The Indian Economy
This paper will highlight economic issues facing the Indian Government and
its ability to maintain high levels of growth by outlining the current conditions of the economy. Policy dilemmas and logic to address these dilemmas will be explored. Analysis of key indicators and statistics as well historical reference and the theory behind their execution will underlay chosen policies which will be followed by a brief conclusion.
2. The Indian Economy
The Indian Economy is listed as the fifth largest in the world at $1.538 trillion US (CIA 2010) and has been able to continue high GDP growth despite the Global Financial Crisis. The country has also moved along a steady path of economic reform and liberalisation since 1990 including privatisation and foreign investment. India is a ‘planned’ economy which follows a series of targets for each five year period, the Eleventh Five-Year plan (Planning Commission (Government of India) 2007) ending in 2012 aimed to increase and maintain growth at 10% (to double by 2017), create new employment for 70 million people, raise real wages for unskilled workers and consider education and infrastructure.
The next five year plan needs to consider economic factors below that may restrict the high levels of growth. There is also an emergence of a two-speed economy emanating between the service sectors employed middle and high income earners with those in agriculture and manufacturing (FitzGerald 2011). Figure 2.1 (TradingEconomics.com 2011)
Figure 2.1 shows India’s strong trend for growth since 2002 and despite a small decrease in growth rate following the Global Financial Crisis in 2008, a major policy issue therefore is maintaining strong economic prosperity. The government has to consider several factors that are a risk to this aim such as a large budget deficit, high inflation and unemployment, all shown in figure 2.2. | Percentage| |
Government Debt| 55.9| of GDP|
Inflation| 11.7| Increase per Year|
Unemployment| 10.8| of Labour Force|
Figure 2.2 Key Indicators 2010 (CIA 2010)
Sustainable growth can be achieved by the Indian Government if it can address these issues both in the short and long term. Therefore the focus is to consider reducing and stabilising inflation, restructure and increase employment and return the budget to surplus. Debt
The current Government Debt in India is around 60% of GDP (TradingEconomics.com 2011; CIA 2010) which puts debt near $1 trillion US. This is an important consideration as it affects the ability of government to embark on public spending necessary to address improvements in infrastructure, education and manufacturing which can help maintain the high growth levels in the long run.
High debt and exchange rates can also affect foreign investment which is rich in the services sector, attributing 55.3% of GDP and only 34% of the Labour market (The World Bank 2009; CIA 2010), a focus on improving education and shifting employment into the services sector therefore becomes an important direction for both reduction of unemployment and maintaining supply of labour.
Wage prices would be kept at a competitive level compared with other outsourcing countries and overall GDP levels. Debt can also create a lower credit rating and the ability to pay back loans, defaulting on a loan can have widespread negative implications to sustaining growth in the economy. Inflation
Inflation is the reduction in the value of money and is 11.7% in India(CIA 2010). High Inflation is a concern because it breads uncertainty in the economy for business, consumers and other investors. This is explained as money being the scale by which an economy can be measured, if the metric of the measurement is uncertain different ideas are formed about how and where money is spent or even if it is spent at all. It also affects the distribution of money across society which is an economic concern in India, high levels of inflation are notable in Food, Manufacturing Prices and Fuel(BBC 2011). Unemployment
Unemployment estimates in 2010 of around 10% (TradingEconomics.com 2011; CIA 2010) become an important policy consideration. Indirectly the economy is burdened with the costs such as health and crime however more direct issues include social welfare, loss of production and therefore taxable income.
India has one of the world’s largest labour forces of around 480 million (CIA 2010) full employment would assist the ability to match aggregate demand increases with aggregate supply in the long terms. India could continue growth and manage sustainable inflation in the long term to reach the potential GDP levels. Figure 2.3 shows the overall break down of employment sector with its contribution to GDP. | % Labour Force| % GDP|
Agriculture| 52| 16.1|
Industry| 14| 28.6|
Services| 34| 53.3|
Figure 2.3 Economic Sectors Labour/GDP (The World Bank 2009) The policy consideration for Government should be to increase the efficiency of the agriculture sector and move employment into the Industry and Services sector in the long run, including a focus on self-employment which is becoming an unattractive option for younger generations (AZAD India Foundation 2010).
3. Policy Direction
Policy recommendations for the Government of India have one overall aim, to maintain strong growth. Three major economic conditions for this focus on, reduction of Government Debt, stability of inflation and addressing high unemployment.
4.1 Monetary Policy
Monetary Policy has recently been engaged by the Central Bank and Government in a contractionary manor in an attempt to slow down the inflation growth that has been gripping India. The long term effect of increase to interest rates is to reduce aggregate demand. Figure 3.1 highlights an inflationary hike trend since 2008 which peaked in January 2010.
Figure 3.1 India Inflation (TradingEconomics.com 2011)
Identifying the cause of inflation is a primary agenda before deciding how effective Monetary will be. While India is experiencing increased AD, interest rates are aligned to but not an overall effect of price increases and in the long run reduce the sustained high growth levels. As seen in Figure 3.2, Interest rate increases are not correlating directly with long
term inflationary decreases.
Figure 3.3 Interest Rates (TradingEconomics.com 2011)
There are three cost-push inflation causes that could explain the peaks and sustained recent high inflation levels of around 11% (CIA 2010).
