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Session 11-12, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv

Nadar Univ.

School of Management and Entrepreneurship,


Shiv Nadar University

Session 11-12: International Linkages and Exchange Rates


Course Instructor:
Vaibhav Chaturvedi
Research Fellow, Council on Energy, Environment and Water
New Delhi, India
Vaibhav Chaturvedi , Research Fellow , Council on Energy, Environment and Water, New Delhi, India., 2014

Session 11-12, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Why is understanding international linkages important?


Two channels through which domestic economy is linked

to the world economy- a) Trade, and b) Finance


Closed versus Open economy
Exports are increase in demand for domestically produced

goods, vice versa for imports


IS-LM should be modified for impact of international

linkages

Session 11-12, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

BoP is the record of transactions of the residents of a

country with the rest of the world


BoP = Current Account (CA) + Capital Account (CapA)

CA records trade in goods and services as well as transfer

payments. Services include returns from domestic


investment in assets abroad
Trade Balance records trade in goods only

CapA records purchase and sales of assets (stocks, bonds,

land, etc.)
So what is CA surplus and CapA surplus?

Session 11-12, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

If a person spends more than her income, the deficit

needs to be financed from somewhere. Same for


international payments.
Any CA deficit necessarily financed by capital inflows
If a country has no assets to sell, no forex reserves, and

no one will lend to it, then it has to achieve CA balance


CapA can be split into private + official transactions
Increase in official reserves is also called BoP surplus
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Session 11-12, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

What is exchange rate?- Price of one currency in terms of

other currency
Fixed Ex. Rate system: When central bank intervenes in

forex market to fix their currencys exchange rate


What is an intervention?: Buying or selling forex
What determines extent of intervention?: BoP

surplus/deficit
Can a central bank intervene indefinitely? no, in long run

central bank will run out of foreign reserves

Session 11-12, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

When central bank allows the exch. rate to equate the

demand and supply for foreign currency


Clean floating: When rates completely determined by

markets
BoP is zero under clean float. Why?: Excg. rate adjusts

to make CA and CapA sum to zero


In reality, dirty or managed float is practiced
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Session 11-12, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Crawling peg
Devaluation versus Depreciation

Market exchange rates versus real exchange rates


R = e*(Pf/P): Measures countrys competitiveness

Market exchange rates will converge slowly to real

exchange rates in the long run, if free market


conditions prevail
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Session 11-12, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Spending by domestic residents = C + I + G


Spending on domestic goods = C + I + G + NX: NX is

trade surplus
Exports = f(Yf, R); Imports = f(Y,R); NX = f (Yf,Y,R)
Or increase in foreign income, decrease in home

income, and real depreciation of home currency all


improve home countrys trade balance
All of the above shift IS curve rightwards

Session 11-12, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

High degree of linkages among financial and capital

markets
If exch. rates are fixed, taxes are same everywhere, and

no political risks exist, investors will invest where they


get highest returns
Perfect capital mobility?: When investors can invest

unlimited amount of money wherever they want with


low transaction cost, or Capital Flow = f(i-if )
BoP hence = NX (Yf,Y,R) + CF(i-if )

Session 11-12, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Does monetary and fiscal policy impact BP?:


a) Through impacting imports/exports,
b) Through impacting i and capital account

Repercussion effects: International effects of domestic

policy
External versus Internal balance

10

Session 11-12, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

MF model about perfect capital mobility under fixed

exchange rates
Even slight i differential provokes infinite capital flows
So what happens under a tight monetary policy?

i increases -> Huge capital inflows -> Huge BoP


surplus -> Exch Rate appreciates -> RBI has to buy
foreign money in exchange for domestic money ->
Domestic MS increases -> Initial monetary
contraction is reversed
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Session 11-12, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Imp conclusion: Under fixed exchange rates and

perfect capital mobility, a country cannot pursue


independent monetary policy
What happens under a fiscal expansion?

