Economic and Political Situation in a Developing Country (India) - Essay Example

Economic and Political Situation in a Developing Country (India) Introduction Indias economic growth and foreign trade has taken new dimensions in recent years and it has expanded considerably. Looking at the huge population base of India, this is indeed a good sign for the country and the world economy. For last several years, India’s GDP is growing at the average rate of more than 7 percent; however in order to maintain high economic growth rate and a recognition in the International arena, India needs to continue with high-powered performance in foreign trade. The paper will focus on Indias foreign trade and GDP, monetary system, exchange rate policy, foreign policy and the reform process that began two decades ago put the country into a fast pace of economic growth. Reform Process and New Trajectory of Growth Indias major policy initiatives began in July 1991, which catapulted the country in the high growth rate trajectory. The reforms undertaken were responsible for high export growth rates in the last few years. International trade is likely to become a major stronghold of the Indian economy if the country continues with more reforms in years to come. Post 1991 international trade liberalization has paid off significantly in the growth of India. Since the days of more liberalized trade, Indias GDP has risen at an aggregate annual rate of about 6 percent. Services have become the largest contributor to GDP reaching to almost 59 percent in 2010. Agricultural share has declined to only 18 percent or less. All this has been achieved in the last two decades after the reform process commenced in 1991 (RBI annual Report, 2005-6). The following table indicates how things changed drastically in 15 years after economy was opened up in many areas. 1990-91 2005-06 Import Controls Tight, detailed Negligible Peak Import Duties 200% plus 12.5% Current Receipts/GDP (%) 8.0 24.5 Debt Service Ratio (%) 35.3 10.2 Software Exports ($ billion) Nil 23.5 Investment from Abroad ($ billion) Very low 20.0 Remittances from Worker ($ billion) 2.1 24.59 Source: RBI, Annual Report, 2005-6 The foreign investment was almost negligible during the base year of reform (1990-91) that jumped to almost $20 billion. Software exports rose from nil to almost $24 billion. The peak import duties went down from almost 200 percent to just average 12.5 percent. Workers remittance also grew from $2.1billion to more than $24 billion. Debt servicing ratio fell down substantially from 35 percent to around 10 percent showing the strength of balance sheet of India Inc. In the year 1991, India was passing through foreign-exchange crisis when it had to sell its gold to pay for the import bill of the crude oil. (RBI annual report, 2005-6) Foreign Trade and GDP In 2007, India’s GDP first time reached $1trillion mark based on the official exchange rate making it the twelfth-largest economy of the world. Indian economy grew at the rate of 9.7 percent in the year 2010, which is the second highest in the world. Exports of goods and services rose by decent 19.9 percent against the growth in imports of 11.2 percent (World Trade, 2010). The following table indicates GDP in purchasing power parity (PPP) terms in trillion dollars as most economists now agree to compare the GDPs of countries in terms of its purchasing power rather than based on pure exchange rate of currencies. Year 2002 2003 2004 2005 2006 2007 2008 2009 2010 GDP in PPP Terms $ 2.66 3.03 3.32 3.67 4.16 2.97 3.30 3.68 4.06 Source: http://www.indexmundi.com/g/g.aspx?c=in&v=65 Despite burgeoning international trade, its share in global trade is still quite low. Its recent high growth has been largely attributable to its modern services sector and growth in Information and Technology sector. Since the onset of global financial crisis in 2008, most of the Europe and U.S businesses are facing severe recession. The growth rate of developed economies has shrunk considerably and so the international trade. Obviously, his has also affected the trade of the India. Monetary System and Policy of Central Bank An independent monetary system is essential for a country to manage macroeconomic factors and for the smooth economic growth of the country. In this perspective, it is pertinent to study the monetary system of India. The Reserve Bank of India (RBI), the central bank, has money management policy in the form of regulating base interest rates and making changes in Cash Reserve Ratio. Objective is to contain inflation rate and liquidity in the market to stabilize macro economy of the country. Besides, RBI also announces a credit policy every quarter. Repo rate (central banks lending rate) and reverse repo rate (rate at which banks lend to central bank) form a part of credit policy. During the financial crisis in 2008, the central bank had