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History of Economic Growth in India

Last month, Morgan Stanly and HSBC lowered India’s economic growth forecast for fiscal years 2013 and 2014 from 5.2 to 5 percent and from 6.2 to 6 percent respectively. These numbers do not sound encouraging, but compared to a GDP growth of 4.5 percent for the October-December quarter of FY2013, this news provides some encouragement for India’s economy. According to Finance Minister Chidambaram Palaniappan, India’s economy would grow 6.2-6.7 percent during FY 2014. If accurate, it would be a good economic recovery. Although it is nowhere near the double-digit GDP growth India was enjoying a few years ago, the recent news of an economic turnaround is a cause for celebration, especially when U.S. and European economies are still struggling to get back to pre-recession levels.

India’s economic journey from an impoverished country to an emerging global economy is an inspiring example for many developing nations. In order to understand India’s economic voyage, it is essential to shed some light on India’s political and economic history. After 200 years of British rule, India became an independent sovereign nation in 1947. This newly born nation faced a number of issues including a shattered economy, a minimal rate of literacy and horrific poverty. It was a mission impossible for Indian leaders, but Sardar Patel, Nehru and others transformed India into a secular and democratic nation.

Early economic growth. To better understand India’s economic growth, its economic history should be divided into two phases, the first 45 years after the independence and the last twenty years as a free market economy. During the first 45 years after independence, India’s economy was divided into two distinct segments, private and public.

The private sector owned and operated small to medium size businesses and industries protected by the government and the government took care of everything else. The government was in charge of most of the consumer services including transportation such as airlines, railroads and local transportation, communication services such as postal, telephone and telegraph, radio and television broadcasting, and social services such as education and health care.

The intention of the government was to provide these services, at a reasonable cost, as well as employment. India adopted a five-year development plan from its closest ally, the Soviet Union, in order to improve infrastructure, agricultural production, health care, and education, but the progress was extremely slow due to India’s democratic system.

The absence of economic policies. India’s economy and political system encountered a severe crisis during the time of Indira Gandhi and her Congress Party rule. During her administration, there was no economic progress because of a lack of attention to economic improvement. Gandhi and her Congress Party paid more attention to how to remain in power rather than solving India’s economic and social problems. In 1975, Gandhi arrested opposition leaders, imposed censorship on the press and suspended elections. During this time, economic growth stagnated and widespread corruption became the norm. Finally, bowing down to tremendous internal and external pressure, she declared a general election in 1977.

Gandhi and her Congress party lost that election. In a few years, she came back into power again and her son Rajiv Gandhi took over after her assassination, as prime minister. While he was campaigning he was killed in a bomb blast and India’s economy was completely ignored.

The collapse of the Soviet Union and the Gulf War. During the early 1990s, India’s economy began to worsen and was faced with growing inflation, unemployment and poverty and historically low foreign exchange reserve. The collapse of the Soviet Union significantly impacted Indian’s economy because the Soviets were India’s major trading partner and a key supplier of low-cost oil. As a result, India had to buy oil from the free market. India was receiving a huge remittance of foreign exchange from Indians working in the Middle East, but the Gulf War sent thousands of Indian workers back home resulting in a huge dent in India’s foreign reserve.

Consequently, India’s foreign exchange reserve fell to a low of $240 million, just enough to support only two weeks of imports. The International Monetary Fund (IMF) and the World Bank offered help to India in exchange for economic reforms. The government ran out of options and finally, the government had to change its closed-door economic policies in 1991.

Time for economic reforms. Fortunately, no one from the Gandhi family was in power to make decisions for the country and Prime Minister Narasimha Rao took steps towards liberalization and privatization to reform India’s economy. Manmohan Singh, who was the finance minister at that time went forward and introduced several economic reforms. He lowered tariff levels, reformed exchange rate policy, liberalized industrial licensing policy and also relaxed India’s foreign direct investment (FDI) policy. These reforms opened the doors for multinational corporations to invest in India. India received positive responses from international investors. Before the 1991 reforms, foreign equity ownership was restricted to 40 percent and the transfer of technology was necessary to do business in India. These barriers were removed for foreign companies. Many multinational corporations (MNCs) took advantage of India’s new economic policies and increased their stakes to more than 51 percent in their subsidiaries resulting in a several-fold increase in foreign direct investment in just three years.

Driving forces behind economic growth. There were three major driving forces behind India’s economic growth and prosperity after economic reforms of 1991; Increased foreign direct investment, India’s expertise in information technology and increased domestic consumption because of a growing middle-class population. The combination of foreign direct investment and expertise in information technology helped produce thousands of new jobs and created a growing middle class that in turn created increased domestic consumption and that resulted, again, in more foreign direct investments to meet the demand of Indian consumers.

India’s growing middle class is the backbone of its economy and it is expected that about half of its population will fall into the category of middle class by 2040 with a substantial amount of disposable income.

Knowledge-based economy. The last phase of growth came from a growing information technology industry and service industry. India became a hub for information technology and a knowledge-based economy. Because of the availability of a highly talented technical workforce and improved protection of intellectual property, many western firms shifted their research and development departments to India in order to reduce their R&D cost. India was able to pick up most of the outsourcing from western countries because of the low cost. India was the major recipient of the outsourced call centers, medical billing centers, and other business administration and insurance related services. India’s economy is now supported by its own expertise in information technology, larger capital market, improving infrastructure and growing middle class with increasing disposable income.

To make India’s economic growth more sustainable, India needs a second generation of reforms to speed up privatization of government-owned businesses, improve financial and legal systems to protect investment and modernize its infrastructure. It is also important to introduce business-friendly tax reforms, upgrade labor laws to the international level and eliminate bureaucracy to attract more international corporations with more investment.

Finally…India joined the club of trillion-dollar economies six years ago and it will undoubtedly double its size to 2 trillion dollars because of economic reforms and globalization in the early 1990s, but some numbers still remain disappointing. More than 40 percent live on little more than $1.00 per day and more than 25 percent live below the national poverty line. The government should pay close attention and take the necessary steps to reduce inequalities so everyone can enjoy economic growth evenly, especially people living in rural area. The government should promote the manufacturing sector for future economic growth, in order to reduce dependency on TI and the service industry, and divert future investments to the rural areas of India to decrease urbanization and increase employment in small towns and villages.

A diversifying strategy like this would compel the government to invest more money in rural infrastructure and other basic public services, such as electricity, sanitation, and clean drinking water, to support manufacturing facilities as well as people living in that vicinity. People living in rural areas are now aware of India’s economic progress and it is important to include the people who were left behind and ignored for twenty some years.