IS shifts rightwards-> i increases -> Huge capital


inflows -> Huge BoP surplus -> Exch Rate appreciates > RBI has to buy foreign money in exchange for
domestic money -> Domestic MS increases -> LM
shifts rightwards-> i back to original and Y increases
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Session 11-12, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Central bank doesnt intervene in markets


BoP = Zero, as CAD must be financed by capital inflows
But now the central bank can set money supply at will
So what happens under a tight monetary policy?

i increases -> Huge capital inflows -> Huge BoP surplus


-> Exch Rate appreciates -> Net exports decline-> IS
shifts leftwards-> Y and i both decline
What if interest rates are decreased by RBI?

13

Session 11-12, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Does increase in global demand of domestic goods have a

lasting impact?
How does fiscal policy impact now?

Tax cut/Govt. Spending -> Increase in i -> Capital inflows


-> Currency appreciation -> Fall in NX -> Complete
crowding out
Earlier, crowding out was only of investment, now it is also

of net exports
Imp conclusion: Real disturbances to demand do not effect

equilibrium output under flexible exchange rates and


perfect capital mobility

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Session 11-12, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

What happens when real money stock increases?


LM shifts right -> i declines and Y increases -> Capital

outflows and currency depreciation -> Export increase ->IS


curves shifts right upto when i increases to original level.

At this level, goods and money market are again in

equilibrium and this is compatible with global interest rates

Monetary expansion hence increases output, leads to

currency depreciation, and improves CAD through induced


depreciation

Contrast with a Fixed Forex rate regime?- RBI can control

money supply now

15

Session 11-12, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Depreciation induced change in Trade balance has also

been called beggar thy neighbour policy


Through exchange rate management, countries can

export unemployment and create domestic


employement at the expense of other countries
When trading countries are in different stages of

business cycle, exch rate management can synchronize


adjustment: otherwise beggar thy neighbour quality
This is the reason why EU became a monetary union
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Session 11-12, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

All discussions till now assumed constant price level


In a closed economy, higher price level implies low

spending, high interest rates, and low real money


In an open economy with fixed exchange rates, higher

price level reduces demand as exports are costlier


There is thus a link between domestic demand,

domestic supply, and external trade balance


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Session 11-12, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

When a trade deficit, a country needs to become either

more competitive (reduce relative prices) or reduce its


income (to reduce import demand)
To reduce CAD under a fixed rate regime, RBI can

intervene in exchange markets, or the country can


borrow
However sustaining CAD unsustainable in long run
Some way needed for adjustment: Can be automatic,

or through policy

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Session 11-12, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

When BoP deficit, RBI has to sell/supply foreign

currency to meet the deficit


Like an open market bond selling, forex selling also

reduces money supply in domestic market, AD shifts


On the supply side, as economy is away from full

unemployment, and market is tight, wages and costs


fall. Both AS and AD shift downwards
Ultimately new equilibrium reached, where NX=Zero,

AD=AS and employment is at full level. This however


is a slow process.

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Session 11-12, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Two kinds of policies: expenditure switching and

expenditure reducing
One policy is of tariffs. Higher tariffs improve CAD
Expenditure reducing policies relate government

budget to external balance


NX = Y (C+I+G) => NX = (S-I) + [TA-(G+TR)]]

If saving equals investment, changes in budget


translate to changes in external balance

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Session 11-12, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Major policy for dealing with payment deficits


Devaluation makes domestic exports attractive to

foreigners
Why are devaluations so often delayed?
Because it makes imported goods more expensive, so

consumers suffer. Also prices of imports of raw


material rises, impacting industry. Ultimately,
devaluations lower standard of living within country

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Session 11-12, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

What happens when domestic inflation higher than

overseas inflation under fixed exchange rate?


