ECONOMIC SYSTEMS

MEANING

Economic system is a social organism through which people make their

living. It is constituted of all those individuals, households, farms, firms,
factories, banks and government, which act and interact to produce and
consume goods and services. Individuals and households put their
resources (land, labour, capital and skill) to one or more of their
alternative uses and make their living; firms buy factors of production
and organize them in the process of production, produce goods and
services, and sell them to their users to make projects.
Consumers are able to get the goods and services of their requirement; producers
are able to produce and sell various kinds of products in appropriate quantities
and so on. The system is operated by, What Adam Smith called “ invisible
hands”, the market forces of demand and supply.
A modern economic system is enormously complex. Millions of people
participate and contribute to its working in different capacities – as producers,
traders, workers, consumers and financers and so on. Thousands of people are
involved in production and distribution of single commodity. A community,
before it reaches its final consumer, passes through a complex process of
production and through a number of intermediary hands.

KINDS OF ECONOMIC SYSTEMS

Free Enterprise Economy

This economic system works on the principle of Laissez Faire system, i.e., the
least interference by the government or any external force. The primary role of

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the government, if any, is to ensure free working of the economy by removing
obstacles to free competition.
A free Enterprise Economy is characterized as follows:

• Means of production are privately owned by the people who acquire and
posses them
• Private gains are the main motivating and guiding force for carrying out
economic activities
• Both consumers and firms enjoy the freedom of choice; consumers have
the freedom to consume what they want to and firms have the choice to
produce what they want to
• The factor owners enjoy the freedom of occupational choice, i.e., they
are free to use their resources in any legal business or occupation;
• There exists a high degree of competition in both commodity and factor
markets and
• There is least interference by the government in the economic activities
of the people; the government is in fact supposed to limit its traditional
functions viz, to defence, police, justice, some financial organizations
and public utility services.
Government Controlled Economy

The government-controlled economies are also called as Command, Centrally

planned or Socialist economies. Such economies are, in contradistinction to the
free enterprise economies, controlled, regulated and managed by the government
agencies.
The other features of a pure socialist economy are:

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 • Means of production are owned by the society or by the state in the name
of the community – private ownership of factors and property is
abolished;
• Social welfare is the guiding factor for economic activities – private
gains, motivations and initiatives are absent,
• Freedom of choice for the consumers is curbed to what society can
afford for all, and
• The role of market forces and competition is eliminated by law.
Mixed Economy

A mixed economy is one in which there exist both government and private
economic systems. It is supposed to combine good elements of both free
enterprise and socialist economies. A mixed economy is widely known as one,
which had both “public sector” (the government economy) and “private
sector” (the private economy). The private sector has features of a free
enterprise economy and the public sector has features of socialist economy. It is
important to note here that most economies in the world today are Mixed
Economies.
There are two different forms of the Mixed Economies.
• Mixed Capitalist Economies

A mixed Capitalist economy is a varient of the free enterprise economic system.

To this category fall the highly developed nations like the United States, U.K.,
France, Japan etc. though these economies have a very large government sector,
their private sectors work on the principles of the free enterprise system. The
government plays a significant role in preserving capitalist mode of production,
ensuring a workable competition in factor and product markets, providing
infrastructure for promotion of private sector economic activities.

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 • Mixed Socialist Economies

To the category of the Mixed Socialist Economies belong the countries which
have adopted “ socialist pattern of society: and economic planning as he means
of growth and social justice (e.g. India) and the former communist countries (eg.
Russia and china) which have of late carried out drastic economic reforms and
liberalized their economies for private entrepreneurship. The government of
these countries takes upon themselves to control and regulate the private sector
activities in accordance with the plan objectives.
BASIC PROBLEMS OF AN ECONOMY AND THE ROLE OF
GOVERNMENT

Whatever the nature of the economic system, all types of economies have been
faced with certain common basic problems. The major economic problems faced
by an economy may be classified into two broad groups: (i) micro-economic
problems called basic problems, which are related to the working of the
constituents of the economic system; and (ii) macro-economic problems related
to the growth, stability, and management of the economy as a whole.
The way the basic problems of an economy are solved depends on the nature of
the economy. While in a socialist economy they are solved by the government
agencies, like central planning authority, in a free enterprise or mixed capitalist
economy this task is performed by the Price Mechanism or Market Mechanism.
Though free enterprise system is capable of bringing economic growth, it does
not ensure a stable, sustained, and balanced growth. It becomes therefore
inevitable for the government to intervene fair competition, and help the
economy in achieving its goals – efficiency, stability, growth and economic
justice.

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Now, the question arises as to what should be the appropriate role of the
government in economic management of the country or what should be the
form, nature and extent of government’s interference with market mechanism.
Nevertheless, the economic role of the government can be broadly categorized
on the basis of the three economic systems which presently prevail in the world,
viz., Capitalist System or Free Enterprise System, Socialist System, and the
Mixed-Economy System.
Capital Society: In this system, the primary role of the government are: (i) to
preserve and promote free market mechanism wherever it is possible to ensure a
workable competition, (ii) to remove all unnecessary restrictions on the free
operation of competitive market, and (iii) to provide playground and rules of the
market game through necessary interventions and controls so that free
competition can work effectively.
It may be inferred that the government’s role in a capitalist society is supposed
to be limited to (a) restoration and promotion of necessary conditions for
efficient working of free market mechanism; and (b) to enter those areas of
production and distribution in which private entrepreneurship is lacking or is
inefficient.
Socialist Economy: In contract with the capitalist system, the role of
government in a Socialist economy is much more exhaustive. While in the
former, the government is supposed to play a limited role in the economic
sphere, in the latter, it exercises comprehensive control on almost all economic
activities. In the socialist system, not only there is a complete disregard for free
enterprise and market mechanism but also these systems are abolished by law.
The private ownership of factors of production is replaced by the State
ownership. All economic activities are centrally planned, controlled and
regulated by the State. All decisions regarding production resources, allocation,

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employment, pricing etc., are centralized in the hands of government or the
Central Planning Authority.
Mixed Economy: In this system, a major part of the economy, the private
sector, is allowed to function on the principles of free enterprise system or free
market mechanism within a broad political and economic policy framework.
The other part of the economy, the public sector, is organized and managed
along the socialist pattern. The public sector is created by reserving certain
industries, trade, services, and activities for the government control and
management. The government prevents by an ordinance the entry of private
capital into the industries reserved for the public sector. Another way of creating
or expanding the public sector is nationalization of existing industries. The
promotion, control and management of the public sector industries is the sole
responsibility of the State.
Apart from controlling and managing the public sector industries the
government controls and regulates the private sector through its industrial,
monetary and fiscal policies. If necessary, direct controls are also imposed.

