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Some Macroeconomics of India's Reforms Experience

An Outline

Mihir Rakshit

Though some tentative steps towards liberalisation were taken in the mid 1980s,it was only from 1991-1992 that
the government of India has been implementing in earnest a fairly comprehensive economic reforms programme.
Without going into the details of all the reforms measures, I shall focus primarily on those policies which seem
to have important short- and medium-run macroeconomic consequences.

I. Economic Reforms in the 1990s

The reforms programme was undertaken in the face of a balance of payments crisis which forced the
country to seek IMF financial assistance. Though India adopted a more cautious and step-by-step approach to
reforms and liberalisation than most other similarly placed emerging economies, the programme bore the
unmistakable stamp of the Washington consensus.
The then prevailing perception among international financial bodies and the most influential
section of Indian economists was that the proximate cause of the payments crisis was the faulty macroeconomic
policies the country had been pursuing during the 80s. More fundamentally, the malady was traced to growing
inefficiency and non-competitiveness of the country's products due to subversion of market forces through a
plethora of controls and quantitative restrictions and to the position assumed by the public sector for controlling
the "commanding heights" of the economy. The problems faced by the country were accordingly sought to be
solved through two sets of policies, the first macroeconomic, the second efficiency promoting, though in a
number of instances the distinction was far from clear cut.
The thrust of the macro-stabilisation programme consisted in the following measures:
(a) reduction in fiscal deficit with curbs on government expenditure including subsidies;
privatisation along with priority accorded to profitability in running public enterprises; and
tax reforms for imparting buoyancy to revenue receipts;
(b) sharp devaluation (in two quick, successive steps) at the initial stage followed by (i) a
fairly rapid transition to a more or less market driven exchange rate system; and
(ii)encouragement of the inflow of foreign capital through opening up avenues for foreign
institutional investment (FII) and considerable relaxation of controls on FDI;
(c) significant scaling down of net central bank credit to the government to meet its financing
requirement and the large measure of autonomy granted to the RBI for maintaining the
country's internal and external balance .
Also important for promoting the medium- and long - term viability of the balance of payments were
abandonment of the import substitution policy and phased liberalization of trade, though the major impact of
these policies were mostly allocative, their effects being primarily on composition of domestic production and
absorption. Similarly, practically all financial sector measures have both efficiency and macroeconomic
implications. The most important of these measures are:
(a) a cutback in the Statutory Liquidity Ratio (SLR) from 38.5% to 25% , along with moves
to make interest rates on government securities market determined( so that there could be
a level playing field for private sector borrowers and the government);
(b) adoption of international best practice (Basle) norms relating to capital adequacy, income
recognition, asset classification and provisioning and these were sought to enforced by
strengthening of the RBI's regulatory - cum - supervisory role;
(c) gradual abolition of the system of fixing banks' lending and borrowing rates of interest,
except for the rate on short-term (savings) deposit; and
(d) abolition of control of capital issues by the government and constitution of the Securities
and Exchange Board of India (SEBI) for making the issues easier and rule based, and
functioning of stock exchanges transparent.
While adoption of the Basle norms and strengthening of the regulatory and supervisory role of the RBI
(as also of the SEBI ) were intended to impart stability to or strengthen the shock absorptive capacity of the
financial and hence of the macro-economic system, steps like cutbacks in SLR, removal of controls on interest
rates, entry of private firms in the financial market, etc were designed to raise allocative efficiency through
greater flows of funds to the relatively productive lines of activity in the economy. Such measures were
complemented by policies relating to de-reservation so that private entrepreneurs were now permitted to set up
production units in any sector except for a few defence or strategic industries.

II. Balance Sheet of the Indian Economy

While all aspects of the behaviour of the Indian economy since 1991 cannot be attributed to the
reforms programme undertaken by the government, it is useful to take stock of the major macroeconomic
indicators over the last two to three decades, and to see whether or in which areas there have occurred
significantly positive or negative developments.
Perhaps the most striking feature of the Indian economy during the 90s was that unlike most other
developing nations which had adopted IMF sponsored structural adjustment programmes, India did not have to
undergo a prolonged period of downturn in GDP and capital accumulation : after a dip in the GDP growth rate
along with a sharp absolute decline in aggregate investment during 1991-92 , there was a smart spurt in both
the variables from 1992-93 onwards. Indeed not only were growth rates of GDP , per capita income and capital
accumulation higher in 1992-2001 than the corresponding averages in the 70s and the 80s, but the coefficients
of variations of these variables were also lower during the former period. The other important positive features
of the post-reforms era are:
(a) a considerable fall in the poverty ratio , from 36.0 percent to 26.1 percent, between 1993-94 to 1999-
(b) a sharp cut-back in monetised deficit from 2.7 percent of GDP in 1990-91 to (-)0.2 percent in 1999-
2000; and
(c) a decline in the inflation rate from double-digit figures in the early 90s to less than 5 percent during the
closing years of the decade.

