RBI Grade B 2021

Descriptive Component
Economics & Social Issues
India’s External Sector
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• The link between free trade and growth is a hotly discussed issue and no consensus
has emerged.
• experiences of the newly industrializing countries (NIC), Hong Kong, South Korea,
Singapore, and Taiwan - intensely studied with mixed conclusions
Openness & Growth in

o successful export of labour-intensive manufactured products throughout the

the Indian Economy

1970s and 1980s

o spectacular export success was actually facilitated by previous import
substitution and careful policy planning
• robustness of the correlation between openness and growth declines as other
variables are included
• greater openness in trade raises the share of industry in value added at the expense
of the agricultural sector. Thus, trade actually facilitates industrialization
• quality of institutions matters a great deal for a positive trade-income nexus
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The major channels through which greater openness is supposed to stimulate an economy
Openness Growth are as follows:
Link
1. Demand pull and cost reduction effect
i. Additional source of demand
ii. Import cheaper and better quality inputs and capital equipment
Openness & Growth in
the Indian Economy

iii. Rising demand and falling costs give a strong boost to profits and encourage
capital formation
2. Competition effect
i. forces domestic firms to improve efficiency
ii. raises the average efficiency
iii. choice of products, production locations, and techniques
3. Learning effect
i. better technology, managerial skills, and marketing networks
ii. efficiency improvement
iii. improvement in total factor productivity
4. Capital inflow effect
i. FDI: transnational transfer of technological knowledge and managerial skills
ii. FPI: depth and liquidity of the stock market
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Openness Growth • Growth spurt

Link o domestically driven
o domestic industrial liberalization
1980s o Import liberalization related to inputs and components
Openness & Growth in

o significant attitudinal change in favor of private sector

the Indian Economy

o fillip to business confidence and profitability stimulated investment

• International trade
o small part of the economy
o stagnant at around 14 per cent
o bulk of the trade, almost 80 per cent, was in goods - in deficit
o Service trade – balanced
o degree of integration with the global market was rather weak
o growth boost was largely due to increase in domestic investments and the
productivity of capital.
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Openness Growth • In the 1990s, the speed and depth of integration went on increasing
Link • net export of services accelerated.
• IT-aided modularization and fragmentation → dramatic reversal of the process of
1980s vertical integration
Openness & Growth in

• India - huge stock of scientific and technical manpower + lower wage rate = leader in
the Indian Economy

the export of business services.

Services • Growth rate of services: 6.2 per cent in 1980–95; 21 per cent during 1996–2004; 27
per cent during 2005–11
• Share in world exports increased: almost 4 per cent in 2011
• Services sector - 57 per cent share in the GDP
• Recent growth in the services sector - dominated by growth in the organized
component - responds positively to the growing global demand
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Openness Growth Agriculture:

Link • GDP share of agriculture - fallen from around 40 per cent to almost 15 per cent – due
to persistently low rate of growth
1980s • Greater openness - failed to provide a stimulus - agricultural exports never really
Openness & Growth in

picked up
the Indian Economy

• developed countries did not (and still have not) opened up their markets to
Services agricultural imports
• pressure on fiscal consolidation + inability to bring down subsidies → cutbacks in
Agriculture & public investments
Industry • serious deficiencies in infrastructural facilities
Manufacturing Sector:
• increased competition from China + larger import penetration + persistent
inefficiency + deficiencies in such basic infrastructural facilities + Deceleration in
public investments → relative stagnation
• Even external capital has failed to provide adequate succour - FDI flows dramatically
shifted towards newly emerging tertiary activities
• absence of a broad industrial base in the rural areas
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Openness Growth
Link

1980s
Openness & Growth in
the Indian Economy

Services

Agriculture &
Industry

Competition &
Productivity Effect
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Openness Growth • Capital inflows: tilted in favour of portfolio investment by foreign institutional
Link investors – highly volatile – fair weathered friends
• considerable stock market growth
1980s • confined to the secondary market for blue chip company shares
Openness & Growth in

• direct contact with the real sector seems to have been lost
the Indian Economy

• Short-term portfolio flows → prospect of capital gains → volatility

Services • Precautionary measure: RBI has decided to maintain a large stock of foreign
reserves mainly invested in low-yielding US T-bills
Agriculture & • Addition to the stock of foreign reserves → growth of high powered money →
Industry inflation → sterilization

Competition &
Productivity Effect

Capital Inflows &

Exchange Rate Policy
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Openness Growth • more open states grew faster by 1–1.5 per cent per annum
Link • States that were able to change their production structure towards export production
showed greater change in growth
1980s • And this ability was strongly correlated with the quality of institutions and the
Openness & Growth in

prevailing investment climate

the Indian Economy

Services

Agriculture &
Industry

Competition &
Productivity Effect

Capital Inflows &

Exchange Rate Policy

Regional Growth
 Is there a link?

Openness Growth • India and other emerging economies were hit hard by the GFC or the Great Recession
Link • recovery was remarkably rapid and spectacular
• GFC’s impact on India
1980s • Capital outflow and value of the Indian currency
Openness & Growth in

• no slowdown in the FDI flows, portfolio investments - net outflow of about

the Indian Economy

USD 6.4 billion in April–September 2008 (flight-to-safety phenomenon)

Services • most precipitous fall in the value of rupee in more than two decades
• Impact on the stock market
Agriculture & • primary and secondary markets got severely disrupted
Industry • corporate plans for raising resources for all types of projects – abandoned
or on hold
Competition & • Impact on the banking sector
Productivity Effect
• did not experience any serious contagion
• did not suffer any direct exposure to the sub-prime mortgage assets
Capital Inflows &
Exchange Rate Policy • Aftermath of the turmoil:
• additional liquidity support
• fiscal stimulus
Regional Growth

India & the Global

Crisis