Steady loss in competitiveness, or increasing CAD
Crawling peg policy : Exchange rate depreciated

roughly equal to inflation differential between country


and its trading partner
Can exchange rate be used to control inflation?
It can be used, however at the cost of competitiveness,

and hence can be continued indefinitely

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Session 13, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

School of Management and Entrepreneurship,


Shiv Nadar University

Session 13: Long Run Economic Growth


Course Instructor:
Vaibhav Chaturvedi
Research Fellow, Council on Energy, Environment and Water
New Delhi, India

23

Vaibhav Chaturvedi , Research Fellow , Council on Energy, Environment and Water, New Delhi, India., 2014

Session 13, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

What accounts for the vast difference in per capita

income and economic growth across countries?


Growth accounting and growth theories answer these

questions
Growth accounting is what part of economic growth is

due to which factor of production


Growth theory helps explain how economic decisions

determine accumulation of factors of production

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Session 13, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Production function is the quantitative link between

inputs and outputs


Y = A * F(K,N)
Where Y is output, K is physical capital, N is labour,
what is A?
Y/Y = (1-)* N/N+ * K/K + A/A: is the share

of capital
A/A is the total factor productivity, i.e. The amount

by which output would increase as result of


improvement in methods of production, with all
inputs unchanged

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Session 13, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Factor shares are important. E.g. Impact of supply side

policies (on GDP) focused on augmenting capital


stock accumulation depends on capital share
Rearranging earlier equation

Y/Y - N/N = * [ K/K - N/N ] + A/A


y/y = * k/k + A/A
i.e. Per capita GDP growth depends on capital labour

ratio and technological progress

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Session 13, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Process of one economy catching up with another is

called convergence, e.g. Japan in the post war period


caught up with the US economy
Empirical evidence shows that in 1 capital

accumulation 973-92 accounts for most catch up


In 1950-73 however it was technology catch up.

Japanese imported technology during the post war


period
Thus different factors of growth important in different

time periods for countries

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Session 13, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Absolute Convergence: If savings rate, population

growth, and technology same then countries will reach


same steady state income
Conditional Convergence: If savings rate, population

growth, or technology different then countries will


reach different steady state income, though same
growth rates
Hence, Capital accumulation, apart from tech progress

an important variable impacting growth


So what determines rate of capital accumulation?

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Session 13, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Natural resources
Human capital: Societys skills increases by investment

in human capital
Y = A * F(K,H,N)
Any change in major factor of production will affect

output
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Session 13, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Focuses on capital accumulation, link to savings

decisions etc.
Assumes no technological progress

What is steady state equilibrium?: Combination of per

capita output and per capita capital where the


economy stays at rest, where per capita economic
variables are not changing
Additional investment is required to provide capital

for new workers and to replace depreciated capital for


staying at steady state level.
Therefore s* f(k) = (n + d) * k

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Session 13, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Let us discuss fig. 3.4. Shape of f(k) due to diminishing

marginal return to capital


Key result: At steady state, growth rate is not affected by

savings rate, but savings rate does impact the long run level
of capital and output per head
Long run growth results from technological progress

Labour is a v imp input: Human capital, physical capita

labour ratio
Exogenous growth theory as output growth not dependent
on savings rate, but on exogenous technology

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Session 13, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Neoclassical theory attributes long run growth to

technological progress, but doesnt explain the


economic determinants of tech progress
Data shows that savings rate and economic growth

positively related
Investment requirement line and savings curve

guaranteed to cross because of diminishing marginal


product of capital
Shape of returns to factors of production important

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Session 13, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Constant returns to all factors taken together means

savings always higher than investment requirement, so


output keeps growing
Total return to capital = Private returns + External returns
This is true for human capital
Economists hence think that investment in human

capital, R & D is key for understanding long run growth


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Session 13, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Lessons from Asian Tigers: HK, South Korea,

Singapore and Taiwan


East Asian growth not due to factor productivity

growth, but due to labour force increase, better human


capital, and high savings rate
Poverty trap: e.g. Sub Saharan countries, fig. 4-3. How

can an economy escape low level equilibrium?


Why do some countries have more capital than others?

