Significance Of Service Sector In India and its Effects on GDP

Presented by: Paras Jain Love Kumar Lalwani

Harshit Parmar Arwa Kanchwala

(F.S II semester)

Service sector

Service sector is the lifeline for the social economic growth of a country. It is today the largest and fastest growing sector globally contributing more to the global output and employing more people than any other sector.

The real reason for the growth of the service sector is due to the increase in urbanization, privatization and more demand for intermediate and final consumer services. Availability of quality services is vital for the well being of the economy.

In advanced economies the growth in the primary and secondary sectors are directly dependent on the growth of services like banking, insurance, trade, commerce, entertainment etc.

Indian Service Sector

In alignment with the global trends, Indian service sector has witnessed a major boom and is one of the major contributors to both employment and national income in recent times. The activities under the purview of the service sector are quite diverse. Trading, transportation and communication, financial, real estate and business services, community, social and personal services come within the gambit of the service industry. One of the key service industry in India would be health and education. They are vital for the country’s economic stability. A robust healthcare system helps to create a strong and diligent human capital, who in turn can contribute productively to the nation’s growth.

Service Sector contribution to the Indian Economy

The Services Sector contributes the most to the Indian GDP. The Sector of Services in India has the biggest share in the country's GDP for it accounts for around 53.8% in 2005. The contribution of the Services Sector in India GDP has increased a lot in the last few years. The Services Sector contributed only 15% to the Indian GDP in 1950. Further the Indian Services Sector's share in the country's GDP has increased from 43.695 in 1990- 1991 to around 51.16% in 1998- 1999. This shows that the Services Sector in India accounts for over half of the country's GDP.

Percentage share of service sector

The Reasons for the growth of the Services Sector contribution to the India GDP

The contribution of the Services Sector has increased very rapidly in the India GDP for many foreign consumers have shown interest in the country's service exports. This is due to the fact that India has a large pool of highly skilled, low cost, and educated workers in the country. This has made sure that the services that are available in the country are of the best quality. The foreign companies seeing this have started outsourcing their work to India specially in the area of business services which includes business process outsourcing and information technology services. This has given a major boost to the Services Sector in India, which in its turn has made the sector contribute more to the India GDP.

Key areas of current and emerging demand in India

information technologytelecommunication servicesfinancial servicesinfrastructure, construction management and consulting serviceseducation and trainingtourism and travel-related servicesfilm and televisionsports and related infrastructurehealthcare servicesresearch, including biotechnologymining servicesretaillogistics, andprofessional services.

Annual rate of growth (in per cent) of the services sector indifferent states of India

An Increasingly Affluent Middle ClassIndia has a large and growing consumer class. India’s National Council of Applied Economic Research (NCAER) estimates that in 2001–02 there were some 53 million households (comprising around 280 million people) with annual incomes of Rs90 000 (US$1900) or more. There were almost 11 million households with incomes of Rs200 000–1million (US$4200–21 000). Bearing in mind the relatively low cost of many goods and services in developing countries and rising per capita incomes, the number of households able to afford an increasing range and quality of services is clearly growing rapidly. By 2009–10, NCAER estimates the number of households with annual incomes of Rs90 000 or more will have increased to 108 million – double the number in 2001–02 and treble that in 1995–96 – while the number of households with incomes of Rs200 000–500 000 could exceed 28 million.

Employment and output in the ‘Organised’ and ‘unorganised’sectors

The organized sector is a major force in the Indian economy, yet is not a major source of employment. The organized sector employed 28 million – or a mere eight per cent – of India’s 337 million-strong workforce in 1999–2000. However it contributed 41 per cent of aggregate net domestic product in the same year. Services (excluding community, social & personal services) are not a major employer within the organized sector, but are a significant contributor to overall GDP. They accounted for just 11 per cent of employment in the private organized sector and 29 per cent of employment in the public sector in March 2003

Commercial services in India

Industry breakdown of FDI inflows in Indian services, 2002–03 to 2005–06

Miscellaneous other commercial services

Finance – work in progress The financial sector has a very important role to play in the

modernization of India’s economy. It serves as a vehicle for channeling savings to individuals and businesses seeking to borrow funds.

