Economic liberalisation in India

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The economic liberalisation in India refers to ongoing economic reforms in India that started on 24 July 1991. After Independence in 1947, India adhered to socialist policies. Attempts were made to liberalise the economy in 1966 and 1985. The first attempt was reversed in 1967. Thereafter, a stronger version of socialism was adopted. The second major attempt was in 1985 by prime minister Rajiv Gandhi. The process came to a halt in 1987, though 1967 style reversal did not take place.1 In 1991, after India faced a balance of payments crisis, it had to pledge 20 tonnes of gold to Union Bank of Switzerland and 47 tonnes to Bank of England as part of a bailout deal with the International Monetary Fund (IMF). In addition, the IMF required India to undertake a series of structural economic reforms.2 As a result of this requirement, the government of P. V. Narasimha Rao and his finance minister Manmohan Singh (currently the Prime Minister of India) started breakthrough reforms, although they did not implement many of the reforms the IMF wanted.34 The new neo-liberal policies included opening for international trade and investment, deregulation, initiation of privatisation, tax reforms, and inflation-controlling measures. The overall direction of liberalisation has since remained the same, irrespective of the ruling party, although no party has yet tried to take on powerful lobbies such as the trade unions and farmers, or contentious issues such as reforming labour laws and reducing agricultural subsidies.5 Thus, unlike the reforms of 1966 and 1985 that were carried out by the majority Congress governments, the reforms of 1991 carried out by a minority government proved sustainable. There exists a lively debate in India as to what made the economic reforms sustainable.6

The fruits of liberalisation reached their peak in 2007, when India recorded its highest GDP growth rate of 9%.7 With this, India became the second fastest growing major economy in the world, next only to China.8 The growth rate has slowed significantly in the first half of 2012.9 An Organisation for Economic Co-operation and Development (OECD) report states that the average growth rate 7.5% will double the average income in a decade, and more reforms would speed up the pace.10

Indian government coalitions have been advised to continue liberalisation. India grows at slower pace than China, which has been liberalising its economy since 1978.11 The McKinsey Quarterly states that removing main obstacles "would free India's economy to grow as fast as China's, at 10% a year".12

There has been significant debate, however, around liberalisation as an inclusive economic growth strategy. Since 1992, income inequality has deepened in India with consumption among the poorest staying stable while the wealthiest generate consumption growth.13 As India's gross domestic product (GDP) growth rate became lowest in 2012-13 over a decade, growing merely at 5%,14 more criticism of India's economic reforms surfaced, as it apparently failed to address employment growth, nutritional values in terms of food intake in calories, and also exports growth - and thereby leading to a worsening level of current account deficit compared to the prior to the reform period.15

For 2010, India was ranked 124th among 179 countries in Index of Economic Freedom World Rankings, which is an improvement from the preceding year.

Pre-liberalisation policies

Indian economic policy after independence was influenced by the colonial experience (which was seen by Indian leaders as exploitative in nature) and by those leaders' exposure to Fabian socialism. Policy tended towards protectionism, with a strong emphasis on import substitution, industrialisation under state monitoring, state intervention at the micro level in all businesses especially in labour and financial markets, a large public sector, business regulation, and central planning.16 Five-Year Plans of India resembled central planning in the Soviet Union. Steel, mining, machine tools, water, telecommunications, insurance, and electrical plants, among other industries, were effectively nationalised in the mid-1950s.17 Elaborate licences, regulations and the accompanying red tape, commonly referred to as Licence Raj, were required to set up business in India between 1947 and 1990.18

Before the process of reform began in 1991, the government attempted to close the Indian economy to the outside world. The Indian currency, the rupee, was inconvertible and high tariffs and import licencing prevented foreign goods reaching the market. India also operated a system of central planning for the economy, in which firms required licences to invest and develop. The labyrinthine bureaucracy often led to absurd restrictions—up to 80 agencies had to be satisfied before a firm could be granted a licence to produce and the state would decide what was produced, how much, at what price and what sources of capital were used. The government also prevented firms from laying off workers or closing factories. The central pillar of the policy was import substitution, the belief that India needed to rely on internal markets for development, not international trade—a belief generated by a mixture of socialism and the experience of colonial exploitation. Planning and the state, rather than markets, would determine how much investment was needed in which sectors.

BBC19

In the 80s, the government led by Rajiv Gandhi started light reforms. The government slightly reduced Licence Raj and also promoted the growth of the telecommunications and software industries.citation needed

The Vishwanath Pratap Singh (1989–1990) and Chandra Shekhar Singh government (1990–1991) did not add any significant reforms.

