To start with, the President is the head of the armed forces of India. He also assigns the various state Governors, the Chief Justice of India and other judges of the Supreme Court and the High Courts, the Attorney General, the Comptroller and Auditor General (CAG) of India. The President also chooses the Election Commissioners and the Ambassadors to different nations. The thing to be noted here is that although the President does not select people for these coveted positions himself, but he can chose not to complete the formal assigning and ask the government to re-look upon the selections. The official procedure for all such posts is finally approved by the President only and hence it is important for him to go through these selections appropriately. Also, being the head of the whole administration, the President is the one who finally approves the bills passed by the Lok Sabha and Rajya Sabha. Here also, if the President is not satisfied with the objectives of the bill, he has the authority to send the bill back to the Parliament once. The President can’t topple the eventual decision of the Parliament, but can interfere to make the cabinet re-think over the objectives of the bill.

One very critical role of the President is the responsibility he has to take while dealing with a death penalty. The decision of death penalty given to a person by Indian Law can be overturned only by the President. This is one of the most crucial decisions that a President may have to make while respecting the legal procedure involved in the particular case. Death penalty in India is imposed only in the rarest of rare cases according to the rule of Supreme Court of India. Hence, it is only at the behest of the President that it can be overturned. Another significant role of the President is during the times of crisis, such as an Emergency, which India has already experienced in the past. In the scenario of an internal crisis or a situation of predicament, the President is the one who declares Emergency and then tries to assist the government. In this case, the President can override many provisions of the constitution, which promise fundamental rights to the citizens of India and provide governing delegation of powers to the states which form the coalition.

As for the appointment of the President, there is a specific reason that the cabinet members and the opposition party members should come as close as possible towards reaching a consensus. This reason is in direct relation with the situation of removal of the President in case he is proved to be guilty of some charges or in case he is found to have dishonoured the constitution. Even in this case, the President can be put on trial only if there is a majority of two-thirds of both the houses of the Parliament. During the voting to decide a new President, the members of Parliament need not follow the instructions of their respective parties as the voting is done through a secret poll.

Looking at a broader level, the President of our country represents our pride and honour simply by the virtue of his designation. Our Presidents in the past have provided motivation to the nation in the form of some inspirational words by addressing the nation on special occasions like Republic Day and Independence Day. This sort of communication with the nation becomes even more crucial when a country is going through a delicate situation or a phase of economic or social vulnerability. Judging by the importance of such occasions, one can say that the job and responsibility of our President is not bounded by a fixed set of regulations and he can continue to serve the country by supporting the decisions of the Government in favour of the people of our country.

Sandeep Sharma

MBA Batch of 2013

Taking a closer look at these issues, the fall in rupee can be attributed primarily to 3 broad factors.

• Firstly, the grim global economic outlook, essentially due to the European debt crisis. Due to turbulence in European markets, investors are considering dollars as a safe haven for their investments in the longer run. This led to an increased demand for dollars vis-à-vis the supply for rupee and thus the depreciation. Another line of thought could be that while investors are shifting from European markets, why are they not investing in the Indian markets?  The Indian economic scenario for the entire 2011 has been plagued by high rate of inflation, hovering above 8%, and extremely low growth in manufacturing sector. The HSBC-PMI (Purchasing Managers index) fell to 51 in the month of December 2011.  The cumulative effect of these factors is leading to a shift in investor sentiments towards dollar market.

• Secondly, the fall in rupee can be largely attributed to the speculations prevailing in the markets. Due to a sharp increase in the dollar rates, importers suddenly started gasping for dollars in order to hedge their position, which led to an increased demand for dollars. On the other hand exporters kept on holding their dollar reserves, speculating that the rupee will fall further in future. This interplay between the two forces further fuelled the demand for dollars while sequestering its supply from the market. This further led to the fall in rupee.
• Lastly, there has been shift of FII’s (Foreign institutional investors) from the Indian markets during the current financial year 2011. FII’s leads to a high inflow of dollars into the Indian market. As per a recent report, the share of India’s FII in the developing markets has decreased considerably from 19.2 % in 2010 to 3.8% in the year 2011. As FII’s are taking their investments out of the Indian markets, it has led to an increased demand for dollars, further leading to a spiraling rupee.

