STATE OF THE ECONOMY AND ECONOMIC REFORMS
1. THE BACKGROUND 1.1 The Father of the Nation, Mahatma Gandhi laid down the basic principle which was to guide and inform India's develop- ment strategy and economic policy for the more than four decades that have passed since Independence:
"I will give you a Talisman. Whenever you are in doubt or the self becomes too much with you, apply the following test : Recall the face of the poorest and weakest man you have seen and ask yourself if the step you contemplate is going to be of any use to him; will he gain anything by it? Will it restore him to control over his own life and destiny? In other words, will it lead to Swaraj for the hungry and spiritually stary- ing millions?" This talisman is at the heart of the twin concerns of attaining rapid growth of output and employment and of ensuring equity and social justice which have informed economic policy-making in the country. This was also the basis of "human development" recognised as the broad objective of the Eighth Five Year Plan.
1.2 The emphasis on distributive Justice, regional balance and alleviation of poverty leading towards empowering the people to achieve their "Swaraj"' has been the corner- stone of our national policy. However, the instruments of our policy, in the absence of adequate flows of domestic and international resources, were characterised by: (a) trade and exchange controls; (b) selective access to for- eign investments and technology; (c) discre- tionary controls on industrial investment and capacity expansion; (d) dominance of the public sector in industrial activity; and (c) public ownership and regulation of the fi- nancial sector. It was increasingly realised since the late 1970s that many of these con- trols and regulations had outlived their utility and were in fact hampering, rather than help- ing, growth and development.
1.3 In response the Government has been attempting to reform many of these policies, especially those related to Inward- oriented trade and investment policies since the early 1980s. Although these policy changes did not constitute a package of reforms compre- hensive enough to fully reverse the protec- tionist bias of the trade regime and other distortions, they started yielding results fairly early, and the Indian economy moved on to a higher growth path in the 1980s as com- pared to the previous three decades. The average annual growth rate of GDP climbed steeply to 5.7 per cent during the Sixth Plan period (1980-85) and 5.8 per cent during the Seventh Plan(1985-90)as compared to the 3.4 per cent that had been maintained during the 1950 to 1980 period. The decade of the 1980s also witnessed a significant reduction in the incidence of poverty in the country from above 40 per cent of the population by one measure to less than 20 percent. This higher growth performance was, however, accompanied by certain inter-related adverse developments.
1.4 First, the Government's savings deterio- rated substantially since the mid-1980s. The savings of the Government (Centre, States and UTs) constituted about 2 per cent of GDP between the mid-1970s and early 1980s, but the Government started dis-savings con- 1984-85. By 1990-91 these dis-savings con- stituted more than 2 per cent of GDP. Reflect- ing this trend in Government savings the fiscal deficit of the Government, which was less than 9 per cent of GDP in 1980-81, shot up to about 12 per cent in 1990-91. The bulk of this deterioration of the fiscal deficit was accounted for by the Centre's fiscal deficit which worsened from 6 per cent of GDP in 1980-81 to 8.4 per cent in 1990-91.
1.5 Second, the country's balance of pay- ments deteriorated more or less continuously through the 1980s, and most particularly since the mind-1980s. The Salient features of the balance of payments developments over this period are presented in Table-1.
