Liberalization, growth and regional disparities in india


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Liberalization, growth and regional disparities in india

  1. 1. Chapter 2Review of Economic Policies and GrowthPerformance2.1 IntroductionThe Indian government has been following the path of planned economicdevelopment since Independence. During the long period of more than six decadessince the adoption of the First Five-Year Plan in 1951, the government hasimplemented various policies and programmes in order to (1) achieve high eco-nomic growth with equality, (2) improve the living conditions of people and reducethe incidence of unemployment and poverty and (3) achieve balanced regionaldevelopment. Naturally, during the regime of planned economic development,economic policies and strategies of the government were influenced by theseobjectives. However, the economy has experienced, among other things, widefluctuations in the growth rate of gross domestic product (GDP) and its variouscomponents, high incidence of unemployment and poverty, large interregionaldisparities in development, etc. The post-Independence period has witnessedmajor policy changes at several time points, and the economy has reached thepresent state of development after passing through various phases.This chapter briefly reviews the economic policies adopted by the government atdifferent time points, with special reference to the large-scale economic reformprogrammes since 1991, and evaluates the growth performance of the economy duringdifferent phases. There exists a huge literature reviewing the large-scale economicreforms and their impacts on various aspects of the economy (see, e.g. Acharya et al.2006; Ahuja et al. 2006; Bhattacharya and Kar 2007; Panagariya 2005). Drawing onthe existing literature, we make a review of the policies adopted by the Indiangovernment since 1950. For convenience of analysis, the period since 1950 is dividedinto three subperiods: (1) 1950–1980, (2) 1980–1991 and (3) 1991 onwards.M. Ghosh, Liberalization, Growth and Regional Disparities in India,India Studies in Business and Economics, DOI 10.1007/978-81-322-0981-2_2,# Springer India 20139
  2. 2. 2.2 Policies and Performance During 1950–1980During 1950–1967, efforts were made to step up investment, accelerate growthand achieve social justice. The First Five-Year Plan (1951–1956) accorded highpriority to agriculture, irrigation and infrastructure. The Second Five-Year Plan(1956–1961) shifted the strategy to industrialisation through development of heavyindustry led by public sector investment. This was influenced by the thought thatunderdevelopment is due to the lack of industrialisation. This view was alsosupported by a number of empirical studies reporting a high degree of correlationbetween the level of industrialisation and growth rate in an economy. The approachto development during this period had three components: (1) import substitutionand inward-looking policies for giving protection and opportunity to Indianindustries to become competitive in the world market, (2) focus on the public sectorand (3) centrality of the planning process.During the period from 1950–1951 to the mid-1960s (the pre-green revolutionperiod), the agricultural sector witnessed various policies concerning agrarianreforms, institutional changes and development of major irrigation projects.Intermediary landlordism was abolished, tenants were given security of farmingand ownership of land, land ceilings were imposed to eliminate large landholdings,cooperative credit institutions were strengthened and land consolidation programmeswere implemented to reduce fragmentation of land holdings. Expansion of areawas the main source of agricultural growth during the pre-green revolution period.Though industry and services grew at the rate of 6.3 and 4.8%, respectively,during 1951–1966, GDP and per capita GDP grew at the rate of 3.4 and 1.4% only.This was due to poor performance of the agricultural sector, registering a lowgrowth rate of 1.8% caused by unprecedented droughts in two consecutive years1965–1966 and 1966–1967.The strategy of ‘development through planning and controls’ adopted during the1950s and 1960s continued during the 1970s. The planners and policymakersunderstood the need for using a wide variety of instruments and controls to promoteindustrial development in a desired direction. The period (1967–1980) witnessed amarked strengthening of the import-substitution strategy and a clear preference forgovernment controls over a widening area of economic activity. These includenationalisation of banks and insurance in 1969–1970, Foreign Exchange RegulationAct (FERA) to control external payments, reservations for small industries, Monop-oly and Restrictive Trade Practices (MRTP) Act and tighter industrial