As India commemorates the 30th anniversary of the 1991 Reforms, ORF looks back at its very first publication.
India is confronted with the most severe financial crisis in her post-Independence history. The task of steering the national economy towards stability and thereafter towards accelerated growth requires, above all, a political and social consensus and a national commitment to overcome obstacles. In this context, we welcome the broad framework of policy initiated by the Prime Minister in his first address to the nation, which has been elaborated further by the Finance Minister in his press conference and consultations with leaders of opposition parties.
The symptoms of the crisis are well known. Inflation has accelerated despite three bumper harvests and satisfactory growth in industrial production. Fiscal deficits have risen to unsustainable levels. The country’s balance of payments situation is precarious. The level of reserves is at an all-time low. The high and increasing levels of current account deficits in the last several years have led to an accumulation of a large foreign debt and an increasing proportion of it on short-term commercial basis. Servicing this debt has presented a major challenge. The large macroeconomic imbalances that have presisted over a fairly long period are now set to push the economy into a situation where growth may be jeopardised, inflation may become uncontrollable and living standards of the vast majority of our people may suffer.
Simply stated, this situation has come about because, as a nation, we have got used to living beyond our means, our persistently high fiscal deficits and current account deficits are testimony to the firmly-grounded belief that social and economic irresponsibility carries no penalty. But history has no special favourites. We cannot afford the luxury of apportioning the blame.
The immediate task of achieving as rapidly as possible, a viable balance of payments position should be pursued alongside the aim of rectifying the major imbalances in a medium-term context. It is essential to address the underlying inefficiencies that constrain sustained growth and development. Behind the twin deficits lie structural deficiencies and rigidities which contribute to inefficiency and slow growth and ultimately, to slower improvements in the well-being of our people. We cannot therefore, ignore or postpone the structural reforms needed to tackle these problems. Adjustments now and reforms later is not a sound strategy. What we need is growth-oriented adjustment as growth cannot be sacrificed at the altar of adjustment.
Due to self-imposed constraints, productive forces in the economy are not allowed to generate more output and employment. If these constraints are not removed quickly and effectively, we will witness a succession of crises of increasing seriousness. The means for ending the present stalemate are at hand. There is inherent strength in our economy. We need to utilise this strength to build a better future.
The present crisis has to be met by a well-considered adjustment programme. The centrepiece of such a programme has undoubtedly to be restoration of the fiscal balance to contain inflation which is hurting the poorer sections particularly hard, and relieve pressure on the balance of payments. We should aim to reduce the fiscal deficit from its present range of 8.5 per cent to 9 per cent to below 4 per cent of GDP over the next three years. Only a comprehensive strategy that ensures fiscal propriety within a framework of structural reform will create confidence in the international community. It will facilitate the needed external financing for moderating the impact of corrective measures essential for restoring the health of our internal and external accounts. Without adequate levels of external financing, the burden of adjustment will fall in a disproportionate measure on the poor. In the immediate future, there is no alternative to going to the IMF for a substantial drawing of around SDR 5 to 7 billion. The conditionality of the IMF need not daunt us. We need indeed, self-imposed conditionality in the three major areas where the IMF also is likely to ask for reform, viz in correcting the fiscal deficit, in having an appropriate and competitive exchange rate and in moving towards and open economy.
A substantial reduction in government expenditure can be achieved through a phased programme of reduction in subsidies and rationalisation of plan expenditure. A sharp reduction in fertiliser subsidy is very essential. Food subsidies will have to be rationalised and targetted at sections of the population not protected against inflation so that the burden of adjustment on the poor can be minimised. Financial incentives for exporters should be provided through an appropriate exchange rate policy rather than through the budget. While these are the overt subsidies, there is a great deal of subsidisation in areas like power pricing, irrigation charges and higher education, all of which call for review and economies. Defence expenditure should be frozen in real terms and then reduced in the medium-term. Plan expenditure should be rationalised with a view to eliminating waste and focussed more on poverty removal and employment generation and completion of on going schemes. In the short run, those who have assured incomes will have to bear a larger share of the cost of adjustment. While expenditure control is important, we should guard against careless fiscal austerity in the form of cutting investment in essential infrastructure.
A sizeable reduction in revenue expenditure is essential for sustaining public investment in infrastructure and for increasing the access of the poor to health, education, nutrition and other poverty alleviation programmes. Investment in agriculture and energy sectors has to be sustained at a level that will generate an adequate rate of growth.
Additional revenue mobilisation is inescapable. The broad approach should be not to tinker with the tax rates, but to widen the tax base and rationalise the tax structure by eliminating exemptions and plugging loopholes and improving tax enforcement. It may not be possible to lower direct tax rates in the current year. However in coming years, income tax rates should be lowered from the present 56 per cent (including surcharge) to about 45 per cent without raising the minimum taxable limit. The indirect tax structure needs rationalisation and greater progress towards adoption of the VAT system.
While fiscal adjustment holds the key to the present balance of payments crisis, this as mentioned earlier, has to form a part of a medium-term structural reform. It is imperative that the concept of planning be refashioned. Pervasive state regulation and intervention, justified in the name of planning, has neither led to high growth and associated autonomous technological development nor made a significant contribution towards reduction of social and economic inequalities or improvement of the welfare of the poorer sections of our society. The next phase of development demands indeed compels, a fundamental change in the way we look at planning. The plan has to be formulated on an indicative basis with reference to market signals. Experience has shown that centralised planning produces waste, inefficiency and stagnation. The logic of reform flows from our national experience in this matter.
