The macroeconomic analysis of India during the late 1990s using the aggregate demand and supply model

Historical Background Before 1991 – Mixed Economy Public – Private Co-existence Private controlled by quota permit system Administered Price Regime / High Subsidies High Tax Rates (Direct – 50 to 60%; Indirect – 30 to 300%) High Interest Rates Fixed Exchange Rate Nationalized Banks – High CRR Developing Regulatory Institutions – Money, Capital and Financial Markets Rigid Labour Laws

Before 1991 – Mixed Economy

Public – Private Co-existence

Private controlled by quota permit system

Administered Price Regime / High Subsidies

High Tax Rates (Direct – 50 to 60%; Indirect – 30 to 300%)

High Interest Rates

Fixed Exchange Rate

Nationalized Banks – High CRR

Developing Regulatory Institutions – Money, Capital and Financial Markets

Rigid Labour Laws

Historical Background 1991 Forex Reserves dropped sharply BOP Crisis Political Instability Action Taken (1991-1995) Economic Liberalization – quota system abolished Currency Devaluation – fixed to floating (current account) Administered Prices withdrawn ( large no. of goods) FDI permitted (in certain sectors like steel, telecom, energy) Improving Regulatory Institutions (RBI, SEBI ) Process for setting up TRAI, IRDA; overhaul DCA

1991

Forex Reserves dropped sharply

BOP Crisis

Political Instability

Action Taken (1991-1995)

Economic Liberalization – quota system abolished

Currency Devaluation – fixed to floating (current account)

Administered Prices withdrawn ( large no. of goods)

FDI permitted (in certain sectors like steel, telecom, energy)

Improving Regulatory Institutions (RBI, SEBI )

Process for setting up TRAI, IRDA; overhaul DCA

Analysis for FY 1995-96, 1997-98 & 1999-2000 1.58 1.47 1.40 1.30 1.28 1.13 1.067 1.17 1.18 1.30 1.31 1.45 output price

Theoretical Framework Recessionary gap can be reduced by increasing Aggregate Supply and Aggregate Demand Increasing aggregate demand : Fiscal Policy Decrease tax rate (  ) leading to increased propensity to consume (  ) Increase  (=G+I+C+NX) through fiscal expansion i.e. Increase Government Expenditure (G) Monetary and Exchange Rate Policy Increase Money Supply by decreasing Interest rate, CRR or bond market operations Exchange Rate intervention can increase Net Exports (NX) due to local currency devaluation

Recessionary gap can be reduced by increasing Aggregate Supply and Aggregate Demand

Increasing aggregate demand :

Fiscal Policy

Decrease tax rate (  ) leading to increased propensity to consume (  )

Increase  (=G+I+C+NX) through fiscal expansion i.e.

Increase Government Expenditure (G)

Monetary and Exchange Rate Policy

Increase Money Supply by decreasing Interest rate, CRR or bond market operations

Exchange Rate intervention can increase Net Exports (NX) due to local currency devaluation

Theoretical Framework Increasing aggregate supply Price Policy Wage Policy Labor Market Reforms Strengthening of institutions dealing with Law and order, financial institutions, public sector Increase expenditure on Education, Technology, Health Environmental Policy as natural resources are factors determining the output in economy

Increasing aggregate supply

Price Policy

Wage Policy

Labor Market Reforms

Strengthening of institutions dealing with

Law and order, financial institutions, public sector

Increase expenditure on Education, Technology, Health

Environmental Policy as natural resources are factors determining the output in economy

Analysis for FY 1995-1996 Policy Recommendations Increase the Aggregate Demand through Fiscal measures Reduction in tax rates - Direct and Indirect Simplification of Tax Regime Increase in Government Expenditure Infrastructure development Monetary Policy Increase in money supply Necessary Exchange rate adjustments

Increase the Aggregate Demand through

Fiscal measures

Reduction in tax rates - Direct and Indirect

Simplification of Tax Regime

Increase in Government Expenditure

Infrastructure development

Monetary Policy

Increase in money supply

Necessary Exchange rate adjustments

Analysis for FY 1995-1996 Policy Recommendations Increase the Aggregate Supply Strengthen the institutions Increased expenditure on health, education, technology monitor Environmental degradation Alterations in Administered Price Regime Revamp and improve Public Distribution System Reduce Subsidies

