General Economic Environment
An Assessment of the Indian Economy

By

Rahul Gosain
Saurabh Jain
Bhairavi. V
Sanket Sanganeria
Abhishek Bejoy
Students: PGP (2007-2009)
Alliance Business School
Bangalore
 

INTRODUCTION

The Indian economy has moved decisively to a higher growth phase in comparison to the previous years. The projected economic growth rate for the current year is nearly around 8.7% which is a significant achievement. In order to meet the targeted growth rate of 9% for the 11th Five year Plan there was acceleration in domestic investment and savings rate. But there are also certain shortcomings with respect to this phenomenal increase in growth rate as the economy was not prepared to face the challenge of inflation in the economy. The world prices of crude oil, commodities and food grains have risen sharply since the last year. Among the commodities the price of copper, iron ore, tin are elevated. So the basic challenge for the government is to keep the inflation under check and manage the capital flows more effectively. Especially now since the rupee has appreciated, the export sector is affected to a great extent and there has been a slowdown in the consumer goods segment. Though this is a boom for the Indian economy it has affected the employment status of those working in the multinational companies as the dollar value has depreciated and they are unable to meet the expectations of the employees with regard to the pay packages. But on the other hand the companies importing goods from other countries will benefit greatly. Now our great concern is that in order to increase the growth rate according to our set target as per the 11th Five year Plan we need to have certain additional reforms. Experts estimate that by 2025, India's share in world GDP is expected to rise from 6% to 11% wherein that of US will witness a fall from 21% to 18%. India is expected to be the 3^rd largest economy in the world by 2025. The country has seen a growth of 9.0 percent during 2005-2006, 9.4 percent during 2006-2007 and 8.7 percent in 2007-2008.

Growth is of interest not for its own sake but for the improvement in public welfare that it brings about. Economic growth, and in particular the growth in per capita income, is a broad quantitative indicator of the progress made in improving public welfare.

Per capita consumption is another quantitative indicator that is useful for judging welfare improvement. It would therefore be appropriate to start by looking at the changes in real (i.e. at constant prices) per capita income and consumption. The per capita income of Indians has gone up as much as 14.2 per cent in 2006-07, enabling them spend more on manufactured products like mobiles and health care services, while increasing their savings. This would also explain the reason for the tremendous increase in the growth rate of manufacturing as well as the service sector by 10.7% and 9.4% respectively. The pace of economic improvement has moved up considerably during the last five years (including 2007-08). The rate of growth of per capita income as measured by per capita GDP at market prices (constant 1999-2000 prices) grew by an annual average rate of 3.1 per cent during the 12-year period, 1980-81 to 1991-92. It accelerated marginally to 3.7 per cent per annum during the next 11 years, 1992-93 to 2002-03. Since then there has been a sharp acceleration in the growth of per capita income, almost doubling to an average of 7.2 per cent per annum (2003-04 to 2007-08).This means that average income would now double in a decade, well within one generation, instead of after a generation (two decades). If adjusted against inflation, the per capital income at current prices rose by 8.1 per cent during the year and was estimated at Rs 22,553 as against Rs 20,858 for the previous year. Analysts said the spurt in households' income levels explains the boom in retail sector, sale of more two and four wheelers, mobiles and branded products in urban and non-urban areas. Commenting on the impact of 9.6 per cent GDP growth during 2006-07 on household income, HDFC Chief Economist Abheek Baruah said, "Since the pie has increased, it would be reflected in the personal income". On an average, the households spent as much as Rs 20,714 at current prices, about 70 per cent of their income, and saved the remaining. In the previous year, the households spent 71.83 per cent of their income and saved the rest. Interestingly, the highest growth in personal expenditure was noticed in communication sector that comprises mobiles, TV and newspapers. The total spent on this sector grew as much as 35.6 per cent during the year.

