GS Notes

6. Economics Notes 46

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Elaborate Notes

International Monetary Fund (IMF) and India

  • Founding and Early Engagement: India is a founding member of the IMF, having participated in the United Nations Monetary and Financial Conference at Bretton Woods, New Hampshire, in July 1944. The Indian delegation, which included figures like Sir Chintaman D. Deshmukh (who later became the first Indian Governor of the RBI), played a role in shaping the post-war global financial architecture. As a developing, post-colonial nation, India’s initial relationship with the IMF was primarily that of a borrower, seeking assistance to manage its balance of payments and fund its developmental objectives.

  • Transition from Borrower to Lender: Over the decades, with the strengthening of its economy and accumulation of foreign exchange reserves, India’s role has evolved. A significant illustration of this shift was during the Eurozone Crisis (2009-2010), also known as the European Sovereign Debt Crisis. This crisis afflicted several EU member states (notably Portugal, Ireland, Italy, Greece, and Spain - PIIGS) who were unable to repay their government debt. In 2012, India, along with other BRICS nations, pledged additional resources to the IMF’s firewall fund to help contain the crisis, marking its emergence as a contributor to global financial stability.

  • IMF Quota and Governance Reforms: India’s voting rights in the IMF are determined by its quota, which reflects its relative position in the world economy. India has long advocated for reforms to give emerging economies a greater voice. The 2010 Quota and Governance Reforms, which came into effect in 2016, resulted in an increase in India’s quota and its voting share from 2.44% to 2.76% (the summary notes 2.3% to 2.64%, which reflects earlier stages of the reform process), making it the eighth largest quota-holding country at the IMF.

  • Key Borrowing Episodes:

    • Extended Fund Facility (EFF) in 1981: In the early 1980s, facing a severe balance of payments problem due to the second oil shock and deteriorating terms of trade, India negotiated a loan of 5 billion Special Drawing Rights (SDR) under the EFF. At the time, it was the largest loan ever approved by the Fund. The EFF is designed for countries with serious medium-term balance of payments problems attributable to structural weaknesses. However, as the Indian economy recovered, the government did not draw the final instalment of the loan.
    • Stand-By Arrangement (SBA) in 1991: This is the most famous instance of IMF intervention in India. By 1991, due to a combination of high fiscal deficits, political instability, and the impact of the Gulf War on oil prices and remittances, India’s foreign exchange reserves had dwindled to a point where it could barely finance a few weeks of imports. India approached the IMF and the World Bank for assistance. The bailout package under the Stand-By Arrangement, a facility for short-term BOP problems, came with a set of conditionalities known as the Structural Adjustment Program (SAP). These conditions mandated the liberalisation of the economy, privatisation of state-owned enterprises, and globalisation (LPG reforms), fundamentally altering India’s economic policy framework under Prime Minister P.V. Narasimha Rao and Finance Minister Dr. Manmohan Singh.

World Bank Group (WBG)

The World Bank Group is a family of five international organizations that make leveraged loans to developing countries.

  • International Bank for Reconstruction and Development (IBRD): Formed in 1944 at Bretton Woods, its initial purpose was to finance the reconstruction of European nations devastated by World War II. After the Marshall Plan took over this role, the IBRD shifted its focus to providing loans and technical assistance for development projects in middle-income and creditworthy low-income countries. Its voting structure is proportional to the share capital contributed by member countries, giving developed nations, particularly the USA, significant influence.

  • International Development Association (IDA): Established in 1960, the IDA is the World Bank’s ‘soft loan’ window. It provides long-term, interest-free loans (known as credits) and grants to the world’s poorest countries, which lack the creditworthiness to borrow from the IBRD. IDA funds are crucial for basic social services like health, education, and sanitation.

  • International Finance Corporation (IFC): Formed in 1956, the IFC is the largest global development institution focused exclusively on the private sector in developing countries. It provides investment, advisory, and asset management services to encourage private enterprise. India has been a significant beneficiary. For instance, the IFC was instrumental in launching Masala Bonds in 2014, which are rupee-denominated bonds issued in overseas markets, helping to internationalise the Indian rupee and raise funds for Indian entities.

  • Multilateral Investment Guarantee Agency (MIGA): Established in 1988, MIGA’s mission is to promote foreign direct investment (FDI) into developing countries by offering political risk insurance (guarantees) to investors and lenders. These guarantees protect investments against non-commercial risks such as expropriation, breach of contract, currency inconvertibility, and war or civil disturbance. This reduces the risk perception for investors, making them more willing to invest.

  • International Centre for Settlement of Investment Disputes (ICSID): Established in 1966, ICSID provides facilities for the conciliation and arbitration of international investment disputes between states and foreign investors. India is not a member of ICSID. India has maintained its reservation due to concerns about the ICSID’s arbitration process, viewing it as potentially infringing on national sovereignty and favouring corporations. It prefers to handle investor disputes through bilateral investment treaties (BITs) or domestic legal channels.