Increase the Aggregate Supply

Strengthen the institutions

Increased expenditure on health, education, technology

monitor Environmental degradation

Alterations in Administered Price Regime

Revamp and improve Public Distribution System

Reduce Subsidies

Analysis for FY 1995-1996 Policies Adopted by Government Fiscal Tax rates reduced Direct Taxes Corporate Tax – from 50% to 40% Personal Income Tax – from 40% to 30% Indirect Taxes Peak rate of customs duty –reduced to 50% Peak rate of excise – reduced to 50% Simplification and rationalization of indirect tax structure Excise – rates to 4 from 11

Fiscal

Tax rates reduced

Direct Taxes

Corporate Tax – from 50% to 40%

Personal Income Tax – from 40% to 30%

Indirect Taxes

Peak rate of customs duty –reduced to 50%

Peak rate of excise – reduced to 50%

Simplification and rationalization of indirect tax structure

Excise – rates to 4 from 11

Analysis for FY 1995-1996 Policies Adopted by Government Fiscal Contd. Government Expenditure- increased from Rs1460b to Rs1720b. Monetary Interest rate – 12 to 10.5% CRR - 12.5 to 10.5%

Fiscal Contd.

Government Expenditure-

increased from Rs1460b to Rs1720b.

Monetary

Interest rate – 12 to 10.5%

CRR - 12.5 to 10.5%

Analysis for FY 1995-1996 Policies Adopted by Government Institution strengthening: TRAI and IRDA Disinvestment Commission Human Capital: Increased expenditure on education from Rs. 98 b to 122.3 b Health & Family Welfare from Rs 39.3 b to 45.6 b Technology: Increased spending on ICT research and development Environmental Capital:Control on CO2 and BOD emissions

Institution strengthening: TRAI and IRDA

Disinvestment Commission

Human Capital: Increased expenditure on

education from Rs. 98 b to 122.3 b

Health & Family Welfare from Rs 39.3 b to 45.6 b

Technology: Increased spending on ICT research and development

Environmental Capital:Control on CO2 and BOD emissions

Analysis for FY 1995-1996 Outcome Economic growth at the rate of 7.5% (GDP) Savings reduced from 25.1% to 23.2% of GDP Investments reduced from 26.9% to 24.5% of GDP Credit to commercial sector reduced IIP decelerated, trade deficit enlarged MPC reduced from 0.8 to 0.74 Annual growth rate of goods and services turned negative from 6.3% to –2.34% which contributed to decelerated GDP growth Inflation declined to 4.6% Unemployment increased marginally

Economic growth at the rate of 7.5% (GDP)

Savings reduced from 25.1% to 23.2% of GDP

Investments reduced from 26.9% to 24.5% of GDP

Credit to commercial sector reduced

IIP decelerated, trade deficit enlarged

MPC reduced from 0.8 to 0.74

Annual growth rate of goods and services turned negative from 6.3% to –2.34% which contributed to decelerated GDP growth

Inflation declined to 4.6%

Unemployment increased marginally

Analysis for FY 1995-1996 Reasons for Increase in Output Gap General Elections Lower investor confidence due to political uncertainty Tax collection targets - not met due to inefficiencies in administration Rise in Oil Prices due to lower domestic production Poor Infrastructure Sluggish Exports

General Elections

Lower investor confidence due to political uncertainty

Tax collection targets - not met due to inefficiencies in administration

Rise in Oil Prices due to lower domestic production

Poor Infrastructure

Sluggish Exports

Analysis for FY 1997-1998 Policy Recommendations The recessionary gap has increased, GDP growth rate and IIP has declined, fiscal deficit has increased and GDS, GDI and trade deficit has stagnated which indicates economy slowdown Actions for increasing Aggregate Demand through fiscal & monetary policy ( same pattern as 95-96) Actions for increasing Aggregate Supply - human capital, technology, environmental capital

The recessionary gap has increased, GDP growth rate and IIP has declined, fiscal deficit has increased and GDS, GDI and trade deficit has stagnated which indicates economy slowdown

Actions for increasing Aggregate Demand through fiscal & monetary policy ( same pattern as 95-96)

Actions for increasing Aggregate Supply - human capital, technology, environmental capital

