India Transformed

by Rakesh Mohan

  The Government is pledged to launching a reinvigorated struggle for social and economic justice, to end poverty and unemployment and to build a modern, democratic, socialist, prosperous and forward-looking India. Such a society can be built if India grows as part of the world economy and not in isolation.

  While the Government will continue to follow the policy of self-reliance, there would be greater emphasis placed on building up our ability to pay for imports through our own foreign exchange earnings. Government is also committed to development and utilisation of indigenous capabilities in technology and manufacturing as well as its upgradation to world standards.

  Government will continue to pursue a sound policy framework encompassing encouragement of entrepreneurship, development of indigenous technology through investment in research and development, bringing in new technology, dismantling of the regulatory system, development of the capital markets and increasing competitiveness for the benefit of the common man. The spread of industrialisation to backward areas of the country will be actively promoted through appropriate incentives, institutions and infrastructure investments.

  The Government will provide enhanced support to the small-scale sector so that it flourishes in an environment of economic efficiency and continuous technological upgradation.

  Foreign investment and technology collaboration will be welcomed to obtain higher technology, to increase exports and to expand the production base.

  The Government will endeavour to abolish the monopoly of any sector or any individual enterprise in any field of manufacture, except on strategic or military considerations, and open all manufacturing activity to competition.

  The Government will ensure that the public sector plays its rightful role in the evolving socio-economic scenario of the country. The Government will ensure that the public sector is run on business lines as envisaged in the Industrial Policy Resolution of 1956 and would continue to innovate and lead in strategic areas of national importance. In the 1950s and 1960s, the principal instrument for controlling the commanding heights of the economy was investment in the capital of key industries. Today, the State has other instruments of intervention, particularly fiscal and monetary instruments. The State also commands the bulk of the nation’s savings. Banks and financial institutions are under State control. Where State intervention is necessary, these instruments will prove more effective and decisive.

  The Government will fully protect the interests of labor, enhance their welfare and equip them in all respects to deal with the inevitability of technological change. The Government believes that no small section of society can corner the gains of growth, leaving workers to bear its pains. Labour will be made an equal partner in progress and prosperity. Workers’ participation in management will be promoted. Workers’ cooperatives will be encouraged to participate in packages designed to turn around sick companies. Intensive training, skill development and upgradation programmes will be launched.

  Government will continue to visualise new horizons. The major objectives of the New Industrial Policy package will be to build on the gains already made, correct the distortions or weaknesses that may have crept in, maintain a sustained growth in productivity and gainful employment and attain international competitiveness. The pursuit of these objectives will be tempered by the need to preserve the environment and ensure the efficient use of available resources. All sectors of industry whether small, medium or large, belonging to the public, private or cooperative sectors will be encouraged to grow and improve on their past performance.

  The Government’s policy will be ‘continuity with change’.

  In pursuit of the above objectives, the Government has decided to take a series of initiatives in respect of the policies relating to the following areas:

  a) Industrial Licensing.

  b) Foreign Investment.

  c) Foreign Technology Agreements.

  d) Public Sector Policy.

  e) MRTP Act.

  II

  THE BIG PICTURE: PAST, PRESENT AND FUTURE

  2

  India’s 1991 Reforms: A Retrospective Overview

  Montek Singh Ahluwalia1

  Much has been achieved in the twenty-five years since the reforms began but as the old problems were solved, new ones have surfaced and solving these needs new initiatives that will have to be as far-reaching as the original reforms were.

  In one sense, economic reforms are a continuing process, because policies are regularly modified to improve performance or respond to new challenges. But every now and then, we witness a paradigm shift in the way the economy is managed. The 1991 reforms in India are special because they represent precisely such a shift.

  The need for policy changes had become evident by the end of the 1970s, when it was clear that India was lagging behind other East Asian and South East Asian countries. Analysts, both inside and outside government, argued persuasively that India’s poor performance was due to the stifling controls over private-sector activity and the insulation of the economy from global competition because of import controls, high tariffs and a generally negative approach towards foreign investment. These controls began to be moderated in the 1980s, at first in a limited way under Prime Minister Indira Gandhi in the first half of the decade and then more aggressively in the second half under Prime Minister Rajiv Gandhi. These changes had a favourable impact on growth performance, raising the average growth rate of GDP to 5.6 per cent in the 1980s, as opposed to only 2.9 per cent in the 1970s. However, the policy changes, though important, were not systemic. They introduced flexibility at the margin but left the control system itself in place, liable to reversal at any time.

  By the end of the 1980s, it was clear that a more fundamental change was needed and the reforms of 1991 signalled the start of this change. A quarter century later, it is necessary to look back and see what worked and what didn’t. This paper presents a retrospective assessment using two somewhat different approaches. Section I focuses on the design of the reforms, whether it was appropriate, and how it was implemented in practice. Section II focuses on the outcomes. Did the reforms succeed in their stated objectives in terms of growth and other goals?

