Indian Economy-IIML-Lect 1-2

Indian Economy
Dr Ritesh Kumar Mishra,

Department of Finance and Business Economics,
University of Delhi
Lecture 1 – 2
Overview of Indian Economy:

The Past, the Present and the way forward
Why you (as a manager) need to study Indian Economy
• It is indeed true that firms organize the production process and produce goods
in their own independent plant which they fully control – so much that they can
control even the air flow inside their office and plant (wow !!!!).
• But the end outcome of their business efforts is determined by (or controlled
by) the overall economic environment prevailing in domestic and the world
economy.
• A company is just like a small cabin in a big building (i.e. the overall macro
economy), which gets affected (positively and negatively) due to good or bad
weather or earthquake (i.e. economic fluctuations and policies).
• The economy provides the umbrella under which firms take birth – organize
production – become unicorns – earn huge profits – and die or exit the market
over time.
• A clear understanding of the functioning of the laboratory (i.e. economy) is

essential for producing vaccines (i.e. goods) that can generate profit for the
firm.
Dr Ritesh Kumar Mishra, University of Delhi

Why you need to study Indian Economy
• Swings in macroeconomic variables have the potential to push a

fundamentally sound firm into bankruptcy by aggravating financial
distress
– GDP A country is not a company - Paul Krugma.pdf

– Inflation
– Unemployment
– Interest rate
– Exchange rate
– International Trade: export – import
• Therefore, a clear understanding of domestic economy is critical in

understanding the prevailing business environment and appropriately
responding to various macroeconomic shocks.

Economy – Firms – Domestic and international Shocks
• Shocks we witnessed during – balance of payment crisis of 1991,

economic boom of 2004 – 2010, global financial crisis of 2008 – 09, Covid
– 19 lockdown – have determined the growth trajectory of economy and
firms.
Indian Economy
Firms (A, B, C)

Indian Economy: the past
• After independence, the Indian economy has travelled a long way on
its economic growth trajectory – From Hindu rate to high growth rate:
Period Growth in Real GDP (MP) Growth in Real Per-capita GDP (MP)
Phase – 1
3.7 1.6
(1951 – 81)
Phase – 2 4.9 2.8
(1981 – 88)
Phase – 3 5.7 3.7
(1988 – 03)
Phase – 4 7.7 6.4
(2003 – 18)
2018 – 19 6.1 **
2019 – 20 (PE) 4.2 **
2020 – 21 (AE) -7.7 **

• Some of the key economic policies that shaped the past (then) and future
of firms in the Indian economy:
Period Growth in R(GDP) Key Economic Policies

Five Year Plans – Industrial Foundation – Import
Phase – 1 Substitution Policy – Industrial Policy (License Raj)
3.7
(1951 – 81) – Green Revolution – Nationalization of Banks (14
banks on 20 July 1969) – Big role for PSUs
Phase – 2 Nationalization of Banks (6 Banks)
4.9
(1981 – 88)
Phase – 3 Balance of Payment Crisis of 1991 – Economic Reform
5.7
(1988 – 03)
Phase – 4 2004 – 2010 High growth phase and slow down due
7.7
(2003 – 18) GFC (2008 – 09)
Now Growth
(2014-21) moderation A set of measures discussed in forthcoming slides
between sub 6%
to Negative

• India’s unique (precocious) growth pattern:
– India is outlier in terms sustaining democracy at very low levels of income, low levels of literacy,
social division and highly agrarian economy.
• Continuous democracy in only a few small countries (Costa Rica, Barbados, Jamica, Mauritius and Botswana)
with higher levels of literacy and fewer social divisions.
– Low importance and contribution of manufacturing compared to services.
• Most countries grow by either specializing in or exploiting their minerals and in some cases exploiting their
geography. But India's development experience is driven by services. Although we have lot of unskilled
workforce, but we are using most of our skilled workforce.
– India exports a lot of FDI which is fairly unique in world's economic history.
– Early expenditure on redistribution and subsidies and then investment in infrastructure. This is
contrary to pattern followed by USA and Europe.
– Integration with the world economy in early stage.
– Socialism with restricted entry and capitalism without exit.

