Current General Studies Magazine (March 2016)

General Studies - III "Economy Based Article" (The ease of living in India)

A quarter century of economic reform has transformed the economy. But governments have been less mindful of addressing social and natural capital

In June 1991 a new government was installed in the country after a period of economic precariousness combined with political instability following the assassination of a prime minister. For the next five years the political process and the economy were managed by the unlikely duo of P.V. Narasimha Rao and Manmohan Singh, respectively. The policy changes that had been initiated then have come to be known as “the economic reforms”. But even decades later finance ministers of both the UPA and NDA speak of the need for “more reforms”. This must confuse the layperson for it suggests a process that is never completed. It is of course true that as our understanding of the working of the economy evolves, fresh avenues for reform of policy open up. However, the reforms of 1991 were based on a certain idea of what was needed and a substantial part of the agenda announced then has been implemented. So as the 25th anniversary of the reforms approaches, it would be legitimate to take stock of what has been achieved, especially the extent to which they have succeeded in terms of the expectation.

The crisis of 1991

In 1991, the focus of the reforms had been on trade, exchange rate and industrial policies. This had everything to do with the immediacy of the balance-of-payments crisis the economy then faced. When the Rao government took charge, it was estimated that foreign exchange reserves would cover up to two weeks’ imports. A rule of thumb is that a country should aim at a cover of about six months. With debt servicing due, the speculation in the international circles was whether India would default on its commitments. In political memoirs of the moment India’s leadership comes across as motivated to ensure that India honoured her obligations. To contain the external deficit, Finance Minister Manmohan Singh had devalued the rupee and reined in public expenditure. He then went to the International Monetary Fund for balance-of-payments support. This would have required courage. Retrenchment, belt-tightening, and devaluation were unpopular across the political spectrum, even within the Congress party — though on the question of how the foreign exchange needed to finance international payments was to be acquired, the critics of the strategy had had little credible to offer. Within three years the crisis was surmounted and the programme with the IMF ended.

There can be no doubt that the reforms have eased India’s balance-of-payments constraint. India’s reserves today exceed $350 billion, compared to less than $6 billion in March 1991. Moreover, the period since is the longest recorded when the country has gone without a foreign exchange shortage. Earlier one had arisen in every decade, starting with the 1950s. It is also significant that this new-found resilience has been achieved while the economy has got increasingly integrated with the rest of the world. This outcome has gone against the pessimistic prognosis of the time that eliminating controls would suck in imports and jeopardise the balance of payments. This did not happen as exports also rose, though mainly in a sector unimagined in 1991, that is, software services. Of course, the rupee has depreciated very substantially after it was floated.

There is the criticism that the balance of payments has been manageable only due to capital inflows, and that the portfolio flows they comprise are subject to reversal. This is indeed correct. But a run has not occurred in 25 years, not even in the last decade when global capital may have stampeded out following the global financial crisis. Altogether, the reforms should be credited with having improved India’s external position. The current account deficit has been financed comfortably, most measures of external indebtedness show an improvement, and the dramatic increase in foreign exchange reserves tells its own story.

Great power ambitions

However, the reforms were not envisaged as merely staving off a balance-of-payments crisis. In Dr. Singh’s words, spoken in Parliament, they were meant to be the harbinger of “the emergence of India as a major economic power in the world”. This is a worthy aspiration and the crude nationalism at times on display today should not discourage us from nursing it. The question is whether we are on the right path to the goal. If per capita income is taken as the measure then we are still some distance away from ‘great power’ status. The most recent World Bank data show that over 2011-15 GDP per capita — measured in PPP dollars — was 5,700 in India, 11,108 in Albania, 13,206 in China and, yes, 25,638 in Malaysia.

Though India’s economy may not at present compare well with that of other countries, it could yet be that its rate of growth has increased after the reforms. This has actually happened, but the claim often encountered that 1991 was a watershed year in that a stagnant economy had finally been energised is false. While the rate of growth of the economy accelerated after 1991, it had done so twice earlier, first in the 1950s and then in the late 1970s. So the reforms have only maintained an existing history with respect to economic growth. What of poverty? Here the record is the same as that of economic growth. Absolute poverty has declined since 1991, but this has been the trend since the early 1970s. Essentially, the decline in poverty has kept pace with growth. Thus, mirroring growth of the economy, while the rate of decline in poverty accelerated since 2004, it had already accelerated on the cusp of the 1970s and the 1980s. However, even after a quarter century of economic reforms, approximately a quarter of the country remains poor according to a poverty line that is low by international standards.

It is important to note that poverty measures are dependent upon the definition of poverty. The official index in India, on which the above cited trends are based, measures access to food a little more accurately than it does access to other conditions of life which are at least as vital. Even beyond health and education, the conditions of life are affected by physical infrastructure, which determines livelihood chances and well-being. Major components of this infrastructure would include transportation, water supply and sanitation.

It is not as if successive governments have not recognised their significance, but they fail to convince that “more reforms” — incidentally called for by both the Finance Minister and the Governor of the Reserve Bank — will be able to provide them. Structural reforms as liberalisation aim to provide access to and raise the profitability of the private sector. This may be essential at times, but there is a wide swathe of an economy where the market fails to deliver. This it does in the presence of what are referred to as externalities and public goods. Public goods are important as they mitigate the impact of income poverty and inequality. We can think of health, education, public infrastructure and recreational facilities as constituting the space in which we actually lead our lives. A significant transformation of it in India would require both a strengthening of the public finances and a generation of political will. The relevance of both can be understood when we see political parties competing in the distribution of kitchen appliances and laptops while the public infrastructure crumbles to pose a threat to life and limb and diminish the quality of life.

Natural capital

Then there is natural capital. An underlying premise of the reforms is the desirability of expanding the scope of markets. In many spheres of the economy controls had proliferated over the decades to the detriment of both growth and welfare, and their dismantling has resulted in an increase in both. But markets are not always the best way to deal with nature, as we discovered when confronted with water shortages across the country this summer. Deep and smart regulation is necessary if we are to deal with depleting natural capital, of which this is only one instance.

Widespread liberalisation of the economic policy regime was long overdue in 1991, and has played a positive role since, but its impact has run its course and the policy has recognisable limits. Liberalisation cannot address all aspects of the man-made environment and now climate change threatens to change everything forever. We do not have another quarter century to deal with these imperatives. Government must be prevailed upon to match their concern for the ease of doing business with a commitment to the ease of living in India.

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