INDIATRYING TO LIBERALISE:

ECONOMIC REFORMS SINCE 1991

CHARAN D. WADHVA1

INTRODUCTION

The foundation of credible national security is based on the level of

economic prosperity and well-being of the population of any country. This is

especially so for developing countries like India. The attainment of sustained

high economic growth is a necessary condition for improving the national

security and the quality of life of the people throughout the country.

Many developing countries in the Asia-Pacific region, including China and

India where nearly one third of the world's population live, are currently going

through economic transitions. The central objective of transition through

economic liberalization is to improve the competitive efficiency of the

economy in the global marketplace to sustain accelerated rates of economic

growth and thereby continuously improve the security and well being of the

people.

India launched its market-oriented economic reforms in 1991. China

launched similar reforms from 1978 and is now well ahead of India in

integrating its national economy with the global economy. However, India is

slowly but surely catching up in this race. The contrast in the experiences of

these two countries with economic reforms under radically different political

systems is remarkable. While comparisons between China and India are often

made by development analysts and are inevitable when we discuss economic

transitions in Asia, a more realistic assessment of the experiences of both these

major countries of Asia can only be made if we explicitly take into account the

stark contrast in their political systems.

In India, post-1991 economic reforms have been evolutionary and

incremental in nature. There have been delays and reverses in some areas due

to the interplay of democratic politics, coalition governments, and pressure

groups with vested interests. However, each of the five successive

governments that have held office in India since 1991 have carried on these

1 I thank Dr. N K Paswan for his help in preparing the statistical tables included in this paper.

259

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260

economic reforms, which have been based on market liberalization and a

larger role for private enterprise.

WHY THE POST-1990 REFORMS?

It is well known that from 1951 to 1991, Indian policy-makers stuck to a

path of centralized economic planning accompanied by extensive regulatory

controls over the economy. The strategy was based on an 'inward-looking

import substitution' model of development. This was evident from the design

of the country's Second Five-Year Plan (1956-61), which had been heavily

influenced by the Soviet model of development.2 Several official and expert

reviews undertaken by the government recommended incremental

liberalization of the economy in different areas, but these did not address the

fundamental issues facing the economy.3

India's economy went through several episodes of economic liberalization

in the 1970s and the 1980s under Prime Minsters Indira Gandhi and, later,

Rajiv Gandhi. However, these attempts at economic liberalization were halfhearted,

self-contradictory, and often self-reversing in parts.4 In contrast, the

economic reforms launched in the 1990s (by Prime Minister P V Narasimha

Rao and Dr. Manmohan Singh as his Finance Minister) were 'much wider and

deeper'5 and decidedly marked a 'U-turn' in the direction of economic policy

followed by India during the last forty years of centralized economic planning.6

THE DRIVING FORCES BEHIND THE REFORMS

As in many developing countries, India also launched its massive economic

reforms in 1991 under the pressure of economic crises.7 The twin crises were

reflected through an unmanageable balance of payments crisis and a socially

2 See Government of India, Second Five-Year Plan, (New Delhi, 1956).

3 Reference may be made to following illustrative books for tracking down these 'tinkering'

changes in the thinking of Indian policy makers and planners : Bimal Jalan ed., The Indian

Economy: Reforms and Prospects, (New Delhi : Viking Publishers, 1991); Charan D Wadhva ed.,

Some Problems of India's Economic Policy (New Delhi : Tata McGraw Hill, 2ed 1977); and Charan

D Wadhva, Economic Reforms in India and the Market Economy (New Delhi: Allied Publishers,

1994), Ch. II.

4 See for example, John Harris, 'The state in Retreat? Why has India experienced such Halfhearted

Liberalization in the 80s? IDS Bulletin(Institute of Development Studies, Sussex,

U.K.), Vol. 18, No. 4, 1987.

5 Jeffrey D Sachs; Ashutosh Varshney; and Nirupam Bajpai eds., Indiain the Era of Economic

Reforms (New Delhi, Oxford University Press, 1991), p.1.

6 Charan D Wadhva, Economic Reforms, op.cit., p.xviii

7 For details of magnitude and diagnosis of causes of this economic crisis, see Ibid.

CHARAN WADHVA

261

intolerably high rate of inflation that were building up in the 1980s and

climaxed in 1990-91.8 This can be seen from the data provided in Table 1.9

The current account deficit as a percentage of GDP peaked at a high of 3.1

percent (compared to an average level of 1.4 percent in the early 1980s). The

inflation rate (as measured by point-to-point changes in the Wholesale Price

Index) had also climbed to the socially and politically dangerous double-digit

level, hitting 12.1 percent in 1990-91.

TABLE 1: SELECTEDMACRO ECONOMIC INDICATORS1989-2003

Indicators 1989-90 1994-95 1999-00 2000-01 2001-02 2002-03

A. Growth of GDP (%) 5.6 6.3 6.1 4.4 5.6 4.4

B. GDP Growth by Sectors (%):

i. Agriculture & Allied 2.7 4.9 0.3 -0.4 5.7 -3.1

ii. Industry, of Which Manufacturing 6.7 8.3 4.0 7.3 3.4 6.1

iii. Services 6.7 6.0 10.1 5.6 6.8 7.1

C. Inflation Rate (WPI Index (%)) 9.1 10.4 4.8 2.5 5.2 3.2

D. Current Account Balance as % of GDP -3.1 -1.1 -0.5 -0.5 na

E. Foreign Exchange Reserves (US $ Bn.) 3.37 19.65 35.06 39.55 51.05 69.89

F. Exchange Rates (Rs/US $) 16.6 31.4 43.33 45.51 47.69 48.44

G. Rate of Growth of :

i. Exports (%) 18.9 18.4 10.8 21.0 -1.6 20.4

ii. Imports (%) 8.8 22.9 17.2 1.7 1.7 14.5

iii. Exports as % of GDP 6.4 9.6 9.1 10.4 9.9 na

iv. Imports as % of GDP 9.3 10.5 12.4 11.8 11.6 na

H. Fiscal Deficit as % of GDP 7.9 4.7 5.4 5.6 5.9 5.5

I. Revenue Deficit as % of GDP 2.6 3.1 3.5 4.1 4.2 3.9

J. Saving Ratio as % of GDP 22.3 24.9 24.1 23.4 24.0 na

K. Investment as % of GDP 24.9 25.4 25.2 24.0 23.7 na

Source: Ministry of Finance, Government of India, Economic Survey, (New

Delhi, various years).

Most economic policy makers and analysts held widely convergent views

on the causes of the unprecedented economic crisis faced by India in 1990-91.

The root cause of the twin crisis could be traced to macro-economic

mismanagement throughout the 1980s as reflected in an unsustainably high

8 This can be seen from all references cited in footnotes 1,2,4 and 5. In addition see, Vijay

Joshi and I.M.D. Little, India's Economic Reforms 1991-2001 (Delhi, Oxford University Press,

1997).

