Financial Stability Assignment 2022

TABLE OF CONTENTS
TABLE OF CONTENTS 1
ABSTRACT 2
I. Introduction: Understanding macroeconomic indicators: India’s situation 2
II. Assessing growth sustainability; demand and supply-side challenges to growth; analyzing
growth from the demand and supply side—the Indian experience 3
III. Assessing India’s external sector vulnerability 6
IV. Fiscal deficit sustainability and fiscal prudence 8
V. Financial stability 9
VI. Macroeconomic lessons for managers: Betting on the India growth story 12
REFERENCES 14

ABSTRACT
In July 2016, India was celebrating the 25th anniversary of its economic reforms. The
reforms, initiated in 1991 as a result of a severe fiscal deficit-driven balance of
payments crisis, comprised three pillars: privatization, liberalization, and
globalization. The reforms saw India gradually break free of the low annual growth
rate of 3.0–3.5 per cent that had characterized it up to the 1980s, euphemistically
referred to as the “Hindu growth rate.” In 2016, with an annual growth rate of 7.6 per
cent, India emerged as the fastest growing economy in the world, outpacing China’s
6.9 per cent annual growth rate. The movement in the country’s macroeconomic
indicators in the past 25 years pointed to a macroeconomic turnaround. What elements
constituted this turnaround? Were these positive macroeconomic indicators
sufficiently sustainable? Should investors be confident about India’s growth story in
2016?
I. Introduction: Understanding macroeconomic indicators: India’s situation
What macroeconomic indicators are used to evaluate an economy? Does the Indian
economy present a picture of a turnaround?
For a 25-year period, some macroeconomic indicators are used to evaluate India's
economy:
GDP
The article tells us that India's GDP at current prices grew from $280.8 billion in
1990/91 to $2,251 billion in 2016/16- a 702 percent increase in 25 years.
Expenditure to GDP ratio:
Employment growth rate: The article tells us that from 1993 to 2009, there was a
decline in employment growth. During the 2000s, there was little to no increase in job
rates.
Fiscal Deficit
During 1990/91, the Indian economy had a fiscal deficit of 7.61 percent; however, it
significantly declined by 3.94 % during 2015/16.
GDP per capita
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GDP per capita explains how much people profit from their country's economy.
India's GDP per capita in constant 2010 prices rose from $309 in 1991 to $1,598 in
2015.
Indeed the Indian economy presents a picture of a turnaround. A new government
leased 20 tonnes of gold out of its stock to the State Bank of India and allowed the
Reserve Bank of India (RBI) to ship 47 tonnes of gold to the Bank of England in July
1991 to raise $600 million. The government then embarked on a new economic
policy, including privatization, liberalization, and globalization. The economic
reforms began in July 1991, and the mid-1990s restored macroeconomic balance.
India's GDP grew from $280.8 billion in 1990/91 to $2,251 billion in 2015/16- a 702
percent increase in 25 years.
II. Assessing growth sustainability; demand and supply-side challenges to
growth; analyzing growth from the demand and supply side—the Indian
experience
Is an 8% growth rate substantial for India?
Since 2005, India has been growing at the rate of >7% (except for the year 2008-09).
It is mainly because of the rapidly rising middle class of the country. The demand for
goods has been on the rise in the economy.
For the full fiscal year 2021-2022 (April 2021 to March 2022), India's real GDP
growth rate is forecast at 8.2%, recovering from a sharp 7.3% decline compared to the
previous year (2020-2021) due to the strong impact of the covid 19 pandemic. The
Indian economy is forecasted to continue to grow strongly in the financial year 2022-
2023, at a rate of 6.7%.
When the country starts showing signs of recovery from the pandemic, we will see a
considerable rise in employment, leading to more disposable income in the hands of
the people, leading to an increase in demand for goods and services. This would cause
a growth rate of >8% in the short run.
