EIC Framework: Economic Analysis of India

In 2016, India held the crown as number one destination for Greenfield Foreign Direct Investment
(FDI) for the second consecutive year in a row. India received US$62.3 billion of foreign
investment through 809 projects during 2016, a growth of 2% over the previous year. India was
followed by China (US$59 billion of announced FDI) and the US (US$48 billion of announced
FDI).1 A survey by the United Nations Conference on Trade and Development 2 (UNCTAD) stated
that India would remain among the top three investment destination globally till 2019. 3
India’s rank in the A.T. Kearney FDI Confidence Index 4 also climbed up by one spot to the 8 th
position. Vikas Kaushal, partner and country head at AT Kearney, said, “Reform efforts by the
current government have improved the country's investment environment. This includes the
national goods and service tax (GST) reform, the largest non-direct tax reform in India in recent
years.”5
Many fund managers and analysts also believed that India was the best global investment
opportunity as it had the highest GDP growth rate in the world which would further improve on
account of the tax reforms6 of 2017. Additionally, India was further powered by the youngest
consumer market in the world and a growing middle-class. However, some experts opined that the
problems of poor infrastructure, corruption, increase in the number of unemployed, low per hectare
yield of agriculture, flagging investment vis-à-vis consumption, the rise in oil prices, weak rupee,
fall in non-food credit growth, and pile up of bad debts with the Indian banking sector could
hamper India’s growth story.

OVERVIEW OF GLOBAL ECONOMY

In 2016, the global economy grew at 2.3% and global trade moved at the slowest pace since the
global financial crisis. This was a result of less demand from advanced countries, less import by
commodity exporters, and protectionist policies (inward-looking trade policies) in the US, the UK,
and other nations. The US government signaled an increased expenditure on infrastructure
projects, reduced tax, and the use of protectionist policies. In the Euro Zone, the overall growth fell
from 2% in 2015 to 1.6% in 2016 due to a fall in local and export demand. But the unemployment
rate decreased and economic sentiment improved despite the Brexit vote in June 2016.7
The Emerging Market and Developing Economies 8 (EMDEs) grew at 3.4% in 2016. Commodity
importers were growing at 5.6% in 2016, significantly higher than the 0.3% growth rate of
commodity exporters. The long-term outlook of EMDEs was not so clear due to various factors
such as uncertainty in the policies of developed economies, uncertainty in global trade prospects,
less than required investment, slow growth of productivity, and other demographic factors. The
growth rate of the EMDEs was expected to increase to 4.1% in 2017, 4.5% in 2018, and 4.7% in
2019. It was also expected that the EMDEs would contribute 1.6% points to global growth in
2017.10
In 2016, Low-Income Countries (LICs) provided a good market for the Indian two-wheeler
industry. However, due to weak commodity prices the growth rate of these LICs dropped to 4.7%
in 2016. In addition to this, the LICs also faced various hurdles such as natural calamities and
political challenges. However, commodity importing LICs were growing sharply in 2016. It was
expected that things would improve for the LICs and these countries would grow at the rate of
5.9% in 2017.
The World Bank forecast that the world economy would grow at 2.7% in 2017 and 2.9% in 2018
due to the increase in manufacturing, trade, and high growth in the EMDEs. It was also expected
that global trade would recover in 2017 and 2018 though at a slower pace.

