Trade Cycle in India ( 2003-04 up to the Present)

India’s Dependence on Foreign Capital and External Demand: Evidences

Here, we will establish our claim regarding India’s helpless dependence on foreign capital and
foreign demand for our goods and services with evidences. The following discussion is based on
a much more detailed study of the macroeconomic performance of the Indian Economy carried
out in Ghosh and Ghosh(2016) in Chapters 8 and 9. We will focus on India’s growth
performance since 2003-04 to bring out India’s helpless dependence on inflows of foreign capital
and external demand for our produced goods and services for sustaining its production and
investment. The growth rate of GDP at constant 2004-05 prices rose to 8.1 per cent in 2003-04
from 4 per cent in 2002-03 and this high growth rate was sustained till 2010-11 except for a dip
to 6.7 per cent in 2008-09. In fact, during 2005-06 – 2007-08, the growth rate equaled or
exceeded 9.5 per cent (see Table 9). This kind of superlative growth performance is
unprecedented in India’s history. However, the growth rate slackened in 2011-12 to 6.5 percent
and further to 4.5 percent and 4.7 percent, respectively, in 2012-13 and 2013-14. We consider it
extremely important to know why or how India’s growth rate rose to unprecedented heights since
2003-04 and why the growth rate ebbed in 2008-09 and again during 2011-12 – 2013-14. A
thorough understanding of these phenomena is essential for understanding how helplessly India
depends upon foreign capital and external demand.
To explain India’s growth performance chalked out above, we will use a model set in the
Keynes-Kalecki tradition. In the model (which is presented in the appendix), aggregate demand
determines GDP. We have to first identify which of the four components of aggregate demand,
namely, consumption, investment, public consumption and net export, was the main driver of
growth in the period under consideration in India. To identify the component of aggregate
demand that was principally responsible for the fluctuations in the growth rates delineated above,
it may be helpful to focus on the jump in the growth rate in 2003-04 from that in 2002-03. Net
export is not the reason for the jump. There did not take place any noticeable increase in the
growth rate of exports in 2003-04. Growth rate of export from 2002-03 to 2003-04 was 21.09 per
cent. It was 20.29 per cent from 2001-02 to 2002-03 and 21.01 per cent from 1999-00 to 2000-01
(calculated from data on export from RBI(2013a)).
Except during 2008-09 – 2009-10, fiscal policy has been either neutral (or at least not
avowedly or significantly expansionary) or dampening. Keeping fiscal deficit in a tight leash has
been an integral part of the New Economic Policy being pursued by the GoI since July 1991. In
fact, we find from Table 9 that fiscal deficit as a percentage of GDP had been significantly lower
during the high growth phase than that in the earlier period. Hence, we cannot attribute the
remarkable jump in the growth rate in 2003-04 to fiscal stimulus. Aggregate consumption
demand, we believe, is driven principally by the current disposable income rather than the other
way round. It is also an increasing function of wealth. However, there is no evidence that there
took place any significant jump in households’ wealth in or immediately before 2003-04. Unlike
investment, consumption is normally quite stable except in times of wide-spread economic crisis
such as the Great Recession that happened in the US since 2007 during which asset prices
collapsed suddenly bringing about a sharp increase in households’ indebtedness and bankruptcy
and, thereby, to a substantial decline in households’ wealth or net worth. Given the state of the
Indian economy, there is no reason to believe that there took place any sudden significant
increase in households’ wealth during or prior to 2003-04 that can in any way account for the
doubling of the growth rate in 2003-04 from that in 2002-03.
From the data given in the last two columns in Table 9, we think that the growth performance of
the Indian economy during the period under consideration was largely investment driven. The
question that automatically arises is what happened in and around 2003-04 to send the investors’
confidence and, thereby, investment soaring. To this issue we now turn. From the relevant data
of the Indian economy we find that the only remarkable thing that happened in 2003-04 was a
very large increase in the inflows of foreign investment and these inflows remained high and
grew at a high rate all through the high growth phase of the Indian economy – see Table 9.
The question is how these large inflows of foreign investment gave a boost to investor
confidence. We get a clue regarding this from the data of the nominal exchange rates given in
Table 10. We find that in 2008-09, when growth rate dipped, the exchange rate rose steadily
from Rs.40.0224 in April 2008 to Rs.57.2887 in March 2009. Similarly, during recession years
2011-12, 2012-13 and 2013-14 exchange rate increased unerringly from Rs.45.4174 in July 2011
to 51.6769 in December 2011 and to Rs.51.3992 in January 2012 and again from Rs.51.8029 in