Impact

  • The low annual growth rate of the economy of India before 1980, which stagnated around 3.5% from 1950s to 1980s, while per capita income averaged 1.3%.20 At the same time, Pakistan grew by 5%, Indonesia by 9%, Thailand by 9%, South Korea by 10% and Taiwan by 12%.21
  • Only four or five licences would be given for steel, electrical power and communications. Licence owners built up huge powerful empires.19
  • A huge private sector emerged. State-owned enterprises made large losses.19
  • Income Tax Department and Customs Department became efficient in checking tax evasion.
  • Infrastructure investment was poor because of the public sector monopoly.19
  • Licence Raj established the "irresponsible, self-perpetuating bureaucracy that still exists throughout much of the country"22 and corruption flourished under this system.8

Narasimha Rao government (1991–1996)

Present prime minister Manmohan Singh was then Finance Minister in Cabinet of prime minister P V Narasimha Rao

Crisis

The assassination of prime minister Indira Gandhi in 1984, and later of her son Rajiv Gandhi in 1991, crushed international investor confidence on the economy that was eventually pushed to the brink by the early 1990s.

As of 1991, India still had a fixed exchange rate system, where the rupee was pegged to the value of a basket of currencies of major trading partners. India started having balance of payments problems since 1985, and by the end of 1990, it was in a serious economic crisis. The government was close to default,2324 its central bank had refused new credit and foreign exchange reserves had reduced to the point that India could barely finance three weeks’ worth of imports. Most of the economic reforms were forced upon India as a part of the IMF bailout.2

A Balance of Payments crisis in 1991 pushed the country to near bankruptcy. In return for an IMF bailout, gold was transferred to London as collateral, the rupee devalued and economic reforms were forced upon India. That low point was the catalyst required to transform the economy through badly needed reforms to unshackle the economy. Controls started to be dismantled, tariffs, duties and taxes progressively lowered, state monopolies broken, the economy was opened to trade and investment, private sector enterprise and competition were encouraged and globalisation was slowly embraced. The reforms process continues today and is accepted by all political parties, but the speed is often held hostage by coalition politics and vested interests.

— India Report, Astaire Research8

Later reforms

Impact of reforms

The HSBC Global Technology Centre in Pune develops software for the entire HSBC group.27

The impact of these reforms may be gauged from the fact that total foreign investment (including foreign direct investment, portfolio investment, and investment raised on international capital markets) in India grew from a minuscule US$132 million in 1991–92 to $5.3 billion in 1995–96.28

Cities like Chennai, Bangalore, Hyderabad, NOIDA, Gurgaon, Gaziabad, Pune, Jaipur, Indore and Ahmedabad have risen in prominence and economic importance, become centres of rising industries and destination for foreign investment and firms.

Annual growth in GDP per capita has accelerated from just 1¼ per cent in the three decades after Independence to 7½ per cent currently, a rate of growth that will double average income in a decade. [...] In service sectors where government regulation has been eased significantly or is less burdensome—such as communications, insurance, asset management and information technology—output has grown rapidly, with exports of information technology enabled services particularly strong. In those infrastructure sectors which have been opened to competition, such as telecoms and civil aviation, the private sector has proven to be extremely effective and growth has been phenomenal.

OECD10

Election of AB Vajpayee as Prime Minister of India in 1998 and his agenda was a welcome change. His prescription to speed up economic progress included solution of all outstanding problems with the West (Cold War related) and then opening gates for FDI investment. In three years, the West was developing a bit of a fascination to India's brainpower, powered by IT and BPO. By 2004, the West would consider investment in India, should the conditions permit. By the end of Vajpayee's term as prime minister, a framework for the foreign investment had been established. The new incoming government of Dr. Manmohan Singh in 2004 is further strengthening the required infrastructure to welcome the FDI.

Today, fascination with India is translating into active consideration of India as a destination for FDI. The A T Kearney study is putting India second most likely destination for FDI in 2005 behind China. It has displaced US to the third position. This is a great leap forward. India was at the 15th position, only a few years back. To quote the A T Kearney Study “India's strong performance among manufacturing and telecom & utility firms was driven largely by their desire to make productivity-enhancing investments in IT, business process outsourcing, research and development, and knowledge management activities”.

Challenges to further reforms

OECD summarised the key reforms that are needed:

In labour markets, employment growth has been concentrated in firms that operate in sectors not covered by India's highly restrictive labour laws. In the formal sector, where these labour laws apply, employment has been falling and firms are becoming more capital intensive despite abundant low-cost labour. Labour market reform is essential to achieve a broader-based development and provide sufficient and higher productivity jobs for the growing labour force. In product markets, inefficient government procedures, particularly in some of the states, acts as a barrier to entrepreneurship and need to be improved. Public companies are generally less productive than private firms and the privatisation programme should be revitalised. A number of barriers to competition in financial markets and some of the infrastructure sectors, which are other constraints on growth, also need to be addressed. The indirect tax system needs to be simplified to create a true national market, while for direct taxes, the taxable base should be broadened and rates lowered. Public expenditure should be re-oriented towards infrastructure investment by reducing subsidies. Furthermore, social policies should be improved to better reach the poor and—given the importance of human capital—the education system also needs to be made more efficient.