Indian Economy’s precocious growth pattern
(Business Line)

Need for Economic Reforms of 1991
Indicator Pre – 1991 – 92 Now (2020 – 21)
Inflation Rate 12% 4.91 CPI - Nov, 2021
Current Account deficit (-) 3.5% (+) 3.1 (April – Sep 2020)
Forex Reserve 2 weeks import USD 640.4 Billion (Nov 19, 2021)
Consolidated FD >10% FD: 4.6 (2019-20) & 6.8 (2020 -21)
External Debt to Export 250% Debt –GDP Ratio: 89.33%

The Economic Reforms of 1991
• Immediate measures: • Later policy measures:
• Devaluation of Rupees • Shift to LPG model

• Abolishing investment and import • Reduction in tariffs
licensing.
• Opened Civil Aviation and Telecom
• Opened doors for FDI for private sector
• Macroeconomic Stabilization
• Eased entry of private domestic
• Control of fiscal deficit and foreign banks
• Income tax rates unified to 20, 30,

40%
• Corporate profit tax reduced to

40% from 50%.

Indian Economy: the Present
India’s historical output growth

India’s historical output growth(Figure 39)
• India’s GDP contraction of 23.9 percent in Q1: FY 2020-21 and 7.5

percent in Q2: FY 2020-21 quarter reflect the unparalleled effect of the
Covid-19 pandemic.
• The contraction was consistent with the India’s enforcement of one of the
most stringent lockdowns as reflected in the Government Response
Stringency Index measured by Oxford University.
• The fundamentals of the economy remained strong as gradual scaling

back of lockdowns, along with the astute support of Atmanirbhar Bharat
Mission has placed the economy firmly on the path of recovery.
• NSO has estimated a contraction of real GDP by 7.7 per cent in 2020-21
as compared to a growth of 4.2 per cent in 2019-20.

India’s historical output growth(Figure 39)
• This is the fourth contraction in India's GDP since 1960-61 (Figure 39 –

previous slide).
• The contraction in 1965-66 and 1971-72 coincided with wars and droughts
while the year 1979-80 was associated with a severe drought and political
instability.
• A common factor in all these years was a steep fall in agricultural output.
• The year 2020-21, on the contrary, has been bestowed with abundant
monsoons leading to the agricultural sector emerging as the silver lining of
the economy.
• The contraction this year reflects the ‘once in a century crisis’ unleashed
by the pandemic and associated public health measures.

Sectoral Contribution to Overall GDP Growth
• Sectoral Contribution to Overall GDP Growth:

Sectoral Contribution to GDP Growth (Figure 40 – 41)
• Government Consumption and Net Exports have cushioned the contraction in

GDP while Gross Capital Formation (GCF) and Private Consumption have
contributed to the contraction in GDP in 2020-21 (Figure 40).
• Government final consumption expenditure has sustained the growth of GDP in

2020-21 with its share increasing to 14.0 per cent from 12.0 per cent in 2019-20
(Figure 41).
• The share of private consumption has almost remained the same indicating the
adverse impact of the pandemic and restrained personal consumption in contact-
sensitive sectors.
• Gross Investment has contributed most to the contraction in GDP in 2020-21 with
its share in GDP pegged at 26.7 per cent, lowest in the 2000s.
• Net Exports have cushioned the fall in GDP in 2020-21 largely due to a sharper
contraction in imports than in exports.

Indian Economy: Demand side of the economy
• Demand Side of the economy (Remember: Y = C + I + G + NX)

Demand side of the economy (Figure 42 a – d)
• On the demand side, the recovery is expected to be broad-based in the

second half (Figure 42).
• The biggest growth driver is likely to be government consumption that is

expected to grow at a strong 17 per cent YoY in second half as against a
3.9 per cent contraction the first half.
• Private consumption is also expected to improve significantly with a mild

contraction of 0.6 per cent as against a contraction of 18.9 per cent in the
first half.
• Investment, as measured by Gross Fixed Capital Formation (GFCF), is

also expected to recover significantly with a mild contraction of 0.8 per
cent in the second half against a sharp 29 per cent drop in H1FY21.

Demand side of the economy (Figure 42 a – d)
• Net Exports (Exports – Imports) turned positive in the first half of the year
with a larger contraction in imports of 29.1 per cent as compared to
contraction in exports of 10.7 per cent.
• With gradual recovery of economic activity, both imports and exports have
picked up and net exports is expected to re-enter the negative territory in
the second half.
• Exports are expected to decline by 5.8 per cent and imports by 11.3 per
cent in the second half of the year.

