As we head towards the 25th anniversary of the economic liberalisation of 1991, we can, of course, expect quibbles about whether the process had actually started earlier during the 1980s. However, in terms of scale, scope and, most importantly, aspiration, there is no doubt in my mind that the process that began with the new government presenting its first Budget in July was a game changer. It decisively put the economy on a new and, I believe, potentially better trajectory. Whether this potential was realised or not will surely be the subject of much of the commentary on the occasion. A fair judgement would be that there have been significant achievements, but the reform process remains a work in progress. Satisfaction must be tempered with impatience with the fact that the benefits of reform are unevenly distributed. The celebration is warranted, of course, but so also is a reflection. What worked, what didn’t and what next? In that spirit, here are a few thoughts.
A striking feature of the reform process is the apparent commitment to the broad agenda by every government that has been in office over the 25 years. We have had seven elections and eight governments. Six of those governments were coalitions. Three of them did not complete their terms. One of them saw a change in Prime Minister. From a distance, this could be seen as a relatively turbulent political scenario. Yet, all these governments—both in their rhetoric and, more importantly, in their actions—have pushed ahead with the broad reform agenda. Neither party identity nor coalition complexity appears to have caused significant deviations from the roadmap. The pace of implementation, the priority placed on different components and so on certainly did vary across regimes, but the roadmap itself became firmly entrenched.
One could look at this from the “glass-half-full, half-empty” perspective. The co-ownership of the broad agenda is commendable and, from an international perspective, rather rare. Political conflicts have characterised reform processes in virtually every country that has initiated them. Many have not been able to overcome these conflicts, severely hobbling the process. On the other hand, it could also be argued that political differences have hamstrung many important reform measures, not only setting the process back but also diluting the effectiveness of other measures that might have been implemented.
“Tipping point” is a term used across a variety of disciplines to denote the convergence of a set of factors, which leads to a dramatic change in outcomes. It has been used, and I think justifiably, to characterise India’s economic performance during the reform period. The most important lesson from the 25-year trajectory, I believe, is that the benefits of reform only accrue when a whole range of reform measures is carried out, leading to a tipping point. This may be either helped or hindered by external forces, but, as they say, fortune favours the brave.
India’s tipping point came in 2003. A brief growth spurt between 1994 and 1997 did hint at the dividends from reform, but, clearly, not all the elements were in place to sustain the momentum. By 2002, serious questions were being raised about the merits of liberalisation in the absence of a significant growth dividend. Fortunately, the performance of the economy during the 2003-08 period quelled these concerns, and the recent deceleration of growth has not revived them. But more on this later. Here, I want to highlight a few of the drivers that converged to create the tipping point.
First, there was a relatively favourable global environment. Of course, this was not within the control of Indian policymakers, but it contributed significantly to the benefits accruing from the broad-based opening up of the Indian economy over the first decade of the reform period. On the trade front, booming traditional exports combined with the ITES surge to produce current account surpluses in three out of those five years. Capital inflows responded to a liberalised investment regime and attractive growth prospects to render the balance of payments stress a thing of the past. During that period, the policy dilemma turned very quickly from dealing with forex scarcity to forex surpluses. That certainly brought with it a new set of challenges, but with Forex (as with many other things), problems of plenty are less stressful than problems of deprivation!
Second, the domestic macroeconomic situation entered into a virtuous upward spiral. Inflation was low, allowing interest rates to turn stimulatory. This contributed to a surge in aggregate investment, which had been relatively steady at around 25 percent of GDP through the previous five years. It accelerated to over 35 percent during the boom period. But, beyond the aggregate, the composition of investment was particularly important. Public investment, most visible in the form of the National Highway Development Programme, also rose significantly, touching a high of almost 25 percent of total public spending by 2008. And, even as this was happening, the fiscal deficit declined sharply, helped by rising tax revenues both at the central and the state levels. The latter was largely due to the VAT implemented by a number of states in 2005.
Third, there were several factors that contributed to an increase in productivity across the board. Some of these were directly the result of the industrial, trade and financial sector policy reforms that began in 1991. These combined to increase competitive intensity in several product and service markets, resulting in greater efficiency. In turn, lower interest rates and greater efficiency fed into higher profitability, reinforcing the investment momentum described earlier. Another important contributor to the productivity improvement was the very rapid increase in the range and quality of telecom services in response to changes in the telecom policy. I remember several occasions when I was stuck in traffic or even sitting in an airplane waiting for the fog to clear, being able to read and send documents and participate in conference calls. Telecom expansion helped to offset the productivity drags created by other infrastructure deficiencies.
As I said, one could add any number of other factors that played a role in the Indian economy reaching the tipping point in 2003. These were, to my mind, the most important and all of them were directly related to the reform process. The key insight here is that, for the reform dividend to be realised, the spread and coverage of reform measures matters. It is naïve to expect actions taken in individual domains to have much of a macroeconomic impact. However, equally important, reforms appear to have had shelf lives; even if they did not have the desired impact immediately, they did kick in when other, complementary measures were implemented. It may have taken 12 years to get to the tipping point, but then, 12 years is better than never!
The high growth phase that followed the tipping point was undoubtedly interrupted by the financial crisis of 2008-09. After the crisis, things appeared to be quickly getting back on track for India as well as other emerging economies, but that relief was short-lived as growth slowed to rates significantly below the ones seen before the crisis. As far as India’s performance during this period is concerned, we could debate the proposition that the crisis was the cause of a change for the worse in the growth trajectory. I would argue that it was a contributory factor, but, just as we had a tipping point in 2003 which triggered an upward spiral, the crisis and its adverse impact on global conditions were accompanied by a combination of structural stumbling blocks which, regardless of the crisis, would have led to a growth deceleration, which interacted with a worsening macroeconomic situation to generate a downward spiral. Once again, without claiming to be exhaustive, let me describe the three that I consider most important.
