) or an amount of Rs. 80,000, whichever is more.
b) Total permanent Disablement: 60 per cent of the monthly wage
multiplied by the relevant factor (age) or an amount of Rs 90,000,
whichever is more.
166
2) The Maternity Benefit Act, 1961 Social Security
Measures in India
It provides maternity protection before and after childbirth, through payment
of wages. The amendment of this Act came into force on April 1, 2017, and
increased some of the key benefits mandated under the previous Maternity
Benefit Act of 1961. The amended law provides women in the organised
sector with paid maternity leave of 26 weeks, up from 12 weeks, for the first
two children. For the third child, the maternity leave entitlement will be 12
weeks.
The Act also secures 12 weeks of maternity leave for mothers adopting a
child below the age of three months as well as to commissioning mothers
(biological mothers) who opt for surrogacy. The 12-week period in these
cases will be calculated from the date the child is handed over to the adoptive
or commissioning mother.
In other provisions, the law mandates that every establishment with over 50
employees must provide crèche facilities within easy distance, which the
mother can visit up to four times a day. For compliance purposes, this
particular provision came into effect from July 1, 2017.
This Act is applicable to (a) every establishment being a factory, mine or

plantation including any such establishment belonging to Government; and
(b) every shop and establishment in which ten or more persons are employed,
or were employed, on any day of the preceding twelve months; and such
other shops and establishments notified by the State Government after prior
approval of the Central Government.
3) National Social Assistance Programme (NSAP)

The NSAP, a 100 percent centrally sponsored programme is designed to
provide protective social security to the very poor citizens. This is the first
nationwide programme of cash transfer. This programme intends to provide
social assistance benefits to poor households in case of old age, death of main
breadwinner and maternity. The programme ensured that Central assistance
does not displace States’ own expenditure in this respect and that the
States/UTs may expand their own coverage of social assistance
independently, wherever they wish to do so. The NSAP is implemented by
panchyats and municipalities so as to make it more responsive and cost
effective. The panchyats and municipalities are encouraged to play an active
role in identifying the poor households.
This programme comprises four pension and disability schemes for the
elderly. These include the Indira Gandhi National Old Age Pension Scheme
(IGNOAPS), under which persons below poverty line (BPL) aged 60 years or
above are entitled to a monthly pension of Rs. 200 up to 79 years of age and
Rs. 500 thereafter. In case of Indira Gandhi National Widow Pension Scheme
(IGNWPS), BPL widows aged 40 to 59 years are entitled a monthly pension
of Rs. 200. Indira Gandhi National Disability Pension Scheme (IGNDPS)
offers Rs. 200 a month to BPL persons 18-59 years with severe and multiple
disabilities.
167
Major Issues Beside this National Family Benefit Scheme (NFBS) entitles a BPL
Confronting Indian household one time assistance of Rs. 10000/- upon the death of the primary
Economy
bread earner aged between 18 and 64 years.
23.6 EXISTING PROVISIONS: PROBLEMS AND

ISSUES
There are many problems and issues in the existing schemes.
i) There are many agencies, which are administering authorities. It causes

high compliance costs to companies as well as beneficiaries. In some
cases, there is multiplicity of policies and laws. Most of the population
particularly belonging to unorganised/informal sector is not covered.
Beside this there is no road map for inclusion of excluded sectors in
future under the same umbrella.
ii) In Social assistance programmes there is very less involvement of

workers in decision making.
iii) Social security is not right based. It can be compromised without any
compensation to the workers.
iv) Migration of unorganised sector workers lead to loss of contribution

made by them which ultimately effects their benefits.
v) There is unsystematic identification and registration system of

unorganised / informal sector workers.
23.7 THE CODE ON SOCIAL SECURITY, 2019

Government felt the need for universal Social Security (SS) Legislation. It
was recommended by 2nd National Commission of Labour (2002). Provision
of adequate social security for the entire workforce regardless of the nature of
their employment has also been accepted as a fundamental element towards
achievement of Goal 8 (Decent work and economic growth) of the 2030
Sustainable Development Agenda adopted at the UN Summit held in
September 2015. Keeping in view the need of universal SS Legislation and to
overcome the problems mentioned above in section 23.6, a Bill to amend and
consolidate the laws relating to social security of the workers and the matters
connected therewith or incidental thereto was presented in the Parliament in
the year 2019. It would extend to the whole of India. This Act would be
called the Code on Social Security, 2019. This has been sent to the Select
Committee of the Parliament.
It is proposed that Acts given below relating to social security would be

subsumed in the proposed Code on Social Security:
• ESI Act
• EPF and MP Act
• Payment of Gratuity Act
168 • Maternity Benefit Act
• Employees Compensation Act Social Security
Measures in India
• Unorganised Workers Social Security Act
• Existing Labour welfare Fund and Cess Acts – Construction workers,
Beedi workers, Cine workers, Mine workers

1) What is the difference between social insurance and social assistance as
approaches to social security?
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2) State the legislation which provides security against risk of
unemployment. Highlight its important features.
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3) What types of security is provided under Atal Pension Yojana?
…………………………………………………………………………….
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4) State the features of National Social Assistance Programme.
…………………………………………………………………………….
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…………………………………………………………………………….
23.8 LET US SUM UP

Social Security is one of the important securities for a person who is in need
of security for meeting a short- term need or a long-term need. With the
modernisation/urbanisation and with the break-up of joint family system the
role of institutions in providing social security has increased day by day. The
169
Major Issues private institutions have their own limitations. Hence, the need for public
Confronting Indian institutions in getting out people from the trap of poverty and insecurity is
Economy
critical. Old age is important. Again, in the countries like India where about
92 per cent of workers work in unorganised/informal sector they do not enjoy
the benefits of social security, fail to demand for social security like
minimum wage rate, accidental benefit and so on. It is also seen in various
studies that the awareness about the provision of various schemes on social
security, particularly in rural areas, is very low. In view of the foregoing
facts, it is encouraging to note that the past decade witnessed an
unprecedented revival in the provisioning of social security in India. Some of
these interventions and initiatives though require further refinements and
proper enforcement, based on informed discussions at the national and
international level. A welcome aspect of these new initiatives is the visible
efforts of the government towards designing and implementing right-based
social security systems, along with enabling governance structures, which
inter alia seek more participation from all other stakeholders, including the
targeted beneficiaries themselves.

1) What is the distinction between social security, social protection, Social
Protection Floor? Why social security has become the need of hour?
Which constitutional provisions provide force for enactment of different
social security measures?
2) Distinguish between social assistance and social insurance programmes
of social security.
3) State the objectives of MGNREGA as a measure of employment
security.
4) What is the role Pension Fund Regulatory Development Authority
(PFRDA) in India? What are important schemes administered by
PFRDA?
5) What do you understand by Social Security Code in India? What are its
advantages?
23.10 REFERENCES
1) Andy Norton, Tim Conway, Mick Foster (February 2001). Social
Protection Concepts and Approaches: Implications For Policy and
Practice In International Development’ Overseas Development Institute,
London SE1 7JD, UK
2) Ahmad, Ehtisham, Jean Dreze, John Hills and A. Sen (1991). Social
Security in Developing Countries, Oxford, Clarendon Press.
3) Annual Reports of Pension Fund Regulatory Development Authority

(2013-14), Employees Provident Fund Organisation (2014-15) and
Employees’ State Insurance Corporation (2015-16)
170
4) Arora, S.L., Akhilesh Sharma, and Dev Nathan (2017). Social Protection Social Security
Measures in India
in India, in “Employment Social Protection and Inclusive Growth in
South Asia, Edited by Dev Nathan and Akhilesh K. Sharma”, Delhi,
South Asia Press.
5) ILO (2017), World Social Protection Report 2017-19, Geneva, ILO.
6) Mahendra Dev, S. (1995). Government Interventions and Social Security

for Rural Labour, Indian Journal of Labour Economics, Vol. 38, No.3.
7) Naik, D.N. (2016). Social Security and Social Insurance, in Journal of

Civil and Legal Sciences, September 12, 2016.
8) Pankaj, Ashok and Rukmini Tankha (2010). Empowerment Effects of

the NREGS on Women Workers: A Study in Four States, Economic and
Political Weekly, Vol. 44, no. 30, July 24, pp. 45-55.
9) Shah, Mihir (2008).‘Radicalism of MGNREGA: Economic and Political

Weekly. VOL 43 No. 23.
23.11 KEY WORDS
BPL and APL : Below Poverty Line is an economic benchmark used

Household by Government of India to identify the disadvantaged
households. It is determined using various parameters
which vary from state to state and within states. The
present criteria are based on a survey conducted in
2002 by taking 13 socio-economic variables. The
households above the benchmark are known as
Above Poverty Line (APL) households.
Defined Benefit : In a defined benefit (DB) pension scheme, the
(DB) pension formula is defined in advance. Often benefits
depend on years of employment and salary over some
period, such as the final year or the average of last ten
years. The rest of society bears the risk that the
economy will not perform as well as expected or that
people will live longer than expected. Protecting the
old people from these risks, because of their less
ability to adjust and recover from these risks as
compared to their younger counterparts, is considered
as one of the big advantages of DB plans (World
Bank, 1994).
Defined : In a defined contribution (DC) scheme, annual
Contribution (DC) contributions are defined in advance, but the benefits
depend on the return on the length of contribution and
the investments made. In this case there is
considerable uncertainty about future rates of return.
Investment returns mainly depend on the economic
health of the country and that of other countries in the
case of foreign investments.
171
Major Issues International : The International Labour Organisation (ILO) was
Confronting Indian
Economy Labour founded in 1919, in the wake of a destructive war.
Organisation (ILO) The ILO became the first specialised agency of the
UN in 1946. The ILO is the international organisation
responsible for drawing up and overseeing
international labour standards. The ILO shape
policies and programmes promoting Decent Work for
all with the involvement of representatives of
governments, employers and workers. The main aims
of the ILO are to promote rights at work, encourage
decent employment opportunities, enhance social
protection and strengthen dialogue on work-related
issues.
Notional Defined : The structure of a notional defined contribution
Contribution (NDC) scheme is very similar to that of Defined
(NDC) Contribution scheme. The main difference is that the
interest rate applied is not the market rate of interest
but some other indicator, such as the rate of growth of
GDP, or the rate of growth of wages. The scheme is
generally mandatory and managed by the
Government (RBI, 2003).

PROGRESS EXERCISES
1) Social security refers to the programmes aiming to help the person facing
threats of economic uncertainties in the event of unemployment, illness,
disability, death and odd age.
2) See Section 23.2
3) See Section 23.2
4) Social Protection floors recommendation, 2012 by ILO calling upon the
states to achieve universal coverage with atleast minimum levels of
protection through implementation of social protection floors.
1) See Section 23.4
172
Regional Disparity in
UNIT 24 REGIONAL DISPARITY IN India: Policy
Implications
INDIA: POLICY IMPLICATIONS
Structure
24.0 Objectives
24.1 Introduction
24.2 Interpersonal and Regional Disparity: Concept and Theory
24.3 Regional Disparity and Domestic Product
24.4 Agricultural Development and Regional Disparity
24.5 Industrial Development and Regional Disparity
24.6 Infrastructural Development and Regional Disparity
24.6.1 Social Infrastructure
24.6.2 Physical Infrastructure
24.7 Human Development and Regional Disparity
24.7.1 Causes of Regional Disparities
24.8 Measures to Remove Regional Disparities
24.8.1 Major Limitations
24.9 Way Forward
24.10 Let Us Sum Up
24.12 Key Words
24.13 References
Appendix 24.1
24.0 OBJECTIVES
● Know the meaning of regional disparity;
● discuss the basic theoretical framework relating to regional disparity;
● analyse regional disparity in terms of macroeconomics aggregates like
growth rate, per capita GDP, sectoral contribution in GDP, etc.;
● examine the regional disparity in agriculture;
● identify regional disparity in infrastructural development; and
● review the regional disparity in human development.
24.1 INTRODUCTION
In India, the inter-state/regional disparity has been a major challenge for
planners and policymakers. Despite plethora of development programmes,
173
Major Issues regional disparity has persisted over time. There has been a huge gap in terms
Confronting Indian
Economy of availability of facilities between active and vibrant regions and hinterland
during the pre-independence period. This manifests in unequal level of
economic and human development. In India not much theoretical work has
been done relating to regional disparity. But many empirical works have been
done by researchers on various development issues. Prof. Mathur (1987)
explains the regional disparity in terms of regional growth. Most of the
empirical studies relating to regional disparity in income and consumption
reflects a growing trend of disparity. Das and Barua (1996) opined that Indian
economy continues to grow at the cost of widening regional inequality. Dreze
and Sen (1995) opined that there has been a wide variation in regional
development resulting in remarkable internal diversities. Dutt and Ravallion
expressed their view that long term progress in rising rural living has been
diverse across Indian states. Likewise, the National Human Development
Report 2001 reveals a considerable difference in human development across
Indian states during 1981-2001. The report reflects that the human
development index of the states like Bihar, UP, MP, Rajasthan and Odisha
has been extremely low and about half of Kerala’s figure. Against this
background, this unit examines the regional disparity in India, in terms of
macroeconomic aggregates, infrastructural development, agricultural
development, industrial development and human development outcomes.
24.2 INTERPERSONAL AND REGIONAL

DISPARITY: CONCEPT AND THEORY
The term ‘disparity’ is very frequently used in the arena of social science
research. This term has evolved from Latin word ‘disparitas’ which means
‘divided’. Hence the term disparity literally means inequality or disproportion
in particular phenomena. The American Heritage Dictionary defined disparity
as inequality or difference, as in age, rank, wages, etc. The regional disparity
means the disproportionate performance of inter or intra geographic region or
sectors in different economic and non-economic indicators. Karin Vorauer
(2007) defined regional disparity as ‘Regional disparities we understand
deviations from any conceptional reference division of characters taken as
relevant, in association with different spatial benchmark levels (region
borders)’.Alois Kutscherauer et al. (2010) defined the term regional disparity
as ‘divergence or inequality of characters, phenomena or processes having
specific territorial allocation (can be allocated in defined territorial structure)
and occurring at least in two entities of the territorial structure’.
Thus, regional disparity refers to a situation where different indicators such

as per capita income, consumption level, food availability, agricultural and
industrial development, infrastructural development are not similar among
regions. The problem of regional development is mostly universal in nature.
However, its intensity differs in different countries (developed/developing).
Almost all countries face regional disparity during their process of
development.
174
There is general agreement for an inverted U-shapes curve of regional Regional Disparity in
India: Policy
disparities with growth. The development theories put forwarded by the Implications
regional experts like Simon Kuznets (1963), Hirschman (1958), Mera (1965),
opined for a regional disparity during the socio-political development and
modernisation. According to these theories, urban primacy, socio-spatial and
individual inequalities increase during the initial period of development, but
reduce over time with advancement in the stage of development. Myrdal and
Hirschman come up with the backwash effect vs. spread effect and
polarisation vis-a-vis trickled down effect. Myrdal concept of multiplier-
accelerator mechanism produce increasing returns in favoured region.
Appearance of development differences creates a chain of cumulative
expansion in favoured region. Myrdal defines this as a backwash effect, on
other region and as a result development differences persist. In the context of
backwash effect, policies must be designed to reduce the backwash effect
(what Hirschman called polarisation effect of interregional development. He
argued for a good policy framework that strengthens trickledown effect. The
trickled down effect favours the development of backward region. Myrdal
called such effect as spread effect. The tricked down effect or spread effect
consists of the increased demand of backward area products and the diffusion
of technology and knowledge. Myrdal (1957) argues that the backwash effect
is weaker than spread effect and if the backwash effect is to be narrowed, the
state must come up with effective regional policies. Lloyd (1990) also
supported this view. Hence the difference increases over time unless
countervailing measures are taken to reduce the problem.
24.3 REGIONAL DISPARITY AND DOMESTIC

