Topic : Economic Structure Balance of Payment

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ECON OM I C STRUCTURE, ECON OM I C POLI CY 1 9 9 1 AN D BALAN CE OF PAYM EN T Paper VI Business Environm ent MBA ( Evening) 3 rd Year COVERAGE

Econom ic St ruct uring: Com posit ion of nat ional out put by sect or Occupat ional st ruct ure of labour

New Econom ic Policy a.k.a. Rest ruct uring t he Econom y Liberalisat ion Privatisation Globalisat ion Expect ed benefit s

I m pact of rest ruct uring: St abilizat ion process using Monit ory & Fiscal Policies and im pact on Balance of Paym ent t rade deficit / Current Account / Capit al Account / Official reserves account

M AI N REFEREN CES I ndian Econom y Problem s of developm ent and planning Silver Jubilee ( 1999) Edit ion By A.N. Agarwal. Publisher Wishwa Publisher Topic Ar e a 1. 2. 3. 4. 5. 6. 7. 8. Workforce and occupat ional st ruct ure Nat ional I ncom e by indust rial origin Privat izat ion of Public Sect or New I ndust rial Policy Balance of Paym ent : Problem s and Policies Rupee : Exchange rat e and convert ibilit y Foreign Capit al Cha pt e r 9 12 30 34 46 50 51 57

th

Five year plan ( addit ional w.r.t t o New I ndust rial Policy)

OTH ER BOOKS FOR REFEREN CE I ndian Econom y By Mishra & Puri Any good book on Balance of Paym ent I ndian Econom y By Dut t & Sundaram

N OTE: 1. St udent s are advised t hat t his handout is m eant as a guide and as a short int roduct ion t o t he m ain t opic. I t should not be confused wit h course m at erial. St udent s should t reat t he handout as indicat ive out line as t o how t o approach t he t opic under considerat ion. They are expect ed t o build up t heir answers t aking int o considerat ion t he reference m at erial given above and in t he course along wit h class not es, newspaper & m agazines et c. Answers by t he st udent s should reflect an underst anding of t he t heory and it s im plicat ions in t he current econom ic scenario incorporat ing recent changes, if any. Business Environment (Economics) Rohit Vishal Kumar, 2001

2.