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 Lesson 4
ECONOMIC TRANSITION IN INDIA:
PRIVATISATION AND GLOBALISATION

PRIVATISATION
Privatization, which has become a universal trend, means transfer of ownership
and/or management of an enterprise from the public sector to the private sector.
It also means the withdrawal of the state from an industry or sector, partially or
fully. Another dimension of privatization is opening up of an industry that has
been reserved for the public sector to the private sector.
Privatization is an inevitable historical reaction to the indiscriminate expansion
of the state sector and the associated problems. Even in the ‘communist’
countries it became a vital measure of economic rejuvenation.
OBJECTS
The objects are:
• To improve the performance of PSUs so as to lessen the financial
burden on taxpayers.
• To increase the size and dynamism of the private sector, distributing
ownership more widely in the population at large.
• To encourage and to facilitate private sector investments, from both
domestic and foreign sources.
• To generate revenues for the state
• To reduce the administrative burden on the state
• Launching and sustaining the transformation of the economy from a
command to a market model.

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PRIVATISATION ROUTES
The important ways of privatization are:
• Divestiture, or privatization of ownership, through the sales of
equity.
• Denationalization or reprivatisation.
• Contracting - under which government contracts out services to other
organizations that produce and deliver them.
• Franchising- authorizing the delivery of certain services in
designated geographical areas- is common in utilities and urban
transport.
• Government withdrawing from the provision of certain goods and
services leaving then wholly or partly to the private sector.
• Privatization of management, using leases and management contracts
• Liquidation, which can be either formal or informal. Formal
liquidation involves the closure of an enterprise and the sale of its
assets. Under informal liquidation, a firm retains its legal status even
though some or all of its operations may be suspended.
BENEFITS
The benefits of privatization may be listed down as follows:
• It reduces the fiscal burden of the state by relieving it of the losses of
the SOEs and reducing the size of the bureaucracy.
• Privatization of SOEs enables the government to mop up funds.
• Privatization helps the state to trim the size of the administrative
machinery.
• It enables the government to concentrate more on the essential state
functions

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 • Privatization helps accelerate the pace of economic developments as
it attracts more resources from the private sector for development.
• It may result in better management of the enterprises.
• Privatization may also encourage entrepreneurship.
• Privatization may increase the number of workers and common man
who are shareholders. This could make the enterprises subject to
more public vigilance.
CRITICISMS
Some of the important argument against privatization is as follows:
• The public sector has been developed with certain noble objectives
and privatization means discarding them in one stroke.
• Privatization will encourage concentration of economic power to the
common detriment.
• If privatization results in the substitution of the monopoly power of
the public enterprises by the monopoly power of private enterprises it
will be very dangerous.
• Privatization many a time results in the acquisition of national firms
by foreign firms.
• Privatization of profitable enterprises, including potentially
profitable, means foregoing future streams of income for the
government.
• Privatization of strategic and vital sectors is against national interests.
• There are well managed and ill-managed firms both in the public and
private sectors. It is not sector that matters, but the quality and
commitment of the management.

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 • The capital markets of developing countries are not developed
enough for efficiently carrying out privatization.
• Privatization in many instances is a half-hearted measure and
therefore it is not properly carried out. As a result that the expected
results may not be achieved.
• In many instance, there are vested interested behind privatization and
it amounts deceiving the nation. In many countries privatization often
has been a “garage sale” to favored individuals and groups.
CONDITIONS FOR SUCCESS
• Privatization cannot be sustained unless the political leadership is
committed to it, and unless it reflects a shift in the preferences of the
public arising out of dissatisfaction with the performance of other
alternatives.
• Replacement of a government monopoly by a private monopoly may
not increase public welfare-there must a multiplicity of private
suppliers. Freedom of entry to provide goods and services.
• Public services to be provided by the private sector must be specific
or have measurable outcome.
• Lack of specificity makes it more difficult to control services
provided by the private sector. Service delivery by non-governmental
organizational or local governments may be more appropriate under
these conditions.
• Consumers should be able to link the benefits they receive from a
service to the costs they pay for it, since they will then shop more
wisely for difficult services.

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 • The importance of educating consumers and disseminating
information to the public is necessary.
• Privately provided services should be less susceptible to fraud than
government services if they are to be effective.
• Equity is an important consideration in the delivery of public
services. Broadly speaking, the benefits of privatization can accrue to
the capital owner to the consumer and to public at large.
PRIVATISATION IN INDIA
In India, although there were some isolated cases of privatization, no definite
policy decision was taken until the new economic policy was been ushered in
.The accumulated loses of many SOEs, including some state transport
corporations, are larger than the capital invested in them. Privatization of certain
sectors and enterprises are, therefore, necessary to reduce the budgetary burden
on the public, to make available more resources for the development activities,
to enable the government to concentrate more on the essential and priority areas.
The new industrial policy, which has abolished the public sector
monopoly in all but a very few industries is a significant step towards
Privatization. The new policy also proposes Privatization of enterprises by
selling shares to mutual funds, workers and the public. The central government
has been reviewing the existing portfolio of public investment with a view to
offloading public investment.
The disinvestments Commission was set up by Government of India in
August 1996, for suggesting the modalities for undertaking disinvestments of
equities for select PSUs. The commission has recommended disinvestments at
varying levels for a number of PSUs

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PRIVATISATION POLICY
The current direction of Privatization policy is to put national resources
and assets to optimal use and in particular to unleash the productive potential
inherent in our public sector enterprises.
The policy of disinvestments specifically aimed at:
• Modernization and up gradation of Public Sector Enterprises.
• Creation of new assets.
• Generation of Employment
• Retiring of public debt
• To ensure that disinvestments does not result in alienation of national
assets, which through the process of disinvestments, remain where
they are. It will also ensure that disinvestment does not result in
private monopolies.
• Setting up a Disinvestments Proceeds Fund.
• Formulating the guidelines for the disinvestments of natural assets
companies.