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Generate many initiatives, for example: “Make in India” - is an initiative by the
Government of India to make and encourage companies to develop, manufacture and
assemble products made in India and incentivize dedicated investments into
manufacturing aimed "to transform India into a global design and manufacturing
export hub."
"Make in India" had three stated objectives: to increase the manufacturing sector's
growth rate to 12-14% per annum; to create 100 million additional manufacturing jobs
in the economy by 2022; to ensure that the manufacturing sector's contribution to
GDP is increased to 25% by 2022 (later revised to 2025).
However, India could not be complacent with such growth in per capita income. As
Raghuram Rajan, the former Governor of the Reserve Bank of India, India’s central
bank, stated:
“At one level, we are still a $1,500 per capita economy. All the way from $1,500 per
capita to $50,000, which is where Singapore is, there are a lot of things to do. We are
still a relatively poor economy, and to wipe the tears from every eye, one would at
least want to be middle-income, around $6,000–$7,000, which, if reasonably
distributed, will have dealt with extreme poverty. And that is two decades worth of
work to be even moderately satisfied.”
=> India has a long way to go to achieve its steady state.
What are the challenges to growth on the demand side and on the supply side?
Supply Side:
Service sector:
In 2015/16, the service sector emerged as the most significant contributor to GDP with
a 61.9 percent share. However, the share in overall employment in India is 26.9
percent.
It had experienced declining growth rates in 2015/16, with the slowdown concentrated
in public administration, defense, and other services because of the restraints on public
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expenditure. Other components of the service sector, such as trade, hotels, transport,
communication, and services related to broadcasting, also decelerate.
Some of the challenges faced by the service sector include inadequate business
development Skills, the mark of sales, management takeovers, etc.
Agricultural sector:
Agriculture had a GDP share of 15.4 percent with a share of employment of 48.9
percent.
The employment-intensive agricultural sector, even in 2016, continued to depend on
the vagaries of the monsoon (as noted by consecutive economic surveys of the
Government of India and annual reports of the RBI).
The southwest monsoons, which were the chief source of rainfall in the country,
determined the fate of the agricultural sector—and the economy. Thus, after two
consecutive subnormal monsoon years, the agricultural sector growth rate faltered
from 2013/14 to 2015/16.
Industrial sector:
The industrial sector had a GDP share of 22.7 percent during an employment share of
24.3 percent.
The industrial sector’s growth rate in 2015/16 marked an improvement over the
previous two fiscal years, with much of this improvement accounted for by
manufacturing.
However, the ground-level data appear to be contradictory; for example, while the
new GDP series shows 5.6% growth in the manufacturing sector in 2013/14, the
actual performance of manufacturing companies listed on the National Stock
Exchange showed that earnings had declined by 4 percent in 2013/14.
Demand-side
The automobile sector witnessed rising sales, with the number of cars sold in India
reaching 2.77 million by 2015.
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The enormous legacy of the post-1991 economy was the telecommunications
revolution. In a country of 1.3 billion people, mobile phone subscriptions in India
reached the 1 billion mark by January 2016. Buoyed by the advent of ultra-affordable
devices and the world’s cheapest call tariffs, India had become the second-largest
mobile-subscribing nation, next only to China.
The share of gross fixed capital formation—a significant component of the investment
expenditure in the country — increased from 23.82 percent of GDP to 29.48 percent
of GDP over the 25-year period.
However, the growth rate of gross fixed capital formation, which more than doubled
from an annual average of 7.2 percent in the 1990s to 15.7 percent in the high-growth
phase of 2004–2008, dropped to 4.07 percent from 2013/14 to 2015/16. Government
final consumption expenditure exhibited a moderate reduction from 11.86 percent to
10.4 percent of GDP. The per capita GDP figure (at constant 2010 prices) rose by 417
percent—from $309 in 1991 to $1,598 in 2015.
Overall, India is primarily a consumption-driven economy.