  • India as a “Blend Nation”: This classification refers to countries that are eligible for financing from both IBRD and IDA. India fits this description perfectly: its economy is large and creditworthy enough to access IBRD’s market-based loans for major infrastructure projects, while its large population of poor people makes it eligible for IDA’s highly concessional financing for social sector programs aimed at poverty alleviation.

Major Reports by World Bank

  • World Development Report (WDR): Published annually by the IBRD since 1978, the WDR is a flagship publication that provides a deep-dive analysis into a specific aspect of economic development. For example, the WDR 2023 focused on “Migrants, Refugees, and Societies,” analysing the developmental impact of cross-border movements.
  • Ease of Doing Business Report: This annual report, published from 2003 to 2020, ranked economies based on 10 indicators related to the regulatory environment for starting and operating a business. A higher ranking was perceived as conducive to business. India made significant strides in this index, moving from 142nd in 2014 to 63rd in 2019. However, the World Bank discontinued the report in September 2021 following an investigation that revealed data irregularities and ethical concerns, including pressure by bank officials to manipulate rankings.
  • Global Economic Prospects: A biannual report (January and June) that examines global economic trends and prospects, with a special focus on emerging market and developing economies. It is a key reference for policymakers for its forecasts on growth, trade, and financial flows.
  • Global Findex Database: Launched in 2011 and published every three years, this database is a comprehensive dataset on how adults around the world save, borrow, make payments, and manage risk. Developed with funding from the Bill & Melinda Gates Foundation, it is a critical tool for tracking progress in financial inclusion globally.
  • Transformative Carbon Asset Facility (TCAF): Launched in 2015 at the Paris COP21, this facility aims to help developing countries implement their nationally determined contributions (NDCs) under the Paris Agreement. It provides results-based payments for emission reductions from large-scale programs, thereby creating a market-based mechanism to price carbon.
  • Poverty and Shared Prosperity Report: A biennial report that provides the most comprehensive look at global poverty and inequality. It tracks poverty using the international poverty line (updated to $2.15 per day in 2017 PPP) and measures ‘shared prosperity’ by tracking the income growth of the bottom 40 percent of the population in every country.

Prelims Pointers

  • India is a founding member of the IMF and the World Bank (IBRD), established at the Bretton Woods Conference in 1944.
  • India borrowed from the IMF under the Extended Fund Facility (EFF) in 1981 and the Stand-By Arrangement (SBA) in 1991.
  • The 1991 Balance of Payments (BOP) crisis led to India’s adoption of LPG (Liberalisation, Privatisation, Globalisation) reforms.
  • India contributed to the IMF’s financial resources during the Eurozone Debt Crisis (2009-2010).
  • India’s voting share in the IMF is currently 2.76%.
  • World Bank Group Formation Years:
    1. IBRD: 1944
    2. IFC: 1956
    3. IDA: 1960
    4. ICSID: 1966
    5. MIGA: 1988
  • India is a member of four of the five World Bank Group institutions: IBRD, IDA, IFC, and MIGA.
  • India is not a member of the International Centre for Settlement of Investment Disputes (ICSID).
  • India is classified as a Blend Nation by the World Bank, meaning it is eligible to borrow from both IBRD and IDA.
  • Masala Bonds are rupee-denominated bonds issued outside India, first launched by the IFC in 2014.
  • Key World Bank Reports:
    • World Development Report (Annual)
    • Global Economic Prospects (Biannual)
    • Global Findex Database (Triennial)
    • Poverty & Shared Prosperity Report (Biennial)
  • The Ease of Doing Business Report was discontinued by the World Bank in 2021.
  • Marginal Standing Facility (MSF): An overnight liquidity window for commercial banks to borrow from the RBI against SLR-approved securities.
  • Repo Rate: The rate at which the RBI lends to commercial banks against non-SLR government securities.
  • Counter-cyclical Capital Buffer (CCCB): Banks are required to build up a buffer of capital in good times, which can be released to maintain credit flow during periods of stress.
  • Harrod-Domar Model: Emphasizes savings and investment as key drivers of economic growth. It formed the basis of India’s First Five-Year Plan (1951-56).
  • Indicative Planning: A form of planning where the state sets broad targets and goals, but implementation is largely left to the private sector. It was introduced in India during the Eighth Five-Year Plan (1992-97).
  • Rolling Plan: Introduced by the Janata Party government for 1978-83, it consisted of a series of one-year plans with rolling targets.
  • Countervailing Duty (CVD): A tariff imposed on imported goods to offset subsidies provided by the exporting country’s government.
  • Anti-Dumping Duty: A tariff imposed on imported goods that are priced below their fair market value or the price in their home market (dumping).
  • Trade-Related Investment Measures (TRIMS): A WTO agreement that applies rules to domestic regulations a country applies to foreign investors, specifically concerning trade in goods only.
  • NFIA (Net Factor Income from Abroad): GNP = GDP + NFIA. It includes net retained earnings of foreign companies, net interest earnings, and net compensation of employees. It does not include transfer payments or grants.
  • Cess: A tax levied for a specific purpose. The proceeds are kept in a dedicated fund and are not shared with states.
  • Surcharge: A tax on tax, levied to raise additional revenue, often to address inequality. Proceeds are not shared with states.
  • Minimum Alternate Tax (MAT): A provision to limit tax exemptions for companies, ensuring they pay a minimum level of tax.
  • Fair and Remunerative Price (FRP): The legally guaranteed price for sugarcane that mills must pay farmers. -tled within 14 days of purchase.
  • Minimum Support Price (MSP): An administrative price set by the government for various crops to insure farmers against a sharp fall in prices. It does not have legal backing.