GLOBALISATION
India’s economic integration with the rest of the world was very limited because
of the restrictive economic policies followed until 1991. Indian firms confined
themselves, by and large, to the home market.
Foreign investment by Indian firms was very insignificant. With the new
economic policy ushered in 1991, there has, however, been change.
Globalization has in fact become a buzzword with Indian firms now and many
are expanding their overseas business by different strategies.
Globalization may be defined as “ the growing economic
interdependence of countries worldwide through increasing volume and variety

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of cross border transactions in goods and services and of international capital
flows, and also through the more rapid and widespread diffusion of technology”.
Globalization may be considered at two levels .Viz, at the macro level
(i.e., globalization of the world economy) and at the micro level (i.e.,
globalization of the business and the firm).
Globalization of the world economy is achieved, quite obviously, by
globalising the national economies. Globalization of the economies and
globalization of business are very much interdependent.

REASONS FOR GLOBALISATION

• The rapid shrinking of time and distance across the globe thanks to faster
communication, speedier transportation, growing financial flows and
rapid technological changes.
• The domestic markets are no longer adequate rich. It is necessary to
search of international markets and to set up overseas production
facilities.
• Companies may choose for going international to find political stability,
which is relatively good in other countries.
• To get technology and managerial know-how.
• Companies often set up overseas plants to reduce high transportation
costs.
• Some companies set up plants overseas so as to be close to their raw
materials supply and to the markets for their finished products.
• Other developments also contribute to the increasing international of
business.
• The US, Canada and Mexico have signed the North American Free
Trade agreement (NAFTA), which will remove all barriers to trade
among these countries.

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 • The creation of the World Trade Organization (WTO) is stimulating
increased cross-border trade.

FEATURES
The following are the features of the current phase of globalization:
New markets
• Growing global markets in services – banking, insurance, transport.
• New financial markets - deregulated, globally linked, working around
the clock, with action at a distance in real time, with new instruments
such as derivatives.
• Deregulation of anti - trust laws and proliferation of mergers and
acquisitions.
• Global consumer markets with global brands.
New actors
• Multinational corporations integrating their production and marketing,
dominating food production
• The World Trade Organization - the first multilateral organization with
authority to enforce national governments compliance with rule
• An international criminal court system in the making
• A booming international network of NGOs
• Regional blocs proliferating and gaining importance – European Union,
Association of South- East Asian Nations, Mercosur, North American
Free Trade Association, Southern African Development Community,
among many others
• More policy coordination groups – G-7, G40, G22, G77, OECD

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New rules and Norms
• Market economic policies spreading around the world, with greater
privatization and liberalization than in earlier decades
• Widespread adoption of democracy as the choice of political regime
• Human rights conventions and instruments building up in both coverage
and number of signatories – and growing awareness among people
around the world
• Consensus goals and action agenda for development
• Conventions and agreements on the global environment – biodiversity,
ozone layer, disposal of hazardous wastes, desertification, climate
change
• Multilateral agreements in trade, taking on such new agendas as
environmental and social conditions
• New multilateral agreements- for services, intellectual property,
communications – more binding on national governments than any
previous agreements
• The multilateral agreements on investment under debate
New Tools of communication
• Internet and electronic communications linking many people
simultaneously
• Cellular phones
• Fax machines
• Faster and cheaper transport by air, rail and road
• Computer-aided design

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STAGES OF GLOBALISATION
There are five different stages in the development of a firm into global
corporations.

First stage
The first stage is the arm’s length service activity of essentially domestic
company, which moves into new markets overseas by linking up with
local dealers and distributors.

Second stage
In the stage two, the company takes over these activities on its own.

Third stage

In the next stage, the domestic based company begins to carry out its own
manufacturing, marketing and sales in the key foreign markets.

Four stage
In the stage four, the company moves to a full insider position in these markets,
supported by a complete business system including R & D and engineering.
This stage calls on the managers to replicate in a new environment the
hardware, systems and operational approaches that have worked so well at
home.

Fifth stage
In the fifth stage, the company moves toward a genuinely global mode of
operation.

GLOBALISATION STRATEGIES
The various strategies of transiting a firm into global corpatation are as follows:

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Exporting
Exporting, the most traditional mode of entering the foreign market is
quite a common one even now.
Licensing and Franchising
Under international licensing, a firm in one country (the licensor) permits a firm
in another country (the licensee) to use its intellectual property (such as patents,
trademarks, copyrights, technology, technical know-how, marketing skill or
some other specific skill).

Franchising is “a form of licensing in which a parent company (the

franchiser) grants another independent entity (the franchisee) the right to do
business in a prescribed manner.

Contract manufacturing
A company doing international marketing, contracts with firms in foreign
countries to manufacture or assemble the products while retaining the
responsibilities of marketing the product.

Management contracting
In a management contract the supplier brings together a package of skills that
will provide an integrated service to the client without incurring the risk and
benefit of ownership. The arrangement is especially attractive if the contracting
firm is given an option to purchase some shares in the managed company within
a stated period.

Turnkey contracts
A turnkey operation is an agreement by the seller to supply a buyer with a
facility fully equipped and ready to be operated by the buyer’s personnel, who
will be trained by the seller.

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Turnkey contracts are common in international business in the supply, erection
and commissioning of plants, as in the case of oil refineries, steel mills, cement
and fertilizer plants etc.

Wholly Owned Manufacturing Facilities

Companies with long term and substantial interest in the foreign market
normally establish fully owned manufacturing facilities there. This method
demands sufficient financial and managerial resources on the part of the
company.
Assembly operations
A manufacturer who wants many of the advantages that are associated with
overseas manufacturing facilities and yet does not want to go that far may find it
desirable to establish overseas assembly facilities in selected markets. The
establishment of an assembly operation represents a cross between exporting
and overseas manufacturing.
Joint Ventures
Any form of association, which implies collaboration for more than a transitory
period is a joint venture. Types of joint overseas operations are:
Sharing of ownership and management in an enterprise
Licensing / franchising agreements
Contract manufacturing
Management contracts
Third country location
When there are no commercial transactions between two nations because of
political reasons or when direct transactions between two nations are difficult
due to political reasons or the like, a firm in one of these nations which wants to
enter the other market will have to operate from a third country base. For

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example, Taiwanese entrepreneurs found it easy to enter People’s Republic of
china through bases in Hong Kong.

