Indian Economic Development Assignment-II

How did the three important macroeconomic indicators- savings, investment and
foreign capital inflows, during 2003-08, behave differently, compared to the
decade preceding this period. To what extent did these differences get reflected in
the sectoral GDP and employment growth rates? In this context, critically analyse
the role of foreign capital inflows, citing examples from recent economic
performances.

The period between 2003-2008 is often referred to as the golden period of the Indian economy.
Growth grew at an unprecedented rate of 8.8% per year with a high of 9% in the years 2005-08.
Growth in this era is attributed to various reasons with one section believing that this growth was a
result of the liberal reforms that the government enacted while the other believes that the dream run
was a corporate debt led growth that until the crisis of 2008 tapped into an unprecedentedly booming
world trade. Whatever one might have us believe, statistics (with their own set of inefficiencies) will
lead us to think that the five year period 2003-2008 boasts the best average outcomes with regard to
savings, investment and foreign capital flows when compared to any other five year period preceding
this period right up to 1991 when India too swallowed the sugar coated poisonous pill of neoliberal
reforms. The following discussion reiterates the point made above.
Savings
India had been registering huge fiscal deficits in the years preceding 1991. This was seen as a
contributory factor to the crisis that occurred the same year. Central governments from thereon looked
at fiscal consolidation as an aim and bought the deficit down to 6.5% of the GDP by the mid 1990s.
From thereon, to 2001/2, the fiscal situation seemed grim again as weak expenditure policies, low
revenue buoyancy and the fifth pay commission all contributed to the fiscal deficit jumping to nearly
10% of GDP while government dissavings stood at 7%. Large fiscal deficits have been known to
crowd out private investment and foster high real interest rates. A sustained effort by the government
saw the fiscal deficit fall to 5% of the GDP by 2007-08 and the dissavings to just 1%. This translated
into a jump in savings from 23.6% of the GDP in 2000-02 to 34.8% in 2006-07 of which public
savings was the biggest contributor. Public savings showed an increase of 5.1% in the mentioned
period. Private corporate savings rose from 4.7% in 1995-97 to 7.8% in 2006-07. Household savings
also rose from 16.4% to 23.8% in the same period. On a whole, gross domestic savings rose from
23.6% in 1995-97 to 34.8% in 2006-07.
Investment and Foreign Capital Flows
Investment rate as a proportion of the GDP hardly changed in the 90s and early 2000s. From thereon,
it has surged from 24% to 36% of the GDP in 2006-07. Nets foreign capital inflows soared from
$10.8 billion in 2002-03 to $108 billion in 2007-08 and as a proportion of the GDP from 2.1% to
9.2%. But these all-encompassing figures hide more than they reveal. To break the story down, one
will have to see the nature of these investments and inflows. In the early years of the previous decade,
the domestic investment rate was lower than the savings rate. Public investment was curtailed to
correct fiscal imbalance and with the private investment low, FDI was seen as the saviour. FDI
approval was sizeable but the actual inflows were a third of the approval, mostly in manufacturing.
Neoliberal reforms were pressed for but the memories of the east Asian crisis were too fresh to
indulge in any potential misadventure.
Yet from 2003 onwards, conditions in which world trade operated changed significantly. World trade
revived and as a result Indias export to GDP ratio doubled between 2002 to 2009, from 14% to 25%.
US, seizing on the communications revolution, liberalized its rules for outsourcing and India emerged
as the worlds back office. Capital flows to emerging economies, dormant after the east Asian
crisis, revived and doubled largely due to low US interest rates after the dot com bubble burst and the
willingness of the investors to take risks in the developing economies. Domestic rules governing FDI
were significantly changed to fall in line with the IMF guidelines.
As a result of the above, significant changes occurred in the economic climate of the country. Industry
and real estate grew at nearly 10% in the boom. Outsourcing from the US created demand for IT and
ITES, merchandise exports grew at 25% annually, software exports and telecom services grew at the
same rate. Construction and commercial real estate expanded from 46.6% in 2001-02 to 58.4% in
2007-08. Gross fixed capital formation rose but most of the incremental investment went into
registered manufacturing. Construction investments share in GFCF declined but underwent
interesting changes as housing investment fell while as noted earlier, commercial investment grew
due to demand from outsourcing firms .Investment in infrastructure, inspite the policy commitment
failed to show an inspiring rise. As can be seen, the bulk of the incremental output has come from a
few narrowly defined industries and services. Agricultures share to GDP growth has declined
steadily to only 7% even though half of Indias population is employed there. Employment has its
own sorry story to tell. NSS results show that between 2004-05 and 2009-10, even though output
grew at an unprecedented rate, employment did not. Labour force participation declined especially for
women- at a time when population grew annually at 1.7%. Manufacturing employment declined by
3.7 millon. Real wage rates, though, rose across the sectors.
As has been previously noted, rules regarding FDI were bent. The definition of FDI invested company
was diluted from 40% of the equity capital to 10% because of which investments by private equity,
venture capital and hedge funds could automatically get qualified as FDI. Permission was granted to
count reinvested capital acquisition of existing factories and firms as FDI; to enter construction and
real estate, in 2005, with up to 100% equity ownership. Also, FDIs were originally investments which
led to long term steady financial and technological relationships. But due to above change PE/VC/HF
came to be regarded as FDIs
FDI increased from $ 4.3 billion in 2003-04 to $ 37 billion in 2007-08. However only 40% of this
was used in augmenting productive potential and incentivising technical spillovers. Majority of the
investment classified under FDI was either from PE/HF/VCs or from round tripping, which is
essentially Indian money reinvested into the economy via tax havens to earn tax-free returns. Flooding
foreign capital, along with the new SEZ policy and easy credit access, increased the real estate prices,
as corporates saw this as an opportunity to amass land banks, as Nagaraj puts it. Deep-pocketed FIIs
are the reason why even the global slump, real estate, as well as the stock market were cushioned.
Almost 40% of the free shares traded in the primary and secondary markets are controlled by these
FIIs. Private equity resorted to predatory lending as promoters of many Indian firms, acquiring firms
and businesses abroad and in undiscovered domestic markets, leveraged such bad loans, a result of
their increased risk appetite, in order to enter the big league. Now, when in 2008, the global sub-
prime crisis cast its shadow on the Indian economy, Foreign Portfolio Investors took a back seat and
withdrew money from the economy. This along with protectionist laws in countries like the US, lead
to a sharp decline in corporate investment demand. Rising external debt, which until now had no
effect on the Debt-GDP ratio, now caught wings! This was due to high interest rates, depreciation and
output slowdown. Corporates had deferred their debts, by issuing Foreign Currency Convertible
Bonds, which were now maturing. They had to counter this issue by selling productive assets.
The pattern of growth described above is all too familiar in the third world countries which either
willingly or were forced to gulp down the neoliberal tonic. As has been seen in other countries,
namely Mexico and Argentina, growth through excessive integration of the financial markets which
leads countries to become storage houses of global capital is always susceptible to bursts and
downfalls. What is required of countries like India is that before neoliberal reforms are put in place,
strong institutions have to be readied. This will require governments to increase its capital expenditure
so that a market economy can make use of them to be successful. Capital flowing in the country, in
the classic case, will move out just as easily as it came in and all of it due to international fluctuations.
India, escaped the 2008 crisis, due to strong regulations and that is the way forward.

Rohan Ranganathan
B.A(hons) Economics
Vth Semester
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