Macroeconomic convergence, economic growth and financial development of India - Dissertation Example

?The Economic Convergence and Economic Growth and Financial Development of India A review of literature Introduction India is an emerging country that has developed into an open market economy. In 2010, CIA World Fact Book ranks India as 5th in the world economy having $4.06 trillion gross domestic product (GDP.). However, same source indicates there are still traces of its past autarkic policies because of the social democratic policies that have governed the country since 1947 to 1991. At that time, the economy was characterized by extensive regulation, slow growth, protectionism, and corruption. Reforms introduced in early 1990s that included trade and industry liberalization, removal of government control from the industries, and transfer of control of government resource to private business sector accelerated economic growth. Vernani (n.d.) estimated India’s economic growth since 1951 up to 1971 stayed at 3%, and in 1995 went up to 5%. Since 1997, India’s expansion has been more than 7%. India’s growth comes from farming, cultivation, craft, new industries and other services (CIA). Total labor force is 478 million; 52% is in agriculture, 34% is in services and 14% for other industries. India boasts of a large educated English-speaking population that becomes its asset for its export of information technology and software workers. The economic growth slowed down to 6.7% in 2008-2009 but has improved to 7.4% for the rest of 2009 to 2010 (Virnani) Due to big local demand  in 2010, the country recovered strongly from the economic meltdown and has charted over 9% growth. (Virmani,) At this time too, investment growth rate doubled as well as private consumption and imports accelerated; however, government consumption slowed down. Vernani explained that in 2007, investments were over 35%; demands were much higher than previous years; investment rate grew to 18%; domestic demands climbed to 60.1% and a negative rate for exports. However, despite the pronounced growths, CIA showed problems of India that include extensive privation, insufficient infrastructures, limited employment opportunities in non-agriculture sector, inadequate way in to quality education, and accommodation of “rural-to-urban migration”. Financial development in India The process of financial system in India according to Sandhya (2009) ”is an interaction of financial institutions, financial markets, financial instruments/assets/securities and financial services which are controlled by the government” . The Indian financial system is also parallel in the role of other governments in the financial markets. Cihak (2011) said the role of governments in finance was less before the global crisis because empirical studies showed harmful effects of government interventions. The crisis changed the minds of the people and thought that it is time for the government to adopt policies to maintain stability, drive growth and create jobs. As such, clearer roles emerged for the government to adopt direct interventions such as ownership, credit guarantees and liability guarantees. Government has to regulate and supervise economic activities and to promote competition, infrastructure and technology, Cihak said. Empirical results of macroeconomic convergence theories. Economic convergence starts with simple cooperation on agreed upon aspects from among member countries that often lead to integration or merger of these countries. Maruping (2005) defines macroeconomic convergence as a local assimilation that requires joining of two or more states, basically thru a Privileged Agreement, sometimes done thru Bilateral Trade Agreeements.  He describes economic convergence as an organized plan intended for the easy access of service and goods as well as coordination of foreign economic policies of these states in the same region. According to the Dictionary of Trade Policy Terms of WTO, regionalism is described as “actions by governments to liberalize or facilitate trade on a regional basis, sometimes through free-trade areas or customs union”. Most common trade agreements entered into by countries and states are the preferential trade agreements, the Free Trade Agreements, Customs Union, Common Market and Economic Community. The basic objectives of macro economic convergence according to Maruping (2005) are formed around the necessities of trade that includes market expansion, looking for interrelated business prospects, and support of domestic trade and the open movement of production factors. Economic integration of India. The economic integration of China and India started with their religious, intellectual and economic needs many years ago. Gupta and Haiyan (2009) related that integration between China and India begun with religion when Buddhism that started in India during the fifth century, found its way to China. In intellectual integration, an Indian Scientist was appointed president of the Board of Astronomy in China. The relations of these two countries have grown rapidly, growing twice as fast or about 50% annually as each country trade with the rest of the world 23-24% annually. Recent example of integration in Asia is the Free Trade Agreements (FTA) wherein the ASEAN organization aims to foster mutual understanding to encourage expansion of new services, products and trade. World Trade Law enumerates composition of AFTA that was organized on 24 February 1976 as the governments of Brunei Darussalam, the Republic of Indonesia, Malaysia, the Republic of the Philippines, the Republic of Singapore and the Kingdom of Thailand. Subsequent integrations to trade services of ASEAN group include China, India and Korea. Jiangyu (2006) viewed ASEAN integration in trade services as shallow and does not have service dimension. Part of the countries’ agreement is to commit the parties to conduct GATS-plus liberalization. Jiangyu, at this point questions the voluntary nature of the commitment in order to attain significant progress. Author commented that in view of the growing comparative advantage of China and India in certain services sector, they should take the lead in liberalizing regional services. Economic integration is also seen in the formation of the South Asian Association for Regional Cooperation (SAARC) in December 1985. SAARC is composed of eight countries: India, Pakistan, Bangladesh, Afghanistan, Bhutan, Maldives, Nepal, Sri Lanka and Afghanistan. (SAARC). The regional cooperation desired by SAARC had been put to a test in the study done Bhatta (n.d) in analyzing the regional