9 Other data used in the text (that is, not in the tables) is taken from Ministry of Finance,

Government of India, Economic Survey (New Delhi, various years) unless otherwise noted.

ECONOMIC REFORM IN INDIA

262

fiscal deficit, in particular the revenue deficit and the monetized deficit.10 The

central government's fiscal deficit alone peaked at 7.9 percent as a percentage

of GDP in 1989-90. Thus growing fiscal profligacy (and irresponsibility) and

the unviable financing patterns of the fiscal deficit prevailing in the 1980s

made high levels of annual GDP growth (peaking at 5.6 percent in 1989-90)

unsustainable.11 Foreign-exchange reserves dwindled to a low of US$2.2 billion

(with less than 15 days' cover against annual imports). India stared bankruptcy

in the face as it struggled to meet external debt obligations.

Prime Minister Narasimha Rao converted the prevailing economic crisis

into an opportunity to launch massive economic reforms. First, he introduced

an economist (rather than a politician) into the Cabinet as Finance Minister

and gave the new Minister his full support, allowing him to evolve and

implement path-breaking economic reforms. The new economic policies

radically departed from the economic policies and regulatory framework

pursued in India during the previous forty years.12

The Rao government recognized in 1991 that the time had come to

reshape India's economic policies by drawing appropriate lessons from the

'East Asian Miracle' based on more export-oriented and more globally

connected strategies of development, as successfully practiced earlier by Japan

and South Korea and also by the South East Asian tigers Malaysia, Singapore,

Indonesia and Thailand.13 The East Asian development model had been

remarkably successful in achieving sustained high growth rates accompanied

by rapid growth in the living standards of the people in just two decades. India

had missed on both these fronts by relentlessly pursing import substitution

and a relatively closed economy model of development.

The Rao government, after launching the relatively aggressive (by past

Indian standards) reforms, was soon confronted with the political constraints

of 'competitive populism' during elections held at the state level in 1993.

Therefore, the government adopted a 'middle path', furthering the economic

10 For further details, see Wadhva, Economic Reforms, op.cit., ch. I.

11 Thus the claim that India had clearly transcended the so-called 'Hindu rate of growth' of

GDP at 3.5 percent per annum (trend annual growth rate) achieved for the two decades of

1960s and 1970s and had moved over to higher annual average growth rate of 5.5 percent in

the 1980s could not be accepted since the latter jump proved to be financially unsustainable.

12 The major economic reforms launched during the full five-year tenure of the Narasimha

Rao Government (1991-96) are highlighted below.

13 There are of course, lessons to be learnt by India from the 'East Asian debacle' of 1997-98

(the so-called 'East Asian Financial Crisis) but these need not detract us here as most South

Asian and Southeast Asian countries had overcome this crisis by 1999.

CHARAN WADHVA

263

reforms in an 'incremental' fashion in order to continue to extending their

width and depth during the remainder of the government's term.

The government took two years to get over the immediate macroeconomic

crisis, initially with the help of a balance of payments loan facility

from the International Monetary Fund. The government came out with a clear

enunciation of its vision and the objectives of its economic reforms only after

regaining macro-economic stability. This was contained in the Discussion

Paper on Economic Reforms brought out by the Ministry of Finance in July

1993. To quote:

The fundamental objective of economic reforms is to bring about

rapid and sustained improvement in the quality of the people of

India. Central to this goal is the rapid growth in incomes and

productive employment… The only durable solution to the curse of

poverty is sustained growth of incomes and employment…. Such

growth requires investment: in farms, in roads, in irrigation, in

industry, in power and, above all, in people. And this investment

must be productive. Successful and sustained development depends

on continuing increases in the productivity of our capital, our land

and our labour.

Within a generation, the countries of East Asia have transformed

themselves. China, Indonesia, Korea, Thailand and Malaysia today

have living standards much above ours…. What they have achieved,

we must strive for.14

MAJOR ECONOMIC REFORMS

Economic reforms launched since June 1991 may be categorized under

two broad areas:

?? major macro-economic management reforms; and

?? structural and sector-specific economic reforms

Naturally, the attention of the new government that took office in June

1991 was primarily focused on crisis management dealing with the balance of

payments. It was of the utmost importance to restore India's international

credibility by meeting its scheduled external debt liabilities and through

maintaining a more realistic exchange rate consistent with market obligations.

Achieving macro-economic stabilization was also an urgent priority,

necessitating control of intolerably high inflation. It was recognized that

14 Government of India, Ministry of Finance, Department of Economic Affairs, 'Economic

Reforms : Two Years After and the Task Ahead', Discussion Paper, New Delhi : July 1993,

pp.1-2.

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macro-economic stabilization would provide a sound foundation for mediumand

long-term structural economic reforms and accelerate the rate of

economic growth in a sustained manner. This would be possible by removing

distortions created by controls and by improving the competitive edge for

Indian goods and services in global markets as well as in the markets of major

regional trading blocs.

I describe below the major economic reforms, with greater focus on

structural economic reforms in selected sectors of the economy.15

MACRO-ECONOMICMANAGEMENT REFORMS

Macro-economic management reforms have focused on controlling the

politically difficult problems of reducing the fiscal and (even more so) revenue

deficits. The capital account deficit does not pose long-term problems as

investment in productive capital made in the present, if prudently carried out,

will generate an adequate income stream to pay for capital costs incurred and

generate positive returns in the future.

India's problem is primarily in the area of revenue deficits. From 1950 to

1980 the national budget was usually characterized by revenue surpluses and

capital account deficits . However, after 1980, all (democratic) governments

for political reasons had willingly allowed the revenue deficit to rise over the

years to dangerously high levels, and had found it increasingly difficult to

reduce. The revenue deficits reflected an excess of annual consumption

expenditure by the government over its annual income. The deficit was caused

by excessive employment in the government sectors, uneconomical pricing of

goods and services by public sector enterprises, a growing interest burden,

mounting subsidies, and rising defense expenditures. Downsizing the

government (through the bureaucracy or public sector enterprises and banks)

was also difficult and met staff resistance from the organized employees.

Attempts at Reducing the Fiscal Deficit

Faced with the necessity of reducing the fiscal deficit in the crisis year of

1991-92, Finance Minister Singh attempted to reduce fertilizer and food

subsidies in 1991-92 and to some extent in 1992-93. Simultaneously, he (and

several subsequent finance ministers) resorted to the softer options of

reducing public investment expenditure and reducing public expenditure on

social welfare services from 1991 to 1995. These measures did help reduce the

fiscal deficit of the central government to 4.8 percent of GDP at the end of

15 I have drawn upon various annual issues of Economic Survey produced by the Government of

India(Ministry of Finance) for this section.

