Indian Economy Chapter Notes - CA Foundation PDF Download

 Status of Indian Economy: Pre-Independence Period (1850-1947) 

•  Ancient and Medieval Periods:  India was likely the largest economy globally, controlling a significant portion of the world's wealth. The economy was self-reliant, with a mix of self-sufficient villages and bustling cities that were hubs of commerce, pilgrimage, and administration.
•  Villages vs. Cities:  Villages were the backbone of the economy, primarily focused on agriculture, but cities offered a wider range of economic opportunities and activities. The division of labor in villages was influenced by factors like race, class, and gender, leading to social and economic differentiation.
•  Artisans and Craftsmen:  India had a rich tradition of skilled artisans and craftsmen who produced high-quality handicrafts, textiles, and other goods for international markets.

 Arthashastra and Ancient Economic Philosophy 

•  Arthashastra:  an ancient Indian text attributed to Kautilya (Chanakya), is a key work on statecraft and political philosophy. It is believed to have served as a guide for King Chandragupta Maurya, offering practical advice on governance and political issues.
•  Concept of Artha:  Artha, as discussed in the Arthashastra, refers to material well-being, primarily focusing on wealth and land. The text emphasizes the importance of land management and agricultural productivity for sustaining the state’s prosperity.
•  Agricultural Focus:  Kautilya highlights the need for strong agricultural policies to ensure surplus production, which would contribute to the state’s treasury. Taxes should be fair and easily understandable for all subjects, regardless of the ownership of businesses.
•  Multidisciplinary Approach:  The Arthashastra covers various aspects, including politics, economics, military strategy, and social organization. It underscores the role of the state in ensuring the welfare of its citizens and the importance of key elements like the king, ministers, farmlands, fortresses, treasury, military, and allies for effective governance.

Introduction 

 Economic History of India: British Colonial Impact 

The arrival of Europeans, particularly the British, marked a significant turning point in India's economic history. British rule in India can be divided into two distinct periods:

 (a) East India Company Rule (1757-1858): 

• This period saw the transition of India from a manufacturer of goods to a supplier of raw materials.
• The British Industrial Revolution created a demand for raw materials from India and a market for British manufactured goods.

 (b) British Government Rule (1858-1947): 

• Following the 1857 revolt, the British Crown took direct control of India, further entrenching the exploitative economic policies.

 Impact of British Policies on Indian Economy 

•  Shift in Trade Dynamics: 
• India shifted from being an exporter of finished goods to an exporter of raw materials.
• This shift was driven by British industrial needs and was detrimental to Indian manufacturing.
•  Discriminatory Tariffs: 
• The British imposed heavy tariffs on Indian exports of finished goods while lowering tariffs on imports.
• This policy made Indian goods less competitive in international markets and led to a decline in indigenous production.
•  Destruction of Indian Handicrafts: 
• Due to the combination of high export tariffs and competition from cheaper British imports, Indian handicrafts and manufactures were severely impacted.

 Cultural Shift and Demand Patterns 

• The British colonial period not only disrupted traditional industries but also altered consumer preferences.
• Many Indians began to prefer imported goods, adopting Western cultural practices and lifestyles.

 Social and Economic Consequences 

•  Unemployment and Agricultural Dependence: 
• The collapse of traditional industries led to large-scale unemployment, forcing many to rely on agriculture for their livelihoods.
•  Land Fragmentation and Poverty: 
• Increased pressure on land resulted in the subdivision and fragmentation of landholdings.
• This shift contributed to subsistence farming, reduced agricultural productivity, and widespread poverty.
•  Survival of Domestic Industries: 
• The influx of cheap machine-made goods from Britain, coupled with changing tastes favoring imported products, made it increasingly difficult for domestic industries to survive.

 Conclusion 

The British colonial policies had a profound and lasting impact on India's economic structure, leading to the decline of traditional industries, a shift in trade dynamics, and significant social changes.

 Impact of British Policies on Agriculture and Industry 

 1. Agricultural Decline 

• The zamindari system created a class of people interested in maintaining British rule.
• Increased pressure on land led to higher demand for land under tenancy, allowing zamindars to extract excessive rents and payments.
• Factors like absentee landlordism, high indebtedness of farmers, exploitative money lenders, and neglect of productivity-enhancing measures contributed to the collapse of Indian agriculture.