How can they save and invest more than others?: Role
of social infrastructure

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Session 14, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

School of Management and Entrepreneurship,


Shiv Nadar University

Session 14: Indian Economy- Structure, Planning Process and


Economic Development
Course Instructor:
Vaibhav Chaturvedi
Research Fellow, Council on Energy, Environment and Water
New Delhi, India

35

Vaibhav Chaturvedi , Research Fellow , Council on Energy, Environment and Water, New Delhi, India., 2014

Session 14, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

What is a Developing Economy? -> per capita real income

decides that per person what he gets, less than 1 quarter of


US then under developed, if more than developing
As per WDR (2012): World Data Report, Gross National
Income Per Capita
Low Income is < 936 US$/capita
Middle Income is 936 - 11455 US$/capita
High Income is > 11455 US$/capita

OECD Organization for Economic Co-Operation and


Development
Page 4,5
Indias GDP in 2013 was 1500 US$/capita, total 1.9 Trillion US$ .
In MER or PPP?
Central problem is mass poverty, low resource base of poor

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Session 14, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Low per capita income


High dependence on primary sector for employment

agriculture, but less share in GDP


Heavy population pressure
Underemployment and disguised unemployment
Steadily improving rate of capital formation
Inequity in wealth distribution: Even after liberalization?
Low level of technology
Poor quality of human capital
Low standard of living: NSSO data indicators
Poor state of socio-economic indicators
ALL THESE ARE ALSO OUR DEVELOPMENTAL
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CHALLENGES

Session 14, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Agriculture land system: Zamindari and Ryotwari


Villages self sufficient, towns dependent on villages
Loss of handicraft units and increase of manufacturing imports
By 1900 Indian was a great exporter of agricultural goods and

importer of British manufacturing goods


Trade flourished but manufacturing lagged: Why? Indian

merchants invested in trade and there were no skilful craftsmen


Swadesi movement and World War I created industrial demand
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Session 14, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Three stages of demographic transition: Rates of birth and death, and

gradual industrialization
1st Stage - Agriculture economy, sanitation poor, poor people, no medical
aid, illiterate, size of family huge
2nd Stage improvement in medical, birth rate more , death rate reduced
3rd Stage Nuclear family, low birth rate, growth rate of population less,
moved to industrial economy
Population pyramid and Demographic dividend(1960 huge birth rate,

2010 huge working population)

Urbanization: 11% in 1901, slow rate of increase since


National Population Policy: Is there a role for economic policies?

HDI: Life expectancy, Literacy rate, and per capita GDP(PPP)

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Session 14, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Share of agriculture, industry and service sectors: Pg 85, Tb 3

Share of GDP versus share of employment

Infrastructure(Physical and Social): Irrigation, Energy,

Transport, Communications, Banking/Finance


Social Infrastructure: Education and Health
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Session 14, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Planning Commission set in 1950


Objectives of Planning: increase in production to achieve

higher per capita income; to achieve full employment; reduce


income inequality; to set up a socialist society based on
equality and justice without exploitation
Economic planning and removal of poverty and Economic
planning and social change
Capitalism, Socialism, and Mixed Economy
Privatization of PSUs- Is it necessary and good?

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Session 14, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Mahalanobis model of growth, 2nd FYP: Development of

rapid industrialization, focus on heavy industries


Why heavy industries?: To build larger volume of capital

stock at a faster rate; to build a self reliant economy,


eliminating import dependence of essential machinery
Still promoting small scale industries to produce consumer

goods to meet demands of a growing population and limit


inflation
Important role of private sector, but as complementary to the

public sector

42

Session 14, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Mahalanobis model focused on capital intensive heavy

industries in conflict with higher employment objective


Policy encouraged labour intensive techniques in consumer

goods industries
Fiscal Policy: Taxation and Govt. Expenditure for bringing

income inequality and social justice and empowerment


Heavy industry development strategy was hailed for many

positives, but criticised for neglecting agriculture, small


industries and increasing trade deficit

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Session 14, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Nehruvian versus Gandhian model of development