CHARAN WADHVA

265

1992-93. However, further cuts in fertilizer and food subsidies could not be

carried out as these measures were opposed in Parliament and proved suicidal

for the ruling Congress Party, which lost power in state elections in 1993-94.

Meanwhile, the fiscal position of the state governments also started

deteriorating. The combined fiscal deficit of the central government and the

states climbed to the unacceptably high level of 10-11 percent of GDP in

2002-03. Some state governments have begun to address their fiscal deficit

problems. The central government has recently started linking further transfers

of resources to the states to the progress of state-specific economic reforms

aimed at reducing deficits.16

The good news for macro-economic management reforms is that the pre-

1990 pattern of 'deficit financing' (that is, the printing of currency) to meet the

fiscal deficit has now been effectively curbed. The autonomy of the central

bank (the Reserve Bank of India) in regulating the money supply to control

inflation has been assured within the limits of monetary policy. This has led

the government to resort to larger and larger domestic borrowing.

The bad news is that government borrowings have risen so high that the

economy is moving towards an 'internal debt trap'.17 Further growth of

internal debt needs to be curbed but the government is in no mood to close

off this easy way of financing its rising fiscal deficit. The finances of most state

governments are in even poorer shape and some have occasionally resorted to

market borrowings to meet their payrolls.

Tax Reforms

Since 1991 several efforts have been made through the annual budget

process to achieve tax reforms.18 These have focused on: (i) expanding the tax

base by including services (not previously taxed); (ii) reducing rates of direct

taxes for individuals and corporations; (iii) abolishing most export subsidies,

(iv) lowering import duties (covered below by us under structural reforms

relating to trade policies/external sector); (v) rationalizing sales tax and

reducing the cascading effect of central indirect taxes by introducing a

Modified Value Added Tax and a soon-to-be implemented nationwide Value

Added Tax; (vi) rationalizing both direct and indirect taxes by removing

unnecessary exemptions; (vii) providing for tax incentives for infrastructure

16 For details see Government of India, Economic Survey 2002-03.

17 It is estimated that the interest payments currently pre-empt more than 60 percent of the

total revenue of the central government leaving very little resources for fresh public

investment. See Economic Survey 2002-03.

18 For details see the relevant official annual documents for the Union Budget usually

presented by the Finance Minister to the Parliament each year on February 28, 2003.

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and export-oriented sectors, including setting up special (Export) Economic

Zones; and (viii) simplification of procedures and efforts for improving the

efficiency of the tax administration system especially through

computerization.19

Resource Generation through Divestment

The governments of India, both at the central and state government levels,

have initiated divestment programs to sell government equity in several

public-sector enterprises. Unfortunately, the sales proceeds have mostly been

used to finance fiscal deficits rather than for fresh public investment, socialsector

spending, or reducing the interest burden on ballooning public debt.

STRUCTURAL ECONOMICREFORMS

Structural reforms since 1991 have been sector-specific. The sectors

subjected to reform have been carefully selected and the coverage of sectors

under structural reforms has been extended over time. The major structural

economic reforms carried out since 1991 have been primarily in the following

areas: Trade Policy/External Sector; Industrial Policy; Infrastructural Sector

Policies; Divestment/Privatization Policies; the Financial Sector; and in

Policies for Attracting Foreign Direct Investment.20

The thrust of the reforms in all areas has been to open India's markets to

international competition, remove exchange rate controls, encourage private

investment and participation in industry and, in the finance markets, to

liberalise access to foreign capital and to ensure that foreign investment is not

penalized merely for being foreign.21

19 For the latest proposals for tax reforms, see the two (published) reports of the Committee

on Reforms of Direct and Indirect Taxes (Chairman Dr. Vijay L Kelkar), New Delhi :

Government of India, Ministry of Finance, 2003.

20 It may be pointed out that in the vital areas of macro-economic policy including fiscal policy

monetary policy and exchange rate policy, there is an overlap between macroeconomic

stabilization policies and structural reforms. The long-term growth inducing roles of all macroeconomic

policies can be considered under structural reforms. We focus here on sectorspecific

reforms although overlaps exist with agro-economic policies in our discussion. For an

annual overview of structural reforms carried out in India, see Government of India Economic

Survey for the relevant year (latest available being 2002-03).

21 Financial sector reforms were initiated on the basis of two reports by the Narasimham

Committee. Government of India, Ministry of Finance, Report of the Committee on Financial

System (Chairman : Mr. M Narasimham), New Delhi : November 1991; and Report of the

Committee on Banking Sector Reforms (Chairman : Mr. M Narasimham), New Delhi 1996.

CHARAN WADHVA

267

Reorientation of Planning

Consistent with the spirit of the market-oriented and private sector-led

economic reforms launched since 1991, the government has reoriented the

role of planning in India. It has been recognized that market forces and the

state should be given roles that play to their comparative advantages and that

they should work together as partners in the economic development of the

nation. While private initiative should be encouraged in most areas of business

activities, the state should increasingly play a pro-active role in areas in which

the private sector is either unwilling to act or is incapable of regulating itself in

the social interest. The areas in which the state has a comparative advantage

over the private sector include poverty alleviation programs; human resource

development; provision of social services such as primary health and primary

education; and similar activities categorized as building human capital and

social infrastructure. The state also has a new role in setting up independent

regulatory authorities to encourage genuine competition and to oversee the

provision of services by the private sector in critical areas such as utilities,

water supply, telecommunications, and stock market operations to avoid the ill

effects of speculation and to maintain a workable balance between the interests

of the producer and the consumers.

Economic liberalization in the organized manufacturing sector (subjected

to rigid labor laws for retrenchment) has led to growth with very little

additional employment. This can create serious social unrest and fertile ground

for terrorist and other anti-social activities that attract unemployed youths in

the absence of gainful employment. Market-based economic reforms also

often lead to increasing disparities between the rich and the poor and between

infrastructurally backward and more developed states. The government has to

intervene and calibrate the contents and speed of market-based economic

reforms to more effectively address the specific areas of 'market failures and

weaknesses' to optimize growth with social justice.

The new role assigned to planning, consistent with market-based economic

liberalization, can perhaps best be illustrated with the goals and the strategies

incorporated in India's Tenth Five-Year Plan (2002-07).22 The Plan has

targeted an annual growth rate of eight percent. Along with this growth target,

the government has laid down targets for human and social development.

Timely corrective actions will be proposed to ensure growth is accompanied

by social justice. The key indicators of human and social development targeted

22 See, Government of India, Tenth Five Year Plan 2002-07 (in three volumes) (New Delhi :

Planning Commission, 2002).

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under this Plan include: a reduction of the poverty rate by five percentage

points by 2007; providing gainful employment to at least those who join the

labor force during 2002-07; education for all children in schools by 2003; and

an increase in the literacy rate to 75 percent by March 2007.