— OECD10

Reforms at the state level

The Economic Survey of India 2007 by OECD concluded:

At the state level, economic performance is much better in states with a relatively liberal regulatory environment than in the relatively more restrictive states".10

The analysis of this report suggests that the differences in economic performance across states are associated with the extent to which states have introduced market-oriented reforms. Thus, further reforms on these lines, complemented with measures to improve infrastructure, education and basic services, would increase the potential for growth outside of agriculture and thus boost better-paid employment, which is a key to sharing the fruits of growth and lowering poverty.10

See also

References

  1. ^ For a complete history & analysis of liberalisation episodes in India, see: Sharma, Chanchal Kumar (2011) "A Discursive Dominance Theory of Economic Reforms Sustainability." India Review (Routledge, UK)126-84
  2. ^ a b Economic Crisis Forcing Once Self-Reliant India to Seek Aid, New York Times, 29 June 1991
  3. ^ Timeline:India -BBC 1991
  4. ^ a b "IMF calls for urgent reform in Indian labour laws". 
  5. ^ "That old Gandhi magic". The Economist. 27 November 1997. dead link
  6. ^ For a critique of the existing explanations and a comprehensive alternative explanation see: Sharma, Chanchal Kumar (2011) "A Discursive Dominance Theory of Economic Reforms Sustainability." India Review (Routledge, UK)126-84
  7. ^ "The World Factbook". Cia.gov. Retrieved 2013-07-10. 
  8. ^ a b c "The India Report". Astaire Research. 
  9. ^ "BBC News - India growth rate slows to 5.3% in first quarter". Bbc.co.uk. 2012-05-31. Retrieved 2013-07-10. 
  10. ^ a b c d e f "Economic survey of India 2007: Policy Brief". OECD. 
  11. ^ "India's economy: What's holding India back?". The Economist. 6 March 2008. 
  12. ^ "The McKinsey Quarterly: India—From emerging to surging". The McKinsey Quarterly. 2001. 
  13. ^ "India's income inequality has doubled in 20 years - The Times of India". Timesofindia.indiatimes.com. Retrieved 2013-07-10. 
  14. ^ GDP growth slumps to 5%, a decade’s low, Hindu Business Line 31st May 2013
  15. ^ India’s Ponzi-styled economic reforms run out of steam, East Asia Forum 4th June, 2013
  16. ^ Kelegama, Saman and Parikh, Kirit (2000). Political Economy of Growth and Reforms in South Asia. Second Draft. 
  17. ^ Sam Staley (2006). "The Rise and Fall of Indian Socialism: Why India embraced economic reform". 
  18. ^ Street Hawking Promise Jobs in Future, The Times of India, 25 November 2001
  19. ^ a b c d "India: the economy". BBC. 12 February 1998. 
  20. ^ "Redefining The Hindu Rate of Growth". The Financial Express. 
  21. ^ "Industry passing through phase of transition". The Tribune India. 
  22. ^ Eugene M. Makar (2007). An American's Guide to Doing Business in India. 
  23. ^ India's Pathway through Financial Crisis. Arunabha Ghosh. Global Economic Governance Programme. Retrieved on 2 March 2007.
  24. ^ What Caused the 1991 Currency Crisis in India?, IMF Staff Papers, Valerie Cerra and Sweta Chaman Saxena.
  25. ^ J. Bradford DeLong (2001). "India Since Independence: An Analytic Growth Narrative". 
  26. ^ "End of policy paralysis: Govt approves 51% FDI in multi-brand retail". Zeenews.india.com. Retrieved 2013-07-10. 
  27. ^ "HSBC GLT frontpage". Retrieved 22 August 2008. 
  28. ^ Local industrialists against multinationals. Ajay Singh and Arjuna Ranawana. Asiaweek. Retrieved on 2 March 2007.
  29. ^ a b c d e Biswas, Soutik (2011-07-27). "Challenges ahead for India reforms". BBC News (BBC). Archived from the original on 2011-09-08. Retrieved 2013-12-23. 
  30. ^ Kaushik Basu, Gary S. Fields, and Shub Debgupta. "Retrenchment, Labor Laws and Government Policy: An Analysis with Special Reference to India". The World Bank. 
  31. ^ R. C. Datta/Milly Sil (2007). "Contemporary Issues on Labour Law Reform in India". 
  32. ^ Aditya Gupta (2006). "How wrong has the Indian Left been about economic reforms?". 
  33. ^ Basu, Kaushik (27 June 2005). "Why India needs labour law reform". BBC. 
  34. ^ "A special report on India: An elephant, not a tiger". The Economist. 11 December 2008. 
  35. ^ "India Country Overview 2008". The World Bank. 2008. 
  36. ^ Gurcharan Das (July–August 2006). "The India Model". The Foreign Affairs. 
  37. ^ Schuman, Michael (2012-11-05). "India vs China: Which Has a Bigger Reform Challenge?". Time (Time). Archived from the original on 2013-03-09. Retrieved 2013-12-23. 

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