Transcript The Returns to Acquiring Privately Held Firms: Costly Value Addition

India: Economic Overview
FIN 680V/ FIN 360
P.V. Viswanath
September 2015
India at Independence
The economy was overwhelmingly agricultural –
85% of the population employed in agriculture
using low productivity techniques
Still the country was not self-sufficient in
foodstuffs.
Illiteracy was high at 84%.
Mass communicable diseases were widespread
and mortality rates were very high (27 per ‘000).
Economic History: 1950-1990
Post-independence India had a mixed economy,
i.e. including both private and public sectors.
The reasons for a strong public sector were:
– Great inequality in income distribution – doubts as to
the viability of laissez-faire – would there be
sufficient savings to invest in growth?
– Free trade would probably have led to exploitation by
stronger foreign countries
• Exports were seen as a drain of resources from the
country.
Post-independence economy
Foreign Investment was seen as foreign domination.
The quickest path to economic development was seen
to be rapid industrialization, which would probably not
happen without government intervention
– Capital goods and heavy industry were seen as particularly
needed.
– Planning was needed to ensure industrial growth and the
concomitant agricultural and service growth, as well as
employment growth
Objectives
The broad objectives were:
– Rapid growth in production with a view to achieving
a higher level of national and per-capita income.
– Full employment
– Reduction of inequalities in income and wealth
– Socialistic pattern of society with a democratic
framework, based on equality and justice and
absence of exploitation.
Policy Measures for Industrial
Development
Trade and Regulatory Regimes designed to
shield industrial producers from competition
– High tariffs
– Industrial licensing of production and investment
– Monopoly and Restrictive Trade Practices (MRTP)
Act
– Foreign Exchange Regulation Act (FERA)
– Export Restrictions
Industrial Policy
Directed allocation of subsidized credit through
the commercial and developmental banking
system
Administered interest rates and financial
institutions required to lend for specific purposes
at the administered rates.
Fixed, overvalued exchange rates; this ensured
cheap imports for the government.
Industrial & Agricultural Policy
Price control for many products
Rigid labor laws that made it difficult to lay off
workers.
Direct public investment in industrial activities.
Management of the agricultural sector to ensure
reasonable supplies of food grains, edible oils,
sugar and cotton to the domestic market.
Agricultural Policy
Procurement prices were fixed, which, in times
of surplus, worked as a minimum support price.
At times of deficit, the government mandatorily
procured a part of the grain at the procurement
price and distributed it to poorer people through
ration shops.
Fertilizer, irrigation, power and credit were
subsidized for the agricultural sector.
Agricultural and Fiscal Policy
The need to procure grain meant that trade
restrictions were imposed.
– Quantitative restrictions on exports and imports,
through licensing
– Canalization – the use of a single parastatal for imports
and exports; the use of minimum export prices.
– High income tax rates to discourage imports and to
finance government activities.
Social Policies
Higher education was emphasized (IITs and
IIMs)
Growth-oriented strategy as a means of
mitigating poverty and unemployment.
However, structural inequalities in land
ownership, availability of water, access to credit
etc. led to growth without income and
employment growth for poorer people.
Social Policies
Land reform; however, it required the cooperation of
the states, which was not always forthcoming for
political reasons.
Alleviation of poverty through special programs and
policies, such as asset creation programs,
employment generation programs, minimum needs
programs.
Intervention programs to solve the problems of
malnutrition and hunger.
Did the policies work? Industry
Industry grew 6% p.a. between 1951 and 1989
There was little competition; hence there was
little R&D.
The capital-input ratio went up considerably;
total factor productivity dropped. Capacity
utilization fell.
Deeply entrenched interest groups.
Agricultural Progress
Between 1950 and 1980, food grain production
increased by 2.8% p.a., due primarily to productivity
gains and multiple cropping.
But, investment growth slowed.
R&D suffered, development of irrigation lagged behind
plan targets.
There was a substantial rise in subsidies for food and
fertilizer and for credit, water and electricity.
India became more or less self-reliant, but at great cost.
Social Progress
From 1970-88, the proportion of population below
poverty dropped from 46.17% to 37.76% in urban areas
and from 58.75% to 48.69% in rural areas.
Average life expectancy improved from 32.1 in 1950-51
to 58.7 in 1990-91. The death rate dropped from 27.4
to 12.5 during the same period.
Literacy was 52.2% in 1990-91 compared to 18.33% in
1950-51.
But compared to other developing countries, this was
not good.
Poverty
The 2011 Socioeconomic Caste Census concluded that:
30.9 per cent of the rural population and 26.4 per cent of
the urban population were below the poverty line in 201112.
The all-India ratio was 29.5 per cent.
Based on the analysis presented in the expert group
report, monthly per capita consumption expenditure of Rs.
972 in rural areas and Rs. 1,407 in urban areas is
considered to be the poverty line at the all-India level.
The crisis and the change
A massive rise in the government deficit spilled
over to the current account deficit because it was
financed by external debt.
Growth of public spending through the 1980s
increased the budget deficit as a proportion of
GNP, rising from 6.4% to 9%.
