India’s 1991 Reform: Better Late than Never

Famously known for lagging behind its East Asian counterparts, have India's reforms stayed on track?

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India has the tools to establish itself as one of the regional superpowers. It is blessed with massive factor endowments, a major element constituting a country's economic growth: it has a huge population with favourable demographic dividend and a vast land yielding diverse resources. However, when China, its neighbour that shows resemblances in terms of population size and resources' abundance, manages to become a global powerhouse and now even have the power to tussle with the ever-mighty United States in a trade war, India is left stranded in the lower-middle income gutter.

While this significant divergence should have raised eyebrows, unfortunately for India, the answer is perfectly simple: India mismanaged its economy for decades. This essay revisits the impoverishing decades that restrained India's economy from taking off and the subsequent much-needed reforms. It then evaluates the direction of the reform in recent times -- whether it bears the same spirit as it had 30 years ago.

Pre-1991

India’s infamous License Raj summarises the state of post-independence Indian economy prior to the liberalization: an extreme protectionism hindering the potential of a rapidly-growing economy. India’s stance was justifiable, however – British colonization of India was undeniably among the harshest in recent memory. Besides crippling the welfare of Indian people by neglecting agriculture, India’s then-most important sector, to push for its ambitious manufacturing ambitions, the British also exhausted the economy (Jha, 2018): India’s economy, which used to contribute to a third of world’s GDP in 0 AD, had been shrunk to a mere 4.2% contribution to the world’s GDP by its independence. This unprecedented draining then led to a firm perception that foreign involvements should no longer be entertained.

Indian government then set up elaborate measures to strengthen its grip on the economy: a comprehensive system of licenses was established to regulate the private business setting and a wide-scale nationalization of firms was done to control most of the economic aspects. More importantly, however, was the restriction of international trade: India pushed for a relentless import substitution industrialization agenda to fend off any “threats” from overseas.

Figure 1: India’s international trade pattern (1960-2009). Notice that the proportion of exports and imports compared to GDP significantly jumped between 1980-89 and 1990-99 (Jha, 2018)

The protectionist approach, stemming from the bitter colonial experience, clouded the government's judgment: it left Indian economy stagnated.

While such populist approach seemed to satisfy the “anticolonial” intention and more notably promote equity among businesses, it left Indian economy stagnated. The period from 1965-66 to 1980-81 was even claimed as the darkest period in India’s post-independence economic history (Panagariya, 2008). Substantial nationalization and introduction of even-stricter regulations for foreign investment gradually cut India’s ties with the global economy, crucially, during a period when globalization started to rapidly take off. India’s progress compared to other economies, predictably, was dismal: GDP growth and reduction of poverty were painfully slow.

Figure 2: Per capita GDP of some economies as a percentage of US GDP (PPP). Notice India’s stagnant performance compared to other economies (except Bangladesh which deteriorated) (Kelegama and Parikh, 2003)

Post-1991 Reforms: Do the Policies Contradict?

While some of the reforms breathed a much-needed fresh air to the lagging Indian economy, the implementation was far from complete. Apart from their complexities, India’s parliamentary democracy often triggered instability, i.e., this was apparent in the second half of Rao’s administration, thus slowing the reform progress. A continuous, sustainable policymaking was then essential to keep steering India onto the right direction.

Business and Trade Reforms

The cessation of License Raj was merely a start: the businesses needed to be nurtured so they could contribute productively to the economy. One of the major rules passed after the 1991 reform (under Vajpayee government) was the major bankruptcy law: bankruptcy had always been unworkable pre-reform due to pressures from the labour union. As a result, sick firms which could not be taken over were cluttered in the economy, hindering economic progression because their existence prevented new market entries (Mukherji, 2002). A more-feasible bankruptcy law, along with liberalization of interest rates (more transparent borrowing), made it easier for companies to expand their businesses.

Another crucial post-1991 reform includes the continuation of India’s systematic opening to the economy. Further reduction of tariffs (Panagariya, 2008), opening up of sectors previously restricted to the government such as insurance, and a more straightforward investment mechanism are just some examples. The FDI eventually increased by tenfold from 1991 to 2001 (Ramamurti, 2002).

Financial and Fiscal Reforms

While the portion of informal economy kept on shrinking, its pace was slow as indicated by figure 8 above. Things completely changed, nonetheless, under Narendra Modi: 25 years after the 1991 milestone, Modi enacted People’s Wealth Plan, one of the largest financial inclusion programmes in modern history. The objective was frank: increasing the penetration of bank account ownership. Modi also initiated a large-scale, slightly controversial demonetization, pushing Indians to store their large currency notes in the bank.