Mergers and acquisitions

Mergers and acquisitions (M & A) have been a very important market entry
strategy as well as expansion strategy. A number of Indian companies have also
used this entry strategy.

Strategic alliance
This strategy seeks to enhance the long-term competitive advantage of the firm
by forming alliance with its competitors, existing or potential in critical areas,
instead of competing with each other. Strategic alliance is also sometimes used
as a market entry strategy. For example, a firm may enter a foreign market by
forming an alliance with a firm in the foreign market.
Counter trade
Counter trade refers to a variety of unconventional international trade practices
which link exchange of goods- directly or indirectly – in an attempt to dispense
with currency transactions. Counter trade is a form of international trade in
which certain export and import transactions are directly linked with each other
and in which import of goods are paid for by export of goods, instead of money
payments.
BENEFITS
The important arguments in favour of globalisation are:
• Productivity grows more quickly when countries produce goods and
services in which they have comparative advantage.

• Living standards can go up faster.

• Global competition and imports keep a lid on prices, so inflation is less
likely to derail economic growth.

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 • An open economy spurs innovation with fresh ideas from abroad.
• Export jobs often pay more than other jobs.
• Unfettered capital flows give access to foreign investment and keep
interest rates low.
DISADVANTAGES
Following are the cases against globalisation:
• Millions have lost jobs due to imports or production shifts abroad. Most
find new jobs that pay less.
• Millions of others fear losing their jobs, especially at those companies
operating under competitive pressure.
• Workers face pay cut demands from employers, which often threaten to
export jobs.
• Services and white-collar jobs are increasingly vulnerable to operations
moving offshore.
• Employees can lose their comparative advantage when companies build
advanced factories in low-wage countries, making them as productive as
those at home.
ESSENTIALS FOR GLOBALISATION
They are some essential conditions to be satisfied on the part of the domestic
economy as well as the firm for successful globalization of the business.
• Business freedom
There should not be unnecessary government restrictions like import
restriction, restrictions on sourcing finance or other factors from abroad,
foreign investments etc. the economic liberalization is regarded as a first
step towards facilitating globalization.

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 • Facilities
The extent to which an enterprise can develop globally from home
country base depends on the facilities available like the infrastructural
facilities.
• Government support
Government support may take the form of policy and procedural reforms,
development of common facilities like infrastructural facilities, R & D
support, financial market reforms and so on.
• Resources
Resourceful companies may find it easier to thrust ahead in the global market.
Resources include finance, technology, R & D capabilities, managerial
expertise, company and brand image, human resource etc.
• Competitiveness
A firm derives competitive advantage from any one or more of the
factors such as low costs and price, product quality, product
differentiation, technological superiority, after sales services, marketing
strength etc.
• Orientation
A global orientation on the part of the business firms and suitable globalization
strategies are essential for globalization.

GLOBALISATION IMPACT ON INDIAN ECONOMY

In India, the process of dismantling trade barriers was started in 1991 and
subsequently, every year the Government has been announcing reduction in
custom duties and removing quantitative restrictions. It is argued that this shall
enable free flow of goods, capital and technology and thus globalization
becomes a motivating force for nations to develop themselves at a faster rate.

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For a developing country like India, it opens access to new markets and new
technology. Thus, the import-substitution strategy has been replaced by export-
led growth during the last decade in India. The recent developments in
information and communications technology have further facilitated and
accelerated the pace of globalization. International financial markets, trans-
border production networks and acceleration in capital flows across national
frontiers have been the driving forces leading to greater global integration of the
economies.

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 : 122 :

PROFILE OF INDIAN ECONOMY IN 21st CENTURY

Objective – This lesson is intended to impart the knowledge about the profile of Indian
economy in 21st century. India is proving herself as a growing economy in new
millennium.

Structure
6.1 Introduction
6.2 Issues and priorities for India
6.3 The three sectors of Indian Economy
6.4 Vat
6.5 Summary
6.6 Questions for Discussions
6.7 References
 : 123 :

6.1 INTRODUCTION
Economics experts and various studies conducted across the globe envisage
India and China to rule the world in the 21st century. For over a century the
United States has been the largest economy in the world but major
developments have taken place in the world economy since then, leading to the
shift of focus from the US and the rich countries of Europe to the two Asian
giants- India and China.

The rich countries of Europe have seen the greatest decline in global GDP share
by 4.9 percentage points, followed by the US and Japan with a decline of about 1
percentage points each. Within Asia, the rising share of China and India has
more than made up the declining global share of Japan since 1990. During the
seventies and the eighties, ASEAN countries and during the eighties South
Korea, along with China and India, contributed to the rising share of Asia in world
GDP.

According to some experts, the share of the US in world GDP is expected to fall
(from 21 per cent to 18 per cent) and that of India to rise (from 6 per cent to 11
per cent in 2025), and hence the latter will emerge as the third pole in the global
economy after the US and China.

By 2025 the Indian economy is projected to be about 60 per cent the size of the
US economy. The transformation into a tri-polar economy will be completed by
2035, with the Indian economy only a little smaller than the US economy but
larger than that of Western Europe. By 2035, India is likely to be a larger growth
driver than the six largest countries in the EU, though its impact will be a little
over half that of the US.

India is slated to become the third largest economy with a share of 14.3 per cent
 : 124 :

of global economy by 2015 and gradually become the "third pole" and growth
driver by 2035.
India, which is now the fourth largest economy in terms of purchasing power
parity, will overtake Japan and become third major economic power within 10
years.

6.2 ISSUES AND PRIORTIES FOR INDIA

As India prepares for becoming an economic superpower, it must expedite socio-
economic reforms and take steps for overcoming institutional and infrastructure
bottlenecks inherent in the system. Availability of both physical and social
infrastructure is central to sustainable economic growth.

Since independence Indian economy has thrived hard for improving its pace of
development. Notably in the past few years the cities in India have undergone
tremendous infrastructure up gradation but the situation is not similar in most part
of rural India. Similarly in the realm of health and education and other human
development indicators India's performance has been far from satisfactory,
showing a wide range of regional inequalities with urban areas getting most of
the benefits. In order to attain the status that currently only a few countries in the
world enjoy and to provide a more egalitarian society to its mounting population,
appropriate measures need to be taken. Currently Indian economy is facing
these challenges:

• Sustaining the growth momentum and achieving an annual average

growth of 7-8 % in the next five years.