Analysis for FY 1997-1998 Policies Adopted by Government Increase the Aggregate Demand Fiscal Tax rates reduced Direct Taxes Corporate Tax – 35% Personal Income Tax – 30% Indirect Taxes Peak rate of customs duty – reduced to 40% Peak rate of excise – reduced to 18% Simplification and rationalization of indirect tax Launched Black Money unearthing scheme VDIS’97, mopped up Rs 105 b

Increase the Aggregate Demand

Fiscal

Tax rates reduced

Direct Taxes

Corporate Tax – 35%

Personal Income Tax – 30%

Indirect Taxes

Peak rate of customs duty – reduced to 40%

Peak rate of excise – reduced to 18%

Simplification and rationalization of indirect tax

Launched Black Money unearthing scheme VDIS’97, mopped up Rs 105 b

Analysis for FY 1997-1998 Policies Adopted by Government Increase the Aggregate Demand Fiscal Contd. Government Expenditure- increased from Rs 2140b to 2510b National Highway Project launched – Golden Quadrilateral Monetary Interest rate from 8 % to 7 % CRR – 10% to 9%

Increase the Aggregate Demand

Fiscal Contd.

Government Expenditure- increased from Rs 2140b to 2510b

National Highway Project launched – Golden Quadrilateral

Monetary

Interest rate from 8 % to 7 %

CRR – 10% to 9%

Analysis for FY 1997-1998 Policies Adopted by Government Increase the Aggregate Supply TRAI set up Disinvestment of PSU’s – Raised Rs. 50 b Increased expenditure on education from Rs. 128.7 b to 151 b Health & Family welfare from Rs 49.1b to 59b Police from Rs. 385.5 b to Rs. 490.3 b spectacular increase in the expenditure on ICT since 1998 Power sector - increased infusion of technology

Increase the Aggregate Supply

TRAI set up

Disinvestment of PSU’s – Raised Rs. 50 b

Increased expenditure on

education from Rs. 128.7 b to 151 b

Health & Family welfare from Rs 49.1b to 59b

Police from Rs. 385.5 b to Rs. 490.3 b

spectacular increase in the expenditure on ICT since 1998

Power sector - increased infusion of technology

Analysis for FY 1997-1998 Outcome Economic growth picked up to the rate of 6.5% (GDP) Fiscal Deficit reduced from 6.34% to 5.29% Savings reduced 21.7% of GDP (due to interest rate reduction) Investments reduced to 22.7% of GDP IIP decelerated to 4.4%, trade deficit reduced MPC reduced to 0.96 Inflation increased to 5.95% Unemployment decreased marginally

Economic growth picked up to the rate of 6.5% (GDP)

Fiscal Deficit reduced from 6.34% to 5.29%

Savings reduced 21.7% of GDP (due to interest rate reduction)

Investments reduced to 22.7% of GDP

IIP decelerated to 4.4%, trade deficit reduced

MPC reduced to 0.96

Inflation increased to 5.95%

Unemployment decreased marginally

Analysis for FY 1997-1998 Reasons for Increase in Output Gap The East Asian crisis Domestic uncertainty arising from non-economic factors Weather related aberrations (drought/floods)affected agricultural production Post-Pokhran II sanctions Government wage and pension bill rose after 5 th Pay Commission Report UTI Scam breaks out shaking Investor confidence

The East Asian crisis

Domestic uncertainty arising from non-economic factors

Weather related aberrations (drought/floods)affected agricultural production

Post-Pokhran II sanctions

Government wage and pension bill rose after 5 th Pay Commission Report

UTI Scam breaks out shaking Investor confidence

Analysis for FY 1999-2000 Policy Recommendations Increase the Aggregate Demand Fiscal No further reduction in direct tax rates as price level low Tax reduction in Customs Widen tax base – Income tax and Service tax Increase in Government Expenditure Monetary Increase in money supply/ reduction in interest rate Reduction in CRR

Increase the Aggregate Demand

Fiscal

No further reduction in direct tax rates as price level low

Tax reduction in Customs

Widen tax base – Income tax and Service tax

Increase in Government Expenditure

Monetary

Increase in money supply/ reduction in interest rate

Reduction in CRR

Analysis for FY 1999-2000 Policy Recommendations Increase the Aggregate Supply Alterations in Administered Price Regime Revamp and improve Public Distribution System Reduce Subsidies on Oil, Kerosene. LPG Cooking Gas & Fertilizer Increase flexibility in Labor Market; Control Trade Unionism Accelerate Deregulation and Disinvestment of - PSUs FDI incentives in new sectors Increased expenditure on health, education and law & order