PRODUCT
During last seven decades Indian economy has been growing at an annual
growth rate of about 5.72 per cent. From time to time the growth has been
fluctuating and the highest annual growth rate registered is 9.6 per cent in the
year 1988 and the lowest was -5.24 in 1979. The structural share of Gross
Domestic Product itself shows a wide variation over time across states.
Some of the sub-sectors have exhibited very wide variations in the annual
growth rates. Among these, agriculture and allied activities have generally
been subject to considerable fluctuations. Mining and Quarrying also falls in
the same category. Manufacturing has been steadier. Growth in service
sector, on the contrary, has shown a continuous rise.
From the perspective of distribution of national product, it is useful to

analyse data relating to trends in per capita net state domestic product. The
relevant data is summarised in Table 24.1 below. The data reflects trend of
gap in per capita income in different time period in India as well as the
income gap between India and other states and among different states.
Table 24.1 provides per capita NSDP from 1993-94 to 2018-19 at different
base prices for both forward and backward states. Among the major states,
the state registering the highest per capita NSDP in 2018-19 was Haryana
(Rs.169409) followed by Uttarakhand (Rs.155151) and Gujarat (Rs.153495).
175
Major Issues On the other hand, states showing the lowest per capita NSDP were Bihar
Confronting Indian
Economy (Rs.28668) and Uttar Pradesh (Rs. 44421).
The states showing the highest growth rate of per capita NSDP between
2011-12 and 2018-19 were Gujarat (8.4 per cent) followed by Karnataka (7.9
percent) and states registering the lowest growth rate during the same period
were Jammu and Kashmir (3 percent), Madhya Pradesh (3.4per cent) and
Arunachal Pradesh 3.5 per cent).
Table 24.1: Per Capita Net State Domestic Product and its Growth Rate
State / Union (Base: 1993-94) (Base : 1999-2000) (Base: 2004-05) (Base: 2011-12)
Territory 1993-94 1999-00 Growth 1999-00 2004-05 Growth 2004-05 2011-12 Growth 2011-12 2018-19 Growth
Andhra Pradesh 7416 9445 4.1 15427 19963 5.3 25959 38556 5.8 69000 107241 6.5
Arunachal
8733 8890 0.3 13990 19339 6.7 4.2 3.5
Pradesh 26721 35527 73068 93191
Assam 5715 5785 0.2 12282 13946 2.6 16782 21741 3.8 41142 60695 5.7
Bihar 3037 3282 1.3 5786 6772 3.2 7914 13149 7.5 21750 28668 4.0
Jharkhand 5897 7238 3.5 11549 12869 2.2 18510 25265 4.5 41254 54982 4.2
Gujarat 9796 13298 5.2 18864 23346 4.4 32021 56634 8.5 87481 153495 8.4
Haryana 11079 13308 3.1 23222 30690 5.7 37972 61716 7.2 106085 169409 6.9
Himachal
7870 11051 5.8 20806 26244 4.8 5.7 6.8
Pradesh 33348 49203 87721 139469
Jammu &
6543 7384 2 13816 15414 2.2 4.1 3.0
Kashmir 21734 28790 53173 65178
Karnataka 7838 10912 5.7 17502 19840 2.5 26882 41492 6.4 90263 153276 7.9
Kerala 7983 10430 4.6 19461 25122 5.2 32351 52808 7.3 97912 148078 6.1
Madhya
6584 8248 3.8 12384 12032 -0.6 6.0 5.6
Pradesh 15442 23272 38497 56498
Chhattisgarh 6539 6692 0.4 11629 14070 3.9 18559 27163 5.6 55177 69500 3.4
Maharashtra 12183 15257 3.8 23011 26603 2.9 36077 61276 7.9 99597 147450 5.8
Odisha 4896 5742 2.7 10622 13311 4.6 17650 24542 4.8 48499 76417 6.7
Punjab 12710 14809 2.6 25631 27905 1.7 33103 46325 4.9 85577 115882 4.4
Rajasthan 6182 8555 5.6 13619 14908 1.8 18565 29612 6.9 57192 78570 4.6
Tamil Nadu 8955 12167 5.2 19432 22975 3.4 30062 57093 9.6 93112 142941 6.3
Uttar Pradesh 5066 5675 1.9 9749 10421 1.3 12950 18014 4.8 32002 44421 4.8
Uttarakhand 6896 7256 0.9 13516 19524 7.6 24726 52606 11.4 100305 155151 6.4
West Bengal 6756 9320 5.5 15888 19367 4.0 22649 32164 5.1 51543 67300 3.9
All-India 7690 10071 4.6 15881 19331 4.0 24143 38048 6.7 63462 92565 5.5
Source:https://m.rbi.org.in/Scripts/AnnualPublications.aspx?head=Handbook+of+Statistics+on+Indian+States
Punjab had highest per capita income in 1993-94 but in 1999-00 Maharashtra
was at the top. Odisha had the lowest per capita income in 1993-94, but in
1999-00 Bihar had recorded the lowest per capital income. During the period
1993-94 and 1999-00 the state Himachal Pradesh registered the highest
growth rate of 5.8 per cent.
During 1999-00 and 2004-05 Uttarakhand registered the highest growth rate
of 5.8 per cent per annum.
Overall the states registering high Per Capita Income (PCI) over the period
are Punjab, Haryana and Karnataka whereas the states usually in the lowest
PCI are Bihar, Jharkhand and Uttar Pradesh.
176
Figure 24.1 shows the gap in per capita net state domestic product between Regional Disparity in
India: Policy
the richer and poorer states. Bihar has been taken as a poorer state whereas Implications
Punjab, Maharashtra and Haryana are considered representing developed
states. We have examined the ratio of NSDP of the three developed states
with the representative backward state Bihar. The higher the ratio indicates
the higher disparity between the states and vis-a-versa.
10
9.4
9
8 8.7
8.1
7
6.7
6 5.9 Haryana/Bihar
6
4.8 4.9 5.1
5 4.3 4.4 Maharashtra/Bihar
4 4.6 4.6
4 4 4.2 4 Punjab/Bihar
4 3.9
3 3.6 Delhi/Bihar
2
1
0
1993-94 1999-00 2004-05 2011-12 2018-19
Fig. 24.1: Ratio of Per capita Net State Domestic Product of Bihar with Delhi, Punjab,
Maharashtra and Haryana
Source: MOSPI as downloaded

fromhttps://m.rbi.org.in/Scripts/AnnualPublications.aspx?head=Handbook+of+Statistics+on
+Indian+States
The graph clearly depicts that the ratio of per capita NSDP between Delhi
and Bihar is 9.4 in 2018-19. This means that Bihar’s per capita NSDP is one-
nineth of Delhi. The same trend is observed in other three states also.

1) State the concept of Regional Disparity.
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
2) What is the difference between backwash effect and spread effect?
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
177
Major Issues 3) What is the relevance of examining GSDP growth rates to understand
Confronting Indian
Economy regional disparity?
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
24.4 AGRICULTURAL DEVELOPMENT AND

REGIONAL DISPARITY
As discussed, the contribution of agricultural sector to the total GDP has been
gradually decreasing over time. Agriculture’s contribution reduced from 51.9
to 16.5 per cent during the period 1950-51 to 2019-20. Even over a shorter
period of time there has been a significant decline in the share of agriculture
in the Gross State Domestic Product (GSDP).
Table 24.2: Share of Agriculture to GSDP and Total Workforce in India

and States
Share of Agl in GSDP Share of Agriculture in

(% at 2011-12 price) Total Workforce (%)
State 2011-12 2018-19 2011-12 2018-19
Andhra Pradesh 13.7 11.2 52.4 43.9
Assam 14.4 11.5 54.3 37.2
Bihar 17.2 10.8 61.6 47.6
Chhattisgarh 11.4 9.9 71.8 60.8
Delhi 0.2 0.0 0.1 0.3
Gujarat 12.9 6.4 46.9 39.4
Haryana 13.7 8.1 40.9 24.3
Himachal Pradesh 9.3 5.8 58.4 56.3
Jammu & Kashmir 10.2 7.1 40.3 35.2
Jharkhand 8.9 5.9 49.4 40.3
Karnataka 8.8 5.2 48.5 38.9
Kerala 8.0 4.1 20.4 16.8
Madhya Pradesh 23.2 21.5 57.7 55.7
Maharashtra 8.0 5.1 49.1 41.8
Odisha 11.1 7.0 54.8 42.8
Punjab 18.8 13.3 35.8 24.0
Rajasthan 16.9 11.5 49.9 51.9
Tamil Nadu 7.2 3.9 33.5 25.3
178
Telangana 9.0 4.9 - 41.8 India: Policy
Uttar Pradesh 17.1 13.3 51.9 49.7 Implications
Uttarakhand 6.6 3.7 46.6 31.8

West Bengal 13.9 12.1 36.8 32.6
India 11.5 7.8 47.8 40.9
Source: Calculated from MOSPI and NSS PLFS, 2018-19
The contribution of agricultural sector to total GSDP in 2011-12 was 11.5 per
cent which reduced to 7.8 per cent in 2018-19. The state level picture also
shows the same declining trend in the contribution of agricultural sector. In
the year 2018-19, the contribution of agricultural sector to state’s GSDP was
high in Madhya Pradesh (21.5 per cent) followed by the state Punjab (13.3
per cent). The change in the contribution of agriculture in GSDP over the
period 2011 to 2018 was highest in Bihar and Gujarat (about 6 percentage
point reduction) whereas Delhi, Madhya Pradesh and West Bengal registered
the lowest percentage point change (see Table 24.2).
On the other hand, the percentage share of agriculture in the total workforce
has only reduced from 48 per cent in 2011 to 41 per cent in 2018. A large
disparity is visible among the states in terms of contribution of agriculture in
total workforce. The states showing the highest proportion of agricultural
workforce to total workforce are Chhattisgarh (71.8 per cent), Bihar (61.6 per
cent), Himachal Pradesh (58.4 per cent) and among the lowest are Kerala
(20.4 per cent), Tamil Nadu (33.5 per cent) and Punjab (35.8 per cent).
The percentage point reduction in the contribution of agricultural workforce

in the total workforce over the period 2011 to 2018 was highest in Assam
(17.1 percentage point), Haryana (16.6 percentage points) and Uttarakhand
(14.8 percentage points) whereas in the states Uttar Pradesh (2 percentage
points), Himachal Pradesh (2.1 percentage points), Madhya Pradesh (2
percentage points) the percentage point reduction was the lowest. The state
Rajasthan shows an increase of percentage of workforce in agriculture from
2011 to 2018.
Figure 24.2 explains the growth rate of Domestic product from agriculture
from 2004-05 to 2018-19. The growth rate of agriculture in India from 2011-
12 to 2018-19 is 8.2 per cent which increased from 4.4 per cent during 2004-
05 to 2011-12. Among the states the highest growth rate during 2011-12 to
2018-19 is marked by Madhya Pradesh (15.3 per cent), Maharashtra (10.6per
cent), followed by West Bengal (10.3 per cent). During 2004-05 to 2011-12
Jharkhand registered the highest growth rate of 9.5 per cent followed by
Chhattisgarh 7.9 percent. Kerala registered the negative growth of 1.1 per
cent during 2004-2011.
179
Major Issues
Confronting Indian 18 15.3
Economy 16
14
12 9.9 10.6 10.3
9.7 9.5
10 8.7 8.6 8.1 8.2
7.9 7.7 6.5 7.3
7.8 6.2 7.1
8 5.4 5.5 6 6 5.7 6.6 6.2 5.5
4.6 5.8
6 4.4 4.3 4.4 4 4.4
2.8 2.7 2.9 3.2 3.2 2.4
4 1.7 1.6
0.9 1
2 0.4 -1.1
0
-2
2004-05 to 2011-12 (2004-05 price)

2011-12 to 2018-19 (2011-12 price)
Fig. 24.2:Growth Rate of Domestic Product from Agriculture, 2004-05 to 2018-19

Source: MOSPI
A sectoral disaggregation of the workforce in rural areas shows that the share
of agricultural sector to the total workforce has declined but at a much slower
pace than the decline in the share of agriculture in GSDP. As expected, there
has been a decline in the share of workforce in agriculture from 81.4 per cent
to 58.2 per cent between 1983 to 2018-19. During this period, the dependence
of workforce declined by 29 percentage point. Considering the state-wise
contribution of farm sector to total employment,in 2018-19, among the major
states Chhattisgarh and Madhya Pradesh contributed the highest proportion
of farm employment, whereas in the states like Kerala and West Bengal, the
share of farm sector in employment was the lowest.
Figure 24.3 explained the proportion of agricultural labour and non-

agricultural labour over the period of 1983 to 2018-19. The figure clearly
shows that the proportion of non-agricultural labour increased from 18.6 per
cent in 1983 to around 42 per cent in 2018-19. On the other hand, the
proportion of worker in agricultural sector reduced from 81.4 per cent in
1983 to around 58 per cent in 2018-19. This clearly indicate that the increase
in proportion of non-agricultural workforce in 2018-19 was more than two
times compared to what it was in 1983. On the other hand, the reduction of
agricultural workforce was only one third in 2018-19 compared to what it
was in the year 1983.
180
120 India: Policy
Implications
100
18.6 21.7 27.4 35.5
80 41.8
60
40 81.4 78.3 72.6 64.5 58.2

20
0
1983 1993-94 2004-05 2011-12 2018-19
Agriculture Non-Agriculture
Fig. 24.3: Percentage Distribution of Workers

