Economic Reforms in India

Economic Reforms in India

India's new economic reforms and challenges ahead - The Financial Express

  • In response to a fiscal and balance-of-payments (BoP) crisis, India embarked on an economic reform process on July 23, 1991. The reforms were momentous in that they would alter the economy’s face and nature in the future.
  • Since the UPA government took office in May 2004, reforms and related programs have continued with varying emphasis and scope, but they have been criticized as tardy. Governments began implementing economic changes in the mid-1980s.
  • While the 1980s reforms saw very limited deregulation and “partial liberalization of only a few parts of the existing regulatory regime,” the early 1990s reforms in the domains of industry, commerce, investment, and later agriculture were much “wider and deeper.” Though administrations announced liberal policies during the 1980s reforms under the banner of “economic reforms,” it was not fully implemented until the early 1990s.
  • However, the economy was crippled by the 1980s reforms, which were influenced by the famed ‘Washington Consensus’ doctrine. The entire Seventh Plan (1985–90) advocated for increased market liberalization and large external borrowings in order to boost exports (as the thrust of the policy reform). Though the thrust boosted GDP by boosting industrial output (by relying on expensive imports backed by foreign borrowings that the industries couldn’t afford to repay and service), it also resulted in a significant increase in foreign debt, which contributed significantly to the 1991 BoP crisis.
  • The First Gulf War (1991), which had a two-fold negative impact on India’s foreign exchange (forex) reserves, precipitated the crisis. First, the war caused oil prices to rise, requiring India to use its currency reserves in a shorter amount of time; second, private remittances from Indians working in the Gulf region dropped sharply (due to their immediate evacuation) – both crises were triggered by the same cause, the Gulf War.
  • However, the balance of payments crisis reflected more serious issues such as growing foreign debt, a budget deficit of more than 8% of GDP, and hyperinflation (above 13%).
  • The minority government of the time had taken a highly risky and divisive step in the form of economic reforms, which were roundly condemned throughout the 1990s by everyone from the opposition in Parliament to communist parties, industrial houses, business houses, media, experts, and the general public.
  • Although the criticism has subsided as the advantages of the changes have accrued to many, the reform process is still viewed as ‘anti-poor’ and ‘pro-rich’ by at least the masses—those who decide the country’s democratic mandate. Everyone holds at least one notion, namely that the benefits of reforms are not reaching the masses (the ‘aam aadami’) at the desired rate. Though the reform has moved the economy to a higher growth path, the necessity of the hour is to pursue “distributive growth.”

Obligatory Reform

  • Since the 1980s, some other economies have been undergoing similar reforms as a result of voluntary decisions made by the countries involved. However, in the case of India, the government of the time made an involuntary decision in response to the BoP issue. Countries receive external currency support from the IMF via the Extended Fund Facility (EFF) program to help them deal with their BOP issue, but such assistance comes with some strings attached.
  • Although they are designed and prescribed to the BoP-crisis-ridden economy at the moment of necessity, there are no established norms of such criteria available with the IMF. It’s worth noting that the conditions imposed on India were of the type that required them to establish all of the economic policies.
  • It means that the reforms that India has implemented or is implementing were neither conceived by India nor required by the Indian people. Yes, there was a sizable group of economists both inside and outside the government that believed in comparable economic measures to get the economy back on track. Since the 1970s, several of them have been making the same point, and many others have believed in them since the mid-1980s.
  • But why was it the Rao-Manmohan government that was credited with initiating India’s reform process? It’s because they believed it was appropriate to follow and politically feasible in India. Imagine a government seeking to sell or close state-owned corporations in a country where these businesses are seen as “temples of contemporary India.” The people believed the administration had caved in to the demands of the IMF, imperialist forces, multinational corporations, and so on.
  • In numerous sectors of the economy, such sentiments still exist today. India has suffered more as a result of the politics of economic reform than the reform itself. If we conclude that economic changes lacked political support, we are not exaggerating. On the question of reforms, India’s political parties are split; both the parties and the people lack the political maturity needed for the reform program to succeed.
  • A multi-party political system can achieve democratic maturity, but it takes time. Where the public is unaware and ignorant, it takes considerably longer. In such cases, religious, caste, and other emotional factors play their own roles.