Key - Sectoral Contribution

1.1 Agriculture

Agricultural sector in particular has seen the most dismal performance for the Indian economy in spite of the fact that more than 58% of the country depends on agriculture, directly or indirectly and there are more than 115 million farming families in the country. From strong roots of a growth of 9.1% in 2003-2004, it has fallen down to 2.7% during 2007-2008. India is the largest producer of jute, tea and jute like fibre. At the same time, the country is the largest consumer of tea in world as well. India imports tea to more than 80 countries and accounts for 14% of world tea trade. India's milk production is also the highest in the world. In terms of area, India has the 1^st rank in total irrigated land in the world. The country is placed 3^rd among cereal production, having the 2^nd largest position when it comes to wheat and rice and the largest in the world for production of pulses. Agricultural sector though heavily subsidized and funded by the government lacks the technological upliftment and the practices in the sector even today are mostly third world. The prime areas that can boost agricultural income in the country include horticulture, organic farming livestock & fisheries, commercial crops and agro-processing. The timely monitoring of minimum support price for agricultural products will result in high sustained agricultural growth and improvements in rural infrastructure. Practices like strengthening R&D, improvements in post harvest management technologies, reforms in legislations will establish a stronger support system for the country's agricultural sector. A substantial amount of labour goes to waste in the form of excess labour in the agricultural sector. Absorbing such labour in other sectors, particularly industry is required. There is a need for increased awareness for public investment in agriculture, especially in irrigation, rural infrastructure and agricultural research and development. The scenario of availability of better institutional credit for farmers has certainly improved, but the emphasis also needs to be on better access to this credit.

Growth in Agricultural sector (Percentage)

Services sector has once again been the largest contributor to the country's GDP. It has maintained a steady growth since 96-97, except for a fall in 2000-2001 which was because of the global dot com bubble bursting. India owes its title of being the world second largest fastest growing economy to the services sector in particular. This growth has been fuelled by a growing urban middle class—largely English speaking, which in turn has given rise to the well documented growth in back-office operations such as call centers. The outcome of economic liberalization that began in 1991 is most significant in the services sector. Due to the services sector, the tax revenue has seen an increase of a whopping 40%+ during the current fiscal year. The growth in "trade, hotels, transport and communication" was at 11.7% in the first half, while the estimate for the full year is 12.1%, implying a growth of 12.5% in the second half of the year. Similarly, "financing, insurance, real estate and business services", which grew at 10.8% in the first half of the year, are estimated by Central Statistical Organization to have grown at 11.7% for the full year. This can be explained by the fact that the stock markets have overall been on a roll which in turn has resulted in a huge growth in the financial services sector. Revenue growth in brokerages and banks was very high. The three segments in the service sectors—trade, hotels, transport and communication; financing, insurance, real estate and business services; and community, social and personal services—account for 56% of the estimated GDP in fiscal 2008. But as a percentage of incremental GDP growth in 2007-08, their share was much higher—at 67%.

Public & Private Sector Employment (Lakh persons as on 31st march)

Indian infrastructure

Infrastructure includes: road, rail, air and water transport, electric power, telecommunications, water supply and irrigation which account for a combined weight of 26.68 per cent in the index of industrial production (IIP). This segment has reported a growth of 8.6 percent as against 05-06.

Sectoral Growth

Projected Sector wise share

India is getting urbanized at a faster rate than the rest of the world and, by 2030, 40.7 per cent of the country's population will be living in urban areas, according to a report by the United Nations Population Fund (UNFPA).

Social Sectors

As per the UNDP's Human Development Report (HDR) 2007

Balance of Payments

Current Account

In the year 2005-06, the total current account balance was (43737) crore where as this figure rose to (45343) crore in 2006-2007. Current Account comprises of merchandise and invisibles.

* The balance of the credit side of current account grew at the rate of 27.23% to 1098553 crore in the year 2006-07 where as the balance of the debit side of the current account grew at the rate of 26.09%

* As compared to the year 2005-06 there has been 24.34% increase in the total merchandise in the year 2006-07 as large amount of money was received from foreigners by the way of merchandising.

