Macroeconomic Developments and Policies in India:

1991-2018

ON GDP GROWTH: VARIOUS PHASES

It can be seen that there are four distinct phases with respect
to the growth of the Gross Domestic Product (GDP) at factor
cost or of Gross Value Added (GVA) at basic prices (after
2011-12) of India from the early 1990s onwards. These are:

1992-93 to 1996-1997 (five years): A phase of relatively fast

growth of GDP.
1997-98 to 2002-03 (six years): A phase of stagnant growth of
GDP.
2003-04 to 2011-12: A phase of fast growth of GDP again.

The period from 2003-04 to 2007-08 (five years) registered

extremely fast rates of GDP growth: annual rates of more than
8 per cent in four out of these five years. However, the Indian
economy had been hit by the global financial crisis during the
2007-09 period. At the same time, the fiscal and monetary
stimulus measures introduced by the Governments and
Central Banks in India and other parts of the world helped the
economy to recover somewhat. The Indian economy
registered fast growth of GDP again in 2009-10, 2010-11 and
2011-12.

Overall, despite the global financial and economic crisis, the

Indian economy recorded a respectable performance with
respect to the growth of the GDP during the period from
2003-04 to 2011-12.

From 2012-13 onwards:

India’s GDP growth had been relatively slow during the years
2012-13, 2013-14 and again during 2016-17 and 2017-18.
India’s latest GDP growth rates (during the 2016-18 period)
are significantly less than the GDP growth registered during
the high growth phase in the country (2003-08). At the same
time, the Indian economy is even today one of the fastest
growing large economies in the world.

Table 1: Annual Growth of India’s GDP at factor cost or GVA at

basic prices, 1991-92 to 2017-18

Source: National Accounts Statistics

WHY AGRICULTURAL SECTOR IS IMPORTANT?

In India, the agricultural sector accounts for 47% of India’s total
workforce, although its share in GDP is only 14%.

Given that close to half of India’s workforce depends on agriculture

for their livelihoods, this sector has an important impact on rural
and overall domestic demand of the country.

The agricultural production can impact food production and

therefore food and overall prices. It can impact consumer prices
(its impact will be seen on Consumer price index for agricultural
labourers (CPIAL).

Agriculture also provides raw material for several agro-based

industries.

India's Workforce and GDP in 2011-12

Source: National Sample Surveys on Employment and

Unemployment; National Accounts Statistics.

It can be seen that the growth of food production and growth of

agricultural incomes have a strong association with the level of
rainfall availability. The years of deficient rainfall in India – 2004,
2009, 2014-15 and 2015-16 – have also been years in which the
growth of agricultural incomes slowed down sharply in India.

Growth of Agricultural Incomes, Growth of Food grain production,

and level of rainfall in India, 1991-92 to 2017-18

Measures of Inflation: Annual Growth of Wholesale Price Indices

and Consumer Price Indices

Source: Data from Reserve Bank of India website

 NATURE OF ECONOMIC GROWTH

There are a number of differences, with respect to the nature

of economic growth in India, between the two time-periods:
the period from 2003-04 to 2011-12 and the period after 2012.

The growth of agriculture and allied activities, construction,

and even of manufacturing had been faster and more stable
during the 2003-12 period compared to the growth of these
sectors after 2012.

During the nine-year period between 2003-04 and 2011-12,

there were only two years of deficient monsoon rainfall: 2004
and 2009. The growth of agriculture and food production was
slow in only three out of these nine years: 2004-05, 2008-09
and 2009-10. During the period from 2007-08 to 2011-12,
there was large increase in government spending on rural
areas, particularly on public employment programmes such as
the MNREGA. All these factors gave a boost to rural demand
during this period. The construction sector grew at fast rates
during the period between 2003-04 and 2011-12. The growth
of the construction sector had been in double digits in each
year between 2003-04 and 2007-08. The construction sector
also created employment in large numbers. It accounted for
almost half of all non-agricultural jobs created in the country
between 2004-05 and 2011-12.

