ECONOMY SINCE THE 1991 ECONOMIC REFORMS

ECONOMY SINCE THE 1991 ECONOMIC REFORMS The 1990s saw far-reaching changes in India's economic policy. A severe balance of payments crisis at the beginning of the decade triggered wide-ranging reforms in economic policy during the early 1990s. These reforms brought about a swift turnaround in India's external sector and catalyzed an unprecedented spurt in economic growth during the five years from 1992–1993 to 1996–1997, coincident with the "Eighth Plan" period. Unfortunately, the program of policy reforms lost momentum after 1995, and the early partial success with fiscal consolidation was reversed after 1996. Coupled with some deterioration in the international economic environment in the final years of the decade, these factors contributed to a clear deterioration in growth for the ensuing six years.

Crisis and Reforms (1991–1992)

The deep-seated roots of the 1991 crisis in fiscal laxity, growing reliance on external borrowing, a weakening financial sector and heavy-handed regulation of trade and industry are well known. The proximate trigger of the 1991 crisis was the Gulf War in the second half of 1990–1991, which jacked up international oil prices (and India's oil import bill) and reduced remittance inflows from the Gulf. Unstable coalition politics of 1990–1991 compounded the economic problems and hastened a full-fledged balance of payment crisis. Foreign exchange reserves fell below U.S.$1 billion in early 1991, short-term external debt rose steeply, and exports declined. Despite imposition of severe restrictions on imports, a default on payments seemed imminent by mid-1991, when the new Congress Party government took office. This government, with Manmohan Singh as finance minister, acted quickly to stabilize the macroeconomic situation and initiate long overdue structural reforms.

The systemic nature of the 1991 reforms may be gauged from the fact that within a few months, the following steps had been taken: virtual abolition of industrial licensing; rupee devaluation by 20 percent; the complex import licensing replaced by a system of tradable import entitlements earned through exports (later replaced by a dual, and then market-determined exchange rate); phased reduction of customs duties; fiscal deficit cut by 2 percent of gross domestic product (GDP); foreign investment opened up; banking reforms launched; capital market reforms initiated; initial disinvestment of public enterprises announced; and major tax reforms outlined.

The Economy Rebounds (1992–1997)

The reforms led to a swift restoration of health in India's external sector. Export growth soared to 20 percent in 1993–1994 and the two years thereafter. Inward remittances by nonresident Indians quadrupled from U.S.$2 billion in 1990–1991 to $8 billion in 1994–1995, and rose further to exceed $12 billion in 1996–1997. The current account deficit in the balance of payments never again exceeded 2 percent of GDP and averaged only about 1 percent for ten years after 1990–1991. Foreign investment soared from a negligible $100 million in 1990–1991 to over $6 billion in 1996–1997. Foreign exchange reserves climbed steeply from the precarious levels of 1991 to over $25 billion by the end of 1994–1995. The debt service ratio was halved over the decade. The critical ratio of short-term foreign debt to foreign exchange reserves (proven critical again in the Asian crisis of 1997–1998) plummeted down from the stratospheric heights (380 percent) of 1991 to a very safe 20 percent by March 1995.

The reforms of the early 1990s (with emphasis on deregulation and market orientation) and partial success with fiscal consolidation also ushered in a strong revival of investment and growth. Aggregate investment rose from 22.6 percent of GDP in 1991–1992 to nearly 27 percent in 1995–1996. GDP growth, which had dropped to hardly 1 percent in the crisis year of 1991–1992, recovered swiftly and averaged an unprecedented 6.7 percent in the five years from 1992 to 1997. Per capita GDP grew by almost 5 percent a year, compared to just over 1 percent in the three decades from 1951 to 1980. Growth was broad based, with all major sectors recording better performance than in the 1980s and far better than the outcomes in the thirty years from 1951 to 1980 (see Table 1). Among the factors propelling this growth acceleration were: the productivity gains from deregulation of trade, industry, and finance; the reform-assisted surge in exports; the investment boom of 1993–1996; the partial success with fiscal consolidation; the improvement in terms of trade for agriculture; and the buoyant world economy.

Growth Slows (1997–2002)

The year 1997 was a watershed, which signaled the end of the economic party. In particular, three events occurred within a six-month period to disrupt the momentum of growth. In March, the instability inherent in coalition governments became manifest in the political crisis that ended the Deve Gowda United Front government and ushered in the Inder Gujral United Front government. In July, the Thai financial crisis raised the curtain on the Asian crisis saga, which dominated the international economic arena for the next eighteen months. Finally, in September, the Gujral government announced its decisions on the Fifth Pay Commission report (regarding government pay scales), decisions that were to prove costly for both the fiscal and economic health of the country.

As the table shows, the rate of average GDP growth dropped to 5.5 percent in the "Ninth Plan" period, 1997–2002. Particularly disquieting were the sharp declines in growth of agriculture and industry. Indeed, the drop in GDP growth would have been much steeper but for the extraordinary buoyancy of the services sector, which averaged growth of 8 percent during these five years. This rapid growth in services was much faster than in industry, a pattern that is quite different from India's past experience and that raises issues of future sustainability. Only a very small part of this services growth can be attributed to the remarkable dynamism in the relatively new sectors of information technology and business process outsourcing. Growth was rapid but from a very small base. By 2002 these new subsectors accounted for perhaps 2 percent of GDP, as compared to over 50 percent of GDP contributed by services as a whole.