Mains Insights

The Evolving Indo-IMF Relationship: From Supplicant to Stakeholder

  • Shift in Dynamics: India’s relationship with the IMF has undergone a paradigm shift, moving from one of dependency, epitomized by the 1991 crisis, to one of partnership and growing influence. This reflects India’s economic resilience, robust forex reserves, and its status as a fast-growing major economy.
  • The Debate on Conditionalities: The IMF’s Structural Adjustment Program (SAP) of 1991 remains a contentious topic.
    • Proponents’ View (e.g., Jagdish Bhagwati): Argue that the conditionalities were a “necessary evil” that forced India to dismantle the inefficient ‘License-Permit-Quota Raj’. The ensuing reforms unshackled the economy, leading to higher growth rates and poverty reduction.
    • Critics’ View (e.g., Joseph Stiglitz’s critique of IMF policies globally): Contend that the ‘one-size-fits-all’ approach of the IMF infringed upon national economic sovereignty, imposed social costs through reduced public spending, and prioritized fiscal consolidation over social welfare.
  • India’s Role in Global Governance: As a key member of the G20 and BRICS, India actively advocates for reforms in Bretton Woods institutions. Its demands include restructuring quota shares to reflect the current global economic reality, increasing the voice of developing nations, and moving away from the convention of having a European head for the IMF and an American for the World Bank.

India’s Development Trajectory and the World Bank

  • An Uneasy Partnership: While the World Bank has been a major source of development finance for India, its role has been debated.
    • Successes: The Bank has funded critical infrastructure projects in sectors like power, roads, and irrigation, and has supported social programs in health and education.
    • Criticisms: Several World Bank-funded projects, notably the Sardar Sarovar Dam on the Narmada River, have faced intense criticism for causing large-scale displacement of local communities and environmental damage. This critique, spearheaded by activists like Medha Patkar, highlights the potential conflict between large-scale development models and social justice.
  • Strategic Abstention from ICSID: India’s decision to not join ICSID is a calculated move to protect its sovereign policy space. Post-2011, after losing several international arbitration cases filed by foreign investors under various Bilateral Investment Treaties (BITs), India terminated most of its old BITs and introduced a new Model BIT in 2016. This new model seeks to balance investor protection with the state’s right to regulate, a stance that is somewhat at odds with the ICSID framework.

Sustainability of India’s Services-Led Growth Model

India’s post-1991 growth story has been unique, characterized by a leap from an agrarian to a service-based economy, largely bypassing the manufacturing stage—a path different from the East Asian economies.

  1. Drivers of the Service Boom:

    • LPG reforms dismantled the license raj, opening up sectors like telecom, banking, and software.
    • Availability of a large, educated, English-speaking workforce.
    • Global demand for IT and Business Process Outsourcing (BPO) services.

  2. Achievements:

    • High GDP growth, breaking free from the “Hindu rate of growth” (a term coined by economist Raj Krishna).
    • Significant contribution to exports and foreign exchange earnings.
    • Creation of high-paying jobs for the skilled urban population.

  3. Concerns regarding Sustainability and Inclusivity:

    • Jobless Growth: The services sector, especially the high-end IT segment, has a low elasticity of employment. It cannot absorb the vast semi-skilled and unskilled labour force moving out of agriculture. This contrasts sharply with manufacturing, which has historically been the engine of mass employment.
    • Rising Inequality: This growth model has exacerbated income inequality, creating a dualistic economy with a prosperous, globally-integrated services sector and a lagging agricultural and manufacturing base. This also widens the rural-urban divide.
    • Weak Inter-sectoral Linkages: The services sector has limited backward and forward linkages with agriculture and manufacturing, preventing a more broad-based and multiplier effect on the economy.
    • External Vulnerability: Over-reliance on service exports makes the economy vulnerable to global economic shocks, trade protectionism, and changes in technology (e.g., automation).

  4. The Path Forward: A sustainable and inclusive growth model for India requires a strategic rebalancing. Policies like ‘Make in India’ and the Production-Linked Incentive (PLI) scheme are steps towards strengthening the manufacturing sector to create mass employment, while simultaneously enhancing the competitiveness of the services sector and modernizing agriculture.

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