On the other hand, out of the six years between 2012-13 and
2017-18, there were four years in which the rainfall received
by the country was less than normal: 2012, 2014, 2015 and
2017. The growth of incomes from agriculture and allied
activities was below 2 per cent in three out of these six years.
The growth of the construction sector was notably slow during
the 2012-18 period: the rate of growth of this sector was less
than 4 per cent in four out of these six years.

Growth over the previous three-year period of various Sectors, in

%, 1992-95 to 2015-18

Source: National Accounts Statistics

GROWTH IN INDIA IN RECENT YEARS: MORE

CONSUMPTION-LED THAN INVESTMENT-LED

GDP = Private Consumption(C) + Private Investment (I) +

Government expenditure (G) + Export (X) – Imports (M)
The growth of India’s GDP between 2003-04 and 2011-12 was led
by investment. Investment as a share of GDP increased sharply
from around 25% in the early 2000s to close to 40% by 2011-12.
However, the share of investment in India’s GDP declined,
particularly after 2011-12.
In the aftermath of the global financial crisis, there has been a
significant increase in investment as a share of GDP in China. On
the other hand, investment as a share of GDP has declined in India
during the corresponding period.

Gross Domestic Capital Formation (Investment) and Gross

Domestic Savings in India, as % of GDP, 1967-68 to 2016-17

Source: National Accounts Statistics

Components of India’s GDP, 1999-2000 to 2016-17, as % of GDP

(market prices)
Source: National Accounts Statistics

Gross Fixed Capital Formation (Investment) as % of GDP

(Source: World Bank)
 EXTERNAL FACTORS AND THEIR INFLUENCE ON INDIA’S
BALANCE OF PAYMENTS

The growth of the global economy – output and trade – had

been at a fast pace between 2003 and 2007. However, the
growth of the global economy and global trade were both
negative in 2009. Global output and trade growth has been at
a low rate from 2012 onwards.

The slow growth of global trade is a factor that has decelerated the
growth of India’s exports (X) and therefore overall GDP growth
(GDP = C+I+G+X-M). At the same time, changes in the price of
crude oil have reduced India’s import bill from the middle of
2014 onwards. International crude oil prices had increased
from less than $80 through most of 2009 to reach $110 by
June 2014. The increase in crude oil prices has led to a sharp
rise in India’s import bill (increase in M) and widened the
country’s current account deficit. India’s current account
deficit was 2.8 per cent of GDP in 2010-11 but rose to 4.8 per
cent of GDP by 2012-13.

It is also interesting to see the impact of trade in services

(invisibles) in India’s overall balance of payments.

During periods of widening current account deficit (such as

during 2012-13 and 2013-14), the Indian economy is
dependent on capital inflows (including short-term capital
flows and loans, both of which are volatile) to balance the
external account.
Growth of Global GDP and Global Trade, in %, 2001 to 2017

Source: Data from Reserve Bank of India website

India’s Balance of Payments, in billions of US dollars

Source: Data from Reserve Bank of India website

International Crude Oil Prices, in inflation adjusted US dollars per

barrel

https://www.macrotrends.net/1369/crude-oil-price-history-chart
India’s Imports in millions of US dollars

Source: Data from Reserve Bank of India website

Exports, Imports, Net Invisibles and Current Account Balance, as

% of GDP,

Source: Data from Reserve Bank of India website

 GOVERNMENT REVENUES, EXPENDITURES
AND FISCAL DEFICITS

Like in the case of any household or firm, government too tries to

match its expenditures with receipts. What if the government’s
expenditures exceed receipts, or if the government incurs a fiscal
deficit? The Keynesian argument is that such governmental
spending, through its multiplier effects, will help to revive the
growth of incomes and employment in an economy that is operating
below its full-employment level. On the other hand, neoclassical
economists contest the above view, arguing that the market
mechanism, in itself, will help the economy reach the full-
employment level.
In recent years, the neoclassical belief in the merits of a low
fiscal deficit has become a watchword for policymakers in India and
elsewhere. In India this was enshrined in the FRBM legislation
(Fiscal Responsibility and Budget Management) bill enacted in
2003 (this legislation envisaged to reduce the fiscal deficit to 3% of
GDP by March 2008).
India has a relatively low ratio of taxes to GDP (gross
domestic product). In 2011, the central government taxes as a
share of GDP was only 8.8 % in India, lower than the corresponding
average for low and middle-income countries (13.3%).1A
government that is powerless to raise tax revenues and at the same
time committed to reducing the fiscal deficit will then have no
option other than to curb its expenditures, hurting the interests of
the poor.