The IMF condition put forth for India were as under:-

(I) A 22 percent depreciation of the currency (which occurred in two stages, with the Indian rupee falling from Rs. 21 to Rs. 27 per US dollar)

(ii) A significant reduction in the peak import tax from its current level of 130 percent to 30 percent (India did this by itself in 2000–01, and it is now voluntarily reduced to 15%)

(iii) Excise duties (now CENVAT) to be increased by 20% to offset revenue shortfalls caused by the customs cut (a significant tax reform effort to streamline, simplify, and modernize the Indian tax structure was initiated and is still ongoing)

(iv) Every year, all government expenditures will be reduced by 10% (i.e., the cost of running the government, including debt, interests, salaries, pensions, and subsidies). The government is under pressure to reduce the fiscal deficit and pursue economic discipline.)

Despite the fact that India was able to repay its IMF debts on schedule, the country’s economy was forced to undergo structural reforms in order to meet the IMF’s requirements. The IMF’s ultimate goal was to assist India in achieving short-term BoP equilibrium and making macroeconomic and structural reforms so that the economy would not face a similar crisis in the future.

There was ample opportunity for detractors to rail against India’s IMF-mandated economic reforms. Despite the fact that the changes were intended to stimulate growth and make the economy more competitive, the process of economic reforms in India was met with harsh criticism from practically every sector of the economy.

Reform Measures

India’s economic reform initiative included two types of actions:

  • Macroeconomic Stabilization Measures (MSM):-

A set of policies that are designed to help the economy It encompasses all domestic and international economic strategies aimed at increasing aggregate demand. Increased purchasing power of the public must be the focus of increased domestic demand, which necessitates a focus on the establishment of gainful and high-quality employment opportunities.

  • Structural Reform Meassures:-

It refers to all of the government’s policy initiatives aimed at increasing the economy’s overall supply of goods and services. It entails, of course, releasing the economy from its shackles so that it might explore its inherent production potential.

The economy requires increased income, which comes from increased levels of activity, in order for people’s purchasing power to be increased. The extra income is then dispersed among those whose purchasing power needs to be raised—this will be accomplished by implementing a set of macroeconomic policies that are appropriate for the situation.

It takes time for revenue to be distributed to the target population, while the government’s efforts to boost supply, i.e., increase output, are noticeable almost immediately. Because production is carried out by producers (i.e., capitalists), structural reform policies appear to be pro-rich, pro-industrialist, or pro-capitalist.

Ignorant people are easily swayed by the logic that anything that is “pro-rich” must be “anti-poor.” In the case of economic reforms, however, this was not the case. Unless the economy achieves higher growth (i.e., income), how will the masses’ purchasing power be increased? It takes time for increased income to reach everyone. If the economy lacks political stability, this process takes even longer due to the unstable and frequently changing governments’ short-term goals—as is the case in India.

The LPG

In India, the reform process must be completed through three additional processes: liberalisation, privatisation, and globalisation, or LPG for short. These three processes define the features of India’s reform process. Liberalisation, privatisation, and globalisation, in that order, show the reform’s direction, path, and ultimate goal. However, it would be beneficial to understand the true meanings of these terms and how they are used in different parts of the world, especially in India.

Liberalization 
The term “liberalisation” comes from the political doctrine of “liberalism,” which emerged in the early nineteenth century (it developed basically in the previous three centuries). The phrase is sometimes used to refer to a meta-ideology that encompasses a wide range of opposing values and views. The ideology arose from the fall of feudalism and the rise of a market or capitalist society in its place, which gained popularity in economics through the writings of Adam Smith (the country’s founding father) and became known as a laissez-faire principle.

In economics, the phrase liberalisation has the same sense as its source word, liberalism. The process of liberalisation is a pro-market or pro-capitalistic leaning in an economy’s economic policy. In the 1970s and especially in the 1980s, we see it all over Europe and North America. The best example of this procedure is China’s announcement of its “open door policy” in the mid-1980s. Even though China lacks (even now) some hallmarks of liberalism, such as individualism, liberty, democratic system, and so on, it is nonetheless referred to as a liberalizing economy.