 2. Stagnation of Industrialization 

• Factory-based production was virtually nonexistent in India before 1850. Modern industrial enterprises began to emerge in the mid-19th century.
• The cotton milling industry grew steadily and became internationally competitive, with India ranking fifth globally in the number of spindles by the 1930s.
• Jute mills expanded rapidly in response to global demand, and by the late 19th century, India had the largest jute mill industry in the world. Other industries like brewing, paper-milling, leather-making, matches, and rice-milling also developed during this period.
• Heavy industries, such as the iron industry, were established early on by British capital, with India ranking eighth globally in iron output by 1930.

 3. Limited Expansion of Producer Goods Industries 

• Producer goods industries did not expand significantly due to pressure from English producers discouraging the development of competing industries.
• India’s industrial growth was insufficient to transform its economic structure, with the manufacturing sector’s share in the net domestic product barely reaching 7% by 1946.
• Factory employment in India was also small, constituting 0.4% of the total population in 1900 and increasing to 1.4% by 1941.

 4. Overall Industrial Growth 

• Despite progress in modern industrial enterprises, India’s industrial growth was not transformative. Just before the Great Depression, India ranked as the twelfth largest industrialized country in terms of the value of manufactured products.

Indian Economy: Post-Independence (1947-1991)

 Introduction   1. At the time of independence  , India was predominantly rural, with a population that was mostly illiterate and extremely poor. The society was highly stratified and varied in many aspects. With a literacy rate just above 18 percent and a life expectancy of only 32 years in 1951, India's poverty was not only about low income but also about a lack of human capital.

 2. Nehruvian Model   a. Post-Independence Policy  : The Nehruvian model, which advocated for social and economic redistribution and state-directed industrialization, became the foundation of India's economic policy after independence.

 b. Centralized Planning  : Centralized economic planning was central to India's development strategy, aiming for rapid economic growth along with equity and distributive justice.

 c. Planning Commission  : The Planning Commission was established to plan India's economic development in line with this socialistic approach, implementing strategies through five-year plans.

 3. Ideology of Industrialization   a. Role of Government  : The political leadership post-independence aimed to create an economic system where the central government would design and implement economic strategies, coordinating investments with the private sector.

 b. Planned Modernization  : Rapid industrialization was central to Nehru's strategy, with "planned modernization" involving systematic planning to support industrial growth.

 4. Industrial Policy Resolution (1948)   a. Public Sector Expansion  : The resolution called for a greater role for the public sector and regulated the private sector through licensing.

 b. State Monopoly  : It established state monopolies in strategic areas like atomic energy, arms and ammunition, and railways, and reserved new investments in basic industries for the state.

 5. Economic Philosophies of the 1950s   a. Nehru’s Vision  : Focused on building a socialistic society with an emphasis on heavy industry.

 b. Gandhian Philosophy  : Emphasized small-scale and cottage industries and village republics.

 6. Industrial Policy Resolution (1956)   a. Framework for Development  : Provided a comprehensive framework for industrial development.

 b. Imbalance in Favor of Public Sector  : The resolution disproportionately favored the public sector, stifling private initiative and enterprise.

 c. Long-term Impact  : The bias towards the public sector discouraged private investments, leading to lasting negative effects on industrial growth.

 Introduction 

The economic history of India from 1950 to 1980 is characterized by a series of significant events and policy shifts that shaped the country's growth trajectory.

 Early Years Post-Independence (1950-1960) 

•  Open Policies:  After gaining independence in 1947, India initially adopted an open foreign investment and trade policy.
•  Balance of Payments Crisis:  In 1958, India faced a balance of payments crisis, leading to concerns about foreign exchange depletion. This prompted a gradual tightening of trade and a reduction in licensing for new investments requiring imported capital goods.
•  Import Controls:  Comprehensive import controls were maintained until 1966.
•  Economic Growth:  During the first three decades after independence, India experienced an average annual GDP growth rate of 3.5 percent, often referred to as the "Hindu growth rate." The focus was on capital-intensive projects such as dams, power plants, and heavy industrialization rather than consumer goods.

 Shift in Economic Strategy (Mid-1960s) 

•  Agricultural Priorities:  In the mid-1960s, the government recognized the need to prioritize agriculture due to continuous monsoon failures and severe droughts in 1966 and 1967.
•  Green Revolution:  The government initiated the Green Revolution, focusing on increasing agricultural productivity through high-yielding seed varieties, improved irrigation, and the intensive use of fertilizers and pesticides. This shift significantly boosted food grain production and helped alleviate the food crisis.
•  Administrative Controls and Nationalization:  Alongside agricultural policy changes, the government introduced stringent administrative controls on trade and industrial licensing. This period also saw the nationalization of banks, with 14 banks nationalized in 1969 and another 6 in 1980.

