In 1991, capital issues by Indian companies were controlled by the Controller of Capital Issues, who decided whether the price of a new share issue was “appropriate”!
TWENTY-FIVE YEARS is time enough to look back at the hits and misses of the 1991 reforms. We can look at the reforms themselves as “inputs” to see how much got done and we can also look at “outcomes” to see what was achieved.
On the input front, I distinguish between the specific reforms promised in 1991 and the “second generation” agenda which emerged subsequently. The 1991 reforms focused on four areas (i) deregulating the regime of industrial licensing, control of large houses through the Monopolies and Restrictive Trade Practices Act (MRTP), and restrictions on foreign direct investment, (ii) liberalising foreign trade by ending import licensing, progressively reducing import duties, and relying on a flexible exchange rate to provide balanced incentives for efficient import substitution and also exports (iii) modernization of the tax system and (iv) financial sector reform.
The reforms in the investment and trade regime have been transformational. Today’s 40-year-olds were only 15 when the reforms began and they cannot even imagine the absurdity of the controls that were in place! Industrialists would frequently, and quite rightly, complain in CII meetings that producing more than the permitted capacity put them in danger of being penalised for violating the conditions of their licence instead of being rewarded for achieving higher productivity! And, MRTP controls ensured that Indian producers could not expand easily, making it impossible for them to aspire to global scales.
Most imports were canalised through government agencies or allowed only subject to clearance from the Directorate General of Technology Development (DGTD) after applying the twin criteria of “essentiality” (were the imports really needed, as judged by a babu?) and “indigenous angle” (was an acceptable domestic alternative available, again as judged by a babu?). The process was highly arbitrary and non-transparent.
For example, DGTD judged that Maruti should not be allowed to import machines from Japan because the HMT products were good enough, after all they were being used to produce the Fiat 1100 and our very own Ambassador! It took someone of V. Krishnamurthy’s—founder chairman and CEO of Maruti Udyog Ltd—clout to get DGTD overruled!
In the private sector, too, the system worked to the advantage of the larger companies, who could more easily get a hearing from the system. The smaller producers lived with what was decided for them, unless they could bribe someone to decide differently.
Mercifully, industrial licensing and MRTP were quickly liberalised. Monopolistic practices can be a problem, but they are now looked after by the Competition Commission. The shift from import licensing to liberalised trade with a flexible exchange rate was achieved within two years, faster than originally envisaged. But, consumer goods remained strictly controlled for much longer. This was largely to give domestic producers more time to adjust and this segment was finally subjected to competition from imports, though subject to relatively high tariffs, only in 2001. On the whole I would call the achievement in these areas a clear hit.
Tax reforms were initiated in 1992, but took much longer to put in place, and the task is still half done. The personal income tax rates were a maximum of 50 per cent in 1991. They were reduced in a series of steps and are now 30 per cent, though with surcharge. The tax rate on corporate profits was also reduced, but less than it should have been, because efforts to get rid of exemptions which would have permitted lower tax rates met with resistance. Hopefully, that transition is now round the corner.
Customs duties were ridiculously high in 1991 and were supposed to be reduced to East Asian levels gradually. We have closed the gap significantly, but our duties are still on the high side and duties on inputs are at times higher than on final products. Reform in domestic indirect taxes has been far too slow. A tax regime integrating state and Central indirect taxes to cover both goods and services was recommended in 2004. Twelve years later it is still in the making, though hopefully now round the corner.
It is difficult to score the hits and misses on the tax policy front. We should have done more, but clearly the system has moved, albeit slowly, in the right direction. We need to do much more to modernise tax administration and there are many excellent recommendations of the Parthasarthi Shome Committee which, if implemented, could give us a world class tax system.
The record on financial sector reforms has many hits and some misses. The changes in the stock markets have been remarkable and are a clear hit. In 1991, capital issues by Indian companies were controlled by the Controller of Capital Issues in the finance ministry and this functionary had to approve whether the price of a new share issue was “appropriate”! The office was abolished in 1992 and SEBI was made the statutory regulator. SEBI has done a superb job since then, and the large flow of portfolio investment testifies to the confidence international investors repose in this institution. This is a clear hit.
It is worth remembering that 1992 also saw the Harshad Mehta scam which led to an uproar against liberalisation of the capital market, which was thought to have been the source of the problem! The real culprit was the laxity in the system of “bankers receipts” issued by banks selling government securities to other banks, which enabled brokers to siphon money out of the system to deploy in the stock market. Fortunately, the approach of strengthening the regulator, while closing a number of loopholes, was followed, and the capital market reforms were not rolled back.