We can use the history of the world economy as an example, placing the United States of America in the early twentieth century and communist China on opposite ends of the scale, with the United States representing the best historical example of the liberal economy and China representing the best historical example of the ‘illiberal’ economy. With the United States on the south pole and China on the north, any policy shift toward the “south” is referred to as “liberalization.” Illiberalisation will be defined as a shift from the south to the north.

Liberalisation is defined as the process of reducing the characteristics of a state economy while strengthening the characteristics of a market economy. Similarly, the process of illiberalisation will be the polar opposite. Both processes shall be referred to as economic reform processes, because the term’reform’ does not imply a ‘direction.’ All of the world’s economic reforms have been from the “north to the south.” The same can be said for the liberalisation process.

It signifies that in India, the term liberalisation is used to indicate the direction of economic reforms, with the state’s or planned or command economy’s influence reducing and the free market’s or capitalistic economy’s impact rising. It’s a step closer to capitalism. India is seeking to strike its own’state-market mix’ equilibrium. It indicates that, even if economic reforms are geared toward a market economy, they cannot be labeled as a blind-run to capitalism. Since the economy resembled the state economy in previous years, it is necessary to pursue a greater degree of market mix. Liberalism, on the other hand, limits the powers of Parliament in the long run.

Privatization 
Under the influence of New Right aims and views, governments in the 1980s and 1990s saw a ‘rolling back’ of the state, particularly in the United States and the United Kingdom. Deregulation, privatization, and the implementation of market reforms in public services were among the policies used to ‘roll back’ the state. Privatisation was a term used at the time to describe the process of transferring public assets to the private sector. The term privatisation has its origins in this period, which gained increasing acceptance around the world after East European countries and later developing democratic countries adopted it. However, the term ‘privatisation’ has taken on a variety of connotations and meanings over time. They can be seen as follows:
(I) De-nationalisation, or the transfer of 100% state ownership of assets to the private sector, is what privatisation means in its simplest sense and lexically. Only once in the history of the globe have such daring moves occurred without political repercussions: in the early 1980s in the United Kingdom under the Thatcher dictatorship. Almost all democratic systems have avoided the privatization road. Along with the United States, certain West European countries—Italy, Spain, and France—took similar steps in the mid-1990s. India has never taken such a step toward privatization.
(ii) The term “privatisation” has been applied to the worldwide process of disinvestment. The sale of state-owned firm shares to the private sector is part of this process. Disinvestment is defined as the transfer of less than 100 percent ownership from the government to the private sector. Even though it is deemed privatization, if the government sells out an asset for only 49% of its value, the state retains control. Even if the sale of shares in state-owned assets amounts to 51%, the ownership is truly transferred to the private sector and is referred to as privatisation.
(iii) The term privatisation has been employed in many different ways around the world in the third and final sense. Experts and governments have dubbed the process of privatisation those economic strategies that appear to favor the expansion of the private sector or the market (economy) directly or indirectly. De-licensing and de-reservation of sectors, even subsidy cutbacks, foreign investment clearance, and so on are only a few instances from India.

In India, we can link liberalization to privatization. Liberalisation indicates the direction of India’s economic changes, i.e., a preference for market supremacy. But how will this be done? Privatization will, in essence, be the road to reform. That is to say, everything that promotes the’market’ will be the course of India’s reform process.

Globalization 
Globalisation has traditionally been described in economic terms, but it has also had political and cultural implications. When economic changes occur, they present themselves in a variety of socio-political ways. The term “globalisation” refers to “an growth in economic interdependence among nations.” Even before multiple nation-states were founded, countries all around the world were pushing for globalisation, or “closer economic integration.” This period of globalisation lasted from 1800 to almost 1930, with the Great Depression and two World Wars causing retrenchment and the erection of many trade obstacles during the early 1930s.