The sector therefore plays a vital role in the investment process, which is a major determinant of economic growth. There is strong empirical evidence of a positive relationship between liberalization and growth in financial sectors.

Financial sector reforms and deregulation have triggered strong growth in the sector as financial intermediation has become increasingly important in the economy. Indian stock markets have also come to greater prominence. Measured in terms of the number of transactions, the National Stock Exchange is the third-largest stock exchange in the world after the NASDAQ and the NYSE, while the Bombay Stock Exchange moved into fifth place in 2003.

Yet much remains to be done. Indian borrowers pay more for capital and depositors receive a lower return than they do in comparable economies, due to the sector’s shortcomings in mobilizing savings and allocating capital.

BankingThe Indian banking system is changing rapidly. Traditionally, it was characterized by poorly-performing public sector banks employing outdated practices and technology. Beginning in the early 1990s, the sector has been gradually liberalized but foreign investment remains severely constrained.

Gradual Liberalization of the Banking Sector In January 1993, The Reserve Bank of India issued guidelines under which new private sector banks could be established. Foreign banks were also permitted more liberal entry and have been able to take modest equity positions in existing private sector banks. Interest rates were deregulated in stages beginning in the early 1990s. Banks have been permitted to invest a greater percentage of their assets outside of cash and government securities and given more freedom in their lending policies. While directed lending requirements have remained in place, the scope of lending deemed as meeting these requirements has been widened (Singh 2005). Legislative amendments in 1994 enabled public sector banks to raise capital through public share issues. New guidelines issued in February 2005 provide greater managerial autonomy and operational flexibility to public sector banks. The greater freedoms afforded to the banks have been accompanied by an improvement in the overall regulatory framework, including a tightening of prudential requirements.

Contd…

The penetration of financial services products in rural India is particularly low, with only 42 per cent of rural households having bank accounts, 21 per cent having access to credit from a formal source and only one percent relying on a loan from a financial intermediary (IndiaMART 2006). Improved access to banking products would greatly benefit rural businesses and households, and help to raise living standards across the rural sector as a whole. Some banks are now beginning to introduce innovative technology products that take account of the higher costs of delivering fnancial services to rural India, which stem from typically low transaction sizes along with poor roads, power and telecommunications connectivity. For example, ICICI Bank has introduced ATMs with integrated power management systems suitable for use in rural areas. Its Kisan Loan Card enables farmers to withdraw cash and take out cash or crop loans (ICICI Bank 2004). The bank has also been involved in the establishment of Internet kiosks in rural India, which can complement the ATMs to provide a powerful medium for farmers to enhance their business interests. While arguably a step in the right direction, these initiatives remain modest given the magnitude of the rural service gap in banking.

InsuranceIndia’s insurance sector, like its banking system, has an important role to play in enhancing financial intermediation, creating liquidity and mobilizing savings in the economy.

Reforms in the Insurance Sector The passing of the Insurance Regulatory and Development Authority Act, 1999 enabled competition from the private sector for the frst time. Previously the sector had operated as a state monopoly – the non-life sector under the General Insurance Corporation and its four subsidiaries plus the Export Credit Guarantee Corporation, and the life sector under the Life Insurance Corporation. In August 2000, the newly formed Insurance Regulatory and Development Authority invited applications for registration from private life and non-life insurers. Foreign investment was also permitted, subject to a 26 per cent foreign equity limit. In November 2000, the General Insurance Corporation became the national re-insurer and its subsidiaries were formally de-linked in March 2002.

Contd….In the non-life insurance sector, there are currently eight private insurers and six government-owned insurers. Premium income of the private insurers for the first nine months of 2005–06 was Rs169 billion (US$3.8 billion), 52 per cent up on that for the corresponding period in 2004–05. By comparison, total industry premium income grew by 16 per cent. The market share of private insurers consequently rose from 19.6 per cent over the first nine months of 2004–05 to 26.6 per cent over the corresponding period of 2005–06. Health insurance has been the fastest growing segment of the non-life sector.

