Economy (Policy Review and Analysis) by Gaurav Bansal

Model Answer

Question #1. “1991 was a landmark moment in India’s post-independence history that changed the nature of the economy in fundamental ways.” Critically analyse how the 1991-92 economic reforms have transformed the Indian economy during the last 30 years. Have economic reforms improved the quality of life in India? Substantiate.

Approach:

• The question requires the analysis of 1991-92 economic reforms
• The demand of the question is examine the pros and cons of reforms
• In intro explain background and define LPG reforms
• Then elaborate on the positives and negatives of LPG reforms and examine if it improved quality of life in India
• Conclude, by suggesting way forward

Hints:

The convergence of peculiar circumstances such as the Gulf war, collapse of Soviet Union and balance of payment crisis in the early 1990s made it imperative for India to announce the New Economic Policy. The government initiated policies which fall under three heads viz. Liberalization, Privatization and Globalization, "LPG Policy".

Liberalization meant that Industrial licensing was abolished for almost all but few categories – alcohol, cigarettes, hazardous chemicals industries, aerospace etc.

Under privatization government started disinvestment by selling off equity of PSU's. The purpose behind such move was to improve financial discipline and to facilitate modernization.

Globalisation: Globalisation is the outcome of the policies of liberalisation and privatisation. Globalisation implies greater interdependence and integration. It involves creation of networks and activities transcending economic social and geographical boundaries.

Positive impacts of 1991-92 reforms on the Indian economy

• Liberalization: Sharp reduction in industries reserved exclusively for public sector led to growth of private enterprises in India.  Also globalization enabled some Indian companies to emerge as MNCs. Ex: Tata Motors, Infosys.
• Privatization: It brought in market discipline and competition among the PSUs which forced them to be competitive.
• Globalization: It attracted MNCs which created new jobs in India. Also, local companies supplying raw materials, etc. to these industries prospered.
• Access to global capital reserves - via the stock market and international debt helped the growth of domestic companies

Negative impacts of 1991-92 reforms on the Indian economy

•   Trade deficit: Ex-India suffers from about $77 billion trade deficit with China
•   Outsourcing of jobs from developed countries to developing countries has led protectionist measures as recently seen in USA strictly regulating issuance of Visa.
•   Indian Economy has become more vulnerable to global shocks like East Asian crisis 1997, Global Financial crisis (2007-08) etc.
•   Steep and fast reductions in custom duties have snatched large part of Indian market from Indian Industry and passed it on to imports from established global players.
•   Increase in unemployment due to shift from labour intensive processes to Capital intensive processes

Impact of economic reforms on the quality of life in India

•   Globalization attracted MNCs which created new jobs in India. This helped improve per capita income of individuals.
•   Liberalization meant more space for private enterprises. Thus wide choices for goods and services are available for consumers.
•   Due to sharing of technology quality of life in India has definitely improved. Ex- access to TB drugs
•   Vast expansion of sectors like IT, telecommunication has helped improve quality of life. Ex-a person seeking a BSNL telephone connection had to wait for months earlier

Conclusion

Thus it could be seen that despite few of its drawbacks the LPG economic reforms ushered a boost to economy of India leading to growth rate of 7-8% in the coming decade and improved standard of living as well.

Question #2. Do you think monetary policy of the RBI which is based on Inflation targeting has proved to be inefficient and needs reform? Comment

Approach

• The question calls for basic understanding of monetary policy that is set by RBI and the inefficiencies that surrounds it.
• The tone of the question is speculative as it mentions that Monetary policy has proved to be inefficient and calls for reform.
• The introduction should explain the meaning of monetary policy and its functions in an economy.
• Elaborate your answer with the achievements and limitations of monetary policy which is reviewed by RBI regularly.
• End the answer with a conclusion suggesting measures to tackle the issue of inefficiencies related to the monetary policy.