Brent Crude Oil Index
Oil is a highly utilised commodity for India and its price can directly affect aggregate supply figure 3.2 Shows a correlation to hikes in Oil price compared with inflation. In January 2008 oil prices began to climb however as the GFC began to take hold, global demand for reduced and prices fell. As India was maintaining strong local Aggregate Demand however inflation was still high.
Figure 3.3 Brent Crude Oil (TradingEconomics.com 2011)
Domestic Food and Manufacturing Prices
Secondary inflation hikes noticed in 2010 do not directly correlate to oil prices. During a poor Food harvest in 2009 as a result of a poor monsoon season (The Economic Times 2009) compounded by international food supply contractions and price rises in the manufacturing sector (BBC 2011) supply side shocks and marginal rise in oil prices can attribute to high inflationary levels.
The effects of the supply shocks would be noted in the shift from AS1 to AS2 with prices rising in the short term. However as India GDP has continued to increase year on year, this can only be explained by an increase in Aggregate Demand from AD1 to AD2 shown in Figure 3.3 of a dynamic AS/AD model for India. Point C is India’s potential GDP in 2009 and Point D for 2010, the economic policy should be aimed towards reaching these targets. Monetary policy, in the short run would assist the reduction of AD to curve inflation however to reach LRAS2, other policies must be considered. Interest rate rises should be put on hold and decreased if the economy can recover from supply shocks allowing AS/AD to shift towards potential GDP.
Figure 3.3 Dynamic AS/AD for India (figures from (TradingEconomics.com 2011))(McTaggart, Findlay, and Parkin 2010; Hubbard et al. 2011; Misistry of Statistics and Progamme Implementation 2011) 4.2 Fiscal Policy
Understanding the complexities of the supply side issues for India is a must for Government to address long term inflation and employment. Investment in agriculture, manufacturing and infrastructure will most likely form the basis of the Twelfth Five-Year plan (2point6billion.com 2011).
Agriculture can increase and sustain output by advancements in farming practise and technology which is also true of the manufacturing sector. In order for the government investment not to compound Aggregate Demand and multiply into further inflation, taxation of the middle and higher income tax brackets is an option. Already highlighted is the disparity between the size of each sector and the share of its GDP, these expenditures would therefore shift demand from the higher earning service sector into agriculture and industry, with a positive knock on effect of an increase in employment in these areas. | % Labour Force| % GDP|
Agriculture| 52| 16.1|
Industry| 14| 28.6|
Services| 34| 53.3|
Figure 3.4 Economic Sectors Labour/GDP (The World Bank 2009) Investment in education, fundable by higher taxation levels can also be aimed to assist the long term shift away from agriculture and into the industry and services sector. Infrastructure is also a key investment consideration to reduce costs of production to all sectors of the economy and sustain ever increasing energy needs. This is also required to avoid the widening of the ‘two-speed’ economy and should be avoided as not to become reliant on one sector of the economy, addressing the balance and disparity can help create a diverse, shock absorbent Indian future. Why would this help stabilise inflation and reduce unemployment?
* Cost push inflation and supply side shock impacts would be reduced in the long term * Investment in agricultural and manufacturing practice would allow for a closer match of Aggregate Supply with Aggregate demand * Shifting employment from Agriculture into Industry and Services sector would reduce unemployment *
Long term government can divert funds from unemployment resource and taxation into reduction of the Government Debt
4.3 Exchange Rate – Exports and Imports
The balance of trade is in deficit of 7.2% (see figure 3.5) however this may not be a major issue for the economic growth of India. The difficulty in policy decision remains the valuation of the Rupee and its impact on a number of variables.
High rupee value impacts exports and is approximately 44.6 rupee to $1 US; a primary focus area is industry which could become a viable source of employment for the 10.8% of people not in work. Continuing to increase interest rates will have two impacts; direct foreign investment will be more attractive. Such things as new iron ore and petroleum mining ventures would become possible, however if the Rupee value is too high the export of this and other exportable goods becomes less attractive.
Figure 3.5 Components of GDP as a Percentage (Misistry of Statistics and Progamme Implementation 2011)
Focused on the aim of sustained high growth, export of services is only 6.6% of GDP however as the Services sector accounts for 55% of industry composition and consumption accounts for 58.3% of GDP, decrease of the ability to export services would reduce private consumption, a direct impact on growth. Export of Goods would also increase if the Rupee were to weaken and address the balance of trade. The government is strongly advised to allow mining and large manufacturing projects to begin and allow the export of these commodities to economies like China.
Comparative cost of labour and production would give India a very competitive selling price in the global market and shift employment from agriculture (and the unemployed) into the manufacturing industry.
The economy of India is very strong in the current global climate of uncertainty and the challenge for the Government is to maintain that level of growth. Managing economic uncertainties that can cause the economy to
fail in its aims are extremely important. Understanding the supply side causes of inflation and the possible negative effect of monetary policy to combat it should be realised. Therefore fiscal policy to increase investment in the agriculture and manufacturing industries is recommended to remove disparity and level the ‘two-speed’ economy.
High levels of inflation and unemployment do not align to the Phillps principle of inflation (McTaggart, Findlay, and Parkin 2010) however at present there may be a need to absorb these pressures in the short term. To some degree the economy may be experiencing stagflation as it has a much higher potential GDP threshold.
In conclusion, there are other factors such as corruption and economic management that if resolved could drastically reduce debt and disparity between all sectors of society.
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