Source: Calculated from different round of NSS Employment unemployment rounds
The labour productivity in agriculture has been growing very slowly. The
slow growth is largely due to the following factors: (i) the impact of green
revolution was limited to a very few states and (ii) the process of
diversification of labour from agriculture to non-agriculture has barely
started.
In short, agricultural performance has varied among different states,
accounting partially though significantly, for prevalent wide disparities in
income among different states.
24.5 INDUSTRIAL DEVELOPMENT AND

REGIONAL DISPARITY
Like other developing countries, industrial concentration is observed in some
pockets of India. Keeping this in view, Government of India has adopted a
plethora of measures to achieve a balanced regional development. The
policies are guided by industrialisation mixed with highly regulated policies.
Also, many industries reserved for public sector. After opening up of the
economy with minimum role of the state in industrialisation and industrial
growth, it has been argued that the industries have concentrated in the
economically advanced states due to their comparative advantages in social
and economic infrastructure. This argument has been supported by several
country level studies.
181
Major Issues
Confronting Indian 1950-51 9
Economy
1960-61 11
1970-71 12.7
1980-81 13.9
1990-91 15.1
2000-01 15.5
2009-10 16.1
2018-19 18.1
0 5 10 15 20
Share of Manufacturing to Total GDP in India
Fig. 24.4: Share of Manufacturing to total GDP in India

Source: RBI; downloaded from https://www.rbi.org.in
The share of manufacturing in total GSDP in 2018-19 in major states ranges

between 5.1 per cent in Delhi to 37.2 per cent in Uttarakhand(refer Table 1 in
Appendix 24.1). The industrially developed states like Gujarat and
Maharashtra also showed a higher contribution of manufacturing in total
GSDP of the state. In the year 2018-19, the contribution of manufacturing to
GSDP in 10 states reduced as compared to the year 2011-12 whereas in 12
states the share of manufacturing increased. The states registering highest
reduction in the share of manufacturing to total GSDP were Telangana (5.0
percentage points) and Andhra Pradesh (3.1 percentage points). The states
showing the highest increase were Gujarat (7.1 percentage points) and
Himachal Pradesh (5.2 percentage points).
The growth rate of Industry has been 8.5 per cent between 2011-12 to 2018-
19. The highest growth rate is of Gujarat (13.8 per cent) followed by Assam
(12.9 per cent) whereas the states registering the lowest growth rate are
Rajasthan (2.6 per cent) and Telangana (2.8 per cent).
Similar conclusions can be drawn when we analyse the trend in share of

service sector in GSDP of different states.
The contribution of service sector increased from 44.8 per cent to 46.8 per
cent between 2011-12 to 2018-19 (refer Table 2 in Appendix 24.1). This
means there is a 2 percentage point increase in the said period. In the year
2018-19, Delhi (73.6 per cent) and Bihar (57.7 per cent) shows the highest
share in service sector and Gujarat (30.8 per cent), Chhattisgarh (34.5 per
cent) and Uttarakhand registered the lowest share in service sector.
The percentage point change among states between 2011-12 to 2018-19

shows that Telangana and Jharkhand recorded the highest percentage point
change of 7.9 and 4.1 respectively, whereas Himachal Pradesh, Arunachal
Pradesh and Jammu and Kashmir show a low change in share of service
sector (1.00, 1.00, and 1.4 respectively). Again Odisha, Delhi and Madhya
Pradesh show no change in the contribution of service sector in GSDP in
182 between 2011-12 to 2018-19.
The growth rate of service sector is 7.9 per cent between 2011-12 to 2018-19. Regional Disparity in
India: Policy
The highest growth rate is marked by Telangana (10.0 per cent) followed by Implications
Karnataka (10.0 per cent) whereas the states registering the lowest growth
rate include Assam (5.3 per cent) and Jammu and Kashmir (5.8 per cent).
24.6 INFRASTRUCTURAL DEVELOPMENT

AND REGIONAL DISPARITY
The importance of infrastructure in economic development, trade,
employment and in reducing disparity within the country/region cannot be
over emphasised. As learnt extensively in Unit 4 availability of adequate
infrastructure facilities, especially the physical infrastructure is the pre-
condition for sustainable economic and social development. Non-availability
or inadequate availability of infrastructure poses a serious threat to growth.
We examine the prevalent situation in regard to available infrastructure in
different states of the country.
24.6.1 Social Infrastructure

The social infrastructure broadly includes health, education. The indicators
used to access the availability of education infrastructure in India are number
of elementary schools (primary schools and upper primary schools) across
states. These indicators are converted on per 10,000 population basis to
facilitate comparison among states.
Education Infrastructure
It is well recognised that the literacy of any region or area has a positive
relation to the overall development. It enables people to access new
opportunities to participate in society in different ways. The census data
shows that the literacy rate increased from 18.3 per cent in 1951 to 74.04 in
2011.
The education infrastructure plays an important role in the literacy rate of a

particular region. The supply side factor, like the availability of school, good
condition building, adequate number of teachers, facility like toilet, drinking
water are the major determinants of the quality of education within a region.
Figure 24.5 shows the number of elementary schools (primary and
secondary) per lakh population in 2016-17. The number of elementary
schools per lakh population in India is 114. Himachal Pradesh (254), Jammu
and Kashmir (223) and Uttarakhand (220) registered a high number of
Elementary school per lakh population. On the other hand Delhi (31), Kerala
(48), Gujarat (68) registered a low number of elementary schools per lakh
population.
183
Major Issues
Confronting Indian 300 254
Economy 250 223 220
200 186
200 182
160
130 142
150 120 113118 101114
83 97 88 99
100 71 68 78
48
50 31
0
Kerala
India
Odisha
Punjab
Delhi
Jammu & Kashmir

Bihar
Assam
Gujarat
Andhra Pradesh
Telangana
Uttar Pradesh
Karnataka
Madhya Pradesh
Rajasthan
Tamil Nadu
Uttarakhand
West Bengal
Chhattisgarh
Jharkhand
Haryana
Maharashtra
Himachal Pradesh
Fig. 24.5: Number of Primary and Upper Primary Schools Per Lakh Population, 2016-17
Note: Total number of school is pertaining to all school up to upper primary level both
government and private and for the year 2016-17 and the population for the year 2016 is
taken from Census projected population.
Source: DISE www.dise.in and Census of India 2011
The regional disparity in education can also be judged from some other
characteristics like percentage of single class room school, percentage of
single teacher school. In India 4.3 per cent elementary schools have only a
single classroom (Refer Table 3 in Appendix 24.1). Among the states Assam
(18.5per cent), followed by Andhra Pradesh (13.0 per cent) registered a high
proportion of single room schools whereas Kerala, Delhi (0.1 per cent), Uttar
Pradesh (0.7 per cent), Tamil Nadu (0 per cent) show a low proportion of
school with single class room. The other important indicator is the single
teacher school. In India 7.2 per cent of schools have only a single teacher.
Among the states, Andhra Pradesh (14.1 per cent), Jharkhand (17.1 per cent),
and Rajasthan (12 per cent) registered a high single teacher school. Delhi (0.1
per cent) and Gujarat (2.0 per cent) have low proportion of single teacher
schools in the year 2016-17.
Some of the basic facilities in schools also influence the educational

development. These facilities include toilet facility, drinking water, girl’s
toilet facility, condition of school building. In India 96.5 per cent of schools
are having girl’s toilet facility. Also, in terms of drinking water facility a very
low variation was found among states. In terms of electricity facility about 60
per cent schools have electricity connectivity. States with a high proportion
of schools with electricity connectivity are Delhi, Gujarat and Haryana
(registering 94 to 99 per cent of schools) whereas states with low proportion
of school with electricity connectivity were Assam, Madhya Pradesh, Jammu
and Kashmir and Jharkhand (ranging from 20 to 35 per cent of schools).
One of the important indicators of education is the pupil-teacher ratio (PTR).

The higher the PTR, the lower the quality of education imparted to children.
PTR in India as a whole was 23 whereas states registering highest PTR were
184
Bihar (45), Jharkhand (32) whereas states showing low PTR were Himachal Regional Disparity in
India: Policy
Pradesh, Jammu and Kashmir and Punjab (below 16). Implications
To sum up, the above brief review helps to bring out that (i) the existing
social infrastructure in India is weak and inadequate, and (ii) wide disparities
prevail between different states.
Health Infrastructure
The availability of health infrastructure shows the status of health sector in
the country. The total sub-centres per million population in rural India was
179. The states showing higher number of Sub-centres were Kerala (458),
Jammu and Kashmir (325) whereas states showing lowest Sub-centre per
million population were Bihar (95), Jharkhand (138) (Refer Table 4 in
Appendix 24.1).
The primary health centre (PHC) per million population in India is 28. The
state showing the highest number of PHCs were Himachal Pradesh (89)
followed by Kerala (72) whereas states showing least number were
Jharkhand (11) and Bihar (18). The availability of doctors in PHCs per
million population was 34 in India and a large variation was found among
states. States having the highest number of doctors was Kerala (130)
followed by Jammu and Kashmir (99) and states having lowest were
Jharkhand (12) and West Bengal (13). The Auxiliary Nurse Midwife (ANM)
particularly in rural areas plays important role in facilitating health services
as well as imparting general health awareness. The number of ANM per
million population in India was 266 and states having the highest number of
ANM were Kerala (638) followed by Andhra Pradesh (343). States showing
the lowest number of ANM per million population were Uttar Pradesh (169)
followed by Madhya Pradesh (201).
24.6.2 Physical Infrastructure

The physical infrastructure includes transport, communication, electricity etc.
As observed earlier in Unit-4, India suffers from inadequate availability of
physical infrastructure, as measured by any accepted indicators. Not only is
infrastructure inadequate and weak, it varies from state to state, and even
within each state from district to district.
The per capita consumption of electricity is one of the important indicators of

development. In 2018, the per capita electricity consumption for India was
1181 kWh, which is quite low when compared with many countries like
Canada kwh 15438 kWh, USA 13098 kWh, Saudi Arabia 10239 kWh. The
per capita electricity consumption by states, shows a huge disparity between
the various states. The developed states like Gujarat (2378 kWh), Haryana
(2082 kWh), Punjab (2046 kWh) show the highest per capita consumption of
electricity. The states like Bihar (311 kWh), Assam (341 kWh) show the
lowest consumption. The ratio of consumption of electricity between Gujarat
and Bihar was more than 7 times.
185
Major Issues
Confronting Indian India 1181
Economy Bihar 311
Assam 341
Uttar Pradesh 606
West Bengal 703
Kerala 757
Jharkhand 938
Madhya Pradesh 1084
Rajasthan 1282
Jammu & Kashmir 1322
Karnataka 1396
Himachal Pradesh 1418
Maharashtra 1424
Uttarakhand 1467
Andhra Pradesh 1480
Delhi 1548
Odisha 1628
Tamil Nadu 1866
Telangana 1896
Chhattisgarh 1961
Punjab 2046
Haryana 2082
Gujarat 2378
0 500 1000 1500 2000 2500
Fig. 24.6: Per Capita Electricity Consumption, 2018-19
Source: Electricity Authority of India

1) Name the states where agriculture sector’s contribution in GSDP have
declined since 1980-81.
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
2) What are implications of relatively lower decline in the share of
agricultural sector’s workforce to total workforce of a state relative to
the decline in the share of agriculture sector SDP in that states GSDP?
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
186
3) State whether regional disparities in industrial development have Regional Disparity in
India: Policy
declined over time. Implications
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
4) State the indicators of educational and health development.
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
24.7 HUMAN DEVELOPMENT AND REGIONAL

DISPARITY
Talking of the disparity in Human Development Index (HDI), Kerala (0.779)
maintained the first place in 2018 followed by Delhi (0.746) (refer Table 5 in
Appendix 24.1). On the other hand, the states showing the lowest position in
HDI were Bihar (0.576) and Uttar Pradesh (0.596).
Over the period of analysis, the states Delhi, Kerala, Punjab were the states
which were maintaining their position in the upper strata in the HDI index
whereas the states Bihar and Uttar Pradesh were the states which remained in
the lower strata of HDI index (UNDP HDR different years1).
24.7.1 Causes of Regional Disparities

In India – just and in majority of the developing world – regional disparities
date back primarily to the colonial rule. It was at that time that the areas lying
farther away from the seacoast began to fall behind those close to it, though
the differences in the state of development were also influenced by other
factors which cannot be attributed to the colonial period alone. The important
factors can be summarised as follows:
1) Disparities in per capita income can be explained in terms of the

economic sector thesis of Colin Clark; it maintains that the levels of
income are higher in those regions where a larger proportion of working
population is engaged in manufacturing and tertiary sectors. Per capita
1 Downloaded from
https://globaldatalab.org/shdi/shdi/IND/?levels=1%2B4&interpolation=0&extrapolat
ion=0&nearest_real=0 187
Major Issues income has tended to be higher in those States where a larger proportion
Confronting Indian
Economy of population is engaged in tertiary occupations.
2) Location pattern of industrial growth in the past had been influenced by

the early pattern of railway construction. These centres of industrial
location, therefore, in conformity with Gunnar Myrdal’s thesis, have
attracted a considerable portion of industrialisation towards themselves
because of conglomeration economies.
3) Historically, the developed states have had relatively more efficient

systems of governance in terms of skills, responsiveness, and quality of
delivery systems. Unlike capital – which is highly mobile across regions
and continents – good governance cannot be transplanted in an area, as it
evolves basically within the prevailing socio-political structure over a
long period. An outmoded social structure can never bring about or
sustain good governance in the modern sense. On the contrary, it can
frustrate exogenous attempts at good governance by its debilitating and
corrupting influence.
4) A related historical factor has been the development of infrastructure.