The development strategy adopted for the Tenth plan envisages:

redefining the role of Government in the context of the emergence

of a strong and vibrant private sector, the need for provision of

infrastructure and the need for imparting greater flexibility in fiscal

and monetary policies. With a view to emphasizing the importance

of balanced development of all states, the Tenth plan includes a

state-wise break-up of broad developmental targets including targets

for growth rates and social development consistent with national

targets. The Tenth Plan has emphasized the need to ensure equity

and social justice, taking into account the fact that rigidities in the

economy can make the poverty-reducing effects of growth less

effective. The strategy for equity and social justice consists of making

agricultural development a core element of the Plan, ensuring rapid

growth of those sectors which are most likely to create gainful

employment opportunities and supplementing the impact of growth

with special programs aimed at target groups.23

THE POLITICAL ECONOMIC DIMENSIONS OF THE REFORMS

India's heterogeneity and unity in diversity through a stable democratic

system must be appreciated. A country like India, with more than one billion

people, some 16 officially recognized major languages, and vast ethnic and

religious diversities, poses major governance challenges. India has achieved

remarkable success in holding the country together.

India had governed its economy through a policy regime of centralized

planning accompanied by an extensive regulatory framework for more than

forty years before it launched economic reforms in 1991. It has, therefore, not

been easy to change the mindsets of policy makers (especially at the lower

levels of bureaucracy) and of other beneficiaries of the entrenched regime.

Building a political consensus on economic reforms across the various

political parties with their vastly different ideologies has been a very difficult

process. This has been especially true under coalition governments but also

even when a single party has held a majority. Consensus building and reform

23 As summarized in Government of India, Economic Survey 2002-03, pp.41-42.

CHARAN WADHVA

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implementation is complicated further when the central government and the

states are in the hands of different parties (or coalitions).

The rapidly increasing frequency of elections at the central and state levels

during the post-1990 period of economic reforms has led the incumbent

governments and the contesting opposition parties to resort to 'vote-bank'

politics or 'competitive populism'. The vested interests of groups such as trade

unions, producers with licenses and holding monopoly interests, and

bureaucrats with 'rent seeking' capabilities have often scuttled or delayed

further market-based economic reforms. These factors explain well India's

'stalled' reforms in certain areas directly hurting vested interests of selected

lobby groups.24 The growth of regional parties and their assumption of power

in many Indian states has further delayed the percolation of central-level

economic reforms down to the state level.

Weiner has recommended the need for a change in the mindsets of state

policy makers:

The pursuit of market-friendly policies by state governments requires

a change in the mindsets of state politicians, new skills within the

state bureaucracies, and a different kind of politics. More

fundamentally, it requires rethinking on the part of state politicians,

activists in non-governmental organizations, journalists and

politically engaged citizens as to what is the proper role of

government, and how and to what end limited resources should be

used.25

Considering the compulsions arising from the above political factors,

Montek S. Ahluwalia explains the rational for adopting the 'gradualist'

approach in implementing of economic reforms and the resultant 'frustratingly

slow' pace of reforms (compared to East Asian standards):

The compulsions of democratic politics in a pluralist society made it

necessary to evolve a sufficient consensus across disparate (and often

very vocal) interests before policy change could be implemented and

this meant that the pace of reforms was often frustratingly slow.

Daniel Yergin (1998) captures the mood of frustration when he

wonders whether the Hindu rate of growth has been replaced by the

Hindu rate of change!26

24 See, 'Introduction' in Jeffrey D. Sachs, Ashutosh Varshney and Nirupam Bajpai, op.cit.

25 Myron Weiner, 'The regionalization of India's Politics and It's Implications for Economic

Reforms' in Ibid., Ch. 8, pp.292-3.

26 Montek S Ahluwalia, 'India's Economic Reforms: An Appraisal', in Ibid., pp.26-27. See also

Daniel Yergin, The Commanding Heights, New York: Simon and Schuster, 1998.

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Finally, most (if not all) political parties implementing market-based

economic reforms since 1990 have failed to 'market' these reforms to the

masses as being highly beneficial for them. The opposition parties have often

termed these reforms as 'pro-rich' and 'anti-poor'. Ironically, even the

Congress Party, which initiated the economic reforms when in power, has, as

an opposition party, opposed some of them (such as further public-sector

divestments) Varshney has made a valid distinction between 'elite-based'

reforms versus 'mass-based' reforms. Market-based reforms have not drawn

mass appeal nor aroused mass passions. This dichotomy between the concerns

of the urban elite and the mass of the population has clearly defined the limits

to economic reforms in India.27

STATE-LEVEL ECONOMIC REFORMS

To increase the effectiveness of the post-1990 economic reforms, they

must be simultaneously extended from central to state governments and below

to the third tier of local governments.

The maladies afflicting the finances of the state governments are similar in

nature to those afflicting the central finances described earlier. According to

the Reserve Bank of India, the Gross Fiscal Deficit of all the states of India

(including the Union Territories) was estimated at 3.3 percent in 1991-92.28

Throughout the 1990s the state governments also experienced a rapid rise in

their revenue expenditures mainly through salaries, pensions, interest payments

and subsidies (including free power to farmers in some states out of political

considerations). This trend has 'severely constrained the states' ability to

undertake development activities' and to devote more funds to provide social

services such as primary education.29 The situation worsened after the states

were forced to follow the center to implement generous pay increases for

government employees recommended by the Fifth Central Pay Commission in

1997-98.

Despite initial resistance in the Communist Party-ruled state of West

Bengal, all state governments (including West Bengal), in their own ways and

suiting their own conditions, implemented economic reforms in the 1990s and

are continuing these reforms broadly in line with the ongoing national

economic reforms. This owes in part to enlightened self-interest combined

27 For further details, see Ashutosh Varshney, 'Mass Politics or Elite Politics?', in Jeffrey D

Sachs, Ashutosh Varshney and Nirupam Bajpai, op.cit., Ch.7.

28 Reserve Bank of India, 'Finances of state Governments : 1992-93', in the Reserve Bank of

IndiaBulletin, March 1993.

29 Government of India, Economic Survey 2002-03, op.cit, p.5.

CHARAN WADHVA

271

with a healthy competitive spirit designed to improve their position and

ranking among the states. There is also the states' desire to avail themselves of

larger transfers of development funds from the center, which the central

government linked to economic reforms at the state level. Every state has

recognized the need to attract private investment flows from both domestic

and foreign investors. State governments have therefore progressively

liberalized their policies and procedures on a competitive basis. Several of

them have also explicitly recognized the need to improve human resource

development and have progressively expanded activities to provide a better

quality of life to the population of their states.

Incentives and Conditionalities

The government of India has introduced a scheme called the States' Fiscal

Reforms Facility (2000-05). Under the Facility, the central government set up a

five-year incentive fund 'to encourage states to implement monitorable fiscal

reforms'. Additional amounts by way of 'open market borrowings' are allowed

if the state is faced with a structural adjustment burden. State governments

may draw up a Medium Term Fiscal Reforms Programme (MTFRP) to achieve

specified targeted reductions in their consolidated fiscal deficit, especially the

revenue deficit.