licensing.The major policies adopted during the control regime (1970s) include industriallicensing policy, import control policy, foreign exchange control, foreign exchangerate control, capital market control, price control and controls of the banking sector.In the early 1960s, the country faced a severe food shortage crisis for which alarge quantity of wheat had to be imported. This provoked the policymakers tosearch for a breakthrough in agricultural production and reduce the dependence onforeign countries for food grains. This prompted the government to introduce thehigh yielding varieties (HYVs) of wheat and rice in the mid-1960s in the areas withassured irrigation. This marked the beginning of the second phase in agricultural10 2 Review of Economic Policies and Growth Performance
  3. 3. policy during which agrarian reforms were given secondary importance and thepolicies concerning research, extension, input supply, agricultural credit, market-ing, price support and dissemination of the HYV technology were given the primeimportance. The green revolution technology was remarkably successful in raisingfood grains production and attaining self-sufficiency in food grains like wheat andrice. Increase in productivity rather than expansion in area became the main sourceof growth in production during the green revolution period.Two important institutions—Food Corporation of India (FCI) and AgriculturalPrices Commission (APC)—were formed in this period. The APC was subse-quently renamed as the Commission for Agricultural Costs and Prices (CACP).These institutions were established to ensure remunerative prices to farmers,maintain reasonable price for consumers, procure food grains and maintain bufferstocks to run the public distribution system (PDS) and to avoid the adverse impactof seasonal fluctuations in output on price stability.Though aggregate investment in the economy continued to rise during most ofthe period (1967–1980), there was no significant acceleration in the GDP or in percapita GDP growth rate from the rate achieved during 1951–1966. It was thoughtthat productivity growth had lost momentum under the development strategy full ofcontrols. Low rates of industrial growth, the economy experienced in the late 1960s,continued through the 1970s. Industrial growth rate declined from 6.3% during1951–1966 to 4.1% during 1967–1980. However, due to introduction of the HYVtechnology, the performance of the agricultural sector improved from the previousperiod as agricultural output grew at the rate of 3.3% during 1967–1980.The slow growth in the industrial sector raised doubts about the efficacy of thesystem of extensive controls on industry, finance and foreign trade and payments.The second oil price shock of 1979–1980 and the subsequent recourse to theInternational Monetary Fund (IMF) strengthened the doubts at the end of the period1967–1980. It was felt that there was a need to move towards a market-ledeconomy, which would ensure higher growth rates. The planners and policymakerswere convinced by this idea, and the moves towards market-led economy gainedmomentum during the 1980s.2.3 Policies and Performance During 1980–1991The policies adopted during this period for the sectors other than agriculture includethe following. The policies concerning the industrial sector were mainlyprobusiness in nature:1. A new Industrial Policy Statement was framed in 1980 that liberalised licensingfor large-scale industries, regularised the installation of excess capacity andallowed automatic expansion of capacity to some of them.2. The growing irrelevance of the MRTP Act was recognised, and a number ofindustries were exempted from this Act.2.3 Policies and Performance During 1980–1991 11
  4. 4. 3. A number of industries were delicensed from the FERA in 1986. The thresholdlimit for FERA was also raised.4. Reforms were adopted in the external sector. In 1985, a trade policy wasannounced to provide more flexibility to the exporters and importers.5. Two important policy changes were made in the fiscal sector: (a) adoption ofexpansionary fiscal policy involving high level of government expenditures and(b) the method of financing these expenditures shifted from a tax-financed to adebt-financed programme.While there was a clear change in economic policy towards delicensing andderegulation in the industrial sector, there was no major change in agriculturalpolicy. The decade of 1980s did not see any major policy initiative for agriculture.However, agricultural growth and the resultant increase in real farm incomes led tothe emergence of interest groups and lobbies, which started influencing the farmpolicy in the country. Subsidies and support to the agricultural sector increasedconsiderably during this period. However, public sector spending in agriculture forinfrastructure