Nehruvian model, even after 5 FYP, failed to provide large scale

employment, huge poverty existed, PSUs inefficient and


bureaucratic as no experts at the helm, subsidized prices of
fertilizer, electricity, irrigation etc.
Gandian model focused on employment rather than product
Agriculture reform most important for attaining self sufficiency

through input improvements and land reforms. Focus on cottage


and village industries
China combines both development models

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Session 17-18, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

School of Management and Entrepreneurship,


Shiv Nadar University

Session 17-18: Planning Policy and Reform Process


Course Instructor:
Vaibhav Chaturvedi
Research Fellow, Council on Energy, Environment and Water
New Delhi, India

45

Vaibhav Chaturvedi , Research Fellow , Council on Energy, Environment and Water, New Delhi, India., 2014

Session 17-18, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Earlier Industrial Policy resolutions (1948,1956): Categorization of industries reserved for public and private
sector . 3 broad categories. Invest more on Heavy industries and Central Govt will have rights over them,
State will get Shipping, Telecom and remaining for Private
1956 More power to State Government
Schedule A 17 Industries - All responsibility for State
Schedule B 12 Industries PPP
Schedule C All private
Not neglect Private Sector, provide support
Different Tax systems, subsidies to small scale industries, Indian control even if foreign investment

Industrial Policy Statement (1977): Janata government, focus on small scale industries 180 to 807 small
scale industries
1985 Rajiv Gandhi Regime - Huge Trade Deficit, Congress Govt insisted on Heavy Industries, at that time
Fixed Exchange Rate, More Import, Less Export, so 1st Economic Reform Liberalization.
License Raj closed, relaxation to export import, technology updation, support for new sectors. Remove
restrictions to encourage private sector in India and increase FDI, but Trade Deficit still kept on increasing,
because importing more and more technology but no exports.

1991 Industrial Policy: Remove bureaucratic control , integration with world economy , reduce restrictions
on FDI, reduce the load of public enterprises

Huge Trade Deficit, govt can run only for 2 weeks, MRTP(Monopoly and Restrictive Trade Policies) act
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abolished, removed public companies which are not performing well

5 big policies

Fiscal Policy Reduce subsidy, take revenue, Tax

increased
Social Policy Drinking Water, Irrigation, Health,
External Policies Restrictions on Import
Trade Policy Restrictions with respect to Trade
Industry Licensing Act (Foreign Investment and
Technology, Public Sector Policy, Some industries
reserved for Public Sector, Hazardous and Polluting
industries should have license, Increase degree of
management in Public sector, abolish MRTP Act)
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Session 17-18, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Public sector expansion was key due to many reasons:


focus on core sectors;
to service equipment needs of strategic sectors like

Railways, Telecom, Nuclear power;


to check the rise of private monopolies;
to ensure availability of articles of mass consumption;
to protect employment

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Session 17-18, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

To accelerate pace of economic development

Pattern of resource allocation


Removal of regional disparities

Source of funds for public expenditure


Limitations and abuses of private sector 1966 Business Recession,

so govt gave few companies to private like drugs, but private people
raised prices, working for profit, less sell, private companies
withdrew, so govt had to import drugs to meet the demand, 1971
Food Inflation, so need to import food, so Trade Deficit increased

Socialistic pattern of society


49

Session 17-18, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Mounting losses
Political interference
Delay in project completion
Regulated price policy
Inefficient use of human resources
Low capacity utilization
Inefficient management
Hence the policy of disinvestment(moving certain

industries to Public) and privatisation

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Session 17-18, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

To essential manufactured goods

Exploration of energy and minerals


Technology promotion
Strategic areas like defence
What is the role of state then?: Market failures (imperfect

competition, monopoly, public goods, infrastructure)