OVERVIEW OF INDIAN ECONOMY

In 2017, India, a South Asian country, was the second most populous country in the world with
more than 1.33 billion people. It was the seventh largest country in the world in terms of area.
India was known for its heritage of thousands of years and its culture which included hundreds of
languages and different sub-cultures. Its heritage and culture had persevered even after more than
two hundred years of British rule.
After Independence from British rule in 1947, India grew quickly and very soon became self-
sufficient in terms of foodgrains and milk production thanks to the Green and White revolution
respectively in the 1960s and 1970s. Between 1951 and 1979-80, Indian GDP on an average grew
at an annual rate of 3.5%. In the same period, per capita income grew at an average rate of 1.3%. 13
During the 1980s, India witnessed a huge gross fiscal deficit, foreign debt, and unfavorable
Balance of Payment (BoP), trade deficit, and Current Account Deficit (CAD). Indian’s gross fiscal
deficit went up to 5.55% of GDP in 1980-81. The country witnessed a BoP crisis starting from
FY80 due to the 1979 Iranian revolution and the Iran-Iraq War in 1980. India’s import bill doubled
between FY79 and FY82, which led to a BoP deficit of Rs.14 113.84 billion by the end of the 6th
five-year plan in 1985. Foreign debt also increased from US$20.6 billion in FY81 to US$64.4
billion in FY90 and gross fiscal deficit further increased to 8.13% of GDP in FY87. Similarly,
CAD rose to 3.5% of GDP and 43.5% of exports in FY91.
In 1991, India went through an economic crisis due to high trade deficit 17, devaluation of the Indian
currency18, high fiscal deficit (7.61% in FY91), and insufficient foreign exchange reserves (US$1.2
billion in January 1991 which further reduced to half in June 1991). To overcome the payment
crisis, the Indian government pledged 67 tons of gold as collateral to get a loan of US$2.2 billion
from the International Monetary Fund (IMF).
In July 1991, with the assistance of the IMF, the Indian political leadership decided to liberalize
the Indian economy and removed 80% of the industries from the licensing framework. India
opened its doors to foreign investment, adopted fiscal reforms, trade policy reforms, and capital
market and financial sector reforms.22
Soon, India reaped the benefits of liberalization and its foreign exchange reserves reached US$15.7
billion by the end of March 1994, further touching a new high of US$372.7 billion in the last week
of April 2017.23 Poverty fell from 36% in 1993-94 to 26.1% in 1999-2000. Many sectors such as
aviation, banking, automobile, telecommunications, software, pharmaceuticals, and biotechnology
reaped the benefits of liberalization. Liberalization also helped India become a software hub and a
back-end office for the world. India also witnessed a big jump in registered motor vehicles thanks
to a reduction in vehicle prices due to increased competition and easy availability of vehicle loans.
The size of the Indian economy jumped from a mere Rs. 10.8 trillion in 1990-91 to Rs. 48.8 trillion
in 2010-11.24 The major contributor to the economy was the service industry followed by the
manufacturing industry and agriculture. CAD dropped from -1.31% of GDP in 2014 to -1.06% of
GDP in 2015. However, India’s trade deficit was expected to increase from US$105.8 billion in
2016-17 to US$111.8 billion due to the increase in the import of petroleum products and gold.
Real GDP growth increased from 5.6% in 1990-91 to 8% in 1996-97 25 and India became the fastest
growing economy in the world with a 7.6% GDP growth rate in 2015-16. But, the GDP growth
rate fell to 7.1% in 2016-17 as the overall growth of the industry sector dropped due to less activity
in the mining and manufacturing industries.26 According to World Bank estimates, the growth rate
would bounce back to 7.5% and 7.7% respectively in 2018 and 2019 respectively.27

POLITICAL SYSTEM AND GOVERNMENT

India became a sovereign democratic republic on January 26, 1950, when its Constitution came
into existence and replaced the Government of India Act (1935). India followed a federal structure
with elected governments in the states. As of 2017, it had 29 states and 7 union territories.
In 2017, India was the largest democracy in the world and its political system was considered to be
stable and strong. India had adopted a parliamentary system of government with a Lower House
(Lok Sabha or the House of the People) and Upper House (Rajya Sabha or the Council of States).
The Upper and Lower houses played a significant role in the formation of new laws, amendment of
existing legislation, and amendment of the Indian Constitution.
SOVEREIGN RATING
In 2017, two international rating agencies – Fitch Ratings Inc. and Standard & Poor’s – rated the
Indian economy ‘BBB–’ (BBB minus), the lowest investment grade rating, with a ‘stable’ outlook.
Another rating agency Moody's Investors Service assigned a Baa3 rating with a ‘Positive’ outlook.28
According to experts, high external debt29 was one of the primary reasons for the low ratings.
In 2016, India’s debt to GDP ratio was 69.5%, significantly lower than in 2004-05 when it was
79.5% and in 2007 when it was 74%). But, it was still higher than that of other emerging market
economies such as South Africa (51.7%), China (46.3%), and Indonesia (27.5%). 30 S&P stated that
the rating would improve if the Indian government brought down the debt to GDP ratio to below
60%.31

DEMOGRAPHY
As per the 15th Indian Census report, in March 2011, India’s population was 1.21 billion with the
literacy rate at 72.99%32. India’s population had grown by 17.41% since the previous census
conducted in 2001. The population density 33 per square kilometer had increased from 325 in 2001
to 382 in 2011. There were 943 females per 1,000 males. The number of females in the age group
of 0-6 years was only 919 for every one thousand males. Out of the 1.21 billion population, 0.83
billion (69%) lived in rural India, and the remaining 0.38 billion (31%) lived in the urban areas.
As per Indian House Listing and Housing Census Data 2011, only 58.7% (35.5% in 2001)
households availed of banking services.34 There were only 21% (11.7% in 2001) households in
India which had two wheelers such as scooters, motorcycles, and mopeds. As per the census data,
about 35.2% of urban Indians had two wheelers in 2011 compared to 24.8% in 2001. 35 As per the
census data, India had the world’s largest youth population with 356 million people in the age
group of 10-24 years. About 41% of Indians were less than 20 years.

