India’s Economic Reforms

India's Economic Reforms

Montek S Ahluwalia*

The past three years have seen major changes in India's economic policies marking a new phase in India's development strategy. The broad thrust of the new policies is not very different from the changes being implemented in other developing countries and also all over the erstwhile socialist world. They aim at reducing the extent of Government controls over various aspects of the domestic economy, increasing the role of the private sector, redirecting scarce public sector resources to areas where the private sector is unlikely to enter, and opening up the economy to trade and foreign investment.

These changes have been accompanied by a lively debate in India and have also attracted interest abroad. International opinion has typically welcomed the reforms and generally urged a much faster pace of implementation, especially in view of changes taking place in other countries. Within India, opinion has been more varied. There are some who question the very direction of reform, but this is definitely a minority opinion. More generally, the broad direction of reform has met with wide approval, but there are differences of view on what should be the pace and sequencing of reforms. While there is widespread support for the elimination of bureaucratic controls over domestic producers, there are differences on such issues as the speed at which protection to domestic industry should be reduced, the extent to which domestic industry can be subjected to foreign competition without being freed from the currently prevalent rigidities in the domestic labour market; the extent to which privatisation should be pursued etc. These are obviously critical issues in designing a reform programme. They become particularly important when all the elements of an optimal package cannot be fully implemented simultaneously owing to social or political constraints. This confronts reformers with typical "second best" problems since the infeasibility of one element of the package could make pursuit of other elements anfractuous even counter- productive. The recently developed literature on the sequencing of reform in developing countries provides some guidance in making these difficult choices though it is far from being conclusive.

This paper presents an overview of what has been achieved in India's current reforms. It indicates some of the compulsions affecting the sequencing and pace of reforms and attempts to evaluate the internal consistency of the resulting package. The paper also presents a tentative assessment of the results achieved at the end of the third year.

I. A Gradualist Approach

An important feature of India's reform programme, when compared with reforms underway in many other countries, is that it has emphasised gradualism and evolutionary transition rather than rapid restructuring or "shock therapy". This gradualism has often been the subject of unfavourable comment by the more impatient advocates of reform both inside and outside the country. Before considering the contents and design of the Indian reform programme, it is useful to review some of the main reasons why India's reforms have followed a gradualist path.

One reason for gradualism is simply that the reforms were not introduced in the background of a prolonged economic crisis or system collapse of the type which would have created a widespread desire for, and willingness to accept, radical restructuring. The reforms were introduced in June 1991 in the wake a balance of payments crisis which was certainly severe. However, it was not a prolonged crisis with a long period of non-performance. On the contrary, the crisis erupted suddenly at the end of a period of apparently healthy growth in the 1980s, when the Indian economy grew at about 5.5% per year on average. This may appear modest by East Asian standards, but it was much better than India's previous experience of 3.5 to 4% growth and was also better than the average growth rate of all developing countries taken together in the same period.

Not only did economic performance improve in the eighties, this improvement was itself perceived to be the result of a process of evolutionary reform. By the beginning of the decade of the eighties it began to be recognised that the system of controls, with a heavy dependence on the public sector and a highly protected inward oriented type of industrialisation, could not deliver rapid growth in an increasingly competitive world environment. The sustained superior performance of East Asian countries was evident to all by the mid-eighties, and this helped create a perception that India could and should do better, but the approach remained one of evolutionary change. Several initiatives were taken in the second half of eighties