Although the per capita GDP has risen over the years, which readily indicates an
increase in India's wealth, many things must be taken care of. "We are still a relatively
poor economy and to wipe the tears from every eye, one would at least want to be a
middle-income earner of around $6000-$7000, which, if reasonably distributed, will
have dealt with extreme poverty. And that is two decades worth of work to be even
moderately satisfied." (Raghuram Rajan, the former Governor of the Reserve Bank of
India, India’s central bank, said).
III. Assessing India’s external sector vulnerability
What do the external sector indicators point to in terms of the Indian economy?
The external sector is the portion of a country's economy that interacts with the
economies of other countries. In the goods market, the external sector involves exports
and imports. In the financial market, it involves capital flows.
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Economic features related to the external sector include:
1.Balance of payments
2.Current account
3.Capital account
4.Foreign direct investment
5.External debt
6.Exchange rate
7.Foreign-exchange reserves
8.International investment position
Talking about the Indian econ growth recently, the external sector was widely
considered a pillar of strength of the Indian economy, even as it faltered at times on
the domestic front on inflation, fiscal deficit and bold structural reforms. External debt
ratios had declined sharply. The Indian economy, being much more domestically
driven, was less vulnerable to external demand shocks than other major emerging
markets.
Is the Indian economy vulnerable to the external sector?
●India's external sector has become increasingly vulnerable. The plunge taken
by the Indian rupee recently affected this perception of an increase in vulnerability.
●The exchange rate fell from /$61.14 to /$65.47₹ ₹
● Rise in external debt from $20.9 billion in 1991 to $53.96 billion in 2016
● Increase in NRI deposits by $16 billion in 2016
● The lowest value of CAD at 1.1% of GDP
Businesses are borrowing overseas due to near-zero interest rates prevailing in those
markets. In India, interest rates are far too high. Besides this, many non-resident
Indians buy short-term Indian deposits to take advantage of interest rate differential in
India and outside India. A rise in external debt - especially short-term debt - increases
a country's vulnerability to capital inflows. Foreign investors have thus moved their
funds out of emerging markets, thus resulting in a net outflow of funds.
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At such a time of volatility in global markets, analysts warn that financing will be a
challenge for India. It will, in turn, put pressure on its forex reserves.
When the rupee has depreciated to its all-time low against the dollar, the RBI needs
sufficient forex reserves to stem the free-fall. A rise in debt, thus, puts pressure on the
rupee too.
So the Indian economy is vulnerable to the external sector.
IV. Fiscal deficit sustainability and fiscal prudence
How do you interpret India's lower fiscal deficit?
After the crisis, for 25 years, India experienced a very fluctuating economic position
regarding the fiscal deficit. During 1990/91, the fiscal deficit was at a very unhealthy
position of 7.61 % of the GDP. However, in 2015/16, the fiscal deficit had reduced to
3.49 % compared to the old rates.
Reducing the fiscal deficit was essential in 1991 because the crisis was caused by
excess domestic demand sucking in imports and widening the current account deficit
(CAD). A loss of confidence triggered an outflow of funds, and financing CAD forced
a sharp drawdown in reserves. Reducing the fiscal deficit was an obvious way of
containing demand.
The 1990s fiscal deficit can be considered pros and cons simultaneously. The high
fiscal deficit tells us that the Government has been spending more than its revenues.
The Government may depend on outsider loans from organizations like the world
bank and the IMF to support this high fiscal deficit. However, this high fiscal benefit
may be beneficial also. The Government may be spending this money on improving
infrastructure and improving the economy. The Government may be using more than
its revenues for Value Investing, which will benefit the future.
The post-2008 period witnessed significant fiscal expansion to avoid the negative
impact of the global financial crises, which led to worsening fiscal deficits, revenue
deficits and primary deficit indicators.
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The decrease in the fiscal deficit in 2015/16 may be a sign of the positive aspect of the
high fiscal deficit of the 1990s. The value investing that the Government would have
made in the past is now paying off. Those value investing decreased the budgetary
deficit. This lower fiscal deficit also points out that the Government is not relying a lot
on organizations like the IMF to support its government spending. The Indian
Government is becoming more self-sufficient day by day as this fiscal deficit
decreases.
