India Transformed Page 9

  The retention of quantitative restrictions on consumer goods is another area where policy action was inordinately delayed. The logic that competition from imports would help achieve cost efficiency and improve product quality applied just as forcefully to the consumer-goods sector as to others. As noted above, the initial decision to leave consumer goods out of import liberalization was a tactical decision to avoid wide-ranging protests at the start of the liberalization process, but imports of consumer goods should have been liberalized a few years later. However, it actually happened only in 2002, following a World Trade Organization (WTO) ruling against India on a case brought by the United States Trade Representative, arguing that quantitative restrictions on imports were only allowable on balance-of-payments grounds, and there was no sign of balance-of-payments stress in India. A voluntary liberalization of consumer goods, without the compulsion of a WTO ruling, would have provided an opportunity to explain the rationale of the move to the domestic industry, which could have been given WTO-compatible protection through tariffs, with the tariff level declining steadily over time.

  Implementation of public-sector reform also fell far short of intention. It was clearly stated when the reforms were unveiled that the public sector must achieve higher levels of efficiency and must be given autonomy of decision-making, but units that continued to make losses would be closed down. This was not done for fear of a backlash from the labor unions, which were well represented in all the political parties. Subsequently, sale of equity to a strategic partner with management control was envisaged for some units, and one or two decisions to implement this policy were taken, but became controversial. A fresh attempt is now being made, based on recommendations made by the NITI Aayog, the successor institution to the former Planning Commission, to sell some public-sector units along with management control and to close down others. It remains to be seen how effectively this will be implemented

  Opening the insurance sector to private participants is another example of slow implementation. The Insurance Act made insurance a government monopoly and the need to introduce competition was recognized as a legitimate objective. The finance ministry appointed the R.N. Malhotra Committee to make recommendations in this area, and the committee recommended that an insurance regulatory authority be established to spell out the regulatory structure under which all insurers would work, after which private-sector insurers could be allowed to enter with foreign partners holding a minority stake. A statutory authority was put in place in 1999 by the NDA government of Atal Bihari Vajpayee. However, when the Insurance Act had to be amended to allow private sector entry into insurance, differences arose on the extent of foreign equity that foreign partners could hold, and it was finally limited to 26 per cent. This was widely regarded as too low and the industry, including the Indian partners, was in favor of raising the limit to 49 per cent. The UPA government, which came into power in 2004, made several attempts to raise the foreign equity limit, but could not get support from the BJP and the Left. Ironically, it was the NDA government under Prime Minister Narendra Modi that was able to make the change in 2016. This example illustrates how reforms requiring legislative changes can become hostage to political posturing, but it also shows that parties which opposed the reforms when in opposition can end up supporting them when in power.

  It is often said that the slow pace of reforms in India is due to the conscious choice of gradualism as a strategy. Gradualism has indeed been a preferred strategy, but it is not clear whether gradualism is the best description to apply to the Indian reform strategy. Logically, gradualism should mean giving a clear indication of where we want to get, but only stretching the transition over a longer time period to give people more time to adjust, or to build a broader consensus. However, this approach implies that the time period and the pace of transition should be clearly indicated at the start of the process so that people begin to adjust accordingly.4 India’s reforms have not been gradualist in this sense. Instead, they have often consisted of giving a broad direction, but without specifying a time path for the transition. Progress is then made in the broad direction outlined, with movement occurring as and when it is politically convenient. This is not so much ‘gradualism’ as ‘opportunism’. It can work under some circumstances, but it doesn’t make the case for reform sufficiently strongly to win public support. It also leaves investors confused on the reform signals, which means investments made on the assumption that the reforms will be carried through can prove infructuous.

  Looking ahead, it is clear that the nature of democratic politics will continue to affect the pace of reforms. Democracy is not a consensual form of government: it is inherently an adversarial form, in which it is the business of the opposition to oppose. This creates less of a problem when the government commands a strong majority and political opposition can be managed through negotiation and compromise, especially when the underlying issue is one on which there is a broad base of consensus. The recent successful passage of a constitutional amendment to facilitate the introduction of a Goods and Services Tax (GST), which is a major step towards modernizing India’s indirect tax system, is a good example of how party positions that appear intractably opposed can be reconciled on issues where there is a broad base of public support. However, not all the reforms that are needed enjoy the broad base of support that the GST did.

  The lesson to be learnt from the experience thus far is that much greater effort is needed to build public support on key elements of the reform agenda. This is especially necessary in the absence of a crisis when there is a real danger of complacency setting in. For example, we seem to be doing well at present, with growth above 7 per cent, but we are nowhere near achieving the objective of transiting to 8 to 10 per cent growth, which is necessary to fulfil the growing aspirations of the people. We will certainly not be able to make this transition unless economic reforms are accelerated, and to do this, it is important to make a clear case for acceleration, which often means having to face unpleasant truths and taking on vested interests.