Minimum state intervention versus effective intervention
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Session 17-18, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Capitalism has done a lot of introspection and learnt from

socialism
However socialist economies failed to appreciate the role of

markets in promoting efficiency and resource allocation


Experience of socialist system: Self righteousness, rigid

doctrines, authoritarian political regimes


Market socialism in China: Market mechanism and private

sector within the broader framework of socialism

52

Session 17-18, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

1985-90: Changes in policy wrt to industrial licencing ,

exim policy, technology upgradation, fiscal policy, FDI,


fiscal & administrative regulation

1990 BoP crisis: Increasing trade deficit since 1985, $7 Bn

loan from World Bank and IMF

Second wave of reforms started hence


53

Session 17-18, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Fiscal policies: Reducing public sector deficit from 12.5% of GDP to

4% of GDP

Social policies: Poverty alleviation still a thrust area with focus on

health, education, water and disadvantaged groups

Industrial policy reform: Industrial licensing abolished for many

sectors, easier bureaucratic processes

FDI policy: Increase in FDI cap for many sectors, automatic

approvals/ permissions for many sectors

Trade policy: From quantitative system to price based system


Public sector policy: Reduction of its role, more managerial

autonomy, reduced budgetary allocation, disinvestment

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Session 17-18, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Objectives of reform: a) higher economic growth; b)

increase in employment; c) reduction in regional


disparities; d) promotion of income equity; e) reduction
of BPL people

Successful in first objective. Failed or only partially

successful in all other objectives

Major sin of economic reforms: Neglect of agriculture

55

Session 17-18, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Infrastructure sector has shown good growth


Inflation eased slightly, except for last few years
Public sector performance improved
Industrial sector growth did not pick up
Satisfactory improvement in trade
Significant increase in FDI

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Session 17-18, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Has regional disparity reduced?: Reform process has

helped forward states more than backward states; seems


to have aggravated regional disparity

Socio economic indicators: Is the reform process oriented

towards socio economic gains

Reform of the reform process?


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Session 17-18, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Free international flow of goods and services, technology,

capital, and labour


Signifies the process of industrialization + liberalization
Globalization is expected to
Promote FDI and capital flow to developing regions
Promote technology transfer to developing regions

Widening access to markets for all countries


Faster knowledge dissemination and productivity

improvements
Reduce cost of transport and communication

58

Session 17-18, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Exports increased @15% pa between 1995 and 2012


However imports rose at even faster rate
Trade deficit increased from 4% in 2000 and over 10% in

2010
FDI increased from $1.3 Bn in 1994-95 to $37.7 Bn in 2009-

10. Globally Indias share- 1.9%, Brazil- 4.8%, China- 9%


Employment situation not improved significantly. What

about labour?

59

Session 17-18, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Five year plans, each had its focus


E.g. First plan focused on GDP growth, seventh on agricultural

improvement
Financing of plans: Taxation, market borrowing, small savings,

loans from international institutions


Many achievements of the planning process: income,

agriculture, industry, infrastructure, exports, S & T, education


system
Failures: Inefficient public sector, low employment growth,

poverty and inequity, concentration of econ. Power, etc.

60

Session 17-18, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

What is poverty?
Inability to fulfil even basic necessities of life
Minimum level versus reasonable standard of living

Numerous studies on poverty, poverty has been declining


Stagnation in rural growth has been identified as the basic

cause of slowdown in poverty reduction


Challenges: Clear definition and upgrading poverty line, a uni

dimensional poverty line, rural growth


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Vaibhav Chaturvedi , Research Fellow , Council on Energy, Environment and Water, New Delhi, India., 2014

Session 17-18, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Coexistence of economically prosperous and poor states

together is Regional imbalance


Indicators: Regional NSDP, growth in NSDP, trends in

investment, infrastructure disparities, social infra and human


development,
Role of the Finance Commission
Backwardness and resource transfer
Special areas development plan
Special incentives to promote investment in backward areas

62

Session 19-20, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

School of Management and Entrepreneurship,


Shiv Nadar University

Session 19-20: Foreign Trade, WTO, and Tax Regimes


Course Instructor:
Vaibhav Chaturvedi
Research Fellow, Council on Energy, Environment and Water
New Delhi, India