Does the Indian economy represent fiscal prudence?
Fiscal prudence means being pragmatic while handling the expenses and not spending
any more than what you have or what you can take in, or we can say, being judicious
with resources. In simple words, fiscal prudence is Spending within the budget to
reduce the country's debt to GDP ratio.
Governments around the globe follow “prudent fiscal policies” such as
● Cutting government spending
● Increasing the tax rate
● Limiting perks and allowances to government employees
For any economy to mature, fiscal prudence is critical. If the Government continues to
spend way more than its revenues, it will have to print more currency or borrow from
the market to meet the shortfall. The printing currency will fuel inflation and, at times,
hyperinflation. Resorting to borrowing will crowd out the private sector and push up
the interest rates, consequently slowing down economic growth.
In conclusion, the Indian economy can be considered one of the most famous and
visible cases of fiscal prudence. In 2003, the Government of India passed the Fiscal
Responsibility and Budget Management (FRBM) Act to stop these situations and
enforce fiscal prudence. The goal was to institutionalize fiscal prudence and reduce
the country's fiscal deficit to balance the budget progressively. India's fiscal deficit hit
6 percent of GDP when the FRBM Act was not passed; however, with this act's
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enactment, the fiscal deficit turned into a steady and sustainable 3 percent by March
2008.
V. Financial stability
BOOSTING GROWTH THROUGH FINANCIAL STRENGTH
India’s banking industry is at a crossroads. They protected home buyers by improving
the transparency of funds channeled into the property. They introduced a unique
identification number system that has made it easier to form government transfers.
This has mainly benefited the poor. Furthermore, they have created a unified
bankruptcy and insolvency code. These are welcome developments.
State-owned banks account for nearly 70 percent of assets within the nation’s banking
sector. This heavy involvement of the general public sector distorts markets, making it
difficult for India to deal with financing gaps in crucial areas of development like
infrastructure, small and medium-sized businesses and housing. Non-banking
financial companies, sometimes called shadow banks, have emerged as a critical new
source of credit for businesses and consumers. However, their growth has also created
linkages with the formal banking sector, presenting new risks.
The financial sector is wrestling with these issues at a challenging moment for the
worldwide economy. Global growth is slowing amid sluggish investment and
weakening trade. Like many countries, India’s economy faces challenges, with
consumption softening and investment slowing. Globally, bond yields have fallen into
low or negative territory for several top bond issuers, benefiting an increasingly
narrow group but leaving the productive investments needed for broad-based growth
underfunded, including in India. This creates a problematic backdrop for reform. At
the same time, it underscores the necessity for decisive action to permit faster growth.
INVOLVING THE PRIVATE SECTOR
In developing countries, state banks generally comprise the minority instead of the
bulk of market share: closer to twenty percent versus 70 percent.
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The financial sector here generates an occasional level of credit compared with other
countries. India’s credit-to-GDP level is 51 percent. That compares with 136 percent
in Malaysia and 70 percent in Brazil. Although India’s gross domestic savings rate, at
nearly 30 percent of GDP, is in line with peer countries, this trend has taken hold. The
savings are sufficient, but the system does not use them effectively.
To reach the goal of building a $5-trillion economy, the credit will grow at a far
brisker pace while maintaining good credit quality and avoiding excessive risk-taking.
More credit would help meet India’s needs in housing and infrastructure. India’s
annual infrastructure finance gap is predicted to average 0.7 percent of GDP through
2035, quite twice the worldwide average of 0.3 percent.
Productive credit growth would benefit the poor. Many voluminous Indian citizens,
businesses and entrepreneurs operate within the informal economy, with only limited
access to financial services. Many could use credit effectively to create a business or
buy a motorcycle to induce a figure.
The experience of other emerging markets and developing countries offers some
valuable lessons. Within the 1980s and 1990s, many developing countries moved to
liberalize their financial sectors. Countries in central and eastern Europe privatized
large parts of their financial systems within the early 1990s as they moved to
restructure their previously centrally planned economies. In geographic regions,
countries including Mexico liberalized their banking sectors following the debt crisis
of the 1980s.