External public sector debt as a % of GNP
increased during the 1980s to 21% in 1987-88.
Foreign Exchange Crisis
Debt service as a proportion of exports
increased more than threefold from 10% in
1980-81 to 27% in 1986-87 (Joshi/Little, 1994)
External shocks, such as increased oil prices,
decreased access to concessionary loans from
abroad
Structural rigidities in the Indian economy made
Indian products non-competitive, globally.
The solution
A twofold solution:
– Make the economic structure more competitive
– Contain the government deficit
Effects:
– Structural Change and
– Fiscal stabilization.
Initial Reforms
Trade policy reforms have done away with most
quantitative restrictions and reduced tariff levels
Industrial policy has removed barriers to entry
and limits on growth in the size of firms
Regimes for foreign investment and foreign
technology have been liberalized considerably
Domestic tax structure has been rationalized.
The financial sector is being deregulated.
Second-generation reforms
Privatization of public sector undertakings
– Very slow, but steady. BHEL
Exit policy for labor
Reforms of the agricultural sector
Reforms of the state governments
Results
GDP Growth, of course, has been very positive,
except for the recent deceleration.
The economy has become more open: exports
plus imports of goods and services jumped from
22.9% of GDP in 1991-2000 to 49.8% in 200911, but it dropped to 37.6 in 2010-2014.
Real GDP Growth Rates
Real GDP Growth Rate
12.00%
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
FDI Flows into India
FDI (US$ mil.)
50,000
45,000
40,000
35,000
30,000
25,000
20,000
15,000
10,000
5,000
0
2015 data for Apr-Jan
GDP from 50-51 to 2008-9
GDP at Factor Cost
6000000
5000000
4000000
3000000
2000000
1000000
0
GDP from 65-66 to 2013-14
GDP at Constant Market Prices
18000
16000
14000
12000
10000
8000
6000
4000
2000
0
GDP: Post Liberalization
GDP at Factor Prices
6000000
5000000
4000000
3000000
Series1
2000000
1000000
0
Industrial Production
Index Nos of Industrial Production (1993:94 Base)
350.00
300.00
250.00
200.00
150.00
100.00
50.00
0.00
Mining & Quarrying
Manufacturing
Electricity
General
Recent Industrial Production
Index Numbers of Industrial Production
Base Year 2004-5
200
180
160
140
120
100
80
2005-06
2006-07
2007-08
2008-09
Mining and Quarrying
2009-10
2010-11
Manufacturing
2011-12
Electricity
2012-13
Total
2013-14
2014-15
Growth in Industrial Production
Atul Kohli, “Politics of Economic Growth in India, 1980-2005,”
Economic and Political Weekly, April 2006, pp. 1251-1259 and
1361-1370
Poverty in India
Percentage population below poverty line
2011-12 based on Consumption
45
40
35
30
25
20
15
10
5
0
Changes post-1991
Disparity in growth across states
Move towards service sector
Lack of sufficient industrial growth
Greater Income inequalities
High poverty in the rural sector – farmer suicides
Continued casteism, gender inequality,
communal unrest
Per Capita Income – by State
Per Capita Income – by State
Benefits of Capital Account
Convertibility
to stimulate economic growth through higher
investment by minimizing the cost of both equity
and debt capital;
to improve the efficiency of the financial sector
through greater competition, thereby minimizing
intermediation costs and
to provide opportunities for diversification of
investments by residents.
Capital Account Convertibility
CAC based on the theory that capital will flow from high
capital-endowment countries to low capital-endowment
countries, from low-return-to-capital countries to highreturn-to-capital countries.
But CAC often led to movement of capital from
developing countries to developed countries.
One reason is information asymmetry problems in
developing countries combined with contract
enforcement difficulties.
Capital flows can be volatile.
Capital Account Convertibility
Currently in India, the rupee is fully convertible
for current account transactions.
Capital account transactions are transactions
that alter the assets or liabilities outside India of
an Indian or inside India of a non-Indian, i.e. that
convert local financial assets into foreign
financial assets – for such transactions,
convertibility is limited.
Capital Account Convertibility
State governments are not allowed to directly
access any form of external borrowing
Banks are not allowed to borrow abroad;
however, Indian companies are allowed ECBs
(external company borrowings).
Foreigners are allowed to invest in India only in
certain sectors and subject to certain limits.
Capital Account Convertibility:
Examples
In insurance, they are not allowed to operate
directly, but they can have a joint venture with up
to a 26% equity interest.
Foreign investment is not permitted in the retail
sector with certain restrictions.
– 100% FDI is permitted for wholesale cash and carry
trading and trading for exports
– 51% FDI permitted for Single Brand product retailing
BSE Sensex Prices
BSE Sensex Index
70000
60000
50000
40000
30000
20000
10000
0
Volume
Close
CNX Nifty Prices
CNX Nifty Adj Close
10000
9000
8000
7000
6000
5000
4000
3000
2000
1000
0
9/17/2007
9/17/2008
9/17/2009
9/17/2010
9/17/2011
9/17/2012
9/17/2013
9/17/2014