After the wars, the Organization for Economic Cooperation and Development (OECD) popularized the term anew in the mid-1980s. The OECD had previously defined globalisation in a fairly narrow and business-like meaning, stating that “any cross-border investment by an OECD company beyond its nation of origin for its advantage constitutes globalisation.” The developed economies of the world pushed ideas to replace the GATT with the WTO after this OECD meeting, which is widely known as the start of the Uruguay Round of GATT talks, which finishes in Marrakesh (1994) with the formation of the WTO. Meanwhile, the OECD characterized globalisation as “a move from a world of separate national economies to a world in which production is internationalized and financial capital flows freely and instantly across countries” (1995).

The World Trade Organization’s official definition of globalisation is the march of the world’s economy toward “unrestricted cross-border flows of goods and services, capital, and labor force.” It simply means that for economies that have signed on to the globalisation process (i.e., WTO signatories), there will be no such thing as foreign or indigenous goods and services, money, or labor. In the course of time, the planet will become a flat and level playing field.

Globalisation, according to many political scientists (and now a very powerful force in the globe), is the creation of a scenario in which our lives are more impacted by events that occur at a large distance from us and about which our conscious self does not make decisions. One group of experts believes that globalisation subordinates the state, while another believes that local, national, and global events constantly interact beneath it, with none of them being subordinated to the others. In this view, globalisation emphasizes the deepening as well as the spreading of the political process.

India became a founding member of the WTO and was obligated to encourage the globalisation process, despite the fact that its economic reforms began with no such responsibilities. It’s a different story that India began the globalisation process soon following the 1991 reforms.

Now we can connect the three parallel processes—the LPG, which India used to launch its reform program. The process of liberalisation depicts the economy’s transition to a market economy, while privatisation represents the path/route it will take to achieve the ultimate ‘objective,’ i.e. globalisation.

It should be observed that the Indian concept of globalisation is deeply and regularly oriented towards the concept of welfare state, which keeps reappearing as an explicit reference in day-to-day public policy. The globe, including the IMF, the World Bank, and rich countries, are increasingly recognizing that the declared goal of globalisation of world economy can not be achieved until the world’s poor have a better quality of life. Will it be called world development if globalisation is complete without including nearly one-fifth of the world’s population, i.e. the poor?

Generations of Economic Reforms   

Although no such pronouncements or suggestions were made when India began its reforms in 1991, governments declared multiple ‘generations’ of reforms in the following years.
Until yet, three generations of reforms have been revealed, with experts recommending a fourth generation as well. To fully comprehend the characteristics and essence of India’s reform process, we can substantiate the components of various generations of reforms.

First Generation Reforms  (1991–2000)
The administration announced the necessity for the Second Generation of economic changes for the first time in 2000–01, and it was initiated in the same year. The reforms that had been implemented by that time (i.e., from 1991 to 2000) were dubbed the First Generation reforms by the administration. The following are the broad coordinates of the First Generation of reforms:
(I) Promotion to Private Sector:- ‘De-reservation’ and ‘de-licensing’ of industries, abolition of the MRTP limit, abolition of the compulsion of phased-production and conversion of loans into shares, simplifying environmental laws for the establishment of industries, and so on were among the important and liberalizing policy decisions.
(ii) Public Sector Reforms:- The initiatives taken to make public sector enterprises lucrative and efficient, as well as their disinvestment (token), corporatization, and other aspects, were key components of it.
(iii) External Sector Reforms:- They included policies such as removing quantitative restrictions on imports, switching to a floating exchange rate, full current account convertibility, capital account reforms, permission for direct and indirect foreign investment, and the passage of a liberal Foreign Exchange Management Act (the FEMA, which replaced the FERA).
(iv) Financial Sector Reforms:-  Initiatives have been launched in areas such as banking, capital markets, insurance, mutual funds, and other financial services.
(v) Tax Reforms:- This included all policy actions aimed at simplifying, broadbasing, modernizing, preventing evasion, and so on.

This generation of economic reforms resulted in a dramatic re-direction—the ‘command’ type of economy shifted decisively towards a market-driven economy, with the private sector (local and foreign) expected to play a larger role in the future.