1.6 As may be seen, the trade balance had remained more or less constant at around- $7.5 billion for the entire period 1980-90 However, the current account balance stead- ily deteriorated from an average of 1.3 per cent of GDP during the Sixth Plan to 2.3 per cent during the Seventh Plan and 3.3 per cent in 1990-91. This deterioration was pri- marily due to the rapid increase in interest payments. Much of the increase in interest payments was the result of the sharp rise in
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TABLE 1
BALANCE OF PAYMENTS 1980 - 1991
(US$ billions)
1980-81 1985-86 1989-90 1990-91
1. Trade balance -7.55 -7.83 -7.46 -9.44
2. Net Invisibles excluding
interest +5.81 +4.08 +3.68 +2.52
3. Interest payments -0.36 -1.12 -3.06 -2.76
4. Current Account balance -2.10 -4.86 -6.84 -9.68
Capital Account Transactions
5.(a) Private receipts 0.20 2.10 5.90 8.40
(b) Private payments 0.08 0.17 3.72 5.70
6.(a) Government receipts 1.28 1.85 7.22 10.36
(b) Government payments 1.58 0.73 3.70 4.11
7. Foreign exchange reserves 5.85 5.97 3.37 2.23
private capital receipts, particularly external commercial borrowings and deposits by non-resident Indians (NRIs), which not only had higher interest liabilities, but also shorter maturities. As a consequence, the govern- ment also had to step up its borrowings and reduce its foreign exchange reserves in order to bridge the difference. Thus the proportion of the current account deficit financed by ex- ternal assistance declined substantially from about 75 per cent in the early 1980s to about 22 per cent in 1990-91. All these factors culminated in the country's external debt liabilities rising sharply from about $23 bil- lion in 1980-81 (12 per cent of GDP) to $82 billion in 1990-91(24 per cent of GDP). The debt service ratio (debt service payments to current account receipts on balance of pay- ments) correspondingly also increased from 10 per cent in 1980-81 to 30 per cent in 1990- 91.
1.7 Matters came to a head in 1990-91, when international oil prices rose sharply as a result of the Gulf War. The trade balance deterio- rated sharply by $2 billion, and remittances from Indian workers in the Gulf also went down. The net result was an almost $3 billion decline in the current account balance, and a sharp reduction in the foreign exchange re- serves, which declined to only about $1 bil- lion by the end of 1990-91. These adverse developments led to a crisis of confidence about the Indian economy among the inter- national lenders. By April 1991, not only was there a significant withdrawal of non- resident Indian (NRI) deposits from India, but more importantly a number of interna- tional banks stopped honouring Indian letters of credit (LC) for import transactions. The economy also suffered from serious infla- tionary pressures, scarcity of essential com- modities and deterioration of fiscal discipline. By June 1991 the annual inflation rate was running at about 16 per cent, and the economy was on the verge of a major crisis.
1.8 In response to the emerging crisis, in July 1991 the Government initiated a series of stabilisation measures to bring the situation under control. The first step was a substantial devaluation of the rupee while retaining the import controls that had been imposed by the RBI. In addition, the fiscal deficit of the Central Government was sharply curtailed from 8.4 per cent in 1990-91 to 6 per cent in 1991-92. Subsequently an arrangement was entered into with the International Monetary Fund (IMF) to provide balance of payments support, which helped to ease the situation considerably. The Government also initiated a process of structural reforms in trade and industrial policies aimed at correcting the macroeconomic imbalances and other distor- tions that had developed during the previous years. However, the dominant influences on the economy in 1991-92 were, those of the stabililsation measures, which led to severe import compression and recessionary condi- tions.
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1.9 At the time the Eighth Plan was formu- lated, the set- backs suffered by the economy in 1990-91 and 1991-92 had to be taken into account. The broad contours of the pro- gramme for structural reform of the Indian economy which were begun in July 1991 were also known by that time. Much of these de- velopments were taken on board during the formulation of the Plan. It was, therefore, observed that : "...in view of the impact of structural adjustment programme, the re- source crunch which the public sector is facing, and the need for correcting the fiscal imbalances, it would be prudent to plan more or less for the growth rate achieved during the decade and lay down foundations for higher growth in the future." Thus the growth target, and the macroeconomic parameters supporting it, were set at relatively conserva- tive levels compared to what may have been possible on the basis of the performance of the economy during the Seventh Plan period. The relevant figures from the Eighth Plan document are presented in Table-2.
1.10 As call be seen front the table, the Eighth Plan envisaged a somewhat lower
TABLE 2
MACRO-PARAMETERS FOR THE EIGHTH PLAN (1992-97)
VIIth Plan VIIIth Plan
1. Growth rate of GDP p.a. 5.8% 5.6%
2. Domestic Savings (% of GDP) 20.3% 21.6%
3. Current Account Deficit (% of GDP) 2.4% 1.6%
4. Investment (% of GDP) 22.7% 23.2%
5. ICOR 3.9 4.1
6. Growth rates of :
(a) Exports 8.1% 13.6%
(b) Imports 10.0% 8.4%
rate of growth than achieved in the Seventh, but with much greater reliance on domestic investable resources. It was also recognised that the earlier trend of imports growing faster than exports would have to be reversed in order to avoid serious balance of pay- ments and external debt difficulties. The in- crease in the incremental capital-output ratio (ICOR) was assumed due to two prin- cipal reasons : (a) gains in output from better utilisation of existing capacities may not be available in the Eighth Plan to the same extent as during the Seventh: and (b) the stock of investments in the pipe-line was less than what it was at the commencement of the Sev- enth Plan.