Tax Revenues Collected by the Central Government as %

of GDP

1
Source: World Development Indicators
Source: World Development Indicators, World Bank

…………………………………………………………………………………………

The challenges India faces in raising tax revenues and expenditures

are evident from an analysis of the Union Budgets presented in the
country over the last one decade. Consider the very first budget
presented by the United Progressive Alliance (UPA) government on
8 July 2004. The stock markets crashed in response to the budget
proposals. The strong disapproval shown by the stock markets was
over a relatively minor tax proposal – a new securities transaction
tax at the rate of 0.15%.
A significant increase in the allocation for the social sectors
occurred in the fourth budget presented by the UPA government, in
2007-08. In this budget, the government also agreed to
substantially hike its spending on its flagship employment
guarantee scheme (which later became the Mahatma Gandhi
National Rural Employment Guarantee Act). In the Union budget in
2008-09, the government announced a major debt relief scheme for
farmers. The stock markets were angered at these budget indices,
and the stock market indices fell in the days immediately after the
announcement of 2007-08 and 2008-09 budget proposals.
------------------------------------------------------------------------------------------------------
--
The years from 2001-02 to 2007-08 witnessed a sharp improvement
in India’s tax revenue collection, especially of direct taxes, aided
partly by the fast growth of the economy during this period.
Central Government taxes as % of GDP

Source: Data from Reserve Bank of India website

At the same time, the Central and State government expenditures

on social and community services as a share of GDP increased in
India from 5% in 2004-05 to 6% in 2008-09 and to 7% by 2012-13.
Also, between 2004-05 and 2008-09, expenditures (as shares of
GDP) classified as ‘developmental’ increased markedly whereas
‘non-developmental’ expenditures, mainly interest payments,
declined (see Figure below).
Expenditures of Centre and States combined, as % of GDP

Source: Indian Public Finance Statistics, various issues, Ministry of

Finance, Government of India.

Fiscal deficit by the Central government touched a low of

2.5% of GDP in 2007-08, which was in line with the target set by
the Fiscal Responsibility and Budget Management (FRBM) Act,
2003 (see the low level of the combined fiscal deficit of the central
and state government in 2007-08).
 Central Government Receipts and Expenditures as % of GDP

Studies have shown that the increase in spending on social sectors

and rural areas, and especially on MNREGA, did have a great
impact in rural areas. The surveys conducted by the National
Sample Survey Organization (NSSO) in 2009-10 and 2011-12
showed a decline in ‘distress’ employment in agriculture, increase
in rural wage rates, and a faster reduction of poverty during the
second half of the 2000s.

MACROECONOMIC POLICIES AFTER THE GLOBAL

FINANCIAL CRISIS OF 2008-09

India’s GDP growth slowed down in 2008-09 in the wake of the

global economic crisis (see Figure 6). To combat recessionary
conditions in the economy, the Union government unveiled plans
for a large increase in fiscal expenditures (a fiscal-stimulus package
amounting to 3.5% of GDP). The budgeted estimates of fiscal deficit
for 2009-10 increased to 6.2% of GDP as the government said it
would now try to achieve the FRBM targets only after the economy
staged a recovery.
 India’s economic growth recovered in 2009-10 and 2010-11.
Clearly, the expansionary fiscal and monetary policies pursued in
the country helped it stage a relatively quick economic recovery.
However, India’s economic growth slowed down markedly by
2012-13. Public sector GFCF (gross fixed capital formation or
investment) as % of GDP had increased between 2002-03 and 2008-
09, but declined afterwards (to 7.5% in 2011-12). Private corporate
sector GFCF as % of GDP had risen sharply from 5.3% in 2002-03
to 14.3% in 2007-08, but fell equally sharply afterwards (to 9.9% in
2011-12) (see Figures 6 and 7). At the same time, India’s current
account deficit worsened sharply from 2008-09 onwards, falling to
4.8% of GDP by 2012-13. Inflation rates in India, especially of food
articles, rose to very high levels since 2008-09 onwards. There
were increases in India’s external debt levels and also in the non-
performing assets (NPAs) of the domestic banking system.

