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Understanding Indian Economy

Current economic scenario

On the eve of independence, India was a highly agriculture driven economy. It was in

an underdeveloped state and the British had drained India of its resources leaving behind

numerous problems to deal with. One of the first problems that had to be addressed was

that of unification of the Indian states and partition of Pakistan. Economically, India had

become a very weak state. Majority of the population was living in rural areas and were

dependent on the primary sector i.e. agriculture for sustenance. The agriculture sector

itself was in a state of stagnation. Productivity was low and the industry was in need of

land reforms to be able to feed the then population of 300 million. There was no sound

base for industrial sector either and it had remained confined to power generation,

railways, etc. The industrial sector had a very low growth rate and its contribution to the

GDP was very small. India then was as exporter of raw material like jute, indigo, silk,

wool, sugar, cotton, etc and was importing finished goods from the foreign countries.

Essential commodities were contributing to large export surplus as a result of which self-

sufficiency had to suffer. The mortality rate was high and life expectancy was also low

(44 years) which indicates the worsening profile of India’s population. When the British

left India, it was clearly in a bad state and in dire need for change.

In 1991, India implemented the LPG (Liberalisation, Privatisation and Globalisation)

policy to give the economy a thrust on market orientation. The policy intended to move

towards higher economic growth and building foreign exchange reserves. Following were

the reforms implemented as a part of the policy:

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LPG

Liberalisation Privatisation Globalisation

Free determination
of interest rate by Sale of shares of Long term Trade
Reduction in tariffs
the commercial PSUs Policy
Banks

Increase in the
investment limit for Freedom to import Minimisation of Disinvestment in
the Small Scale capital goods Public Sector PSU’s
Industries (SSIs)

Freedom for
Abolition of
expansion and
Restrictive Trade
production to
Practices
Industries

Empirical research into the impact of this policy done by Ravana S.V. (2014) has

confirmed the positive impact it has on the Indian economy. India’s GDP growth rate was

only 1.1% but after 1991 reforms owing to LPG policy India’s GDP growth rate is increased

year by year and in 2015 it was recorded 7.26 and in 2015-16 it is estimated to be 7.5% by

IMF (Ravana, 2014). Following this, India has now established itself as a lucrative foreign

investment destination. There has been a significant increase in foreign direct investment

with a current inflow of $16.3 billion. Per Capita income also experienced an increase due to

increase in Employment, as a resultant of globalization and privatization. Many job

opportunities have been created which has helped in improving the unemployment rate and

subsequently the standard of living of the people. Privatisation also helped in reducing

government’s financial and administrative burden but on the down side, widened the gap

between the haves and the have nots.

Today, India has evolved itself into one of the worlds fast developing market

economy. It has become a mixed economy with the co-existence of public and private

sectors. It is considered as a lower-middle income economy with 44% of the population still
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engaged in the agriculture sector, 25% in the industrial sector and the remaining 31% in the

service sector. In terms of FY2019, India currently stands at a GDP growth rate of 7.1%. It is

experiencing an economic slowdown due to the recent collapse of the automobile sector,

rising non-performing assets, low consumer demand and failing manufacturing sector.

Organisations are conducting layoffs as a result of inability to sustain in the market which is

affecting the whole condition of the market. On account of people losing their jobs, demand

for consumer goods is also falling low which is further adding to the cycle by failing the

manufacturing units. This fall in consumption expenditure is attributed to an all time low of

3.1%. Output and employment have been affected to such an extent that it has created a

situation of stagnation of the economy. Another major contributor to the current economic

slowdown is the change in attitude of the new generation employees. There is a shift in the

workforce mindset in terms of income expenditure. Previously, Indian population was keener

on saving and gave importance to investment. Today’s workforce has a spending mindset

which has affected the extent and level of saving in India. Less savings leaves less money in

the economy for investment which attributes to the inability of the economy to grow at a

rapid pace.

