APPENDIX : STATE OF THE ECONOMY AND ECONOMIC REFORMS (REVISED FINAL DRAFT)
1. THE BACKGROUND 1.1 The Father of the Nation., Mahatma Gandhi, laid down the basic principle which was to guide and shape India's development strategy and economic policy for the more than four decades that have passed since Inde- pendence:
"I will give you 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 weakestman you have seen and ask yourself if the step you contemplate is going to be of any use to him; will be gain anything by it? Will it restore him to control over his own life and des- tiny? In other words, will it lead to Swaraj for the hungry and spiritually starving mil- lions?"
This talisman is at the heart of the twin con- cerns of attaining rapid growth of output and employment and of ensuring equity and social justice which have influenced economic pol- icy-making in the country. This was also the basis of human development" being recog- nised as the broad objective of the Eighth Five Year Plan.
1.2 The emphasis on distributive Justice, re- gional balance and alleviation of poverty lead- ing 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 attempts to allocate the scarce resources to priority uses, through : regulation of markets, trade and exchange controls, li- censing of investment, regulation of the finan- cial sector and selective access to foreign investment and technology. It was increas- ingly realised since the late 1970s that many or these controls and regulations had outlived their utility and were in fact hampering, rather than helping, growth and development.
1.3 In response the Government has been at- tempting 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 comprehen- sive enough to fully reverse the protectionist bias of the trade regime and correct all the distortions created by the regulatory policies followed over the years, they started yielding results fairly early, and the Indian economy moved on to a higher growth path in the 1980s as compared to the previous three decades. The average annual growth rate of GDP climbed steeply to 5.3 per cent (5. 8 per cent compound) during the Sixth Plan period (1980-85) and 5.8 per cent (6.0 per cent compound) 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 total factor produc- tivity in manufacturing production, indicating efficiency in the use of resources, increased. according to an IMF study, by 2.7 per cent a year during 198 1-89 as compared to (-)0.5 per cent in the preceding period of 1960 to 1980. The decade of the 1980s also witnessed a sig- nificant reduction in the incedence of poverty in the country from above 40 per cent of the population by one measure to less than 20 per cent.
1.4 This higher growth performance was, how- ever, accompanied by certain inter-related ad- verse developments. First, the Government's savings deteriorated 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- saving since 1984-85. By 1990-91 these dis- savings constituted 2.8 per cent of' GDP. Reflecting this trend in Government savings, the fiscal deficit of the Central and State Gov- ernments, which was about 8 per cent of GDP on the average during the Sixth Plan (1980/81 - 1984/85), shot up to 10 per cent during the Seventh Plan (1985/86 - 1989/90) and further to about 12 per cent in 1990-91. The bulk of this deterioration of the fiscal deficit was ac- counted for by the Centre's fiscal deficit which worsened from 6.1 per cent of GDP in 19 80-81 to 7.8 per cent in 1989-90 and further to 8.3 per cent in 1990-91. Only a fraction of this in- crease was due to increases in capital expendi- tures, which for the Centre was about 5.6 per
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cent of GDP in 1980-81 and 5.9 per cent in 1990-91. The revenue deficit, denoting the difference between revenue receipts and reve- nue expenditures, on the other hand, increased sharply from 1. I per cent average for the Sixth Plan to 2.6 per cent for the Seventh Plan and to 3.5 per cent in 1990-91. Financing capital expenditure through borrowings may not be unviable if the returns on that expenditure are higher than the interest rates. But financing revenue deficits through borrowing is fraught with grave risks as there would hardly be any prospective returns. A steady increase in the revenue deficits in the late-1980s therefore exposed the economy increasingly to unviabil- ity.
1.5 Second, the country's balance of payments deteriorated more or less continuously through the 1980s, and most particularly since the mid- 1980s. The salient features of the balance of payments developments over this period are presented in Table-1 below :
TABLE 1
BALANCE OF PAYMENTS 1980 - 1991
(USS 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 -4.87 -6.84 -9.68
Capital Account Transactions
5.(a) Private receipts 0.21 2.10 6.83 8.40
(b) Private payments 0.08 0.17 3.72 5.97
6.(a) Government receipts 1.28 1.85 7.22 10.36
(b) Government payments 1.58 0.73 3.70 4.11
7. Change in FE Reserves -2.27 -1.82 -0.21 -1.00
8. Foreign exchange reserves 5.85 5.97 3.37 2.23
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. How- ever, the current account balance steadily de- teriorated from an average of 1.3 per cent of GDP during the sixth Plan to 2.2 per cent during to seventh Plan and 3.3 per cent in 1990-91. This deterioration was primarily due to the rapid increase in interest payments. Much of the increase in interest payments was the result of the sharp rise in private capital receipts, particularly external commercial bor- rowings and deposits by non-resident Indians (NRIs), which not only had higher interest liabilities, but also shorter maturities. As a consequence, the government also had to step up its borrowings and reduce its foreign ex- change reserves in order to bridge the differ- ence. Thus the proportion of the current account deficit financed by external assis- tance 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 billion in 1980-81 (12 per cent of GDP) to $83.8 billion in 1990-91 (30.4 per cent of GDP). The debt service ratio (debt service payments to current account re- ceipts on balance of payments) correspond- ingly also increased from 10 per cent in 1980-81 to 35.3 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 $1.1 billion by June 1991. These adverse develop- ments led to a crisis of confidence about the Indian economy among the international
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lenders. By April 1991, not only was there a significant withdrawal of non-resident Indian (NRI) deposits from India, but more impor- tantly a number of international banks stopped honouring Indian letters of credit (LC) for import transactions. The economy also suf- fered from serious inflationary pressures, scarcity of essential commodities and deterio- ration 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 sta- bilisation measures to bring the situation un- der 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 Cen- tral Government was sharply cur-tailed from 8.3 per cent in 1990-91 to 5.9 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 case the situation considerably. The Government also initiated a process of structural reforms in trade and in- dustrial policies aimed at correcting the mac- roeconomic imbalances and other distortions that had developed during the previous years. However, the dominant influences on the economy in 1991-92 were those of the stabili- sation measures, which led to severe import compression and recessionary conditions, and it took some time for the economy to get back onto the trajectory of recovery and growth Consistent with the economic reforms.