• Simplifying procedures and relaxing entry barriers for business

activities.
 : 125 :

• Boosting agricultural growth through diversification and development of

agro processing.
• Expanding industry fast, by at least 10% per year to integrate not only
the surplus labour in agriculture but also the unprecedented number of
women and teenagers joining the labour force every year.
• Developing world-class infrastructure for sustaining growth in all the
sectors of the economy.
• Allowing foreign investment in more areas
• Effecting fiscal consolidation and eliminating the revenue deficit
through revenue enhancement and expenditure management.
• Empowering the population through universal education and health care.

Fig(6.1) India - a growing economy

A growth rate of above 8% was achieved by the Indian economy during the year
 : 126 :

2003-04 and in the advanced estimates for 2004-05, Indian economy has been
predicted to grow at a level of 7 %. Growth in the Indian economy has steadily
increased since 1979, averaging 5.7% per year in the 23-year growth record.
(However in comparison to many East Asian economies, having growth rates
above 7%, the Indian growth experience lags behind.) Many factors are behind
this robust performance of the Indian economy in 2004-05. High growth rates in
Industry & service sector and a positive world economic environment provided a
backdrop conducive to the Indian economy. Another positive feature was that the
growth was accompanied by continued maintenance of relative stability of prices.
However, agriculture fell sharply from its 2003-04 level of 9 % to 1.1% in the year
2004-2005 primarily because of a bad monsoon. Thus, there is a paramount
need to move Indian agriculture beyond its centuries old dependency on
monsoon. This can be achieved by bringing more area under irrigation and by
better water management.

Because of the continuos weakening of the US dollar for the last two years,
(caused mainly by widening US deficits), Indian Rupee has steadily appreciated
vis-à-vis US dollar. Though, this trend saw a brief reversal during may-august
2004. The latest Re/$ Exchange rate (March 2005) stood close to 44. Despite
strengthening nominally against US $, Rupee depreciated against other major
non-dollar currencies. Thus, the Real Effective Exchange rate of the Rupee
depreciated and this trend continued until end 2004. This resulted into Indian
export being cheaper and more competitive.

A strong Balance of Payment (BOP) position in recent years has resulted in a

steady accumulation of foreign exchange reserves. The level of foreign exchange
reserves crossed the US $100 billion mark on Dec 19, 2003 and was $142.13
billion on March 18, 2005. The capital inflows, current account surplus and the
valuation gains arising from appreciation of the major non-US dollar global
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currencies against US dollar contributed to such a rise in Forex reserves.

The current account of BOP having been in surplus since 2001-02, turned into
deficit in the first half of the current year( April-September 2004-05). Growth
momentum in exports was maintained; India's exports during Apr-Nov registered
a growth of 24% from the last period but India's position was down from 30th to
31st rank in the top exporting countries of the world.

The main contributors to capital account surplus were the banking capital inflows,
foreign institutional investments and other capital inflows. Alike current account,
capital account too witnessed decline. The capital account surplus in April-
September was also down by around US $ 1.5 million.

The downward trend in interest rates continued in 2004-05, with bank rate
standing at 6% as on Dec 10, 2004. Banks recovery management improved
considerably with gross NPAs declining from Rs 70861 crore in 2001-02 to Rs
68715 in 2002-03. During the current financial year (up to December 10, 2004)
incremental gross bank credit increased by 20.5 per cent (exclusive of
conversion, 16.6 per cent) as compared with a growth of 5.9 per cent in the same
period of the previous year. Non-Food credit during the financial year so far,
registered a growth of 20.5 per cent (exclusive of conversion, 16.5 per cent) as
compared with an increase of 8.4 per cent during the same period of the last year
indicated a positive outlook. Equity market return was 85% in 2003-04, second
highest in Asia. With continued higher corporate earnings in 2004-05, the sensex
crossed 6800 mark in March 2005 but high stock market volatility remained
higher in India compared to other Asian countries. The expectation of sensex
crossing 7000 mark is not yet realized. Fiscal deficit of states & center was
decreasing in early 90s but due to rise in fiscal deficit in recent years, corrective
measures have been adopted. The fiscal deficit decreased to 7.9% in 2004-05
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from a 9.4% of GDP in 2003-04. According to recent estimates, fiscal deficit in

April-October 2004 is 45.2 per cent of BE compared with 56.0 per cent of BE in
the corresponding period last year. This was the broad picture of Indian
economy; however it is imperative to look at the sectoral performance for a better
grasping of the Indian economy.

6.3 THE THREE SECTORS OF INDIAN ECONOMY

6.3.1 Agriculture
More than 58% of country's population depends on agriculture, a sector
producing only 22% of GDP. The agriculture and allied sector witnessed a growth
of 9.1% in 2003-04, which fell steeply to 1.1% in the fiscal year 2004-05.
Favourable monsoon facilitated an impressive growth rate of 9.6% in 2003-04 on
the back of negative growth in the preceding year. However, deficient rainfall
from the southwest monsoon is primarily responsible for the significant fall in
kharif crops production in the current year.

While looking at some of the agricultural products, one finds that India is the
largest producer of Tea, jute and jute like fibre. India is not only the largest
producer but also largest consumer of tea in the world. India accounts for around
14% of the world trade in tea. Indian tea is exported in various forms such as
bulk tea, packet tea, tea bags, instant tea etc, to more than 80 countries of the
world. Among livestock cattle and buffalo are found maximum in India. Indian
total milk production is highest in the world. India has also the privilege of having
the 1st rank in total irrigated land in area terms in the world. Among cereals
production, India is placed third, having second largest production in wheat and
rice and the largest production in pulses. However, the full potential of Indian
agriculture as a profitable activity hasn't been realized yet. Agriculture upliftment
will not only benefit farmers and a large section of the rural poor, but also will
give fillip to overall growth of the economy through the backward and forward
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linkages of agriculture with the rest of the economy.