* Invisibles which comprises of services, transfer and income shows a phenomenal increase of 30.62% primarily due to 35% increase in providing software services to the foreign countries (141356 crore). Financial services grew at the rate of 41% as compared to 2005-06 and business services grew at the astonishing rate of 110% to 86928 crore and communication services grew at the rate of 36.8%. Transfers grew at the rate of 17.57% and incomes grew at the rate 47.75% to 42000 crore.

Capital Account

In 2005-06 the total balance of the capital account was 111965 crore which rose to 206389 crore in the year 2006-07 posting a rise of around 84.33% as compared to the year 2005-06. Capital Account comprises of Foreign Investment, Loans, Banking Capital, Rupee Debt Service and Other Capital. The following are the key highlights:

* Foreign Investment rose to 74.49% to 598106 crore due to 154.63% increase in foreign direct investment and 63.69 % increase in portfolio investment
* Loans  grew at the rate of 41.31% to 246908 crore
* Banking Capital grew  at the rate of 74.5% to 167494 crore
* Rupee Debt reduces to 725 crore from 2557 crore
* Other Capital rose to 30.58% to 34540 crore

The overall Net Balance in the year 2006-07 was 163634 crore as compared to 65496 crore in the year 2005-06; thus posting a phenomenal increase of 148.32%. The Total Credits increase to 2148149 crore in 2006-07 from 1503354 crore in 2005-06 posting a growth of 42.89%. The Total Debits increase from 1503354 crore to 1984555 crore with the increase of 32%.

The growth in the Net Overall balance and in the credit balance clearly indicates the growth story of India.

Inflation

The highlights of macroeconomic and monetary developments during 2006-07 are:

The Real Economy

* The Indian economy witnessed robust growth during 2006-07 for the fourth year in succession. According to the advance estimates released by the Central Statistical Organisation (CSO), real Gross Domestic Product (GDP) growth is estimated to accelerate from 9.0 per cent in 2005-06 to 9.2 per cent in 2006-07. The acceleration in growth during 2006-07 was driven by the continued momentum in the services and the manufacturing sectors, both of which are expected to record double-digit growth. 'Agriculture and allied activities' growth, however, slowed down from 6.0 per cent in 2005-06 to 2.7 per cent in 2006-07.

Price Situation

* In Financial Year 2006/07 inflation rate was 6.1% (in 2005/06 – 4.7%).
* Headline and core inflation remained at elevated levels in many economies during the first half of 2006-07 reflecting high commodity prices and strong demand conditions. Although headline inflation eased somewhat internationally from August 2006 levels in tandem with the softening of international crude oil prices and favorable base effects, it remains above the inflation targets/comfort zones in many economies. Many central banks continued with pre-emptive monetary tightening to mitigate the second round effects, especially in the face of continuing strong demand. Central banks in emerging market economies also raised cash reserve requirements to address concerns regarding excess liquidity arising, particularly from large external flows.
* In India, prices of primary food articles and manufactured products exerted upward pressures on headline inflation in 2006-07. Wholesale price inflation was generally within the Reserve Bank's indicative projections of 5.0-5.5 per cent up to mid-November 2006 and rose above the upper end of the band thereafter. The year-on-year (y-o-y) inflation was 5.7 per cent as on March 31, 2007 as compared with 4.0 per cent a year ago.
* Measures of consumer price inflation remained above the WPI inflation throughout the year, mainly reflecting the impact of higher food prices.
* The Reserve Bank continued with the policy of gradual withdrawal of monetary accommodation, using various instruments at its disposal flexibly to stabilise inflationary expectations. The Government also took fiscal and supply-side measures to contain inflation.