Contd… Architectural, engineering and other technical services exports, which reached US$4.64 billion in 2005–06, a 227 per cent increase on the previous year. Maintenance of offices abroad exports, which grew by 106 per cent to US$1.49 billion in 2005–06. Trade related services exports: US$880 million in 2005–06, a 107 per cent increase on 2004–05. Research and development services exports: $US519 million in 2005–06, a 135 per cent increase. Merchanting services exports: US$504 million in 2005–06, an 81 per cent increase. Advertising / trade fair exports: US$435 million in 2005–06, a 169 percent increase. Legal services exports: US$390 million in 2005–06, a 52 per cent increase. News agency services exports: US$339 million in 2005–06, a 98 per cent increase.

TelecommunicationAs at November 2005, there were 48 million fixed-line subscribers and 71 million mobile subscribers (Indian Investment Commission 2006a). Despite the recent rapid growth, tele-density is still relatively low at around 11 phones per 100 people. Penetration in rural areas is significantly lower still. However, a number of mobile operators have plans to tap into the rapid growth expected in rural areas, which is being spurred by the availability of cheap handsets and a wide array of tariff plans. Internet usage has increased nearly tenfold since 2000 to reach 50.6 million in 2005, a penetration rate of 4.5 per cent. However the take-up of broadband has been relatively slow. By November 2005, there were about 750 000 broadband subscribers (Indian Ministry of Finance 2006). The Broadband Policy announced in October 2004 had set a target of three million broadband subscribers by December 2005 and 20 million by 2010 (Indian Ministry of Finance 2005).

Transport infrastructure – vital for growthA modern economy depends upon an efficiently functioning transportation network. Infrastructure shortcomings are frequently cited as among the chief causes for the failure of India’s manufacturing sector to make greater headway as tariff barriers have come down. India has made some progress in recent years in upgrading and modernizing its transport infrastructure, including through Public Private Partnerships (PPPs). But despite the Government’s recognition of deficiencies, much remains to be done. The rate of infrastructure development is likely to lag behind demand and constrain economic growth for some years to come.

RoadsThe private sector has been permitted to participate in national highway projects since 1995, when the National Highways Act was amended. The top priority for the current Five Year Plan period is the completion of the National Highway Development Project (Phase I and II), comprising the so-called Golden Quadrilateral’ connecting Delhi, Mumbai, Chennai and Kolkata, and the North-South and East-West corridors. The Project involves the four/six-laning of 14 000 km of the existing road network, as well as port connectivity (Indian Planning Commission 2002a). The Project was launched in 1999 at an estimated cost of US$12.3 billion.11 NHDP (Phase III), involving the upgrading and 4-laning of 10 000 km of selected high-density corridors of National Highways, was launched in 2005 at an estimated cost of US$12.5 billion (2005 prices).

Contd….Construction of a dedicated high axle-load freight corridor with computerised control on the western and eastern routes was proposed in the 2006–07 budget. In October 2006, work commenced on the Western corridor linking the Jawaharlal Nehru Port Trust and other ports in western India to industries in northern and central India (Singh 2006). Such infrastructure development should go some way to enabling India’s rail network to cope with anticipated growth in freight.

PortsMajor reforms have been introduced to the ports over recent years. Private-sector, including foreign-investor, participation in port development has increased markedly. As of 2005, 13 private-sector port projects with a capacity addition of around 47.4 million tons per annum – or over ten per cent of existing cargo throughput at major ports – and involving an investment of Rs26 billion (US$600 million) had been completed (Indian Department of Shipping 2005). Significant investment has also been directed to ‘minor ports’ (a state responsibility) in some states.

Contd….Airports and air servicesDomestic air services were liberalized in 1994. Private carriers have since been permitted to operate scheduled services in India, subject to the fulfillment of certain criteria. Emulating the emergence of ‘no-frills’ carriers in the United States and Europe, several new low-cost airlines have commenced operations in India since August 2003 to capitalize on increased demand for air travel from rapidly-expanding middle class. The number of domestic passengers is expected to grow from around20 million a year in 2005 to 50 million a year in five years (The Economist 2006d). Today several private airlines compete to provide regular domestic air services, alongside the government-owned Indian Airlines. Currently, the biggest private airlines are Jet Airways, Sahara and Air Deccan. The limit on FDI in domestic airlines has been raised to 49 per cent, although the Government decided not to allow direct or indirect participation of foreign airlines.

