Introduction:
The
Economic reforms currently underway in India represent both continuity and a
break with India's post-independence development. Its main objective is to
restore sustained high growth to alleviate poverty and raise the standard of
living.
Development of Thought:
Changes in
the policy packages towards deregulation, liberalization and opening up of the
economy were initiated in the late 70s and early 80s but it was not until 1991
that major economic reforms were undertaken. The major changes in India's economic
reforms fall broadly under five heads-industrial, trade, financial, fiscal and
monetary.
However
these measures of stabilization are not by themselves enough. The main impetus
for sustainable economic growth has to originate with efficiency and productivity
growth brought about through the expansion of investment and exports.
Another
important aspect to be considered is the large number of people in the country
living on the poverty line. To make any reform process socially acceptable a
poverty alleviation programme must be in. In the context of resource
constraints, a serious thinking has to be done as to the extent and pace of
economic reforms.
Conclusion:
India has
to go through a painful period of adjustment before the liberalization can have
its fruitful impact upon the economy. In liberalizing the economy the
government must not forget to protect the poor and the needs of human
development.
The
present bout of economic reforms in India-those started in the nineties- marks
both continuity and a break with India's post-independence development
strategy.
India's
development strategy after independence was largely influenced by reservation
regarding the ability of the market forces to bring about, on their own, an
optimum allocation of resources, thus balancing the country's two main
"Objectives "growth' and 'equity'.
A
realization has since dawned on policy-makers, based on India's own experience
and the experience of other countries, that: The domestic economy has now
reached a threshold where for better utilization of resources the benefits of
the market forces can be harnessed, by proper market-friendly macro and micro-
economic policies helping both in higher growth and more equity.
This has
initiated a serious debate in the country on our development strategy for
opening up the economy and allowing more market orientation, by removing major
Government interventions and regulations.
Since
1977, and specially after 1985-86, the Government has embarked upon a series of
economic reforms leading towards liberalization and deregulation Subsequently,
there has been a significant improvement in the growth rate of the country-from
the long existing, low rate of income growth of 3.5 percent to an average
growth rate of 5.5 per cent and above.
As noted,
the changes in the policy packages towards deregulation, liberalization and
opening up of the economy had been initiated in the late 70s and early 80s.
These changes were not systematic and were never integrated into an overall
framework.
According
to many economists, these changes were rather slow but not monotonic, until
July 1991 when the new Congress Government came to power. Since then the change
in the policy packages have picked up momentum. There have been major changes
since July 1991.
The
present Man Mohan Singh led Congress Government came into power in 2004. It has
further extended the liberalization policy started in 1991. In its 2004-2005
and 2005-2006 budgets, the government has brought along with almost
simultaneous changes in trade and finance announced outside the Budget.
These
changes are primarily confined to Central Government activities and have not
been given an} general policy directive to integrate with the overall policy
packages of the State Government.
The major
changes in India's economic reforms fall broadly under five heads-industrial,
trades, financial, fiscal and monetary. The Government's key economic objective
is to restore sustained high growth which is essential to alleviate poverty and
raise the standard of living.
In pursuit
of these objectives the Government's reform strategy aims at achieving over the
course of the next five years:
(1) a
liberalized trade regime characterized by tariff rates comparable to other
industrializing developing countries and the absence of discretionary import
licensing (with the exception of a small negative list);
(2) an
exchange rate system which is free of the locative restrictions of trade;
(3) a
financial system operating in a competitive market environment and regulated by
sound prudential norms and standards;
(4) an
efficient and dynamic industrial sector subject only to regulations relating to
environmental security, strategic concerns- industrial safety and unfair
trading and monopolistic practices; and
(5) an
autonomous, competitive and streamlined public enterprise sector geared to the
provision of essential infrastructure goods and services, the development of
key natural resources and areas of strategic concern.
It
involves taking every step necessary to ensure that the burden of adjustment is
fairly distributed and that the very poor are protected. As a first step in
this direction the Government has established a National Renewal Fund to
provide social safety net.
The thrust
of the reform programme would initially be on casing the country's extremely
tight external payments situation and reducing inflation. In this context, the
Government intends to pursue a. stab le exchange rate policy geared to maintain
the rupee constant in nominal terms- and to rely on fiscal adjustment
accompanied by a tight monetary policy to contain inflation.
But this
is an initial phase. Stabilization by itself is not enough. As traditional
demand impulses originating from fiscal policy will remain constrained in the
next two to three years, the main impetus for sustainable economic growth has,
to originate with efficiency and productivity growth brought about through the
expansion of investment and exports.