Indian Economy: Supply Side of the economy
• On the supply side of the economy also indicates massive impact of covid
– 19 lockdown on the economy:

Supply Side of the economy (Figure 43 – 44)
• On the supply side, Gross Value Added (GVA) growth is pegged at -7.2 per cent in 2020-21
as against 3.9 per cent in 2019-20.
• Only Agriculture contributed to positive growth while Service and Industry contributed to the
contraction in GDP (Figure 43).
• Agriculture is set to cushion the shock of the COVID-19 pandemic on the Indian economy in
2020- 21 with a growth of 3.4 per cent – resulting in an increase in its share in GDP to 19.9
per cent in 2020-21 from 17.8 per cent in 2019-20 (Figure 44).
• This indicates that agricultural activities for rabi harvesting and kharif sowing were largely
unaffected by the COVID induced lockdown.
• Industry and Services are estimated to contract by 9.6 per cent and 8.8 per cent during the
year.
• Within Industry, Mining is estimated to contract by 12.4 per cent, Manufacturing by 9.4 per
cent and construction by 12.6 per cent.
• The utilities sector has shown a sharp recovery and is set to register a positive growth of 2.7
per cent in 2020-21.
• Within Services Sector, trade, hotels, transport & communication are estimated to contract
by 21.4 per cent

Indian Economy: Twin Economic Shocks
• So the Indian economy is currently facing the impact of Twin Shocks due to
Covid-19 and trying to rebound strongly.

Twin Economic Shocks (Figure 11)
• The pandemic has been a unique economic shock that has triggered both
supply and demand side shocks simultaneously across economies around the
world.
• Increased uncertainty, lower confidence, loss of incomes, weaker growth

prospects, fear of contagion, curtailment of spending options due to closure of
all contact-sensitive activities, the triggering of precautionary savings, risk
aversion among businesses and resultant fall in consumption and investment
– leading to the first order demand shock.
• The supply chain disruptions caused by closure of economic activity and

restricted movement of labour lead to the first order supply shocks.

Twin Economic Shocks (Figure 11)
• The first order supply side disruptions potentially created second round
effects on both demand and supply.
• The initial supply shock, resulting in wage and income loss, could impact
aggregate demand and impair productive capacity leading to supply shocks.
• These effects were further amplified through international trade and financial
linkages, dampening global activity and pushing commodity prices down.
• The feedback loops of demand and supply generated potential hysteresis

effects - when households demand less, firms get reduced revenues, which
feeds into reduced activity by firms, and thus reduced household income.

What kind of recovery we are likely to face
• May be a V-shaped or U-shaped or L-shaped recovery…

• May be a V-shaped or U-shaped or L-shaped recovery…

• V, U, W, L, and K are the most common letters used to characterize all these
various recovery paths.
• The letters resemble the shape the economy takes on a graph that shows
GDP plotted against time.
• From these shapes, you can glean the duration of the recession and the
nature of the economy's comeback.
• For example, a V-shape shows the economy declining quickly, spending

almost no time at the recession's low point, and then bouncing back just as
quickly.
• These aren't necessarily official terms, as there's no formal system for

classifying recessions or their aftermath.
• Rather, the letter-naming first took off during a turn-of-the-21st-century

recession as a short-hand to describe predictions of how the economy might
recover.

The Economic Reforms of Present
• In the recent past various governments have initiated a series of economic

reforms to put the economy on higher growth trajectory:
– Jan Dhan Yojana (28th August, 2014 )
– Flexible Inflation Targeting Regime (May, 2016) – CPI 4% (+_2%)
– Demonetization (8 November 2016)
– GST (1st July, 2017)
– Push for privatization of PSUs (Budget 2021-22)
– Shift towards capital expenditure (Budget 2021-22)
– Direct Benefit Transfer (DBT)

why we need inflation targeting
• Flexible Inflation Targeting Regime (May, 2016) – CPI 4% (+_2%).

Flexible inflation targeting regime
• The primary objective of monetary policy (See Mohan and Ray, 2019; www.rbi.org):
– is to maintain price stability while keeping in mind the objective of

growth. Price stability is a necessary precondition to sustainable growth.
• May 2016 – the RBI Act, 1934 was amended to provide a statutory basis for
the implementation of the flexible inflation targeting (FIT) framework.
• The amended RBI Act also provides for the inflation target to be set by the
Government of India, in consultation with the Reserve Bank, once in every
five years.
• The CPI base inflation target for the period from August 5, 2016 – March
31, 2021 is 4% (with the upper tolerance limit of 6 per cent and the lower
tolerance limit of 2 per cent).

Indian Economy: the challenges ahead
• Important challenges, among others, faced by the Indian economy are as follows:
1. Avoiding (in the medium term) another taper tantrum as happened in June 2013.
2. The Twin Balance sheet problem
3. Avoiding the middle income trap to achieve higher income levels.
4. Achieving equitable growth – international catching up is visible but within economy

catch-up is not taking place.
5. Dealing with negative effects of technological disruptions in the economy.

