6. Economics Notes 03

Based on the provided summary, here are the detailed academic notes in the requested format.

Elaborate Notes

India’s Growth Model vs. Chinese Growth Model

• Historical Context of India’s Model: Post-independence in 1947, India, under the influence of Fabian socialism and the Soviet model, adopted an inward-looking economic strategy known as Import Substitution Industrialization (ISI). The primary objective, as outlined in the Five-Year Plans (starting 1951), was to achieve self-sufficiency. This led to a focus on producing consumer goods domestically to reduce reliance on imports. However, for industrialization, India had to import heavy machinery and technology, i.e., capital goods. This created a structural pattern where the domestic industry was dominated by consumer goods production. As the summary notes, even today, this tilt remains, with consumer goods forming a significant majority (approx. 71%) of industrial output compared to capital goods (approx. 29%). This model is characterized as consumption-led growth, where domestic demand is the primary engine of economic expansion.
• China’s Export-Led Model: China initiated its economic reforms in 1978 under Deng Xiaoping. Unlike India, China aggressively pursued an export-led growth strategy. It focused on becoming the “world’s factory” by leveraging its vast, cheap labor force. A key element of this strategy was capital formation—the massive accumulation of capital goods like machinery, equipment, and infrastructure. By prioritizing capital goods (approx. 45% of output vs. 55% consumer goods), China built the capacity to produce on a massive scale. This surplus production was then exported globally. China actively attracted Foreign Direct Investment (FDI) by creating Special Economic Zones (SEZs) like the one in Shenzhen, offering tax breaks and subsidized utilities to foreign firms.
• Make in India vs. Make for India: The “Make in India” initiative, launched in 2014, aims to transform India into a global manufacturing hub, focusing on exports, similar in ambition to the Chinese model. In contrast, former RBI Governor Raghuram Rajan proposed the “Make for India” concept. He argued that instead of solely focusing on exports for the world, India should leverage its large domestic market by producing customized, high-quality goods and services for its own population. This aligns more closely with strengthening the traditional consumption-led growth model.

Fundamentals of International Trade and Currency

• Liquidity (Asset & Currency): An asset is considered liquid if it can be converted into cash quickly without significant loss of value. Cash is the most liquid asset. A liquid currency is one that is widely accepted for international transactions and is stable, making it a reliable store of value. The US Dollar is the world’s foremost liquid and reserve currency. Other examples include the Euro, British Pound, and Japanese Yen. These currencies are part of the IMF’s Special Drawing Rights (SDR) basket, which signifies their global importance. India’s Rupee is not fully convertible on the capital account and is not a major international reserve currency, hence it is not considered a liquid currency in the global context.
• FOREX Reserves: Due to the non-liquid nature of the Rupee, India must maintain a reserve of foreign currencies to settle international transactions. This is the Foreign Exchange (FOREX) Reserve, managed by the Reserve Bank of India (RBI) under the RBI Act, 1934. These reserves are primarily accumulated through exports, FDI, Foreign Portfolio Investment (FPI), and remittances. They are used to pay for imports and service external debt. The reserves comprise Foreign Currency Assets (FCAs, mostly held in US dollars), Gold, SDRs, and the Reserve Tranche Position (RTP) with the IMF.
• Trade Deficit: This occurs when the monetary value of a country’s imports exceeds the value of its exports over a specific period (Imports > Exports). A persistent trade deficit leads to an outflow of foreign currency, which can deplete a country’s FOREX reserves. India has historically run a trade deficit, primarily due to large imports of crude oil, gold, and electronic goods.

