The Indian economy before and after the economic reform

Foreign direct investment has been recognized as an imperative driver of economic growth and development. One of the most prominent developments during the last two decades is the spectacular growth of foreign direct investment in the global economic scenario (Goel et al. 2012). Prior to  independence, exports in India were primarily agricultural products and the industrial products were backward and underdeveloped. Over the last six decades, the Indian economy has completely revolutionized.

The industrial sector has come a long way from its dilapidated state to a more modernized state. The exports now cover a wide range of traditional products like coffee, cocoa, bauxite, gypsum etc. Similarly, the non-traditional products like bakery products, dairy products; alcoholic, non-alcoholic beverages, limestone, furniture and mineral fuels also constitute a major part of exports from India. Whereas imports mainly consist of capital goods, petroleum products, raw materials, intermediates and chemicals to meet the ever increasing industrial demands (Bhat 2011).

Scenario of Indian economy before the economic reform

There have been significant changes in the capital formation after the introduction of economic reforms. The net savings and final consumption expenditure of the Indian economy have changed due to the increase in the inflow of the foreign direct investment. Before 1991 the inflow of foreign investment in India was mainly in the form of borrowing. In the second five-year plan of 1956-61, main focus was on imports from foreign investments and loans to focus on the rapid industrialization in India. Furthermore the inflow of foreign direct investment was encouraged in the period of sixth five-year plan 1980-85. However, the primary and tertiary sectors were ignored in the period before 1991 (Bose 2015). The table displays that in the period before 1991, the inflow of foreign direct investment was very less and limited to a few sectors.

Year 1980 1985 1990
GDP (million US$) 189594 236589 326608
Exports (million US$) 11274 12849 22639
Imports (million US$) 16927 18984 29526
FDI (million US$) 79.16 106.09 236.69
Savings (% OF GDP) 19.3 21.1 23.5
Gross capital formation (% of GDP) 18.0 23.5 24.9
Unemployment (% of Labour force ) 3.5 3.6 4.3
Final Consumption Expenditure ( % of GDP) 80.7 78.9 76.5

Economic policies and the overall impact on GDP, Exports, Imports, FDI, Savings, Gross Capital Formation and Final Consumption Expenditure (pre reform period). Source: the World Bank Data (data.worldbank.org/) (Bank 2015).

The rate of savings and capital formation increased with the inflow of foreign direct investment in the Indian economy. In this case, the argument for removing the restrictions on foreign direct investment stems from the need for developing the industrial sector in the country.

Need and inception of foreign direct investment in India

The historical background of foreign direct investment in India can be traced back to the formation of East India Company of Britain. Before gaining independence foreign direct investment in India came from  British Companies. Consequently, after the Second World War Japanese companies entered the Indian markets and enhanced their trade with India. However UK remained the dominant investor in India (Ray & Ghosh 2014). The need for foreign capital was felt in the face of maintaining a high level of investment in the country. Indian economy was essentially poor and unable to finance the development needs. Therefore, increased investment stems from foreign investors for industrialisation was an important part of the planning in the initial period after independence. Also to bridge the gap of technological investment and to get out of the “low-level equilibrium trap” foreign investment played an important role.

Furthermore, the Indian economy required investment for establishing infrastructure for the utilization of natural resources and minerals which had unexplored potential. Foreign investment was required to take up huge investments like the Railways which involved big risks. In a capital scarce country like India, it was not possible for risky investments without the inflow of foreign capital (Malhotra 2014). Thus, due to lack of capital which coincided with the balance of payment crisis in 1990-91, led to opening up the  Indian economy for foreign investors. Furthermore with the increase in import of heavy machinery and equipment, the foreign investment was required to stay afloat with the payments of principal and interest.

Impact of foreign direct investment on the Indian economy 

The foreign direct investment is crucial for the economic growth and development of any country. The main advantage of the foreign assistance is that the capital inflow from investing nations helps to fill the gap between capital requirement and domestic saving. Apart from capital, foreign investments also  introduce technical expertise, machinery, capital goods which are scarce but essential for the economic growth of developing economies (Madem et al. 2012)

The foreign direct investment had a multi-faceted impact on the economy of India. Mathiyazhagan (2005) has identified that there has been an upward trend in the growth of foreign investment after the liberalization policy of 1991. The foreign investment has played a catalytic role in the development of Indian economy. The foreign direct investment has had a positive relationship with the growth of the GDP because of the increased volume of production in the country (Pami Dua & Rashid 1998). (Banga 2005) in her paper demonstrated that foreign direct investment , trade and technological progress have a different impact on wages and employment. While a higher extent of foreign investment in an industry leads to higher wage rate in the industry. However, it has no impact on its employment. Alternatively, the higher export concentration of an industry intensifies employment in the industry, however no effect on its wage rate (Banga 2005).