Encompassing all these factors, there is a lack of firm initiative by government on issues such as allowing FDI in retail. Recent debacles such as 2G have further rendered the Indian market unattractive to a certain extent.

Evaluating the impact of the falling rupee on the Indian economy -

The first major impact of the falling rupee can be seen on the rising import bill. India imports close to 70% of its net fuel requirements. This means the companies importing oil have to shell out more rupees for the same dollar invoices. As is clear from Fig.1 although the price of oil has gone down from $118  per barrel to $109 per barrel, not much benefit can be derived since exchange rate too shoot up from Rs. 44 to Rs. 52.7 a dollar.. Instead, the price of importing oil increased to an extend of RS 489 (as is clear from Fig2 (b)). This has severely impacted the bottom line of these companies as well as the subsidy bill of the Indian government. Huge buying of dollars from the market in order to meet the import bill has further added to the existing woes. Additionally, the falling rupee has added further to the inflationary pressures, as imports have become costlier and thus increasing the prices of key commodities such as oil, imported coal, minerals, and metals. However the falling rupee has substantially appreciated the revenues for the exporters, who receive more rupees for their dollar receipts.  These industries include the IT Services industry, textiles and other export oriented industries. Increasing imbalance in trade i.e. increasing imports over exports is bound to have severe impact on country’s fiscal deficit, which is pegged to increase by .8 percentages to 5.4% of GDP from the originally estimated value of 4.6% of GDP.

Figure 1 – oil prices and exchange rates

Source – RBI

Role played by RBI: RBI has been extremely cautious in its intervention during the entire rupee depreciation crises. RBI has however reacted with timely interventions by selling dollars intermittently to tame sharp fall in the currency. The outflow of dollar reserves from RBI coffers has been extremely cautious, mostly due to the dwindling foreign exchange reserves. The foreign exchange reserves of India in December 2011 stood at 270 billion USD. Recently RBI has intervened with key policy initiatives such as intervening in the forward contracts policy. As per new RBI policy the cancelled forward contracts cannot be rebooked. Exporters in order to rake in more profits, were booking forward contracts, then cancelling the contracts, and again rebooking at better rate. This process led to a further depreciation in rupee and fuelled speculations.  Also, RBI intermittently put trading limits for the banks in the foreign exchange market in order to tame the speculative forces.

Looking at the current economic outlook, the currency crises seems to stay for a much longer period this time around. However, a structuring of Greek debt coupled with higher inflows from FII’s can lead to an arrest in the falling rupee.

Source of Data:

http://www.hsbc.com/1/2/emerging-markets/em-index/purchasing-managers-index http://www.rbi.org.in/scripts/statistics.aspx

–

Contributed by:

Himanshu Joshi

himjoshi@iitk.ac.in

MBA – 2011-13

Through this paper, I aim to bring into perspective the role of markets and governments in initiating, promoting and sustaining growth in these emerging economies. The close coordination of the various forces which shape an emerging economy requires better understanding to appreciate the dynamicity and core growth equations behind the success story of emerging economies. Through this study, we may be able to better understand their deep interplay as well as the intrinsic challenges they face.

The final part in this 3 part series covers the counter balancing forces of government policy needed to stabilize and drive emerging economies into a progressive future.

Role of Government as a Regulatory and Growth promoting body

Monetary and Fiscal Policies

Modern economics is greatly influenced by Keynesian theories propounding the increased role of governments in regulating and stabilizing markets to ensure stable growth. Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and therefore advocates active policy responses by the public sector, including monetary policy actions by the central bank and fiscal policy actions by the government to stabilize output over the business cycle. In the Keynesian economic model, the government has the very important job of smoothening out the business cycle bumps. They stress on the importance of measures like government spending, tax breaks and hikes, etc. for the best functioning of the economy.