reduced the cash Reserve Ratio several times in a row to the tune of 4 percentage points and released about Rs. 1,600,000 million funds to the banking sector. This brought down short-term money market rates. Due to excess liquidity overnight rates came down below the reverse repo rate. In January 2010, the central bank again raised the CRR. In March 2010, the repo and reverse rates were further moved upwards by 25 basis points followed by repo rate increase by 25bps in April 2010. By July 2010, the reverse repo and repo rate were 5.5 and 4.0 percent respectively. (Economic Outlook…2010 p73) Monetary Policy Stance for the fiscal 2011-12 In its report of May 3, 2011 Central Bank has specified that the current conditions are significantly different than that prevailed a year ago. Global economy is still in an uncertain state. Greek sovereign debt crisis has made the international economic recovery more uncertain. Inflation is running pretty high on the domestic front due to high food prices. The policy document specifies that the goal of monetary policy was to contain the supply-side inflation. High inflation reduces investment as it creates uncertainty. It clearly spells out that bringing down the inflation even at the cost of growth will take precedence as policy. (Monetary Policy Statement, 2011) The following graph clearly depicts how inflation has remained a crucial factor for Central Bank in management of monetary policy for the last several years. Source: http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=6376&Mode=0 Exchange Rate Policy The Indian foreign exchange market was highly regulated prior to 1992. Several measures were taken to float the rupee against major currencies in the subsequent years. In March 1992, the central Bank first partially floated the Indian rupee introducing the Liberalized Exchange Rate Management System (LERMS). In March 1993, unified exchange rate came into being followed by direct quotation system that came into place in August 1993. Thereafter, the Reserve Bank stopped quoting buying and selling rate so that market could take its own course. In April 1996, the banks were allowed to freely trade in the overseas markets. In October 1996, banks were allowed to provide foreign currency loans to their clients. In April 1997, banks were permitted to invest in the overseas markets (Exchange Rate Policy 2010). From the last several years’ working of exchange market, it seems that Indian rupee is moving in line with the economic fundamentals. Full capital account convertibility is a crucial goal ahead so that it can get more integrated with the rest of the world. In coming times, the exchange rate management, independent monetary policy and opening up of capital account is going to be a big challenge for India. The exchange market in India today offers several derivative instruments. Trading volumes in the Indian exchange market has grown substantially in the last few years. With the increase in daily turnover, spread (bid-ask difference) has reduced considerably. At times, spread is found to be as low as 1 paisa or even less. The exchange market in India has evolved in the last few years to become liquid and efficient providing necessary depth to the investors. Rupee gaining strength against dollar rose up to 39.6 in January 2008; however, there after it continued to fall against dollar and other currencies after the onset of financial crisis in U.S and Europe. In recent times, due to high rate of inflation of around 10 percent and above, it has showed considerable weakness and depreciated almost 15 percent against the U.S dollar. Currently, it is hovering at around 52 per dollar. A below-mentioned graph shows movement of dollar-rupee exchange rates for the period between 1996 and 2007. This clearly shows that the rupee is free-floating and its movement follows the ‘demand and supply principle’ of economics. Source: http://www.rbi.org.in/scripts/PublicationsView.aspx?id=12252 Foreign Trade Exports The Indian economy’s resiliency can be seen from the fact that recently the exports from India jumped from US $ 105240.82 million to US $ 160048.51 million registering a handsome growth of 52 percent for the period from April to September (fiscal 2011 -12), which is certainly a commendable achievement in the backdrop of recessionary conditions prevailing in the developed countries. (Indias Foreign Trade: September, 2011) Imports The imports too rose by 32 percent during the same period, which in dollar terms was estimated at US $ 160048.51 million from the last years figure of US $ 105240.82 million. (Indias Foreign Trade: September, 2011) Foreign Trade Policy In the year 2009, the entire world experienced an unprecedented economic slow-down; however, India was not affected to the same extent. Indias export though declined considerably in that year. Many countries resorted to the protectionist