Indian Economy: the challenges ahead
• Important challenges ..... Contd...
6. Return to high (or pre-Covid 19) growth phase with internal and external balance.
7. Restoring fiscal prudence: breach of FRBM target of 3% deficit – there is need for
expenditure switching for strong and sustained development. (Current FD – 6.8%)
8. Avoiding the possibility of a stagflation – Retail inflation (5.59 CPI - Dec, 2021)
and unemployment 7.6%
9. Moving towards strong industrial and manufacturing base to fully utilize unskilled
and semi-skilled pool of workers – demographic dividend.
10. Moving beyond stigmatized capitalism to a vibrant market economy.

The challenges: The fear of Taper Tantrum Revisited

The challenges: the fear of Taper
• Figure 1 (previous slide) highlights starkly that the two episodes of Indian macro
vulnerability in the last 35 years—1991 and 2013—were associated with, even preceded
by, large increases in fiscal deficits.
• In the early 1980s, there was an expansion in spending and deficits in response to
accelerating growth.
• The inability to rein in these deficits played a key role in undermining India’s
external situation, which led to the balance of payments crisis of 1991.
• The difference between the 1991 and 2013 episodes is that in the former there was a fixed
exchange rate which created a full-blown crisis.
• Whereas in 2013, the exchange rate was floating, which attenuated disruptions in other
asset prices.

The challenges: the fear of Taper
• During the mid-2000s growth boom, new spending programs were

introduced, which could not be sustained when receipts fell back to more
normal levels.
• Then, after the Global Financial Crisis there was a renewed surge in budget
deficits, which rose to exceptionally high levels.
• This boom-financed spending (since 2005-06) combined with the sharp

stimulus (4 percent of GDP) in the wake of the GFC, which was then not
withdrawn adequately or on time, led to the financial-currency “near-crisis”
in the autumn of 2013.
The Taper Tantrum Revisited _ PIIE.pdf

The Problem of Stagflation
• Indian economy is expected to face the co-existence of high inflation and

high unemployment in the near term (source- unemployment rate CMIE).

The challenges: Twin Balance sheet
• In February 2016, financial markets in India were rocked by bad news from the
banking system.
• One by one, public sector banks revealed their financial results for the December
quarter. And the numbers were stunning.
• Banks reported that nonperforming assets had soared, to such an extent that
provisioning had overwhelmed operating earnings. As a result, net income had
plunged deeply into the red.
• The news set off alarm bells amongst investors, who responded by fleeing public
sector bank shares.
• This brought their (PSBs) prices to such low levels that at one point the medium-sized
private sector bank HDFC was valued as much as 24 public sector banks put together.

• In February 2016, financial markets in India were rocked by bad news from the
banking system.
• One by one, public sector banks revealed their financial results for the December
quarter. And the numbers were stunning.
• Banks reported that nonperforming assets had soared, to such an extent that
provisioning had overwhelmed operating earnings. As a result, net income had
plunged deeply into the red.
• The news set off alarm bells amongst investors, who responded by fleeing public
sector bank shares.
• This brought their (PSBs) prices to such low levels that at one point the medium-sized
private sector bank HDFC was valued as much as 24 public sector banks put together.


• What had happened?
• Normally, non performing assets (NPAs) soar when there is an economic crisis,
triggering widespread bankruptcies.
• This is precisely what happened in East Asia during 1997-98 and the US and
UK in 2008-09.
• But there was no economic crisis in India; to the contrary, GDP was growing at
a world-beating pace. Nor had there been any major calamity in the corporate
sector; no large firm had gone bankrupt.
• Credit Suisse reported that around 40 percent of the corporate debt it monitored
was owed by companies which had an interest coverage ratio less than 1.
• Meaning they did not earn enough to pay the interest obligations on their loans.

• As this data filtered into the public consciousness, it became clear that
India was suffering from a “twin balance sheet problem”:
– where both the banking and corporate sectors were under stress.
• Not just a small amount of stress, but one of the highest degrees of
stress in the world.
• At its current level, India’s NPA ratio is higher than any other major
emerging market (with the exception of Russia), higher even than the
peak levels seen in Korea during the East Asian crisis.