  One can easily understand why politicians favor reforms by stealth, because it suggests that one can achieve what one wants without disturbing the hornet’s nest of vested interests. However, this is unlikely to succeed in an active participatory democracy like India, where all interests have ample opportunity to have their say. It can work briefly in crisis situations, but in the end, those who want change have to build sufficient consensus for change. This is why the best we have been able to do is to build a strong consensus for weak reforms. To transform that into a strong consensus for strong reforms is the real challenge.

  II. Assessing the Impact of Reforms

  We now turn to an assessment of the reforms in terms of outcomes. The Twelfth Plan, which covered the period 2011–12 to 2016–17, had a subtitle that presented a tripolar objective: ‘Towards faster, more inclusive and sustainable growth’. This section presents a brief assessment of performance in each of these three areas.

  Impact of Reforms on Growth

  Since the rethinking on economic policy in the 1980s was motivated by the realization that India’s growth performance did not compare well with East and South East Asian countries, it is appropriate to begin with an assessment of the impact of the reforms on growth. Table 1 summarizes the growth rate in different sub-periods, treating 1991–92, which was the year of the crisis when growth dipped to 1.4 per cent, separately. Growth rates are presented for India and also for comparator countries or country groups for the period after 1980 from the IMF’s World Economic Outlook database.

  The following are the main points relating to India’s growth experience pre- and post-reforms, which emerges from the table.

  (i)     The growth rate of the economy in the three decades prior to the 1980s averaged only 3.5 per cent per year. It was a little higher in the first two decades and deteriorated to 2.9 per cent in the 1970s. This is the background in which policy rethinking of the 1980s took place.

  (ii) �
��  The growth rate in the 1980s improved to 5.6 per cent, reflecting the positive impact of the incremental reforms undertaken in that decade, mainly in the second half. However, some of this growth was fed by an expanding fiscal deficit in the later years of the decade, which laid the foundations for the balance-of-payments crisis in 1991. The growth rate of 5.6 per cent recorded in the 1980s was, therefore, not sustainable.

  (iii)   In the first five years of the post-crisis period, i.e., 1992–93 to 1996–97, the economy grew at 6.5 per cent, which was significantly better than in the 1980s. It slowed down to 5.4 per cent in the next six years, 1997–98 to 2002–03, possibly reflecting the impact of the East Asian crisis, which led to a tightening of monetary policy in 1998 and also contributed to some worsening in the investment climate. This was also a period when economic reforms had slowed down, which may have had some effect on private investment intentions. Nevertheless, the average growth rate in the first ten years of the post-reforms period was around 6 per cent, about half a percentage point higher than in the 1980s.

  (iv)   The story of India’s growth in the 1990s compared to the 1980s and its relationship to reforms has been the subject of interesting debate in literature. Bradford de Long first pointed in 2001 out that despite the hype around the reforms of 1991, the growth rate in the 1990s was not much different from the 1980s, when there was very little by way of reforms and only a more ‘business friendly’ approach in operating the control system. On this basis, he argued that perhaps this business-friendly approach, and not reforms, was what mattered the most. In 2004 Dani Rodrik and Arvind Subramaniam came to the same conclusion, but went further to argue that perhaps the external liberalization undertaken in the 1991 reforms had been given undue importance by many analysts because of the importance ascribed to external liberalization in the Washington Consensus. In their view, it was the business-friendly approach of the government that mattered much more than external liberalization. I have argued in Ahluwalia (2016) that the Rodrik–Subramaniam proposition that external liberalization was not important is questionable for four different reasons. First, as noted above, the 5.6 per cent growth in the 1980s was in part fuelled by an excessively expansionary fiscal policy and was, therefore, not sustainable. Second, retaining a system of discretionary control but operating it in a business-friendly manner is not the best way of building a strong private sector. In fact, it poses a serious risk of degenerating into cronyism. Third, opening the economy in the early 1990s was critical for the long-term health of the economy. We would not have seen the explosion in IT services and software development if external liberalization had not occurred. Finally, the gradualist nature of the reforms meant that many of the changes were implemented only over time and, therefore, their full impact was probably felt only after the 1990s. The rapid growth experienced after 2003 is perhaps due to these lags working their way through the system.

  (v)    The thirteen-year period (2003–04 to 2015–16), which shows an average growth rate of 7.8 per cent, can be viewed as a vindication of the economic reforms. This period too can be divided into the first five years—2003–04 to 2007–08—before the financial crisis, when the economy grew at 8.7 per cent, and the next eight years—2008–09 to 2015–16—when it averaged only 7.2 per cent. The slower growth in the second period was partly a reflection of a global downswing and partly the emergence of domestic constraints, widely described as ‘policy paralysis’ in the last two years of UPA II, ending May 2014. The issue of whether the UPA government could have dealt better with the domestic constraints is a legitimate subject for study, but is beyond the scope of this paper. The point to emphasize for the present is that the average of 7.8 per cent growth for the entire thirteen-year period is an impressive demonstration of the impact of reforms on India’s growth performance.