Education services•While India has expanded its education system over recent years, many shortcomings still need to be addressed to lessen the constraints it imposes on the growth potential of the Indian economy. •The number of out-of-school children in the 6–14 year age group fell from 42 million at the beginning of the Tenth Five Year Plan period to 8.1 million in September 2004 – although the target of achieving universality of elementary education by 2003 has not been met.•In the higher education sector, enrolments grew at around five per cent annually over the two decades to 2002–03, from 3.3 million in 1983–84 to 9.2 million. In 2000–01, 1.9 million students were enrolled in tertiary-level technical subjects (science, engineering, mathematics and computing) (UNCTAD 2005a). •The gross enrolment rate in higher education (18–23 year age group) is around seven per cent, which is considerably higher than the average across developing countries, but lower •than the average across Asia.•The Indian government acknowledges the need for private sector investment in higher education, including from reputable foreign universities (Indian Planning Commission 2002b). Otherwise, those unable to get into the prestigious institutions will often look to overseas study if it is within their means. The extremely capable students who are not accepted into the IITs and IIMs will often look for an education outside India.•FDI in the education sector with up to 100 per cent equity is permitted under the ‘automatic route’, that is without requiring government approval. However, qualifications issued by these institutions are not recognized by the Indian Government.

Healthcare services•A clear duality has arisen in India’s healthcare systems. Public spending on healthcare is increasingly constrained by public finances. Private healthcare now provides the bulk of the country’s healthcare services, primarily through independent practitioners and increasingly through well-equipped private hospitals.

•The 2002 National Health Policy put forward the objective of increasing public expenditure on healthcare to 2.0 per cent of GDP by 2010 (Indian Ministry of Health & Family Welfare 2002). To achieve this, it envisaged state sector health spending increasing to eight per cent of state budgets by 2010 with the share of central grants to constitute at least 25 per cent of total health spending.

•The National Rural Health Mission (2005–12) aims to tackle the poor health infrastructure in rural areas. It forms an important part of the Government’s strategy to raise public spending on health from 0.9 per cent to 2–3 per cent of GDP.

The success of India’s IT Sector •By any standard, India’s IT sector has enjoyed remarkable success. Revenues of the sector grew more than five-fold in the space of six years to reach an expected US$28.2 billion in 2004–05 (NASSCOM 2005a).• IT services and software is the largest segment (US$16.5 billion),followed by ITES-BPO (US$5.7 billion) and hardware (US$6 billion). According to NASSCOM,the sector’s share of GDP grew from just 1.2 per cent to 4.1 per cent, which would place it ahead of the communications sector.• Total IT–ITES revenues (i.e. excluding the hardware segment) increased by a further 30 per cent in 2005–06 to US$29.5 billion and are expected to reach US$36–38 billion in 2006–07. IT–ITES’ share of GDP is projected to increase to 4.8 per cent in 2006–07 (NASSCOM 2006b, 2006c). While IT services and software revenues have been contributing more to growth in total IT–ITES revenues, ITES-BPO revenues increased ten-fold over the five years to 2004–05.•‘Software services’ (predominantly IT–ITES) exports have grown at a compound annual rate of around 35 per cent over the past six years. In 2005–06, they were valued at US$23.9 billion, comprising US$23.4 billion in IT–ITES, and US$0.5 billion in hardware.• Large companies dominate the export profile, with the top ten companies accounting for 60 per cent of total computer services exports in 2002–03 (RBI 2005c).• India’s share in global IT software and services (including ITES-BPO) spending was 2.3 per cent in 2004–05, and an estimated 2.8 per cent in 2005–06 (Indian Ministry of Finance 2006).

IT BOOM

Interrelationship of services With manufacturing, agriculture and mining

Services sector developments are facilitating modernization in India’s relatively capital-intensive manufacturing sector and in agriculture. Job creation in manufacturing, particularly in labour-intensive industries such as textiles, could play a key role in absorbing India’s growing labour force, lifting millions of rural Indians out of poverty.