Exchange Rate Dynamics

• Determination of Exchange Rate: In a floating exchange rate system, which India follows (managed float), the value of a currency is determined by the market forces of demand and supply in the FOREX market.
  • Demand for Dollars: Arises from Indian importers paying for goods, students paying fees abroad, tourists, and investors moving capital out of India.
  • Supply of Dollars: Comes from Indian exporters receiving payments, foreign investment (FDI/FPI) into India, and remittances from Indians abroad.
• Depreciation vs. Appreciation:
  • Depreciation: A fall in the value of one currency in relation to another due to market forces. For example, if the exchange rate moves from ₹70/$1to₹75/$1, the Rupee has depreciated. It takes more rupees to buy one dollar.
  • Appreciation: A rise in the value of one currency in relation to another. If the rate moves from ₹75/$1to₹70/$1, the Rupee has appreciated.
• Impact of Depreciation:
  • Exports become cheaper: An American importer who previously paid $1fora₹70productnowpaysonly$0.93 for the same product when the rate is ₹75/$1. This makes Indian exports more competitive.
  • Imports become costlier: An Indian importer paying $1 for a product now has to pay ₹75 instead of ₹70. This can lead to imported inflation.
• Devaluation: This is a deliberate downward adjustment of a country’s currency value by its government or central bank in a fixed exchange rate system. Depreciation is market-driven; devaluation is policy-driven. India devalued its currency in 1966 and again significantly in 1991 as a part of its economic reforms.
• Currency War: A situation where countries engage in competitive devaluation, deliberately weakening their currencies to boost their exports and gain a competitive advantage over other nations. This is often viewed as a “beggar-thy-neighbor” policy.
• Dutch Disease: An economic concept, first observed in the Netherlands after the discovery of large natural gas fields in the 1950s. It describes a phenomenon where a large inflow of foreign currency (e.g., from a natural resource boom or foreign aid) causes the domestic currency to appreciate significantly. This sharp appreciation makes the country’s manufactured exports non-competitive in world markets and harms the domestic manufacturing sector.

India’s Pre-1991 Economic History

• Post-Independence Socialist Path: India’s first Prime Minister, Jawaharlal Nehru, was influenced by socialist ideals. The Avadi Resolution of the Indian National Congress (1955) formally adopted the goal of establishing a “socialistic pattern of society.” This translated into state-led development, centralized planning (via the Planning Commission), and a dominant role for the public sector, as enshrined in the Industrial Policy Resolution of 1956. The aim was to promote social justice and prevent the concentration of wealth.
• Land Reforms: To address the inequitable land ownership patterns inherited from the British colonial era (Zamindari, Ryotwari, Mahalwari systems), India initiated land reforms. The key objectives were:
  1. Abolition of Intermediaries: Zamindari Abolition Acts were passed by states to eliminate the parasitic class of zamindars.
  2. Tenancy Reforms: To provide security of tenure to tenant farmers, regulate rent, and grant them ownership rights. ‘Operation Barga’ in West Bengal in the late 1970s is a noted example of successful tenancy reform.
  3. Land Ceilings: Imposing a limit on the amount of land an individual or family could own and redistributing the surplus to the landless.
  • Outcome: The success of land reforms was limited. While zamindari was abolished, tenancy reforms and land ceilings were largely unsuccessful due to legal loopholes, lack of political will, and resistance from landed elites. Success was more pronounced in states with strong political movements, like Kerala and West Bengal.
• Food Security and Green Revolution: Severe droughts in the mid-1960s and heavy dependence on food aid (like the PL-480 program from the USA) created a food security crisis.
  • This led to the establishment of the Food Corporation of India (FCI) in 1965 to manage procurement, storage, and distribution of food grains, and the creation of a buffer stock.
  • The First Green Revolution (late 1960s) was launched to achieve self-sufficiency. Spearheaded in India by M.S. Swaminathan and globally by Norman Borlaug, it involved the use of a package of inputs: High-Yielding Variety (HYV) seeds, chemical fertilizers, pesticides, and assured irrigation. It was highly successful in increasing wheat and rice production, particularly in Punjab, Haryana, and Western Uttar Pradesh.
• Bank Nationalization: To fund the Green Revolution and direct credit towards agriculture and other “priority sectors,” the government under Prime Minister Indira Gandhi nationalized the 14 largest commercial banks in 1969, followed by another 6 in 1980. The stated objective was to promote financial inclusion—extending banking services to all sections of society, especially the unbanked rural population.