integration and peace in Southeast Asia. The objectives of regional cooperation of SAARC, according to Bhatta are not completely attainable because of political strife that is rooted on the religious and cultural beliefs surrounding the countries of South East Asia. Thus, it is concluded in the article that the main dilemma behind functioning integration and durable peace through integration in South Asia is over-optimistic at least in the present settings. One of the dramatic events in trade agreements is the culmination of the World Trade Organization on January 1, 2005. The WTO has 146 members worldwide, and India is one of its members. The participation of India in the World Trade Organization has been scrutinized by Gupta (2005) wherein he said India’s participation in the world trade is insignificant or only 0.75% of the “pie”. Author said that even in IT services, India’s share in the overall world market is just “peanuts”. To address these inconsistencies, suggestions were laid that requires India to hasten up infrastructure development, and to focus on knowledge generation in important fields like IT high end products, textiles, pharmaceutical molecules and other technological process in order to take advantage of the globalization opportunities. The role of India Financial institutions believed that both China and India have the capacity to play the role of leaders because of their growing economic strength. As far as India is concerned, Director Srinivasa Madhur of the Office of Regional Economic Integration of Asian Development Bank, said India can spearhead the South Asian assimilation following the SAARC framework, as well as becoming an instrument of connections with other regions.(Madhur, 2011). ADBI (2011) Institute believes that because of the economic rise of China and India, they could be the principal agents for global growth. ADBI thinks that India could rebalance Asia-Pacific economic growth because of its large domestic market, ample supply of skilled labor, relatively low wages and dynamic entrepreneurial class. Growth of the Indian Economy The growth of India has always been compared with China as they are both fast growing economies in the region. But growth of India is seen differently from that of China as Bossworth and Collins (2005) raised the issue that India could also be like China because of its potential for growth. They reasoned out that the growing optimism for the prospect of India’s growth is due to its accelerated performance over the past two decades which is a contrast in the slowing growth of other regions. This growth brought significant changes in India as it enabled to grow a considerable number of middle class of society. These authors observed that India’s economic performance differed from China and other Asian regions because the country did not depend on export but rather concentrated on the rapid expansion of service-producing industries. This expansion has been associated with modest level of investment. However, authors were not impressed on the physical capital accumulation of India and observed that despite attempts for higher education, illiteracy rates remain high. The Indian Economy posed a positive upfront as financial institutions sees a growing economy in India. The International Monetary Fund in its latest World Economic Outlook, projects a 9.7 percent growth in the Indian economy in 2010 and 8.4 percent for 2011 because of growth of its economy. (The Times of India, 2010). China is expected to grow by 10.5 percent in 2010 and 9.6 percent which is driven by domestic demand. In comparison, IMF projects a momentary deceleration of the economy for the second half of 2010 up to early part of 2011. projections for advanced economies are expected to be just 2.7 per cent in 2010 and 2.2 percent in 2011, . IMF projects a momentary deceleration of the economy in the second half of 2010 up to the first half of 2011 by as much as 4.8 percent in 2010 and 4.2 percent in 2011. In the light of these economic forecasts, Timmons (2009) viewed India as a country that maintains sense of optimism and growth. He contends that the Indian government’s protectionist policies have insulated India from the global fall out. He construed that while U.S. and Japan, each had contracting economy, India reported a growth of economy by 5.3% in 2009 and is expected to grow by 7% in succeeding years. As compared with other Asian exporting countries, India has the lowest dependence on export, with Singapore and Hong Kong found to be heaviest dependence on exports. According to Timmons, India was saved from the economic recession by their economic policy that is not dependent on overseas market, slow moving export due to bureaucratic system, sub-standard infrastructures and millions of agricultural workers who planted crops for local use. Using a simple growth theory, the study of Timmons (2009) suggests that a change in economic policy can speed up economic growth in a steady rate. For instance, the accelerated expansion of India in the mid-1980 was due to the structural changes caused India’s long-range growth of economic path.  With exception of India, Krishnan of ADBI refers to the dominant use of export-oriented model that increased dependence of the Asian developing countries to the advanced economy markets. This practice according to Krishnan made the exporting countries vulnerable to any negative development in these economies. Prior to the economic crisis, Asian economies, led by China, had exported to EU and Northern America 33% of its total exports, and have absorbed about $1.03 trillion of its exports. Krishnan thinks that the overdependence of the Asian economies to the downturn of these economies needs to be reduced by expanding networks to other areas. The need for economic convergence is more pronounced in the study of Rajiv and Pankaj (29 March 2011) because of the large current account surpluses of many emerging Asian economies, and the issue of rebalancing. These authors took note that India suffered only an indirect impact from the financial crisis while the People’s Republic of China and other East Asian countries suffered from the crisis differently because of heavy reliance to the United States for market growth. Financial development in India Authors Vermani, Reddy and Sandya shared views of the need for financial reforms in 1900s because of deficiencies in the system. The banking sector at this time had no rivalry, had small resources, had inefficient production and absorbed “high cost of intermediation”. Even the nationalization of the banks did not bring relief to the financial