measures during the time making the situation even worse. The Foreign Trade Policy was designed keeping these issues in mind so as to accelerate the growth of exports. The objectives set out during 2004 by the previous government were (a) to double the global trade within 5 years (b) using trade expansion to fuel economic growth and generate employment. Both of these objectives were largely achieved in the period of five years during 2004-9 (Foreign Trade Policy, 2009-14). The total exports of India rose from US$ 63 billion in 2003-4 to US$ 168 billion in 2008-9. The share of global trade was 0.83 percent in 2003 that went up to 1.45 percent in 2008. Global commercial services export rose from 1.4 percent in 2003 to 2.8 percent in 2008. In the period of last five years, the increase in trade created almost 14 million new jobs (Foreign Trade Policy, 2009-14). The new policy document of 2009 speaks about achieving various objectives in foreign trade with a special emphasis on the following. First and foremost is to arrest and reverse the downward trend of exports by providing additional support to the sectors which have been affected hugely due to recession in the developed world. The annual export growth target of 15 percent has been set totaling US $200 billion for March 2011. The growth target of 25 percent per annum has been envisaged for the period between 20011 through 2014. The long term objective is to double Indias share in global trade by the end of this decade (Foreign Trade Policy, 2009-14). Fiscal incentives, rationalization in procedures, and enhancing access to the global market are the measures taken by the policy makers. Full refund of all indirect taxes and levies and reducing transaction costs are other measures that will boost up the export earnings. Improvement in infrastructure will be done to facilitate exports of goods and services. More thrust is being provided to the areas which have potential to expand the employment in the country. New emerging markets are given due consideration so as to make competitive exports of goods and services. Market Access Initiative Scheme and Market Development Assistance Scheme are the additional resources to boost the exports from the country (Foreign Trade Policy, 2009-14). A Trade in Goods Agreement with ASEAN has been made effective from January 1, 2010 to give enhanced market access for exports. A Comprehensive Economic Partnership Agreement has been signed with South Korea to get easy market access for Indian goods. In line with export promotion and to boost Indian brands, Made in India’ shows are being organized around the world every year (Foreign Trade Policy, 2009-14). To make exports competitive, it is necessary for any manufacturer to upgrade the quality and reduce the cost. For the purpose of technological enhancement, any import of capital goods is provided under EPCG scheme at nil duty. In line with the international norms and acceptance of green products, a special incentive scheme has been put through to promote the export of such products including green vehicles (Foreign Trade Policy, 2009-14). Conclusion India has taken several effective steps in terms of economic reforms and various policy measures in relation to foreign trade, monetary policy, floating rupee free in relation to major world currencies (a free floating exchange mechanism). All these macroeconomic measures has put the country into a big league and given the large population base, it is certain to become one of the leading economies of the world in a decade or so. Moreover, given the well-established democratic institutions and independent grievance redressal mechanism (industrial courts and trade related tribunals); there is no doubt that India will continue to attract huge foreign direct investment in the years to come, which is necessary for the country to continue with increasing share of international trade. References 1. World Trade (2010), online from November 26 2011 http://www.wto.org/english/news_e/pres11_e/pr628_e.htm 2. Index Mundi (2011), online from November 26 2011, http://www.indexmundi.com/g/g.aspx?c=in&v=65 3. Economic Outlook (2010), Economic Advisory Council To The Prime Minister, New Delhi, also available online November 26 2011, http://eac.gov.in/reports/ecoout_1011.pdf 4. Monetary Policy Statement (2011), online from November 26 2011, http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=6376&Mode=0 5. Exchange Rate Policy (2010), online from November 26 2011, http://www.rbi.org.in/scripts/PublicationsView.aspx?id=12252 6. Indias Foreign Trade: September 2011, online from November 26 2011, http://commerce.nic.in/tradestats/Indiastrade_press.pdf 7. Foreign Trade Policy 2009-14, Ministry of Commerce & Industry, Directorate General of Foreign Trade, also available online November 26 2011, http://164.100.9.245/exim/2000/dn/ftpdnl/high0910-eng.pdf Read More