  I. Issues Related to the Content of the Reforms

  The 1991 reforms were introduced in the context of a severe balance-of-payments crisis and, as such, consisted of two components. One was a conventional macroeconomic consolidation package aimed at reducing the fiscal deficit to lower aggregate excess demand, which had spilled over into the balance of payments. The other component was a package of structural reforms, designed to raise productivity and make the economy more competitive, laying the foundations for more rapid growth.

  It is the structural reform component that signalled a paradigm shift in the way the economy was to be managed. The earlier suspicion of the private sector—and of markets in general—gave way to a new emphasis on freeing the creative energies of the private sector by allowing it to respond to market forces. It was explicitly stated that the domestic industry had been excessively protected for too long through high tariffs and import controls, making it inefficient and uncompetitive. The new strategy signalled a reduction in the level of protection and a shift to a much more open economy, in which self-reliance meant exports paying for imports with a modest requirement for external capital flows. In addition, it was proposed that historical fears of foreign direct investment—the ghost of the East India Company—be laid to rest and foreign investment be welcomed as an instrument for modernizing Indian industry. The public sector had traditionally been viewed as occupying the commanding heights of the economy. There was no invocation of privatization rejecting the public sector on ideological grounds, but it was clearly asserted that the public sector was expected to perform efficiently, or shut down if it couldn’t stop making losses.

  Several questions arise about the design of the reforms and how they were implemented. Were the 1991 reforms comprehensive enough to cover a sufficient range of areas, and were th
ey appropriately sequenced? Were they thrust upon a reluctant government solely under pressure from the IMF and the World Bank? Was the pace of implementation too slow? Were they incomplete in the sense of not being followed up by a second generation of reforms and, if so, what should these reforms have attempted? My answers to these questions are summarized below.

  Was the 1991 Package Sufficiently Comprehensive and Well Sequenced?

  The reform package was clearly much more comprehensive than anything attempted earlier. Its comprehensiveness can be seen from the following ten most important changes mentioned in the Budget speech.

  (i)     Industrial licensing was abolished for all but a handful of industries where it was retained for either strategic reasons or because of environmental sensitivity.

  (ii)    Abolition of licensing also meant that the location of industries was no longer decided by the government as part of the licensing approval but by the entrepreneur, subject to local government approvals.

  (iii)   The list of industries earlier reserved for the public sector was drastically reduced from eighteen to eight.

  (iv)   Control over investment by the so-called ‘large houses’ covered by the Monopolies and Restrictive Trade Practices Act, intended to discourage the concentration of wealth, was abolished.

  (v)    FDI, which was earlier allowed only up to 40 per cent of total equity, and that too subject to discretion, was freely allowed up to 51 per cent of total equity in a large range of industries. In addition, a Foreign Investment Promotion Board was set up to actively pursue FDI.

  (vi)   Industries were allowed to freely enter into agreements for technology transfer as long as the royalty payments were within stipulated levels as a percentage of turnover.

  (vii)  There was major liberalization of foreign trade, with import controls abolished for intermediate goods, capital goods and components, all of which could be freely imported against tradeable import entitlement licences (called exim scrips) issued to exporters at 30 per cent of export value (40 per cent in some cases).2

  (viii) A new policy was articulated towards public-sector enterprises, under which loss-making PSUs deemed non-revivable would be closed down.

  (ix)   A phased programme of tax reform covering direct and indirect taxes was to be undertaken based on the recommendations of the Chelliah Committee.

  (x)    A programme of financial-sector reforms was to be undertaken based on the recommendations of the Narasimham Committee.

  The first six items listed above were implemented in the very first year. In the case of trade policy (item vii), the exim scrip arrangement introduced in July 1991 was quickly replaced by a dual exchange rate on 1 March 1992, which, in turn, was replaced by a unified market-determined exchange rate on 2 March 1992. In the short space of two years, investment controls on the private sector were more or less abolished, and the rigid import-licensing system was also dismantled, and all items of capital goods, components, intermediates and raw materials were made freely importable. The fact that decontrol of investment occurred simultaneously with trade liberalization was an important act of sequencing, since otherwise, the industrial decontrol would have been negated by the need to get import licences.

  The liberalization of trade policy simultaneously with an initial devaluation, followed by a shift to a flexible exchange rate, was another example of sensible sequencing. The exchange rate was very significantly depreciated over a two-year period, and this made it possible to liberalize import controls and reduce import duties with far fewer problems than would have arisen if trade liberalization was not accompanied by exchange-rate depreciation.

  The exclusion of finished consumer goods, such as garments, processed foods, household appliances, consumer electricals, scooters and cars, from the initial stages of liberalization was also a conscious sequencing decision, since most of these items were produced by a large range of smaller and middle-sized industries and would have needed more time to face competition. However, as we argue later, the liberalization of this segment was unnecessarily delayed.