MBA(E) 3rd Year

Topic : Economic Structure Balance of Payment ECON OM I C STRUCTURE

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D e finit ion: Econom ic st ruct ure of an econom y is t he com posit ion of various econom ic act ivit ies of t he count ry in which t he workforce of t he econom y part icipat es. The econom ic st ruct ure of any econom y can be broadly divided int o t hree broad sect ors : Prim ary Sect or: Consist s of all prim ary econom ic act ivit ies like agricult ure, forest ry, m ining et c. Secondary Sect or: Consist s of m anufact uring, const ruct ion, elect ricit y et c. Tert iary Sect or: Consist s of t ransport , t rade, services and ot her relat ed indust ries. The various sect ors cont ribut e t o t he nat ional incom e of t he count ry and t o t he occupat ional pat t ern of t he populat ion or t he workforce. According t o Sim on Kut net z " Share of agricult ural sect or in t he nat ional incom e declines in t he course of t he econom ic developm ent ... while t hat of t he secondary and t ert iary sect or increases" Cha n ge s in Se ct or a l com posit ion in I ndia : The share of t he prim ary sect or, as a percent age of Gross Dom est ic Product ( GDP) fell from 58.3% in 1950- 51 t o 36.2% in 1988- 89. The m ost not iceable change t ook place in t he m ining sect or. The cont ribut ion of t he Mining sect or grew from 0.6% in 1950- 51 t o 12% in 1988- 89. The share of t he secondary sect or rem ained m ore or less st able. The share of organised m anufact uring sect or grew from 6.3% of t he GDP t o 12.2% in 1989- 90. But t his growt h was negat ed by t he fact t hat t he unorganised m anufact uring sect or declined from 9% in 1950- 51 t o about 5% in 1989- 90. The t ert iary sect or has shown a st eady growt h since independence. I t 's share has grown from 1.9% of t he GDP t o 4.6% in 1988- 89. Maj or cont ribut ors t o t his growt h were t he t ransport and com m unicat ion sect ors. Services indust ries whose cont ribut ion was negligible in t he pre liberalisat ion period have shown a m arked growt h in t he post liberalisat ion. D id st r uct ur a l cha nge t a k e pla ce in I ndia ? According t o est ablished t heories - t he t ert iary sect or and t he secondary sect or are t he dom inant sect ors in a developed count ry. Seeing t he changes t hat have t aken place in t he t hree sect ors since independence one can be led t o believe t hat sect oral changes in I ndia has t aken place following t he well est ablished norm s of econom ic growt h and developm ent . However a deeper look in t he occupat ional dist ribut ion of t he work force reflect s a com plet ely different pict ure. The t heory of st ruct ural change is im plicit ly linked wit h t he assum pt ion t hat t he changes in t he sect oral im port ance of t he sect ors are also reflect ed in t he occupat ional dist ribut ion of t he work force of t he count ry. However t hat has not been t he case in I ndia. The percent age of people em ployed in t he agricult ural sect or has rem ained m ore or less t he sam e since independence. The percent age of people em ployed in t he agricult ural sect or has never fallen below 65% . This im plies t hat t he gains from t he st ruct ur al changes have been negat ed due t o alm ost negligible change in t he w ork force dist ribut ion. Various fact ors com bined t o negat e t he gains of t he st ruct ural changes. Rapid growt h of populat ion aft er independence coupled wit h inadequat e m anpower planning by successive governm ent s can be ident ified as t he t wo m aj or fact ors for t he lack of developm ent . Aft er independence st ress was laid on indust rialisat ion leading t o a increase in em ploym ent in t he indust rial sect or wit h t he hope t hat em ploym ent generat ion in indust ry would lead t o a fall in t he proport ion of labour force engaged in agricult ure. But since t he populat ion growt h was rapid and t he rat e of indust rial growt h fell short of expect at ion - t he desired t ransfer of populat ion from agricult ure t o indust ry did not t ake place. To m ake m at t er worse lit t le at t ent ion was given t o m anpower planning. The governm ent policies failed t o creat e adequat e j obs out side t he agricult ural sect or result ing in widespread unem ploym ent . I n Sum : Even t hough t he share of sect ors has changed; t he levels of em ploym ent in t he various sect ors have rem ained t he sam e negat ing any growt h effect s of t he change in sect oral com posit ion.

MBA(E) 3rd Year

Business Environment (Economics)

Rohit Vishal Kumar, 2001

Topic : Economic Structure Balance of Payment

Page 3 of 6

N EW ECON OM I C POLI CY 1 9 9 1 I nt r oduct ion Beginning m id 1997, t he Governm ent of I ndia m ade som e radical changes in it s policies of t rade, foreign invest m ent , exchange rat e, indust ry, fiscal affairs et c. These various elem ent s when put t oget her const it ut e an econom ic as well as indust rial policy, which m ar ked a big depart ure form , t he old policy. The overall aim of t he new policy was t o achieve a sort of developm ent which would m ake indust ries dynam ic in t heir growt h and which rendered social j ust ice. The 3 key words t o t he NI P of 1991 were LPG i.e. Liberalisat ion, Privat isat ion and Globalisat ion. Libe r a lisa t ion: The NI P laid a lot of st ress on t he m ar ket forces and a m ar ket driven econom y. I t int ended t o dism ant le t he rest rict ive and regulat ory syst em and allow privat e ent repreneurs t o vent ure int o any indust rial sect or based on t heir own com m ercial decisions wit h no governm ent j udgem ent . I n t he absence of Governm ent cont rols t hese decisions were in t erm s of m arket prices and profit s. I n ot her words, allocat ion of resources am ong indust ries wit h respect t o t he scale, size of product ion and t he nat ure of t he product would be det erm ined by m arket prices. The role of t he st at e was confined t o select ed non- m arket areas- t o ensure a sm oot h funct ioning of t he m arket econom y. Pr iva t isa t ion: The NI P aim ed at st rengt hening t he privat e sect or in a big way. The t hrust of t he NI P was a m arket driven econom y ; so in line wit h t hat obj ect ive, t he new policy provided for t he privat isat ion of t he public sect or unit s ( PSUs) . The NI P provided for an enlargem ent in t he field of operat ion of t he privat e sect or ( and a cont ract ion in t he fields of operat ion of t he public sect or) . A num ber of act ivit ies ( 17 in num ber) which so far had been t he exclusively in t he realm of t he public sect or were t hrown open t o privat e sect or. Only 8 indust ries where securit y and st rat egic concerns predom inat ed were reserved for t he public sect or under t he new policy. The Governm ent also, t o a cert ain ext ent , privat ised t he ownership of t he PSUs. This was done by t he sale of a part of t he capit al of som e ent erprises. Thus by disinvest m ent of a part of t he capit al, t he Governm ent m ade t he public sect or account able t o t he privat e sect or crit erion, nam ely m arket - relat ed profit s. Globa lisa t ion: The NI P t ook great st eps t owards t he int egrat ion or t he unificat ion of t he I ndian econom y wit h t he world econom y. I t m ade t he econom y out wardly orient ed so t hat it s act ivit ies were now governed bot h by t he dom est ic as w ell as t he foreign m arket . The following st eps were t aken: 1. 2. 3. The rupee was also m ade fully convert ible on current account of t he balance of paym ent s. The cust om dut ies on im port s were also reduced wit h a view t o bring t hem in line wit h cust om dut ies of ot her count ries. The NI P of 1991 t he doors of t he I ndian econom y were t hrown open t o foreign invest m ent . Foreign invest ors were allowed t o have 51% equit y holdings.