The coverage of the MTFRP has been extended to cover a Debt Swap

Scheme in order to help state governments reduce their growing public debt.

This scheme is designed to help liquidate the burden of high-cost loans taken

from the central government through the allocation of additional market

borrowings at currently prevailing lower interest rates.

The major structural reforms carried out by several state governments

include:

(i) Measures to improve quality of life through improvements in basic

public services such as primary health, primary education, and rural

infrastructural services such as electricity, water, and roads. Madhya Pradesh

has brought out the first state-level Human Resource Development Report. Other

states have followed suit. The Planning Commission has also published a

comprehensive National Human Development Reportassessing human

development nationwide and in the major states.30

(ii) Clustering high-tech industries and services (for example, in software

parks).

30 Government of India, National Human Development Report 2001 (New Delhi : Planning

Commission, 2002).

ECONOMIC REFORM IN INDIA

272

(iii) Setting up Special Economic Zones and Agri-Economic Zones to

promote exports.

(iv) Formulating state-level industrial policies to attract investments.

(v) Power-sector reforms that restructure state Electricity Boards by

separating generation, transmission and distribution activities, encouraging

independent power producers in the private sector to invest in the power

sector, and setting up independent state Electricity Regulatory Authorities.

THE PERFORMANCE OF THE INDIAN ECONOMY

Despite the slow pace of implementation of the economic reforms and

certain hiccups and delays caused primarily by the compulsions of democratic

politics, the performance of the Indian economy under the reforms carried out

so far shows a mixed picture of notable achievements and weaknesses. The

performance has been impressive on some fronts, satisfactory on several other

fronts, and inadequate in certain respects. India has still to launch deeper (socalled

'second-generation') reforms in various areas to get the best results.

Areas of Impressive Performance

Through reform, India overcame its worst economic crisis in the

remarkably short period of two years. Macro-economic stabilization reforms

(along with structural economic reforms) were launched in June 1991.

Through prudent macro-economic stabilization policies including devolution

of the rupee and other structural economic reforms the balance of payments

crisis was clearly over by the end of March 1994. Foreign exchange reserves

had risen to the more than adequate level of US$15.07 billion and the current

account deficit as a percentage of GDP was nearly eliminated. Export growth

rate at 20.0 percent in 1993-94 over the previous year was quite encouraging.

Macro-economic stability has endured in the ten years of economic

reforms to 2003. Foreign-exchange reserves peaked at US$70 billion at the end

of March 2003 (and touched US$80 billion in June 2003).31 The current

account 'recorded a surplus-equivalent to 0.3 percent of GDP-in 2001-

02'.32 Food stocks with the Food Corporation of India, held to ensure national

food security, peaked at sixty million tons (compared to the required twenty

million tons). It took longer to control inflation but this led to relatively more

enduring results (excluding the impact of externally determined fuel prices).

Since 2002, the country has enjoyed a low interest-rate regime. These

31 The Rupee had started appreciating against US$ after April 2003.

32 Government of India, Economic Survey 2002-03, op.cit., p.3.

CHARAN WADHVA

273

performance indicators have helped to provide an 'enabling environment for

the macroeconomic policy stance.'33

India has also increasingly integrated its economy with the global economy.

After half a century of inward-orientation, the share of India's trade as a

proportion of GDP rose from 13.1 percent in 1990 to 20.3 percent in 2000. By

Indian standards this is an impressive performance.

India's economy has also successfully moved into a higher trajectory of

growth and displayed strong dynamism in selected sectors. This encouraging

performance brightens the prospects for stepping up India's growth rate and

improving the competitive edge in the years to come through further

appropriate economic reforms.

The average annual growth rate of 5.8 percent achieved by the Indian

economy during the years of economic reforms since 1992 is encouraging.

Currently, after China, India is among the fastest-growing countries in Asia.

Since the annual rate of population growth has slowed significantly to nearly

1.8 percent during the 1990s, per capita income has been growing at a healthier

real rate of four percent per annum.

India's growing middle class of more than 350 million people, with a

reasonably affluent standard of living, provides a huge market for foreign

corporations, especially since April 2003, when all quantitative restrictions on

imports were lifted.

Along with its fairly good growth rate (which, however, is far below the

potential growth rate of eight percent targeted by India's Tenth Five-Year

Plan), India has been successful in reducing poverty. The poverty ratio (that is,

people below the poverty line as a percentage of the population) as estimated

by the Planning Commission at the national level came down from 36 percent

in 1993-94 to 26.1 percent in 1999-2000. The poverty ratio during this period

declined both in rural areas and in urban areas. There is little doubt that

poverty in India has been reduced during the last decade. The Planning

Commission has set a poverty ratio target of 19.3 percent by the end of the

Tenth Plan period (to March 2007).

An important indicator of gains from economic reforms, reflecting the

attractiveness of India as an investment destination, is shown by the increasing

inflows of both FDI and Foreign Institutional Investment (FII) into India.

Inflows of both FDI and FII into India has increased in the decade to 2002.

On average, according to the Ministry of Finance's Economic Survey, India has

33 Reserve Bank of India, Annual Report 2001-02, Mumbai, Reserve Bank of India, p.1.

ECONOMIC REFORM IN INDIA

274

been attracting US$2.5 billion to US$3 billion and nearly US$4 billion in 2001-

02 in FDI per annum mostly in various infrastructural sectors such as large

power and telecommunication projects.

India's economy under the reforms has made rapid strides in selected

industrial areas and knowledge- and skill-intensive services. These specific

growth areas have experienced significant restructuring under more

competitive conditions in the marketplace through mergers and acquisitions

and technological and managerial innovations. This has led to the achievement

of recognizable increases in international competitiveness in a number of

sectors including auto components, telecommunications, software,

pharmaceuticals, biotechnology, research and development, and professional

services provided by scientists, technologists, doctors, nurses, teachers,

management professionals and similar professions. The spillover effects of

India's increasing international competitiveness have helped in improving the

rate of growth of export earnings. They have also directly benefited Indian

consumers by making better quality, lower-priced goods available.

Areas of Weakness

The most notable weakness of the reform process has been in fiscal

consolidation. Indian governments at both the central and state levels have

failed miserably to reign in growing revenue deficits and reduce the overall

fiscal deficit. The foundations for a sustainable high growth rate in any

economy lie in maintaining fiscal discipline. This has not been adequately

achieved by Indian policymakers. Excessive use of market borrowing to cover

budget deficits has often put upward pressure on interest rates and pre-empted

('crowded out') borrowings by the private sector. The structure of revenue

expenditure and political obstacles to any reduction of subsidies and

downsizing the government at all levels have been primarily responsible for

the lack of progress on fiscal reforms. The real issue in restructuring

government finances is 'right-sizing' the government by adequately increasing

government expenditure on infrastructure of both the hard and soft varieties,

based upon growing resources.

