Economics
As with any other country, the global economic crisis had a strong impact on the Indian economy. The global money supply squeezed which also had an impact on the Indian economy. The decline in aggregate demand in the international markets led to decline in demand for Indian exports which ultimately led to slow growth of GDP. Shortage of credit also led to crunch in the Equity and Debt markets of India making it difficult for businesses to fund their expansions and new businesses. The problems were compounded by the inflation rates fuelled by Oil and Commodity prices across the world.
The Indian economy registered a growth of 7.9 percent in the second quarter of the fiscal year 2009-10. This growth can be attributed to the strong recovery of the industrial sector which recorded an increase of 7.6 . The service sector showed a growth of 12 which was largely due to growth in the community, social and personal services. India, being an Emerging market economy, has shown a strong recovery based on the domestic demand and recovery of exports. India is one of those countries which has shown strong domestic demand.
The tax collection done by the Central Government has increased by 8.5. Even though companies have shown a slump in sales, but the profitability in general has improved over the last two quarters which has also led to recovery in stock prices and the increase in tax collections.
Macroeconomic Policy
The fiscal policy was a challenge for the government since the government had to come up with fiscal and monetary policy to mitigate the commodity and fuel prices and the global financial crisis. During the first half of the previous year, the focus was more on curbing inflation which had touched the levels of 12.9 in August 2008. To tackle this, the Indian government decided to come with fiscal measures on tax revenue and expense areas to help sort out the supply side issues. To complement them, the Reserve Bank of India enacted policy rate changes as part of the monetary initiative. This led to a decrease in inflation to a level of 5 in January, 2009. Even though the fiscal expenditures, which included tax concessions, subsidies and salary bills, proved successful, it worsened the budget deficit for the government (Indian Ministry of Finance, 2009).
In the second half of the previous year, the focus of the government shifted to tackling the financial crisis in order to encourage growth which had started to suffer. The effect of the recession was evident in the tax receipts which were lower than the previous fiscal year. To stimulate growth, a package worth 243 billion consisting of subsidies, pay commissions and debt waivers were introduced. This further widened the fiscal deficit to 6.2 percent in comparison to a manageable 2.5 percent of the GDP in the previous fiscal year (Sloman, 2003).
Even though the country cannot be entirely blamed for its economic situation, since the impact of the financial crisis and the recession has been global, the government cannot sit and wait for things to get better.
To handle the situation, the government had two options. The first one was to cut down its expenditures and keep the budget deficit under control. However, this would have resulted in a negative effect on the growth due to lack of investments and hence making the revival of the economy even more difficulty. Another option was to increase public expenditure to stimulate demand and to generate future revenue streams. Needless to say, the government opted for the second alternative. The decisions were supported by the idea of providing a safety net to the lower economic classes and encourage growth in the other sectors of the economy.
Inflation has become a concern for the Indian government in the current fiscal year. Last year, the inflation was largely due to global factors. But this year, inflation has been largely limited to food and been helped by monsoons effect on kharif crops (Reserve Bank of India, 2010). The combination of growth and inflation in India is very different from what it is seen in other G-20 countries. Several other countries have shown slight recovery without any inflation concerns, while others have bounced back strongly with manageable levels of inflation. However, in Indias case, the growth has been coupled with high inflation rates. Since the inflation is fuelled by the increase in food prices, it is a huge challenge for the Indian Central bank to come up with a solution to tackle inflation without compromising on the high growth rates. The Indian Central Bank and the government was hoping that the economic slowdown and decrease in aggregate demand would slow down inflation but that did not happen. A deceleration in aggregate demand was seen in the first quarter of the fiscal year 2009-10 but the economy bounced back to post a growth in the aggregate demand figures again in the second quarter of 2009-10. Other indicators also show that the country has started to rebound from the global financial crisis and is on the road to recovery. In the Industrial Outlook survey conducted by the Reserve Bank of India has also shown a positive turnaround in the business sentiments of the economy (Reserve Bank of India, 2009).
If we look at the inflationary expectations, we see that inflation can be expected to increase in the future while there are other factors which can lead to it subsiding. The reasons due to which we can see an increase include a high base effect, the momentum being carried forward from the past fiscal year putting pressure on the increase, and increase in commodity and fuel prices due to increase in aggregate demand. Reasons which could lead to a decrease in inflationary pressures include the lengthening of global recession leading to a decrease in commodity prices, unaffected agricultural growth due to monsoon and the return of the monetary stance to the normal levels.
The IMF has revised its growth projections for the Indian economy from 4.5 to 5.4 for the fiscal year 2009-10. The country is expected to return to its full growth potential in the next fiscal year. Although uncertainties still exist due to several negative possibilities, but the economists are optimistic about Indian economys resilience.
In the second quarter of the fiscal year 2009, the Reserve Bank of India decided to increase the Cash Reserve Requirement (CRR) by 75 basis points while maintaining the repo and reverse repo rates. The objective of this move was to reduce the excessive liquidity in order to curb inflation while simultaneously avoid adverse effects on recovery process. The reserve bank also plans to keep an eye on the future inflation trends and adjust the monetary policy accordingly. At the same time, it is important that the economic growth does not slow down by meeting the credit demands of the productive sectors. Hence, it can be said that the policy makers intend to maintain price and financial stability.
Under the fiscal side, the capital has started to flow and the stock markets have shown significant recovery. Even though the government borrowing from the Central bank has been considerably high, the government and the central bank feels that there is no concern for crowding out taking place for the private sector. The reserve bank states that the 80 of the budget deficit needs of the Indian government have already been met by the financial sector therefore the government demand for money is not a concern for the future.
To handle the problem of budget deficit, economists suggest that either the government can curb its spending, or it can hope that spending stimulates economic activity which leads to economic growth and hence higher tax returns. Another option for the government is to sell capital assets to fund spending, although it is not advised. The best solution for the Indian economy is to invest in development expenditure from where revenue streams can be generated for the future. But it should be made sure that the spending is done wisely and transparently by minimizing corruptions and leakages (Rajadhyaksha, 2010).
In the current fiscal year, the effect of this policy can be seen by the fact that the expenditures increased but the revenues for the government fell. However, the national GDP growth rate registered a steady increase over the next two quarters, showing that the decisions made were right. The government will continue its policy to continue stimulating growth in the recession hit world economy and continue to make expenditure. However, in the medium term, measures for fiscal consolidations will be required to make up for the budget deficit and to bring the fiscal numbers on track.
The tax policy being followed by the Indian government is to increase the tax to GDP ratio and simultaneously gain fiscal consolidation. The ratio has shown an increase of 3 percent over the past five years by improvement in the tax structure, widening of tax base and reduction in costs.
The introduction of IT systems and business process reengineering has also played its role in it.
Despite encouraging signs in the past, the consolidation process had slowed down due to slowing down of the global and domestic economy. Therefore, policy changes were required to maintain the level of growth to prepare for worse times in the future.
Conclusion
By analyzing the macroeconomic policy undertaken by the Indian Central Bank and the government in the last one year, we can say that the country has been successful in keeping the effects of global financial crisis under control and has been able to come back towards positive growth again. Other developing countries can learn from the Indian strategy carrying out the balancing act of sustainable growth and moderate inflation rates. However, there is still a long way to go for the Indian economy and still needs to address several issues such as growing food and fuel inflation and the increasing budget deficit which has to be controlled in the near future.