  An important feature of the 1991 reforms is that the extent of the change in policy, which was very considerable, was deliberately underplayed for political reasons. Jairam Ramesh (2016) reported that when the proposed changes in industrial policy were presented to the Cabinet Committee on Economic Affairs, there was a strong negative reaction from senior Congress party politicians, who saw it as a reversal of traditional Congress policies. However, the same proposals were found acceptable later when presented along with a preamble that acknowledged the contributions of earlier Congress prime ministers, outlining the changes as a continuation of a long-established tradition of modifying policies in the face of new challenges. Instead of a forthright declaration that fundamental change was needed, it was found more practical to emphasize continuity to avoid dissension within the party. This is an example of political considerations leading to a conscious choice of ‘reform by stealth’. While it had some advantages in the short term, it is evident that it also had long-term disadvantages, since it kept the political class locked into older slogans.

  Were the Reforms Home-grown?

  The reforms were severely criticized by opposition parties and the large community of left-leaning academics opposed to liberalization, on the grounds that they were thrust upon a reluctant but helpless government by the IMF and the World Bank as the price for providing financial assistance. Since issues of sovereignty often cloud debates on public policy, it is worth putting the record straight on this issue.

  There is no doubt that the new government, which took office on 21 June 1991, faced a desperate situation. Foreign-exchange reserves were down to $1.1 billion—roughly within two weeks of imports—and a fear of default was in the air. Support from the IMF and the World Bank was absolutely necessary, and it would not have come without conditionality. It is also true that the reforms announced in 1991, including both the reduction in the fiscal deficit and the structural reforms in industrial, trade and public-sector policy, were incorporated in the agreement with the IMF/World Bank financing. However, it would be wrong to believe that the reforms were thrust upon an unwilling government. I have outlined in some detail the build-up of the internal thinking in the years preceding the reforms, and it is clear that many of the steps taken in 1991 had been discussed internally and had supporters within the government.3

  It is fair to say that the crisis became the occasion for the reformers within government to push for what they had been talking about. I have no doubt that in the absence of a crisis, these changes might not have been made so quickly. It is to the credit of the Narasimha Rao–Manmohan Singh duo that they did not ‘waste the crisis’. In an article I wrote for the Economic and Political Weekly (2016), I mention four reasons why one can argue that there was internal commitment to the reforms, independent of pressure from the international financial institutions. First, in some areas, notably trade liberalization and the shift to a market-determined exchange rate, the reform package went well beyond what the IMF and World Bank were advocating. Second, the reforms consciously excluded any commitment to privatization, which was a part of the then prevalent ‘Washington Consensus’, but would not have been acceptable politically. Third, the balance-of-payments crisis was over by the end of 1993, and if IMF pressure was the only factor pushing the reforms, the process would have ended in 1993. On the contrary, reforms continued subsequently, though admittedly at a slower pace. Finally, despite the opposition to the reforms when they were introduced, the political process worked in such a way that the reforms were continued by the succeeding United Front Government, and was carried on by the Atal Bihari Vajpayee-led NDA government that followed. In other words, even as there was considerable political posturing and criticism of the reforms when they were first announced, there was a working consensus of sorts, which extended beyond the Congress party and made it possible for the reforms to be carried forward by subseq
uent governments.

  Was the Pace of Implementation Too Slow?

  It is a fair criticism of the reforms that implementation was very slow. The original reform strategy did envisage gradual implementation and not a ‘big bang’ approach. While industrial controls were lifted in a big-bang manner, the trade reforms, the reform of the exchange-rate system, and the reduction in import duties took place more gradually. Similarly, financial-sector reforms and tax reforms were also expected to be rolled out in a phased manner. However, it would be fair to say that the actual implementation was significantly slower than gradualism alone would justify.

  As noted above, the first two or three years saw a fairly impressive pace of implementation in the area of industrial decontrol, trade liberalization and the shift to a market-determined exchange rate, as well as the start of a process of duty reduction. Some elements that were not in the original list of reforms were implemented quickly as well. For example, the liberalization of FDI inflows was accompanied by a parallel liberalization of inflows from Foreign Institutional Investors (FIIs) towards the end of 1992, allowing them to invest in shares and bonds through stock exchanges. This window ensured a substantial inflow of funds in subsequent years.

  At the same time, there were long delays in implementing many elements compared with targets announced. For example, P. Chidambaram, as the finance minister of the United Front government, lowered the peak rate of duty to 40 per cent and the capital goods duty to 20 per cent in 1997–98, and also stated that further reductions were needed, implying that our import duties would be lowered to ASEAN levels in three years, i.e., by 2000. Unfortunately, the NDA government, under Atal Bihari Vajpayee, did not follow through on this component of the reforms, nor did the Congress-led UPA government, which took office in 2004, pick up the thread. The present position is that sixteen years after the target date was announced in 1997–98, our duty rates are still higher on average than of ASEAN countries though the difference has narrowed.