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This article provides information about the impact of liberalisation on Indian economy:
Liberalisation on the external account implies making the flow of goods in and out of the country easier. This can involve a reduction in procedures as well as tariffs or removal of quotas. Quotas on import of various commodities had earlier been introduced because the government wanted to offer domestic industry an assured market in which to establish itself.
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The removal of quotas meant that goods could be imported in any amount on payment of appropriate tariff. In the reform period, there has been a substantial increase in exports, but the trade balance continued to be negative as imports grew faster than exports. However, the positive side to this is that an increase in net inflows of invisibles has moved the current account balance to be positive.
In recent years, the current account and capital account are both positive, which implies that the foreign exchange reserves have been rising rapidly. There has been substantial inflow of funds from Foreign Institutional Investors into the stock markets which has increased the foreign exchange reserves to “unsustainable” levels. There have been suggestions from some economists that the rising foreign exchange in the RBFs coffers should be used for financing imports for infrastructure.
This is fraught with danger since it amounts to borrowing in the international market. The increase in reserves is due to short run stock market inflows, which could exit with ease at little notice, and the RBI would have to come up with the necessary hard currency. If India chooses to invest these reserves in infrastructure it would have two flaws: (a) it would be borrowing short to invest long which runs the risk of a liquidity crisis, (b) infrastructure is not a foreign exchange earning area, therefore these projects even in future would not generate the necessary foreign exchange for repayment.
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The liberalisation of the external account involved not only an easier flow of goods but also a large devaluation of the currency and a simultaneous move from a system of fixed exchange rates to a “managed” float. Devaluation, theoretically, is good news for exporters because their goods become relatively cheaper in the international market and imports become more expensive resulting in a decline in the demand for imports in the country.
The trade balance should therefore improve. However, if the domestic industry is undergoing inflation and imports are liberalised, then it could have the opposite effect, especially if exports are elastic and imports are not. A commodity is said to have elastic demand if a small price fall brings about a proportionately larger change in quantity demanded. So if exports are elastic and imports are not, then the import bill will rise further after devaluation since we will import the same volume of goods.
In an inflationary situation, even after devaluation, if exports are elastic, we will not see an equivalent rise in the volume of exports. Therefore, the trade balance could worsen even when devaluation occurs in the process of external sector liberalisation.
There have been more serious fears about the domestic consequences of import liberalisation – it could lead to de- industrialisation. Much of the discussion on de- industrialisation here borrows from Patnaik. De-industrialisation here is defined as a situation where there is a decline in the work force of the industrial sector due to a decline in aggregate demand, which pushes people out of the work force.
This could happen on three counts. The first and most straightforward one is where imports exceed exports and the current account balance is negative. This implies that there is a decline in demand for domestic goods, which reduces employment. In the second instance, de-industrialisation could occur even in the presence of a trade balance of export surplus where the agricultural surplus instead of augmenting production or demand in the domestic economy is used to consume imported goods.
This is the classic colonial drain situation where the colonial ruler would siphon off a part of the surplus to the metropolis without either generating adequate demand for non- agricultural goods or augmenting the productivity of the land. This killed the market for domestic non- agricultural goods, which led to de-industrialisation. In the third instance, which is representative of modern day globalised economies, assume that we have an open capital account with a flexible exchange rate.
If for some reason, there is an increase in capital inflow, then the rupee will become more valuable vis-a-vis the foreign currency. This would make the imported commodity less expensive as compared to the domestic good even in the home market. Consumers will switch from domestic goods to imported goods thereby reducing domestic production and employment.
In such circumstances, the state could autonomously act by increasing expenditure to counteract the de-industrialisation. But even that may be curtailed by multilateral agency pressures who believe in “prudent finance” policies to balance budgets even at the cost of rising unemployment in the economy. The exercise of trying to curb fiscal deficits in India therefore must be seen with care since it is now well accepted that the decade of the 1990s was a period of “jobless growth”.
There are two possible ways of reducing the fiscal deficit – pruning expenditures or increasing tax and non-tax receipts. It is politically easier to cut expenditures where there are no lobby groups opposing this, unlike increase in taxes which is politically undesirable. For example, social sector and capital expenditure reductions attract the least direct opposition, as the immediate effect of the decline is not felt by the current generation. It is therefore no surprise that these are the two areas, which have seen substantial reductions in expenditures as a proportion of the total national income.
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Public expenditure as a proportion of GDP has declined from about 30% at the beginning of the reform period to 27% at the end of the 90s. The share of capital expenditures as well as the share of development expenditures has also declined substantially over the decade of the 1990s. Capital expenditures impact on long term growth since these are in the nature of infrastructure investments. Social sector expenditures enhance human security by ensuring access of the citizen to affordable healthcare and education. Reduced expenditures in both these areas therefore have long-term impacts on accumulation of physical assets as well as the growth of human capital in the economy.
The social sector includes Education, Health (and Family Welfare) and Rural Development. One of the core arguments of neo-liberal ideology is that intervention by the state should be restricted to social development and defence, which are its fundamental duty, and economic activity should be left with the private sector. Going by this logic, we should expect that irrespective of allocation changes in other sectors, in the social sector there should have been an increase.