1.9 The economic reform measures which were introduced in 1991-92 and the sub- sequent period, by deregulating the markets, removing much of the controls on foreign trade, dismantling the licensing of domestic investment, reforming the financial sector and the tax system and reducing the prohibitive rates of tariffs and taxes, radically changed the economic set-up of the country, and placed it in a position to fully utilise the opportunities created and potentials established for a rapid growth of output, investment and employ- ment, based on increased efficiency of re- source allocation. These measures were much more comprehensive than the earlier liberali- sation measures and policy changes intro- duced in the 1980s and would therefore be expected to accelerate the growth process and expand the scope for structural changes which had already been initiated in the Sixth and the Seventh Plan periods. However, as has been noted above, the earlier policy changes were becoming increasingly unviable because of the mounting fiscal and current account deficits and rising domestic and external debt burdens, and the more recent economic reforms were expected to ensure the sustainability of these policy changes by correcting the fiscal and external payments imbalances. The following sections would analyse the significant and often very impressive performance of the economy in all the sectors in terms of growth of output and efficiency, clearly demonstrat- ing the positive outcome of the policy changes in the post-reform period. But the record on budgetary deficits and current account imbal- ances as well as the debt burdens in recent years show that we have still not been able to solve all the problems. The over-all fiscal defi- cit of the government, taking into account the Centre, States and public sector undertakings together (known as the Public Sector Borrow- ing Requirement (PSBR)), was 12.2 per cent of GDP in 1990-91 and declined to 11.1 per cent in 1994-95. More importantly, however, the revenue deficit of the Government, Centre and States, has actually increased from 4.5 per cent of GDP in 1990-91 to 4.6 per cent in 1994-95(RE). Although the current account imbalance has come down from 3.3 per cent of GDP in 1990-91 to 0.7 per cent in 1994-95, but it is expected to go up. Similarly, while the external debt service ratio has declined from 3 5 percent in 1990-91 to 27 percent in 1994- 95, the total external debt to GDP ratio has increased from 30.4 per cent to 32.9 per cent over the same period.
1.10 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 program me for structural reform of the Indian economy which were begun in July 1991 were also known by that time. Much of these develop- ments were taken on board during the formu- lation of the Plan. It was, therefore, observed that : "...in view of the impact of structural adjustment programme, the resource 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 macroeco- nomic parameters supporting it, were set at relatively conservative levels compared to
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what may have been possible on the basis of the performance of the economy during the
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 (in volume terms) of
(a) Exports 8.1% 13.6%
(b) Imports 10.0% 8.4%
Source : Eighth Five Year Plan, vol. I, P.44
Seventh Plan period. The relevant figures from the Eighth Plan document are presented in Table-2 below :
1.11 As can be seen from the table, the Eighth Plan envisaged a somewhat lower rate of growth than achieved in the Seventh, but with much greater reliance on domestic investible resources. It was also recognised that the car- her trend of imports growing faster than ex- ports would have to be reversed in order to avoid serious balance of payments and exter- nal debt difficulties. The increase in the incre- mental capital-output ratio (ICOR) was assumed due to three principal reasons : (a) gains in output from better utilisation of exist- ing capacities may not be available in the Eighth Plan to the same extent as during the Seventh; (b) the stock of investments in the pipe-line was less than what it was at the commencement of the Seventh Plan; and (c) increased investment in human capital, which would show up only with a time lag.
1.12 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. Al- though some set-back was expected in the short-run from the structural adjustment pro- gramme, 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 dur- ing 1990-91 and 1991-92. The need to step up the investment rate in order to compensate for the likely lower utilisation of existing capaci- ties was the corner-stone on which the Plan was built whereby the objective of attaining full-employment by 2002 could still be at- tained.
1.13 There is a general acceptance or 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. However, it is important to work out mechanisms of its implementation which can withstand the short- to medium-run effects of the reforms, particularly during the transition phase, on the more vulnerable sections of society and on the economic and social infrastructure of the country. Economic reforms and market liber- alisation are not ends in themselves but are means to achieve the goals of development, consisting not only of increasing the per-capita GDP with efficient use of resources, but also of equity and and reduction of poverty. If the latter cannot be achieved by market reforms, supplementary positive action must be adopted, and their financing must be provided for in any plan allocation of investible re- sources.
1.14 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 economy since the inception of the economic reforms 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 investments will have to play at this juncture, making the most effective use of our resources. Since the pro-
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