Increase the Aggregate Supply

Alterations in Administered Price Regime

Revamp and improve Public Distribution System

Reduce Subsidies on Oil, Kerosene. LPG Cooking Gas & Fertilizer

Increase flexibility in Labor Market; Control Trade Unionism

Accelerate Deregulation and Disinvestment of - PSUs

FDI incentives in new sectors

Increased expenditure on health, education and law & order

Analysis for FY 1999-2000 Policies Adopted by Government Increase the Aggregate Demand Fiscal Tax rates reduced only in Indirect Taxes Peak rate of excise – reduced to 16% Simplification and rationalization of tax structure New Services brought under service tax net Government Expenditure- increased from Rs 2640b to 2840b Monetary Interest rate reduced from 7 to 6.5 % CRR – reduced

Increase the Aggregate Demand

Fiscal

Tax rates reduced only in Indirect Taxes

Peak rate of excise – reduced to 16%

Simplification and rationalization of tax structure

New Services brought under service tax net

Government Expenditure- increased from Rs 2640b to 2840b

Monetary

Interest rate reduced from 7 to 6.5 %

CRR – reduced

Analysis for FY 1999-2000 Policies Adopted by Government Increase the Aggregate Supply Disinvestment of PSUs Increased expenditure on Education from Rs. 238.9 b to 255.4 b Health & Family Welfare from Rs 90.6b to 94.3 b Police from Rs. 636.1 b to Rs. 683.1 b Increase in the expenditure on ICT Good Governance

Increase the Aggregate Supply

Disinvestment of PSUs

Increased expenditure on

Education from Rs. 238.9 b to 255.4 b

Health & Family Welfare from Rs 90.6b to 94.3 b

Police from Rs. 636.1 b to Rs. 683.1 b

Increase in the expenditure on ICT

Good Governance

Analysis for FY 1999-2000 Outcome Economic growth dropped to the rate of 4.4% (GDP) Savings increased 23.4% of GDP Investments increased to 24% of GDP. Credit to commercial sector increased Trade deficit reduced Inflation increased to 7%.

Economic growth dropped to the rate of 4.4% (GDP)

Savings increased 23.4% of GDP

Investments increased to 24% of GDP.

Credit to commercial sector increased

Trade deficit reduced

Inflation increased to 7%.

Analysis for FY 1999-2000 Reasons for Increase in Output Gap Substantial increase in Oil Prices Dot Com bubble bust - Collapse of stock market Erratic monsoon affected agriculture General Elections, Kargil War, Gujarat Earthquake, Rising Wage &Pension Bill

Substantial increase in Oil Prices

Dot Com bubble bust - Collapse of stock market

Erratic monsoon affected agriculture

General Elections, Kargil War, Gujarat Earthquake, Rising Wage &Pension Bill

GDP Growth Rate ( in %)

Fiscal Deficit ( as % of GDP)

Trends in Inflation & Unemployment

G.D.Savings/ Investments (as % of GDP)

FOREX Reserves

Expenditure on Education ( as % of GDP)

Expenditure on Health ( as % of GDP)

Expenditure on ICT ( as % of GDP)

Limitations Y* is based on unemployment rate which means that output gap can never be bridged since natural rate of unemployment will always be present.

Y* is based on unemployment rate which means that output gap can never be bridged since natural rate of unemployment will always be present.

CONCLUSIONS Recessionary Output gap shows increasing trend in absolute terms The gap as a percentage of the GDP is constant The suggested and adopted policy measures have been successful in increasing the GDP of the economy Many domestic and world events affect the outcome Besides fiscal and monetary policies, role of institutions, labor, price, education, technology, environment etc affect the output

Recessionary Output gap shows increasing trend in absolute terms

The gap as a percentage of the GDP is constant

The suggested and adopted policy measures have been successful in increasing the GDP of the economy

Many domestic and world events affect the outcome

Besides fiscal and monetary policies, role of institutions, labor, price, education, technology, environment etc affect the output

THANK YOU ________________________________________________________ Sources: http://indianbudget.nic.in www.frost.com www.finmin.nic.in

THANK YOU

________________________________________________________

Sources: http://indianbudget.nic.in

www.frost.com

www.finmin.nic.in