It was in the external sector , however, that the performance of the economy was quite remarkable.
Considerable improvements in the balance of payments over the period 1990-91 to 2000-01 were attested by
(a) a reduction, as percentages of GDP, in external indebtedness and current account balance from 28.7 percent
and 3.1 percent to 22.3 percent and 0.5 percent respectively;
(b) increase in foreign exchange reserves from USD 5.8 billion (amounting to 2.5 months' import bill) to USD
42.2 billion (representing an import cover of 8.6 months);
(c)a sharp decline of short-term debt as percentage of forex reserves from 146.5 percent to 8.2 percent; and
(d)a fall in debt service payments as percentage of current receipts from 35.3 percent to 17.1percent.
The economy also became much more open during the reference period, with (a) merchandise trade- and
invisible trade - GDP ratios recording spectacular increases from 14.6 percent and 4.8 percent to 22.8 percent
and 12.0 percent respectively; and (b) a rise in the country's share of exports in world trade from below 0.5
percent to nearly 0.6 percent.

Some disquieting developments

Despite all the apparent signs of strengthening of the external balance and recognition of India by the
IMF and the World Bank as a less indebted nation, about a couple of months back an international agency not
only downgraded the credit rating of the country, but the ( sovereign ) rating was put below that of an Indian
financial company, not renowned for its performance in recent years. Though the credit rating agencies have
become notorious for their failure to detect in time the worsening economic conditions of companies or
countries, in this instance , I believe, the agency was on the whole right, but for the wrong reason. The single
most important factor cited for downgrading was the persistence of large fiscal deficit which, as we shall see, is
only a symptom (and not a very important one at that) and provides little clue to the ills afflicting the economy.
Before trying to search for the diagnosis and suggest remedial measures, let us first summarise the main
manifestations of the malady the economy has been suffering from over the last six years or so.
That all is not well with India's reforms experiment is suggested by the fact that the economy, after
managing a rapid recovery, lost its growth momentum within a few years. Note only were the average GDP and
per capita income growth during 1997-01 significantly lower than in 1992-97, but they were also less than the
corresponding averages in the 80s. In fact, on the basis of the behaviour of growth rates of investment and other
relevant macro variables, it appears reasonable to identify 1996 or even 1995 (rather than 1997) as the turning
point when the prolonged period of deceleration set in.
The second and no less disturbing development during the 90s was the extremely low growth of overall
employment, belying the expectation that the reforms programme, through stimulation of labour intensive
activities, would help harnessing in the growth process the country's huge untapped human resources. As the
latest Economic Survey reveals , between the periods1983-94 and 1994-00 the average annual growth rate of
total employment recorded a steep fall from 2.04 to 0.98 percent (— something which together with the decline
in per capita net availability of foodgrains in the latter part of the 90s cannot be easily reconciled with the
official estimates of the poverty ratio).
Financial sector reforms have been much more comprehensive than reforms in other areas. However
this sector also has displayed quite a few negative developments. The most important of these are:
(a) decline in bank credit to the commercial sector and increasing bank holding of SLR securities far
in excess of the stipulated minimum; and
(b) failure of the capital market, especially during 1995-2000, to provide finance for domestic capital

Finally for the fiscal scenario, which constitutes, by common consent, the weakest area in India's reforms
programme and has prompted, as we have seen, downgrading of the country's credit rating by an international
agency. In marked contrast to the behaviour of the two ratios during the earlier decade, the 90s were
characterised by a declining trend in both the total revenue- and tax-GDP ratio. Again as ratios of GDP,
government consumption, revenue deficit, fiscal deficit, primary deficit and public debt showed a declining
trend during the initial phase of the reforms programme, but the trend has been completely reversed since the
mid 1990s. The focus of successive budgets over the last 5 to 6 years has been reduction of these ratios; but the
problem has proved intractable and their actual figures have tended to be consistently higher than the budget
estimates by a fairly wide margin.

III. A Diagnostic and Prescriptive Exercise

Remembering that in recent years the Indian economy has become much more open and hence subject
to external shocks to a greater extent than in the 80s, all the weaknesses of the economy noted above may not
perhaps be attributed to the reforms programme. However, not only the trade balance but exports also constitute
even now a relatively small fraction of GDP so that their behaviour cannot as yet account for major changes in
the country's GDP or other macro variables. Again, loss of the growth momentum and declining trend started
well before the Asian crisis, not to speak of the recent slowdown of the world economy. It is also pertinent to
note that India was an important beneficiary of the IT revolution in the 90s. If despite that the economy has
been experiencing deceleration in growth rates of GDP, investment and employment, and showing signs of
growing fiscal fragility, it appears reasonable to surmise that there must be something wrong, by way of
omissions or commissions, with the reforms programme itself.
The main sources of weakness of the reforms programme seem to be the following:
(a) Abdication of the government's responsibility to ensure adequate effective demand, confirmed
both by past policies and the Fiscal Responsibility and Budget Management bill lying before the
(b) Reforms, especially in the financial sector, without first promoting and ensuring well functioning
markets so that (i) there could be adequate credit delivery systems for small and medium
borrowers; and (ii) investors were not taken for a ride by unscrupulous companies or financial
(c) Fiscal fetishism or the bogey of public borrowing irrespective of its purpose or the state of the