1.11 The Plan envisaged that even with the conservative targets laid down, the objectives of reducing unemployment to zero by the year 2002 and attaining significant reduction in the incidence of poverty could be realised. Although some set-back was expected in the short-run from the structural adjustment programme, it was at least partially captured in the parameters of the Plan. In particular, the higher incremental capital-output ratio (ICOR) assumed in the Plan was primarily to take account of the adverse developments during 1990-91 and 1991-92. The need to step up the investment rate in order to com- pensate for the likely lower utilisation of existing capacities was the comer-stone on which the Plan was built whereby the ob- jective of attaining full-employment by 2002 could still be attained.
1.12 There is a general acceptance of the need to pursue the structural reform programme for the long run viability and sustainability of the growth process in India across a wide cross-section of Indian public opinion. How- ever, it is important to work out mechanisms of its implementation which can withstand the short- to medium-run effects of the re- forms, particularly during the transition phase, on the more vulnerable sections of society and on the economic and social in- frastructure of the country. In addition steps must be taken to overcome a certain amount of pessimism that might be generated in the course of the reforms regarding the likely growth in output, investments, employ- ment and the general standards of living.
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1.13 The following paragraphs describe the current status of the various critical variables and parameters of the Indian economy and take stock of the developments in our econ- omy since the inception of the economic re- forms in 1991 and during the Eighth Plan period. They also indicate the areas of success as well as areas of concern, and evaluate the role that Plan expenditures and public invest- merits will have to play at this juncture, making the most effective use of our resources.
2. Growth Performance 1. 14 The response of the economy in terms of growth performance since the initiation of the reforms in 1991 appears somewhat negative when compared to the past trends. The average rate of growth of the GDP dur- ing the period 1980-1991 was 5.63 percent per annum. The growth rate came down to 1.10 per cent in 1991-92, and rose to 4.3 per cent in 1992-93. If the advance estimates of growth made by the C.S.O. of 4.3 per cent in 1993-94 and 5.3 per cent in 1994-95 ma- terialise, the average growth during the four years of economic reforms (1991-95) will be 3.74 per cent. For the first three years of the Eighth Plan (1992-95), however, the growth would average to 4.6 per cent - one percent- age point lower than the target. If the Eighth Plan target is to be achieved, the economy will have to grow at the rate of 7.1 per cent in each of the remaining two years of the Plan (1995- 97).
1.15 A comparison of the sectoral growth rates over the two periods, i.e. 1980-1991 and 1991-1994 [Table 31, shows that the per- formance of the manufacturing sector has suffered severely. Manufacturing had been a leading sector during the eighties and, after a relatively low growth performance during the first three decades of, planning, it had achieved a growth rate of 7.6 per cent on average for a whole decade. Even with an expected revival in growth of 3.6 per cent in 1993-94 and 8.3 per cent in 1994-95, the av- erage growth rate for the period 1991-95 will be only 2.6 percent and for the Plan period 1992-95 will be 4.7 per cent. This is consid- erably lower than the Plan target of 7.3 per cent.
1.16 Agriculture and infrastructural sectors also had done well during the eighties and their performance too has been somewhat lower during the, 1991-94 period. Insofar as the Plan is concerned, however, agriculture growth has been more than satisfactory at an expected average of about 3.7 per cent for the three years 1992-95, as compared to the tar- getted 3.1 per cent. Investments made in the past in electricity, gas and water and trans- port sectors have sustained their growth, al- though at a somewhat lower rate than during the eighties.