April 2012 to Rs.56.0302 and Rs.55.4948 in June and July 2012 respectively. Again, the
exchange rate rose from Rs. 54.4971 in April 2013 to Rs.64.3885 in September 2013 and, then,
slid down to Rs.62.3136 in February 2014. Thus, it seems that the direction of change in the
exchange rate is a crucial determinant of the sentiments of domestic investors who invest in
domestic physical capital. (It should be pointed out that a deterioration in investors’ sentiments
that brings about an exogenous decline in investment in domestic physical capital will lower
GDP, demand-driven as it is in the short-run, and, thereby, will reduce import and the exchange
rate. Thus, there is unlikely to be any reverse causality between deterioration of sentiments of the
investors referred to here and a rise in the exchange rate). An increase in the exchange rate
indicates BOP deficit and this seems to adversely affect investor morale. One simple way of
explaining this is the following. India is heavily dependent on imports of capital goods. As India
is fully dependent on foreign technology, investment in India is highly import intensive.
Following a ceteris paribus increase in the exchange rate, imported capital goods become costlier
dampening, given expectations, profitability of investment. This is a likely explanation of why
investor sentiments deteriorate with a rise in the exchange rate. Of course, the RBI intervenes
regularly in the foreign exchange market to keep the exchange rate stable. But, since its foreign
currency reserves are far too inadequate, it has extremely limited means to tackle adverse BOP
situations. This should be clear from Table 10, where we, as we have already pointed out, find
that in 2008-09 and also in 2011-12, 2012-13 and 2013-14, exchange rate soared in the face of
BOP difficulties. Thus, it is reasonable to postulate that India has a flexible exchange rate
regime.
The RBI regulates interest rates too through liquidity adjustment facility (LAF), monetary
stabilisation scheme (MSS) and open market operations (OMO) (see Ghosh and Ghosh (2021)
chapter 4 for details). Given RBI’s interest rate stance, the effect of influx of foreign capital may
not operate through the interest rate route much. It affects investor confidence through its impact
on the exchange rate. This likely link between the exchange rate and investment in India, in our
view, played a vital role in driving up investment and thereby pushing up the growth rate
following an increase in the influx of foreign investment since 2003-04. (We have proved this
theoretically in the appendix.) The large and growing foreign investment during 2003-04 – 2007-
08 led to high rate of growth of domestic investment in physical capital inducing a high rate of
growth of real GDP (see Table 9). In 2008-09, just the opposite happened. Foreign investment
declined considerably from $43,325 million to $8311million– see Table 9. As a result, the
exchange rate soared (see Table 10) inducing a fall in the rate of growth of real GDP from 9.6
percent to 6.7 percent. Again, foreign investment increased from $8311million in 2008-09 to
$50361 million in 2009-10 raising the rate of growth of real GDP to 8.4 percent.
India entered into a recession again since the second quarter of 2011-12 – see Table 8.1. The
reason perhaps was different from that in 2008-09. The recession, according to RBI (2012), was
on account of a “slackening of export growth owing to a slowdown in external demand”. The
ensuing BOP difficulties caused the exchange rate to increase (see Table 10) inducing a fall in
the growth rate of real GDP from 8.4 percent in 2010-11 to 6.5 percent in 2011-12.
In the Union Budget for the year 2012-13 placed in the parliament at the end of February 2012,
GoI introduced ‘General Anti Avoidance Rule’(GAAR). At the same time it brought about a
‘retrospective amendment to the Income Tax Act pertaining to indirect transfer of Indian assets’.
Both these measures implied an increase in the tax rate applicable to foreign investors’ income
from their investments in India. Immediately, the credit rating agencies swung into action. S&P
downgraded India’s sovereign rating in April 2012 and threatened to downgrade it further to junk
status. Other credit rating agencies such as Moody’s and Fitch also followed suit. Following this
rating downgrade, there took place a drastic decline in the inflow of foreign capital in 2012-13.
In a press statement released on 15 May 2012 (GoI, Ministry of Finance, Press Information
Bureau), GoI stated: “However, all the SCRAs (Sovereign Credit Rating Agencies such as
Moody’s Investor Services, Standard & Poor’s, Fitch Ratings etc.) have not favourably
commented on India’s fiscal deficit and debt. In their April 2012 report, S&P had revised the
outlook on the long term rating on India from stable to negative. In its report, S&P also stated
that the outlook has been revised “to reflect at least a one-in-three likelihood of a downgrade if
the external position continues to deteriorate, growth prospects diminish, or progress on fiscal
reforms remains slow.”
With the rating downgrade, there took place a large decline in capital inflow and, consequently,