• The standard path to twin balance sheet • What happened in Indian economy?
problem
• The standard model, however, doesn’t
seem to fit India’s case. True, India had
• Typically, countries with a twin balance boomed during the mid-2000s along with
sheet (TBS) problem follow a standard the global economy. But it sailed through
path.
the GFC largely unscathed.
• Their corporations over-expand during a • May be this happened because Indian

boom, leaving them with obligations that companies and banks had avoided the
they can’t repay. boom period mistakes made by their
counterparts abroad – i.e. excessive and
• So, they default on their debts, leaving careless lending and risk taking.
bank balance sheets impaired, as well.
• More precisely, prudential restrictions
• This combination then proves devastating kept bank credit from expanding
for growth, since the hobbled corporations excessively during the boom, while
are reluctant to invest. capital controls prevented an undue
recourse to foreign loans.
• While those that remain sound can’t invest • If this narrative is correct, then it is
much either, since fragile banks are not puzzling that India nonetheless wound up
really in a position to lend to them.
with a twin balance sheet problem.

The challenges: The Middle-Income Trap
Why strong equitable and sustainable growth is vital for India
• As the rural labor force shrinks and wages rise, the factor accumulation that
once propelled high growth eventually loses strength.
• Unless new sources of economic growth are found, a country may find itself
unable to compete with either low-wage countries that dominate mature
industries or high-income countries that dominate innovative, high
technology industries.
• What does the empirical evidence suggest? Middle Income Trap.pdf
• Out of 101 middle-income countries in 1960, approximately 13 became high-

income by 2008 based on per capita income level relative to the United
States.
• Some studies support the existence of a middle-income trap by finding

empirical evidence that growth slowdowns are more likely at middle-income
levels.

The challenges: The Middle-Income Trap
• Is there a chance for Indian economy to fall in the middle income trap?
• GDP per capita in India was last recorded at 1,797.76 US dollars in 2020
• The direct answer – there is a chance.
• What is the solution?
• In order to make transition to prosperity or high levels of economic

growth, (middle-income countries) we need to:
– Invest heavily in human capital (training and skill development)

– Develop a culture of in-house R&D and technological innovation
– Improve the quality of education
Middle Income Trap.pdf

Growth or equitable growth: convergence or divergence
• What is happening to the distribution of growth at the state level?
• Are poorer states catching – up with their rich counterparts in India?
• Economic theory provides one metric to make such comparisons:

convergence.
• Convergence means that a state that starts off at low performance levels
on an outcome of importance, say the level of income or consumption,
should see faster growth on that outcome over time, improving its
performance so that it catches up with states which had better starting
points.
• For example, example, since the per capita GSDP (gross state domestic
product) of Odisha in 1984 was 25 percent lower than the per capita
GSDP of Kerala.

Growth or equitable growth: convergence or divergence
• Traditional convergence theory would suggest that Odisha would

experience higher growth rates over time, thereby reducing the gap
between the two states.
• Convergence is thus an intuitive measure of absolute and relative

performance, allowing national and international comparisons.
• It measures the rate of catch-up, in particular whether less developed

states have caught up with richer ones and hence whether regional
dispersion is increasing

Convergence or Divergence
• In terms of income convergence, Indian states offer a striking contrast to

the catch-up that is happening globally and within China.

Convergence or Divergence (Figure 3)
• Figure 3 captures these divergent developments for the period 2004-

2014. It plots income convergence for the world, China and India.
• In the figure, the growth of per capita GDP is on the y-axis and the log
value of initial level of per capita GDP (in PPP terms) on the x-axis.
• For convergence or catch-up to occur, the relationship should be

negative (the line of best fit should be downward sloping because
convergence theory says that the less developed you are to start off with
the faster you should grow subsequently).
• The blue, red, and green lines plot, respectively, the relationship for
India, China, and the world.

Convergence or Divergence (Figure 3)
• Figure 3 speaks for itself: the relationship is strongly negative for the
world and China, and weakly positive for India.
• At the world level – Poorer countries are catching up with richer

countries,
• The poorer Chinese provinces are catching up with the richer ones,
• But in India, the less developed states are not catching up; instead they
are, on average, falling behind the richer states.
• However, there are evidence to suggest that Indian economy as whole is

catching – up with other countries.

Growth or equitable growth:
Income convergence has evolved overtime
• What is especially striking is how convergence has evolved over time.

• What is especially striking is how convergence has evolved over time.
• In the 1990s, convergence patterns were not dissimilar (Figure 4 plots

the same for the 1990s) across the world, China and India with either
weak convergence or divergence.
• But things really changed for both the world and China in the 2000s; they
did not, however, for India.
• This was despite the promise that less developed states such as Bihar,
Madhya Pradesh and Chhattisgarh had started improving their relative
performance.
• But the data show that those developments were neither strong nor
durable enough to change the underlying picture of divergence or
growing inequality.