Gross Fixed Capital Formation in India,

Combating a
by Sectors, as % GDP Recession with
16

14

12

10
Shares in %

4
Public sector GFCF
2
Private corporate sector
0 GFCF

Austerity Policies

The response by the government and the central bank to the

deteriorating economic situation in the country was rather meek.
On the one hand, India’s taxes-to-GDP ratio was on a declining
trend from 2008-09 onwards, reducing the fiscal capacity of the
state to intervene in the economy. On the other, the government
became too careful not to earn the displeasure of the stock
markets, and therefore, tried to reduce its expenditures and
thereby the fiscal deficit.
The Finance Minister announced a phased withdrawal from
fiscal stimulus measures in his budget-speech in February 2010.
The budget allocation (as a share of GDP) for agriculture and rural
development including for MNREGA was on a decline from their
peak level in 2008-09. The allocation on social sectors increased,
but only marginally. Legislation on food security was one of the
promises made by the UPA during the 2009 elections, and the Right
to Food Act was eventually made into a law by the Parliament in
July 2013. Nevertheless the increases in budgetary allocations that
were crucial to operationalizing the Act did not happen. The
government also made clear its intentions to substantially reduce
the subsidy bill. It hiked duties on petroleum products (in the 2010-
11 budget), announced plans to replace subsidies with direct
transfer of cash to beneficiaries (in the 2011-12 budget), and
restricted the number of subsidized cooking gas cylinders available
to a household (in 2013).
To combat inflationary pressures in the economy, the RBI
followed a tight monetary policy, by raising the repo rates and
thereby keeping interest rates in the economy at relatively low
rates. As the Economic Survey 2011-12 notes, RBI hiked the repo
rate 13 times between March 2010 and January 2012, cumulatively
by 375 points. However, as the various Economics Surveys by the
government itself points out, inflation especially of food articles
was mainly on account of supply-side constraints to agricultural
growth and monsoon deficiency in certain years. Therefore the
tight monetary policy has impacted investment and economic
growth negatively.
On what then went wrong with India’s economic growth especially
after 2011, one should perhaps examine the implications of the
opening up of India’s capital account for foreign capital flows
during the 2000s.

FOREIGN CAPITAL FLOWS AND ECONOMIC GROWTH

India has been gradually opening up its capital account to foreign

capital flows since the 2000s. In successive budget speeches,
Finance Ministers have made announcements that made it easier
for short-term foreign capital to flow into and out of the country.
The budges presented by the Union government in 2001-02, 2002-
03 and 2003-04 liberalized the rules for foreign institutional
investments (FIIs) or foreign portfolio investments (FPIs) into India.
They also significantly increased the limits for overseas
investments by Indian companies (this was increased to $50 million
in the 2001-02 budget, and to 100 per cent of the net worth of the
Indian company in the 2003-04 budget). In the budget Speech of
2004-05, the government expressed its welcoming approach to
short-term foreign capital flows: “many genuine FIIs ……can
enhance the flow of equity capital and lend depth to the capital
markets”, according to the Finance Minster (The budget Speech of
2004-05).

As a result of these liberalization measures, foreign capital inflows

to India increased sharply since 2003-04 onwards. Notably, a large
share of foreign capital that India received has been short-term in
nature. These include foreign portfolio investments (FPI), External
Commercial Borrowings (ECBs) and bank deposits by Non-resident
Indians (NRIs). Capital inflows on account of these three sources
combined (FPI, ECBs and NRI deposits) amounted to more than
twice the capital flows to the country on account of FDI between
2000-01 and 2012-13 (see Figure 8).