AGRICULTURE AND MONSOON

As per the 2011 census, there were 263 million cultivators and workers in India, which was
31.55% of the total rural population and 21.72% of the entire population of the country. In 2016, a
large portion (about 60%) of the Indian population depended on agriculture. The Indian agriculture
sector was largely dependent on the monsoon. 38 Good rain ensured a good harvest and a good
income for more than half the population, which led to the high demand for two-wheelers,
especially from rural India.

EMPLOYMENT

Employment conditions are still not good in the country although the unemployment rate has fallen
from 4.1% in 2008 to 3.5% in 2018. As per the International Labor Organization’s (ILO) report –
‘World Employment and Social Outlook: Trends 2018’, India could witness a 3.5% unemployment
rate in 2018 – higher than the earlier estimate of 3.4%. As per the report, the number of
unemployed people will increase to 18.9 million in 2019. 39

PER CAPITA INCOME AND PURCHASING POWER PARITY

The growth of the economy enhanced the per capita income of the country. Per capita income
increased from Rs 6,270 in 1991 to Rs 93,293 in 2016, though it had a long way to go to catch up
with the levels of per capita income achieved by developed countries. In June 2006, Raghuram
Rajan, the then RBI governor, said, “...We are still a US$1,500 per capita economy. All the way
from $1,500 per capita to $50,000, which is where Singapore is, there is a lot of things to do.”.40
Purchasing power parity (PPP) also improved significantly after liberalization and increased from
US$1,173 in 1991 to US$5,701 in 2014
PERSONAL DISPOSABLE INCOME AND NATIONAL SAVINGS

In 2016, disposable incomes in India went up to Rs. 154.96 trillion from Rs. 138.19 trillion in 2015 It
was set to go up further as the Indian government had revised salaries and pensions of government
employees as per the recommendations of the Seventh Pay Commission and had implemented the
One Rank One Pension scheme for defense personnel. Experts stated that in the coming one to three
years (from 2016), a similar step could be initiated by state governments to give similar benefits to
state government employees. The Indian government had also committed itself to doubling by 2022
the income of farmers, who constituted 21.72%42 of the total population of India as per the 2011
census.43 In 2015-16, the Gross saving as a percentage of Gross National Disposable Income (GNDI)
stood at the previous year’s level of 32.3%.

INFLATION RATE

The combined (rural and urban) Consumer Price Index (CPI) moved down from 9.4% in 2013-14
to 4.9% in 2015-16. This was mainly due to a decrease in the price of food and beverages and
housing. The CPI further declined to 3.4% in December 2016. Similarly, the wholesale price index

of all commodities fell from 6.0% in 2013-14 to -2.5% in 2015-16. The CPI – Industrial Workers
(IW) index also moved down from 9.7% to 5.6% in the same period.
In May 2016, the Indian government amended the Reserve Bank of India Act, 1934. The
amendment empowered the government to set an inflation target for the RBI once every five years
in consultation with the RBI. Later, in August 2016, the government fixed a consumer inflation
target for the RBI at 4% with a plus and minus 2% level of tolerance. 46

INTEREST RATE
In FY17, the Indian economy benefited from a relatively low interest rate environment. It was
further supported by the lower Consumer Price Index (CPI). The demonetization of Rs. 500 and
Rs. 1,000 currency notes on November 9, 2016, increased liquidity with the Indian banks, resulting
in a drop in interest rates. For example, the State Bank of India, India’s largest bank with regard to
assets, brought down the interest rate by 0.9%, which reduced overnight the Marginal Cost of
funds-based Lending Rate (MCLR) from 8.65% to 7.75%.
At the start of the 21st century, India had witnessed a significantly high yield on the government’s
10-year bond. At that time, the government bond yield was more than 10%. However, as the
economy progressed, the yield came down and reached a level of 5% in 2003-04 before it went up
again to above 9% in July 2008. During the period 2012-17, the bond yield was in the range of
6%-9%

EXCHANGE RATE
In 2015-16, the rupee had traded with a downside bias due to various external factors such as the
Greek crisis, the global sell-off, the hard-line guidelines of the US Federal Committee – the
Federal Open Market Committee (FOMC), devaluation of the Renminbi – the Chinese currency,
uncertainty in the international crude price movement, and the developments in the international
financial markets in January and in the first half of February of 2016. In addition to these factors,
various domestic factors also affected the rupee exchange rate such as fall in exports and money
outflow by foreign portfolio investors due to the Minimum Alternate Tax (MAT). Despite all
these, the rupee depreciation against the US dollar was modest in 2015-16 compared to the
currencies of other emerging market economies. However, during the period 2014-17, the
USD/INR exchange rate moved within the range of Rs. 58.86 – Rs.68.25 and Indian currency
significantly lost its value against US dollar in these three years

CRUDE OIL PRICES

Crude oil prices had recovered from a low of US$30 per barrel (bbl) at the start of 2016 but were
still at half of their pre-2015 level. The rise in consumption and decline in oil supply by non-OPEC
suppliers, especially in the US, were the main reasons for the recovery of oil prices. In 2016, the
average crude oil price was US$43/bbl, and it was expected to increase to US$55/bbl in 2017.