Under-pinning
such a path of growth must be a consistent and comprehensive structural reforms
strategy designed to promote exports, to improve the relationship between the
return on investment and the cost of capital, and to increase the degree
competition between firms in the domestic and external markets so that there
are adequate incentives for upgrading the technology, improving efficiency and
reducing costs.
The main
emphasis of the fiscal policy is to reduce the Central Government's fiscal
deficit, within the broader context of adjustment of the overall public sector
budget.
Reducing
the overall public sector budget will require increased financial discipline by
the State Government as well, and the Central Government will encourage the
State Government to take steps to improve their fiscal performance and to
streamline the working of the enterprises.
In this
context a comprehensive tax reform is proposed. It will improve:
(i) the
elasticity of tax revenue through identification of new areas and increasing
the share of direct tax a proportion of total tax revenue,
(ii) a
more equitable and broad based system particularly with regard to commodity
taxation and personal taxation,
(iii) the
removal of anomalies that distort economic incentives and simplification and
rationalizations of customs, tariffs, elimination of exemptions as well as a
reduction the average level of tariffs and finally improve compliance of direct
taxes and strengthen enforcements.
In this
context also, the need for rationalization and reduction of subsidies and for
moving to a more objective system of administered price has been emphasized.
Regarding
exchange rate policy it emphasized the adjustment of exchange so as to provide
a significant real depreciation, to improve export incentives and international
competitiveness. In this context the Government intended to keep the nominal
exchange rate stable by a suitable fiscal and monetary policy.
In the
immediate future, to achieve stabilization. Government visualizes a tightening
of credit and monetary policies, free higher interest rates and higher cash
reserve ratios. It also proposes, by declining the recourse to financial
savings the Government, a larger volume of supply of domestic credit to the
private sector.
The
Government recognizes that trade reform is an essential element securing supply
response to facilitate the overall restructuring of the economy and to restore
external payment viability.
There are
five key medium term objectives in the Government's trade policy agenda:
(1) The
broadening and implication of export incentive measures and the removal of
restrictions on exports:
(2) The
elimination of quantitative restrictions on imports;
(3)
Substantial retail in the tariff rates;
(4) The
decanalisation of exports and imports with the exception of a few items and
finally moving to a foreign exchange system which is free of locative
restrictions for trade.
The
Government also recognizes that the temporary restriction on import which had
to be imposed by the Reserve Bank of India no to be relaxed.
The
Government recognized that a major restructuring of Indian economy, implied by
its agenda, will very much depend on the success of its industrial policy
reforms.
In this
context a large number of sick firms which constitute drain on the Government
budget, with their unpaid outstanding loans, weaken the financial system, in
many cases with the firms closing down leaving their creditors unreimbursed,
have to be taken care of.
For the
restructuring of existing sick and loss-making companies, both in the public
and private sector, Government will review the existing provisions of various
laws governing labour relations, the State and the local government's role in
restructuring regulation governing transfer of land, the procedure of
liquidation under the Companies ACT and other relevant aspects.
The
Government is aware that the prerequisite of having a safety net or social
insurance scheme is to provide support for displace workers in the organised
sector. The Government's industrial policy strategy marks a major step forward
towards changing the regulatory structure of industries.
It
initiated major changes, including comprehensive deli censing, abolition entry
controls related to the MRTP Act and automatic approval of foreign technology
agreements and foreign investments, among others.
The
changes policies concerning foreign technology and foreign investment will
enable Indian industries to forge much more with foreign investors and
suppliers of technology than has been possible in the past.
The
Government's ownership of the financial and banking institutions enabled it to
achieve the multiple objectives of mobilization of resources integration of the
rural population into the financial mainstream, enhancement availability of
long-term loans to all levels of industry and agriculture and increased access
to credit to small industrialists, farmers and weaker sections of sock.
However,
there are weaknesses and imbalances. The statutory liquidity ratio and cash
reserve ratio levels are high, which implies low return for commercial banks on
their funds. This reduces the reserves available to non-priority borrowers and
raises their costs in moving to market based operations of the financial
institutions.
Measures
have been taken to strengthen the capital markets, the rates for debentures
have been freed, and mutual funds have been opened to the private sector and
the full statutory powers are to be given to independent agencies to regulate
security markets. The high level Narasimham Committee had been established to
review the structure.
In line
with the recommendations of the Narasimham Committee further reforms of the
financial sector will be formulated to increase the efficiency of the financial
intermediation.
