Why economic reforms are necessary for growth of India?

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Q: Why economic reforms are necessary for growth of India?

A: For India to try to get back on the growth path the following may need to happen

1) Inflation moderates

2) Interest rates soften

3) Growth picks up

For this to happen, the reform process needs to be re-kindled. People are talking about renewing reforms but why are reforms vital?

Let’s say there is a small factory that is manufacturing goods and services.
The population of the town buys everything from this factory. As the population grows, the demand for goods also grows. Naturally, the factory raised prices because of the excess demand. This is how inflation steps in.

So how does one fight inflation and bring prices down?
One way may be to reduce the amount of money people have so that they buy less.
To make this happen the Central Bank will increase interest rates.
This way, money is less and prices are controlled.

But people may not be satisfied because they cannot buy much.
But if money is supplied cheaply, prices could go up and inflation could be back.
So what does the government do?

The government may need to make it easy for people to set up more factories and increase supply.

To set up more factories, entrepreneurs would need

1) Land

2) Good quality people

3) Reasonably cheap capital

4) Good infrastructure

In order to make the above available the government has to initiate reforms as explained:-

• Land: To get land, the government has to make policies so that both buyer and seller of land are happy.

• Labour: To get good people, the government has to make policies that will encourage entrepreneurs to set up educational and vocational colleges. This would also include FDI in the Education sector. Since we need to be efficient and competitive with the rest of the world, our labour needs to be productive. For this to happen, we need Labour Reforms.

• Capital: To get reasonably cheap capital the government can do one of the following:-

1. Frame policies to encourage people to invest so that capital is formed. However, people will invest if they have sufficient funds and if they are optimistic about the future. To have adequate funds, money should be available cheaply which means interest rates should be low. But if interest rates are low without commensurate economic production, inflation is likely to step in. Nevertheless reducing interest rates can spur investments.

2. Frame policies that attract foreigners to invest in India. When foreign capital comes in, the value of the rupee goes up and inflation is kept at bay. With inflation at bay, the government can take measures to reduce interest rates. However, the profits arising out of foreign investments have to be shared with them. Either people share and move forward or stay standstill. Hence the need of reforms in the retail sector such as FDI in retail.

• Infrastructure

To be competitive, the manufacturer may need to be efficient; gets supplies in time and can deliver finished goods in time and needs to hold minimum inventory. This is possible on the back of good infrastructure like roads and railways, storehouses, refrigerated vans etc. For infrastructure to come up, we need land reforms so that people are clear what they will get when they hand over their land for infrastructure projects.

So when we have reforms in place, more factories will come up. When more factories come up, the country will produce more goods. When more goods are produced, more money can be printed without losing value.

When more money is printed, the interest rates can be reduced. When interest rates are reduced more entrepreneurs jump into the fray creating more production and more jobs. With more jobs, people have more money and are in a good position to consume the additional production. This gives rise to more investment and thereby a virtuous cycle kicks in.

With adequate supply, inflation is kept at bay even as people have cheap money for investment and for consumption. With interest rates low, inflation low, value of rupee stable, high production, the GDP of the country improves. With higher GDP, more jobs and prosperity in place, the tax collection increases. With higher taxes from higher GDP the situation turns win – win.

People don’t mind paying more taxes because they are earning more. Higher taxes help the government keep its fiscal deficit in check. In the meanwhile, the government is in a good position to invest in bigger infrastructure projects and improve the productivity of the nation.

The moot point of the above explanation is that if the country wants to get a glimpse of utopia, it must reform its policies to infuse efficiency and productivity in the system.

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