Business climate in India

According to a report published by the World Bank, India has jumped 14 places to

take the 63rd position on the World Bank's ease of doing business ranking. Importing and

exporting became easier for companies for the fourth consecutive year. India now ranks 68th

globally in trading across border indicators and is performing significantly better. One of the

major facilitators of this has been the government’s efforts to resolve issues and promoting of

investment by making the business processes simple and easy. In an attempt to promote

business, compliance policies have been simplified by the government in the sense that

paperwork has been reduced, licensing has become easier, permissions and grants are
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possessed faster, etc. The introduction of GST has been attributed as a great advantage to the

businesses and Indian economy as a whole. It was aimed at simplifying the tax structure by

aiming to remove the cascading effect of taxation on goods and services. With the

implementation of GST, a varied number of indirect taxes have been removed including the

VAT, CST, service tax, etc and brought under one roof. It had reduced the burden of taxes

from the producers and paved way for growth and accelerated economic development. GST

has helped ease the process of starting a business and has also made its sustenance in the

market easier. Particularly for small and medium enterprises, by making registration at a

centralised platform, a wide gap has been bridged. Earlier the businesses were required to

register for VAT with the state and had to undergo numerous rules, regulations and policies

associated for practice and functioning of the business. The introduction of GST has also

made exceptions for businesses based on their annual turnover and made provisions to apply

for return policies.

The GST has a greater good attached to it. It reduces the possibilities of tax evasion,

also contributes towards curbing black money and holds a promise for sustaining growth of

the economy. In addition to this, there are other new policies that the government has

implemented to promote business in India. One of these is the Make in India policy which

promotes the establishment of manufacturing units in order to be able to produce import

goods indigenously to help gain self-sufficiency, generate more employment, increase

demand by increasing the purchasing power of an average customer and thereby regulate the

flow of cash in the economy. Another such effort is the Digital Indian initiative. It is focused

mainly on three components i.e. creating a strong digital infrastructure, delivering services

digitally, and increasing digital literacy. The successful implementation of this campaign will

help open new opportunities for businesses to grow via means of the digital platform.

Demonetisation however, has been a debateable policy of the government. Though it was
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aimed at reducing black money, prevent hoarding and re-generating the cash flow in the

economy, it has brough the country to a stagnation. Because India is a cash driven economy,

due to disturbed flow cash-intensive industries like manufacturing and construction

experienced a huge set back. It affected revenue collection and even threatened the existence

of small-scale industries. It has helped curb black money and terror funding but it’s long-term

effects of boosting the economy are still awaited. Small businesses are only able to survive

through this change and business in general is experiencing slow growth. MSMEs were the

worst of affected, and are still recovering from the set back.

Structural features of Indian economy

Since the time of independence, India has been a mixed economy. On the basis of

ownership industries can be categorised into –

Public sector. Industries that are owned by the government and are run with the motive

of social welfare. These help the government ensure equal distribution of goods and services.

Private sector. Industries that are owned by private individuals and are run with the

profit motive. These industries function oblivious to maintaining equality and cater to the

middle-upper class.

Forgien sector. Indistries that are owned by forgien entreprenuers (multi national

corporations).

In terms of input and output, the Indian economy can be understood as a classification of

three broad sectors. This traditional understanding of the primary, secondary and tertiary

sector can be broadened to understand the various economic activities taking place in India.

These sectors function in terms of the resources that they use for production. In this sense,

these sectors can be understood as –

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Natural resource (primary sector). Sectors that use natural resources intensively in their

production process include agriculture, poultry, fishing, etc. Agro-based sectors like cotton

textile, jute, food and beverages etc also fall under this category. In addition to these coal,

crude oil, iron ore, etc industries also fall under this category.

Research and development (secondary sector). The industries falling under the

research and development category use sophisticated technology. These include

manufacturing sectors like industrial electrical and non-electrical machines, electronic

equipment, communication equipment, etc.

Labour and capital (tertiary sector). The labour and capital-intensive industries include

iron and steel, printing and publishing, furniture, etc. Banking, insurance, transport, etc also

fall under this category.

On the basis of size of investment, industries can be classified into three types –

Large-scale industries. Those whose capital is more than 35 lakhs.

Medium-scale industries. Those with a capital between 35 lakhs to 5 lakhs.

Small-scale industries. Those with a capital of less than 5 lakhs.

Another classification can be made on the basis of output generated by the industries –

Basic industries. These industries provide essential inputs to all industries and

agriculture. For eg – iron and steel, chemicals, fertilizers, etc.