The
measures required to meet these objectives would particularly involve a phased
reduction of priority lending schemes towards the targeted deserving groups and
eventual elimination of the subsidies involved, formulation of prudential norms
and standards to guide efforts in recapitalization of the banking sector and
full decontrol of deposit rates.
India's
severely constrained budgetary circumstances create both the need and the
opportunity for placing greater reliance on the private sector for resources
mobilization and investment. Public enterprises provide many of the basic and
critical inputs in India.
It is a
matter of serious concern that inadequate attention has been paid to improving
their efficiency. In the context of public enterprise structuring it will be
important to assess the social cost involved, with the closure of sick units,
and to develop options and measures for compensation of retrenched labour.
Enterprises
in areas judged appropriate for continued public sector involvement will be
provided with greater degree of managerial autonomy along with a progressive reduction
in budgetary transfers and loans. Sale of selected firms or partial divestment
for specific sectors is being increasingly, pursued.
The
Government recognizes that adjustment programmes entail significant
transitional cost. This cost includes potential loss of output, employment and
consumption due to the deflationary impact of fiscal consolidation and
frictions in the restructuring process which must be equitably borne by all
sections of the society.
However, a
large proportion of India's population continues to be subject to malnutrition
and ill health. For this group, the Government is committed to minimise their
share of the burden of adjustment.
Thus the
Government should provide higher outlays on elementary-education, rural
drinking water supply, assistance to small and marginal farmers, programmes for
women and children, programmes for welfare of scheduled caste and scheduled
tribes and the weaker sections of the society, and increased expenditure on
infrastructure and employment generation projects in rural areas.
Further
steps have to be taken to re-allocate social expenditure, particularly in
health and education for the poor. Additional cost-effective compensatory
programmes, particularly in the areas of nutrition and employment, should be strengthened
and broadened.
In this
context the establishment of a National Renewal Fund has been proposed. Against
this backdrop of proposed policy changes, the first set of changes introduced
by the Government comprises increasing of taxes and reduction in Government
expenditure, in order to reduce the deficit.
Simultaneously,
there have been adjustments in the exchange rates to make exports more
attractive and to control imports to narrow the balance of payment gap. Along
with this a tight monetary policy was followed. Subsequent assessments however
revealed that these measures were insufficient to reduce excess demand for
imports.
Consequently,
the Government imposed emergency credit restrictions on imports. Unfortunates
although the Government took timely measures in the field of trade, industrial
policy and fiscal measures, it took a comparatively longer time to introduce
financial liberalization measures, public enterprise reform and measures
affecting the mobility of labour and capital which are normally known as
entry/exit policy.
By
introducing all these changes, the Government has been successful in its
stabilization attempts to a certain extent. For instance, the foreign exchange
reserve has reached 128.9 billion $ on 4 February, 2005, increasing by $31
billion from 2003-04, though it should be realized that this benefit is only a
one time gain, resulting primarily from multilateral aids.
Thus a
major part of multilateral aid has been used for debt servicing. Even NRI
outflow which increased $10.2 billion in 2002-03 to $14.3 billion in 2003-04.
Thus, the net inflow is still positive. There are differences of opinion as to
the potential adverse effect of attaining stabilization by this method.
For
example, to reduce the gap the contribution of export growth has long term
stable implications, but resorting to too much import compression, will affect
adversely the possibility of export growth, and may prove to be self-defeating,
especially if the import component of non-tradition exports is very high.
The 2005-06
budgets further has accelerated the reform process by reducing the deficit to
4.3 per cent of GDP but again by a modest increase in revenue and a heavy
reduction in expenditure, especially expenditure on capital formation and on
human development. For further reduction in fertilizer subsidy, nothing has
been worked out.
With
regard to the impact of economic reforms on social expenditure and poverty
alleviation it is noted that the reforms have affected public expenditure and
many of the key social services areas like health, sanitation, water supply
etc. which contribute to the welfare of the poor.
It does
not mean that there is no scope for economizing these expenditures but it
implies that it should be done carefully. Any across the board reduction may be
politically and administratively easy but would be harmful to the poor.
The
essence of the present economic reforms, understandably, is to resort to the
market and make price corrections according to the relative scarcity values and
rates of returns for all inputs in the productive system.
But
experience shows that in the long run, when the economy is not growing at a
fast pace (i.e., under a concretionary stabilization phase) these price shifts
results in the reduction in the reduction in the welfare of some sections of
the society while benefiting other sections, both in absolute and relative
terms.