Monetary Policy works by lowering the interest rates, which attractive private companies to invest in real assets which increase the aggregate demand indirectly, by raising the private sector expenditure. The opposite is also done to reduce the money supply in the economy so that inflationary tendencies are minimized and economy over-heating is prevented.

Fiscal Policy is more direct, but acts more slowly. It works by increasing demand for goods. Government does the borrowings to build roads, buildings etc, does the tax cutting, and tries to put more spending power in the hands of households.

Traditionally, the working of monetary policies can be summed up as: Central Bank lowers the interest rates as a result injecting liquidity in the financial system. Commercial banks try to lend the additional money leading to the falling of interest rates further. This leads to the fact that risky business becomes profitable. Firms and houses, as a result, begin to buy more number of goods, thereby increasing employment.

The financial tools available in the hands of the Reserve Bank of India to control the monetary and fiscal policies are:

1. Bank Rate: It is the Discount Rate, rate which the central bank charges on loans and advances to commercial banks (Short term).
2. Repo Rate: It is the rate at which the RBI lends money to commercial banks, a short term for repurchase agreement. A reduction in the repo rate will help banks to get money at a cheaper rate. It is equivalent to the discount rate of US. (Long term).
3. Reverse Repo Rate: It is the rate at which Reserve Bank of India (RBI) borrows money from banks.
4. Cash Reserve Ratio (CRR): It indicates the amount of funds that the banks have to keep with RBI. If RBI decides to increase the percent of this, the available amount with the banks comes down. RBI is using this method to drain out the excessive money from the banks
5. Statutory Liquidity Ratio (SLR): It is the amount a commercial bank needs to maintain in the form of cash, or gold or govt. approved securities (Bonds) before providing credit to its customers. SLR rate is determined and maintained by the RBI in order to control the expansion of bank credit.

Thus, through the use of Monetary and Fiscal policies, the government can effectively control the money supply and hence the demand fluctuations of the market. This is essential as growth cannot be uncontrolled. An uncontrolled spiral of growth invariably is built on shaky foundations which are bound to cave in bringing everything crashing down. Until growth of the economy is backed by strong fundamentals, the speculative trading would remain strictly short term with the specter of a long term crash imminent. The sub-prime mortgage crisis caused by speculative trading in realty is an apt example of such a scenario. This long term thinking is what stabilizes growth and makes emerging economies an attractive destination since they have robust fundamentals.

Production in Core Sectors

The government steps in for production of goods or services in areas which either are economically unviable for private enterprise, natural monopolies requiring heavy capital investments or are restricted from private industry participation. Investment and growth of these sectors are in the best interests of the nation. However, some of these industries require very high capital investment and may achieve break-even after many years. This makes it an unviable project to be invested and pursued by private enterprise that is mostly answerable to shareholders for their business results. The role of governments here is to invest in the long term growth and development of the nation. Pandit Nehru, the first Prime Minister of India, called these as nation building activities which required state involvement for sharing the fruits of growth and prosperity with the entire society. The investment of government in such areas as infrastructure also provides a firm foundation for the future growth of the country. Infrastructure provides connectivity, new untapped markets and a chance to boost commerce in distant corners of the nation. Secondly, such capital investments provide employment opportunities as well as a boost to the country’s GDP. This GDP boost also in turn shows an effect on the valuation of the private firms trading through the stock markets (see Figure 1). Government can also use this as a chance to collaborate with indigenous industries and increase their growth prospects. Thus, similar to the magic multiplier effect in banks, the government capital infusion and government controlled industries produce multiple positive effects on the economy thus producing robust growth prospects.

Sectoral spending patterns of governments reveal that the emphasis is towards promoting areas having lower growth as well as empowering disadvantaged sections of the nation to ensure the trickling down of prosperity in an equitable manner. Additionally, government spending even in developed countries is seen in such areas such as education, law and judiciary, healthcare, pension schemes and defense. This shows the central role of government in nation building for the future as well as in providing services for the betterment of the citizens.