All t his adds up t o an open econom y wit h respect t o t he m ovem ent s of exchange rat e, foreign exchange, im port s, export s and foreign direct invest m ent ( FDI ) . Fe a t ur e s: 1. Abolit ion of indust rial licensing : I n a m aj or m ove t o liberalise t he econom y t he Governm ent Of I ndia abolished all indust rial licensing irrespect ive of t he levels of invest m ent ,except for cert ain indust ries( 18 in num ber) for securit y and social concerns. I n April 1993, t he Governm ent exem pt ed t hree m ore indust ries from licensing - leaving only 15 indust ries in w hich licensing is com pulsory. Wit h t his st ep, alm ost 80% of t he indust ry have been t aken out of t he licensing fram ework. 2. Rem oval of t he MRTP lim it : Under t he MRTP Act , all firm s wit h asset s above a cert ain lim it ( Rs. 100 crores since 1985) were classified as MRTP firm s. Such firm s were perm it t ed t o ent er select ed indust ries only and t his also on case- by- case approval basis. The new I ndust rial Policy scrapped t he t hreshold lim it of asset s in respect t o MRTP and dom inant undert akings. These firm s were now at par wit h ot her firm s for ent ry or expansion int o t he delicensed areas. However firm s holding m ore t han 25% of t he m arket share were now ident ified as m onopolies MBA(E) 3rd Year Business Environment (Economics) Rohit Vishal Kumar, 2001