The fall
in real consumption per has resulted in a significant increase in the level of
poverty ratio and accordingly the number of people below the poverty line. A
conservative estimate using Planning Commission methodology and database shows
that nearly 6 to 7 Billion people went down the poverty line during this
period.
This is a
contrast with an annual improvement of nearly 10 to 15 million moving above the
poverty line over the last decade. Thus overall, it makes a difference in terms
of a in the poverty alleviation pace by nearly 20 millions, with reference to
the trend values.
This
scenario has high political and social sensitivity. In order make the reform
process morally and socially acceptable and politically feasible, conscious
positive programme on poverty alleviation will be needed. The need for such a
programme will be more felt if the message is that the present structural
adjustment phase will last for more than 3 to 4 years.
The
economic reform process also breeds a class of "new poor". These are
the people who will be affected by the restructuring process through
'closures', many of them are at the higher and middle income level, mostly in
the organised or and easy to identify.
They are
the target groups which can be covered by the National Renewal Fund. In this
context it should be noted that already there has been a significant increase
in the percent of unemployed.
To provide
a cushion to the poor against high price increase, the Government uses the
Public Distribution System (PDS); however its effectiveness needs to be
improved. For lance:
(I) The
inter-State PDS's allocation is made on a per capita basis regardless of
income;
(2) within
a given area the poor-income groups are not functionally the most important
beneficiaries of the PDS. In West Bengal, for ample, the PDS financed 54 per
cent of wheat consumption of the rural highest income groups;
(3) the
PDS is grossly inadequate, especially in areas with high poverty intensity. The
income of the poor is much too low to take advantage even of the PDS; and
finally, the whole approach towards impact on the vulnerable section of the
society should be reviewed in the light of reduced public expenditure on social
programmes.
For
example, cuts in the health programme could lead to increase in India's already
high incidence of tropical diseases. In addition, a poor location programme has
its impact not only on the rural wage of the poor but also in the drive for
export growth and adoption of better technology, by making the labour force
more illiterate.
The
stabilization package is giving the anticipated results: it has also skillfully
combined some of the structural adjustment changes. However, the adequacy of
the structural adjustment elements and the growth factors in the stabilization
programme of the Government has been questioned by many economists.
It is that
many of the measures taken are on the soft side, as it does not remove many
implicit subsidies. In this context, measures to contain the Government wages
bill have not been given proper priority. With regard to taxation, it is felt
that even now, the indirect tax rates in India, particularly on imports, are
very high compared to other LDCs.
Of the
measures on adjustment that have bet implemented, almost all are in the Central
Government sector; whereas substantial fiscal deficit exists in the States,
almost close to that of the Centre of nearly 1.8 per cent of GDP. More exhaustive
measures need to be taken to curtail the States' expenditure pattern.
With
regard to the cut in the capital expenditure, is rightly realized that there
are many wasteful expenditure items in the present composition of public
investment.
One
should, however, be cautious not to reduce them indiscriminately, since in this
process, along with the unproductive, productive sectors, also may suffer a
cut.
The 'exit
rules' constraining firms from liquidating their assets or retrench workers,
remain major hindrances to improving their efficiency and new investments in
the organised sector. Any postponement of a policy in this arc does not fit
with the basic philosophy of structural reform and efficiency.
As to the
role of foreign investment, they should be given more open-ended facilities
since even now there remain a large number of constraints in the form
Government restrictions on remittances of profit, and Government's approval
required for some major productive sectors.
In the
field of financial liberalization a quicker action is needed on the Narasimham
Committee's Report. Without a sound financial superstructure the passage to the
market system may result problems, as was observed in the stock market debacle
very recently.
The
financial reforms would strengthen the prudential financial recoveries and
allow private banks, foreign and domestic, to bring competition to the
financial sector. In the field of agriculture, no specific action has been
taken for its betterment.
This is
the area where coordination with the States Rector would be required. Public
sector needs greater positive reforms in addition to reduction in the capital
expenditure as given in the last two Budgets.
The public
sector should be allowed to adjust to the new policy frame by focusing on issues
like: (i) privatization and (ii) closure of enterprises that would not survive
in a competitive environment.
Finally,
although India has successfully diversified and expanded its export base, the
major contribution in India's export growth has come from the demand pull of
the receiving countries (especially the developed countries). Only a vet; small
portion can be accounted for by changes in market composition and price
competitiveness.
Indeed it
is only the price factor and a prudent spread over different markets which can
help in further increasing India's exports, in future. This is true especially
when the international trade buoyancy does not give rise to much optimism.