 Consequences of Interventionist Policies 

• The interventionist policies established in the 1960s had lasting impacts on the Indian economy, influencing the trajectory of economic growth and development in the subsequent decades.

 Economic Performance (1965-81) 

• The period from 1965 to 1981 is considered the worst in terms of economic performance in independent India. The main reason for the decline in growth during this time was a decrease in productivity.
• Factors contributing to this decline included:
• The license-raj and autarchic policies of the 1960s and 1970s.
• External shocks such as three wars (1962, 1965, and 1971), major droughts (notably in 1966 and 1967), and oil shocks in 1973 and 1979.
• Being a closed economy, India missed opportunities from a rapidly growing global economy.

Government policies aimed at equitable income and wealth distribution actually reduced incentives for wealth creation.

• The Monopolies and Restrictive Trade Practices (MRTP) Act of 1969 regulated large firms with significant market power, imposing restrictions on licensing, capacity expansion, mergers, and acquisitions.
• These restrictions hindered the expansion of big business houses, limiting their presence to a few capital-intensive sectors.
• In 1967, the government reserved many products for exclusive manufacture by the small-scale sector to promote small-scale industries.
• This policy aimed to encourage labor-intensive growth and redistribute income by benefiting lower wage earners.
• However, it excluded big firms from labor-intensive industries, hindering India’s competitiveness in the global market for these products.
• Stringent labor laws also discouraged the establishment of labor-intensive industries within the organized sector.
• There was a growing recognition among policymakers and industrialists that the strict regulatory regime was counterproductive.
• It became clear that adequate incentives and openness were necessary for sustained rapid growth.

 THE ERA OF REFORMS 

The early seeds of liberalization and reforms were planted in the 1980s, particularly after 1985. In the early 1980s, efforts were made to restore price stability through tight monetary policy, fiscal moderation, and some structural reforms. These initiatives, from 1981 to 1989, aimed at shifting from inward-oriented trade and investment practices. This phase of liberalization is often called “reforms by stealth” because it was ad hoc and not widely publicized.

• While not a comprehensive package like the 1991 reforms, these efforts led to higher growth rates in the 1980s compared to the previous decades.
• The average annual growth rates of GDP during the sixth plan period (1980–1985) and the seventh plan period (1985–1990) were 5.7% and 5.8%, respectively.

 Early Reforms in the 1980s 

The early reforms of the 1980s focused on three main areas: industry, trade, and taxation. During this time, the government also managed the exchange rate skillfully. The industrial policy initiatives aimed at removing growth constraints and fostering a more dynamic industrial environment included:

•  Delisting of Industries:  In 1985, the government delisted 25 broad categories of industries, later extending this to more sectors.
•  Broad-Banding Facility:  This allowed industry groups to change their product mix without needing fresh licensing, providing flexibility. For instance, engineering firms could switch production between trucks and cars within their existing capacity.
•  Relaxation of MRTP Regulations:  In 1985–86, the asset limit for firms subject to MRTP regulations was raised from 20 crore to 100 crore, easing licensing and capacity constraints.
•  Introduction of MODVAT:  The multipoint excise duties were converted into a modified value-added tax (MODVAT), reducing taxation on inputs and associated distortions.
•  Establishment of SEBI:  The Securities and Exchange Board of India (SEBI) was established as a non-statutory body on April 12, 1988, to regulate the securities market.
•  Expansion of Open General Licence (OGL) List:  The OGL list was expanded, increasing the number of capital goods items included in the list, reaching 1,329 by April 1990.
•  Introduction and Expansion of Export Incentives:  Various export incentives were introduced and expanded to promote exports.
•  Realistic Exchange Rate:  The exchange rate was set at a realistic level, facilitating exports and reducing pressure on foreign exchange for imports.
•  Abolition of Price and Distribution Controls:  Price and distribution controls on cement and aluminum were completely abolished.
•  Depreciation of the Rupee:  The rupee was depreciated by about 30 percent from 1985–86 to 1989–90 based on the real effective exchange rate (REER), reflecting a shift in official policy towards exchange rate depreciation.
•  Budget Policies of 1986:  The budget introduced policies to cut specific taxes, liberalize imports, and reduce tariffs.

Despite these reforms, the economy's growth was hindered by structural inadequacies and distortions. Private sector investments were discouraged due to complicated licensing policies, public sector reservations, and excessive government controls. The reservation of goods for the small-scale sector and strict price and distribution controls further deterred private sector investments. The public sector, despite its size and monopoly in various areas, suffered from inefficiency, government controls, and bureaucratic hurdles, resulting in poor performance and low returns on investment.