India's record on social development expenditure has been poor

considering Indian requirements and poor also in relation to many developing

countries, including some of the least developed countries in Sub-Saharan

Africa. The abysmally low ranking of India on the Human Development

Indices computed by the United Nations bears testimony to this assertion.34

Dreze and Sen remarked in 1995 that India's social development indicators in

34 United Nations, Human Development Report, available annually at http://hdr.undp.org.

CHARAN WADHVA

275

1991 (when reforms were launched) were lower than in several East and

Southeast Asian countries three decades ago.35

India must bridge this social development gap by significantly increasing its

public expenditure on social services if it wishes to achieve the targeted annual

growth rate of eight percent set by the country's Tenth Plan. As Ahluwalia has

remarked, larger investment in the social sectors is 'necessary not only because

social development is an end in itself, but also as a precondition of accelerating

growth'.36

The massive shift required in the pattern of government expenditure in

India in favor of social sectors and infrastructure can only be carried out

through structural fiscal reforms. The Fiscal Responsibility and Budget

Management (FRBM) Act (2003) provides for complete elimination of the

revenue deficit by 31 March 2008. This Act is, therefore, a step in the right

direction. Despite 'dilution' of the original draft bill, it is important legislation

because it sets the condition that the government can run a fiscal deficit only if

borrowings are made to finance investments which will enhance productive

capacity'.37

Another major weakness of the Indian economic reforms is the economy's

experience with 'jobless growth' in the post-1990 period. Rigid labor laws

relating to retrenchments have constricted growth in the organized

manufacturing sector. As a labor surplus country, there already exists a huge

backlog of both 'open' and 'disguised' unemployment. With a growing

population, every year adds to the labor force. Economic reforms have

accelerated growth but failed to generate adequate employment. For example,

the rural unemployment rate, after declining to 5.61 percent in 1993-94, rose

to 7.21 percent in 1999-2000 as did the All-India (urban plus rural) rate of

unemployment. If this disturbing trend is allowed to continue, it will breed

social unrest and add to the ranks of terrorists and other anti-social elements in

the country.

Last but not least, the reforms have led to growing disparities between

richer and poorer states (more and less developed, especially in terms of

infrastructure) within India. Although the all-India average annual growth rate

in the reform era has been on the order of 5.8 percent, this masks wide

35 Jean Dreze and Amartya Sen, India: Economic Development and Social Opportunities, (New Delhi :

Oxford University Press, 1995).

36 M S Ahluwalia, op.cit., p.74.

37 C Rangarajan, 'Focus on Revenue Deficit', Business Line (New Delhi), June 10, 2003, p.4

ECONOMIC REFORM IN INDIA

276

variations in inter-state growth rates, growth of per capita income, and social

development.

Most state governments are not well prepared to meet the challenges

posed by globalization. The farming sector and the innumerable small-scale

industrial units are vulnerable to the impact of global competition. The

government and economic players in the private sector need to work more

closely as partners to evolve strategies to meet the challenges of global

competition more effectively.

THE ECONOMY IN THE INTERNATIONAL ARENA

The Indian economy has been moving towards closer integration with the

global economy and with the leading regional trading blocs. This can be seen

using three indicators: (i) Trade in goods and services as a proportion of GDP;

(ii) Gross Private Capital (In)flows; and (iii) Gross Foreign Direct Investment

as a proportion of GDP. In all three areas, China has had the most

outstanding performance and is clearly far ahead of India. However, within the

constraints of democratic politics (which have forced India to adopt

incremental and relatively 'softer' economic reforms), and despite being a late

starter in the economic reform process, India can be seen to have done

'reasonably well' in globalizing its economy. The ratio of trade to GDP

increased from 13.1 percent in 1990 to 20.3 percent in 2000. The proportion

of Gross Capital Inflows to GDP during the same period increased from 0.8

percent to 3.0 percent. Gross Foreign Direct Investment as a percentage of

GDP (which was zero in 1990) rose to 0.6 percent in 2000.

India's trading relations with major regional trading blocs in 1990 and 2000

can be seen in Table 2. For the year 2000, APEC countries were India's largest

trading partners, accounting for 47.4 percent of India's global exports and 57.4

percent of global imports. India has, therefore, shown keen interest in joining

this forum. Unfortunately, APEC has currently imposed a moratorium on new

membership.

There is naturally a sharp contrast between India and East Asian countries

in their relative rates of export growth due to sharp differences in their export

strategies. The contrast is the sharpest when we compare India and China for

the period 1950-2000. In 1950, both had roughly similar shares in world trade.

China pursued a more aggressive export strategy in 1978 when it created

export-oriented Special Economic Zones in Southern China. By 2000, China

had captured around 4.0 percent of world trade. In contrast, India's share of

world trade had stagnated at around 0.5 percent for the three decades 1960-90

CHARAN WADHVA

277

due to its inward-looking policies.38 By 2000, this share had moved up to 0.7

percent. India has formulated and is further strengthening its latest Medium-

Term Export Strategy (MTES) (2002-07), coinciding with the period of the

Tenth Five-Year Plan.

TABLE 2: TRENDS ANDPROJECTIONS FOR INDIA'SEXTERNAL TRADE 2000-2025

Year Exports to Imports from

1990 2000 2020 1990 2000 2020

Actual/Projected A P p A P P

India's Global Exports

and Imports (US $

Billion)

18.2 37.1 63.6 23.3 41.3 61.2

1. APEC-21 52.06 47.4 43.44 40.98 58.68 57.41

2. ASEAN-10 4.99 6.87 7.38 6.92 9.41 13.1

3. BIMSTEC-4 2.91 4.65 5.45 1.55 1.28 1.45

4. BISTEC-3 2.9 4.51 5.3 1.55 0.8 0.98

5. EU-15 27.6 24.76 25.14 36.62 25.72 23.79

6. GCC-6 5.21 7.17 7.71 8.7 21.05 32.57

7. IOR-ARC-18 13.55 19.26 22.22 13.4 20.93 30.76

8. NAFTA-3 17.13 19.65 16.08 11.2 10.14 11.01

9. SAARC-7 2.65 4.12 4.52 1.78 0.47 0.68

Note : A-Actual and P-Projected

APEC - 21: Asia Pacific Economic Cooperation

ASEAN-10: Association of South East Nations

BIMSTEC-4: Bangladesh-India-Myanmar-Sri Lanka-Thailand Economic

Cooperation

BISTEC-3:Bangladesh-India-Sri Lanka-Thailand Economic Cooperation

EU-15: European Union

GCC-6: Gulf Cooperation Council

IOR-ARC-19: Indian Ocean Rim Association for Regional Cooperation

NAFTA-3: North America Free Trade Area

SAARC-7: South Asia Association for Regional Cooperation

Source : Charan D. Wadhva, "India's External Sector" Chapter - 12 in the

Report of Research Project on India-2025: A Study of the Social, Economic and Political

Stability, Centre for Policy Research, New Delhi, May, 2003.