Priority must be given to livestock's & fisheries, horticulture, organic farming,

commercial crops and agro-processing, as these are the potential areas of high
growth. Further, rationalization of minimum support price regime and introduction
of other risk- mitigation measures, improvements in rural infrastructure are
essential for sustaining high agricultural growth. It is conceived that reforms in
legislations, strengthening R&D and improvements in post harvest management
technologies will give a required boost to Indian agriculture. While acceleration in
agriculture growth to 4 - 4.5% is imperative, even with such growth rate; share of
agriculture in total GDP is likely to reduce further. Therefore, there is a need to
absorb excess agricultural labour in other sectors, notably industry and service
sector. Rapid growth of agro - processing industry close to the agricultural
production centers can bring about this shift without moving people from rural to
urban areas. Also, public investment in agriculture needs to be augmented,
especially in rural infrastructure, irrigation, and agricultural research &
development. Better access to institutional credit for more farmers, is also high
on priority list. The New trade policy gives focus to agriculture and all the hurdles
in Indian agriculture will be crossed gradually.

6.3.2 Industry
Index of industrial production which measures the overall industrial growth rate
was 10.1% in October 2004 as compared to 6.2% in October 2003. The double
digit growth in Industrial Production was aided by a robust growth of 11.3% in the
manufacturing sector followed by mining and quarrying and electricity generation.
But industrial production saw a decline in Dec 2004 when IIP dipped to 8 %.
Thus one of the critical challenges facing Indian economic policy consists in
devising strategies for sustained industrial growth. Final phase-out of the MFA
and India's conformity with the international intellectual property system from Jan
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1st Jan 2005, have been two significant developments in the world of commerce
& industry.

Textile industry is the largest industry in terms of employment. From the current
US $37 billion to $ 85 billion by 2010 creation of 12 million new jobs in the textile
sector and modernization & consolidation for creating a globally competitive
textile industry. With the phasing out of quota regime under MFA, from Jan 1st
2005, developing countries including India with both textile & clothing capacity
may be able to prosper. Automobile sector has demonstrated the inherent
strengths of Indian labour and capital. The pharma industry and the IT industry
are two sunrise sectors for India. Among the sectors that have experienced the
greatest transformation in India, the pharmaceutical is perhaps the most
significant.

India's WTO involvement during the last decade has encouraged our pharma
companies to adopt a strategy of R & D based innovative growth. Indian pharma
exports were 14000 crore Rupees & accounts for more than a third of the
industry's turnover. Apart from manufacture of drugs, the pharma industry offers
huge potential for outsourcing of clinical research. A vast pool of scientific and
technical personnel & recognized expertise in medical treatment & health care
are India's strength, India can take advantages of its strength once patent
protection is given to the result of the researches. By participating in the
international system of intellectual property protection, India unlocks for herself
vast opportunities in both exports as well as her potential to become a global hub
in the area of R & D based clinical research outsourcing, particularly in the area
of bio-technology.

The three main sub sectors of industry viz. mining & quarrying, manufacturing,
and electricity, gas & water supply recorded growths of 5%, 8.8% and 7.1%
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respectively. Apart from infrastructure, particularly adequate and reliable power

supply at reasonable cost and transportation facilities, there is need for stepped
up investment in manufacturing. Industry needs to grow rapidly not only to boost
the overall growth rate in the economy but also to generate gainful employment
for the existing unemployed, as well as the new entrants. In a diverse range of
industrial activities, several Indian firms have succeeded in getting integrated into
global production chains and realized rapid growth of exports. This experience
suggests that with appropriate scale, investment and technology, rapid industrial
growth is indeed possible.

6.3.3 Services
Service sector has maintained a steady growth pattern since 96-97, except into a
fall in 2000-01. Trade hotels, transport & communications have witnessed the
highest growth of level 10.9% in 2004, followed by financial services (With a
overall growth rate of (6.4) % and community, social & personal services (5.9)%
of all the three sectors, services have been the highest contributor to total GDP
growth rate.

While in most parts of the developed world, the services sector's share of
employment rose faster than its share of output in India there has been a
relatively slow growth of jobs in the service sector. This is primarily because of
the rise in labour productivity in services in sectors such as information
technology that is dependent on skilled labour. Growth in tourism and tourism -
related services such as hotels, holds a large potential for employment
generation.

IT enabled services, such as Business Process Outsourcing have been growing

rapidly in the recent past and will continue to rise. However, the skill
requirements for such services are of a specialized nature and the emergence of
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somewhat inexplicable protectionist tendencies in some developed countries is a

disturbing trend. However, it is important that India sees BPO in a larger
perspective, than the Internet, as India's share is just $ 3.5 billion in December
2004 compared to the global market of US $ 178 billion. Also India outsourcing
companies need to work more closely with their customers. In the complex
BPOs, customers would like to have hybrid processes to control value. Indian
companies need the right mix of domain expertise and process expertise, further,
mere knowledge of English is not sufficient; management skills are also needed.
Education for the offshoring industry needs to be given impetus too.

6.4 VAT
Value-Added Tax, one of the most radical reforms to be proposed for the Indian
economy, could finally become a reality after four years of political and economic
debate. So far 21 States have given their nod for the April 1 2005 deadline for
switching over to VAT. The decision to introduce VAT was publicly discussed first
at a conference of state chief ministers and finance ministers in November 1999.
At that time, the deadline of April 2002 was agreed upon to bring in VAT but it
couldn't be implemented due to political instability and a lack of initiatives. Now,
despite a backlash from the trading community and some political circles, there
appears to be a realistic scope for VAT to be introduced. VAT is value added a
sales tax collected by the government (of the state in which the final consumer is
located) - which is the government of destination state on consumer expenditure.
Over 120 countries worldwide have introduced VAT over the past three decades
and India is amongst the last few to introduce it. India already has a system of
sales tax collection wherein the tax is collected at one point (first/last) from the
transactions involving the sale of goods. VAT would, however, be collected in
stages (installments) from one stage to another. The mechanism of VAT is such
that, for goods that are imported and consumed in a particular state, the first
seller pays the first point tax, and the next seller pays tax only on the value-
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addition done - leading to a total tax burden exactly equal to the last point tax.

VAT is necessary, as it will close avenues for traders and businessmen to evade
paying taxes. They will also be compelled to keep proper records of their sales
and purchases. Many sections hold the view that the trading community has
been amongst the biggest offenders when it comes to evading taxes. Under the
VAT system, no exemptions will be given and a tax will be levied at each stage of
manufacture of a product. At each stage of value-addition, the tax levied on the
inputs can be claimed back from the tax authorities. At a macro level, there are
two issues, which make the introduction of VAT critical for India. First, Industry
watchers say that the VAT system, if enforced properly, forms part of the fiscal
consolidation strategy for the country. It could, in fact, help address the fiscal
deficit problem and the revenues estimated to be collected could actually mean
lowering of the fiscal deficit burden for the government. Second, any globally
accepted tax administrative system will only help India integrate better in the
World Trade Organization regime.