Hints:

Monetary policy is a set of tools that a nation's central bank has available to promote sustainable economic growth by controlling the overall supply of money that is available to the nation's banks, its consumers, and its businesses.  The Reserve Bank of India Act, 1934, was amended by Finance Act (India), 2016, to constitute MPC which will bring more transparency and accountability in fixing India's monetary policy. The governor of the Reserve Bank of India is the chairperson ex officio of the committee. The monetary policy are published after every meeting with each member explaining his opinions. The committee is answerable to the government of India if the inflation exceeds the range prescribed for three consecutive quarters. The current mandate of the committee is to maintain 4% annual inflation until 31 March 2026 with an upper tolerance of 6% and a lower tolerance of 2%.

Functions of monetary policy committee:

• Exchange rate stability – MPC aims at maintaining the relative stability in exchange rate.
• Equal income distribution – MPC fix special provisions for sectors like agriculture, MSME and thus help in bridging the economic inequality.
• Rapid economic growth – MPC influence economic growth by controlling real interest rate and its resultant impact on investment.
• Price stability – MPC helps in controlling both Inflation and Deflation thus maintains price stabilization policy.
• The current mandate of the committee is to maintain 4% annual inflation until 31 March 2021 with an upper tolerance of 6% and a lower tolerance of 2%.

Inflation in India in recent time

• India's retail inflation surged to a five-month high of 7.4 percent in September 2022, logging the third straight quarter where the average print stayed above the RBI's tolerance ceiling of 6 percent and it has breached the medium-term target of 4 percent for three years.  Recent inflation shows failure of MPC to keep the country’s inflation rate within the mandated 2%-6% band for three straight quarters.
• As mandated by a law, the MPC has to explain to the government the reasons for the failure to bring it within the 2-6% mandate and the remedial measures to fix it.

Though, the current mandate of the MPC is to maintain 4% annual inflation until 31 March 2026 with an upper tolerance of 6% and a lower tolerance of 2%.However, the recent inflation in India is due to several other internal and external factors which is beyond the control of MPC.

Moreover, India is not only the country with high inflation in recent time. Data available with Trading Economics showed that Zimbabwe’s inflation stood on the top at 285 per cent in August 2022. Among the major economies in Asia, inflation in Sri Lanka stood at 64.30 per cent in August. Iran, Pakistan, Myanmar and Kazakhstan had inflation of 52.20 per cent, 27.26 per cent, 17.78 per cent and 16.1 per cent, respectively

Reasons for inflation in India in recent time

• Russia-Ukraine war: Higher inflation has been a concern for central banks across the globe, including India, as the uncertain nature of the Russia-Ukraine war compounded supply side disruptions in the post-pandemic world that was barely going through a nascent recovery from economic shocks. The recovery was accompanied by rising global commodity prices as pent-up demand overwhelmed supply.
• The outbreak of the conflict aggravated the commodity upcycle and almost obliterated the supply chains of key critical commodities such as coal, metals, edible oils, and crude oil, with the latter two being essential and major imports of India.
• Post pandemic effect: Both the Indian as well as global economies are recovering from the COVID shock. Their pace of recovery is getting affected by not only the extent of the impact of COVID but also their capacities to deal with the challenges emanating from the economic fallout of the present geopolitical conflict. Given the pressure on global crude prices and supply side bottlenecks all major countries are experiencing unprecedented domestic inflationary pressures coupled with erosion of growth. 
• Fiscal deficit: Fiscal deficit can lead to cost-push inflation. With the lockdown resulting in all economic activities grinding to a halt, government revenue collections drastically declined. On the other hand, stimulus expenditure resulted in a substantial increase in government expenditure, leading to fiscal deficit of 6-7% of gross domestic product (GDP) for FY2021 against the budgeted 3.5%.

Conclusion:

We live in a difficult world where macroeconomic management is hostage to global economic condition apart from other internal factors. Controlling inflation cannot be the function of MPC alone.  It is responsibilities of both the government and MPC to jointly control the inflation. By implementing effective monetary policy, stable prices can be maintained, thereby supporting conditions for long-term economic growth and maximum employment.