Ways of Doing Business

• Debt vs. Equity: A business can raise capital in two primary ways:
  • Debt: Borrowing money that must be repaid with interest. The lender is a creditor, not an owner. Bonds are a common debt instrument. A bond is a formal contract where the issuer promises to repay the principal amount at a future date (maturity) and pay periodic interest (coupons).
  • Equity: Selling ownership stakes in the company. The investor becomes a shareholder and part-owner. This is done by issuing shares.
• Primary and Secondary Markets:
  • Primary Market: Where a company sells new stocks and bonds for the first time to raise capital. An Initial Public Offering (IPO) is when a company issues shares to the public for the very first time. A subsequent sale of shares by a listed company is a Follow-on Public Offer (FPO).
  • Secondary Market: Where existing securities are traded among investors (e.g., the Bombay Stock Exchange, National Stock Exchange). The company is not directly involved in these transactions.
• Venture Capitalist (VC): An investor who provides capital to startups and early-stage, high-risk, high-potential businesses in exchange for an equity stake.
• Crony Capitalism: A pejorative term describing an economic system where business success depends on the close, collusive relationship between business people and government officials. It can involve bribery, preferential allocation of licenses (e.g., 2G spectrum), government grants, or tax breaks, leading to a distortion of market competition and reduced economic efficiency.

The Path to the 1991 Economic Crisis

• Economic Stagnation (1970s-80s): The Indian economy faced numerous challenges. The “License Raj” (a complex system of licenses and regulations) stifled industrial growth. Public Sector Undertakings (PSUs) were often inefficient and loss-making. The high tax rates disincentivized compliance and investment.
• Macroeconomic Imbalances: The government consistently spent more than it earned, leading to a high fiscal deficit. This, combined with low productivity, fueled inflation. Both rural and urban demand was weak. Externally, the persistent trade deficit put continuous pressure on the FOREX reserves.
• The Trigger (1990-91): The situation culminated in a severe Balance of Payments (BoP) crisis. The Gulf War (1990-91) acted as the final blow. It caused a sharp rise in global oil prices, drastically increasing India’s import bill. Simultaneously, it led to a fall in remittances from Indian workers in the Gulf region.
• The Crisis: By 1991, India’s FOREX reserves had fallen to just $1.2 billion, barely enough to cover three weeks of imports, pushing the country to the brink of a sovereign default. This crisis was a watershed moment, compelling India to seek assistance from the IMF and World Bank and initiate the landmark Liberalization, Privatization, and Globalization (LPG) reforms.

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Prelims Pointers

• Capital Formation: Accumulation of capital goods (machinery, equipment, infrastructure) in a country.
• India’s Growth Model: Primarily Consumption-led.
• China’s Growth Model: Primarily Export-led.
• Make for India: Concept proposed by Raghuram Rajan, focusing on manufacturing for the domestic market.
• Liquid Currency: A globally accepted currency for trade (e.g., US Dollar, Euro, Yen, Pound).
• FOREX Reserves: Managed by the RBI. Components: Foreign Currency Assets (FCAs), Gold, SDRs, Reserve Tranche Position (RTP).
• Trade Deficit: Value of Imports > Value of Exports.
• Depreciation: Fall in a currency’s value due to market forces (demand and supply).
• Devaluation: Deliberate reduction in a currency’s value by the government/central bank in a fixed exchange rate system.
• Effect of Rupee Depreciation: Makes exports cheaper and imports costlier.
• Dutch Disease: A phenomenon where a large inflow of foreign currency leads to currency appreciation, harming the manufacturing sector’s export competitiveness.
• Currency War: A situation of competitive devaluation among countries to boost exports.
• Food Corporation of India (FCI): Established in 1965 to manage food grain procurement and distribution.
• First Green Revolution: Associated with Norman Borlaug (global) and M.S. Swaminathan (India). Focused on HYV seeds, fertilizers, and irrigation.
• Bank Nationalization in India:
  1. 1969: 14 major commercial banks were nationalized.
  2. 1980: 6 more banks were nationalized.
• Bond: A debt instrument used to raise capital. The interest paid on a bond is called a ‘coupon’.
• Initial Public Offering (IPO): The first time a company sells its shares to the public. It occurs in the Primary Market.
• Crony Capitalism: A nexus between business houses and government officials that distorts fair competition.
• 1991 Economic Crisis: A severe Balance of Payments (BoP) crisis, triggered partly by the Gulf War (1990-91).