The better developed regions owe it to their inbuilt infrastructure dating
back to the time when they were still princely states. In other regions the
princely states did not pay much attention to the development, priding
themselves on being messengers of God or something believing they
were born to rule.
5) Similarly, in more recent times, there has been substantial decline in the
government’s budgetary support for financing infrastructure. Developed
states and, especially large cities and towns have been the major
destinations for domestic institutional funds as well as external
assistance.
6) Operations of the term-lending institutions as also the commercial banks

have also shown a distinct tendency towards concentration of
investments in the relatively more developed States.
Subsidised lending by banks for financing priority credit and refinancing

facilities given by financial institutions have helped the richer states to
gain greater access to investible funds at subsidised rates.
Likewise, the approach of full cost recovery for urban basic services and
strict financial discipline on state governments by the RBI has resulted in
the further concentration of funds in the developed states and larger
cities.
7) There exist glaring regional imbalance and disparity among different

states in the country in the provision of educational and training
facilities, specially the technical education.
8) Operations of the system of public finance in the country have also

contributed to the creation and aggravation of inter-State disparities.
188
 In the low income States, the level of public investment, Regional Disparity in
India: Policy
infrastructural growth and standard of administrative services are Implications
lower compared to those in the high income States, thus perpetuating
disparities.
 The system of sales taxation enabled the richer states to export a
significant portion of their tax burden to the residents of poor states.
 Subsided lending to the states from the Central Government has led
to regressive inter-governmental transfers.
9) With increasing globalisation, India has chosen a skill-intensive path to
growth; wages for skilled labour are already being bid up. In this
situation, it is necessary for firms to have scale to ensure the proper use
of scarce skilled labour. But it is only in the fast-growing state that the
environment and infrastructure exist for scale. This further identify
disparities.
10) In the pre-reform period, the public sector had played a crucial role in
maintaining regional equality by directing resources to backward areas.
With a change in the focus of the public sector following the reforms,
this process has become weaker.
The economic reforms gave greater freedom and impetus to the private sector
and export-oriented production. These sectors, which were attempting to
reduce costs and become competitive, were attracted to areas that were
relatively more developed. As a result, investment and activity shifted to
these areas, strengthening the forces of divergence.
In short, the richer states are rich because of relatively developed
infrastructure and higher infrastructure spending. A positive significant
correlation is observed between infrastructure and real per capita gross state
domestic product across states.
24.8 MEASURES TO REMOVE REGIONAL

DISPARITIES
The Convergence Theorem postulates that when the growth rate of an
economy accelerates, initially some regions with better resources would grow
faster than others. But after some time when the law of diminishing marginal
return sets in, first growth rates would converge, due to differential marginal
productivity of capital (higher in poorer regions and lower in richer regions),
and this in turn would bridge the gaps in the level of income across regions.
However, in India, as brought out above, there is no conclusive evidence of

convergence so far.
The various programmes undertaken to remove/reduce regional disparities

can be identified as follows:
1) Resource Transfers from the Centre to the States, Weighed in

Favour of Backward States: The resource transfers, take place via the
Finance Commission in the form of plan and non-plan transfers. The
189
Major Issues location of Central projects and Centrally-sponsored schemes are
Confronting Indian
Economy determined in the planning process by the NITI Aayog in collaboration
with the relevant wings of the Government. A good initiative taken by
Government of India to develop backward area is the ‘Aspirational
Districts Programmes’ (ADP). The ADP are those districts which are
affected by poor socio-economic indicators. The improvement of these
districts can lead to a overall improvement in human development in
India. A total of 115 districts were identified from 28 states, at least one
from each state. In this initiative all the ministries have assumed the
responsibility to drive the progress of the identified districts. The
development is being monitored by the real time progress through
updating the database of development indicators. The five areas in which
development taken place are Health and Nutrition, Education,
Agriculture and Water Resources, Financial Inclusion and Skill
Development, and Basic Infrastructure. The broad contours of the
programme are convergence, collaboration and competition.
2) Priority given to Programmes which spread over the entire Area

within the Shortest Possible Time: Programmes of agriculture,
community development, irrigation and power, transport and
communications and social services have the widest coverage, and aim at
providing basic facilities and services to people in all the regions. Since,
these programmes are included in State plans, it is largely through the
shape given to State plans and the changes through which they pass in
the course of the plan period that the benefits of development are carried
to every part of the country.
3) Provision of Facilities in Areas which Lag Behind Industrially:
River valley projects from the most important segment in the plans of
several States and large investments have been made in multi-purpose
projects. These and other projects are essential for the development of
vast regions in the country, some of which suffer from scarcity or
unemployment or are otherwise poorly developed. The implementation
of agricultural production and community development programmes, and
of education and health schemes also carries the benefits of development
to the remotest areas.
4) Programmes for the Expansion of Village and Small Industries:

Village and small industries are spread all over the country and various
forms of assistance provided by the Central and State Governments are
made available in the areas according to programmes which are
undertaken. Industrial estates have been set up in all States, and
increasingly, they are being located in smaller towns and rural areas.
5) Diffusion of Industrial Activity:In the location of public sector

projects, the claims of relatively backward areas have been kept in view
wherever this could be done without giving up essential technical and
economic criteria. The location of several important projects has been
determined on the basis of expert study and on economic considerations.
But as they are situated in areas which were hitherto industrially
190 backward, the latter will benefit.
While in the selection of sites for basic capital and producer goods Regional Disparity in
India: Policy
industries, proximity to raw materials and other economic considerations Implications
have naturally been important, it is felt that in a wide range of consumer
goods and processing industries, it is possible to foster a regional pattern
of development.
To some extent, the development of new processes and new uses of raw
materials has assisted in the spread of industry. In encouraging such
development, care has of course to be taken to ensure that a balance is
maintained between regional distribution and considerations of economy
in production.
6) Schemes for Development of Backward Areas:The present policy for

the development of backward areas comprises a set of special schemes
under which plan funds are provided over and above the funds allocated
for general sectoral programmes. The special schemes can be classified
as follows:
 Schemes focusing on areas with special features (the desert

development programme, the drought-prone area programme, the
command area development programme, the hill area development
projects and sub-plans, the North Eastern Council set-up, and the
tribal area sub-plans and tribal development agency projects). Also
central assistance for special area programmes such as Hill Area
Development Programme (HADP) and Western Ghats Development
Programme (WGDP), Border Area Development Programme
(BADP) are the targeted area development programmes.
 Schemes focusing on target group (small farmers’ development

agencies and the special component plan for Scheduled Castes).
 Schemes providing incentives and concessions for particular

activities in backward areas (concessional finance from financial
institutions, tax relief, investment subsidy, transport subsidy, and
priority in raw material allocations and hire-purchase of machinery,
for industries located in 246 backward district/areas, and relaxed
viability and loan repayment terms for extensions of electricity by
the Rural Electrification Corporation in backward areas).
24.8.1 Major Limitations

1) A great drawback of all schemes is that there is hardly any feedback
about the actual physical progress of these schemes in the field. There is
a widespread feeling that most of the plans are paper plans without
techno-economic teeth and without a corresponding real action on the
ground. Leakage of vast funds into the bureaucracy itself and/or the
local oligarchy is also suspected.
2) Although the amounts of funds earmarked for area development schemes
nominally appear to be large, the total development outlays per capita
191
Major Issues available to less-developed areas remain small in comparison with those
Confronting Indian
Economy in the more developed regions.
3) The effects of industrial and transport subsides remain unevaluated. But

the scrappy evidence available suggests that subsidies have an
inducement effect only if basic infrastructure is accessible.
4) There was no uniformity and consistency of norms for identification of

backward areas from different States and Union Territories for either
income tax concession or Central investment subsidy scheme and
licensing. As a result, the existing procedures for selection of backward
areas may have detracted from the potency of the provision in promoting
the growth of regions and areas which were backward in all India
perspective.
24.9 WAY FORWARD

A recent study on the subject suggests following measures, per se, for
balanced regional development:
1) Investment in agriculture needs to be stepped up especially in the lagging

regions. The backward and forward linkages of agriculture in poorer
regions need to be emphasised more. Investment in water harvesting,
soil conservation, rural roads, warehouses, processing activities and
promotion of high value crops should be emphasised. Since agricultural
growth is found to be different in different regions, steps to equalise it
will certainly reduce the regional imbalances.
2) Service sector has been found to be the new driver of the growth process,
the banking and insurance sector and infrastructure have contributed to
acceleration of growth in many states. There is a need to promote these
sectors, on priority, in backward regions.
3) Improvement in basic infrastructure facilities like power, transport,

telecommunication, and irrigation in backward states is a precondition to
improve the quality of life of people and to usher in sustainable
development in them. Availability of assured power supply, developed
transport system and modern telecommunication facilities are important
factors to attract private investments in these states.
4) Devolution of financial Resources: The formulae according to which

Centrally-collected resources are transferred to the States should be made
steadily more progressive. The 14th Finance Commission considerably
increased the devolution of tax from centre to states from 32 per cent to
42 percent. The different criteria followed for devolution of finance from
centre to states are (a) population, (b) area, (c) income distribution, tax
collection, (d) forest cover etc. Besides the taxes devolved to states,
another source of transfers from the centre to states is grants-in-aid. As
per the recommendations of the 14th Finance Commission, grants-in-aid
constitute 12 per cent of the central transfers to states. The grant in aid
192
as recommended by 14th Finance Commission, are for three purposes Regional Disparity in
India: Policy
such as: (i) disaster relief, (ii) local bodies, and (iii) revenue deficit. Implications
Further, it needs to be pointed out that backward regions within states are
not considered when Centre-State transfers are set. Moreover, it is not
the fact or size of such transfers that affects poverty but how such
transfers are used. In view of this, it is necessary that unit of resource
allocation ought to be district rather than States, with highest priority
given to the most backward districts. Here also instead of spreading the
butter too thin by scattering funds and concessions all over the place, it
could be more beneficial to concentrate on intensive resource
deployment by identifying the priority investment areas on the basis of
industrial backwardness.
5) Direct public sector investment by the Central Government in the states
is likely to dry up gradually due to severe budget constraint of the
Centre. Under the above circumstances, and important factor that
influences the economic progress of a state is the quality of governance
and the state level policy environment. A better administered state is
more efficient in raising revenues and putting them to better use. They
are the states, which will attract more investment both from domestic and
foreign sources. Such states are also in a position to prepare viable
projects and successfully bid central assistance or external funding.
Hence, governance needs to be given immediate attention, especially in
the backward states.
6) In the coming years, a key factor affecting choice of location in

investment decision-making will be environmental policies of states.
Global rules and agreements are creating demand for a coherent set of
policies related to the environment, particularly for the extractive
industries such as oil and metals. The states need to pay more attention
to this aspect.
Ultimately, the key to balanced regional development lies not merely in

increasing resource flows to backward regions but in creating an enabling
environment to attract more resources, using them properly and assuring a
fair deal to investors. The overall investment climate and governance need to
be upgraded.

1) List the causes of regional disparities.
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
193
Major Issues 2) State the role of term-lending institutions in narrowing down the regional
Confronting Indian
Economy disparities.
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
3) What are some of the steps taken by Govt. of India towards removing
regional disparities?
…………………………………………………………………………….
…………………………………………………………………………….
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…………………………………………………………………………….
…………………………………………………………………………….
24.10 LET US SUM UP

Regional disparity in India has been a major challenge for planners and
policymakers. Despitea number of development programmes overtime,
regional disparities have persisted. Regional disparities are observed in
growth rates, per capita SDP, per capita consumption expenditure, sectoral
contribution to GSDP, agricultural development, Industrial development,
infrastructural development and also in human development outcomes. The
important factors responsible for regional disparities are: variation in the
occupational structure of workers, historical factors like variation in
infrastructure development, decline in budgeting support for financing
infrastructure, financial institutions, provision of education and training
facilities etc. Various programmes have been launched towards removal of
regional disparities. However, all these schemes and programmes have
suffered from several limitations and a lot need to be done for ensuring
balanced regional development.

1) In the context of regional disparity, what do you mean by multiplier
accelerator mechanism? How will you examine the regional disparities
of a country?
2) What do you mean by the term regional disparity? Examine the sectoral
disparities in India.
3) Empirically examine the role of infrastructural development in
explaining the regional imbalances in India.
4) Critically evaluate the various steps taken by Govt. of India towards
removal of regional disparities. Which suggestions would you like to
194 overcome the problem of regional imbalances?
24.12 KEYWORDS India: Policy
Implications
Regional Disparity : ‘Regional disparity means divergence or

inequality of characters, phenomena or
processes having specific territorial allocation
(can be allocated in defined territorial structure)
and occurring at least in two entities of the
territorial structure’.
Backwash Effect and : Once economic and social forces occur in
Spread Effect favoured region development produce a state of
disequlibrium. According to Myrdal once an
economy obtains a growth advantage it will tend
to keep it. The cumulative movements of labour,
capital, and trade which tend to economically
weaken region were termed backwash effects.
The benefit of trade will accrue to the host
region. The spread effect or positive externalities
is that such a new growth stimulus might induce
other region, such as increased demand for
backward areas product, diffusion of technology
and knowledge. However, the spread effects are
weaker than backwash effect, and interregional
differences remain widen.
GDP and NDP : Gross domestic product (GDP) refers to the
market value of all final goods and services
produced within a country in a given period. The
net domestic product (NDP) equals the gross
domestic product (GDP) minus depreciation on
a country’s capital goods.
The credit-deposit : The credit-deposit ratio is one of the most
ratio widely used banking indicators for analysing the
role of banks in promoting productive sectors
and contributing to economic growth. In a bank-
based financial system, the CD ratio assumes
greater significance as an aggregative measure
for gauging the effectiveness of credit delivery
system. Higher the CD ratio implies for greater
credit orientation of banks.
Human Development : The Human Development Index (HDI) is a
Index composite statistic used to rank countries by
level of “human development”, taken as a
synonym of the older term standard of living.
This is a comparative measure of life
expectancy, literacy, education and standards of
living.
195
Major Issues
Confronting Indian 24.13 REFERENCES
Economy
1) Vorauer, K. Europäische Regionalpolitik Regionale Disparitäten.
Theoretische Fundierung, empirische Befunde und politische Entwürfe.
Passau: Münchener Geographische Hefte, (1997). ISBN 3-932820-01.
2) Alois Kutscherauer, Hana Fachinelli, Miroslav Hučka, Karel Skokan, Jan

Sucháček, Petr Tománek, Pavel Tuleja, (2010). ‘Regional disparities in
regional development of the Czech Republic’, 2010WD-55-07-1, VŠB-
Technical University of Ostrava, Faculty of Economics.
3) Mera, K (1975). Income Distribution and Regional Development,

University of Tokyo Press, Tokyo.
4) Myrdal, Gunner (1957). Economic Theory and Underdeveloped Regions,

Gerald Duckworth and Co Ltd, London.
5) Hirschman, A(1958). The Strategy of Economic Development, Yale

University Press, New Haven.
6) Kuznets, S (1963). "Quantitative Aspects of the Economic Growth of

Nations, V111. Distribution ofIncome by Size", in Economic
Development and Cultural Change Vol Xl, No 2, Part 11, pp 1-45.
7) Bhattacharya BB, Sakthivel S (2004). Regional Growth and Disparity in

India: Comparison of Pre- and Post-Reform Decades. Economic and
Political Weekly, 39(10): 1071-77.
8) Kar S, Sakthivel S (2007). Reforms and Regional Inequality in India.