Topic : Economic Structure Balance of Payment

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and t he em phasis had shift ed t o t aking appropriat e act ion against m onopolist ic and unfair t rade pract ices. 3. Dilut ion of t he role of t he Public Sect or : The NI P rem oved various indust ries from t he Reserved List , which were previously t he dom ains of PSUs. I ndust ries, which cont inue t o be reserved for t he public sect or, are in areas where securit y and st rat egic concerns predom inat e. 4. Disinvest m ent of Public Holding: Under t he NI P, Governm ent act ively t ook part in disinvest m ent of public holdings. A beginning in t his direct ion was m ade in 1991- 92 it self by divest ing part of t he equit ies of 30 select ed PSUs ( w hich were placed wit h m ut ual funds) and Rs. 3000 crores was raised t hrough t hese m eans. 5. Ent ry of foreign invest m ent and t echnology : The NI P envisaged a broader role of foreign invest m ent and capit al in t he indust ries. The NI P had a specific list of high t echnology and high invest m ent priorit y indust ries where aut om at ic perm ission would be available for FDI up t o 51% foreign equit y. The list cont ained 34 indust ries. This was a m aj or depart ure from t he earlier policies, which required case- by- case approval of foreign invest m ent norm ally lim it ed t o 40% equit y part icipat ion. 6. I ndust rial locat ion policy liberalised : The new indust rial policy provides t hat ent repreneurs willing t o set up new indust ries m ay choose t he locat ion based on t heir own j udgem ent of availabilit y of resources. Except for indust ries subj ect t o com pulsory licensing ent repreneurs were allowed t o have a free hand. 7. Rem oval of m andat ory convert ibilit y clause : A large part of indust rial invest m ent in I ndia is financed by loans from banks and financial inst it ut ions. These inst it ut ions followed a m andat ory pract ice of including a convert ibilit y clause in t heir lending operat ions for new proj ect s. This has provided t hem wit h t he opt ion of convert ing part of t heir loans int o equit y. This opt ion has always been int erpret ed as a t hreat t o privat e firm s of t ake- overs from financial inst it ut ions. The NI P provided t hat hencefort h financial inst it ut ions would not im pose t his m andat ory convert ibilit y clause. 8. Abolit ion of phased m anufact uring program m es for new proj ect s : To force t he pace of indigenisat ion in m anufact uring, phased m anufact uring program m es had been in force in a num ber of engineering and elect ronic indust ries. The NI P abolished such program m es in t he fut ure as t he Governm ent felt t hat wit h subst ant ial reform s m ade in t he t rade policy and t he devaluat ion of t he Rupee, t here was no longer any need t o enforce local cont ent requirem ent s on a case- by- case basis. Som e e x pe ct e d be ne fit s fr om t he N I P: 1. I m proved efficiency in t he use and allocat ion of resources: Wit h t he rem oval of cont rols and rest rict ions t he NI P would prom ot e individual ent repreneurs and t his increased com pet it ion would help in prom ot ing indust ry in I ndia. The privat isat ion of t he PSUs and t he ent ry of FDI would also bring about an im provem ent in efficiency. 2. I ncrease in t he econom ic growt h rat e: The growt h rat e of t he econom y was also expect ed t o go up sizeably as a result of t he im plem ent at ion of t he NI P t hrough an increase in t he efficiency of t he indust ries. I ncrease in em ploym ent levels: Wit h higher rat e of growt h; expansion of em ploym ent was also expect ed. Fall in rat e of inflat ion: The rat e of inflat ion was also predict ed t o fall due t o com pet it ion. I m proved Foreign Exchange posit ion: The NI P was also expect ed t o im prove t he Forex reserves of t he count ry by im proving t he Balance of Paym ent s.

3.

4. 5.

[ MAKE A COMPREHENSI VE NOTE ON THE EFFECTI VENESS OF NI P I N THE LAST DECADE ]

MBA(E) 3rd Year

Business Environment (Economics)

Rohit Vishal Kumar, 2001

Topic : Economic Structure Balance of Payment STABI LI SATI ON PROCESS AN D BALAN CE OF PAYM EN T

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Ba la nce of Pa ym e nt : The Balance of paym ent ( BOP) of t he count ry is a sum m ary record of t he int ernat ional econom ic and financial t ransact ion of t he count ry during a specified period of t im e. I n ot her words, BOP is m erely a way of list ing receipt s and paym ent s of int ernat ional t ransact ion of a count ry. I n t his sense t he BOP is an applicat ion of t he Double Ent ry Bookkeeping syst em and done properly t he debit s and credit s will always balance : hence BOP will always be in equilibrium . Cr e dit s Export of Goods Export of Services Unrequit ed receipt s ( Gift s, indem nit ies et c.) Capit al Receipt s ( Borrowings from , capit al repaym ent by, or sale of asset s t o foreigners) D e bit s I m port s of Goods I m port of services Unrequit ed paym ent s ( Gift s, indem nit ies et c.) Capit al Paym ent s ( Lending t o, capit al repaym ent t o, or purchase of asset s from foreigners)

Ba la nce of Tr a de : I s t he count rys visible t rade i.e. t he export s of goods less t he im port of goods. Ba la nce of Cur r e nt Account : The it em s t hat are ent ered int o t he current account are as follows: Tr a nsa ct ion Merchandise Foreign Travel Transport at ion I nsurance Prem ium I nvest m ent I ncom e Sale and purchase of goods and services by t he governm ent Miscellaneous Cr e dit Export Earnings Earnings Receipt s Dividends Receipt s Receipt s D e bit I m port Paym ent Paym ent Paym ent s Dividends Paym ent s Paym ent s