a shooting up of the exchange rate (from Rs.49 in February, 2012 to Rs.56 in June and Rs.55 in
July, 2012 – see Table 10). Government of India grew terribly nervous and started adopting since
12 September 2012 a slew of measures to appease the foreign investors and the credit rating
agencies. On September 12, 2012, GoI allowed, for example, FDI (foreign direct investment) in
retail and promised more reforms on this line. It also brought about a steep increase in the
administered prices of diesel and cooking gas. The measures were obviously so detrimental to
the interest of the poor that it evoked a nation-wide protest. The protest was so true and forceful
that the Prime Minister of India had to address the nation to explain why such harsh measures
were necessary to reverse the economic slowdown. It may be instructive to quote a few portions
of the speech the PM delivered on 21 September 2012. “We are at a point where we can reverse
the slowdown in our growth. We need a revival in investor confidence domestically and globally.
The decisions we have taken recently are necessary for this purpose. Let me begin with the rise
in diesel prices and the cap on LPG cylinders......If we had not acted, it would have meant a
higher fiscal deficit. If unchecked this would lead to .....a loss of confidence in our country. The
last time we faced this problem was in 1991. Nobody was willing to lend us even small amounts
of money then.......I know what happened in 1991 and I would be failing in my duty as Prime
Minister of this great country if I did not take strong preventive action.”
The above discussion shows that India is in a precarious state. A large reduction in the inflow
of foreign capital will lead to severe recession and substantial depreciation of Indian rupee
engendering a price spiral, as imported intermediate inputs are essential ingredients of
production. Thus, a large sudden decline in foreign capital inflow will have a devastating impact
on our economy. Our discussion suggests that the unprecedented high growth phase of 8-9 per
cent evinced during 2003-04 - 2010-11 (excepting the year 2008-09) was principally due to large
inflows of foreign capital. Unfortunately, India has no control over these capital flows. On
account of India’s very critical and helpless dependence on foreign capital inflows for sustaining
its growth and stability, it has lost its policy-making autonomy. Its policies are dictated by the
credit rating agencies which assess and monitor economic activities and performances of
different countries all across the world on behalf of the foreign investors. We find the echo of
this helplessness in the PM’s speech delivered on September 21, 2012, portions of which were
quoted above. From the speech it is clear that the policies adopted since September 2012 are
designed at the behest of the credit rating agencies. In 1991, the IMF thrust upon India its policy
packages. Now, at every step policies have to be formulated to appease the foreign investors who
dictate terms through the credit rating agencies. In other words, India has lost its independence in
policy making. Globalisation in the case of India has allowed it to grow substantially beyond its
means but at the cost of its economic independence.
The recession continued in 2013-14 – see Table 9. This was due to a large decline in net capital
inflow – see Table 9 – on the back of the rumour that the US was going to reverse its quantitative
easing programme or expansionary monetary policy, which would lead to an increase in the
interest rates in the US and, thereby, raise the relative profitability of investment in the US.
The above discussion makes it amply clear how crucially dependent India is on external demand
and inflow of foreign capital.
The data of growth rates of real GDP from 2014-15 onward have been computed using a new
method. The base year has also been changed from 2004-05 to 2011-12. Accordingly, growth
rates of 2014-15 onward are not comparable to the ones preceding 2014-15. However, there is no
reason to believe that India’s helpless dependence on foreign capital and external demand
slackened in any manner since 2014-15. From the data given in Table 13 it is clear that the new
methodology and the base year have substantially inflated the figures of growth rates of real
GDP – compare the growth rates of 2012-13 and 2013-14 of the old series and the new series.
Clearly, if the growth rates of the high growth phase (2003-04 – 2010-11) were computed using
the new method and the base year, the average annual growth rate of the high growth phase
would have been more than 10 percent instead of 8.5 percent. From this point of view, the Indian
economy remained in recession since 2014-15. Besides the foreign investment and external
demand, the factors that kept the growth rates depressed were a series of shocks such as the
imposition of Demonetisation (2016-17), incorporation of the Goods and Services Tax (GST)
(2017-18) and, finally, the outbreak of COVID-19 (2019-20 - 2021-22). To see how
Demonitisation, GST and COVID-19 generate recession, go through Ghosh(2017), Ghosh and
Ghosh (2021a) and Ahamed and Ghosh (2021), respectively.