Capital goods industries. These industries produce the machinery and equipment

required for all industries and agriculture. For eg – machine tools, engineering goods,

electrical equipment, etc.

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Intermediate goods industries. These industries produce goods which are used in the

production process of other goods, rather than for final consumption. For eg – petroleum

products, tyre industry, etc.

Consumer goods industries. These industries produce goods for final consumption

such as power products cosmetics and electronic goods, etc.

The Indian economy has low per capita income. This indicates to widespread

underemployment and unemployment. This can be attributed to the fact that majority of the

population is agriculture dependent. A high proportion of the population is engaged in

agriculture and allied activities which also indicate high possibilities of disguised

unemployment (when individuals more than the required number are employed at the same

work field). In addition to this, there exists a high rate of population growth which imposes a

greater economic burden even to provide basic needs such as food, clothing, housing, etc.

Capital deficiency is another feature of the Indian economy. Owing to the current economic

slowdown, this further is aggravated by weakness of inducement of investment and low

propensity to consume and save.

Application of economic policies at micro and macro level

Economic policies are indicative of governments proposed plan of action in order to

regulate the economy of a country. Economic policies are based on future expectations of the

condition of the economy. The main aims of implementing economic policies are to induce

growth, employment and price stability. Economic policies are formulated keeping in view

the market forces of demand and supply. They relate to a variety of aspects including

industries, trade, agriculture, etc. The market forces impact an economy at two levels of

operation – micro and macro. Microeconomics is considered with how supply and demand

affect individual market. Macroeconomics on the other hand is a holistic view of the overall
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economy of the country. The subject matter of micro economics is regarding single market

eg. automobile sector whereas macro economics looks at the bigger picture and talks about

all markets in terms of nations as a whole.

Government polices impact both macro and micro economics of a country. Economic

policies frame the inputs and incentives for individual economic decisions. Intentional and

unintentional consequences affect the expenditure, investment and saving decisions of micro

units. One of the major impacts is induced by taxation strategy as it determines the

purchasing power of consumers. The monetary polices that influence the banks’ rate of

interest for loans also greatly influence consumer decisions. The repo rate (rate at which the

bank borrows money from the central bank) is a key monetary policy instrument that

influences the money supply in the economy. In its simplest of implications, the repo rate

impacts the interest rate (rate at which the bank gives money to the general public) which

determines the micro units’ investment or expansion decisions. Fiscal policies directly impact

the prices as short-run production decisions are impacted by these policies. On the macro

economic front, economic policies directly impact the market conditions and forces of

demand and supply. In a broader sense, economic policies impact the GDP growth, balance

of payments, balance of trade, foreign exchange rates, etc. Economic policies determine the

fate of a nation and the face of economic market in the near future. Apart from these direct

and observable effects, economic policies also determine a nations foreign relation, stand in

global politics, regional influence and political stability in the global arena.

Role of government in economic planning

Planning is an essential activity which is undertaken by all governments to regulate

the flow of business in an economy. The government’s fiscal and monetary policies impact

the functioning of businesses and keeping those in mind they engage in various activities.
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Import and export is also largely impacted as the government regulates trade policies by

means of tariffs, quotas, duties, etc. Since India is a developing economy, wise and efficient

utilisation and allocation of limited resources is crucial to keep up with the fast-growing

population. Economic planning therefore, becomes all the more important so as to be able to

prioritise according to the populations’ needs and conditions. By engaging in this process, the

government is also capable of stabilising the market, maintaining equalities of income and

wealth, increase capital formation and control the growth of inflation.

The free play of economic market forces often leads to unemployment and instability

in the economic system. Since the time of independence, the Indian government has

continually tried to guide the economy in order to achieve a balanced economic development.