Second-Generation Reforms (starting in 2000–01)
In 2000–01, the government began the second round of reforms. Basically, the early 1990s reforms in India did not go as planned, and the government saw the need for a new set of reforms, dubbed the Second Generation of Economic Reforms. These reforms were not only more extensive and delicate, but they also necessitated a stronger political resolve on the part of governments. The following are the primary reform components:
(i) Factor Market Reforms:- It consists of the dismantling of the Administered Price Mechanism, which is regarded as the “backbone” for the success of India’s reform effort (APM). Many products in the economy were fixed or regulated by the government, such as petroleum, sugar, fertilizers, pharmaceuticals, and so on.

Despite the fact that the private sector produced the majority of the products covered by the APM, they were not marketed on market principles, which hampered the profitability of both manufacturers and sellers, as well as the expansion of the affected businesses, resulting in a demand-supply gap. These products were supposed to be brought into the market as part of market reforms.

Only kerosene oil and LPG remain under the APM in the petroleum sector, whereas petrol, diesel (by March 2014), and lubricants have been phased out. Similarly, income tax-paying families do not receive sugar from the TPS as a subsidy; only urea remains under APM among fertilizers, and many pharmaceuticals have been phased out of the system. Opening the petroleum sector to private investment, reducing the burden of the sugar levy (the levy obligation was repealed by mid-2013), and other measures are already paying off for the economy. However, we cannot declare that India’s Factor Market Reforms (FMRs) are complete. It hasn’t stopped yet. In India, reducing subsidies on vital items is a socio-political issue. It will be impossible to complete the FMRs until all consumers have access to market-based purchasing power.
(ii) Public Sector Reforms:- Greater functional autonomy, freer leverage to the capital market, international tie-ups and greenfield ventures, strategic disinvestment, and so on are all part of the second wave of public sector reforms.
(iii) Government and Public Institution Reforms:-This includes all actions aimed at transforming the government’s function from “controller” to “facilitator,” or administrative reform, as it is sometimes referred to.
(iv) Reforms in the Legal Sector:- Though legal reforms had begun in the first generation, they were now to be expanded and newer areas included, such as the repeal of outdated and contradictory laws, reforms in the Indian Penal Code (IPC) and Code of Criminal Procedure (CrPC), Labour Laws, Company Laws, and enacting appropriate legal provisions for new areas such as Cyber Law.
(v) Critical Area Reforms:- The second generation reforms also commit to appropriate reforms in the infrastructure sector (i.e., power, roads, especially given the telecom industry’s encouraging performance), agriculture, agricultural extension, education, and healthcare, among other areas. The government has designated these sites as “vital regions.”

There are two parts to these revisions. The first segment is similar to FRMs, while the second segment gives the reforms a broader scope, such as corporate farming, agricultural research and development (which has largely been handled by the government and requires active participation from the private sector), irrigation, inclusive education, and healthcare.

Aside from the above-mentioned focus of this reform generation, some other crucial issues were also highlighted:
(a) The State’s Role in the Reform: For the first time, the state was given a significant role in the economic reform process. All new reform initiatives were to be initiated by the state, with the center acting as a supporter.
(b) Fiscal Consolidation: Despite being a significant co-ordinate of change in India since 1991, fiscal consolidation now has a constitutional commitment and responsibility. The FRBM Act is approved by the Centre, and the states follow suit with the Fiscal Responsibility Acts (FRAs), ushering in a new age of fiscal discipline in the country.
(c) Greater Tax Devolution to the States: Though there was a political trend in this direction by the mid-1990s, we witness a visible shift in central policies favoring greater budgetary leverage for states once the second generation reforms began. Even the tax reform process has taken on a new dimension. Similarly, the Finance Commissions and the Planning Commission begin to pay more attention to the states’ finances. In the fiscal year 2007–08, the states enjoyed a net revenue surplus for the first time.
(d) Increased Focus on the Social Sector: The government is paying more attention to the social sector (particularly healthcare and education) by increasing budgetary allocations and demonstrating greater compliance with development program performance.

The second generation changes have yielded mixed results, although the reforms are still ongoing.