1.17 The sectors which have clearly per- formed better in the post-reform period are the Communications and Financial sectors. The growth in the communications sector was facilitated by a large back-log of unfulfilled demand and the ability of the Government to raise resources by raising the tariffs. Cost reductions arising from induction of new technologies also contributed significantly. Insofar as the financial sector is concerned, much of the boom is attributable to an active stock market, supported to an extent by ex- cess liquidity in the system during this pe- riod and the recessionary conditions prevailing in the real sectors of the economy.
1.18 The relatively poor growth performance during the first three years of the reform process need not in itself be a source of concern. Indeed, if this episode is seen in the context of international experiences in stabilisation and structural adjustment, the Indian experience of low growth has been both brief and mild. At no stage has the Indian economy had to suffer a negative growth rate of GDP, and in the fourth year of the reforms (1994-95) the growth rate has picked up almost to its pre-reform level. In contrast most other countries have had to suffer ex- tended periods of negative growth and it has taken even longer for them to regain their historical growth rates. The 1991-94 reces- sionary episode in India was no doubt the outcome of the stabilisation efforts, and the effects or the structural adjustment pro- gramme are expected to be felt on output and employment growth in the next few years. The success or failure of this programme will however depend critically on the Gov- ernment's ability to identify the areas of vul- nerability and to take appropriate action for addressing them.
3. The External Sector 1.19 Since the stabilisation efforts were initi- ated, the country has been able to tide over in a most impressive manner the balance of payments crisis that erupted in early 1991. Both the balance of payments situation
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TABLE 3
SECTORAL GROWTH RATES
S.No. Sectors Eighth 81-82 91-92 92-93 93-94
Plan to
Target 91-92
1. 2 3 4 5 6 7
1. Agriculture 3.85 -2.74 5.3 3.0
2. Forestry & Logging 3.1 -0.44 -1.29 0.4 0.5
3. Fishing 5.56 5.65 6.4 6.1
4. Mining & Quarrying 8.0 8.46 3.66 1.5 4.8
5. Manufacturing 7.3 7.59 -3.23 3.1 3.6
6. Electricity, Gas & Water 7.8 8.82 7.52 7.5 5.9
supply
7. Construction 4.7 4.44 4.60 0.5 1.2
8. Trade 6.0 6.12 0.32 6.5 4.4
9. Hotels & Restaurent 6.0 6.42 0.06 6.0 5.8
10. Railways 4.15 6.02 -1.1 -0.7
6.7
11. Transport by other means 7.92 6.91 6.1 6.5
12. Storage 6.0 4.09 -1.66 -0.6 -1.7
13. Communication 6.1 6.22 6.86 10.8 11.0
14. Banking & Insurance 6.0 11.99 21.68 2.8 12.9
15. Real Estate ownership of 6.0 3.57 3.81 3.3 3.3
dwelling & business services
16. Public administration 6.0 6.99 2.21 5.1 4.4
and Defence
17. Other services 6.0 5.60 5.81 3.7 5.2
18. Gross Domestic Product 5.6 5.63 1.10 4.3 4.3
and the foreign exchange reserves posi- tion have improved considerably in the last three years. The current account deficit, which was about$ 10 billion in 1990-91, has come down to less than a billion dollars in 1993-94 and 1994-95. As a percentage of GDP it has declined from 3.3 per cent to about 0.3 per cent over the period. This sharp reduction in the current account deficit has obviated the need for exceptional external financing within a short period of three years.
1.20 The improvement in the current account balance has also been accompanied by a major turn-around in the capital account. Not only has the capital flight that had started in 1990-91 been arrested, there has also been& surge in capital inflows, especially in the form of foreign portfolio investments, in recent years. Total foreign investment, which was about $165 million in 1990-91 has gone up to about $4.1 billion by 1993-94 and $3.9 billion in the first three quarters of 1994-95. Most of the surge in foreign in- vestments is accounted for by portfolio in- vestments, which increased from only $65 million in 1990-91 to about $3.5 billion by 1993-94 and $3.1 billion in the first 9 months of 1994-95.