4.2 Our Interpretation of the Trade Cycle Described Above

The trade cycle described above brings out clearly India’s helpless dependence on foreign capital
and external demand. Since the Western capitalists in our view control all the firms in the
capitalist world, they are in complete command of all the foreign investments made in India and
the external demand for the Indian products. They, therefore, created the trade cycle. The
question is why. We will try to give an answer to this question here. We have already argued
that the most plausible hypothesis that explains the existence and survival of the Indian
capitalists is that they are representatives of the Western capitalists and running the business of
the Western capitalists in India on their behalf. Therefore, the most reasonable explanation of the
boom in India since 2003-04 is that the Western capitalists instructed the Indian capitalists to
step up the growth rate of production and investment since 2003-04. To enable the Indian
capitalists to do so, the Western capitalists started investing heavily in India’s bond and stock
market so that the supply of foreign exchange to the Indian capitalists increases substantially.
Using this large inflow of capital and borrowing very heavily from the Indian banks, the Indian
capitalists sustained high rates of growth of real investment and, thereby, that of real GDP
creating the boom period. However, the inflow of capital tapered off, the stock market crashed
and India entered into a recession since 2011-12 and this recession is continuing even today (see
Table 13 and Ghosh and Ghosh (2016), Chapter 8). Why did the Western capitalists turn this
boom into a recession? The events narrated below, in our view, throws light on this issue. With
the onset of the recession, the ordeal of the public sector banks (PSBs) in India began. The
corporate sector, fully under the control of the capitalists, started defaulting on their loans on a
very large scale giving the excuse of recession. As a result, the PSBs’ stock of non-performing
loans (defined as loans that do not yield any income) as a fraction of their total amount of loans
given started increasing at an alarming rate driving them towards bankruptcy (see Table 14).
This problem of non-performing loans remained confined principally to the PSBs and left the
domestic private banks unaffected (see Table 14). At the same time, bank frauds, which also
were confined principally to the PSBs, started increasing at an alarming rate. Apart from the
dramatic episodes of Vijay Mallya and Nirav Modi who defrauded the public sector banks
(PSBs) of Rs.9000 crore and Rs.11,500 crore and left India in 2016 and 2018, respectively,
evidences that have come up recently suggest that bank frauds are quite widespread in the
banking sector in India and these frauds are concentrated principally in PSBs. The Annual
Report 2018-19 of RBI (2018-19, pp.122-123) states that the number of cases of frauds reported
by the banks increased by 15 percent in 2018-19 on a year-on-year basis, with the amount
involved rising by 73 percent from Rs.382608.7 million to Rs.645094.3 million. More than 90
percent of the defrauded amount is related to the PSBs. According to the RBI’s Financial
Stability Report 2018 (RBI (2018)), large borrowers accounted for 58.8 percent of gross loans
and 85.6 percent of gross non-performing loans of banks. Thus, it seems reasonable to assume
that the bank frauds were principally perpetrated by the corporate sector. The evidences cited
above give us a plausible explanation as to why the capitalists created the above mentioned
boom and recession in India. We delineate it below.
In the period of boom, the Indian capitalists, at the behest of their Western counterparts,
borrowed from the PSBs on a very large scale and it was quite possible for them to steal a large
part of it. Let us explain this with an example. Suppose a capitalist borrows Rs.40,000 crore from
a PSB to build a company and offers the company to be built with the loan as the collateral to the
PSB. The capitalist uses only half of it to build the company and steals the rest. However, on
paper, he shows the value of the assets of the company to be equal to Rs.40,000 crore. Given the
nexus between the government and the capitalists, the PSB turns a blind eye to it. The capitalist
runs it for a few years and, when the recession sets in, declares his company to be bankrupt and
stops servicing the debt. The PSB takes over the company and the obligation of the capitalist
ends there. The PSB sells the company but by selling it the PSB can recover only a small part of
its dues. The PSB again turns a blind eye to it and writes off the rest of the loan. Most of the time
the PSB cannot even sell the bankrupt company because other companies of the capitalist move
the court saying that the bankrupt company owes them money and the PSB has to pay them their
dues first before selling the company (see Chandrasekhar and Ghosh(2018)). These litigations
usually continue indefinitely and no party shows any interest in resolving the problem. The PSB
in such a case writes off the whole of the loan. This scenario is highly plausible, given the
alarming rate of increase in the incidence of bank frauds in recent years in India. Since the
capitalists own the private banks, they did not default on the loans taken from the private banks.
Another reason for defrauding the PSBs may be the following. The capitalists want to make them
sick and show them as inefficient relative to the private banks. This gives the government an
excuse to sell off the PSBs at throw away prices to the capitalists. The capitalists want to gobble
up the government owned financial institutions, which at the present dominate by far India’s
financial sector. Thus, the capitalists created the trade cycle described above to rob the workers’
savings parked with the PSBs and provide the government with a reason for selling off the PSBs
at throw away prices to the capitalists.
In fact, trade cycles all across the capitalist world are created by the capitalists to make gains at

the expense of the workers. For a detailed discussion of this view, go through Chapters 5 and 7

of Ghosh and Ghosh (2019b)