The government plays a vital role in regulating the market and more importantly guiding the

expenditure and consumption of the people throughout the nation. Beginning in the 1950s the

planning commission was set up to devise five-year plans as a tool for the government during

its ruling tenure. These five-year plans consist of short-term and long-term goals for

economic restructuring and development. Beginning from 1951, till today the government

has devised and implemented twelve five-year plans. Each plan is guided by some basic

objectives which help determining the priorities of development keeping in mind the needs of

the country. The last five-year plan was stated for 2012-2017 and was aimed at improving the

rate of growth of the economy, reducing poverty, removing the gender and social gap, and

betterment of infrastructural project amongst other objectives. Post 2014, the dissolution of

planning commission was announced and following its replacement by the NITI Aayog.

Economic planning is a necessary task in view of which the initiative of establishing

NITI Aayog was taken by the Indian government. Acronym for National Institute for

Transforming India, the NITI Aayog is a think tank of government of India established with

the aim to achieve sustainable development goals with cooperative federalism by fostering
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the involvement of State Governments of India in the economic policy-making process using

a bottom-up approach. It is supposed to be providing advice on strategic policy matters to the

government at the centre and states. The role of NITI Aayog is not to plan. It is only to

support the federal structure at the centre and state to formulate the policies. Unlike the

planning commission, it is not responsible for allocating funds either. It is now taken care of

by the finance ministry’s department of expenditure. It is only required to give critical

directional and strategic inputs in aiding the planning process by the centre and states.

Fiscal policy and impact on business

Fiscal policy refers to the governments policies regarding taxation and public

expenditure for the stabilisation and growth of the economy of a country. Fiscal policies

typically target business taxation, individual taxation and government spending. These

policies are changed when the economy is running low owing to decrease in aggregate

demand (deflation) and/or running in a situation of increased aggregate demand (inflation).

Since the main tools of fiscal policy are taxes and spending, a right balance needs to be struck

between these two in order to regulate the flow of the economic flow. There are three types of

fiscal policies –

Expansionary. This type of policy is designed to stimulate the economy. These are

undertaken during times of recession to induce economic activity. For example, the

government reduces the tax collection to increase the purchasing power of consumers and

tries to spend more to stipulate the flow of currency.

Contractionary. This type of policy is used to slow down the economic growth.

These are undertaken to pay down government debt and to cap inflation. For example, the

government increases its tax collection to reduce the purchasing power of consumers and

refrains for excessive expenditure.

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Neutral. This type of policy exists at the time of economic equilibrium. In such a

situation, the government spending is based off of the tax collected which has a neutral effect

on the economy.

Following are the key objectives of fiscal policies:

1. Development of effective mobilisation of resources via taxes and public and private

savings

2. Reduction in inequalities of income and wealth

3. Price stability and control of inflation

4. Employment generation

5. Balanced regional development

6. Reducing deficit in the balance of payments

7. Increases national income

8. Development of infrastructure

9. Foreign exchange earnings

Businesses are directly impacted by fiscal policies. This is because the decisions

regarding investment and/or disinvestment are based on the favourability or unfavorability of

fiscal policies. To illustrate, expansionary policies promote businesses to invest and expand

whereas contractionary policies curb their will to invest or expand. For small businesses

especially, compliance with these polices are essential to ensure sustenance and profits. Fiscal

policy is used as an effective tool to correct inflation and deflation in an economy.

During inflation, the economy experiences excessive demand which is unable to be

met by the current level of supply in the economy. Beyond an extent, supply cannot be

expanded owing as the factors of production lose the ability to generate more output. Due to

less supply and more demand (AD>AS), the prices of the goods begin to rise leading to an
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inflationary condition. In such a situation, the government uses the contractionary fiscal

policy to reduce the cash flow in the economy by increasing the taxation and reducing

expenditure. When the people and businesses pay more taxes, their purchasing power is

reduced and the demand is adjusted to the supply leading to equilibrium.

On the other hand, during deflation, the economy experiences excessive supple which

is unable to be met by the current level of demand in the economy. Demand cannot be

increased due to less cash flow in the economy. Due to excess supply and less demand

(AD<AS), the prices of the goods begin to fall leading to a deflationary condition. In such a

situation, the government uses the expansionary fiscal policy to induce the cash flow in the

economy by decreasing the taxation and increasing expenditure. When the people and

businesses pay less taxes, their purchasing power is increased and the demand is adjusted to

the supply leading to equilibrium.

Thus, via means of fiscal policy the output, income and employment of businesses is

regulated.
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