Indian economy has witnessed major reforms in the year 1991 which include-liberalization of foreign trade, abolishment of
industrial license system and opening up of foreign direct investment. The
growth witnessed by Indian economy after 1991 can be attributed majorly to
these reforms. However, the current scenario is quite gloomy with a GDP growth
of 6.9%, fiscal deficit of 5.7% of the GDP and credit rating
of negative BBB-. In the wake of such turbulent situation, Indian Government
has introduced various reforms recently which include:
- FDI in Retail Sector
- Removal of subsidies on diesel and cooking gas.
- FDI in Civil Aviation Sector
- FDI in Financial Sector
FDI in Retail:
Retail
Market in India is one of the fastest growing retail markets contributing 14 to
15% of the GDP of Indian Economy. As per the new FDI policy 51% investment in
multi brand retail is allowed with half investment in backend infrastructure
and 30% sourcing from local players as mandatory policies.
Advantages:
FDI in retail will encourage local players to invest
in the remaining 49% stake and form joint ventures with the foreign players.
The improvement in storage facilities brought by the foreign players will
reduce the food wastage of farmers (currently 40% of the total produce). This
will reduce the selling costs of the farmers who will be willing to be produce
more. Wages of employed farmers will also rise because of the increase in
demand to produce more. Small land holding farmers who cannot produce beyond a
certain capacity will be employed by large land holders at better wages thereby
making this reform benefit the rural society as a whole in the long run.
Disadvantages:
Multinationals will facilitate smooth international
trade which will lead to an inundate flow of low priced imports to Indian
markets. Small and Medium manufacturing units in India will suffer because of
this in the short run. FDI in retail will also disrupt the price quantity
relationship of the demand curve. When quantities are low, farmers cannot
expect better prices as they cannot influence foreign prices leading to great
fluctuations in their income levels. Also, in the long run the investments from
foreign players will phase out and imports will continue which might lead to
balance of payment crisis as well.
Therefore, in order to leverage the best from this
policy, government has to ensure that FDI in Retail in India takes the current
infrastructure to a new high level, improve the supply side demand and thereby
lead to an increase in overall output of the economy rather than improving mere
trade relationships.
Removal of Diesel Subsidy-Impact on Indian Economy:
Rise in Diesel prices is targeted to reduce the high
fiscal deficit accumulated by the Indian Government. There has been an outcry
in the society that this policy will lead to high inflation. On the contrary to
this popular notion, diesel subsidy will cause inflation in the long run which
is as explained below:
The accumulated under
recovery of Rs. 200, 000 crores of the oil marketing companies is funded by
increasing the M3 component of money supply. This leads to ‘too much money is
chasing too few goods phenomenon’, leading to rise in inflation. Central Bank
cannot put control on this money supply as it further squeezes the funds
available for other companies thereby leading to recession. Also,
countries which do not provide subsidies
have low levels of inflation E.g. is 1.76% in U.S, 1.9% in Germany, -0.2% in
Japan, 2% in China and 2.8% in Philippines. All these reasons prove that diesel
subsidy is more detrimental to the society in the long run than rise in prices.
However, the impact of
rise in diesel prices will increase the expenditure of farmers on diesel pump
sets. This can be handled through targeted subsidy which can also be achieved
through conditional cash transfers.
Thus, a rise in diesel
prices though inflationary for India in the short run, will help in reducing
its fiscal deficit to a great extent. Also, as industries migrate to other
sources of energy, this will further enhance in better distribution of
resources. The GDP rises because of removal of pointless subsidies, leading to
increase in jobs and opportunities, thereby improving the production overall.
FDI in Insurance and Pension fund
sector
Foreign Direct
Investment is allowed in this sector as this is one of the largest reservoirs
of infrastructure funds needed by the country currently. By allowing FDI in
pension fund, private sector employees and self employed will get more options
of pension products-most of who do not have viable pension savings option
currently. This will pull more funds from the public which can be channelized
into infrastructure projects. But, Government of India should ensure that there
is strict regulation for pension sector even after the entry of foreign players.
This will ensure the government to achieve its objective of long term growth
without any collapse of the system.
The bad pricing
structure currently being followed in the General Insurance Sector can be
mended by the entry of foreign players. Those players of Life Insurance who are
not well established or those who have ventured newly into this sector will
also benefit from the process improvements by foreign players. The huge growth
(40% in past six years) and low penetration (4% of Indian GDP) will let foreign
players explore this opportunity by bringing diversified products from their
expertise to this sector. This will boost public participation which will
further improve the funds that will flow to this sector and increase overall
contribution to India’s GDP of this sector.
(Note: According to insurance regulator
IRDA, foreign participation will help this sector contribute 10-11% of our
nation’s GDP.)
FDI in Civil Aviation:
Similar to the case of
FDI in Retail, FDI in Civil Aviation will benefit the industry in the long run.
In the long run it will help in adding extra capacity, strengthen the existing
supply chain and thereby improve the operational efficiency of the industry.
This will in turn lead to better profit margins. But, the current problem being
faced by the industry is of profitability. This is mainly because of the huge
fuel tax the domestic airline players have to pay to the government. The tax
paid by the industry is 45% higher than other players of foreign market. Thus
FDI might be beneficial in the long run, but not for short term profitable
gains. The profitability can be achieved by changing the domestic Tax Policies.
Conclusion
From the analysis of
the implications of the recently introduced reforms in India, we can conclude
that FDI in Retail, Insurance and Pension fund sector are targeted in the right
direction. Removal of diesel subsidy is also one of the major reforms taken by
Indian Government to reduce the fiscal deficit. All these reforms have sent
positive signals to the investor circle that India is willing to support
foreign investors. If implemented with right regulations and proper checks and
balances as suggested above, these reforms will be very fruitful in bringing
back Indian economy back to the required growth track.
References
Written By
Soumya Ch.
IIM Raipur (PGP 2012-14)
FINATIX MEMBER
Soumya Ch.
IIM Raipur (PGP 2012-14)
FINATIX MEMBER
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