First, there is the issue of food prices. Even as I write this, it has come back strongly into the policy spotlight after a period of relative moderation. It is a complex story, but the root causes of the food inflation problem that has been with us since 2009 is a structural mismatch between supply and demand. Even as rising levels of income have induced people to diversify their diets to include more proteins and vegetables, the incentive system that farmers respond to continues to steer them towards producing more cereals. It would not be an exaggeration to say that the roots of the current food inflation problem lie in the success of the policy response to the cereal shortages of the 1960s. The entrenchment of the incentive framework that proved to be so successful in solving that problem is now coming in the way of solutions to this one.
There are many aspects to the burden that food prices impose on the economy. Let me just focus on the enormous pressure that they exert on monetary policy. Even if interest rates cannot directly contain food inflation, they have to be used to contain the pressures and prevent them from spilling over into a broad-based inflationary spiral. Consequently, the stimulus that low-interest rates provided to investment (and borrowing-based consumption) during the high growth phase were necessarily replaced by a contractionary stance. The problem is that unless there are significant improvements in the supply situation of the food items that people are demanding more and more of, the problem is not going to go away. Whatever space may emerge for monetary stimulus can be shrunk by a resurgence of underlying food demand-supply imbalances.
An important lesson that emerges from the experience of several countries that have gone through extended periods of rapid growth is that they all usually managed to keep persistent food price increases in check. India went through a similar phase from the 1980s until the mid-2000s. There were episodes of high food inflation, but they were typically short-lived. I believe that this is a pre-condition for the next episode of rapid and sustained growth in India.
The second stumbling block is infrastructure. The reasons why the country’s infrastructure strategy did not deliver as expected are now well known. The consequences of this for the financial sector are vividly playing out as banks are compelled to be transparent about and provide for their bad assets. Of course, infrastructure is not the only cause of bad assets, but it is the single largest contributory factor.
Policy uncertainty, regulatory clearances and so on are legitimately viewed as factors that derailed the infrastructure strategy. But to view it in financial terms is to see that the core problem was the incapacity of the private sector to take on the risks associated with project development, which includes all the policy and regulatory risks as well. The net result is a combination of stalled projects accompanied by impaired bank loan books. It is pretty obvious that a sustained revival of growth is not going to take place without breaking through these infrastructure bottlenecks.
The third challenge is employment. While the Indian growth experience has not been entirely jobless, it is quite evident that the transformation in the economic structure has not been accompanied by a comparable transformation in the structure of employment. In particular, agriculture now accounts for less than 15 percent of GDP but remains the principal employer of about half the workforce. Of course, the story is complicated by state-level, sectoral and skill details, but the big picture that is so familiar to everybody is that the number of relatively high-productivity jobs that are being generated, in both industry and services, is a fraction of the people available.
Once again, no country in recent times has grown rapidly and persistently without moving a significant proportion of its workforce out of agriculture and into industry. In the Indian case, services may be playing a more significant role than in the other countries, but the unavoidable fact is that the transition out of agriculture has to take place at a much faster rate than is happening now.
The challenge is intensified by rapidly evolving technology. Automation and robotics are making more and more industrial and service activities less and less labour-intensive. In contrast, the skill intensity of the jobs that remain is increasing. India, along with a number of other countries in the region, is entering a sweet spot in its demographic transition at a time when the links between economic activity, growth and jobs are breaking down.
On the issue of political co-ownership, I had argued in a column a few years ago that, just as coalition governments agree to a common agenda, political parties across the spectrum should formally converge towards a national agenda. This is, in any case, borne out by the actions taken by parties or coalitions when they have been in office. Taking it to the next step would mean that parties commit to supporting specific reform measures whether they are in government or opposition. This will bring predictability and consistency to the process and, I emphasise, is not a very big leap from what has already happened.
On the three structural stumbling blocks, many steps have been and are being taken, which is a source of reassurance. On food prices, capping procurement prices of cereals and open market sales from stocks were very effective first steps. However, as recent developments underscore, these need to be followed by measures that change the long-term incentives on the basis of which farmers make their cropping decisions.
On infrastructure, as I have argued over the past couple of years, the re-design of the public-private partnership (PPP) is a critical requirement. Instead of PPP being a simultaneous process, I have argued that it needs to be a sequential one: First Public, then Private or FPTP. Only the public sector can take on the kind of risks that undermined the earlier strategy. But, at an opportune time in the project’s trajectory, private capital and organisational capabilities can come in and run the project efficiently and profitably. The recently established National Infrastructure and Investment Fund (NIIF) will be an important instrument in the FPTP approach. The new bankruptcy and resolution framework will also contribute to dealing with the financial sector impact of infrastructure, as well as with the larger asset quality problem.
On jobs, the reforms in labour market regulations that are being carried out by some states are an important first step in the effort to generate more jobs in manufacturing. Large-scale but quick skilling of young workers is also an essential part of the response. But, ultimately, jobs have to be generated, which means that investment in sectors that remain relatively labour-intensive has to step up. Improving the business climate will contribute to this. However, the scale of the challenge is so large and the risks of falling short are so high that every instrument available has to be brought to bear.
In the late 1990s, before the tipping point was reached, the debate centred around the question “to reform or not to reform?” Today, notwithstanding concerns induced by slower-than-desirable growth, the dominant reaction seems to be impatience with reforms not moving ahead quickly enough. That is a substantial positive legacy from the past 25 years.
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