STRENGTHENING NON-BANK FINANCIAL COMPANIES
The growth of non-bank financial companies (NBFCs) has played a vital role in
channeling credit to under-served markets through new products. IFC, the planet Bank
Group’s private-sector arm, has supported the NBFC sector and has helped channel
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credit to underserved markets. NBFCs are a helpful complement to commercial banks,
helping fulfill the nation’s financing needs in infrastructure and among entrepreneurs
and consumers.
The sector has recently experienced a downturn, resulting in liquidity issues among
some NBFCs. Many non-bank banks face asset-liability mismatches and borrowings,
although they largely depend upon commercial banks and market funds for financing.
Thus, some banks have experienced this trend has taken hold sure to weakness among
NBFCs. Resolving this “twin balance sheet” issue of weakness in NBFCs and related
banks will be a vital step in strengthening India’s financial set-up and reinvigorating
the economic process.
The RBI has done a commendable job overseeing the expansion of NBFCs. We would
recommend that the authorities view the world constructively as a broad, eclectic
coalition of varied styles of institutions with different business models and risk
profiles. You must consider applying the identical risk-based approach to supervising
NBFCs as you apply to banks, applying more stringent regulations and greater
scrutiny to institutions, betting on the risks they present to the economic system.
VI. Macroeconomic lessons for managers: Betting on the India growth story
Before answering this question, we need to look at India's state of the economy.
Overall GDP
India’s nominal GDP grew from $280.8 billion in 1990/91 to $2,251 billion in
2015/16—a 702 percent increase over the 25-year period.
The service sector emerged as the most significant contributor to GDP with a 61.9
percent share. Agriculture and industry had shares of 15.4 percent and 22.7 percent,
respectively.
Employment
In 2016, eight key sectors were: gems and jewelry, textiles, leather, metals,
automobiles, transport, information technology, and handloom products. From
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October to December 2015, more than 20,000 people in these sectors lost their jobs
due to shrinking exports. Nevertheless, most popular farm commodities are selling
below international market values in India, as farmer labor is cheap.
Inflation
Retail inflation has been declining over the past few years. It has dropped from 8.3%
in 2012-13 to 4.9% in 2015-16, owing to a fall in food and oil prices. Food inflation,
which accounts for 54% of the retail inflation basket, fell from 6.3% to 1.4% during
the same period. It is mainly owing to a fall in the prices of vegetables and pulses,
which decreased by 19.6% and 35.8%, respectively.
Industry
India's service sector can be considered one of the most beneficial for investment
during this period. Wages are low, and most youths shifted from farming to formal
employment sectors. As a foreign investor, we see this as an excellent opportunity for
investment because we can get preferable qualified employees at a low wage rate.
In conclusion, we would be pretty confident about the Indian economic situation in
2016 and would invest in India during this period.
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REFERENCES
[1] Wikipedia, “Make in India”.
[2] Government of India, Economic Survey, 2014–15, op. cit; Government of India,
State of the Economy: An Overview,” in Economic Survey 2014–15, accessed
February 6, 2017,
[3] Reserve Bank of India, “Annual Report 2015–16,” op. cit.
[4] Deshpande, Tanvi. Vital Stats: State of the Economy 2016-17. No. id: 11602.
2017.
[5] Professor GS Hiremath, Indian Economy, Macroeconomic turnaround, 2020
Tulsi Jayakumar, THE INDIAN ECONOMY: A MACROECONOMIC
TURNAROUND, Copyright © 2017, Richard Ivey School of Business Foundation
[6] Montek Singh Ahluwalia, “From 1991, the lessons for the India of 2021”. (2021)
[7] PRINCIPLES OF ECONOMICS, Chapter 31. The Impacts of Government
Borrowing, “Introduction to the Impacts of Government Borrowing”.
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