Consumption Convergence within India: 1993-2004, 2004-2011

Consumption Convergence within India (Fig. 5)
• Figure 5 plots state level consumption convergence regressions for the three
decades.
• Again, no sign of convergence in the 2000s was found.
• The 1990s (purple line) and 2000s (orange line) show that consumption has
been diverging for the last two decades.
• The available empirical evidence suggest that convergence occurred

within the United States and Japan over long periods.
• The opposing results in India versus those in China and internationally

pose a deep puzzle.

Consumption Convergence within India (Fig. 5)
• Convergence happens essentially through trade and through mobility of

factors of production.
• If a state/country is poor, the returns to capital must be high and should

be able to attract capital and labor, thereby raising its productivity and
enabling catch up with richer states/countries.
• The main finding suggests that India stands out as an exception.

Within India, where borders are porous, convergence has failed whereas
in China, we observe successful convergence.
• Even across countries where borders are much thicker (because of

restrictions on trade, capital and labor) the convergence dynamic has
occurred.

• Why do we need an equitable growth?
– Higher inequality leads to adverse socio-economic outcomes (Wilkinson and

Pickett, 2009; Atkinson, 2014; Piketty, 2020).
– Firms grow, business flourish and firms survive to earn profits in a politically,
economically and socially stable environment. Along with good policies, this is a
necessary condition for long-term existence of firms – USA, UK and Japan,
Singapore.
Economic Social
Political Stability Stability harmony/stability
Good Business Prospects, Survival and

Profitability of firms

Business and Economic inequality
• Is business a reason for economic inequality, or does business reduce

economic inequality?
• Private business both increases and decreases inequality, in conjunction

with changes in the structure of the economy, technology, social attitudes
and public policy.
• Private business does not definitively determine the distribution of

income, but influences it.
• Business practices affect inequality in three different ways:
– Through corruption, Business Is One Reason For Economic Inequality--And Also

– Scalability of innovation
– Through the search for undervalued resources.
3 Ways Businesses Are Addressing Inequality in Emergin

Drivers of Economic growth:
• What are the drivers of economic growth?
• Even though their individual paths may differ, all rapidly growing
countries share certain common traits.
• The same fundamental process of economic growth and development

that helped shape Britain and Japan is at work today in developing
countries like China and India.
• Indeed, economists who have studied growth have found that the engine
of economic progress must ride on the same four wheels, no matter how
rich or poor the country.

• These four wheels, or factors of growth, are:
– Natural resource (land, minerals, fuels, environmental quality)
– Capital (factories, machinery, roads, intellectual property)
– Human resources (labor supply, education, skills, discipline,

motivation)
– Technological change and innovation (science, engineering,

management, entrepreneurship)

Human Capital and Demographic Dividend
• Given the huge young workforce available in India, the potential and
probability of a large demographic dividend is high.
• But the prevailing high level of unemployment in the economy, if not

controlled, will not allow the optimal use of available workforce.

Human Capital and Demographic Dividend

Why does unemployment exist in any economy?
• A high unemployment is not always bad and doesn’t always require

immediate policy response.
• High unemployment may be, among others, because of the following

reasons:
– Frictions in the economy (frictional unemployment)

– Efficiency wages (leading to wages more than market clearing wages)
– Insider – outsider model explanation
– Due to structural factors (structural unemployment – mismatch in skill and
job)

Unemployment and its nature in India
• Two major division of Indian economy:
– Organized sector – The organized sector comprises certain

companies or workplaces in which the employment term is regular
and employees are also guaranteed employment. They are
authorized by the government and must comply with the laws and
regulations set out by the governments, including the Minimum
Wages Act, Factories Act, the Gratuity Payment Act, the Shops and
Establishments Act, and so on.
– Unorganized sector – The unorganized sector is characterized by

small and scattered units, which are largely outside the control of the
government.

Unemployment and its nature in India
• Organized and unorganized sector display considerable amount of bias

for skill and job opportunities:
– Organized sector – high productivity of workers – high wages and better working
conditions – but employs only a small amount of workers.
– Unorganized sector – low productivity of workers – low wages and poor working
conditions – a large amount of workers are crammed here.
• An important reason for India’s employment problem is that the workforce is

mal-distributed between sectors of the economy.
• India is also facing structural issues leading to the supply of labour far
exceeding the demand for labour by the industries.

Skilled Biased Production Method
• Two glaring manifestations of the bias against labour are worth noting:
– Firstly, pattern of production in organized industry has moved sharply

towards capital- and skill-intensive sectors.
– The same thing has happened in exports as the export composition has
moved in favour of capital and skilled labour intensive goods
– The second manifestation of the bias against labour is the highly peculiar
employment-size-distribution of India’s business enterprises.