Capital Flows to India: FDI and FPI

India faced severe macroeconomic challenges both when short-

term foreign capital flowed into and out of the country in large
quantities. During periods of heavy capital inflows into India such
as between 2003-04 and 2007-08, there was pressure on the
country’s exchange rate to appreciate (see Figure ). The
appreciation of the Indian Rupee (Rupee-dollar exchange rate
varied between Rs.39 and Rs.41 per dollar between May 2007 and
April 2008) hurt the growth prospects of export-oriented industries
such as textiles, garments, leather and diamond cutting.

Volatility in FPI Flows into India: leading to fluctuations in

exchange rate
Rupee Dollar Exchange Rate
To slow down the appreciation of the Rupee, the Reserve Bank
intervened by accumulating foreign exchange reserves. Net foreign
exchange assets of RBI increased almost five-fold: from 2.6 trillion
Rupees in 2001-02 to 12.3 trillion Rupees in 2007-08 (see Figure
10). The accumulation of foreign exchange reserves contributed to
the growth of reserve money and to the rise in inflation during the
2006-08 years. (The Economic Surveys in 2006-07 and 2007-08
pointed out that the main driver of reserve money growth in these
years was the net addition to foreign exchange assets of the RBI).
To reduce the inflationary impact due to the increase in its foreign
exchange assets, the RBI resorts to sterilization, which it achieves
by decreasing its domestic assets, mainly its credit to the
government (see Figure).
The Central bank’s (CB) credit to the government or ‘printing
money’ is an important means to finance fiscal deficits. However, as
shown above, with the increase in capital inflows and the
inflationary pressures they tend to generate, it becomes impossible
for the central bank to extend credit to the government. In any
case, eliminating the financing of the fiscal deficits by the Central
bank (CB) was part of the financial sector reforms, and was one of
the provisions of the FRBM Act was that to eliminate this option.

Central Bank Balance Sheet

But this was not all. As capital inflows continued, the CB had to
continue engaging in sterilization for which it was required to sell
government securities more and more. Eventually it reached a
stage where the stock of government securities that could be sold
in the market became limited. The solution came in the form of
government bonds issued under the market stabilization scheme
(MSS), which the RBI sold to the public as part of its sterilization
efforts. The government paid interest rates on the MSS bonds, but
the proceeds from the sale of these bonds were not used to support
the government finances (This explains why RBI’s credit to Central
and State governments were negative during 2007-08 period. See
Figure 10), However, MSS balances were used to support the fiscal
stimulus measures introduced by the government from 2008-09
onwards (there had been a sharp increase in RBI’s credit to
government’s as a % of reserve money from 2008-09 onwards).

As a result of these changes, the net RBI credit to the government

declined since the 2000s, and was, in fact, negative in 2004-05 and
2007-08 (See Figure). In these years, the net flow of credit was
from the government to the RBI, and not the other way round, so
that the RBI could use the proceeds for sterilizing the capital flows.

The economy suffered fiscal costs on account of the intervention

and sterilization operations that the RBI did in response to the
large foreign capital inflows. Fiscal costs arose due to the interest
payments of the government on the MSS bonds that it issued.
Another source of these costs was when the RBI replaced its
domestic assets with foreign assets (comprising mainly US treasury
bonds), which offered very low rates of return. The difference
between the returns that the RBI could have received by holding
domestic assets and the returns it actually received from its foreign
assets entailed a cost to the economy. According to estimates by
the RBI, the cost to the Indian economy on account of the
sterilization operations ranged from 0.6% to 2% of the country’s
gross domestic product (GDP) during the period from 2004-05 to
2008-09 (RBI, 2012, p.90). In addition, there was, of course, the
opportunity cost arising from the inability of the Central Bank to
finance the government deficits.
The large inflows of foreign capital also created difficulties for the
Central Bank in monetary management. Given the ‘impossible
trinity’, it is difficult for any country to simultaneously allow free
capital mobility, maintain fixed exchange rates, and be able to
pursue independent monetary policy. The Finance Minister
admitted this in the 2008-09 Union Budget: “We have … witnessed
capital inflows that are far in excess of the current account deficit.
This poses a challenge to monetary management.”
Short-term foreign capital flows into emerging economies
often in search of high returns. A fall in domestic interest rates
could, therefore, trigger capital outflow from these economies. This
creates pressures on domestic interest rates in emerging
economies from falling in a downward direction. In other words,
even with greater openness to foreign capital flows, cost of capital
for domestic entrepreneurs has not actually gone down in India.
Capital inflows to India were also marked by high degree of
volatility. Net inflows of FPI into India turned sharply negative in
2008-09 as foreign investors took the ‘flight to safety’ out of
emerging market economies in the wake of the global financial
crisis. Consequently, the Rupee depreciated sharply in 2008-09.
Driven by the rapid rise and equally rapid fall in global commodity
prices, there were sharp fluctuations in domestic prices too during
January 2008 to March 2009 (see Economic Survey 2008-09).
Foreign Capital Flows: Why too much of it can be a problem?