Improvement in export oriented industries

After the increase in the flow of foreign direct investment in India after 1990-91, the volume of exports has been stimulated. The foreign investment has improved the productivity of the export-oriented industries that further improved the export performance (Dr A. Jayakumar, Kannan.I 2014).

Year 1990 1995 2000 2005 2010 2015
GDP
(million US$)
326608 366600 476609 834214 1708458 2048517
Exports
(million US$)
22639 39068 60878 160837 375353 475029
Imports
(million US$)
29526 48225 73075 181858 439059 553125
FDI
(million US$)
236 2143 3584 7269 27396 33871
Savings (% OF GDP) 23.5 26.1 25 35 34.2 31.3
Gross capital formation
(% of GDP)
24.9 26.1 24.1 34.3 36.5 31.6
Unemployment
(% of Labour Force)
4.3 4.0 4.3 4.4 3.5 3.6
Final Consumption Expenditure
(% of GDP)
76.5 75.1 76.8 68.5 67.8 70.7

The inflow of foreign direct investment has been on an upward trend since its liberalization in 1991 and the inflows have gone higher since 2010. As seen from the table there always has been a gap between the imports and export. But the volume of both imports and exports has gone up when compared to the period before the liberalization, with the improvement in international trade, the economic development, and capital formation has increased in the country.

Linkage between foreign direct investment and the Indian economy

Foreign investment, from the perspective of development, is crucial for providing the developing nations with the necessary momentum towards the path of sustained growth. The positive linkages between foreign direct investment and the international trade are corresponding to foreign direct investment inflows have been observed. Foreign direct investment inflows have a positive impact on the capital formation in a country and hence increase its productive capacity and thus exports. Foreign direct investment also tends to improve the overall social welfare of a nation through reduced unemployment. Thus, it is important for both the public and private sectors to realize the complementary between international trade, social welfare, and investment, and liberalize the foreign direct investment in the nation.

References

  • Abuzeid, B.F., 2009. Foreign Aid and the “Big Push” Theory: Lessons from Sub-Saharan Africa. Stanford Journal of International Relations, XI(1), pp.16 – 23.
  • Banga, R., 2005. Impact Of Liberalisation On Wages And Employment In Indian Manufacturing Industries.
  • Bank, T.W., 2015. World Bank Data. World Bank Group. Available at: http://data.worldbank.org/ [Accessed June 25, 2016].
  • Bhat, T.P., 2011. Structural Changes in India ’ S Foreign Trade. , (November).
  • Bose, S., 2015. Indian Foreign Trade: Trends And Policy. International Journal of Social Science , 4(5), pp.10–19. Available at: http://commerce.nic.in/MOC/pdf_download/annual_report_14_15_eng.pdf [Accessed June 27, 2016].
  • Dr A. Jayakumar, Kannan.I, A.G., 2014. Impact of Foreign Direct Investment , Imports and Exports. International Review of Research in Emerging Markets and the Global Economy, 1(1), pp.51–58.
  • Goel, S., Kumar, K.P. & Rao, K.S., 2012. Trends And Pattrens Of Fdi In India And Its Economic Growth. Asian Journal of Research in Business Economics and Management, 2(4).
  • Madem, S., Gudla, S. & Rao, K.B., 2012. FDI Trends during the Last Decade and Its Effect on Various Sectors in India. International Journal of Scientific and Research Publication, 2(12), pp.1–6.
  • Malhotra, B., 2014. Foreign Direct Investment : Impact on Indian Economy. , 4(1), pp.17–23. Available at: http://www.ripublication.com/gjbmit/gjbmitv4n1_03.pdf.
  • Mathiyazhagan, M.K., 2005. Impact Of Foreign Direct Investment On Indian Economy: A Sectoral Level Analysis. Available at: www.isas.nus.edu.sg [Accessed June 24, 2016].
  • Pami Dua & Rashid, A.I., 1998. Foreign Direct Investment and Economic Activity in India. Indian Economic Review, 33(2), p.16. Available at: http://www.ierdse.org/.
  • Ray, A.K. & Ghosh, D., 2014. Foreign Direct Investment : A time of Indian Economy. Journal of Business and Management, 16(1), pp.54–61.
Shikha Chauhan

Shikha Chauhan

Analyst at Project Guru
Shikha is masters in Economics from Kurukshetra University and major in International Economics and Finance. She graduated in Business Economic (Hons.) from University of Delhi.
Shikha Chauhan

Related articles

Discussions

3 Comments.

  1. Arun kumar K R

    changing patrren of saving and capital formation afer and before economics reforms

  2. Mam,
    I want to write a project. The subject is economic reforms since 1991
    Compared to latest update. But I can not understand plzzzzzz you explain How can I write…

Discuss

We are looking for candidates who have completed their master's degree or Ph.D. Click here to know more about our vacancies.