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Budgeting for Progress: How Government Policies Shape India’s GDP Trajectory?

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  • Post published:October 27, 2023
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India needs several elements in place for its GDP growth to accelerate. Investment rates must increase with private investors playing an active role; net services exports must also increase significantly.

Shenoy was one of the early disciples of libertarian economist F.A. Hayek and was often ignored during his lifetime because he believed that deficit financing to support heavy industrialization would threaten young democracy. However, his opinions were widely ignored at that time.

GDP Impact

1. Agriculture

Agriculture growth is key to India’s economic development and achieving Sustainable Development Goal 2 of the UN (Zero Hunger). Furthermore, agriculture provides incomes four times greater to poor rural communities than other sectors.

India faces a formidable challenge: it risks falling off of the world’s list of fastest-growing economies unless it embraces reform quickly and decisively. Digitization, offshoring and energy transition represent major opportunities to boost India’s economy while lifting 90 million people out of poverty by 2030.

Step one is to unleash farmers’ productivity. To do this, the government must liberalize agriculture, eliminate industrial licensing and foreign exchange controls, open capital markets and import tariffs, and cut red tape – steps that would add over 10% to GDP and allow India to rejoin emerging economies in 2021.

The second step should be improving government services. India has already taken some strides in this regard by relaxing some old controls; however, new ones have arisen in areas such as environmentalism, health standards and tribal territories; often, these rules are misused by politicians to create patronage networks and line their pockets with cash.

Furthermore, government services have been severely under-delivered on every front imaginable – from police and justice to education and health. With some notable exceptions, most government workers remain ineffective or even hostile toward the public; hence, corruption, wastefulness and mismanagement remain prevalent.

Thirdly, the government must improve its fiscal stewardship. This requires cutting subsidies and freebies – which account for more than 6 per cent of GDP and allow politicians to curry favour with various groups – as well as cutting taxes on labour and land; demonetizing state-owned enterprises; monetising roads, railways, ports, airports, power infrastructure; market linking household financial savings accounts and increasing efficiency in procurement processes.

India must increase the net foreign investment into productive firms and deepen its capital markets, which requires reform of FDI policy implementation and making the Bombay Stock Exchange more accessible to international investors. Furthermore, household financial savings must double and ensure more of these funds are invested into productive assets rather than physical ones.

2. Industry

During the last 25 years of economic reforms, India has achieved dramatic economic progress, transitioning from low-income to middle-income status. But to become a high-income economy, further market opening and quality improvements of government services must occur, citizens become empowered and political and business criminals must be jailed quickly, with speedy redress offered for citizens’ grievances quickly resolved. While this task remains challenging and expansive, encouraging signs have already shown promise in India’s pursuit.

India must generate enough investment to maintain economic growth and create jobs. Aside from domestic private investment, they will also need to raise household savings rates, increase the percentage of savings invested in financial assets, and boost gross foreign capital flows – such as by increasing FDI inflows or raising the pool of savings invested in financial intermediation services or by attracting foreign private equity funds.

Reducing industrial output without inflaming inflation will be another formidable task, requiring major structural adjustments and rapid productivity gains. Reducing labour costs while simultaneously increasing worker quality requires further education, training, upgrading skills, improving worker-management relations, and addressing issues like corruption or weak corporate governance.

India is well positioned to take advantage of global trends that are fuelling post-pandemic recoveries, such as rising productivity and urbanization, supply chain shifts, and an increased focus on sustainability, health, and safety.

India can play an invaluable role in meeting the growing demand for business services by capitalizing on its large pools of skilled labour, from software and other business services to pharmaceuticals and automobiles. Construction sector opportunities could also arise through improved quality housing at reduced cost via reduced land prices and easier financing solutions, rationalizing stamp duties, offering tax incentives for residential development and changing tenancy and rent control policies – just two examples.

3. Services

India began opening up to the global economy in the 1990s by abolishing industrial and import licensing, reducing foreign exchange controls, liberalizing capital markets, and cutting red tape. This created an economic boom, making India one of the potential economic superpowers. But as some areas reverted back to old controls while creating new ones – particularly regarding the environment, tribal rights, land ownership rights, natural resources, etc. – leftist critics saw neo-illiberalism.

The COVID-19 crisis revealed that India’s key demand engines of domestic private investment and global trade had become inactive. Bank credit to industry declined significantly while household financial savings decreased substantially; exports also fell, with manufacturing contributing only 19 percent of GDP.

Domestic private investment and international demand are essential ingredients of economic expansion, but they only represent half the picture. The deepening of financial markets to enable more household savings to flow directly to productive firms allows the economy to expand sustainably over time.

To do so, the government requires an improved budgetary control system. In various forms, this means more realistic planning, procedures for recording expenditures at each stage in the process, and centralized reporting. Furthermore, ministries tasked with spending must ensure payment orders and checks don’t delay to meet financing ceilings, reducing effective financing of their budget and deferral.

India’s large firms have not reached their productivity and profitability potential; relative to peers from outperforming emerging economies, they are one-tenth to one-quarter less productive and account for only 20 per cent of total profits. This suggests a lack of a middle sector in India, which helps smaller firms grow while competing with larger competitors.

While India has successfully created market-based businesses, its public services lag behind those offered in other nations. Institutions remain weak while social indicators have made only gradual improvements; political appointees undermine both independence and quality across institutions from courts to universities; corruption remains widespread.

4. Finance

India needs to undertake extensive reforms to deepen liberalization and establish high-quality institutions, thus improving public goods provision while simultaneously increasing productivity and inclusiveness.