38 As per World Bank's annual World Development Report, various issues and other sources.

ECONOMIC REFORM IN INDIA

278

The MTES for 2002-07 envisages the achievement of India's target of one

percent of global trade by 2007 and provides sector-wide targets for niche

products and targets for selected niche markets.39 The active participation of

state governments is being sought in establishing and strengthening Special

Economic Zones (SEZ) modeled on Chinese SEZs and setting up Agri-

Economic Zones to provide a strong push to raise the country's export growth

rate. The development of world-class infrastructure in the SEZs will take more

time. A new labor policy regime allowing freedom for entrepreneurs in the

SEZs to 'hire and fire' labor according to the needs of the market (as

permitted in the highly successful Chinese SEZs) will have to be put in place

to maximize gains from India's SEZs. As of May 2003, eight SEZs had been

approved and have became operational. More such SEZs will be set up in

India in the future.

India is trying its best to liberalize and to transform itself into a global

player of consequence in the world economy by 2020. It has been ranked by

the World Bank as the world's fourth-largest nation in terms of the size of

GNP measures in terms of Purchasing Power Parity (PPP) in 2001. Ahead of

India in 2001 on this front were only Japan, the US, and China. The World

Bank has projected that by the year 2020, China will take the top spot,

followed by India.

India's economy clearly is on the move and most certainly has the potential

to emerge as a global economic power within next twenty to twenty-five years.

However, this potential can be made a reality only if India mobilizes adequate

political will and quickly commits itself to design and fully implement the next

phase deeper 'second-generation reforms'.

The concept of 'second-generation' reforms has been in the making for

some years. However, these are yet to take concrete shape. Considering that

India currently has no social security system in place for nearly 90 percent of

its labor force employed in the unorganized sectors, India needs to evolve a

well-calibrated approach to its future economic reforms. This would also be

necessary to meet the challenges posed by the further intensification of the

process of globalization. However, clear prioritization of future economic

reforms in India will have to be laid down during implementation of the most

critically needed 'second-generation reforms'.

39 Government of India, Export Import Policy 2002-07, New Delhi : Ministry of Commerce

2002.

CHARAN WADHVA

279

THE NEXT GENERATION OF REFORMS

The following are ten recommended areas of special focus in the second

generation of economic reforms:

1. Political Reforms for Good Governance;

2. Re-engineering the Role of the government;

3. Administrative and Legal Reforms;

4. Strategic Management of the Economy with a focus on knowledgebased

HRD Activities;

5. Fiscal Prudence;

6. Agricultural Sector Reforms;

7. Industrial Restructuring;

8. Labor Sector Reforms;

9. Foreign Trade and Outward Investment Policies;

10. Financial Sector Reforms.

Political Reforms for Good Governance

Political reforms are urgently required in concert with economic reforms.40

Both are essential to ensure good governance. A paradigm shift is required in

the prevailing system of governance. Serving the people and putting their

interests above the interests of the ruling elite must be the prime motivating

force driving the reformed system of governance. Good governance can be

ensured through the provision of an adequate quantity of public services and

by improving their quality. Indian politicians need to become fully aware of the

costs and benefits of economic reforms. Ruling politicians with limited terms

in office are often guided by narrow and short-term motivations while

formulating policies in the national interest. The Indian public at large also

needs to be thoroughly educated on the inevitable need to bear short-term

pain in order to reap the somewhat uncertain longer-term gains from

economic reforms.

Economic reforms in the future must be more people-centered. They must

be given a human face so as to continuously enhance the social

empowerments of the poorer and most vulnerable sections of the society.

They must be gender-sensitive to improve the status of women and girls. The

burden of adjustment to structural reforms must be more heavily borne by the

richer sections of the society. Appropriate electoral reforms, including state

40 For a discussion of the required political reforms in India, see Subhash C. Kashyap, Political

Reforms for Good Governance: A Policy Brief (New Delhi: Shipra Publications, 2003).

ECONOMIC REFORM IN INDIA

280

funding of elections, will help to reduce the lobbying power of the entrenched

vested interests.

Re-Engineering the Role of the Government

Reforms must be aimed at 'right-sizing' (often involving downsizing) the

government. Governments must specialize in performing roles that they can

perform better than free-market private enterprise. The government must

expand its role in areas such as the provision of public goods, especially

primary health, primary education and the creation of social infrastructures.

The role of the Planning Commission must be changed to that of a strategic

think tank. The mindset of the politicians and the administrators needs to be

changed to accept the re-engineered role of government in the context of

market-oriented economic reforms. The intensification of economic reforms

at the state level needs to be given a higher priority in the future since most

social services and infrastructural activities are primarily the responsibility of

the state governments.

Administrative and Legal Reforms

No matter how good the design and intent of economic reforms, their

success ultimately depends on efficient and speedy implementation through

sensitive and responsive administrative and legal systems. Transparency and

accountability must be guiding principles for the formulation and

implementation of policies and procedures. Improved administrative systems

should be devised to ensure that merit subsidies directly benefit the targeted

(generally the underprivileged) sections of society. Legal support services

should be made available with more public funding and must be strengthened

to provide justice to genuinely aggrieved sections of society more quickly and

affordably.41 Second-generation economic reforms also must focus on

changing the mindset of administrators (especially at the grass-roots level) and

of the judiciary (especially at the lower level) to support administrative and

legal reforms that synergize with economic reforms for maximizing social

welfare.

Strategic Management of the Economy

Macroeconomic management must be dovetailed with a well-formulated

strategic national vision for the economy for the year 2020 (and beyond).

Clarity, transparency and accountability (through identifiable responsibility

centers) with properly designed incentive (and disincentive) systems should be

the guiding principles governing strategic management of the economy. An

41 See Subhash C Kashyap (ed.), The Citizen and Judicial Reforms under Indian Polity (New Delhi :

Universal Law Publishing Company, 2002).

CHARAN WADHVA

281

appropriate code of conduct should be evolved and observed by economic

actors under a new managerial system of governance. The strategic

management of the Indian economy in the twenty-first century must focus on

human resource development to promote knowledge-based and skill-intensive

economic activities in line with India's dynamic competitive advantage.

Fiscal Prudence

The fiscal deficit (especially the revenue deficit) needs to be quickly

reduced. India must sincerely implement the Fiscal Responsibility and Budget

Management Act . Simultaneous action is required at both central and state

levels to raise the tax-to-GDP ratio by expanding the tax base (for example, by

taxing services and rich agriculturists) and improving tax administration (for

example, through computerization). The revenue deficit must be brought to

zero within five years.