63

Vaibhav Chaturvedi , Research Fellow , Council on Energy, Environment and Water, New Delhi, India., 2014

Session 19-20, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Started with development imports, then maintenance imports,

and anti inflationary imports


Have to increase exports to finance imports as other finance is

limited
Initially developing country has to export food grain and raw

material
Gradually as population grows, food grains start getting

imported
Developed nations can help industries in developing countries

by reducing trade barriers for consumer goods and semi


manufactured goods

64

Session 19-20, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

India had consistently experiences worsening trade deficit

since independence
Declining Exports: Since 1997, south Asian crisis,

increased competition from China and Taiwan, non-tarrif


barriers created by developed countries and failure of big
industrial houses to boost exports
Import bill increased because: Industrial growth resulting

in import of capital goods and raw materials; and


liberalization of imports for export promotion
65

Session 19-20, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Indian exports are diversified and non traditional export

items are growing in importance


Large expansion of engineering goods export to industrial

and middle eastern countries


Favourable demand situation and attractive price

situation in international markets


Some commodities have tremendous export potential,

some have fluctuated widely


New emphasis on export growth of agricultural products

66

Session 19-20, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

1985 ExIm Policy:


a) Facilitate production through easier and quicker access to

imported inputs
b) To strengthen export production base
c) Facilitate technology upgradation
Balance of trade suffered due to policy of indiscriminate

import liberalization pursued under pressure from


WB/IMF in name of technology transfer
Export promotion limited at best
67

Session 19-20, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Balance of invisibles was positive, but huge trade deficit

Reasons:
a) Import liberalization
b) Import intensity increase due to higher demand for

consumer durables like TV requiring assembly of imported


kits

Finally steep depreciation of Rupee after the crisis

68

Session 19-20, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Step up exports to finance imports

Import liberalization focused on technology upgradation


In place of debt creating inflows, promote non debt

creating inflows
Invisibles exports have received commendable success:

Especially remittances and software exports


Still trade balance deteriorating significantly impacting

Current Account

69

Session 19-20, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Advances economies used their protectionist and export promotion

policies for their development


Post independence, Mahalanobis strategy was:

a) Keeping minimum the import of non essential consumer goods


b) Comprehensive control on import items
c) Liberal import of development goods
d) Import substitution policy
e) Vigorous export promotion through trading institutions and fiscal
incentives

Since 1991: Check dumping of goods, promotion of small scale

industries
2002-12: Focus Africa; OBUs; reducing control; reducing transaction

cost; focus key areas of manufacturing; however failed to boost ag70


exports

Session 19-20, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Areas which enjoy special privileges compared to non SEZ

areas
EPZs converted into SEZs
Logic: Promoting exports by concentrating resources in some

pockets
Incentives:

a) No IT for first five years, 50% exempt for 2 years thereafter


b) Exemption from other taxes and duties
c) All raw materials exempted from duty/customs
d) Government will acquire vast land for this purpose
e) 25% area for export promotion activities, 75% for social and
economic infrastructure
71

Session 19-20, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

SEZ policy motivated by the Chinese experience

Six pillar industries in China: Automobiles and spare part

components; Micro electronics and computers;


Household electronics and appliances; Bio-medicines and
opticals; Mechanical products; Electrical products
Rapid growth in coastal region but not in other parts in

China
Critques of SEZ policy: Impact on fiscal deficit; have SEZ

units accelerated exports; SEZ v/s SMEs; SEZ v/s nonSEZs; checking mad rush of IT SEZs; putting a cap on
SEZs region wise

72

Session 19-20, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

General Agreement on Trade and Tariffs 1948: Aimed at

reducing tariff barriers in commodity trade and also non


tariff restrictions in imports
Since 1986, new areas such as TRIPs, TRIMs and trade in

services included in negotiation


TRIPS: Haldi, Neem, Basmati. Biopiracy and need to

document Indias huge herbal wealth


TRIMS: Push by USA, treat foreign capital equal to

domestic capital
73

Session 19-20, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Critics feel that unrestricted freedom to foreign capital

will harm economic sovereignty


Social clauses like cost of labour, child labour, etc

highlighted. G15 opposed vehemently and US had to


retreat
Environmental protection clause
Multilateral approach OR Bilateral approach?
74