Services and manufacturing•While the share of manufacturing in India’s GDP remained largely static throughout the 1990s at around 20 per cent, it has recently posted growth rates in the order of ten per cent. The sector’s competitiveness is being enhanced by the tendency to contract out an increasing array of service functions, which has been made possible by the services tradability revolution.• India remains relatively unrepresented in many labour-intensive manufacturing sectors, despite boasting healthy productivity growth and much lower wages than its competitors. In 2002 Indian workers in the manufacturing sector earned about US$23.80 per month, compared to US$110.80 in China (Thirlwell 2006). India may be able to exploit its competitive advantage in labour costs to significantly expand labour-intensive manufacturing but to do so would need to be able to address transport infrastructure bottlenecks, improve the business environment.•Several global studies have estimated that every job created in manufacturing can lead to the creation of 2–3 jobs in services .

Indian Economy: Future Challenges • Sustaining the growth momentum and achieving an annual average growth of 9-10 % in the next five years. • Simplifying procedures and relaxing entry barriers for business activities and Providing investor friendly laws and tax system. • Checking the growth of population; India is the second highest populated country in the world after China. However in terms of density India exceeds China as India's land area is almost half of China's total land. Due to a high population growth, GNI per capita remains very poor. It was only $ 2880 in 2003 (World Bank figures). • Boosting agricultural growth through diversification and development of agro processing. • Expanding industry fast, by at least 10% per year to integrate not only the surplus labour in agriculture but also the unprecedented number of women and teenagers joining the labour force every year.

Contd….• Developing world-class infrastructure for sustaining growth in all the sectors of the economy. •Allowing foreign investment in more areas. •Effecting fiscal consolidation and eliminating the revenue deficit through revenue enhancement and expenditure management. •Some regard globalization as the spread of western culture and influence at the expense of local culture. Protecting domestic culture is also a challenge. •Global corporations are responsible for global warming, the depletion of natural resources, and the production of harmful chemicals and the destruction of organic agriculture.

The Role of Services in Development• While high-end services are a key driver of economic growth, other services have a critical role to play.• Broadly speaking, the services driving economic growth in India have either not been subject to significant amounts of regulation (notably IT–ITES) or have been deregulated and opened to competition (most prominently, telecommunications).• Growth in high-end services like IT–ITES has the potential to generate significant spin-offs, including productivity growth in other services and in agriculture; technological improvements in manufacturing; and the emergence of a large consumer base with the discretionary spending power to spur demand and employment growth in key labour-intensive sectors.• Financial services and transport infrastructure can be expected to face further pressure to expand capabilities and improve productivity through reform if these sectors are to play their critical role in facilitating economic expansion.• The services sector has a major role to play in absorbing India’s rapidly growing labour force. – Retail and wholesale trade and housing and construction in particular have the potential to employ large numbers of less skilled workers.

Contd…. Restrictive labour laws and a raft of other regulations provide a strong disincentive to small Indian companies growing above a certain size, and prevent modernization and inhibit productivity growth in a number of sectors, including retail, logistics, and legal and accountancy services. Improvements in the delivery of education and healthcare services, particularly in rural areas, are vital for sustainable growth. Services sector developments are facilitating modernization in India’s relatively capital-intensive manufacturing industries and in agriculture, and services inputs should enable India to derive maximum benefit from mineral exploitation once an investment-friendly platform is established for the mining sector.

ConclusionTo conclude, leaving some loose ends aside, this analysis does give a handle to enter into a vast and complex problem of the Indian economy. While services sector growth in the recent era is a common experience to all the Indian states, the nature and determinants are not exactly the same. The industrial sector turns out to be the most important determinant of the services sector growth in different states. However, the analysis suggests that it is necessary to have high and stable rate of growth as well as diversification over time in the commodity-producing sector to foster growth in the services. Under these conditions, agriculture is also likely to generate substantial demand for the services. Inter-regional divergences in the development experience thus become highly influential in this context. The rest of the Indian economy’s commodity producing sector may play an important role in determining the services sector performance of a specific state depending upon inter-regional disparities in labour cost, infrastructure facilities etc. that basically relate to the supply side issues. Incidentally, except for the services sector hardly any significant change can be identified in the growth performances in the other two sectors in the post reform period, including industry, when compared to the early reform era of the eighties. This is true for the output elasticities of the services output as well. If this is so, it is essential to take a hard look at the macro policies that promoted a more open and liberal economy particularly after the early 1990s.

Thank You.