However,
for increasing exports, apart from reducing domestic costs, the country
will-need better links, with the international market. For this efficient
transport and communication links will be needed to back our trade an
investment policy.
It is the
experience of most countries that in the process of reducing costs and
improving quality of products the role of literate labour force and skilled
manpower should get high priority. Indeed, absorbing higher technology needs a
correspondingly well-trained, literate and healthy labour force.
In this
context the heavy cut in human development expenditure under the recent budget
and the low emphasis on domestic R&D (needed to improve the ability to
absorb and indigenize foreign technology) are disappointing.
India
initiated the process of economic reforms with several handicaps. A high poverty
ratio with nearly 32 to 40 per cent of the population living below the poverty
line. A very low foreign exchange reserve and level of confidence about India's
credit worthiness.
An
unfavorable world scenario with its projected low income growth and increasing
regionalism and a substantial loss in RPA trade (Former USSR and Post European
countries) for India.
India's
hang-up with anti -market socialistic development strategies and people's
shaken confidence arising from unsatisfactory sporadic liberalization attempts
since 1990s. The existence of a large but inefficient public sector with its
own vested interest.
All these,
in the light of inter-country experiences, forewarn of a longer gestation
period with heavy social costs and raise doubts as to the tolerance level of
Indian society for withstanding such less impending social cost.
However,
there are plus points: The liberalization package is preceded by the minimum
essential political setup: India's democratic form of society. In the
transformation of economy into a highly efficient one, moving towards a market
economy, India can benefit from her past experience of a mixed economy.
Indeed,
this places India on a better footing vis-a-vis China, East Europe and other
centrally planned economies. India has a very good track record of fulfilling
international commitments, with a comparatively low debt service ratio compared
to Latin American and some of the African countries.
India has
a large supply of skilled manpower and cheap labour. India has a reasonably
good basic infrastructure.
It is
against this backdrop, that India's stabilization measures should be assessed.
In the short run, it has fulfilled the specific stabilization objectives i.e.,
reducing the balance of payments and the budgetary gaps and recouping all the
losses in the foreign exchange reserves.
However, a
word of caution is needed, from the experience of other countries it has been
observed that a short-term success in the stabilization phase often tempts
policy-makers to sit back and prolong the phase of stabilization process. In a
number of cases this has led to stagflation.
The
continuance with too high a foreign reserve ratio (as in India) against a heavy
import compression requires a warning. Indeed, a large part of the present
problem is due to India's lack of proper foreign exchange reserve management.
This
warning is specially needed when stabilization is achieved through soft option
(import and expenditure compressions and heavy foreign exchange borrowings)
regardless of the needs for growth and productivity (as observed in number of
other countries).
This may
retard and render difficult the desired transition to growth. To avoid this,
the adjustment process could be slowed down if necessary, specially in certain
areas of reform (for example, the rate of decline in the budget deficit as percentage
of GDP). The therapeutic approach of a shock treatment in the reform process
may not work in India.
As
observed in the case of other countries, a structural adjustment process is
much more complex than the stabilization process, and therefore should not be
left only with the bureaucrats and politicians. There is no standard recipe for
the structural adjustment phase, although there is a far degree of commonality
in the stabilization phase.
In
choosing proper sequencing a very strong financial and banking infrastructure
is a pre-requisite to establishing appropriate market codes of conduct.
Therefore financial liberalization should not be postponed for too long.
Moreover,
in tune with the spirit of present economic reform, decisions on privatization
and exit policy should follow early in the game. Although a high rate of
inflation is a problem the key issue is to revamp the real growth of the
economy by suitable investments and incentives.
In the
context of improving productivity and international competitiveness, technology
improvement should be the buzz word. The attempts to reduce the costs
exclusively through fiscal. Monetary, financial and trade policies have their
limits. Ultimately, it is the technological progress which matters.
Imports of
technology via foreign direct investment should accordingly feature at the
centre as a necessary condition for increasing efficiency. However, the
absorption and indigenization of foreign technology alone will satisfy the
requisite condition for success.
This will
be made possible by the growth of research and development in the domestic
economy. Reforms, therefore, the research and development policy, must provide
a clear strategy and sufficient resources.
To
conclude, when Liberalization reforms were initiated the economy was suffering
with the heavy foreign exchange constraints and import compression and a
relatively unfavorable international scenario but India will have to go through
a painful prolonged period of adjustment.
Thus, the
country must prepare itself to meet this challenge by first protecting the poor
and second by protecting the infrastructure and human development needs.
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