Macroeconomics of Post‐reform India

• Author: Cledwyn Fernandez
• Date: 01 May 2018
• Published date: 01 May 2018
• DOI: http://doi.org/10.1002/pa.1684

BOOK REVIEW

MACROECONOMICS OF POST‐REFORM INDIA

This book has very precisely covered the journey of the Indian

economy from the period of pre‐reform to post‐reform era. The

economic reforms which took place in the year 1991 are very

significant for India. It brought about a lot of socio‐economic

changes which changed India's economy completely.

This book has been divided into two sections. The first section

deals with the theoretical framework and approaches (a brief

understanding of the Indian macro economy), and the second

section deals with the behaviour of the Indian economy. The

second section is a more comprehensive section as it discusses

about topics like—inflation, service‐led growth, balance of

payment crisis, and some macroeconomic puzzles.

The author concisely explained the different phases of the Indian

economy, right from pre‐reform to post reform, from manufactur-

ing to service, and from food to oil inflation. The book is a

thorough revision of the Indian economy at hand, and it gives

the readers a clear overview of the country.

1|THE PRE‐REFORM INDIAN ECONOMY

While we discuss about the nature of the Indian economy in the pre‐

reform era, what comes to our mind is the build up to the balance of

payment crisis. However, first we take a look at the external account

in the 80s. There was a decrease in the trade deficit ratio to gross

domestic product (GDP), and the current account also showed a

declining trend in this period. The external debt problem, however,

was a major source of imbalance to the economy. The external debt

as a ratio of GDP increased from 12% to 27% in a period of 10 years.

The level of the current account deficit and the interest rates are two

deciding factors on which the external debt will be measured. As

interest rates go up or the current account deficit level rises, there will

be an increasing external debt for the India economy. Apart from just

focussing on interest rates and current account, we need to look at

other factors involved. When the external borrowing increased in the

80s, much of it was used for financial consumption and not for capital

accumulation.

The exchange rate regime too was not conducive to the balance of

payments problem. The rupee was pegged to a basket of currencies

and the Nominal Effective Exchange Rate was brought down

significantly.

After much speculation, it was studied that an important means of

tackling the Balance of Payments problem is to hold sufficient amount

of foreign reserves. The amount of foreign reserves should be around 4

to 5 months of the import bill. It is also important to note that if the

country has a lot of short term accumulated liabilities, then the

country's central bank should also hold enough of large reserves to

stop a crisis from happening.

2|INDIA'S MACROECONOMIC PUZZLE

The behaviour of the Indian macro economy has been rather strange

and unique as compared to the rest of the economies. This chapter

focuses on the uniqueness of the economy over the years. First, it

was seen that with the high fiscal deficit, the current account balance

was positive. Second, it was studied that in spite of debt financing by

the government, both the interest rate and inflation showed a negative

trend. Third, as interest rates declined, private capital investment

started to decline instead of increase. Lastly, it was seen that in spite

of public and private investment falling, India's GDP continued to grow.

It was noticed that during this period, the agricultural sector,

which composed of around 75% of the GDP, had a lot of excess

capacity. Most analysts failed to understand the driving force behind

the Indian macro economy. They mostly focussed on variables like

revenue deficit to GDP, which primarily do not constitute the primary

instruments to the government policy.

Another starking feature noticed was that the major cutback in

public investment in infrastructure was one of the major reasons for

a decelerating growth. This cutback in public investments also had an

externality effect where private investment also saw a drop, depress-

ing agricultural growth. However, increase in consumption from

government sector help revive the economy a bit.

Some of the major macroeconomic variables were also a major

root cause for India's macroeconomic puzzles. It was studied that the

interest rate and fall in growth was primarily due to the slow growth

in the public and private investment. This fall in public investment

coupled with an increase in government consumption increased the

fiscal deficit for the economy. Thus, the major underlying lesson to

be learnt is that it is not important to focus only on the intermediate

target, but also to keep the long term goals in mind, and thereby set

the right policy instruments. This could help the economy from

negative consequences. Another important point to keep in mind is

that the prerequisites ready for a high investment should be ready.

That is to say that there should be skilled supply of labour, there should

be adequate level of infrastructure, and no demand deficiency. Other

such measures would include removing entry barriers, globalisation

of the economy, and ensuring healthy competition.

Received: 14 September 2017 Accepted: 17 September 2017

DOI: 10.1002/pa.1684

J Public Affairs. 2018;18:e1684.

https://doi.org/10.1002/pa.1684

Copyright © 2017 John Wiley & Sons, Ltd.wileyonlinelibrary.com/journal/pa 1of3