Moving towards a more open economy will, of necessity, be a process of well-sequenced and interconnected reforms in several sectors. In industrial policy, our objective should be to eliminate, as soon as possible, all industrial licencing subject only to laws relating to environment and industrial safety. While the small-scale, village industry and tiny sectors should be promoted, this should be done through fiscal measures on a time-bound basis and not, in any case, by product reservations. While the right of entry into industry should be liberalised, it is equally imperative that we liberalise the right of exit as well. Deregulation of industrial production is a pre-requisite for exposing the economy to international competition, bereft of domestic competition, the economy will be totally vulnerable to the onslaught of foreign capital.
A well-conceived policy for a freer induction of foreign investment can also be effectively deployed to stimulate domestic competition. Foreign investment can fill many existing gaps in our industrial structure and needs to be encouraged as a source of both finance and technology as long as it is foreign exchange neutral in its impact. It needs to be recognised that fears of foreign investment have been grossly exaggerated and a more welcoming stance is necessary to attract MNCs to invest in India . A target of $2 to $3 billion per year in the next few years should be both desirable and feasible. The paramount objective, however at this stage, is to promote domestic competition. The whole corpus of policies and regulations that today inhibit such competition has to be decisively and definitively swept away. As a step in that direction, the MRTP act should be drastically revised. Restrictions on growth of firm size should be removed. At the same time, the section related to restrictive trade practices should be further strengthened.
The public sector, which dominates the economy, should be made to follow rules that reward profitability and punish inefficiency. The budget, rather than public enterprises, has to take care of the welfare aspects. There is no social justification for the continuation of public sector enterprises that show losses year after year, nor is there any justification for public sector activity in areas where private entrepreneurs can do the job better. Unless the public sector is subjected to the test of competition and efficiency, there will be no accountability, nor any improvement in managerial performance. Reform and restructuring of the public sector enterprises is a task of national importance. It can no longer be postponed.
In the sphere of trade policy, the goal should be to replace quantitative restrictions by tariffs and to lower tariff levels to about 40 per cent in the next four to five years with a view to building an internationally competitive industrial structure. The loss in custom revenues should be made good by raising excise duties suitably. The incentive structure has to be fashioned to encourage exports and not, as now, high-cost import substitution. The exchange rate policy has an important role in giving signals to the economy. We should aim to have a liberal exchange rate regime with the object of making the rupee fully convertible in the medium-term and allow it to settle at a level which more truly reflects the relative scarcity of foreign exchange.
The financial and banking sectors are also in urgent need of reform. Greater autonomy, more transparency in accounts, adequacy of capital, elimination of behest lending and eschewing populist measures such as loan meals and loan waivers and a greater measure of competition are called for. The health of the financial system can only be ignored at the peril of weakening the entire economic edifice.
Movement towards a vibrant and competitive economy calls for new approach to industrial relations and exit policies. The issue is whether we can continue our present emphasis on overprotecting organised labour at the cost of the vast number of unorganised and unemployed labour. Our present policies are biased against the use of labour which is abundant and in favour of use of capital which is scarce. Wage policies and wage negotiations are distorted because of undue and unwarranted intervention by the state. We recognise that relaxation of labour market rigidities will take time, but we stress that a discernible movement for lowering such rigidities will lead to larger employment and output benefits for the economy. Closures of unviable units, with adequate provision for employment termination benefits and schemes for worker training are a sine qua non for a strong industrial sector. The present policy structure of providing fiscal and credit reliefs to sick units has been a costly, inefficient and wasteful form of protecting employment.
The state has to play a major role in absorption and adaptation of technology, not by imposition of unimaginative controls of one kind or another, but by providing the right fiscal signals to encourage domestic R&D and by coordinating corporate planning.
The process of creating conditions for a more open and competitive economy will thus call for simultaneous and concerted action over a broad array fiscal, trade, exchange rate, industrial and labour policies. Going about it in piecemeal or only in some sectors could be counterproductive but if done together, we could well find the whole being larger than the sum of the parts.
Our intention is not to furnish a detailed blueprint of reform. The main guiding principle is that within a framework of macroeconomic stability, which only the state can provide and nurture, decision-making in economic spheres should be decentralised to the maximum extent consistent with our basic socio-economic objectives.
The present crisis is an opportunity to learn and unlearn. There is no escape from the painful process of adjustment. The national economy has to be stabilised. The bitter medicine of fiscal austerity has to be swallowed if we have to have a change of recovering from our self-inflicted injuries. But having recovered, vigorous growth will not come from doing more of what we have done before. A bold programme of setting free initiatives and capabilities will have to be put in place. For this, resolution and courage are needed. But, more importantly, shedding of dogma is indispensable.
India is at crossroads. The colossal challenges ahead cannot be met by hesitant, faltering and half-hearted steps. The entire country must act with the courage of conviction that reforms are necessary to pave the way for making India a stable, strong and vibrant nation. All representative organs of our society, and above all, the Parliament must reflect that the nation is poised to grasp the future unitedly and with determination.
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