 Table 9

Growth Rate of GDP, Net FDI, Foreign Portfolio Investment, Government Consumption
and Gross Fiscal deficit (GFD)
Year Growth Net Net Total Government GFD1 Rate Rate
Rate of FDI Portfolio (US $ Consumption (% of Of Of
GDP (US Investment Million) (in Rs bn) GDP) GDCF2 NDCF
At $ Million) (US $
Factor Million)
Cost
(At
constant
prices
Base
2004-
05)
2000 5.3 3270 2590 5860 3247.27 5.65 24.6 16.7
-01
2001 5.5 4734 1952 6686 3323.69 6.19 24.6 16.5
-02
2002 5.0 3157 944 4101 3317.53 5.91 25.4 17.3
-03
2003 8.1 2388 11377 13765 3409.62 5.48 27.3 19.5
-04
2004 7.0 3712 9291 13003 3545.18 3.88 32.8 25.5
-05
2005 9.5 3033 12492 15525 3860.07 3.96 34.9 27.8
-06
2006 9.6 7693 6947 14640 4005.79 3.38 36.2 29.2
-07
2007 9.6 15891 27434 43325 4389.19 2.54 39.0 32.2
-08
2008 6.7 22343 -14032 8311 4845.59 5.99 35.6 27.9
-09
2009 8.4 17965 32396 50361 5517.02 6.48 38.4 30.9
-10
2010 8.4 11305 30292 41597 5843.52 5.87 39.8 32.5
-11
2011 6.5 22006 17171 39177 6345.59 5.89 38.8 31.1
-12
2012 4.5 19819 26891 46710 6620.33 5.06 38.9 30.9
-13
2013 4.7 21564 4822 26386 6873.89 4.85
-14
Source: RBI 1Gross fiscal deficit, 2Gross domestic capital formation
 Table 10
Exchange Rate of the Indian Rupee vis-a-vis the US Dollar (Monthly average)
Year/ US $ Year/ US $ Year/ US $ Year/ US $
Month Average Month Average Month Average Month Average
2008 Oct 46.7211 Jul 44.4174 Apr 54.4971
Jan 39.3737 Nov 46.5673 Aug 45.2788 May 55.1156
Feb 39.7326 Dec 46.6288 Sep 47.6320 Jun 58.5059
Mar 40.3561 2010 Oct 49.2579 Jul 60.0412
Apr 40.0224 Jan 45.9598 Nov 50.8564 Aug 64.5517
May 42.1250 Feb 46.3279 Dec 52.6769 Sep 64.3885
June 42.8202 Mar 45.4965 2012 Oct 61.7563
Jul 42.8380 Apr 44.4995 Jan 51.3992 Nov 62.7221
Aug 42.9374 May 45.8115 Feb 49.1671 Dec 61.7793
Sep 45.5635 June 46.5670 Mar 50.3213 2014
Oct 48.6555 Jul 46.8373 Apr 51.8029 Jan 62.1708
Nov 48.9994 Aug 46.5679 May 54.4735 Feb 62.3136
Dec 48.6345 Sep 46.0616 June 56.0302 Mar 61.0021
2009 Oct 46.7211 Jul 55.4948 Apr 60.3813
Jan 48.8338 Nov 46.5673 Aug 48.3350 May 59.3255
Feb 49.2611 Dec 46.6288 Sep 54.3353 June 59.7143
Mar 51.2287 2011 Oct 52.8917 Jul 60.0263
Apr 50.0619 Jan 45.3934 Nov 54.6845 Aug 60.9923
May 48.5330 Feb 45.4358 Dec 54.6439
June 47.7714 Mar 44.9914 2013
Jul 48.4783 Apr 44.3700 Jan 54.3084
Aug 48.3350 May 44.9045 Feb 53.7265
Sep 48.4389 June 44.8536 Mar 54.5754

Source: RBI
Table 11

Foreign Investment Inflows during 2011-12 and 2012-13 (US $ billions)

2011-2012 2012-13

Q1 Q2 Q3 Q4 Q1 Q2

FDI(Net 9.3 6.5 5.0 7.4 3.9 8.9

FPI(Net) 8.3 - 18 13.9 -8.0 7.6

7.4
 Growth 8.0 6.7 6.1 5.3 5.5 5.3
Rate of
GDP
Source: RBI

Table 12

Goods and Services Balance (US$ billion)

2011-12 2012-13

Q1 Q2 Q3 Q4 Q1 Q2

-28.6 - -38.5 -35.0 - -38.8

30.5 28.3

Source: RBI

Table 13
GDP and Its Growth Rate at Constant 2011-12 Prices

Item/Year 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18

Annual Growth
Rate of GDP(%) 5.46 6.39 7.41 8.15 7.11 6.68

Source: RBI: Handbook of Statistics on Indian Economy

 Table 14
Non-Performing Asset in Absolute Terms and as Percentage of Total Advances in Four
Bank-Groups
GNPA( as % of total advances)
Year Scheduled Public Privat Foreign
e
1996 15.7 17.8 2.6 4.3
1997 14.4 16.0 3.5 6.4
1998 14.7 15.9 6.2 7.6
1999 12.7 14.0 4.1 7.0
2000 11.4 12.4 5.1 6.8
2001 10.4 11.1 8.9 5.4
2002 8.8 9.4 7.6 5.3
2003 7.2 7.8 5.0 4.6
2004 5.2 5.4 3.6 2.8
2005 3.3 3.6 1.7 1.9
2006 2.5 2.7 1.9 1.8
2007 2.3 2.2 2.5 1.8
2008 2.3 2.0 3.1 3.8
2009 2.4 2.2 2.9 4.3
2010 2.5 2.4 2.7 2.5
2011 3.1 3.3 2.2 2.8
2012 3.2 3.6 1.8 3.1
2013 3.8 4.4 1.8 3.9
2014 4.3 5.0 2.1 3.2
2015 7.5 9.3 2.8 4.2
Source:Database on Indian Economy, India
 Appendix

Identification of the Major determinants of India’s Growth Performance in the Post-

Reform Period in a Mathematical Model

We will prove here mathematically the propositions regarding India’s growth performance
during the period 2003-04 – 2013-14 using a macro-theoretic model that we hope captures all the
relevant salient features of the Indian economy at the present. The model belongs to the tradition
set by Keynes (1936) and Kalecki (1954) and it is borrowed from Ghosh and Ghosh (2019 a).
Following Keynes (1936), aggregate output in our model is demand-determined. The goods
market equilibrium condition is, therefore, given by

( )
P¿ e
( )
Y =C ( Y ( 1−t ) ) +I r , e +G+NX
− − P
, C ( Y ( 1−t ) ) , I ( r , e ) ;Y ¿ , φ
+ +
+ (A.1)