FDI AND FII

Foreign long-term investment had significantly increased in India after liberalization. FDI was
only US$74 million in 1991. It increased gradually year after year except for a few years when it
went down due to a slowdown in the global economy. Since 1991, there was a total foreign direct
investment of US$371 billion until March 31, 2016
Foreign institutional investment (FII), – short-term investment by institutional investors – had also
increased considerably from a US$4.2 million inflow in 1992-93 to US$45.69 billion in 2014-15

FISCAL POLICY

Post-independence, accelerating growth was the primary objective of the Indian fiscal policy.
During the 1970s, fiscal policy focused on equality and social justice. But, the high marginal tax
rates were not able to generate much revenue for the government and revenue lagged behind
government expenditure. During the 1980s, high inflation, a low economic growth rate, and
increased BoP deficit due to the sharp jump in oil prices further increased the fiscal imbalance.
A significant development in fiscal policy came in 2003 when the Indian government adopted the
Fiscal Responsibility and Budget Management (FRBM) Act to ensure financial discipline, reduce fiscal
deficit and debt, remove revenue deficit, and ensure better management of public funds The
implementation of the FRBM Act brought positive visible results – a fall in fiscal deficit48 and
expenditure as a percentage of GDP. Fiscal deficit and expenditure as a percentage of GDP increased
after 2007-08 due to the stimulus package offered by the Indian government during the period 2008-
10, but again moved southward after 2008-09).
In May 2016, the Central government set up an FRBM Committee headed by N.K. Singh, former
Member of Parliament and former Revenue Secretary, to review the FRBM Act. In January 2017,
the FRBM Committee suggested a target of 3% fiscal deficit by 2020. It also recommended 40%
debt-to-GDP for the central government by 2023. 49 Experts opined that the pay hike for
government employees and the adoption of the Goods and Services Tax (GST) would put pressure
on the fiscal deficit of 2017-18 before it improved in 2018-19. India’s tax to GDP ratio was
17.23% in FY16. The corporate tax collection to GDP ratio was 3.25% and personal income tax to
GDP ratio was 2.28% in FY17.50

FOREIGN TRADE POLICY 2015-2020

In April 2015, the Indian government came out with its new Foreign Trade Policy (FTP) or EXIM
policy 2015-2020. The FTP had two new schemes – ‘Exports from India Scheme’ (MEIS) and
‘Services Exports from India Scheme’ (SEIS). These replaced various old schemes 51. The main
aim of FTP was to increase goods and services export to the maximum extent. The other objectives
were to increase employment and improve the BoP position. The government planned to increase
exports from US$465 billion in 2015 to US$900 billion by 202052 and secure a larger share of
global trade from 2% in 2015 to 3.5% by 2020.53
GOVERNMENT SPENDING

The Indian economy had witnessed an increase in infrastructure activities, which would further
increase in the coming years as the government planned to speed up infrastructure projects related
to the road, railway sector, aviation industry, and ports sector. Under a central government scheme
for rural roads, the Pradhan Mantri Gram Sadak Yojana (PMGSY), 47,400 km of roads were added
and 11,641 habitations were connected by road in 2016-17.54
In 2015, the government started the Sagarmala project to ensure overall development of the port
sector. By 2017, the government had identified 415 projects worth Rs. 8 trillion and had begun
implementing Rs. 1.37 trillion worth of port sector projects.
CHALLENGES FOR THE ECONOMY

Since India was a net importer of oil, any upward movement in the oil price would create
inflationary pressure on the economy, increase the import bill, CAD, and the oil related subsidy by
the government. In addition to this, corruption, poor infrastructure, a high unemployment rate,
terrorist activities, and flagging investment could hurt the future growth of the country.
As per a CRISIL report published in early 2017, private sector investment would be subdued in
2017-18, due to capacity overhang, less demand, and the debt-laden balance sheet of companies,
and it would grow only in the fiscal year 2019. However, experts stated that a stable government at
the center was ready to take its reform agenda forward and was strong enough to take tough and
bold decisions to ensure continuous growth of the economy.

QUESTIONS
1. Analyze the present day Indian economy based on various parameters given in the case study?
2. What is your decision about investment in India? Elaborate.