In this article, we deal with various macroeconomic factors which not only influence the economic condition of the country but also the working of financial services in the country.
Macroeconomic Aggregates and Policies
Economic factors at the national level, influencing the economic condition of the country can be stated as macroeconomic aggregates. These are
- Savings of the economy
- Economic Growth
- Capital formation
- Capital output ratio
- Population growth
- Growth of foreign trade
- Balance of payments
- Foreign debt
- Exchange rate stability
- Employment level
- Capital inflow
- Per capita income as an indicator of economic development.
1. Savings of the economy
In most of the developed countries, savings of the people form a major part of investment in the country. Savings can be there only when the income level of the people is higher and the people are living above the poverty level. In India, savings are on an average only 9% of the total Gross Domestic Product. As against this, in developed countries, they are nearly 28 to 30% of GDP.
When there are low savings, there is little scope for investment and also whatever little savings are made, they do not reach the organized sector. They get fretted away in conspicuous consumption (for example, the purchase of jewels in the rural economy). Instead, if such savings are invested in corporate securities, they promote more investment. Hence, the financial services in our country are unable to play a major role due to poor savings.
The growth of the economy depends on the extent of investment made in the country. Investments must generate more production and they should promote a balanced growth of all the sectors in the economy. In some countries, investment may be made in those sectors which have favorable factors and they will create a thrust in the economy leading to the growth in other sectors. Thus, more production in agriculture will create conditions for growth in industrial sector and service sector. Investment can be done both by public and private sectors.
The government should play a role in promoting more investment by granting incentives and facilities so that more promoters and investors enter the market. A stable government with a steady economic policy will also promote investment. A proper climate for investment should be created in the country through the promotion of capital market, money market, financial institutions with various financial services.
Investment as a percentage of GDP should be sufficient so that the desired growth is achieved in all the sectors of the economy.
3. Economic Growth
The increase in physical production in all the three sectors of the economy namely, agriculture, industry and service is referred as economic growth. An increase in economic growth need not bring an increase in economic development. Because, the increased production may be consumed by the increased population. Hence, the increase in production experienced in all the 3 sectors should be sufficient not only to cater to the needs of population but also provide some surplus for the economy to grow. The financial services have to play a supportive role in channelizing the savings and investment so that growth is achieved overall.
4. Capital Formation
When a company earns profits, it may plough back a part of its profits in the business which expands its capital. In this way, capital formation takes place. For capital formation, a reduction in consumption is very essential. If all the production is consumed, without allowing any savings for ploughing back, capital formation will become nil. Thus, capital formation is a kind of sacrifice the producer has to make by ploughing back his profit. But, this will be done when the prospects of earning more profits are bright. Financial services can play a major role by attracting the savings or the profit earned by the companies for a beneficial investment.
5. Capital-output ratio
The amount of capital required for an output is dealt in the capital-output ratio. The significance of this ratio is the quantum of capital needed for generating the required output. If lesser capital is generating more output, it reflects a healthy capital-output ratio. This is possible when the technological growth is at its peak in the country. With more technology, lesser capital is utilized and more output is obtained. With a higher amount of investment, the capital-output ratio is bound to bring in more benefits to the economy. The difference between an under developed and a developed country is this — a developed country consumes less capital but brings out more output, while an under developed country consumes more capital and turns out lesser output due to poor technology. We can very well experience this in our agriculture.
6. Population Growth
Increase in population may retard the economic growth of a country, if the increased population is not put to use for productive purposes. But unfortunately, the productive force in the increasing population is of lesser percentage, while the consumption force is of a higher percentage. There are countries which regard ‘population’ as a human resource, contributing for capital so that they are responsible for increasing the Gross Domestic Product of the country. China is an example wherein the productivity of human labor is very high.
Skill formation and creation of more skilled labor contribute more to the service sector. Of the 3 sectors in an economy, it is the service sector which contributes more to the economy and the development of human resources enables a country to earn more national income. Of late, the export of services is gaining ground and in this context, India has earned more than 15% of its export earnings in the IT industry by exporting software. Financial services require more human touch and it is here that a trained person in financial service contributes more to the economy.