Equilibr ium a n d D ise quilibr ium of BOP: A BOP is said t o be in equilibrium when t he dem and for foreign exchange is exact ly equal t o t he supply of foreign exchange. When t here is a deficit in t he balance of paym ent s t he dem and for foreign exchange exceeds t he supply of foreign exchange. Re a son s for D ise quilibr ium : A. Econ om ic Fa ct or s: ( 1) Developm ent Disequlibrium : I t is m ore com m on in developing count ries. Developm ent disequilibrium arises because developing nat ions im port capit al goods on a large scale t o carry out various developm ent program s. ( 2) Capit al Disequilibrium : Capit al disequilibrium occurs due t o cyclical fluct uat ion in t he general business act ivit y. During depression a shrinkage in world t rade t akes place leading t o a disequilibrium in t he BOP. ( 3) Secular Disequlibrium : This t ype of Disequilibrium is caused by cert ain secular t rends in t he econom y and persist s for a long t im e. For exam ple in a developed count ry t he disposable incom e and t herefore aggregat e dem and for consum pt ion product s is high. This m ay lead t o heavy im port s and cause BOP Disequilibrium . ( 4) St ruct ural Disequilibrium : St ruct ural changes m ay also affect t he BOP. For exam ple exhaust ion ( or inadequat e product ion) of product ive resource ( say pet roleum ) m ay lead t o Disequilibrium MBA(E) 3rd Year Business Environment (Economics) Rohit Vishal Kumar, 2001

Topic : Economic Structure Balance of Payment

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as t he governm ent m ay have t o purchase t he scarce resource from ot her count ries who have an abundance of it . B. Polit ica l Fa ct or s: Polit ical st abilit y or inst abilit y also plays a large role in m aint aining BPO equilibrium . A count ry wit h polit ical inst abilit y m ay experience large dom est ic and foreign capit al out flow which m ay lead t o disequilibrium . C. Socia l Fa ct or s: Changes in t ast e, preference, fashion of t he populat ion m ay lead t o large scale im port s of t he desired com m odit ies leading t o BOP problem s.

BOP D ise quilibr ium a nd St a bilisa t ion policie s: ( A) M onit or y M e a sur e s: ( 1) Cont ract ion of m oney supply: A fall in m oney supply leads t o a fall in purchasing power and t hereby reduct ion in aggregat e dem and and consequent ly leads t o a fall in dem and of im port s. ( 2) Devaluat ion: Devaluat ion m eans t he reduct ion of t he official rat e at which t he dom est ic currency is exchanges for foreign currency not ably pounds ( ) and Dollars ( $) . Devaluat ion m akes foreign goods cost lier in t erm s of dom est ic currency and t hereby discourage im port s. On t he ot her hand devaluat ion m akes dom est ic export s cheaper in t he foreign m arket and t hereby st im ulat e export s. ( 3) Exchange Cont rol: The cent ral bank or t he governm ent assum es com plet e cont rol of t he forex reserves and earnings of t he count ry, and lim it s t he am ount of forex t hat can be t ransact ed t hereby m aint aining t he forex reserves. ( B) Fisca l M e a sur e s: ( 1) Export Prom ot ion: Reduct ion in export dut ies, providing export subsidy, and encouraging t he product ion of export able goods by various incent ives t hereby earning forex t o balance t he BOP Disequilibrium . ( 2) I m port Cont rols: I ncreasing im port dut ies, rest rict ing im port t hrough im port quot as et c. help in cont rolling im port s and consequent ly help in arrest ing t he out flow of forex.

( C) M isce lla ne ous M e a sur e s: Obt aining foreign loans, developing t ourism , providing incent ives for inward rem it t ances, using Special Drawing Right s ( SDR) available wit h t he I nt ernat ional Monit ory Fund ( I MF) . [ SHOW HOW THE STABI LI SATI ON POLI CI ES HAVE WORKED I N I NDI A I N THE LAST DECADE W.R.T NEW ECONOMI C POLI CY ]

MBA(E) 3rd Year

Business Environment (Economics)

Rohit Vishal Kumar, 2001