• Appreciation of currency (2006-07) – slows down

exports
• Depreciation of currency (2012-13) – imports, external
loans become costlier, rise in India’s external debt
• Volatility in prices
• Capital flows into speculative areas – increase in
current account deficit – further crises
• Sterilization – reduction of Central bank financing of
fiscal deficit
• Interest rates cannot fall down too low

Liberalization of the Capital Account: After the Global Financial

Crisis

As shown earlier, many of the problems on account of short-term

foreign capital flows became evident to India by the late 2000s,
especially during the 2007-09 period. Nevertheless, India has
continued to welcome foreign capital flows.
Part of the reason is that India’s current account deficit
worsened since 2011-12 and capital flows were helpful to support
the rising current account deficits (see Economic Survey 2010-11,
p. 17). Therefore, the government further liberalized the rules on
short-term foreign capital flowing into the country. In the 2012-13
Union Budget, the limits on FII investments in long-term
infrastructure bonds, corporate bonds, government securities, and
external commercial borrowings (ECBs) were raised. Also, qualified
foreign investors were allowed to invest in specified Indian mutual
funds and directly in equities. In the 2013-14 Union Budget, the
government announced several proposals relating to the capital
market that simplified the procedures for FPIs to enter the country.
India’s overall macroeconomic situation turned adverse since 2011-
12 onwards. The country’s GDP growth slowed down considerably,
its current account deficit increased, and there was considerable
rise in food inflation. According to Economic Survey 2012-13, the
factors that led to the decline in private investment include the
increase in cost of borrowing (due to the rise in policy rates), lower
demand for exports, and policy bottlenecks relating to land
acquisition and obtaining environmental permissions. In the
changed circumstances, outflows of foreign capital became
substantial. As a consequence, the Indian Rupee was on a decline
since August 2011, and the decline became much sharper after
June 2013.

With liberalization in rules on ECBs, many Indian firms have been

borrowing foreign currency loans. This has contributed the most to
the rise in India’s external debt, which increased from 113 billion
dollars in 2004 to 440.6 billion dollars in 2014. The share of short-
term debt in overall debt increased sharply from 2005 onwards.
The share of ECBs in India’s total external debt rose from 19.5% to
33% between 2004 and 2014 (while the corresponding share of
government borrowing decreased from 35.3% to 13.8% during the
same period). With the depreciation of the Indian Rupee during the
2011-13 period, the external liabilities of firms that had taken
foreign-currency loans earlier increased significantly.

Non-performing assets of the banking system sharply increased, as

many of the projects in industry and infrastructure for which banks
had lent money did not take off. Gross NPAs of public sector
scheduled commercial banks increased from 2% in 2008-09 to 3.6%
in 2012-13.
SLOW GROWTH OF CREDIT TO SMALL-SCALE INDUSTRIES
AND AGRICULTURE
One of the problems facing the Indian economy is the relatively
slow growth of credit, especially to small-scale industries and
agriculture.

Shares of Industry and Agriculture in outstanding non-food gross

bank credit in India, in %

50
45
40
35 Medium &
30 large industry
in%

25
20
15
Agriculture
10
5 Small-scale
0 industry
1979-80
1981-82
1983-84
1985-86
1987-88
1989-90
1991-92
1993-94
1995-96
1997-98
1999-00
2001-02
2003-04
2005-06
2007-08
2009-10
2011-12
Source: Reserve Bank of India