system as technology and proper risk management were not given importance. Sandya said that the poor financial system resulted in “poor asset quality and low profitability”. Reddy characterized the financial environment in those years as segmented, underdeveloped, and lack of instruments. The financial reforms in 1900s brought openness to the economy and integration with the international markets. This integration resulted to a large capital inflows and rise of reserves to USD 90 billion coming mostly from foreign investments. Mohan, in his study, said that there is a need for continuously responding to variations of micro and macroeconomic situations. .According to him, government should exercise exchange rates management to attain flexibility and in order to introduce intervention when needed. Mohan describes the Indian financial system as one that has inflation control, has assurance of financial support to the system, has the ability to sensitize banks to the impact of probable monetary changes, and is ready to put up control in capital flows whenever industrial countries shift monetary policies from easy to a tighter control. Two studies that used statistical model to test reliability of evidence came from Praddan (2009 ) and Ouro 2008. From evidences of research, Ouro concluded that that there is an existing inefficiency in Indian financial sector, and that this inefficiency affects growth of other industries. However, according to the study, the inefficiencies in the financial sector and infrastructure are not enough to hamper growth of Indian economy. Thus, he concludes that there are other factors contributory to the Indian economic development such as productivity which is the major source of GDP growth. Implication in Ouro’s study suggests that the underdeveloped financial system of India did not jeopardize its growth, rather the strong productivity growth covered up the negative impact of financing side. Pradan said that an enhanced economic growth is responsible for financial development in the economy. His study states that a policy variable is needed to accelerate economic growth and financial development in the economy. To Pradan, this means the government has to reinforce development through financial integration, less government intervention in the financial system, etc. Pradan observed that in 1933 to 2008 growth of economy and financial development are inter-related and that a causality existed between either money supply, bank credit capital, foreign trade with growth of economy. He concluded that an enhanced economic growth is responsible for financial development of the country. Thus, he implies that financial development is the variable that could generate development in the economy. Authors Acharya, Joy and Amanulla (2009) applied statistical tests to determine relationship of financial development and economic growth in India. Study concluded relationship existed between these two factors. The statistical analysis showed “sensitivity of credit and output relationship to be lower in BIMAARU states and a need for a clear government intervention to induce credit output growth” . BIMAARU (Bihar, Madhya Pradesh, Rajasthan, and Uttar Pradesh) is referred to as the poorest states in India. Nilesh (2010) contends that the poor states remain behind other states in India; that the economic gap between the rich and the poor states is shrinking.  When Chakavorty tested relationship of stock market and capitalization, bank credit and growth rate of real GDP, his findings showed a stable long-run relationship existed between these variables. He showed that growth rate of real GDP is co-integrated with financial depth, and that causality runs from the growth rate of real GDP to stock market capitalization. Both studies established the idea that economic growth has caused financial developments in India. Conclusion From the standpoint of macroeconomic convergence that is formed thru bilateral agreements between nations, it is observed that objectives are not fully realized because of lack of cooperation and commitment of participating member countries as shown in SAARC’s experience. This becomes a stumbling block to the progress of alliances of these countries. This initiative requires the willingness, openness and political will of its leaders to see the attainment of its objectives. Foregoing integrations apparently lack the steam to progress because of inconsistencies in their government policies and regulations and cultures. As such, ASEAN looks forward to India as a resource to balance the decline. India, because of its vast domestic resources is being groomed to become a leader in Asia. With reference to financial developments, monetary policies have cushioned the Indian economy from inflation, ensured liquidity, and have sensitized banks for possible changes in monetary conditions. Statistical results from several studies showed relationships of economic variables to financial development. There are evidences found that financial development is the variable needed for a long run stable economic growth; that there consistent changes to the micro and macro economic conditions. Thus, as a process, financial development policies should always address the improvements of interactions of activities associated to the development of financial services. Apparently, it appears that there is still a need for government intervention, policies and regulations to solve the poverty, inadequate infrastructure, limited opportunities for employment, insufficient access to higher education and local immigration in order to take advantage of global opportunities. The conclusion put forward is that India is in a better position to help other East Asian Economies to achieve greater export diversification and rebalancing of growth because of its large domestic market. Meantime, government intervention is still needed to institute policies to strengthen financial development and to institute measures to solve problems seen that hamper economic growth. End. Word count: REFERENCE LIST Achryria, Debaschis, Amanulla, S. and Joy, Sara. (2009). Financial Development and Economic Growth in Indian States: an Examination. International Research Journal of Finance and Economics. ISSN 1450-2887 24 (2009) EuroJournals Publishing, Inc. 2009 Anil, Gupta and Haiyan Wang. Aug. 27, 2009. Economic integration between China and India. VIEWED 30 August 2011 Bossworth, Barry, Collins, Susan M. and Virnani, Arvind. Sources of Growth in the Indian Economy Viewed 30 August, 2011 CIA – The World Factbook. 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