India is a net exporter of services, manufacturing and IT; however, due to a lagging productivity level, its domestic producers cannot expand these exports and create jobs at home. India can catch up by strengthening competitiveness among high-potential sectors that could make India an international powerhouse, such as electronics and capital goods, chemicals, textiles & apparel, auto parts, pharmaceuticals/medical devices/IT services, etc.

The government can improve domestic competitiveness by revising labour and tax laws that place undue burdens on firms and workers. Labour legislation must be made more user-friendly; further, corporate tax rates need to be decreased so firms are encouraged to hire more people, increasing productivity by doing so.

Lower corporate tax rates would make it easier for Indian businesses to save and invest, thus helping India reduce its reliance on foreign investment, contributing to its current account deficit and stunting economic growth. The government could encourage domestic savings by reducing taxes, eliminating deductions for deposit interest payments, or permitting market-linked rates on small savings schemes.

Finally, the government should remove unnecessary and counterproductive regulations and red tape that hinder production. Entrepreneurs in private industry often express frustration at being unable to secure bank loans quickly enough and being subjected to government rules requiring upfront fees for registering a business. By streamlining bureaucratic requirements and licensing requirements as well as clearing away regulatory hurdles that prevent SMEs from expanding globally, government regulation could help ease bottlenecks that impede growth.

Additionally, the government should prioritize improving the quality of its government services. Education, health and physical infrastructure remain dismal; therefore, the government should provide teachers with better training, strengthen hospitals and medical facilities, boost digital connectivity, and increase accountability by linking wages to the performance of government servants – this may prove challenging. Still, India may become the second-largest economy by 2040 if successful!

Government Policies

India’s economic reforms have helped move it from low-income to middle-income status, but its institutions remain weak. In contrast, social indicators remain far below those seen elsewhere in South Asia.

Poor government services encompass police and judicial services, education, health and infrastructure provision. Staff members do not report directly to the consumers they serve; politicians, in turn, reward them with patronage.

The Role of Government Policy

Government policies are the rules and guidelines enacted by a government to address certain issues or accomplish certain goals. They may be devised through democratic processes and can have far-reaching societal ramifications.

India is a middle-income nation with great potential for economic development, yet it still requires improvements to its sluggish bureaucracy and quality of government services. Poorly delivered government services impede economic development by decreasing productivity and social indicators; gains made in private-sector competitiveness have yet to translate to improvements in government service competitiveness, and political interference undermines independence among institutions from courts to universities.

India must accelerate and sustain growth to stay on the path towards development by opening markets more widely, increasing public good quality, empowering its citizens, jailing business and political criminals more swiftly, improving the reliability of government services, and strengthening economic governance – these are major tasks which the government can overcome.

The Role of the Private Sector

The private sector is essential in providing jobs, goods, and services. It invests in research and development activities that could result in new products that increase productivity and drive growth. It also pays taxes that go toward financing public services and infrastructure projects.

India’s leaders sought economic independence to support political independence and implemented five-year plans inspired by Soviet models to facilitate industrialization while neglecting private sector dynamics.

Now, India must revitalize the private sector by creating an environment conducive to its expansion. This may mean relaxing labour restrictions that impede manufacturing companies’ expansion, combatting corruption and bureaucracy that hinder decision-making processes, lowering financing costs through market-linked interest rates on government savings accounts, streamlining public finances through privatizations or asset sales, etc.

The Role of Foreign Direct Investment

Foreign direct investment (FDI) has been one of the primary drivers of India’s GDP growth over recent years. This includes transactions that increase equity ownership (shares and voting rights) by residents from one economy in enterprises residing in another, along with investments made indirectly influenced by controlled enterprises or debt financing arrangements.

India needs to deregulate labour markets, increase productivity and boost private investment to accelerate its economic development. Furthermore, it should leverage its vast and growing workforce by increasing labour force participation rates, including upskilling workers and encouraging women’s participation.

Red tape that hinders growth must be reduced by eliminating poorly enforced regulations and corruption. As one example, import restrictions on natural resources should be lifted to reduce reliance on costly imports.

The Role of Government Subsidies

Government subsidies provide governments with an effective tool to encourage industries they wish to see flourish, be they direct cash payments or tax breaks. Production subsidies reduce production costs, while consumption subsidies help consumers save on consumption costs.

According to Goldman Sachs, India faces the daunting challenge of providing enough jobs for its large workforce. According to their estimates, 90 million nonfarm jobs must be created to absorb existing workers while meeting population aspirations.

India will need to deepen its market reforms, strengthen institutions and the quality of public goods, prosecute political and business criminals swiftly, and provide citizens with swift redress for grievances. Furthermore, household savings rates must increase market-linked with financial assets.

The Role of Technology

The emergence of an aspirational consumer class has propelled economic expansion and lifted millions out of poverty. This trend will likely continue as the middle classes expand and household consumption rapidly increases.

India must increase its investment rate (gross fixed capital formation/GDP). With limited fiscal space and private sector entrepreneurship playing an essential role, increasing gross fixed capital formation per GDP requires India to increase investment rates through private-sector-driven initiatives. Encouraging further investment and lowering financing costs through market-linked interest rates on government small savings accounts or streamlining corporate bond markets could all help the nation stay on its current high growth path.

Lousy government services also hurt the economy. Improving services would increase business confidence and enhance economic performance; unfortunately, this progress has been delayed by issues like corruption and slow decision-making processes in state governments.


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