Hearing from caption of industry would give us a comprehensive picture of Indian

economy as they are the people who are directly involved in evolution of current
state of Indian economy.
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An Indian renaissance

India’s top CEOS discuss the rewards of restructuring, both for the country and for
companies

Mukesh Ambani

There is new found confidence in India. Indian information technology prowess has already become a legend. Other
areas of technology, such as biotechnology and nanotechnology, are taking roots in India. We are beginning to see
resurgence in science. Research-led companies of global reach are turning to our country to create science facilities
here. India is emerging as a global manufacturing hub.

India has already made a mark in business process outsourcing. The width, depth and geographical reach of such
services are expanding. Indian businesses are aspiring to be world-class players. Several industries, like steel,
automobiles, pharmaceuticals, textiles and media, are beginning to imprint their footprints overseas.

An Indian renaissance is, therefore, no longer a dream. But in a world of globalization and intense competition,
India has to go beyond the feel-good factor and the sense of newfound confidence to attain global leadership. This
will call for concerted efforts by Indian business leadership to scout for global opportunities, seed nodes for
innovation and build brand India. Business leadership will have to be obsessed with a passion for fostering global
initiatives and attaining global leadership.

At the strategic level, Indian business will have to go beyond business process outsourcing to attaining global
leadership in services; go beyond outsourced manufacturing to creating global brands; and go beyond contract
research to creating new vistas of knowledge.

This cannot come about unless India invests heavily in science and technology education. This is because
technology is driving economic growth and development in the New World and research-led higher education in
science and technology is the crucible for ideation and innovation.

Indian institutions must also be geared to nurture innovation as it leads to greater productivity, higher economic
growth and better standards of living. This can come about with sizeable public funding for research, surpluses from
traditional businesses of large corporations channeled to research-led initiatives, protection for intellectual capital,
vibrant venture capital participation, a competitive market place and a demanding environment for academic
researchers.

Global leadership for India also means that India must access markets for goods, services and professional resources
in other parts of the world. The developed world is gripped by the paranoia of protectionism. Non-trade barriers are
emerging in the form of quantitative restrictions and phytosanitary requirements.
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Subsidy for farmers in US and Europe is already a volatile issue. In this milieu, the Indian political and economic
leadership must skillfully promote the interests of Indian trade in global conclaves. This would call for several
bilateral and multilateral trade agreements to be put in place. Side by side, there is an urgent need to foster an
efficient infrastructure within the country to support global trade. Efforts made by the government in roads need to
be extended to ports, electricity, civil aviation and telecommunications. India must also have many more free trade
zones.

India today has an once-in-a-lifetime opportunity to forge a new destiny of global leadership and transform the lives
of over a billion of her people. With an eye on education, innovation, competition and market access and a vision
that goes beyond business process outsourcing, contract manufacturing and contract research to building brands,
technology and owning the global customer, India can make the grade.

The feel-good factor will stay

Kumar Mangalam Birla

India is back in currency. As the nation stands on the cusp of explosive growth, I believe the feel good factor is here
to stay. The year 2003 has been remarkable on practically all fronts, signaling a tremendous resurgence in the
economy. We have had a good monsoon. The faith and confidence of foreign investors in our country’s economic
prospects have been amply demonstrated with their putting in a record $7 billion during this year.

Today, foreign exchange reserves in excess of $100 billion are at an all- time high and secure us against any adverse
external shock. In turn, this has prompted rating agencies to revise their outlook on India. Quarterly profits of
corporations are soaring, helped by low interest rates, increasing demand for their products and improved
productivity.

Overseas jobs are moving to India as the outsourcing wave gains momentum. Fifty per cent of Fortune 500
companies have taken this route. Interestingly, 100 of the Fortune 500 companies have set up R&D centres in India,
and General Electric’s R&D centre here is its second largest with over a 1000 PhDs.

As India outperformed the global economy in 2003 by a considerable margin, the whole world became alive to our
country’s potential. Stock markets are booming and currently represent wealth close to 55 per cent of our GDP.

The underlying trends in the economic fundamentals point to a performance that will be sustained well into the
future. India’s cost advantage and availability of a pool of skilled labour are proving to be sources of competitive
strength. Our brain power has reshaped corporate America and continues to march on. One-third of NASA scientists
are Indians and there are over 5,000 Indo-American professors in American colleges. At Harvard itself, I believe, 10
per cent of the faculty comprises Indian intellectuals.

In today’s world, globalization is not an option but an imperative. Indeed the only option is how to harness the
forces of globalization to one’s advantage. Companies will locate where the costs are the lowest, and will service
those markets where the returns are the highest. Therefore, it should come as no surprise that global auto companies
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are increasingly sourcing their components,

and even designs from India. Many other sectors are following this trajectory. And this will further fuel our growth.

Earlier, India’s traditional strength in services could not be exported, as services were seen as a non-tradable sector.
Today, the scenario is different. Our techno takeoff has been and continues to be spectacular. Additionally, with
growth in the telecommunications infrastructure, the skills even of a radiologist, a secretary, a financial analyst or a
computer programmer have all become exportable.

High quality customer services can now be delivered over a telephone link, one end of which could be in Bangalore
or Hyderabad. And this is causing the great exodus of jobs from high cost countries to India. The relative youth of
India’s labour force is another vantage point. The need to harness these favourable demographics to its maximum
potential is well recognized today. It will also be the mainstay of India’s pension reforms.

Finally, we can all bet on India’s prosperity. With an expected 7 per cent to 8 per cent GDP growth and inflation
under control at 4 per cent to 5 per cent, the scene at the macro level is indeed encouraging. Oil prices seem stable
too and there is hardly any likelihood of pressures from other quarters. One hope that the rain gods will continue to
be benevolent and no untoward global incidence occurs, in which case, we can all keep smiling.

Focus on infrastructure

Anand Mahindra

Corporate India has built a culture of cost cutting which has trimmed the flab and set our basics right. Many of us
have also achieved global milestones in terms of quality. But cost cutting is only a first step - what will now take us
forward is cost leadership. Cost cutting is only a small part of this. Leveraging cost leadership and delivering global
quality are the factors that will drive our future growth. I think Indian companies are well aware of this, and we are
already beginning to see the emergence of Indian multinationals.