Agricultural Sector Reforms

While some agricultural reforms have already been carried out, these are

highly inadequate. Primacy must be given to the agriculture sector in all future

reforms since many more jobs can be created in the agricultural sector, broadly

defined, including activities related to rural industrialization and overall rural

development. Both on-farm and off-farm employment potential must be fully

exploited. This will raise incomes of farmers and rural labor on a sustainable

basis and provide a much-needed boost to demand for industrial products and

services, thus spurring all-around economic growth.

There is an urgent need to raise public investment in agriculture

substantially. Areas needing investment include: irrigation; watershed

development; rural infrastructure; drinking water; housing and sanitation. This

will help raise the productivity of Indian agriculture to international levels and

help in promoting rural (and interlinked urban) prosperity in India.

Second-generation reforms must reduce the perennial anti-agricultural bias

by permitting free® exports of all primary products. This will provide a major

boost to India's exports consistent with the rules set by the World Trade

Organization. Simultaneously, India must improve its marketing infrastructure.

Agricultural reform will unleash high growth rates in agriculture, on which

nearly sixty percent of India's population is still dependent for employment.

Agricultural prosperity will help to markedly reduce endemic rural poverty.

Industrial Restructuring

Industrial reforms must be geared to explicitly improve the productivity

and international competitiveness of Indian industry by focusing on niche

products and niche markets. Economic policy in this respect must facilitate

ECONOMIC REFORM IN INDIA

282

mergers and acquisitions and the winding up of terminally ill enterprises in

both the public and private sectors by restructuring bankruptcy laws. Massive

restructuring is required of Public Sector Units. Most non-performing public

sector units should be quickly sold through a privatization process that also

safeguards the interests of workers through fair compensation for loss of jobs.

Public sector enterprises should be governed by a commercial culture in which

government holdings are no more than 26 percent of equity and are retained

only to preserve strategic control. It is of the utmost importance that microlevel

reforms must supplement macro-level reforms in the future to achieve

synergy. The private sector in India needs to become more international in its

outlook to become more competitive and to increase its overseas presence

through outward FDI.

Labor Reforms

A properly formulated labor policy must form the core of secondgeneration

reforms. This will require viable alternative social safety nets and

effective retraining and re-employment opportunities. Once satisfactory safety

nets are in place, more intensive competition should be injected into the labor

market by allowing 'hire and fire' policies unambiguously linked to the

productivity and profitability of micro-enterprises. The government should

start by exempting units in the newly created Special Economic Zones from

the rigors of labor laws. These measures would be of great help in redressing

inefficiency of workers in public enterprises and public services (such as health

care in rural areas).

Foreign Trade and Outward Investment Policies

No economic reforms can succeed in India without ensuring adequate

growth of exports of goods and services to ensure longer-term viability of its

balance of payments. While anti-dumping measures need to be strengthened to

protect Indian industry from unfair import competition, the longer-term

reforms must continue to lower import duties to levels comparable to those in

leading Southeast Asian countries. Simultaneously, measures should be taken

by the government to replace quantitative restrictions (wherever they still

remain in place) through appropriately determined tariffs.

The second generation of economic reforms must facilitate the growth of

India's own Multi-National Corporations (MNCs). The government must

further liberalize outward foreign investment to allow potentially competitive

Indian MNCs to establish production bases abroad and trade internationally.

Finally, industry and government must make cooperative efforts to prepare

Indian industry to meet the new and ever-emerging challenges posed by the

CHARAN WADHVA

283

new world trade order and the new world investment order being evolved

under the World Trade Organization.

Financial Sector Reforms

India must heed the lessons of the East Asian economic crisis and

recovery, and attached the utmost urgency the next phase of financial-sector

reforms. The high level of Non-Performing Assets plaguing long-term

Development Financing Institutions and commercial banks must be

dramatically reduced.

To summarize, greater competition in the financial sector with an

appropriate exit policy to reduce overstaffing together, along with sound

macro-economic policies, will help to lower the real rate of interest and spur

investment and efficiency, thereby raising growth rates and benefiting

consumers. Coupled with the current regime of falling interest rates, greater

competition in the financial sector in general and among the commercial banks

in particular will help to increase the rate of investment in the economy.

Simultaneously, foreign insurance and pension funds should be allowed to

operate with fewer restrictions to make more resources available to finance the

modernizing of India's infrastructure. Further policy and procedural reforms

(especially in the power sector) will help to attract substantially higher

investment in India's infrastructural sectors.

Finally, credible policy measures that protect investors, especially

individual investors with small savings must be adopted. These measures, if

effectively implemented, will help to revive growth in India's capital and stock

markets. It must be remembered at all times that the be-all and end-all of all

economic activities is the consumer. Future economic reforms must aim to

directly benefit Indian consumers through cost reductions, enhanced quality of

goods and services, and by expanding customer choice through competition.

CONCLUSIONS

Within the constraints of democratic politics and the relatively 'soft' nature

of the economic reforms implemented since 1991, the Indian economy has

reaped several welcome rewards from its reforms. These have strengthened

the conviction that the broad direction of the reforms is right and, in that

sense, made the reform process irreversible. However, India needs to launch a

'second generation' of economic reforms, with a more human face, if it is to

reap their full potential. Politicians and administrators need to display greater

pragmatism while designing and implementing future economic reforms. The

ECONOMIC REFORM IN INDIA

284

reforms must be based on the long-term vision of transforming India into a

global economic power in the next twenty to twenty-five years.

It will be of the utmost importance that all sections of society are educated

as to the long-term benefits of reform in order to mobilize public support.

These reforms, therefore, will have to be drastically redesigned and politically

'marketed'. Future economic reforms must be seen and experienced as not

only good economics but also good politics.

Two paradigm shifts in the reforms, backed up by the effective fulfillment

of the promises made, will help to garner the support of the Indian people.

First, these reforms must aim to raise the productivity of Indian labor and

improve the work culture and, over time, provide significant rewards to the

people of India by spurring growth, providing a higher level of real wages, and

generating wider avenues for employment and re-employment. Growth with

employment is the most effective strategy for eliminating poverty and

improving the quality of life of the people.

Second, the reforms must aim to directly benefit Indian consumers. Over a

reasonable time span, the reforms must reduce prices of goods and services

(including public goods), improve their quality, and allow much more freedom

of choice by maximizing the benefits of healthy competition. This will further

expand the size of the market-both domestic and international-and provide

incentives to entrepreneurs to raise their investment, output, and employment.

A combination of more productive labor and pro-consumer economic reforms

will be a win-win, proving to be both good economics and good politics.

Visionary political statesmanship will be required for this. It should not be

slogan-oriented but more result-oriented since it will likely be perceived and

experienced as 'pro-people'.

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