These measures looked to be successful at first: a cashless society would reduce tax evasion, promoting a healthier fiscal balance. The demonetization was also hoped to clamp down counterfeit money and unreported wealth (popularly coined as "black money", Modi administration hoped that by rendering huge currencies worthless, individuals holding black money would run out of options as they could not deposit their cash unless they wanted to be exposed). More importantly, it would promote the prospering of businesses registered formally (limiting the circulation of cash, a primary tool in the informal sector, would slowly suppress its growth), leaving adequate spaces for further prudent fiscal reforms in the future (i.e. introduction of Goods and Services Tax).

Looking Ahead: Brewing Issues?

India’s turnaround in the last three decades has been remarkable. From its despondent remnant of highly-socialistic policies, India has become one of the fastest growing economies with 6-7% average annual GDP growth, propelling it to the top summit of the world’s largest economies (3rd largest, PPP-adjusted). It even occasionally becomes the fastest growing major economies, exceeding mighty China in 2015 and 2018 (IMF, 2017).

However, like Indonesia, India must not be complacent: various issues still need to be solved if it wants to be an economic powerhouse: lowering the reliance on agriculture remains a critical stumbling block. Meanwhile, despite recently rolling out the world’s largest public health insurance, Modi administration still has a huge mountain to climb to improve other welfare aspects. Moreover, further cleanups and transparency measures are also required to ensure all the policies are channelled efficiently.

A public spat between Modi administration and Research Bank of India’s governor Urjit Patel certainly does not help the progress of additional reforms. Riding on the waves of populism that has hallmarked Modi’s policies, the administration has recently tried to ramp up its influence on the RBI, pushing it to loosen several monetary policies ahead of the 2019 general election. This dispute casted doubts on the sustainability of Modi’s policies, particularly when the RBI was demanded to make it easier for financially-troubled banks to lend more (Financial Times, 2018). As previously known, financial inclusion of India’s grass-root communities, often facilitated through bank lending, is one of the Modi administration’s trademarks.

While the conflict has since subsided, the unprecedented outburst of the spat has already sent some jitters. Besides questioning the administration’s huge-budgeted programs, the pressures applied to independent institutions such as RBI might be wrongly perceived as a heightened interventionism from the government. In a country where interventionism has caused numerous cases of lost opportunities, further unthoughtful actions could potentially dent its free-market reform efforts.

The administration's unconventional policies that used to become its trademark, most notably demonetization, have also been under intense scrutiny recently. Several media, basing on Reserve Bank of India's report, have even remarked the demonetization as a "complete failure". As the initial euphoria of the headline-grabbing policies waned, the administration is facing mounting questions on its actual direction.

Figure 3: Human Development Index of several economies. Notice that India’s HDI change lags behind its neighbors such as China, Bangladesh, and Nepal (The Economist, 2010)

In conclusion, using the famous economy-development theory, India’s take on the future could be summarized in one sentence: stiffen the growth reforms and concentrate on development efforts. Nevertheless, the government must be careful in planning their next moves: missteps such as a public dispute with an independent institution could easily erode the confidence on both the administration and its reforms. While it has suffered from decades of missed chances and has just started on its China-like development trajectory, India could not afford any further unnecessary disruptions.

Reference

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IMF. (2017). World Economic Outlook Update January 2017. Retrieved from https://www.imf.org/external/pubs/ft/weo/2017/update/01/

Jha, R. (2018). ASIA2067: Economies of emerging Asia-lecture 7 [class handout]. College of Asia and the Pacific, Australian National University, ACT, Australia.

Jha, R. (2018). ASIA2067: The Indian economy [class handout]. College of Asia and the Pacific, Australian National University, ACT, Australia.

Kelegama, S., & Parikh, K. (2003). Political economy of growth and reforms in South Asia. The South Asian experience with growth, 80-145.

Mukherji, J. (2002). India's long march to capitalism. India Review, 1(2), 29-60.

Panagariya, A. (2008). India: The emerging giant. Oxford University Press.

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Ramamurti, R. (2001). Finance Minister Yashwant Sinha on India's changing role in the world economy. Academy of Management Perspectives, 15(2), 8-12.

The Economist. (2010). Human Development Index. Retrieved from https://www.economist.com/economic-and-financial-indicators/2010/11/04/human-development-index