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Mains Insights

1. A Comparative Analysis of Indian and Chinese Growth Models

• Sustainability and Resilience: India’s consumption-led growth model is often considered more internally resilient and less susceptible to global economic shocks, such as the 2008 financial crisis. However, its pace of growth and job creation has been slower. China’s export-led model delivered unprecedented growth and poverty reduction but made its economy highly dependent on global demand. This has prompted China to now focus on a “dual circulation” strategy to boost its own domestic consumption.
• Policy Implications for India: The debate between “Make in India” (export-oriented) and “Make for India” (domestic-oriented) is central to India’s future economic strategy. A balanced approach is needed. While leveraging the large domestic market is crucial, integrating into global value chains through an export focus is essential for technology acquisition, efficiency gains, and large-scale job creation. The Aatmanirbhar Bharat Abhiyan can be seen as an attempt to synthesize these two approaches.

2. Land Reforms: An Unfinished Agenda with Lasting Consequences

• Historiographical Debate: Historians and economists are divided on the impact of land reforms. Some, like P.S. Appu, argue it was a massive failure due to a lack of political will and bureaucratic apathy. Others contend that the abolition of the Zamindari system was a significant structural change that empowered millions. The success stories of Kerala and West Bengal (Operation Barga) demonstrate that with political commitment, reform was possible.
• Cause and Effect: The general failure of land ceilings and tenancy reforms has had long-term consequences. It contributed to the persistence of land inequality, fragmentation of landholdings, and rural poverty. These issues are directly linked to the ongoing agrarian distress, farmer suicides, and the demand for policies like farm loan waivers. The incomplete agenda of land reforms remains a critical bottleneck in enhancing agricultural productivity and farmer incomes.

3. Nationalization of Banks: A Double-Edged Sword

• Positive Outcomes: Nationalization was instrumental in expanding the banking network into rural areas, promoting financial inclusion, and directing credit to previously neglected priority sectors like agriculture and small-scale industries. It played a vital role in financing the Green Revolution.
• Negative Consequences: It led to a decline in efficiency, poor customer service, and increased political interference in lending decisions, which culminated in the problem of Non-Performing Assets (NPAs). This has burdened the public exchequer with the need for repeated bank recapitalizations.
• Contemporary Relevance: The legacy of nationalization continues to shape India’s banking sector. Current government policies, such as the merger of public sector banks (PSBs) and discussions around privatization, are aimed at addressing the efficiency and NPA issues that emerged in the post-nationalization era, representing a significant policy reversal.

4. The 1991 Crisis: A Catalyst for a Paradigm Shift

• Not a Sudden Event: The 1991 BoP crisis was not a sudden event but the culmination of decades of flawed economic policies. The inward-looking, state-controlled model (License Raj) created inefficiencies and stifled innovation, while fiscal profligacy created unsustainable macroeconomic imbalances.
• Crisis as an Opportunity: The crisis forced a fundamental rethinking of India’s economic philosophy. It served as the political catalyst for the government under P.V. Narasimha Rao, with Finance Minister Manmohan Singh, to dismantle the License Raj and usher in the LPG reforms. This marks the most significant turning point in India’s modern economic history, shifting the country from a closed, socialist-oriented economy to a more open, market-oriented one. The debate continues on whether the reforms were driven by domestic consensus or dictated by the conditionalities of the IMF and World Bank (the “Washington Consensus”).