Skilled Biased Production Methods
• Two glaring manifestations of the bias against labour are worth noting:
– Firstly, over time, the pattern of production in organized industry has moved
sharply towards capital- and skill-intensive sectors, such as chemicals,
metals, electrical machinery, petroleum refining, automobiles, and
engineering products, and away from labour-intensive sectors such as food
products, textiles and apparel, leather, wood, furniture, and bicycles.
– The same thing has happened in exports. Export composition has moved in
favour of goods that intensively use capital and skilled labour such as
engineering goods, chemicals, petroleum products, and gems and jewellery;
the share of labour-intensive goods such as garments has fallen.
– The second manifestation of the bias against labour is the highly peculiar
employment-size-distribution of India’s business enterprises. The economy
has an inordinate number of tiny firms with very low productivity.

Employment structure in India
Nourishing Dwarfs to become Giants
• In India there is a large amount of smaller firms that never grow bigger
and generate only a few jobs and less productivity.
Role of small firms in employment.pdf

Nourishing Dwarfs to become Giants
• What is the impact of the size distribution of firms on jobs and productivity?
• Figure 4 compares growth of employment and productivity with firm age in three
countries: U.S., Mexico and India (Hseih and Klenow, 2014).
• The average employment level for 40-year old enterprises in the U.S. was more
than seven times that of the employment when the enterprise is newly set up.
• In contrast, the average employment level for 40-year old firms in India was only
40 per cent greater than the employment when the enterprise is newly set up.
• Even Mexico does far better on this dimension than India.
• A similar tale unfolds with productivity as well when we compare these three
countries for the effect of aging of firms on productivity.
• The average productivity level for 40-year old enterprises in the U.S. was more
than four times that of the productivity of an enterprise that is newly set up.
• In contrast, the average productivity level for 40-year old firms in India was only
60 per cent greater than the productivity of an enterprise that is newly set up.

Drivers of Economic Growth:
R&D and productivity
• Innovation and improvement in technology play critical role in determining
the level of economic growth and employment.
• Algebraically, the APF (aggregate production function) is:
• Where, A represents the level of technology in the economy.
• R&D efforts lead to innovation and improvement in technology. And

determine the ability of firms to produce increased amount of goods with
the same level of inputs.
• This results in lower cost and higher profits.

Higher past innovations lead to higher growth
• The positive correlation between past innovation performance and current

GDP per capita can be examined empirically.
• It may be seen that India has performed below expectation for its past
innovation performance in terms of recent GDP per capita.

Drivers of Economic Growth:
R&D, Innovation and employment
• Innovations or improved advanced technology although leads to higher
output and profit for firms, but it also affects to level of employment or
demand for labour.
• Two types of innovations are:
– Product Innovation (job creation effect)

– Process Innovation (job destruction effect)
• The overall effect on the level of employment depends on which effect is

more dominant in the economy.
• Many a times job creation effect is more dominant leading to creation of

new jobs.

Where we stand in world innovation ranking
• The economic survey 2020 – 21 has answer for this critical question.
• India entered the top 50 innovating countries for the first time in 2020
since the inception of the Global Innovation Index (GII) in 2007, by
improving its rank from 81 in 2015 to 48 in 2020.

Who is doing innovations in India

• In India, the Government contributes 56 per cent of GERD while this

proportion is less than 20 per cent in each of the top ten economies.
• Yet, India’s GERD is much lower than that of the top ten economies
because India’s business sector contributes a much smaller per cent to
total GERD (about 37 per cent) compared to 68 percent, on average, of
China, US, Japan and UK.
• This can be clearly seen because the proportion contributed to GERD by

higher education is similar in India as in the top 10 economies.


• Figure 38 shows the trend in total patent applications filed in India by

resident and nonresidents during the period 1990-2019.
• The total number of patents filed in India has risen steeply since 1999,
mainly on account of increase in patent applications filed by non-
residents.
• While patent applications filed by residents have increased steadily since

1999, they have risen at a much lower rate than patent applications by
non-residents.
• So we are innovating less!!!
Innovation - who is innovating.pdf

Summary and the way forward
• Economic growth has declined, but expenditure switching policy

response, as presented in the budget 2020-21, gives us reasons to
believe the growth will pick-up in the near future.
• A series of new reforms in form of GST, IBC, DBT, aggressive efforts

toward financial inclusion, improvement in ease of doing business will
create new wave of growth.
• Unemployment in India is more of structural in nature. We need to focus

on labour intensive industries (such food products, textiles and apparel,
leather, wood, furniture, and bicycles) for faster creation of more new
jobs.
• Corporate India and residents are not doing enough innovations and the
bulk of innovations are coming from the government. We need to
reverse this to achieve more growth and highly competitive industries.