  It is relevant at this stage to ask whether the high growth experienced by India in recent years was due to policy or simply to the buoyant state of the world economy during most of the 2000s. Table 1 shows the comparative picture of India’s performance relative to China and other relevant groupings using the IMF’s World Economic Outlook data. The following conclusions emerge from Table 1: (a) India’s growth performance was poorer than China’s through most of the period, though the differential between the two narrowed in the later periods as China’s growth slowed down. In 2015–16, India’s growth, at 7.3 per cent, exceeded China’s at 6.9 per cent; (b) India’s growth performance was poorer than the ASEAN five in the 1980s, and also in the earlier years of the 1990s up until the ASEAN crisis, but it was much better than the ASEAN five after 1997–98; (c) India’s growth performance has been consistently better than Latin America and Sub-Saharan Africa; and (d) India’s performance is also better than all EMDE countries excluding India and China in all the sub-periods.

  Based on this, it is reasonable to conclude that India’s growth performance in the post-reforms period has been commendable. It certainly belies the fears of the many critics who, when the reforms were first introduced, predicted that they would have a disastrous effect on the economy and that the opening up would kill domestic industry. On the contrary, the economy has done well, better than in the past and also better than all other groups other than China.

  Impact on External Vulnerability

  The reforms were much criticized on the grounds that import liberalization would make us vulnerable to balance-of-payments crises, necessitating repeated recourse to the IMF, with a consequential subordination of national policies to the diktat of the IMF. These fears have also proved baseless, and India has not needed the IMF since the 1991 crisis.

  India did experience external stress in the years after the Eurozone crisis when the current-account deficit increased to 4 per cent of GDP in 2011–12, thanks to a sharp increase in oil prices and a domestic fiscal policy that was excessively expansionary. The current-account deficit widened further to 4.7 per cent of GDP in 2012–13, much of it due to sharp increases in gold imports, which played the role of speculative capital outflows anticipating a depreciation. The ‘taper tantrum’ in April 2013 created uncertainty, putting pressure on the rupee, which depreciated from $1=Rs 54.4 in April 2013 to $1=Rs 63.2 in August, a depreciation of 16 per cent in four months.

  Fortunately, timely corrective steps helped stabilize the situation without any need for the IMF. These steps included firm assurances of the following kind: action to reduce the fiscal deficit by P. Chidambaram, who had returned to the finance ministry in the second half of 2012; action to limit gold imports, which were playing a role similar to capital outflows; and unconventional action by the Reserve Bank of India in supporting Indian banks obtaining forward cover for dollar deposits from NRIs. The flexible exchange rate introduced by the reforms also helped by avoiding the need to defend an increasingly unrealistic exchange rate. The fact that reserves were built up in good times paid rich dividends in the form of a sizable cushion of reserves of over $320 billion, which helped to stabilize expectations. It is worth noting that although the current-account deficit in 2012–13 was much larger as a percentage of GDP than in the crisis year of 1990, the situation was managed without recourse to the IMF.

  Has Growth Been Inclusive?

  While the growth performance has been indisputably impressive, the record on inclusiveness is mixed. The Indian debate on inclusiveness has traditionally focused on poverty reduction, and experience in this dimension has been good, as documented below. But the Twelfth Plan had identified many different measures that were also relevant, including the growth of employment opportunities, the provision of essential public services to the poor, interregional inequality, and inequality across households. Much more needs to be done in these areas.

  Trends in poverty reduction based on the Tendulkar Committee poverty line applied to the NSS consumer surveys are presented in Table 2.

  Table 2: Percentage of the Population and Absolute Number in Poverty

  (Tendulkar Committee Poverty Line)

&
nbsp; Poverty Ratio

  (Percentage of the Population)

  Absolute Number of Poor

  (Millions)

  1993–94

  45.3

  403.7

  2004–05

  37.2

  407.1

  2011–12

  21.9

  269.3

  In the eleven-year period immediately following the reforms, from 1993–94 to 2004–05, the percentage of the population in poverty declined significantly. However, the total population had increased in this period, and the absolute numbers in poverty actually increased marginally. This is basically similar to the pattern observed in earlier estimates of poverty based on the pre-Tendulkar poverty line, not reported above because the poverty lines are not comparable. The situation changed dramatically in the later period from 2004–05 to 2011–12. The percentage of the population in poverty declined much more sharply than earlier, and for the first time, there was also a sharp reduction in the absolute numbers below the poverty line—from 407 million in 2004–05 to 269 million in 2011–12.

  These data refute the somewhat pessimistic assessments offered by many sceptics that growth has not benefited the poor.5 The scale of poverty remains very large, but there is little doubt that the rapid growth witnessed in recent years has reduced the scale of the problem. It is useful to consider the different mechanisms that may have been at work. Three possible mechanisms suggest themselves.

  (i)     First, there is the pure growth effect. GDP growth in the second period was much faster, with GDP growing at 8.5 per cent per year compared to 6.2 per cent in the first period. If we look at growth in per capita GDP, which is actually more relevant for poverty reduction, the proportional difference is more dramatic. Per capita GDP grew at 6.8 per cent per year in the second period, compared to only 4.4 per cent per year in the first period. Faster growth in per capita income would imply that for any given degree of ‘trickle down’ built into the growth process, we would expect a faster reduction of poverty