Economic and Political Weekly, 42(47): 69-77.
9) Puga D (1999). The Rise and Fall of Regional Inequalities. Eur. Econ.
Rev., 43: 303-34.
10) Kim S (2008). Spatial Inequality and Economic Development: Theories,
Facts, and Policies. Commission on Growth and Development Working,
Washington DC. 16.
11) Papola, T.S, Nitu Maurya, Narendra Jena(November 2011). Inter
Regional Disparities in Industrial Growth and Structure, Institute for
Studies in Industrial Development, New Delhi
12) Anjani Kumar, Sant Kumar, Dhiraj K. Singh and Shivjee (2011). ‘Rural
Employment Diversification in India: Trends, Determinants and
Implications on Poverty’ Agricultural Economics Research Revie, Vol.
24 (Conference Number) 2011 pp 361-372.
13) Postel, Sandra. (1999). Pillar of Sand: Can the Irrigation Miracle Last?,
New York & London: WW Norton & Company.
14) Lin Yang (2017). ‘The relationship between poverty and inequality:
Concepts and measurement, London School of Economics and Political
Science, CASEpaper 205/LIPpaper 2, downloaded from
http://sticerd.lse.ac.uk/dps/case/cp/CASEpaper205.pdf
196
24.14 ANSWERS OR HINTS TO CHECK YOUR India: Policy
PROGRESS EXERCISES Implications

1) See Section 24.2
2) See Section 24.2
3) See Section 24.3
1) See Section 24.4
2) See Section 24.4
3) See Section 24.5
1) See Sub-section24.7.1
2) See Section 24.8
3) See Section 24.8
197
Major Issues
Confronting Indian APPENDIX 24.1
Economy
Table 1: Share of Manufacturing Sector to Total GSDP
Growth 2011-12
State 2004-05 2011-12 2018-19
to 2018-19
2004-05
Price 2011-12 Price
Andhra Pradesh 11.5 13.4 10.3 3.3
Assam 10.5 10.8 15.3 12.9
Bihar 5.6 5.9 8.8 12.3
Chhattisgarh 21.9 15.4 14.5 4.7
Delhi 7.3 5.5 5.1 6.8
Gujarat 27.3 25.5 32.6 13.8
Haryana 21.4 17.9 21.0 11.1
Himachal Pradesh 11.5 24.8 29.9 10.1
Jammu & Kashmir 6.1 10.2 8.8 3.2
Jharkhand 33.7 20.0 19.8 5.8
Karnataka 18.4 16.0 16.5 9.7
Kerala 8.6 9.4 11.8 9.8
Madhya Pradesh 11.1 12.1 11.1 6.1
Maharashtra 20.6 19.2 20.3 7.7
Odisha 12.1 17.8 20.5 9.6
Punjab 15.1 14.1 13.7 5.5
Rajasthan 12.5 15.3 11.8 2.6
Tamil Nadu 19.8 20.2 22.0 8.4
Telangana 13.2 17.3 12.3 2.8
Uttar Pradesh 13.5 12.1 16.3 11.3
Uttarakhand 12.7 37.8 37.2 7.4
West Bengal 11.1 13.4 14.4 6.3
India 15.9 16.2 17.6 8.5
Source: www.mospi.gov.in
Table 2: Share of Service sector
2004-05 Price 2011-12 Price Growth Rate

State 2004-05 2011-12 2011-12 2018-19 2011-12 to 2018-19
Andhra
Pradesh 48.5 53.7 37.7 38.8 7.7
Assam 46.9 55.4 44.0 38.7 5.3
198
Bihar 54.7 56.6 54.3 57.7 7.1 India: Policy
Implications
Chhattisgarh 34.4 37.2 32.5 34.5 6.5
Delhi 80.5 88.2 73.6 73.6 8.0
Gujarat 43.9 46.7 32.9 30.8 8.8
Haryana 44.0 54.5 41.3 44.0 9.6
Himachal
Pradesh 36.1 42.6 37.2 38.3 7.5
Jammu &
Kashmir 43.7 54.1 52.0 53.4 5.8
Jharkhand 32.9 43.1 35.5 39.6 7.5
Karnataka 51.0 55.3 51.8 55.9 10.4
Kerala 59.6 68.0 53.1 56.0 7.1
Madhya
Pradesh 45.2 47.1 37.6 37.6 7.4
Maharashtra 59.6 62.3 45.7 49.4 8.1
Odisha 42.4 48.6 36.7 36.8 7.5
Punjab 42.6 47.6 41.7 45.6 7.2
Rajasthan 43.8 45.9 37.2 40.7 7.9
Tamil Nadu 57.2 61.0 46.6 46.3 7.0
Telangana 53.8 58.5 49.4 57.3 10.2
Uttar Pradesh 47.0 54.0 42.9 44.5 7.3
Uttarakhand 49.5 52.1 31.8 35.4 9.3
West Bengal 54.4 63.6 47.8 50.8 6.1
India 51.4 56.7 44.8 46.8 7.9
Source:www.mospi.gov.in
Table 3: Basic Infrastructural Facility in School, 2016-17
State Single Class Single Girls Drinking School Pupil-

Room Teacher Toilet Water with Teacher
School (%) School (%) (%) Electricity Ratio
(%) (%)
Andhra
Pradesh 13.0 14.1 99.7 94.8 93.2 19
Assam 18.5 7.2 79.8 87.7 20.2 18
Bihar 1.8 4.4 87.3 94.8 41.4 45
Chhattisgarh 2.2 5.6 99.5 99.3 69.5 20
Delhi 0.1 0.1 100.0 100.0 99.9 21
Gujarat 1.1 2.0 99.9 100.0 99.9 27
Haryana 0.8 3.9 99.4 99.9 97.3 18
199
Major Issues
Confronting Indian Himachal
Economy Pradesh 3.3 6.7 99.9 100 91.6 10
Jammu &
Kashmir 6.9 6.3 93.7 92.5 31.1 10
Jharkhand 0.8 17.1 97.9 96.1 31.3 32
Karnataka 3.3 8.3 96.1 98.5 95.6 27
Kerala 1.9 2.2 97.9 99.7 96.4 16
Madhya
Pradesh 3.1 13.3 95.0 96.4 27.2 23
Maharashtra 6.8 3.1 98.2 99.6 85.4 22
Odisha 9.2 2.4 95.8 99.8 33.1 19
Punjab 1.8 3.2 99.4 100 99.9 15
Rajasthan 2.7 12.4 99.0 97.5 58.3 18
Tamil Nadu 0.0 1.9 99.7 100 99.3 16
Telangana 9.3 12.6 96.3 99.2 87.9 21
Uttar Pradesh 0.7 5.6 99.6 98.7 41.5 31
Uttarakhand 1.2 8.2 95.4 96.2 72.5 15
West Bengal 5.1 4.2 97.6 98.4 79.1 21
India 4.3 7.2 96.5 97.1 59.8 23
Source: DISE www.dise.in
Table 4: Number of medical institutions per Million Population in Rural Areas

State Sub PHCs* CHCs Doctors ANM Sub
Centre* in PHCs center &
PHCs
Andhra Pradesh 216 33 4 50 343
Assam 159 32 6 66 395
Bihar 95 18 1 20 230
Chhattisgarh 244 37 8 15 320
Gujarat 253 41 10 60 253
Haryana 151 22 7 31 267
Himachal Pradesh 319 89 13 74 282
Jammu and
Kashmir 325 67 9 99 527
Jharkhand 138 11 6 12 227
Karnataka 258 56 5 56 224
Kerala 458 72 19 130 638
Madhya Pradesh 174 20 5 18 201
Maharashtra 166 28 6 46 339
Odisha 187 36 11 23 257
Punjab 166 23 5 32 254
200
State Sub PHCs* CHCs Doctors ANM Sub Regional Disparity in
India: Policy
Centre* in PHCs center & Implications
PHCs
Rajasthan 236 36 10 34 270
Tamil Nadu 239 39 11 49 274
Telangana 142 19 3 36 237
Uttarakhand 251 35 9 37 248
Uttar Pradesh 121 17 4 18 169
West Bengal 165 14 6 13 302
India/Total 179 28 6 34 266
*Including health and wellnesss Centres
Source: Rural Health Statistics 2018-19, Ministry of Health and Family Welfare
Table 5: State-wise Value and Rank of Human Development Index, 1990-2018

1990 2000 2018
State Value Rank Value Rank Value Rank
Andhra Pradesh 0.424 17 0.478 18 0.650 14
Arunachal Pradesh 0.437 16 0.502 16 0.660 13
Assam 0.411 18 0.488 17 0.614 17
Bihar 0.378 23 0.436 23 0.576 23
Chhattisgarh 0.562 4 0.564 7 0.613 18
Gujarat 0.470 12 0.527 13 0.672 11
Haryana 0.467 13 0.549 10 0.708 5
Himachal Pradesh 0.479 10 0.589 5 0.725 3
Jammu and
0.493 0.528 0.688
Kashmir 8 12 8
Jharkhand 0.562 4 0.564 7 0.599 21
Karnataka 0.444 14 0.518 14 0.682 10
Kerala 0.544 6 0.598 4 0.779 1
Madhya Pradesh 0.406 19 0.460 21 0.606 19
Maharashtra 0.493 8 0.558 9 0.696 7
New Delhi 0.577 3 0.664 1 0.746 2
Odisha 0.400 21 0.458 22 0.606 19
Punjab 0.496 7 0.578 6 0.723 4
Rajasthan 0.403 20 0.469 19 0.629 16
Tamil Nadu 0.471 11 0.542 11 0.708 5
Telangana 0.622 2 0.627 3 0.669 12
Uttar Pradesh 0.397 22 0.463 20 0.596 22
Uttarakhand 0.629 1 0.630 2 0.684 9
West Bengal 0.440 15 0.505 15 0.641 15
India 0.431 0.498 0.647
Source: Different reports UNDP
201
Major Issues
Confronting Indian UNIT 25 INGREDIENTS OF GOOD
Economy
GOVERNANCE
Structure
25.0 Objectives
25.1 Introduction
25.2 Governance
25.3 Good Governance
25.4 Variants and Versions of Good Governance
25.5 Dimensions of Good Governance
25.6 Governance in India
25.7 Let Us Sum Up
25.9 Key Words
25.10 References
25.0 OBJECTIVES
● explain the meaning of governance and its importance;
● narrate the evolution of definition of good governance;
● discuss the features of good governance;
● examine the dimensions of good governance; and
● describe the state of governance in India.
25.1 INTRODUCTION
Good governance is a phrase that emerged at the close of 1980s in a World
Bank report but got soon incorporated and developed by other international
development aid and cooperation agencies such as the United National
Development Programme (UNDP), the Organisation for Economic
Cooperation and Development (OECD), and the International Monetary Fund
(IMF). In view of some scholars it was a shift in the paradigm from ‘getting
market right’ to ‘getting institutions right’ in the approach of aid agencies.
A study by a World Bank team in the late 1980s on countries in Sub-Saharan

Africa came to a conclusion that, among the reasons for non-success of
development projects funded by multilateral organisations was the lack of
good governance. It may be recalled that during 1980s and to some extent in
1990s international aid agencies had attached conditionalities in terms of
202 stabilisation policies and structural adjustment programmes while providing
Ingredients of
aid, which entailed increase in scope of private sector and market along with Good Governance
curtailment of government and public sector. But the results of these reforms
were found counter-productive in certain cases. By the end of 1990s, most of
the international development literature went on to emphasise the need to
end mal-governance in developing countries.
Naturally, debate on good governance was shaped by these international

organisations, such as the World Bank, the IMF, the OECD and the UNDP,
which have been major players in international development aid and
cooperation. A former UN Secretary General, Kofi Annan went to the extent
of saying that ‘good governance is perhaps the single most important factor
in eradicating poverty and promoting development’. Following this lead, an
UN agency for HABITAT asserted that ‘it is not just money or technology, or
even expertise, but also good governance that makes the difference…’ which
is sometimes stated as ‘...neither money, nor technology, nor even expertise,
but good governance that makes the difference.’
Slowly and steadily, national governments, sub-national governments, and

other vocal sections along with international aid and non-aid agencies
extended the idea of good governance to all public spheres and some private
spheres rather than just development projects.
What makes the difference when emphasis is put on governance rather than
government? The proponents of good governance assert that governance is
not the monopoly of the government. There are other actors and agencies in
the arena of governance of public affairs, which in their reckoning are both
private sector and non-governmental civil societies and there could be a
partnership between public and private and between government
departments/organisations and non-government organisations – which is
more than contractual. Nevertheless, what you have to note is that the agenda
across the spectrum continues to be neo-liberal in content and approach.
We can recall Adam Smith in 18th century and Henry Thoreau in 19th century
who had broadly suggested that the government should hold minimum role or
that government is the best, which governs the least. Prime Minister Narendra
Modi extended the idea in recent years by suggesting the phrase ‘minimum
government and maximum governance’. But all such references are limited to
the role of government. The idea is that societal affairs are not to be dealt
with by the government only. They are never dealt with only by the
government. However, the idea promoted by international development aid
agencies is also to diminish the scope of government, nay, the State. Yet,
there are agencies like United Nations Economic and Social Commission for
Asia and the Pacific (UNESCAP) which assigns the responsibility to the
government to promote good governance as its major responsibility.
While accepting the importance of good governance, most agencies decided

to fill the content and their approach to development practice generally
getting guided by their respective mandates and interests. While there is a lot
of convergence, there is significant divergence. Scholars and others also
proposed alternative phrases such as Humane Governance, Smart
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Major Issues
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Governance, Public Governance, or Democratic Governance – articulated
Economy somewhat differently.
With this in background, in this unit we propose to discuss different ideas of

governance and good governance, and deliberate on the variants, dimensions
and ingredients of good governance. In addition, a modicum of governance in
India will also be covered.
25.2 GOVERNANCE
The concept of governance is as old as human civilisation. But the term has
become fashionable in the last few decades. Thanks to international donor
agencies which found bad governance as the root cause of all evils and
insisted on reforms in governance as a major condition to providing aid, the
term acquired a new status in international development literature.
Governance surely goes beyond the activities of government. For instance,

there is no world government yet there exists some kind of a global
governance in many areas, for example, environment (UNEP), labour affairs
(ILO), and economy (WTO for trade and investment)—purportedly for good
governance in their respective spheres. Further, local government in an urban
area may be a municipal board but local governance allows existence and
operation of a local development authority outside the municipal board.
Outside the government, there exist Industry Chambers, Commerce
Chambers, Citizens Forums, Trade Unions, Farmers’ Unions, Professional
Associations (Medical Council, Chartered Accountants) Passengers
Associations, etc. These may well now be part of governance.
One can well imagine that public affairs predate the invention of State and
thus, governance predates government. It implies that a society is founded on
the rules it forms and follows in conduct of its affairs. Governance is thus
making of rules and making members follow those rules. As society becomes
complex, making of rules and ensuring that the rules are followed by its
members and groups also becomes complex. As far as a country is
concerned, government is a part, an essential part, of a State while
governance covers practically all public (and some private) affairs of the
State and thus involves non-state agencies. Governance has now become so
popular a word that it is used in several other contexts so much so that it has
been asserted that governance is important to all organisations and entities,
including corporates, non-governmental organisations (NGOs), and
international relations.
In the context of a country, one finds a wide variety of definitions of