Third Generation Reforms
On the eve of the commencement of the Tenth Plan (2002–07), the third generation of reforms were announced. This reform generation is dedicated to the creation of fully functional Panchayati Raj Institutions (PRIs) so that the benefits of economic reforms can reach the people.

Though the constitutional frameworks for a decentralised developmental process were put in place in the early 1990s, it was not until the early 2000s that the administration realized the importance of ‘inclusive growth and development.’ The administration of the period determined that until the public are involved in the development process, development will lack the ‘inclusion’ aspect. The Eleventh Plan continues to ratify the same feelings and opinions about the necessity for India’s third generation of reforms (albeit the political mix at the center has changed).

Fourth Generation Reforms
In India, there is no formal ‘generation’ of change. In early 2002, several experts created the phrase “information technology-enabled India” to describe this wave of reforms. They proposed a ‘two-way’ relationship between economic changes and information technology (IT), with each supporting the other.

The Reform Approach
By the mid-1980s, the world had begun to undergo economic reforms (in Western Europe and Northern America). After the idea of the Washington Consensus gained traction, we see similar reforms being implemented in countries all over the world. Over time, experts and the IMF/WB began to divide such countries into two groups, one that followed the ‘Gradualist Approach’ and the other that followed the ‘Stop-and-Go Approach.’

Experts have described India’s reform process, which began in 1991, as gradualist (also known as incremental) in nature, with occasional reversals and no major ideological U-turns—coalitions of various political parties at the Centre and different political parties ruling the states lacked a general sense of reform consensus. It reflects the constraints imposed by India’s extremely pluralistic and participatory democratic policymaking process. Though such an approach helped the country escape socio-political upheavals/instability, it prevented the reforms from yielding the expected economic results. The first generation of economic reforms failed to provide the desired effects due to a lack of another set of changes, the second generation of economic reforms, which India has been pursuing for nearly a decade. In the absence of an active public policy oriented at inclusion, the economic advantages (whatever they were) remained non-inclusive (commencing via the third generation of economic reforms). This fostered a sense of pessimism about the chances for transformation, and administrations were unable to mobilize sufficient public support for reform.

Unlike India, some other countries (including Brazil, Argentina, and South Africa) adopted a stop-and-go approach to reform. In such reforms, governments first determine which sectors require reform, then specify the prerequisites (which will create a favorable environment for reforms to occur), and then activate both sets of reforms at the same time. In their situations, the economic outcomes of reforms were as planned. Despite the fact that these countries incurred significant socio-political risks, their governments were able to mobilize adequate popular support for reforms in the medium term (which encouraged the governments to go for further reforms). Such reforms are unlikely in India, which is why the Economic Survey’s most recent volumes (2015–16, 2016–17, and 2017–18) advocated for a gradual approach to reforms.

The Indian government is currently working for “transformational reforms,” as defined in the Union Budget 2017–18. Some of these reforms include: (I) Inflation targeting and the establishment of the Monetary Policy Committee by amending the RBI Act, 1934; (ii) Resumption of’strategic disinvestment’ of PSUs; (iii) Demonetisation of high denomination currency notes (aimed at combating corruption, black money, tax evasion, fake currency, and terrorism); (iv) Enactment of the new Benami Law (aimed at combating black money);

Transformational reforms are unique in that they are intended at causing behavioural changes in the targeted group’s activities, and they have been said to be quite successful in this regard.

Though the overall plan of reforms in India is still incremental (i.e., gradual), ‘transformational reforms’ are examples of non-gradual (stop-and-go) changes. Meanwhile, the government was recommended to implement large-scale incremental reforms across the country.

According to the new Economic Survey 2019-20, the government must use its strong mandate to quickly implement reforms in order to help the economy recover in 2020-21. The Survey does not openly advise the government to pursue “non-gradual” reforms, but it does advocate for faster and more efficient improvements. Speed is required for reforms to achieve their targeted outcomes (i.e., efficient reforms), and speed always carries the risk of shock.

In this sense, it appears that the government has a strong willingness to pursue “non-gradual” reforms. The government has already taken several such moves in 2019-20, including speeding up the insolvency resolution process, easing financing for NBFCs, and announcing the National Infrastructure Pipeline 2019-2025.

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