Session 19-20, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

WTO established in Jan 1995, India became a founder member

Indian capital goods industry hit hard


International tariffs reduced but host of domestic taxes still

there
Import of Chinese goods, small scale industries hit

WTO and Agriculture


WTO has not helped India and other developing nations as

expected

75

Session 19-20, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

M1 = Currency with public + Demand deposits


M2 = M1 + Post office saving deposits

M3 = M1 + Time deposits
M4 = M3 + Total post office deposits
CRR and SLR
External value of Rupee: depreciated since 1975 due to

high inflation
Inflow of money due to FDI and higher stock market

growth leads to Ex rate appreciation. Outflows of money


due to recession in foreign markets and addressing
76
liquidity concerns

Session 19-20, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Economic crisis due to fiscal deficit and trade deficit


Forex reserves down from $7 Bn in 1979-80 to $ 750 Mn in 199.

Only good for two weeks of import requirement


Huge foreign debt: International commercial borrrowings $ 90

Bn in 1991
Debt service increases from 8% of export earnings to 30% of

export earnings
Sold $ 200 Mn of confiscated gold to meet immediate

international obligations in time


Loan from IMF & WB with conditionalities on India

77

Session 19-20, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Huge increase in foreign exchange reserves

Liberalization in India and also external conditions like

US interest rate decreases


Forex accumulation in India due to FDI and FII, not due

to current account surplus like in China and Singapore


Current account convertibility versus Capital account

convertibility
78

Session 19-20, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

For investment in financial products

Investment for Indias growth like investment in

manufacturing by providing money through banks


Raising capital base of banks
Payment of commercial debt of high interest rates

Infrastructure development in India through IDFC


Major opposition is that most of forex is hot money,

however part of it can certainly be used

79

Session 19-20, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Direct(Salary, Property) and InDirect Tax(Goods, Service, etc), State

and Central Tax


Income tax and Sales tax

Progressive versus Regressive tax structure(Sales Tax, all have to pay

same amount of Tax) High Income, High Tax

Central versus State taxes: States have exclusive power to tax sales

and purchase of goods

Central government has exclusive power to tax sales and purchase of

goods in the course of inter state trade but state will collect and
retain it
Corporation Tax For setting up new industries.
Sales tax easiest to administer, however negative cascading effect
mostly goes to State Govt
Wealth Tax/Property Tax, Custom Duty, Excise Duty, Service Tax 80

Session 19-20, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Proposed in place of state sales tax, VAT is tax on value

added to goods in process of production and distribution


Spread across a large number of firms
Cannot be easily evaded as no single point of taxation
Easier to enforce through cross checking
Producer goods can be excluded and therefore incentive
to invest and produce more
Encourage export since fully rebated on exports

Difficulties: Demands that all producers, distributers, and

traders keep books of accounts and details of transactions


Still, VAT doesnt impact the cascading effect
81

Session 19-20, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Three main objectives: Streamlining of tax

administration, Avoid harrasment of business, higher


revenues
Fiscal consolidation versus Revenue led approach
Concurrent power to levy GST, hence change in

Constitution required
Based on some key principles

82

Session 19-20, Macroeconomics , Economic Environment and Policy, Term II, MBA, School of Management and Entrepreneurship, Shiv Nadar Univ.

Number of tax rates proposed restricted to three ad valorem

rates
Withdrawal of all cascading taxes
Imports charged two parts levy: Central and State GST
Exempt for all small manufacturing and service businesses
Basically, a completely new tax regime
Income versus Expenditure tax

GST a much more simpler system


Criticism: States will lose revenue as well as taxing power. GST

cant ensure tax compliance.

83