Over the next few years up to the year 2010, as a nation we would have to focus on infrastructure, which has a
multiplier effect on the economy, on agriculture, where we need to set our house in order, and focus on human
development and improving the quality of life. Within our own group, growth will come from a combination of
market leadership, innovative strategies, a quest for globalization and a ruthless focus on financial returns.

There are numerous areas where we need to pull up our socks. Although there has been a marginal improvement on
the fiscal front, greater efforts are needed to discipline the burgeoning fiscal deficit. The unprecedented deterioration
in the rate of public sector saving is a matter of concern. We need a faster reform process, especially in the areas of
agricultural and fiscal reform.

We must also address the larger problems of civil society. We still need to overcome problems relating to
corruption, economic scandals and good governance. Above all we must create an all-encompassing vision of the
India that we want. To do this, there has to be a mechanism for dialogue between all stakeholders, so that we all
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work in our respective fields towards the same vision of a better, more affluent and more inclusive India.

The Confederation of Indian Industry has been maintaining that 8 per cent sustainable growth is eminently feasible.
With a stable external sector, a growth-oriented financial regime and a rejuvenated corporate sector, the final growth
rate of 7 per cent for 2003-2004 appears well within our reach. In fact, we should be ambitious for more.

Creating a brand image.

A M Naik

After more than four years of recession, the Indian economy is recovering and is poised on the growth path. No
doubt the WTO regulations have made inroads into the country’s trade policies, but they have also been nudging
India to integrate with global economies. This has led to a mix of opportunities and challenges for Indian
corporations.

While the service sector is set to boom, manufacturing organizations have to rethink their business models to survive
and grow. The controlled economy regime forced Indian industries to invest in uneconomic volumes as well as
expand outside their core areas. This legacy has come to haunt industry in the changed scenario. Therefore,
restructuring to build upon the economies of scale in core areas and a capable human resource pool will be the key
challenges for the survival and growth of Indian manufacturing.

The development of a strong and vibrant capital goods sector is a must for the growth of Indian industry. Since
1992, this sector has been rightly thrown open to international competition through a substantial reduction in duties
as well as removal of trade barriers. At the same time, the sector continues to wallow in high costs. To sustain the
manufacturing sector’s growth, the government needs to expedite second generation reforms on labour issues,
remove infrastructure bottlenecks and leverage India’s strengths to promote the export of manufactured goods.

While the business environment has opened Indian industry to competition, the current situation has also made us
realize the need to become international players. To manage the demand fluctuations in the domestic economy, L&T
proactively embarked on the path of becoming an Indian multinational as an EPC (engineering, procurement &
construction) organization.

To cope with these challenges, L&T is restructuring itself by hiving off unrelated businesses, reducing its interest
burden by proactive treasury management and adopting the latest HR practices. L&T plans to generate 40 per cent
of its revenues from international sales by 2007-2008.

The development of a global management pool, management of international business risk and creation of a
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sustainable India brand image will be the key challenges for Indian corporations in the years ahead.

Looking to the future

Harsh Goenka.

Only a few years back, many started writing epitaphs for the Indian manufacturing sector and most believed them.
The old economy companies were the prime targets. They heard the wake up call. Most realized that with
globalization and competition, they had to act and now. They began to attack costs both in manufacturing and in
supply chain management.

With a majority of the sectors surpassing their own standards, the turnaround that companies were waiting for
finally became a reality. They consolidated their positions in the global arena too, an indicator being the ever
increasing export figures witnessed in the pharmaceuticals, auto and IT industries. The second post-reforms growth
is clearly visible now. This is the first time in a decade that the stock market has witnessed a broad-based rally and
stock markets now play an important role in India’s economic growth.

The story at RPG has been fairly representative of this sequence of events. A large diversified group like RPG had
its fair share of challenges – a large workforce, the high cost of debt, very small and very large businesses and many
associated issues. The situation could have been worse, if not for a major restructuring exercise initiated in 1993.

The group was then reorganized along core lines of business, processes were changed and fresh talent was infused
into management. Restructuring, at RPG and outside, however, is an ongoing exercise . We may feel we are now
somewhere close to completion. But in a dynamic environment, it never is really finished.

The last four years were indeed amongst the most challenging for the group. The key constituents of the group like
power, transmission and tyres were facing a lot of challenges. We looked at three or four major areas of cost –
manpower, interest, supply chain and process efficiencies. One of the biggest problems in power, high transmission
and distribution losses, were dramatically reduced.

Looking to the future of Indian industry, the silver lining is clearly visible and signs of growth are evident. The
evidence will ultimately rest on how the political framework lives up to the demands of a growing economy.

The commitment to the reform process has to be aided by a unified approach amongst all political parties when it
comes to specifics. Indian industry has gained immense confidence on a global platform and as a nation we have
earned a great deal of respectability. If we make a breakthrough in the way we manage and administer our nation I
am sure we will see India shining for many years.

6.5 SUMMARY
India is in process to become an economic superpower. Since independence India has thrived
hard for improving the pace of development. Indian economy has achieved a GDP growth rate of
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above 6% during the last 4-5years. Growth in Indian economy has steadily increased since 1979,
averaging 5.7% per year in the 23 year growth record. All the three sector namely, Agriculture,
Industries, and service sector has contributed towards this growth . VAT proposed itself as a one
of the most radical reforms for Indian economy.

6.6 Questions for Discussion

1. What are the various issues and priorities for India in new millennium?
2. “India prepares herself for becoming an economic superpower,” discuss the statement
with strong facts.
3. Discuss in detail the growth of three sector of Indian economy.
4. What do you mean by VAT? Also discuss the pros and cons of VAT.

6.7 References
1. www.naukri.com
2. www.onlypunjab.com
3. www.economicwatch.com
4. www.microscan.com
5. www.business-standard.com
6. Singh, Charan, Financial Sector Reforms and State of Indian Economy, Indian Journal
of Economic and Business, Vol. 3, No. 2, (2004), pp 215-239.
7. Jain T.R.Jain and SenVir, “ Micro Economics and Indian Economy ”, V.K publications.
8. Kumar Raj, Gupta Kuldeep, Singh Surat and Kumar Pradeep, “ Development Economics”,
Deepak Publication.