7. Growth of Foreign Trade
Export forms a major part of any developed economy. Most of the countries which have developed rapidly have given due importance to foreign trade. The promotion of foreign trade requires the active support of financial services. Banks provide export finance. Factoring and forfaiting companies finance the exporter. Leasing companies provide equipment, while a merchant banker finances an exporter in foreign exchange to import capital equipment. In this way, every aspect of financial service promotes foreign trade which in turn plays a crucial role in the development of the economy.
8. Balance of Payments
The receipts and payments of a country from abroad are represented by the balance of payments statement. If the receipts are more and the payment is less, the country experiences a favorable balance of payments position. But sometimes, it may face a reverse situation, with more payments and less receipts, leading to unfavorable balance of payments. When a country borrows heavily and combines it with a heavy imports, it is bound to experience adverse balance of payments position. It can overcome the situation only by increasing its exports and repaying its foreign loans.
The financial services in the country can help the nation from coming out of its adverse balance of payments situation. They can raise more foreign loan or attract more foreign savings and invest them in profitable ventures so that they can provide a better return to the foreign investors. Thus, the financial services can act as a bridge between the foreign investor on the one hand and the domestic producer on the other.
9. Foreign Debt
Financial services help the economy in mobilizing foreign debt. Such debts can be obtained in the global financial market at a competitive rate of interest. Normally, the credit rating of the country is taken into consideration before extending any foreign loan. The past performance of the country in the repayment of the foreign loan is yet another factor that decides the interest rate for the loan.
If the foreign debt is utilized for unproductive purposes or is not properly invested, then the chances of the country raising more loan in the foreign financial market will be dim. Hence, raising foreign debts at a competitive rate of interest and putting them for proper use is another important factor and the financial services ensure that the returns commensurate with the interest rate on the foreign debts.
10. Exchange rate stability
When a country continuously borrows in the foreign market, followed by heavy imports, then it will experience a decline in its currency value in relation to foreign currency. For example, if India has an exchange rate of 1 US Dollar = Rs. 68, after the imports and foreign debts, its exchange rate may slide to 1 US Dollar = Rs. 80. This slide will affect India, as we have to pay more for our debts which are now 25% more than what they were at the time of ow borrowing. Due to this, India’s foreign debt burden will increase. The financial services can reduce this by two methods. First, they can find out methods to reduce our supply of currency in the Foreign exchange market, thereby push up the exchange rate in favor of India.
Secondly, the financial services themselves can export services (invisible trade) by way of Banking, Insurance, etc., and earn foreign exchange by which the debt burden can be reduced. This will also increase our currency value. If exchange rate stability is not maintained, it will affect our foreign trade prospects and thereby exchange earnings.
11. Employment Level
Another macroeconomic aggregate influenced by financial services is the level of employment. With more financial services such as leasing, hire purchase finance, housing finance, insurance, etc., the level of employment opportunity in the country is bound to increase. This will create more demand and other industries will also expand. Thus, the country can reach the level of full employment.
12. Capital Inflow
The capital market in the country can attract more capital from abroad, leading to capital inflow. This will take place only when the return on capital is much higher or the interest rate offered is higher than what is prevailing in the domestic country. Financial services play an active role in attracting capital by selling various products and services. India, by selling American Deposit Receipt (ADR) and Global Deposit Receipt (GDR) could attract more foreign funds. Similarly, SBI could mobilize more funds through India Resurgent Bonds and Millennium Deposit Receipts.
13. Per capita Income as an indicator of economic development
When the national income of the country increases, due to increased production and services, the benefit goes to the population in the form of per capita income which is an indicator of the economic development of the country. Financial services can increase the per capita income by providing various types of loans and encouraging self employment schemes. They can also help in the mobilization of the savings by providing various sources of investment.
The mobilization of savings and channelizing them in productive investment are bound to improve the economy and thereby the national income and per capita income. The financial services form a part of service sector and their activities will have a direct impact on the population and the economy.