Readings
• Main readings are as per the course outline
• Pay attention on the PDF files attached with the PPT in different slides.
That will help in expanding the discussion on the related topic.
• Most of the figures included in the PPT are from economic survey (2016-
17 and 2020-21). You can refer that for further readings.
• For further discussion on stigmatized capitalism and unique growth

pattern followed by India, you can refer the book – Arvind Subramanian,
Of Counsel: The Challenges of the Modi-Jaitley Economy, 2018

Thank you

Indian Economy-IIML-Lect 1-2

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Indian Economy-IIML-Lect 1-2

Uploaded by

Copyright:

Available Formats

Indian Economy

Dr Ritesh Kumar Mishra,

Overview of Indian Economy:

• A clear understanding of the functioning of the laboratory (i.e. economy) is

Dr Ritesh Kumar Mishra, University of Delhi

• Swings in macroeconomic variables have the potential to push a

– GDP A country is not a company - Paul Krugma.pdf

• Therefore, a clear understanding of domestic economy is critical in

Dr Ritesh Kumar Mishra, University of Delhi

• Shocks we witnessed during – balance of payment crisis of 1991,

Dr Ritesh Kumar Mishra, University of Delhi

Dr Ritesh Kumar Mishra, University of Delhi

Period Growth in R(GDP) Key Economic Policies

Dr Ritesh Kumar Mishra, University of Delhi

– Low importance and contribution of manufacturing compared to services.

– Integration with the world economy in early stage.

– Socialism with restricted entry and capitalism without exit.

Dr Ritesh Kumar Mishra, University of Delhi

Dr Ritesh Kumar Mishra, University of Delhi

Indicator Pre – 1991 – 92 Now (2020 – 21)

Inflation Rate 12% 4.91 CPI - Nov, 2021

Consolidated FD >10% FD: 4.6 (2019-20) & 6.8 (2020 -21)

External Debt to Export 250% Debt –GDP Ratio: 89.33%

Dr Ritesh Kumar Mishra, University of Delhi

• Devaluation of Rupees • Shift to LPG model

• Income tax rates unified to 20, 30,

• Corporate profit tax reduced to

Dr Ritesh Kumar Mishra, University of Delhi

Dr Ritesh Kumar Mishra, University of Delhi

• India’s GDP contraction of 23.9 percent in Q1: FY 2020-21 and 7.5

• The fundamentals of the economy remained strong as gradual scaling

Dr Ritesh Kumar Mishra, University of Delhi

• This is the fourth contraction in India's GDP since 1960-61 (Figure 39 –

Dr Ritesh Kumar Mishra, University of Delhi

• Sectoral Contribution to Overall GDP Growth:

Dr Ritesh Kumar Mishra, University of Delhi

• Government Consumption and Net Exports have cushioned the contraction in

• Government final consumption expenditure has sustained the growth of GDP in

Dr Ritesh Kumar Mishra, University of Delhi

• Demand Side of the economy (Remember: Y = C + I + G + NX)

Dr Ritesh Kumar Mishra, University of Delhi

• On the demand side, the recovery is expected to be broad-based in the

• The biggest growth driver is likely to be government consumption that is

• Private consumption is also expected to improve significantly with a mild

• Investment, as measured by Gross Fixed Capital Formation (GFCF), is

Dr Ritesh Kumar Mishra, University of Delhi

Dr Ritesh Kumar Mishra, University of Delhi

Dr Ritesh Kumar Mishra, University of Delhi

Dr Ritesh Kumar Mishra, University of Delhi

Dr Ritesh Kumar Mishra, University of Delhi

• Increased uncertainty, lower confidence, loss of incomes, weaker growth

• The supply chain disruptions caused by closure of economic activity and

Dr Ritesh Kumar Mishra, University of Delhi

• The feedback loops of demand and supply generated potential hysteresis

Dr Ritesh Kumar Mishra, University of Delhi

• May be a V-shaped or U-shaped or L-shaped recovery…

Dr Ritesh Kumar Mishra, University of Delhi

• May be a V-shaped or U-shaped or L-shaped recovery…

Dr Ritesh Kumar Mishra, University of Delhi

• For example, a V-shape shows the economy declining quickly, spending

• These aren't necessarily official terms, as there's no formal system for

• Rather, the letter-naming first took off during a turn-of-the-21st-century

Dr Ritesh Kumar Mishra, University of Delhi