  The MRTP Act had many restrictive conditions that created barriers for entry, diversification, and expansion for large industrial houses. Import controls in the form of tariffs, quotas, and quantitative restrictions ensured that foreign manufacturers and components did not cross the borders and compete with domestic industries. Foreign investments and foreign competition were not allowed on grounds of affording protection to domestic industries. Briefly put, the rules and regulations aimed at promoting and regulating the economic activities became major hindrances to growth and development.  

  Though the reforms in the 1980s were limited in scope and were without a clearly observable roadmap compared to the New Economic Policy in 1990, they were instrumental in bringing confidence to the minds of politicians and policymakers regarding the efficacy of policy changes to produce sustained economic growth. The belief that well-regulated competitive markets can ensure economic growth and also increase total welfare was fostered in the minds of policymakers. In other words, the idea that government intervention in markets need not always be accepted as ‘the standard’ and that markets should be given priority over government in the conduct of a good number of economic activities gained broad acceptance. Thus, the liberalization in the 1980s served as the necessary foundation for the more universal and organized reforms of the 1990s.  

  THE ECONOMIC REFORMS OF 1991  

  India embarked on a bold set of economic reforms in 1991 under the Narsimha Rao government. The causes attributed to the immediate need for such a drastic change are:  

•   The fiscal initiatives for enhanced economic growth in the 1980s saw government revenue expenditure consistently exceeding revenue receipts. The fiscal deficit was financed by substantial amounts of both domestic and external debt. The high level of current expenditure proved unsustainable, resulting in extremely large fiscal deficits and an adverse balance of payments.  

•   Persistent huge deficits led to swelling public debt, and a large proportion of government revenues had to be earmarked for interest payments.  

•   The surge in oil prices triggered by the Gulf War in 1990 and the consequent severe strain on the balance of payments.  

•   In 1991, the foreign exchange reserves dropped to their lowest level of only $1.2 billion, which was barely sufficient for two weeks of imports. This was the major context that triggered economic reforms.  

Due to stricter import restrictions aimed at conserving foreign exchange for essential imports, there was a decline in industrial output. India had to rely on external borrowing from the International Monetary Fund (IMF), which imposed strict conditions on corrective policy measures before any additional funds could be accessed. The fragile political situation, coupled with economic crises, led to what can be termed a ‘crisis of confidence.’

The year 1991 marked a significant turning point in Indian policy reforms. India, which had followed a ‘socialist model’ with the state playing a dominant role in the economy and intervening in markets, faced new challenges after the collapse of the Soviet Union and the economic reforms in China. These reforms in China, based on outward-oriented policies, provided valuable lessons for Indian policymakers. The reforms initiated in 1991 aimed to shift the economy towards greater market orientation and external openness.

The reforms, commonly referred to as liberalization, privatization, and globalization, represented a major shift in economic philosophy and approach, with two primary objectives:

•  Reorienting the Economy:  Shifting from a centrally directed and highly controlled economy to a ‘market-friendly’ or market-oriented one.
•  Macroeconomic Stabilization:  Achieving significant reduction in fiscal deficit.

The reform package was designed to address the balance of payments crisis and structural rigidities, marking a shift from central direction to market orientation.

The policies can be broadly classified as:

•  Stabilization Measures:  Short-term measures to tackle inflation and adverse balance of payments.
•  Structural Reform Measures:  Long-term measures aimed at enhancing productivity and competitiveness by addressing structural rigidities in various sectors.

The Fiscal Reforms

The rising levels of deficit made stabilization efforts quite challenging. It was crucial to establish fiscal discipline by reducing the fiscal deficit because the crisis stemmed from excessive domestic demand, a spike in imports, and an expanding current account deficit (CAD), which needed to be financed by depleting reserves. To address this, radical measures were implemented to increase revenues and cut government spending.

The measures aimed at achieving fiscal discipline included:

•  Introduction of a stable and transparent tax structure:  This involved creating a tax system that was clear and consistent, making it easier for taxpayers to comply.
•  Ensuring better tax compliance:  Efforts were made to improve compliance rates, ensuring that individuals and businesses paid their fair share of taxes.
•  Curbing government expenditure:  The government aimed to reduce its spending, focusing on essential services and cutting back on non-essential expenditures.
•  Reducing and abolishing unnecessary subsidies:  Subsidies that were not crucial were either reduced or eliminated to free up government resources.
•  Disinvesting part of the government’s equity holdings in select public sector undertakings:  The government decided to sell part of its stake in certain public sector companies to generate revenue.
•  Encouraging private sector participation:  Initiatives were taken to involve the private sector in various projects and services, reducing the burden on the government.