More generally, the problem lies with acceptance of the (intermediate) targets laid down in the
canonical reforms agenda, without examining critically, in the context of the structural and other characteristics
of the Indian economy, how the various targets are related to one another ; whether they are consistent; or how
far they promote the basic objectives. The result has been intellectual lethargy in official circles. Indeed, the
counter-productive nature of many a government measure or failure to follow appropriate policies at critical
junctures may be traced to an inadequate appreciation of India's macro-economic linkages and hence of the
short- and long-run implications of the instruments used for attaining the (intermediate) goals. It is this
inadequacy which seems to lie at the root of:
(a) cutbacks in public capital formation, especially in infrastructure , for purpose of reducing fiscal deficit;
(b) reduction in agricultural investment along with rising procurement prices and fertilizer subsidies;
(c) failure to implement an expansionary policy even while the FCI has been carrying mountainous and rotting
food stocks; foreign exchange reserves are far above the requirement; and the economy has been suffering
from demand deficiency for a number of years;
(d) sharp reductions in monetised deficit despite the growing interest burden of the government and widening
output gap; and
(e) encouragement of FII inflows and accumulation of large forex reserves in the face of growing
unemployment and unutilised capacity in the economy.

Performance of Indian Economy

(per cent)
1970-71 1980-81 1990-91 to 1992-93 1992-93 1997-98
to to 2000-01 to to to
1979-80 1989-90 2000-01 1996-97 2000-01

GDP Growth Rate 2.95 (141.9) 5.81 (38.9) 5.61 (32.7) 6.1 (20.9) 6.68 (16.9) 5.35 (21.6)
Percapita GDP Growth Rate 0.73 3.67 3.68 4.17 4.75 3.42
Investment Growth Rate 4.65 (238.4) 6.48 (82.1) 6.93 (136.3) 8.31 (47.0) 9.63 (38.9) 6.68 (54.6)
Fixed capital formation Growth Rate 3.62 (181.2) 6.72 (33.8) 6.88 (86.9) 7.73 (75.6) 8.49 (84.2) 6.48 (57.2)
Public Investment Growth Rate na 6.9 (151.3) 3.2 (260.5) 4.3 (197.1) 2.28 (63.9) 7.75 (10.5)
Private Investment Growth Rate na 7.60 (251.2) 9.01 (205.1) 11.41 (151.7) 11.68 (189.8) 10.98 (74.4)
Public Consumption Growth Rate 4.42 6.92 (37.2) 6.38 (78.5) 7.63 (61.6) 4.66 (57.44) 12.58 (16.6)
Investment as % of GDP 17.64 21.23 24.42 24.41 24.82 23.90
Saving as % of GDP 18.38 19.51 23.20 23.15 23.50 22.80
ICOR 5.98 3.65 4.35 4.00 3.72 4.47
WPI Inflation 9.4 (100.6) 7.97 (48.8) 8.04 (42.1) 7.16 (54.6) 8.74 (42.9) 5.18 (70.5)
Services Share in GDP 34.40 38.60 44.30 44.92 43.04 47.28
Growth Rate 4.5 (36.2) 6.6 (29.9) 7.6 (24.9) 8.1 (19.6) 7.55 (24.4) 8.82 (11.4)
Contribution to 52.70 43.60 57.60 59.65 48.66 77.94
GDP growth
Industry Share in GDP 22.80 25.00 27.10 27.12 27.11 27.13
Growth Rate 3.7 (95.8) 6.8 (31.3) 5.9 (56.7) 6.39 (44.3) 7.61 (42.6) 4.86 (26.7)
Contribution to 28.70 28.90 27.60 28.42 30.91 24.67
GDP growth
Agriculture Share in GDP 42.80 36.40 31.15 30.40 32.42 27.88
Growth Rate 1.3 (585.7) 4.67 (125.6) 2.87 (131.2) 3.12 (125.1) 4.64 (80.8) 1.23 (297.8)
Contribution to 18.60 27.50 14.80 15.55 22.54 6.38
GDP growth
Sources: RBI, Report on Currency & Finance, 2000-01; RBI Handbook, 2001;Economic
Survey, 2001-02
Note: Figures in brackets indicate co-efficient of variation (%)