In (A.1), Y  GDP, P  domestic price level, t  income tax rate on income, P  foreign
*

price level in foreign currency, e  nominal exchange rate, Y  foreign GDP, and   a
*

parameter that indicates Western capitalists’ attitude towards India. An increase in  implies an
improvement in the Western capitalists’ attitude towards India. Hence, export and, therefore, net
export denoted NX is an increasing function of  . In (A.1), consumption is made a function of
aggregate real disposable income. Investment is made a decreasing function of the interest rate r
as well as that of e. The reason why we have made I a decreasing function of e is the following:
In India, there are strong reasons to believe that it is a decreasing function of e, as well. In case
of India, an important determinant of the cost of investment is the exchange rate as a large part of
investment demand represents demand for imported capital goods, whose average price in terms
of domestic currency is P*e. Since India is a small open economy, it is a price taker in the world
market. This implies that P* is given to India. So, an increase in e raises the cost of investment
and, hence, given expectations, reduces investment demand for Y. Production in India is highly
import intensive. An increase in e, therefore, generates a strong cost-push. Both these adverse
supply shocks demoralize the investors and dampen investment demand. Studying the relevant
data carefully, we have already pointed out above that there is a strong inverse relationship
between the exchange rate, the rate of capital formation and growth rate in India. (For more
details, one may go through Ghosh and Ghosh (2016)). For all these reasons, we think that
investment is highly sensitive to exchange rate in India. Hence, we have incorporated e as a
determinant of investment and made it a decreasing function of e.
P¿ e
Net export, as standard, is made an increasing function of the real exchange rate, P .
Moreover, consumption and investment are highly import-intensive. Hence, we have
incorporated them in the net export function. Their increase represents a rise in import demand.
*
Hence, net export falls. Net export is also an increasing function of Y . Since India is a small
* *
open economy, it has to regard Y and P as given. We, therefore, take their values as given
exogenously.
We also make net export an increasing function of the Western capitalists’ attitude towards
India.
Besides exports and imports of produced goods and services, there also occur cross-border
capital flows. Since net inflow of capital depends on the plans and programmes of the Western
capitalists in the main in India, we take it as exogenously given and denote its exogenously given
value by K . Thus, we write the BOP equilibrium condition as

( )
¿
P e
,C ( Y ( 1−t ) ) , I ( r , e ) ; Y , φ + K̄ =0
¿
NX
P + +
+ (A.2)
Following Kalecki(1954), we assume that the producers set P on the basis of the average variable
*
cost of production. The determinants of cost are the money wage rate W and P e . We assume
W to be given in the short run. We, therefore, write P as an increasing function of e. We do not
*
show W and P as determinants of P explicitly, as it is not necessary for our purpose. Thus, we
have
P=P e
()
+ (A.3)
Substituting (A.3) into (A.2), we write it as

( )
¿
Pe
NX , C ( Y ( 1−t ) ) , I ( r ,e ) ;Y ¿ ,φ + K̄=0
P (e ) + +
+

(A.4)
NEP imposes stringent restrictions on government’s fiscal deficit, which means government’s
borrowing. We assume for simplicity and without any loss of generality that the government
seeks to achieve a target of zero borrowing so that government’s budget constraint is given by
G=tY (A.5)
In India interest rates are the policy variables of the Reserve Bank of India (RBI). The RBI keeps
the interest rates at target levels through policies such as the Liquidity Adjustment Facility, open
market operations etc. Denoting the RBI’s target level of the interest rate by r̄ , we have
r= r̄
(A.6)
Substituting (A.6) into (A.4), we rewrite (A.4) as
 ( )
¿
Pe ¿
NX , C ( Y ( 1−t ) ) , I ( r̄ , e ) ;Y , φ + K̄ =0
P (e )
(A.7)
¿
Note that in (A.7), following a ceteris paribus increase in e, both P e and P go up. Since
production in India is highly import intensive, the increase in P is likely to be substantial. Hence,
¿
Pe
the increase in the real exchange rate will be quite small. For simplicity, we shall assume P ,
which we denote by p , to be independent of e and fixed. We, therefore, rewrite (A.7) as
follows:
NX ( p , C ( Y ( 1−t ) ) , I ( r̄ ,e ) ;Y , φ ) + K̄ =0
¿
(A.8)

Determination of the Exchange Rate

NX+K NX+K

e
e0

Figure A.1
 ¿
We can solve (A.8) for e as a function of, among others, Y ,Y ,φ and K̄ . Thus, we get

( )
¿
e=e Y , Y , φ , K̄
− − − − (A.9)
We can explain the partial derivatives of (A.9) using Figure A.1, where the equilibrium value of
e corresponds to the point of intersection of the NX+K schedule representing the LHS of (A.8)
and the horizontal axis. The NX+K schedule is upward sloping for the following reason.
Following an increase in e, investment falls. This lowers import and, thereby, raises net export.
Let us now examine how a ceteris paribus increase in Y is likely to affect the equilibrium value
of e. Following a ceteris paribus given increase in Y, consumption demand will go up bringing
about an increase in demand for imported consumption goods. Note that, given the very high
degree of income inequality in India, most of the additional income will accrue to a small section
of extremely rich people. Hence, most of the increase in consumption demand will represent
additional demand for imported consumption goods bringing about a BOP deficit. Therefore,
following a ceteris paribus increase in Y, the NX+K will decline corresponding to any given e
bringing about a downward shift in the NX+K schedule in Figure A.1. Hence, the equilibrium
value of e will increase. Similarly, one can easily explain the signs of the other partial
derivatives.