governance. One can appreciate that government decisions are influenced by
political parties, lobbies, chambers, advocacy groups, think tanks, and the
media. Governance may therefore be defined as the dispensation by which
rules, norms and actions are structured, sustained, and regulated. Governance
may assume several forms, driven by different motivations and may produce
different results. For instance, there may be a governance system whereby
citizens decide as to who should become a part of government. The
204 Commission on Global Governance (CGG) therefore puts, in 1995,
Ingredients of
governance as ‘the sum of the many ways individuals and institutions, public Good Governance
and private, manage their common affairs’.
Some scholars, though drawing from the literature from international aid
agencies, hold that governance comprises the mechanism, methodology and
institutions which help the citizens and groups to protect their interests.
Others articulate governance as institutionalised modes of coordination
through which collectively binding decisions are adopted and implemented
irrespective of hierarchical relationship. One can well see that there exists a
minimal normative dimension since it refers to institutionalised modes of
coordination that intentionally aim at the provision of certain collective goods
rather than serving individual self-interests. A variation may suggest
governance to cover processes, mechanisms, and practices that steer decision-
making and implement those decisions.
It would be interesting to see evolution of the concept of good governance

within an agency itself. The World Bank which started identifying good
governance as the manner in which power is exercised in the management of
a country’s economic and social resources. A little later it suggested
governance as the exercise of political authority and the use of institutional
resources to manage society’s problems and affairs. Still later, it equated
good governance with ‘(i) the form of political regime; (ii) the process by
which authority is exercised in the management of a country’s economic and
social resources for development; and (iii) the capacity of governments to
design, formulate, and implement policies and discharge functions’. By 2002,
good governance was to include ‘all rules, enforcement mechanisms and
organisations’. In between, in 1996, the initiators of the Worldwide
Governance Indicators (WGI), as they admit, struck a middle path, by
defining it as ‘the traditions and institutions by which authority in a country
is exercised’. Bank could not yet hold back from recommending to foster
more local ownership and decentralisation as well as the encouraging of civil
society institutions and participatory approaches. Thus, the bank seeks to
promote effective government within good governance.
International Monetary Fund (IMF) proposed to promote ‘good governance
in all its aspects, including ensuring the rule of law, improving the efficiency
and accountability of the public sector and tackling corruption’. These are
considered essential elements of a framework within which economies can
prosper. Around the same time, the OECD (organisation for economic
cooperation for development) came to accept governance as ‘the use of
political authority and exercise of control in a society in relation to the
management of its resources for social and economic development’. OECD
referred to good governance as the rule of law, efficient public sector
management, controlling corruption and reducing excessive military
expenditures. It did not ignore the political dimension and paid attention to
the linkages between good governance and political principles, such as
participation, human rights and democratisation. The OECD suggested that
the democratic elements of good governance were not only a prerequisite for
development, but also as ‘values in their own right’. Good governance has
205
Major Issues
Confronting Indian
thus to have not only effective government but effective and democratic
Economy governance.
The UNDP, an UN agency with development concerns, came to dwell on the

issues of good governance in 1997 and 1998. Taking off from the World
Bank’s conception, it viewed governance as ‘the exercise of economic,
political and administrative authority to manage a country’s affairs at all
levels’ and thus does not ignore political dimension. Rather, it further
explicates political dimension by holding that governance ‘comprises the
mechanisms, processes, and institutions through which citizens and groups
articulate their interests, exercise their political rights, meet their obligations
and mediate their differences’. Thus, the UNDP seeks to promote the
interaction among these actors in order to reach sustainable human
development. However, a regional UN agency, the UNESCAP chooses to
define governance as a process – the process of decision making and the
process of implementing decisions – without mentioning mechanisms and
institutions. Thus, definitions of general governance for a country cover from
narrow to broad canvass and differ from author to author.
There are others who go beyond the country level governance. For example,
the UN Global Compact suggested that governance is the systems and
processes that ensure the overall effectiveness of an entity– whether business,
government or multilateral institution. Governance concerns after all framing
and operation of rules.
Thus, governance presupposes existence of institutional arrangements

whether traditional, formal or informal and exercise of power bestowed on
these institutions to make decisions and implement them, irrespective of the
field, level, and organisation. Yet, one can also talk of meta-governance that
is ‘governing of governing’. One can attribute different meanings to the
phrase of meta-governance, depending on the context, like the Constitution of
a Country or value system behind customary laws, or the principles behind
practices.

1) Differentiate between governance and government.
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
2) How do international agencies differ in conceptualising governance?
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
206
Ingredients of
3) What could be meant by meta-governance? Good Governance
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
25.3 GOOD GOVERNANCE

Whether governance, irrespective of context, is good or bad, fair or foul,
proper or faulty, smart or dull, ethical or unethical, and healthy or poor, is an
important issue. But such notions are normative and this is what differentiates
good governance from governance. Philosophically, governance itself must
have been evolved to conduct societal affairs in certain desirable directions. It
is true that norms may differ somewhat from society to society and within a
society from time to time. Fair governance, good governance, sound
governance, humane governance, and effective governance are expressions of
normative notions of governance in a positive direction and have clear
prescriptive connotation. Since norms are expressions of a people’s social
preferences, howsoever aggregated, good governance is expected to ensure
these preferences into political decisions.
Goodness of anything is defined by certain parameters. Whether a man is a

good man is determined by certain qualities. People might differ on what
those qualities are, yet it is expected there exists a universal set of core
values. The same is true of good governance. One scholar, perusing
international development literature on good governance, found it so
confusing as he discovered that good governance may mean so many
different things to different organisations and to different actors within these
organisations. For instance, human rights scholars will look from that angle
and UN Human Rights agency actually asks: Are the institutions of
governance effectively guaranteeing the right to health, adequate housing,
sufficient food, quality education, justice and personal security? IMF would
prefer to dwell on those institutions and processes which concern foreign
exchange and trade. Good governance may thus have endless concerns and
definitions that it becomes difficult to find a core.
However, some scholars have chosen to define good governance as

‘legitimate, accountable, and effective ways of obtaining and using public
power and resources in the pursuit of widely accepted social goals’, thus
linking good governance with the rule of law, transparency and
accountability, and partnerships between state and society, and among
citizens. Others referred to it as ‘all kinds of institutional structures that
promote both good substantive outcomes and public legitimacy’. Thus, some
prefer to put emphasis on the process and others on the institutions while
both sets of scholars refer to outcomes. Again, whether legitimacy is about
the process or inputs or about outputs and outcomes. The literature offers
different conceptualisations of good governance, in which the political 207
Major Issues
Confronting Indian
content of good governance varies and is controversially discussed. Narrow
Economy definitions confine themselves to administrative processes and broad
definitions cover all political aspects from formation and constitution of
different government wings to decision-making process involving all
stakeholders and implementation of those decisions. Showing its disgust with
the focus of good governance being on ‘almost exclusively on economic
processes and administrative efficiency,’ the UNDP, since 2002-HDR and
thereafter, preferred to use the term ‘democratic governance’, perhaps, in
order to draw even more attention to the political dimension.
As indicated earlier, the term of good governance originated in international

development literature sponsored by several multilateral agencies that are
interested in economic development and particularly in poverty eradication.
Though general ends are similar, they differ in details of normative ends.
Therefore, unsurprisingly, different organisations are found to define
governance and good governance somewhat differently. For instance, human
rights agencies will look from rights perspective while financial agencies will
be more concerned with accountability and corruption. Yet, they all
deliberate on how public institutions ought to conduct public affairs and
manage public resources.
Taking the cue from UNESCAP’s definition in terms of the process of

decision making and the process of implementing decisions, good
governance can be better defined as effectiveness and efficiency in the
process of decision making and the processes by which decisions are
implemented. This is how Centre for Good Governance in India attempts to
define it in its report on Good Governance Index: Assessment of State
Governance. But it is a narrow approach as it does not explicitly state the role
of non-state agencies.
Finally, the debate whether means have to be legitimate or the ends have to
be legitimate or legitimate ends justify the means, will continue. For Gandhi,
means had to be pure and, for Marx or Mao, ends justified the means. So,
some definitions will look towards processes whether they are legitimate and
follow rule of the law while others will look towards outcomes as to how
good they are there. Some definitions (in fact, agencies and scholars) have
tendency to mix up the two. Therefore, despite wide usage of the term, its
meaning and scope are not always clear. While this flexible position enables
one to have a contextual application, the very lack of conceptual clarity is a
source of some difficulty. Some scholars found good governance to have
become a “one-size-fits-all” buzzword lacking specific meaning and content.
Yet, it is better to have many ways to look at rather than none.

1) Which agency started the campaign for good governance and why?
……………………………………………………………………………
……………………………………………………………………………
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208 ……………………………………………………………………………
Ingredients of
2) Why are there so many definitions of good governance? Good Governance
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3) Differentiate between input legitimacy and output legitimacy.
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25.4 VARIANTS AND VERSIONS OF GOOD

GOVERNANCE
The previous sections, though quite enlightening, leaves an impression that
good governance is almost an indeterminate term even in international
development literature. Generally speaking, it is about the quality of conduct
of public affairs and management of public resources by public institutions –
including authorities, they differ on normative accounts, which are often
justified on the grounds that they are thought to be conducive to promote
certain ends. There ought to be no surprise on the state of affairs in this
context.
There is another set of literature which is less confusing which propose

democratic governance, public governance, Humane Governance, SMART
Governance. We choose to discuss the latter two.
Humane Governance
Though the term ‘humane governance’ was proposed long back by a political
scientist Rajni Kothari in 1987, in the context of paradoxes that existed and
exist in the contemporary times. Pointing towards ‘paradoxes of
overproduction and scarcity, of information explosion and increasing
ignorance, of proliferation, of commodities and shrinkage in nature’s
diversity, of affluence and poverty, of liberalisation and human rights
violation, of States that are at once too strong and too vulnerable’, he finds
‘ecocide and ethnocide are no longer imaginary scenarios created by
doomsday prophets’. Written for some Committee for a Just World Peace, he
bemoans the marriage between the State and the corporate business, and gave
a call for moving from government of humans to humane governance.
Subsequently, the phrase was used in the context of good global governance
as if to reform the United Nations.
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Major Issues
Confronting Indian
The Mahbub-ul-Haq Human Development Centre in 1999 took human
Economy development perspective and viewed Humane Governance as good
governance that seeks to secure human development. Holding ownership,
decency, and accountability as the bedrock principles of humane governance,
it unfolds Humane Governance into political, economic, and civic (instead of
social) dimensions. Good political governance seeks riddance of the state
from interest groups, lobbyists, and politicians with short-sightedness (and so
are the voters interested in low taxation, high private gains, and freebies and
civil servants who are interested in building their own empires.) Good
political governance would seek to include:
1) Decentralisation and deconstruction of power to afford people ample

opportunities to participate in decision-making.
2) Accountability and transparency of elected representatives and public

officials.
3) Full access of all citizens to prompt and affordable justice.
4) Elimination of all forms of discrimination, and
5) Maintenance of peace and social cohesion within and between states.
Humane Governance proponents accept that role of government has

increased over time. Despite classical and neoclassical economists’
reservations, they point out, ratio of government expenditure to GDP in the
OECD countries has increased from 10 per cent in 1913 to 20 per cent in
1937 to 50 per cent by 1995. Even in the developing countries, the central
government expenditure has risen from 15 per cent of GDP in 1960 to 30 per
cent by 1985. Yet, they point out, fiscal crisis has not been unknown and
governments have miserably failed in directly productive activities and thus
state’s capability has been found inadequate to its responsibility. Therefore,
while accepting the inevitability of neo-liberal order, the proponents of
human development seek good economic governance in terms of those
competitive policies that make market a fairer place by insisting on
elimination of discrimination against weaker sections including women. In
addition, good economic governance also seeks sufficient budgetary
provisions for priority social sectors, progressive taxation and subsidy
systems, and equitable access to credit and land. Good political and economic
governance would entail strong institutions as institutions finally determine
the efficiency of market functioning.
Economists and political scientists have largely been ignoring the civic
dimension in which individuals, families, and communities frequently
operate. As freedom to form association is a basic human right and very often
a constitutional one, business associations, trade unions, religious
organisations, and various forms of NGOs (such as voluntary associations,
community-based organisations, philanthropic trusts, and research
foundations) have a definite and distinctive role in self-help, self-initiative,
and self-development. In erstwhile Soviet Union, this was completely
missing. Flourishing civic organisations will not only assert for rights but
also engender responsibility. Self-policing is the best policing.
210
Ingredients of
It is rightly suggested that each of the three dimensions are complementary to Good Governance
the other two; they are intractably linked; and they together achieve human
governance.
SMART Governance
However, in India, acronym SMART was coined to denote Simple, Moral,
Accountable, Responsive and Transparent. SMART governance owes its
origin to politicians’ reliance on e-resources as their use was found to be
more dependable in terms of pace but also making rent-seekers less powerful.
E-governance is the vehicle through which SMART governance has been
sought to be achieved.
The Eleventh Report of Second Administrative Reforms Commission is

named as “Promoting E-Governance – The SMART Way Forward”.
Defining e-Governance as the application of Information and
Communications Technology to government functioning in order to create
‘Simple, Moral, Accountable, Responsive and Transparent’ (SMART)
governance, the Report recommends use of ICT for wider participation of
citizens in public affairs in decisional processes. E-Governance and SMART
governance are a kind of twins. E-Governance can however be useful only
when processes, procedures, and structures of Government are re-engineered
and made compatible with ICT requirements in terms of software and
hardware. There is no denying that ICT can to an extent accommodate
specific structures as no two governments would be a replica of each other.
Thus, SMART Governance is more than using technology.
E-governance is surely different than E-government which nevertheless is an

essential part of the former. If G and C were to stand for government and
citizens respectively, and ‘2’ for ‘to’, then there could be four kinds of
communications: G2G, G2C, C2G, and C2C. While G2C, besides G2G, is
very much part of e-Government as government is essentially to deliver
certain services to citizens, it is C2G communication whereby citizens
become participants which is what ought to be e-Governance. C is inclusive
of all other stakeholders, like business, labour, civil societies. G2C is very
similar to business-customer relationship B2C in e-Commerce where B and C
respectively denote business and customer and C2G is similar to C2B. E-
governance seeks to move from passive information and service providing to
active citizen involvement.
No doubt, E-governance is a highly complex process requiring provision of
hardware, software, and networking but it is the re-engineering of procedures
for decision-making which holds the water. And as ICT is dynamic, e-
governance too will have to be a dynamic. One can recall that many of the
cards that are in our possession are smart and the move is to have a smart
citizen card wherein most of the information is tagged in. In many places, it
is bio-metric information in lodged in.
Let us note how these attributes of good governance are spelt:

• Simple: Meaning simplification of rules, regulations and processes of
government through the use of ICTs and thereby providing for a user-
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friendly government. For example, government may use Single Window
Economy one-stop service to facilitate delivery of services to a common citizen. E-
governance comes handy.
• Moral: Connoting emergence of an entirely new system of ethical values
in the political and administrative machinery. Technology interventions
can improve the efficiency of anti-corruption agencies, police, judiciary,
etc. if they wish. Electoral reforms, empowerment of women, enhancing
literacy, etc. could also be also carried out in a better way through ICT
intervention. Use of EVM in elections in India helped improve the
fairness of elections.
• Accountable: Facilitating design, development and implementation of
effective Management Information System and performance
measurement mechanisms and thereby ensuring accountability of public
service. Through ICT intervention, accountability can be ensured in more
efficient ways.
• Responsive: Streamlining the processes to speed up service delivery and
make system more responsive. For instance, Citizen Charter as a set of
assurances given by the government agencies, is an instrument on the
quality of service delivery. Through ICT intervention, responsiveness
could be quickened.
• Transparent: Bringing information hitherto confined in the government
files, into public domain and making processes and functions transparent.
Transparency brings some of the essential virtues into public life such as
equity, level playing field and the rule of law. They reduce the scope of
discretion and corruption. Right to Information (RTI), the right to know
why certain decisions were taken, is an instrument of transparency. E-
governance would be helpful in quick dissemination of information.
Commentators on SMART Governance sometimes relate these features with

the work of bureaucracy which is greatly responsible for the formulation and
implementation of various programmes and policies of the government.
Though not included in the acronym, SMART approach is expected to enable
people’s participation, beyond elections, in decision-making. It is further
expected that SMART approach to governance makes government efficient,
bereft of hierarchical barriers and red tap.
Automation of administrative processes, the first step of e-governance, will

minimise human intervention leading to bias less service delivery and
availability of online information for each department will enable file
movement faster and user friendly by reducing paper-work (and thus saving
physical space and exploitation of environment. With E-Governance, public
action comes under media and public glare, and thereby inducing norms and
values of accountability, openness, integrity, fairness, equity, responsibility
and justice. They expect reduction in transaction costs, empowerment of
common citizens. SMART Governance and its sister e-Governance are thus
harbinger of the new century ethos.
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Ingredients of
However, it appears that SMART Governance largely concentrates on the Good Governance
working of public sector – mainly bureaucracy. It is indeed so. That is why it
was favoured by the Second Administrative Reforms Commission whose
main mandate was reforming administration and was promoted and
propagated by the Department of Administrative Reforms (and Public
Grievances).
It may be noted that both humane governance and SMART governance
belong to two different genres. While the former is more about judging the
quality of governance process in terms of humane outcomes, the latter is
judging the quality of administrative processes. The schism is substantially
akin to that between the end and the means. SMART Humane Governance is
using e-technology but will be judged by the quality in terms of humane
governance outcomes.

1) What is humane governance? State its components.
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
2) What are the features of SMART Governance and how does it differ
from E-governance?
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
25.5 DIMENSIONS OF GOOD GOVERNANCE

The World Bank, as proposed in its Worldwide Governance Indicators
Project, defines good governance in terms of the traditions and institutions by
which authority in a country is exercised. As noted in Section 25.3, there are
three dimensions, viz.:
1) The process by which governments are selected, monitored and replaced;
2) The capacity of the government to effectively formulate and implement

sound policies; and
3) The respect of citizens and the state for the institutions that govern
economic and social interactions among them.
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While this description is fraught with a number of issues. The main stem does
Economy not say anything which qualifies governance as good though they include
constitutional arrangements in (1), government personnel in (2), and nature of
people and their State in (3). The qualification of ‘sound’ before policies
would mean different things for different groups of people and agencies.
While economy-centric people would look for efficiency, society-oriented
ones would search for equity. The inclusion of ‘sound policies’ in the second
dimension raises the question whether international experts (mostly
economists) can really be expected to know what constitutes ‘sound
policies’? For example, should pensions or health care or education be
privately or publicly funded or should they be imparted physical provisions
or through insurance? This broad definition can further be criticised for
mixing together policy content (‘sound policies’) and procedures (‘rule of
law’) as well as citizens’ evaluations (‘respect’). The mixture refers to both
institutions that provide access to political power and those that exercise and
implement laws and policies. To what extent and how should financial
institutions be regulated? Obviously, some political institutions or aspects of
politics are more important than others in determining the quality of
governance. If we examine other definitions, they are likely to meet the same
fate. The result is Grindle wanted Good Governance to ‘rest in peace’ (in a
paper in 2017) as he found proliferation of muddy thinking on governance.
So, we only note dimensions suggested in some of the contributions by
international agencies.
While making good governance index, the WGI in 1996 clearly unfolds six
dimensions by splitting three aspects mentioned above. They are:
1) Voice and accountability;
2) Political stability and absence of violence;
3) Government effectiveness;
4) Regulatory quality;
5) Rule of law; and
6) Control of corruption.
In contrast, the UNDP has identified five areas of intervention along which
governance could be improved:
1) Legislature, judiciary, and electoral bodies;

2) Public and private sector management;
3) Decentralisation and local governance;
4) Civil society organisation, and
5) Governance in special circumstances.
There is little common between them. But, in another policy document in

which UNDP admits importance of good governance suggests nine criteria,
viz.:
1) Participation
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Ingredients of
2) Rule of law Good Governance
3) Transparency
4) Responsiveness
5) Consensus-orientation
6) Equity
7) Effectiveness and equity
8) Accountability, and
9) Strategic vision
The OECD countries seem to include another set of ten criteria:
1) Effectiveness
2) Efficiency
3) Transparency
4) Accountability
5) Predictability
6) Sound financial management
7) Fighting corruption
8) Respect for human rights
9) Democracy
10) The rule of law.
By 2013, it stopped using the phrase good governance in its Human

Development Report and suggested governance principles for democratic
governance through following three double criteria:
1) Participation and Inclusion,
2) Non-discrimination and Equality, and
3) Rule of Law and Accountability.
This tilts more towards political side than administrative. There are quite a
few things common.
One can easily make a distinction between the administrative core of good
governance – which is a legitimate part of government and a closely
associated political area – which involves people in governance. Principles
such as accountability, efficiency, transparency or the rule of law, belong to
the first category, that is, administration while respect for human rights,
participation and democratisation belong to political area.
Various other international agencies including those of UN System and
outside have also put their neck into the matter. They also try figure out some
common dimensions, without criticising others, but finally end up differing.
It would be instructive to prepare a comparative chart of representative sets
of dimensions and ingredients listed by some of these agencies in some or the 215
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other place. We choose here one or the other affiliate of the UN System or
Economy the World Bank’s regional counterparts, which have not been discussed in the
preceding paragraphs.
UNESCAP UNESCAP/ UNCHR IDA ADB AfDB

UNDP
Participation Participation Participation Participation Participation Participation
Accountability Accountability Accountability Accountability Accountability Accountability
Transparency Transparency Transparency Transparency Transparency
Efficiency Effectiveness
Fairness Equity
Rule of Law Rule of Law
Responsiveness
Decency
Responsibility
Predictability
Combating
Corruption
Legal & Judicial
Reforms
One can notice agency’s concerns reflected as well as regional variations.

Maximum common dimensions come out to be only two: Participation and
Accountability. It means, in the agencies’ estimate, people seek their
participation in decision making, which is very much expected in a
democratic dispensation and they wish to hold authorities to be accountable
for their actions.
Moreover, beyond enumeration, the agency narrations may add new

dimensions. For example, the UNESCAP further writes, “it (good
governance) assures that corruption is minimised, that the views of the
minorities are taken into account, and that the views of the most vulnerable in
society are heard in decision-making. It is also responsive to the current and
future needs of society”

1) List three key attributes of good governance.
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
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Ingredients of
2) Reason why the list of attributes of good governance so widely differ Good Governance
between agencies.
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
3) How do rights agencies and donor agencies differ in prescribing
characteristics of good governance?
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
25.6 GOVERNANCE IN INDIA

Judging governance in any country requires knowing:
1) Whether proper institutional structure of governance is in place?

2) Whether proper mechanisms and procedures have been adopted?
3) Whether proper roles have been assigned to different stakeholders and

how well they play their roles? and
4) Whether there exists a resilient framework for accommodating dynamics
of the time?
First, let us broadly know about the institutional structures and operational
mechanisms as they exist in India. Then, we shall indicate, in brief, the state
of affairs of governance.
A Constituent Assembly, though through indirect elections, was constituted a

little before Independence. Passing through turbulent times of facing partition
of the country, and getting hundreds of princely states accessed to India and
getting them turn into viable units, the Assembly could prepare a Constitution
in three years’ time. Members put the final signatures by 26 November 1949
but it was decided to promulgate the Constitution to replace the Government
of India Act of 1935 on 26 January 1950 as 26 January 1930 was the day set
for Complete Independence in Poorna Sawraj resolution carried out on 31
December 1929 in the Session of the Indian National Congress which was
held in Lahore. Since then the day of 26 January was celebrated as Poorna
Swaraj Day for next 17 years.
The Constitution adopted parliamentary form of government and provided an
elaborate legal framework and institutional structures as well as mechanisms,
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Major Issues
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and procedures for the three wings of government and three levels of
Economy government (local governments were explicitly incorporated in 1993). The
Constitution guarantees certain rights to people vis-à-vis the State which is
further guided by certain principles for governance of the country. They are
called as Fundamental Rights (of people) and Directive Principles (of State
Policy) respectively. It is generally accepted that they embody the concept of
a Welfare State in India. Besides, there are provisions regarding oversight
constitutional bodies like Comptroller and Auditor General of India and
Election Commission besides Judiciary which is a wing of government. It
may be noted that word Government is invariably used for the Executive
Wing of the government – Government of India for the Union Executive and
Government of a State for State Executive.
The Fundamental Rights entitle people to certain rights that are enforceable
by a court of law, such as the Right to Life, the Right to Freedom of
Association, the Right to Freedom of Expression, and the Right to Education
(since 2009), Equality before Law and Equal Protection under Law. Besides,
a citizen of age 18 and above has a right to vote in elections to Parliament,
State Legislatures and Local Governments. And one of age 21 is eligible to
contest for membership in a local government, and one of 25 to House of
Representatives (Lok Sabha) and Legislative Assemblies (Vidhan Sabha).
Elections have also been organised frequently under the supervision of the
Election Commission for Parliament and State Legislatures and State
Election Commissions for local governments. Compared to several other
countries, Indian elections have generally been fair and the process has
generally been improving over time. But for this, India – the largest
democracy – is also said to be a vibrant democracy. Many young leaders are
making history by becoming Mayors of municipal corporation and Sarpanchs
of gram panchayats in their 20s.
Further, there exists an independent Judiciary that interprets the Constitution,

upholds the Constitutional Rights of Indian citizens, punishes violations of
the law of the land and also strikes down laws and policies made by the
Executive that run counter to the provisions of the Constitution. The Supreme
Court has adopted an innovative device of Public Interest Litigation (PIL)
since 1980s to enable any person or civil society group to approach the court
seeking legal remedies in cases where public interest is at stake. Higher
judiciary has acted even on the basis of post cards/letters from individuals,
articles in newspapers and petitions from a wide cross-section of people. The
Supreme Court’s positive pronouncements in areas of civil liberties, and
social, economic, and development rights have alerted people and
governments alike.
There are several watchdog institutions, some constitutional and some

statutory. To name a few, there are the Comptroller & Auditor General
(CAG), the Election Commission, the Central Vigilance Commission (CVC),
the Securities and Exchange Board of India (SEBI) and the Reserve Bank of
India (RBI), the National Green Tribunal (NGT) to oversee and check
malpractices in areas coming under their respective jurisdictions. All States
have Lokayuktas and a Lokpal has just been appointed at Union level in
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Ingredients of
2019. They are empowered to look into cases of corruption against Good Governance
government officials, including CMs and PM. It took fifty years but finally it
happened.
There are also in existence National Commissions for Scheduled Castes,

Scheduled Tribes, Backward Classes, Women, and Minorities as well as
National and State Human Rights Commissions to oversee the wrongs
committed against the sections they are empowered to protect for their rights
and promote their welfare.
A little-known fact about the legislative wing of the government is the
existence and work of Parliamentary Committees and Committees of the
Legislative Assemblies, which function almost as ‘mini legislature’ and are
there to scrutinise legislative and executive actions. Actually, they are also a
link between people and legislature on the one hand and between legislature
and government. In the Parliament, number of committees went on increasing
over time. As of now, there are three finance committees of standing nature
(Estimates Committee, Public Accounts Committee, and Committee on
Public Undertakings); 24 Standing Committee related with Government
Departments, 16 Standing Committees for other subjects, and 9 Ad Hoc
Committees. A minister is not eligible for election or nominations to all such
committees except a few in the ad hoc category which are either as Select
Committees or Joint Parliamentary Committees. Select Committees examine,
in consultation with the public and experts, legislative Bills brought before
Parliament and recommend for the consideration of Parliament but can revise
or reject them. For example, the National Identification Authority Bill, 2010
was rejected. Similar mechanisms exist in the Legislatures at the State levels.
The system of parliamentary committees is becoming more and more
consultative, as various stakeholders, including the state governments,
present their cases before these committees. However, at times, some
standing committees are not constituted and due diligence is not applied in
the scrutiny of the bills. This is what happened in 17th Lok Sabha.
But governance goes beyond government. As is well-known, media is often
considered as the fourth estate or fourth power/pillar of democracy in modern
times as they can wield considerable power to influence the role of the three
wings of the government. Media in India is quite free and has been quite
vigilant about public affairs. Sting operations have been a recent addition in
its armoury to unearth corrupt practices. Media has exposed several unethical
practices in public life; for example, corruption in the procurement of
weapons for the armed forces, influencing and winning over of a witness for
one of the parties to litigation, and the sale of S-Band spectrum to a private
company by Antrix Corporation of the Department of Space, 2G scam, coal
auction, commonwealth games, etc. The Press Council of India guards the
freedom of the press. The Right to Information Act, 2005 has strengthened
the media also, besides individuals. Many Government Organisations felt
compelled to put up Citizens’ Charters to ensure transparency in their
dealings. Then, there exists a modicum of think tanks in the country.
Further, the role of non-governmental organisations (NGOs) cannot be
belittled. They promote the participation of civil society in the governing 219
Major Issues
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process by (i) bringing forth the views of the public on various issues (ii)
Economy creating awareness about issues of importance, and (iii) fighting for the rights
of the people or of specific sections of society. For instance, enactment of
Lokpal and Lokayuktas Act in 2013 owes entirely to the agitation by NGOs.
Private (corporate) sector also has its associations, chambers, federations at