Banking reforms were on the 1991 agenda and there has been significant progress in some areas. The first priority was to tighten up on regulatory norms and this was done very quickly—a clear hit. The regulations restrained Indian banks from excessive exposure to foreign borrowing, and this helped protect us from the East Asian flu of 1997—another clear hit.
A landmark agreement between the finance ministry and the RBI (signed by me as finance secretary and Dr C. Rangarajan as the deputy governor on September 9, 1994) initiated a process under which the system of automatically creating ad hoc treasury bills to finance the government deficit was to be phased out in three years. This ended the automatic monetisation of the deficit. The fiscal deficit remains a problem, but the fact that it is no longer automatically monetised is an important gain for monetary management.
Disinvestment of equity in public sector banks was accepted, but reducing the government’s equity below 51 per cent proved politically impossible. Finance minister Yashwant Sinha in 1998 publicly voiced his support for the reduction, but he had to backtrack. There was a clear bi-partisan consensus to follow a “no- go” policy on this issue, rather than the normal “slow-go”. Allowing more private sector banks into the system has also been slow. Fortunately, RBI Governor Raghuram Rajan has laid out a clear roadmap and started the process of licensing new private sector banks. Better late than never, but given the time that new banks take to start making their presence felt, we would have been much better off had we started the process several years earlier.
There are many other issues of reform that came up in subsequent years, all of which belong in the second generation category. I propose to cover all these in a book on which I am working. While the political compulsions of gradualism have often forced a slow pace of change, we do not have the luxury to continue with this slow pace any more. This is because expectations have gone sky high and the growth rate we need to meet these expectations cannot be achieved unless the pace of change is accelerated. We have done a lot, and that should make us bolder to forge ahead and complete the task.
Let me now turn to outcomes. Of course, it takes time for reforms to have effect, but there is little doubt that we have much to celebrate. In 1991 we faced an imminent collapse in the balance of payments and a possible external default and were forced to tighten imports through licensing in a manner that was highly disruptive. Within one year, the economy was clearly stabilised and two years later, we ended the International Monetary Fund arrangement earlier than scheduled, and accelerated the repayment schedule. More importantly, we managed the balance of payments in the world of liberalised imports without having to go to the IMF. The current account deficit in 2012-13 was over 4 per cent of GDP, as bad as in 1990-91, but the strong reserves position and the system of flexible exchange rates worked to restore stability relatively quickly with no disruptive import controls.
The impact of reforms on growth has also been positive. Growth accelerated initially, but then slowed as the East Asian crisis dampened investor expectations everywhere. Some delay in seeing the full benefits of reforms was also inevitable, because the reforms had generated much controversy and investors would wait to be convinced that the reforms would not be reversed. Fortunately, the next two governments—the United Front in 1996 and 1997, and the A.B. Vajpayee government until 2004—continued in the same direction. The return of the UPA in 2004 also promised continuity.
The cumulative effect of the reforms on economic growth was to deliver an average growth rate of 7.7 per cent in the 12-year period from 2003-04 to 2014-15. This is the fastest growth rate India has ever recorded since independence, and that too over a period which included two years of global crises in 2008 and 2011. Assuming 7.4 per cent growth in 2015-16, India will be the fastest growing emerging market economy in the current year because China has slowed down. Most analysts believe that China will settle into a lower growth trajectory, but India could continue to grow between 7.5 and 8 per cent, provided the tempo of reforms is accelerated. On the growth front, the reforms score a clear hit and the experience points to the need for more action. However, the growth needs to generate more employment.
The impact of reforms in poverty reduction is also a clear hit, because poverty declined from 37 per cent in 2003-04 to 22 per cent in 2011-12, which was much faster than in the previous period from 1993-94 to 2003-04. For the first time, the absolute numbers in poverty fell substantially. Of course, there are still too many people below the poverty line, and the line is also arbitrary. We could raise the poverty line, but that will not alter the underlying trend of decline.
None of this is to suggest that we can be complacent. Poverty is still too widespread and intense. We need to do more to ensure better education and better health care, and we need to think about longer term problems of social security. However, all this takes time and more money. Money will be easier to mobilise if the economy is growing, provided the tax system is also modernised. However, we also need to ensure that money devoted to these sectors is well spent. In the social sectors, this depends almost entirely on the states.
An important “miss” in the reforms is environmental sustainability. In every other field, we are making progress, even if we have not quite reached our targets. Unfortunately, in the area of environment protection, there is evidence of deterioration. Whether it is air pollution in our cities, the water quality in our rivers, the quality of underground water or the quality of forest cover, things have only deteriorated. Fortunately, there is growing recognition of this weakness in our development process. We need to do much better, but one thing is clear—it will require more reforms, not less.