Budget Impact: 2008

Key Highlights:

* Debt waiver for 4 crore marginal farmers to the extent of Rs 60,000 crore
* CENVAT decreased from 16% to 14%
* Excise duty cut for cement
* Excise duty on mass consumption items abolished
* Excise duty increased from 8% to 12% for packaged software
* Export duty on iron ore unchanged
* Fiscal deficit at 2.5% (better than targeted 3%)
* No extension in 10A and 10B for the services sector
* 20% increase in educational spending
* Increase in tax slab from current Rs 1,10,000 to Rs 1,50,000

Analysis:

The Finance Minister P. Chidambaram was strong against his stand that either we are for the farmer or against the farmer. He announced a debt waiver for marginal farmers to the extent of Rs 60, 000 crore of which Rs 50,000 crore would be written off and the balance Rs 10,000 crore would be in the form of one time settlement. This would hit the PSU banks who had floated this amount. Even though the Finance Minister mentioned that he would ensure that the banks would have enough liquidity, he did not mention them getting compensated for the entire amount in the form of cash. Sources say that the banks would get Rs 25,000-Rs27,000 crore by June and the rest would be in the form of bonds. This would amount to a burden of 3% on Total Net Credit for the banks. The fiscal deficit of 2.5% is on grounds of this Rs 60,000 crore not being accounted for in reaching that figure. India Inc. was particularly unhappy with the budget due to no cuts in corporate tax or peak customs duty. An increase in excise duty on packaged software means that companied like Infosys will have a considerable impact on their bottom line this year. Cement, Retail and Auto have a positive impact due to cut in excise duty and decrease in CENVAT. Refineries this year would have a negative impact to a certain extent due to the duty levied on import of Naphtha for Polymer. This will hit Reliance in particular. Keeping in mind that Reliance alone contributes 4% to the country's GDP, this could have a considerable impact on the country's growth. An increase in the tax slabs means that people will have more money to spend. This increase in consumption is expected to benefit the Retail sector during the year.

Contribution to Consumer Spending and Potential Savings

The evidence demonstrates that the economy is clearly on its way to sustained growth but what is critical in the coming years is a combination of inflation control, increased consumer spending, adequate liquidity and emphasis on development of industry & educational infrastructure. In the long run, the emphasis will have to be on decreasing the amount of dependence on the services sector and taking concrete measures to develop agriculture in the country. This can be only possible with sound governmental reforms, increased R&D spending and adequate import of technology and training. The future for the economy looks bright heading into the second year of the 11^th 5 year plan.

References:

Ministry of Finance: Government of India, (2008), Economic Survey of India 2007-2008.
http://indiabudget.nic.in/es2007-08/seconomy.htm

Ministry of Finance: Government of India, (2008), Union Budget 2008-2009
http://indiabudget.nic.in/ub2008-09/ubmain.htm

Ministry of Statistics and Programme Implementation: Government of India, (2004), National Industrial Classification.
http://mospi.nic.in/nic_2004.htm

The Reserve Bank of India, (2007), Handbook of Statistics on Indian Economy.
http://www.rbi.org.in/scripts/AnnualPublications.aspx?head=Handbook%20of%20Statistics%20on%20In dian%20Economy

Chakravarty, M., (2008), Services Sector Growth, Live Mint: The Wall Street Journal
http://www.livemint.com/Articles/2008/02/09001455/Services-sector-growth-continu.html

Rajadhyaksha, N., (2007), The Downside of India's Economic Rise, Wharton Business School
http://knowledge.wharton.upenn.edu/india/article.cfm?articleid=4156

Economy Watch, (2007), An Overview of the Indian Economy
http://www.economywatch.com/economyoverview/index.html

Law, V., (2008), Budget 2008 Report and Views, Moneycontrol
http://www.moneycontrol.com/budget2008/article.php?id=328683
http://www.moneycontrol.com/budget2008/highlights/
 

Rahul Gosain
Saurabh Jain
Bhairavi. V
Sanket Sanganeria
Abhishek Bejoy
Students: PGP (2007-2009)
Alliance Business School
Bangalore
 

Source: E-mail March 5, 2008

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