sectoral level as well as at regional, state and national levels. The same is true
of other interests like non-corporate business which may organise at local
level and may have federations. Labour, farmers, wholesalers, retailers and
street vendors do organise as do residents through associations, forums, etc.
India is full of them. They communicate among themselves as well as with
the governments and agencies at various level. There are religious
organisations and trusts which are guided by the law of the land. However,
several oversights regulatory authorities had to be created to check the abuse
of dominance. Competition Commission of India, SEBI, IRDAI, TRAI,
ERCs, etc. are examples to be studied.
In recent decades, quite a few developments have taken place in technology,

the most important being in the area of information and communication. With
development in ICT, e-Governance has been introduced with National e-
Governance Programme since 2006. Over the years, various government
operations and services have been brought within its fold, especially at the
cutting edge of administration to cut down delays in the delivery of services
and reduce the scope for mal-practices and corruption. Most notable example
of e-Governance is existence of the universalised Unique Identification
Number to citizens through Aadhar card since 2009.
Thus most of the institutional structures considered necessary for ensuring
good governance exist in India and as, noted above, with some good
governance outcomes. Yet, the present governance scenario in India is far
from satisfactory, as indicated below.
A majority of the people – the poor and the illiterate – is unaware of its
entitlements. Rights violations do occur; the socially disadvantaged sections
of society are at times maltreated and discriminated, socially segregated, and
even physically assaulted and the police is often found to look the other way.
Women, even the educated ones, fare no better. At times, it is felt that
atrocities against women are rising.
Notwithstanding the efforts of the Election Commission to rid the election

process of the influence of money and muscle power, elections continue to be
driven by these factors, thereby preventing a real competition for political
power. There exists another worrying trend, which is the loss of Parliament’s
and Legislatures’ time by disruption of proceedings – resulting into
disruption of passage of bills. While increase in representation of women in
legislatures has improved, the presence of industrialists, businessmen, traders
and builders, and those from allied groups is rising; while the former’s share
is 15 per cent that of the latter is reaching 25 per cent. Most people consider
the former as welcome sign and the latter as bemusing. Only happy
development people see in this regard that women, and at that young women,
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Ingredients of
are actively participating in local governments, thanks to positive approach of Good Governance
some States.
One notice rampant corruption at all levels. Take any scheme, for example,
MGNREGA, there are issues at implementation level. People often say that
Indians are good at planning and bad in implementation. A plan which is
cannot be implemented, is not a plan at all!
For ensuring better behaviour from private corporate sector, Companies Act
of 1956 has been replaced by Companies Act of 2013 whereby corporate
governance has improved in the composition of board of directors,
appointment of company secretary, corporate social responsibility. But it is
found that rules are followed in letter but not in spirit.

1) State the institutional structure as provided in the Constitution of India
towards good governance.
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
2) Who are the players that should be kept in mind while evaluating
governance of the country?
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
3) State the major oversight/watchdog institutions with their roles.
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
4) Identify some of the major pitfalls in the governance of the country.
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
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Major Issues
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5) Explain the role of civil society in India.
Economy
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
……………………………………………………………………………
25.7 LET US SUM UP

We started with introduction about the idea of good governance which made
inroads across the board and the role in it played by the international/
multilateral aid and cooperation agencies for development, starting with the
World Bank. Naturally, the unit first considered what governance means and
how it can be distinguished from government and highlighted the importance
of agencies within and outside government and various other players in
societal affairs. But then, word governance found so great acceptance that it
almost replaced administration and management from many contexts and
with some qualifying adjective, it found place across sectors, modes, fields,
areas, and goals.
Though mal-governance was found to be major issue in non-success of aided

projects, good governance attracted many definitions and descriptions from
varied institutions. National governments adopted good governance but
adapted somewhat different definitions – befitting their areas of interest.
Scholars joined the debate and analysed contents of various conceptions in
terms of implications. Some were found closer to administrative systems and
others towards political systems. There is some kind of evolution over time
and tilting towards democratic governance. Some found the developments
quite bewildering. There were also suggestions for democratic governance,
public governance, humane governance, SMART governance, and e-
governance.
Several agencies put forward certain criteria to judge the quality of

governance. There is some convergence but a lot of divergence. By and large,
people’s participation in decision-making, transparency in administrative
processes, accountability of government officials, and responsiveness/
responsibility of government departments/agencies were given as yardsticks
of good governance. Rule of law and combating corruption also find favour.
But then, depending upon an agency’s focus, other criteria are also
mentioned. For example, those interested in human rights may suggest
inclusion, fairness and equity.
Finally, we discussed governance in India – institutional structure,

mechanisms, and instruments as enshrined in the Constitution, other agencies
and their roles thrown up by statutes, role of media and NGOs, contribution
of influence groups and pressure groups, etc. However, everything is not
hunky dory with governance in India and a few pitfalls and weaknesses are
also pointed out.
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Ingredients of
25.8 TERM-END EXERCISES Good Governance
1) Go through website https://info.worldbank.org/governance/wgi/ of

Worldwide Governance Indicators Project and study the aggregate
indicators for India. How has India fared in different dimensions?
2) Read Chapter 8 of Human Development Report of the year 2011

published by the UNDP and assess how the Principles of Governance
enunciated therein are different from those in the Worldwide Governance
Indicators.
3) Visit the website of the OECD and read the section on OECD work on
public governance. Pick up a topic of your interest and develop a
narrative.
4) Read the Eleventh Report of the Second Administrative Reforms

Commission (of India). Evolve a brief story of e-Governance initiatives
in India.
5) Visit the website of one of the Commissions whether for SC, ST, or BC,
as mandated by Art 338, 338A, and 338B respectively of the
Constitution of India. Discuss the chosen Commission’s role in
protection, welfare, and socio-economic development of relevant section
of Indian society
25.9 KEY WORDS
UNESCAP : United Nations Economic and Social Commission for

Asia and the Pacific (UNESCAP) is the regional
development arm of the United Nations in Asia and the
Pacific, to promote cooperation among member States
for creating a more interconnected region working to
achieve inclusive and sustainable economic and social
development.
UNDP : The United Nations Development Programme (UNDP)
is the global development network of the United
Nations, to promote technical and investment
cooperation among nations.
UNHCR : The United Nations High Commissioner for Refugees
(UNHCR) is a UN agency mandated to aid and protect
refugees, forcibly displaced communities, and stateless
people, and to assist in their voluntary repatriation, local
integration or resettlement to a third country.
IDA : The International Development Association (IDA) is the
part of the World Bank that helps the world’s poorest
countries. It aims to reduce poverty by providing zero to
low-interest loans (called “credits”) and grants for
programs that boost economic growth, reduce
inequalities, and improve people’s living conditions.
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Major Issues
Confronting Indian ADB : The Asian Development Bank (ADB) is a regional
Economy development bank aimed at promoting social and
economic development in Asia.
AfDB : The African Development Bank Group (AfDB) is a
multilateral development finance institution catering to
African governments and private companies investing in
the regional member countries (RMC).
25.10 REFERENCES
It would be worthwhile to visit websites of the World Bank, IMF, OECD,
and United Nations’ agencies – particularly UNDP, UNESCAP, and
UNESCO, to appreciate the evolution of the concept as well as differentiation
between conceptualisations by various agencies. Reports of Second
Administration Reforms Commission, particularly 11th one, would also be
very useful. Reports are available on the website of Department of
Administrative Reforms and Public Grievances, Government of India. Read
some scholarly articles which raise questions on the idea as promoted by
international aid agencies. Some of the books and articles which would be
very helpful, are:
1) Grindle, Merilee S. (2017). Good Governance, R.I.P.: A Critique and an
Alternative, Governance, vol. 30, issue 01 (January), pp. 17-22.
2) International Monetary Fund (2017). The Role of the Fund in
Governance Issues: Review of the Guidance Note – Preliminary
Considerations (Background Notes)
3) Kaufmann, Daniel; Kraay, Aart & Mastruzzi, Massimo (2010). The
World Governance Indicators: Methodological and Analytical Issues –
World Bank Policy Research Working Paper No. 5430.
4) Kuldeep Mathur (2008). From Government to Governance, National
Book Trust, New Delhi.
5) United Nations (2009). What is Good Governance? United Nations
Economic and Social Commission for Asia and the Pacific.
6) UNESCAP (2011), What is Good Governance?, www.unescap.org).
7) World Bank (1991). Managing Development – The Governance
Dimension, The World Bank, Washington DC.
8) World Bank (1994). Governance; The World Bank’s Experience, The
World Bank, Washington DC.
9) World Bank (2002). World Development Report, 2002 “Building
Institutions for Markets”, The World Bank, Washington, DC.
10) World Bank (2007). A Decade of Measuring the Quality of Governance,
The World Bank, Washington, DC.
224
Ingredients of
25.11 ANSWERS OR HINTS TO CHECK YOUR Good Governance
PROGRESS EXERCISES
1) Government is one, though an essential, part of a State and a mechanism
of governing it whereas governance is the total way all societal affairs,
particularly the public affairs, are conducted.
2) Depending upon their mandates international agencies orient their way of

operationising the idea of governance. For example, Human Rights
agencies will focus more on rule of law whereas Financial agencies will
focus more on corruption and public sector performance.
3) Meta-governance is the framework of governance. For example,

Constitution of a country is expected to provide the background for
making the laws.

1) The World Bank started the campaign as it discovered that the
conditionalities attached with development project aids in 1980s did not
bear the fruits and the major reason was bad governance.
2) As the idea was lurking for long that there are substantial issues in
governance in most of the countries but agencies other than World
Bank/IMF found World Bank/IMF too much focused on public sector
management or management of public resources. So was the case with
scholars also. They added their own angles generally from the
perspective of their disciplines.
3) Administration is traditionally more interested in seeing whether the

procedure/ processes in a particular case have followed the rule book. As
that process may be a link in a long chain, it appears sensible also.
However, taste of pudding is in eating. So, it was suggested that it has to
be seen in total perspective. While the former is input legitimacy, the
latter is output or outcome legitimacy.

1) Humane governance is good governance seeking to secure human
development. Its components are political governance, economic
governance, and civic governance.
2) SMART in SMART governance stands for simple, moral, accountable,

responsive and transparent. Acronym SMART sounds similar to smart
which was already in use in the context of urban governance or cities
which attempted to provide modern facilities and amenities to its
populace.
3) E-governance is an attempt to make good use of ICT tools in governance

and it can help a great deal to improve the pace of good governance but it
is not a substitute for SMART governance.
225
Major Issues
Confronting Indian
Economy
1) People’s participation in decision making, accountability of agencies to
the people they serve, and responsiveness of agencies in solving the
people’s issues.
2) Mandates of the agencies, the time they are written, and the people who
articulate them.
3) Rights agencies, like United Nations High Commissioner for Human

Rights or Amnesty International, will seek to protect and promote human
rights whereas the World Bank or International Monetary Fund will like
to see that aid projects are successfully conducted.

1) Better you have look at the Constitution of India. There are three levels
of government. There are bodies/agencies prescribed by the Constitution
and there are agencies created by statutes or organised for administrative
convenience.
2) Government departments, government wings and agencies, media,
NGOs, people’s forums, section unions, trade unions, advocacy groups,
business chambers and federations, and think tanks.
3) Judiciary, particularly higher judiciary, is a watchdog for any excesses
committed by governments and their agencies. Comptroller and Auditor
General is another watchdog in the sphere of financial matters. Election
Commission of India responsibly conducts/supervises the elections for
legislatures, and offices of President and Vice President. State Election
Commissions likewise conduct elections for local government in their
respective States. There are others like National Green Tribunal for
environmental issues and Lokpal/Lokayuktas for corruption in offices
and by officers and officials – including PM and CM.
4) It is an exercise for you!
5) Civil society comes in various forms like voluntary associations, user’s

groups, rights groups, sectional associations. Some cooperate and
facilitate government in governance, others point out pitfalls and seek
redressal. Some resolve societal issues on their own.
226

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MEC-205

School of Social Sciences

COURSE COORDINATOR : Prof. Narayan Prasad

BLOCK 1 INDIAN ECONOMIC DEVELOPMENT:

UNIT 1 Indian Economic Development – A Historical Perspective 9

UNIT 2 Growth and Structure of the Indian Economy 31

UNIT 3 Demographic Transition and Its Implications 54

UNIT 4 Natural Resources 81

UNIT 5 Physical and Social Infrastructure 108

BLOCK 2 DEVELOPMENT STRATEGIES 137

UNIT 6 State and Market: Indian Context 139

UNIT 7 Economic Reforms in India 162

UNIT 8 Major Developments in Post Economic Reform Period 187

Unit 1: Indian Economic Development: A historical perspective provides an

Unit 3: Demographic transition and its implications throws light on theory of

Unit 5: Physical and Social infrastructure provides a profile of the availability

1.2 INDIA IN THE EIGHTEENTH CENTURY

Fig. 1.1: Trend in the Share of Major Countries in World GDP

Import of Indian textile was largely financed by bullion. European traders

1.3 BRITISH RULE: STATE OF COLONIAL

1.3.2 Impoverishment of the Peasantry

1.3.3 Commercialisation of Agriculture

The growing commercialisation of agriculture also helped the moneylender-cum-

1.3.4 Agricultural Labourers

1.3.5 Lack of Modernisation

At a time when agriculture in developed countries was being modernised and

The result was continued impoverishment of peasantry, along with an increase

1.3.6 Ruin of Artisans and Handicrafts

With introduction of railways, the destruction of Indian industries, particularly

1.3.7 Status of Modern Industries

Overall, industrial progress in India was exceedingly slow. Both in terms of

Check Your Progress 1

1.5 POVERTY AND FAMINES

Check Your Progress 2

1.6.1 Savings and Investments

1.6.2 Fiscal Policy

i) Regressive Tax Structure

iii) Meagre Spending on Development of Agriculture, Industry, and Social

1.6.3 Trade Policy

Check Your Progress 3

Since early stages of the national movement, nationalist believed in complete

Indian capitalists had a long-term strategic interest in success of the national

Check Your Progress 4

1.8 LET US SUM UP

1.9 KEY WORDS

1.10 TERM-END EXERCISES

1.12 ANSWERS OR HINTS TO CHECK YOUR

2.2 OVERALL TRENDS

Phase II: 1980-1990

Phase III: 1990-2008

One, consumption spending was a large contributor to the growth performance.

Phase IV: 2008-2014

A significant stimulus package in three tranches was put in place by the

Phase V: 2014-2019 and 2019 onwards

Check Your Progress 1

The process of development requires structural change. The structural change of

2.3.1 Composition of Gross Domestic Product

2.3.2 Sectoral Share of Employment

2.3.3 Share of Organised and Unorganised Sector in Output and

However, notwithstanding all these changes and trends towards modernisation,