To maintain fiscal discipline, it was important to avoid financing the deficit through the easier route of money creation. Consequently, the government entered into a historic agreement with the Reserve Bank in September 1994 to reduce the fiscal deficit gradually, aiming for a deficit of zero by 1997–98.

 Monetary and Financial Sector Reforms 

To enhance the efficiency and transparency of the financial system, drastic monetary and financial sector reforms were introduced. The focus was on reducing the burden of non-performing assets on government banks, introducing and sustaining competition, and deregulating interest rates.

The important measures included:

1.  Interest Rate Liberalization:  The Reserve Bank of India (RBI) liberalized interest rates, reducing its controls over the interest rates that banks could charge on loans and offer on deposits.
2.  Opening of New Private Sector Banks:  New private sector banks were allowed to open, increasing competition among public sector, private sector, and foreign banks. Administrative constraints that hindered efficiency were also removed.
3.  Reduction in Reserve Requirements:  The statutory liquidity ratio (SLR) and cash reserve ratio (CRR) were reduced in line with the recommendations of the first Narasimham Committee Report of 1991.
4.  Liberalization of Bank Branch Licensing:  The bank branch licensing policy was liberalized, granting banks the freedom to open, relocate, or close branches as they deemed fit.
5.  Introduction of Prudential Norms:  Prudential norms for accounting were introduced, focusing on asset classification, income disclosure, and provisions for bad debt. These norms aligned with the Narasimham Committee recommendations to ensure that commercial banks' financial statements accurately reflect their financial position.

 Reforms in Capital Markets 

 Securities and Exchange Board of India (SEBI) 

• SEBI was established in 1988 and received statutory recognition in 1992.
• It is an independent regulator of the capital market, tasked with creating a transparent environment for resource mobilization and efficient allocation.

 The ‘New Industrial Policy’ 

The ‘New Industrial Policy’ introduced on July 24, 1991, aimed to deregulate industry significantly to foster a more efficient and competitive industrial economy.

•  End of the ‘License Raj’  : The policy abolished licensing restrictions for all industries except for 18 sectors related to security, strategic concerns, social reasons, safety issues, and environmental impacts.
•  Public Sector Limitations  : The public sector was restricted to eight sectors based on security and strategic grounds. Eventually, this was narrowed down to railway transport and atomic energy.
•  Restructuring of MRTP Act  : The Monopolies and Restrictive Trade Practices Act was restructured, eliminating the need for pre-entry scrutiny of investment decisions and prior approval for capacity expansion or diversification by large companies.
•  De-reservation for Small-Scale Industries  : Many goods produced by small-scale industries were de-reserved, allowing the entry of large-scale industries.
•  Ending Public Sector Monopoly  : The policy ended public sector monopolies in many sectors, narrowing the areas reserved for public sector participation. Initially, only eight industries were reserved for the public sector, and now only a portion of atomic energy generation and certain core railway transport activities remain reserved.
•  Liberalization of Foreign Investment  : Foreign investment was liberalized, introducing automatic approval for foreign direct investments up to 51 percent, which was later extended.

Foreign Direct Investment (FDI) is now allowed in almost all industries, with the exception of a few reserved sectors. FDI is prohibited only in four areas:  retail trade, atomic energy, lottery business, and betting and gambling. 

The policy on external trade was further liberalized by changing from the  positive list approach  , which involved listing license-free items, to the  negative list approach  . This meant that import licensing was eliminated for all but a few intermediate and capital goods. Over time, the consumer goods that remained under licensing were also made free from restrictions.

Today, with just a few exceptions related to health, environmental, and safety concerns, as well as specific items like edible oil, fertilizer, and petroleum products, the import of goods is largely unrestricted.

In 1990-91, the highest tariff rate was 355%. This rate was significantly reduced over the years: to 85% in 1993-94, 50% in 1995-96, and down to 10% by 2007-08, although some exceptions, like automobiles with a 100% tariff, remained.

The rupee was devalued by 18% against the dollar. Starting from 1994, all current account transactions, including those for business, education, medical purposes, and foreign travel, were allowed at market exchange rates, and the rupee became officially convertible on the current account.

The disinvestment of government holdings in public sector enterprises marked a significant shift in policy. Public sector units, which were previously constrained, were given greater autonomy in decision-making and opportunities for professional management to ensure reasonable returns. Budgetary support for the public sector was progressively reduced.

undefinedundefinedundefinedundefinedundefinedundefinedundefinedundefinedundefinedundefinedundefinedundefinedundefinedundefinedundefinedundefinedundefinedundefinedundefinedundefinedundefinedundefinedundefined