Substituting (A.9), (A.5), (A.6) and (A.8) into (A.1), we rewrite it as follows:
Y =C ( ( 1−t ) Y ) +I ( r̄ ,e ( Y ;Y ,φ , K̄ ) ) +tY − K̄
¿
(A.10)

Determination of Y

450line
Y

AD

Y0 Y

Figure A.2

The specification of our model is now complete. It contains two key equations (A.8) and (A.10)
in two endogenous variables: Y and e. We can solve (A.10) for the equilibrium value of Y.
Putting it in (A.8), we get the equilibrium value of e. The solution of (A.10) is shown in Figure
A.2 where we measure Y on the horizontal axis and the LHS (Y) and the RHS (AD) of (A.10) on
the vertical axis. The values of the LHS, when plotted against Y give us a 45 0 line. The AD
schedule representing the RHS of (A.10) has a positive vertical intercept under the assumption
that the sum of the autonomous components of C and I is larger than K̄ . Following a unit
increase in Y, C and G go up by [C ( 1−t ) +t ] , while I goes down by ( e Y ) . The slope of the
' −I e
'
AD schedule, {[C 1−t +t ]−( −I e e Y ) } , is, therefore, ambiguous. For simplicity and without any
( )
loss of generality, we assume the slope of the AD schedule to be positive and less than unity. The
equilibrium Y that corresponds to the point of intersection of the AD schedule and the 45 0 line is
labeled Y0. We are now in a position to examine how an increase in K̄ and φ affect Y, e and P.
Western Capitalists’ Two Instruments for Controlling Indian Economy: K̄ and φ
We shall examine here how an increase in K̄ and φ affects the economy. Let us focus on K̄ first.
Consider (A.8). Following a given increase in K̄ by d K̄ , there emerges a BOP surplus of d K̄
corresponding to any given e, with the values of Y and the exogenous variables remaining
unchanged. In terms of Figure A.1, the NX+K schedule shifts upward by d K̄ . To equilibrate the
BOP, e, therefore, falls so that NX falls by d K̄ . A decline in e lowers net export by raising I. An
increase in I raises import and, thereby, lowers net export. However, a unit increase in I raises
import by less than unity since a part of a unit increase in I represents demand for Indian goods.
Therefore, when net export falls by d K̄ , I increases by more than d K̄ . Now, consider the RHS
of (A.10) representing the AD schedule of Figure A.2. Corresponding to any given Y, e has
fallen to lower NX by d K̄ . But, the fall in e has increase I by a larger amount. (Thus, even
though K̄ has increased by d K̄ , I has increased more.) Thus, the AD schedule in Figure A.1 will
shift upward. However, the values of the LHS of (A.10) will still be given by the 450 line. Hence,
the equilibrium Y will increase.
Let us explain how Y increases. Following a given increase in K̄ by d K̄ , there emerges an
excess supply of foreign currency at the initial equilibrium ( e , Y ) of d K̄ . e begins to fall to clear
the foreign currency market. To clear the foreign currency market, e has to fall by such an
amount that the net export goes down by d K̄ making ( NX + K ) zero again. As we have already
mentioned, the impact of a fall in e on the real exchange rate is insignificant. It clears the foreign
currency market mainly through its impact on investment. Investment rises and, since it is highly
import intensive, raises import and, thereby, lowers net export. As per unit increase in I net
d K̄
export falls by (− NX I ) , I has to rise by
−NX I to lower net export by d K̄ and, thereby, restore
BOP equilibrium. At the initial equilibrium Y, therefore, there emerges an excess demand for

goods and services of

(1
−NX I )
−1 d K̄
. This is because , which measures the import-
intensity of investment, is less than unity. This sets off the multiplier process. Y in the first round

goes up by
dY 1 =
( 1
−NX I )
−1 d K̄
. This increase in Y produces two effects on aggregate planned
demand for Y. On the one hand, it raises public and personal consumption demand by
[ C' ( 1−t )+ t ] dY 1 . It also raises import demand creating a BOP deficit. e rises to restore NX to its
initial value. It does so by lowering I. Therefore, while NX goes back to its initial value, I falls
by . Therefore, in the second round, aggregate planned demand for Y increases by
. Accordingly, in the second round, Y increases by
. Similarly, in the third round Y goes up by
. This process of expansion will
continue until the additional demand that is created in each successive round eventually falls to
zero. When that happens, the economy achieves the new equilibrium. Thus, the total increase in
Y from the initial equilibrium to the new one is given by

(A.11)

The above discussion makes it clear how the economy moves from the initial equilibrium to the
new one.
Note that, even though it is not explicitly stated in many text books, the model presented above
actually determines the growth rate of real GDP and the rate of inflation in the price level from
one given short period (such as a quarter or a year) to the next. Let us explain. Equations (A.1) -
(A.10) represent a given economy (which is India here) in a given short period of time. In the
given short period, values of Y and P that prevailed in the previous short period are given and
known. Therefore, determination of Y and P in the given period amount to determination of the
rate of growth of the real GDP and the rate of inflation from the previous period to the given
period. From the above it is clear that, if in any given period, there takes place an increase in the
net inflow of capital or net foreign investment, the rate of growth of real GDP from the previous
period to the given period will increase.