Regulatory Responsibilities

The governments in emerging economies also shoulder regulatory responsibilities which enable it to control various macro-economic aspects of the economy. Through regulation, government can iron out the inconsistencies and inefficiencies of the market as well as shape the economic environment as per the shifting global and local trends. Regulations are essential in certain areas to ensure fair practices, preservation of rights and the empowerment of the citizens. Government also holds in its grips the tariff regulations which enable it to preserve the indigenous small scale industries from global competition as well as prevent dumping of inferior goods on local markets. The presence of multinational companies and low cost markets abroad having incentive to dump such rejected goods in the market can skew the prices and hence create inefficiencies in the free market price discovery process as well. This kind of actions can severely affect indigenous industries and can result in monopolies emerging. The regulation of trade is another key focus area of policy since unrestricted trade can lead to local markets facing inflation. The working of the CCI (Competition Commission of India), SEBI (Security Exchange Board of India), IRDA (Insurance Regulatory and Development Authority and other such regulatory bodies working in tandem with central and state government in India ensure that legal and ethical practices are followed and the general public is given a fair deal.

Overall, we can see the central role taken up by government in controlling and shaping the growth in emerging economies. While their involvement definitely has its benefits, there needs to be a balance since open market policies work best when they have minimal intrusions from external entities so that pure market forces determine the valuations and expectations of the consumers. Stringent government regulation and high tariff walls lead to protectionist tendencies which can choke private industries and mar the conducive environment for foreign investment.

Conclusion

Overall, through the various aspects considered above, we can see that emerging economies possess great dynamism which is fostered through the market economy as well as regulated through the presence of government intervention. The initiatives taken through promotion of free markets, investment in developmental projects, the focus on improvement of social development indexes, the maturing of governmental policies all point towards a focused effort at breaking into the league of world super-powers. Through their growing political, economic and trade clout, these maturing economies have started shifting the balance of power slowly and surely towards themselves. Through the exploration of various aspects of the role of markets and government in fuelling their growth, it has been clearly seen that such markets are increasing in the complexity of their operations and the span of their influence. The interconnectedness of development in laws, policies, frameworks, growth sectors, social indices, new markets, indigenous small scale industries etc. shows a uniformity of purpose as well as a clear roadmap charted out by these emerging economies in being the engines of growth for the world of tomorrow.

Figure 1 - This figure shows the relation between GDP growth on the stock market through a study using index data of a wide range of funds over a period of time in the BSE Indian Stock Exchange.

Data captured from http://www.sscommonsense.org/page04.html

Nabarun Sengupta

Masters of Business Administration (2010-2012)

IIT Kanpur

Through this paper, I aim to bring into perspective the role of markets and governments in initiating, promoting and sustaining growth in these emerging economies. The close coordination of the various forces which shape an emerging economy requires better understanding to appreciate the dynamicity and core growth equations behind the success story of emerging economies. Through this study, we may be able to better understand their deep interplay as well as the intrinsic challenges they face.

The 2nd part in this 3 part series covers the role of Markets as growth drivers in Emerging economies while the final part of the series next issue will deal with the counter-balancing forces.

Role of Markets as a Growth Engine

Price Discovery – Economists have traditionally believed that there exists an invisible hand in a free market based economy, which bring a state of equilibrium in market and this in-turn result in price discovery. Advocates of the free market form of economy argue that price discovery is a natural process that ensures fair, accurate, and responsive pricing. The essential philosophy of price discovery is that firms maximize their profit and consumers maximize their benefits. The preconditions for price discovery to happen are the presence of a large number of buyers and sellers, absence of any buyer/seller having absolute power to influence the market and absence of any form of information asymmetry among the parties involved. This concept of price discovery is the most intrinsic feature of a free market based economy. The mechanism of price discovery ensures that there is an unbiased way to determine the intrinsic value of any good in the market. Through the presence of a large number of buyers and sellers, the continuous exchange of goods enables all parties involved to obtain the best value with minimal inaccuracies. This technically ensures that skewed pricing schemes or incorrect valuation is not followed and every product has a constantly varying price affected by its quality and the nature of its demand. This dynamicity brings out the competitive forces in the market and ensures that innovation is always at the forefront of any industry policy.