Both macroeconomic and structural factors contributed to the growth slowdown. On the fiscal front, there was a significant deterioration in the consolidated deficit of central and state governments, about half of which was directly due to government pay increases following the Fifth Pay Commission. This deficit, which had declined from 9.4 percent of GDP in 1990–1991 to 6.4 percent in 1996–1997, rose steadily in subsequent years to around 10 percent by the end of the decade. Revenue deficits (government dissaving) also worsened by over 3 percent of GDP and fully explained the sharp decline in public saving and aggregate saving. The fall in savings was reflected in similar declines in aggregate investment.

From India's perspective, the international economic environment also weakened after 1997. The Asian crisis of 1997–1998 hurt exports and private capital inflows. The problems were compounded by the economic sanctions, which followed the nuclear tests in May 1998. In the next two years, the surge in international oil prices (much of it eventually passed on to Indian energy users) exerted negative effects. Finally, from the last quarter of 2000, the global economic slowdown took its toll of India's economic performance. The growth of exports slowed to below 10 percent per year in the period from 1996 to 2000.

Other, more structural factors also influenced the deceleration in economic growth. They included the petering out of productivity gains from economic

reforms, which clearly slowed after 1995. Although reforms continued throughout the decade, they never regained the breadth and depth of those of the early 1990s. Key reforms in the financial sector, infrastructure, labor laws, trade and industrial policy, and privatization remained unfinished or undone. Despite good intentions, the bottlenecks in infrastructure became worse over time, especially in power, railways, and water supply, reflecting slow progress in reforms of pricing, ownership, and the regulatory framework. The low quality and quantity of investment in rural infrastructure, moreover, combined with distorted pricing of some key agricultural inputs and outputs to dampen the growth of agriculture. The continuing decline in governance and financial discipline in (especially, but by no means exclusively) the populous states of the Gangetic Plain constrained growth prospects for over 30 percent of India's population.

The postreforms period saw a significant decline in poverty headcount ratios. The percentage of people below a minimally defined poverty line fell from 36 percent in 1993–1994 to 26 percent in 1999–2000. However, over the same period, total employment growth was sluggish, just over 1 percent a year. This is partly attributable to a decline in the labor force participation rate and partly to various policy distortions (including rigid labor laws), which discourage a more labor-intensive pattern of development. Regarding the spatial distribution of income expansion, the continued slow growth of the populous states of Bihar, Uttar Pradesh, Madhya Pradesh, and Orissa in the 1990s has contributed to increasing regional inequalities and raised serious concerns.

Recent Trends and Outlook

Since 2003 there has been renewed optimism about the growth prospects of the Indian economy. The "Tenth Plan," published in early 2003, projected an overall growth of 8 percent for the period from 2002 to 2007. A boom in software exports and remittances (together with reduced import needs of a somewhat sluggish industrial sector) has swelled the country's foreign exchange reserves to unexpectedly high levels (exceeding U.S.$100 billion), dispelling the old fears of a "foreign exchange constraint." The demographic outlook of a rapidly growing labor force and falling dependency ratios hold promise of rapid economic growth. GDP growth in 2003–2004 actually exceeded 8 percent, lending credence to the Tenth Plan projections.

In actual fact, the medium-term growth outlook for India is less bullish. The 8.5 percent growth in 2003–2004 followed slow economic expansion of 4 percent in the preceding year. Much of the economic dynamism of 2003–2004 reflected an exceptional rebound in agriculture from a drought-affected decline of 7 percent in 2002–2003 to a strong 9.6 percent recovery, thanks to the best monsoon in over twenty years. Growth requires investment. India's investment-GDP ratio in recent years remained stuck in the 23 to 24 percent range, not enough to generate sustained growth at 7 to 8 percent. East Asian experience suggests the need for investment levels of 30 percent or higher. A major constraint on India's investment performance has been the high levels of negative saving (revenue deficits) of government budgets, which have offset a strong private savings record. Although the reforms of the 1990s achieved a significant opening up of the Indian economy to external trade and investment, the country's integration with the world economy remains limited, with merchandise exports accounting for only 0.8 percent of the world exports and foreign direct investment inflows for hardly 0.5 percent of the global total. Despite recent initiatives, infrastructure constraints remain severe, especially with respect to electric power, roads, ports, airports, and urban services. The low (2 percent) growth of agriculture reflects serious problems with the organization of support services, low investments, and inappropriate pricing policies. As for the "demographic dividend," the constraints lie on the side of labor demand, which remains seriously inhibited by policy impediments such as labor laws.

Sustained economic growth at 7 to 8 percent is possible, but only if serious policy reforms are undertaken to reduce government deficits, improve infrastructure, revamp agriculture, enhance labor market flexibility, and accelerate integration with the international economy. Until then, India's economy is more likely to average growth in the range of 6 percent, which is good but not commensurate with the country's compelling needs for job creation and poverty alleviation.

Shankar Acharya

See alsoBanking Sector Reform since 1991 ; Economic Reforms of 1991 ; Trade Liberalization since 1991

BIBLIOGRAPHY

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