Small steps taken, long road ahead

In the first thirty years of post-independence India, it ran an over-regulated economy with GDP growth hovering around 3 per cent — the infamous ‘‘Hindu rate of growth’’. The early 1980s saw some deregulation and the growth rate concurrently rose to 5.5 per cent and 5.8 per cent per annum in the 6th and 7th Five Year Plans based on what some describe as that Hindu rate of reforms.

By the 1990s, however, the fiscal deficit of over 10 per cent of GDP, combined with a steep rise in oil prices, government fragility, and loss of international investor confidence, led to a balance of payments crisis necessitating a fundamental break from the approach followed in the earlier four decades.

Changes over the past decade have resulted in greater openness to trade with almost total elimination of quantitative restrictions and a significant reduction in import tariffs, industrial deregulation, a calibrated movement towards greater capital account convertibility, financial and capital market reforms with increased application of Basle norms, and infrastructure deregulation, most notably the public-private partnerships. This reform programme is ongoing.

In the following paragraphs, we will attempt a balance sheet of the successes and failures in several key areas to assess the progress of the daunting reform agenda that the nation has committed to in adopting an 8 per cent annual growth target for the next five years.

Fiscal policy

The fiscal challenge remains substantially unmet. The consolidated fiscal deficit of Centre and States was 10 per cent of GDP in 2001-02 compared to 9.4 per cent on the eve of the 1991 balance of payments crisis. The fiscal deficit of the Central Government declined from 6.6 per cent of GDP in 1990-91 to a low of 4.1 per cent in 1996 but rebounded to 6.1 per cent 2001-02 and 5.9 per cent estimated for 2003.

The gross fiscal deficit of states, after falling from 3.3 per cent in 1990-91 to 2.4 per cent in 1993-94 rose to 4.6 per cent in 2001-02 but has registered a marginal decline to 4.4 per cent for 2003.

Further reforms require difficult decisions including implementation of the Expenditure Reforms Commission as well as rationalisation of non-merited subsidies, particularly on food, fertilisers, and fuel. Increased recourse to performance-linked criteria for resource transfers to the State Governments and the development of State-level medium-term fiscal policy plans will also be important to nudge States towards improved financial management.

Tax policy restructuring focused on elimination of exemptions, tax widening, and improved quality of tax administration will be necessary to improve the tax to GDP ratio. Several States and the Central Government have passed Fiscal Responsibility and Budget Management Bills, but the sustainability of the growth strategy relies greatly on the ability to take the difficult decisions they entail.

External sector policy

External sector reforms is a mixed but positive process. The removal of quantitative restrictions and creation of special economic zones with more flexible labour laws are steps in a positive direction.

There has also been a significant increase in the trade (exports and imports) to GDP ratio from 14.6 per cent in 1990-91 to 21.4 per cent in 2001-02 (though India’s share of world exports remains only about 0.7 per cent over the last decade). Increased services exports, particularly software, from US$ 4.6 billion in 1991 to US$ 20 billion in 2001-02 represent a new growth area. On the other hand, while tariff rates declined from a weighted average rate of 72.5 per cent in 1991-92 to 24.6 per cent in 1996-97, they rose again to 35.1 per cent in 2001-02 and remain misaligned with the 4-10 per cent range found in neighbouring Asian countries.

India also equalled the US and EU in initiation of anti-dumping investigations in 2001 and 2002. The excessive protectionist mentality and misplaced apprehensions also shadow India’s negotiating stance in multilateral trade negotiations in several areas, particularly its insistence on differential treatment for developing countries.

While concerns about developmental needs need more transparent resolution to secure public support for continued liberalisation, the demands for exemptions from a rule-based multilateral world trading system are in the long run not sustainable.

Advances in the area of exchange rate policy, balance of payments, and reserves management have been significant gains. The exchange rate was unified and a system of managed float was introduced in 1992-1993. The rupee is now fully convertible on the trade and current accounts and substantially on the capital account.

Indian corporations thus enjoy much freer access to external commercial borrowing. Moving from meagre reserves of less than US$ 1 billion in 1991 to US$ 80 billion at the end of May 2003 is no mean achievement, as indeed are gains in the management of external debt.

Short-term debt dropped from 1.9 per cent of GDP in 1991 to around 0.6 per cent in 2002 and total external debt over GDP fell from 28.7 per cent to 20.9 per cent during the same period. Debt service obligations fell from 35.3 per cent of exports of goods and services to just 14.1 per cent as well. A current account deficit of 3.1 per cent of GDP has been changed to a surplus of 0.3 per cent. These are noteworthy advances by any standard.

Reforms have also opened the economy to capital inflows, though India has had limited success in attracting foreign investment. There has been progressive relaxation of restrictions of foreign direct investment (FDI), culminating in a policy of automatic approvals for all but a few industries in 2000.

The reconstitution of the Foreign Investment Promotion Board and liberalisation of foreign investment in Indian government dated securities and Treasury Bills have represented progressive liberalisation. Nonetheless, even the considerably liberalised foreign investment regime in India has failed to attract a significant surge in foreign investment. China secured 24-34 per cent of FDI flows to developing countries over the 1990s while India’s share remained in the region of 2 per cent.

Several steps are necessary to attract significantly larger foreign investment flows to India. These include a policy regime that provides comfort and consistency; an improved marketing strategy; institutional and procedural simplification at the central and state levels, removal of some caps on equity, an improved investment climate for both foreign and domestic private investment as well as improvements in the physical and legal infrastructure.