Thus, the Western capitalists can create booms and recessions in Indian economy through their
control over K̄ . In fact, from the data given in Table 9, we find that during 2003-04 to 2010-11,
with the exception of the year 2008-09, India experienced unprecedented high rates of growth of
GDP. The growth rate more than doubled from 2002-03 to 2003-04 and this very remarkable
jump in India’s growth rate can only be explained in terms of a substantial increase in the net
inflow of capital (foreign investment). From 2002-03 to 2003-04, foreign investment more than
trebled (see Table 9). All through the boom period, India received very large foreign investment.
In fact, the dip in the growth rate in 2008-09 was also accompanied by a sharp fall in foreign
investment (see Table 9). Thus, there is prima facie evidence that the Western capitalists created
the boom in India during 2003-04 to 2010-11 by raising their investment in Indian assets very
substantially. During the boom period mentioned above, India’s average annual growth rate of
GDP was around 8.5 percent. However, India went into a recession since 2011-12, when growth
rate slumped to 6.5 percent. The growth rate dropped further in 2012-13 and 2013-14 when
growth rates of GDP were 4.5 percent and 4.7 percent respectively (see Table 9). In both 2012-
13 and 2013-14, the deep recession was on account of large drops in Western capitalists’
investment in India (see Table 9). Let us first focus on the experiences in 2012-13. In February
2012, Government of India announced General Anti Avoidance Rule in the budget and also
undertook Retrospective Amendment to Income Tax Law pertaining to indirect transfer of Indian
assets. Both these measures aimed at restricting the scope for tax evasion on the part of foreign
investors. This angered the Western capitalists. The global credit rating agencies downgraded
India’s credit rating and threatened to downgrade it further to junk status in April 2012. There
took place a large fall in foreign investment. Exchange rate soared. This made both the domestic
investors and the government extremely nervous. The growth rate plummeted to a low
level.Hastily, to reassure the foreign investors, the GoI announced postponement of the
implementation of the two measures mentioned above, removed the then Finance Minister,
Pranab Mukherjee, who tabled the budget and announced the anti-foreign investor measures and
brought in his place P.C. Chidambaram. The GoI also allowed foreign investment in retail and
promised further relaxation of restrictions on foreign investment on that line in future. The GoI
also brought about a steep hike in the administered price of diesel and cooking gas. Thus, the
large fall in foreign investment and the nervousness it created together were responsible for the
deepening of recession in 2012-13. The deep recession in 2013-14 was also the handiwork of the
Western capitalists. They spread the rumour that the Fed was going to hike its policy rate. This
created a basis for expecting higher return from investments in US assets. As if using this rumour
as an excuse, foreign investors cut down their investment in India substantially (see Table 9).
Exchange rate increased sharply. In fact, between May and September 2013, exchange rate
increased by 17 percent (see Table 10). As a result, investment and growth rate declined sharply
perpetuating the recession. From the above it is clear that in the post-reform period, India is
completely under the control of the Western capitalists. They create recessions and booms in
India at will by changing their investment levels in Indian assets.

The Effect of an Increase in φ

We shall now examine how an increase in φ for exogenous reasons affects India’s growth rate.
Following a given increase in , NX rises corresponding to any given e, given the values of Y
and the other exogenous variables. Thus, the NX+K schedule in Figure A.1 shifts upward
lowering the value of e. The fall in e raises I, given the values of Y and other exogenous
variables. Therefore, the AD schedule in Figure A.2 shifts upward raising the equilibrium value
of Y. The process of adjustment is similar to the one in the previous case. Explain it yourself.
The Western capitalists, therefore, can control India’s growth rate through their control over
India’s exports. In fact, the unprecedented boom that India experienced during 2003-04 to 2010-
11 came to an end since 2011-12. In 2011-12, the growth rate slumped to 6.5 percent from 8.5
percent. This large decline in the growth rate was due to a decline in the growth rate of export for
exogenous reasons.
Proposition A.1: The Western capitalists can create large booms and recessions in India at
their will by raising or lowering their investments in India and/or by purchasing more or
less of India’s produced goods and services. Available evidences lend prima facie support to
the proposition that the unprecedented boom in India during 2003-04 – 2010-11 was on
account of remarkable increases in foreign investment in India and the recession in 2011-12
was due to a large fall in the growth rate of India’s exports. The perpetuation and
deepening of recession in 2012-13 and 2013-14 were also on account of large falls in the
level of foreign investment.
We cannot extend our analysis beyond 2013-14 because comparable data on growth rates are not
available for the subsequent financial years.