Foreign Investment Opportunities – A major attraction of following free market policies is its ability to attract foreign investors into funding growth and development projects in the country. Foreign investors and angel investors generally look for high growth opportunities to invest their money in as seen by the increasing FII and FDI inflows into India (see Chart 1). With the maturity of developed markets and flat growth seen in such economies, these developed countries divert large sums of money into such emerging investment locations offering higher growth rates. The only caveat is the added risk introduced into their investment profile. For this reason, such investment vehicles generally prefer politically stable and economically progressive countries which have transparent policies and lower regulations on investments. Such foreign investments are crucial for augmenting the government spending on key sectors like education, healthcare, infrastructure, natural resources. India recently made news when FII inflows crossed the magical figure of Rs. 1 Lakh Crore which reinforced the confidence of foreign funds on the robustness of the Indian markets and its capability to sustain high growth with balanced policy (see Chart 2).

Chart 1

Chart 1

Data Source: Department of Industrial Policy & Promotion, Govt. of India
* Data for FY10 is for the first 11 months – Apr. 2009-Feb. 2010

Chart 2

Chart 2

Data shows the Total FII Inflows of 2010 which went beyond Rs. 1 Lakh Crore

However, a word of caution must be added to this rosy picture. The basic premise of foreign investment into emerging economies is to capitalize on the high growth rates offered. Hence, this funding is primarily profit seeking in its nature. An over dependence on these inflows would leave a country in a sensitive position where a slight destability may lead to huge outflows of investment. The onus is firmly on these emerging countries to establish and maintain a stable environment conducive for investment and presenting a balanced picture of sustainable growth. There are many instances of economies encountering pricing bubbles and speculative trading on the back of erratic foreign investments. So not only is it essential that investment is attracted, but regulations must also be made to limit these inflows to ensure sustainable growth. The inflationary tendencies of the economy as well as the speculative valuation of stocks on the back of FII and FDI inflows are well documented and hence need extra caution to be exercised.

Growth in GDP – Gross Domestic Product or GDP is a primary measure of the vitality of an economy as it conveys the dollar value of all the goods and services produced by that country over a specified period of time. As can be clearly seen, a robust and dynamic market can spur growth in the investment in private industries which in turn helps fund their growth plans. The highly capital intensive nature of heavy industries and core sectors requires heavy investments and this is where markets come into the picture. Through the stock markets as well as foreign investment vehicles, industries gain the capital required to pursue high growth strategies and scale up their businesses. This in turn results in increased production of goods and services and hence a robust GDP growth. As seen in Chart 3, the promising growth of emerging economies such as India and China is set to outstrip Western countries and sustain at much higher rates as per independent estimates.

Chart 3

Chart 3

Data shows the projections of the Real GDP growth of the major economies of today based on growth rates and figures taken historically.

Rise of the Consumer – The market structure promotes transparency of pricing, infusion of cash for growth initiatives and provides competitively priced technologically superior products in the hands of the consumers. In addition to this, the growth impetus provided by market economies results in huge employment opportunities resulting in increased per capita income. This increased income thus boosts consumer spending and helps in developing high growth markets internally. The presence of large number of competitive firms in every sphere helps shift the power into the hands of the consumer and empowers him to make informed decisions. Consumer spending accounts for nearly 60% of the total GDP of United States of America and international trends show the importance of a strong local consumer demand to ensure robust growth patterns.

As we have seen above, there are numerous benefits of an open economy which triggers and sustains high  growth in an economy. However, an area of concern is the formation of asset and valuation bubbles due to large inflows of investments. Since emerging economies are currently riding high on consumer sentiments, FIIs and FDIs are reaching unprecedented levels. This is primarily backed by strong short term profit making interests. An uncontrolled free market structure can result in valuation bubbles which are basically high valuations built on weak fundamentals. Preventive measures for such scenarios require a strong presence of regulatory authorities and balancing policy shifts to ensure that growth is balanced and sustainable.

Part 3 concludes next issue with the counter balancing forces of government policy needed to stabilize and drive emerging economies into a progressive future.

Nabarun Sengupta

Master in Business Administration(2010-2012)

IIT Kanpur