1.21 The surge in capital inflows coupled with a declining current account deficit has led to a substantial build-up of foreign exchange reserves (excluding gold and SDRs), which increased from about $1 billion at the end 1990-91 (equivalent to about two weeks of imports) to over $15 billion by the end of 1993-94 and stands at about $19.4 billion at present. This is certainly a positive re- sponse of the economy to the stabilisation and adjustment efforts. However, it has
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also brought with it certain problems in managing monetary and exchange rate poll- cies, and has sonic adverse long-run impli- cations which will be discussed further in later sections.
1.22 Imports declined in absolute terms in 1991-92, and although they have picked up since 1992-93, their annual growth rate has been lower on the average in comparison to 1990-91 [Table 4] While the decline in imports consequent to the devaluation or the rupee was to be expected, other factors sonic of which are exogenous to the reform process have also influenced the behaviour of imports. Imports of POL measured in dollars have declined in absolute terms in the post-reforms period, even though the do- mestic output of petroleum was failing. This decline has largely occurred due to the fall in the international prices of crude oil since 1991 associated with the general re- covery of world oil output after the disloca- tions caused by the Gulf War. Non-POL non-food imports in 1993-94 had not crossed the pre-reform level primarily due to the reces- sionary conditions in the manufacturing sector. The indications, however, are that with industrial revival in 1994-95, imports have grown at a rate above 22 per cent. Thus during the three years of the plan period import growth will have averaged about 14 per cent per annum as compared to the target of 8.4 per cent.
1.23 The growth in exports in the three years following the reform of trade and exchange rate policies, le. the period 1991-92 to 1993-94, has been slower than in the six year period preceding the reforms, ie, 1985-86 to 1990-91, [Table 5]. However, seen in relation to GDP. the buoyancy of exports has improved. More importantly, in the last two years (1993-94 and 1994-95) the growth rate or exports has picked up remarkably to about 20 per cent and 17 per cent respec- tively. Such rates of growth will have to be sustained for the next few years, since it has been estimated that with a growth rate of imports of about 13.5 per cent, a growth rate of exports or about 18 per cent will have to be maintained over the next decade or so if the external debt burden is to be gradually re- duced to manageable proportions while maintaining a reasonable rate of growth of the economy. Some slackening in the export growth target call be accomodated if foreign investments continue to expand, but it may not be prudent to rely on this possibility in the initial years of the reform process. It is there- fore necessary to examine the nature of the export performance and to assess the likeli-
TABLE 4
GROWTH OF IMPORTS
(Percentage)
Items 90-91, 91-92 92-93 93-94 94-95
(1) (2) (3) (4) (5) (6)
1. Total Imports 14.4 -24.5 10.3 3.2 24.9
2. DGCIS Imports 13.2 -19.4 12.7 6.1 21.7
3. Non-DGCIS Imports 22.4 -57.0 -18.0 -43.0 119.3
4. POL Imports 60.0 -11. 0 13.7 -5.6 0.7
5. DGCIS Non-POL imports 3.1 -22.2 12.3 10.6 29.1
6. Food Imports* 1.5 -50.8 85.0 -37.2 244.7
7. Non-Pol Non-Food Imports 3.1 -21.2 10.9 12.2 25.1
8. Memo Items :
(a) Non-DGCIS 3842.0 1.653.0 1355.0 773.0 1695.0
Imports ($Million)
(b) Non-DGCIS
(% of Imports) 13.8 7.9 5.8 3.2 3.7
9. Capital Goods 10.4 -27.5 7.0 33.3 50.3
* Cereals + Edible + Oils + Fruits & Nuts + Pulses + Sugar.
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hood of maintaining such high growth rates.
TABLE 5
Performance of External Trade in Pre-reform
& Post-Reform Periods.
Unit 1985-86 to 1991-92 to
1990-91 1994-95
1. Exports Growth rate % p.a. 10.7 10.1
2. imports Growth rate % p.a. 10.1 3.5
3. Trade Deficit % of GDP 3.0 1.3
4. Current Account % of GDP 2.5 0.7
Deficit
5. GDP Growth Rate % p.a. 5.8 3.6
6. Exports-GDP 1.8 2.8
Elasticity
7. Imports-GDP 1.7 1.0
Elasticity