The recent reforms in areas such as telecommunication, power, ports, roads, airport privatisation will significantly improve the climate for such investment.

Industrial sector reforms

The debilitating Monopolies and Restrictive Trade Practices (MRTP) Act has been substantially removed and industries delicensed, freeing private sector initiatives. Nevertheless, concerns remain, particularly in relation to labour policies. The Contract Labour Act of 1970 and the Industrial Disputes Act of 1948 have yet to be amended.

Similarly, movement towards total dereservation of small-scale industries has been hesitant. The future of small-scale industries lies in technological improvements, assured access to low-cost finance, and improved marketing linkages to make them internationally competitive.

Manufacturing production increased only temporarily in the mid- 1990s and the share of industry in GDP has hardly changed from 24 per cent in 1990 to 25 per cent in 2000. Productivity gains through technological improvement, mergers and acquisition, admittedly liable to methodological and measurement errors, do not appear significant.

The productivity of Indian industry has to significantly improve and this is dependent on factors such as easier exit policy, flexibility in labour markets, access to finance at more reasonable costs, and improved quality and reliability of infrastructure.

Disinvestment

Disinvestment began tentatively in 1991 when small equity shares in public sector companies were disinvested. Significant privatisation was begun later with the constitution of a Ministry of Disinvestments in 1998 and several successful privatisations such as BALCO, and a significant sale of equity in VSNL Ltd. and Maruti Udyog Ltd. The Supreme Court’s affirmation of privatisation in the BALCO case lent credibility to the process, however the current debate in Parliament and elsewhere about disinvestments of BPCL and HPCL suggests that the process will be continuously beset by controversies of one form or another even as it moves forward. Strong political support for the disinvestments process, both by the Central and more importantly State Governments, is central to the reform strategy.

Infrastructure reforms

Reforms in infrastructure have varied by sector. Power has been an endemic story of mismanagement, but telecommunications and physical infrastructure have been more successful. State electricity boards’ bankruptcy, transmission and distribution losses of around 48 per cent, and an appaling minus 35.4 per cent rate of return on investment in the state power utilities in 2002-03 accompany a decline in average cost recovery of costs from 82.2 per cent in 1992-93 to 68.6 per cent in 2001-02.

Attempts to attract investment by providing Central Government guarantees to fast-track projects and creating escrow accounts for State Governments to set aside money to guarantee payments to generators have failed as they have not addressed endemic reform issues required to ensure state power sector enterprises were financially solvent.

Two recent initiatives are more promising. Almost all State Governments have signed up for the Accelerated Power Sector Reform Initiative, obtaining access to resources contingent upon their meeting performance criteria including improvement in distribution, better metering, energy audits, unbundling of production and transmission, and reduction of transmission losses.

The Electricity Bill of 2001 stipulating greater competition to the sector by deregulating generation, transmission and distribution and significantly enlarging consumer choice was passed in Parliament last week. We need to ensure credible progress along these lines. Regulators at all levels will need to meet the challenge of pricing power appropriately and reducing cross-subsidisation. Indeed the financial health of State Governments is inextricably linked with power sector reforms.

Reforms in the telecommunication sector have been a spectacular success. Value-added services were opened to the private sector in 1992, followed by opening of basic telecom services to competition in 1994-95 with the National Telecom Policy. Foreign equity of up to 49 per cent was permitted in joint ventures between Indian and foreign firms. Cellular and basic telecommunications have since been totally deregulated. Competition has improved teledensity significantly, giving better service to consumers at internationally competitive costs.

The separation of service-providing and policy-making functions in the Telecom Regulatory Authority and creation of a dispute resolution body have improved the institutional environment, while the ‘‘Convergence Bill’’ pending parliamentary approval will fully integrate telecommunications policy and enable India to take the full advantage of the information communications and entertainment economy based on best international practice.

The Universal Service Support Policy (in effect as of April 1, 2002) will use a universal levy of 5 per cent to enable the financing of community phones in villages where commercial economics may not justify investments by public or private entities. Nevertheless, difficult transitional issues such as interconnection charges, the sharing of revenue, tariff rebalancing, and decisions about telecommunications coverage remain.

Transport infrastructure is also a bright spot in reforms. International-quality roads will connect Delhi, Chennai, Calcutta, and Mumbai and create North-South and East-West corridors over the next few years. The project is fiscally sound: road connectivity has been financed by a duty on fuel that, given the relationship between fuel and road use, is a well-designed user tax.

The securitisation of the future revenue streams from these coffers will enable financing and long-term maintenance for these roads. Port operations have been privatised and port constraints are no longer a significant bottleneck to trade. Legislation pending in Parliament to convert Port Trusts to corporate entities will give a boost to efficiency.

Indian railways and airports are in need of further reform. Even while the budget proposals last year made a credible effort at railway tariff rebalancing, much remains to be done. Future changes must alter the relative rates for freight and passenger traffic, rationalise the railway portfolio, farm out non-essential activities to separate corporate entities and create an apolitical tariff regulatory authority. The civil aviation sector, similarly, requires major reforms in securing private participation in modernisation and construction of airports. More importantly, we require a civil aviation policy based on open skies policy and not merely bilateral slot trading arrangements that would make India an easier destination for tourists and investors. To be concluded.

— N.K. Singh is Member, Planning Commission. T.N. Srinivasan is a professor of economics at Yale University