development in real term and total public investment in agriculturestarted declining after 1980–1981, although private investment was rising. Therural economy started witnessing a process of diversification, leading to growth innon-food grain output like milk, fishery, poultry, vegetables, fruits, etc. Thisaccelerated the growth in GDP originating from agriculture during the 1980s.The economy performed far better during 1980–1991 than in the previousperiod. The performance of the agricultural sector, with a growth rate of 3.5%during this period, was better than in the previous period (3.3%). Industry achieveda remarkably higher growth rate of 7.1% during this period, presumably due to theprobusiness policies. The services sector also performed very well during thisperiod, as it recorded a growth rate of 6.8%, which is significantly higher than inthe previous period. The improved performance of agriculture, industry andservices yielded an impressive growth rate of GDP (5.6%) and per capita GDP(3.4%) during the 1980s, a significant decade for the Indian economy, as itsuccessfully broke free of the ‘Hindu rate of growth’.2.4 Economic Reforms Since 1991Some of the policies followed during the 1980s had given rise to a number ofproblems that created a critical situation in the economy in the early 1990s:1. The shift from the tax-financed expenditure to the debt-financed expenditureprogramme had led to steady increase in both the domestic and externaldebt–GDP ratios. By the end of the 1980s, these ratios had reached such highlevels that there was a genuine worry to India falling into a debt trap.2. Fiscal deficits–GDP ratio mounted to as high as 8.14% and spilled over to theexternal sector, requiring growing recourse to external borrowing on commercialterms.12 2 Review of Economic Policies and Growth Performance
  5. 5. 3. Low export–GDP ratio, rising trade and current account deficit and deterioratingexternal debt profile and external shocks, viz. the 1990 Gulf War, leading to ahike in oil prices and the import bill, and slowing down in remittances from theGulf countries put pressure on the balance of payments situation. The situationwas such that foreign exchange reserves came down to a level that was less thanthe cost of 2 weeks worth of imports.4. Inflation rate during the 1980s was 8.58% on average with the highest at10.94% and the lowest at 6.82%.To break out of this critical macroeconomic and balance of payments situation,India took a substantial amount of loan from the IMF in 1991, devalued the rupee by22% against the dollar and adopted comprehensive economic reforms involvingstructural adjustment and liberalisation programmes. The severe economic crisis inthe early 1990s provoked the Indian government to make fundamental changes inthe content and approach to economic policy. The economic reform programmesinvolving radical changes in trade and industrial policies aiming at improving theefficiency of the economy and increasing its international competitiveness werethought to be essential to ensure long-term viability in the balance of payments(BOP) and to restore the condition for rapid growth in the economy.The major thrusts of the reforms involved measures to address the macroeco-nomic and balance of payments crisis through (1) fiscal consolidation and taxreforms, (2) removal of controls on industrial investment and imports, (3) reductionof tariffs, (4) creation of a favourable environment for attracting foreign invest-ment, (5) prudent management of exchange rate allowing the market to play a majorrole in its determination and making the rupee convertible for current accounttransactions and (6) opening the energy and telecommunication sectors for bothdomestic and foreign private investment.These pro-market policies are classified into (1) fiscal policy reforms involvingtax reforms, expenditure management, restructuring of the public sector and fiscaland monetary coordination; (2) financial sector reforms including the bankingsector and capital market; (3) industrial policy and abolition of the license system;(4) foreign investment policy reforms; (5) reforms in the external sector coveringforeign trade and exchange rate policies; and (6) agricultural sector reformsconcerning the internal and external trade in agricultural commodities. The majoreconomic reforms undertaken for different sectors of the economy are listed below.2.4.1 Fiscal Sector1. Measures for reduction in fiscal deficit.2. Reforms in major taxes: significant reduction in direct and indirect tax rates tomaintain them at international levels and introduction of a number of schemesincluding the famous ‘one by six’ criteria to expand the tax base and increase taxrevenues.2.4 Economic Reforms Since 1991 13
  6. 6. 2.4.2 Public Sector1. Disinvestment of public enterprises.2. Greater autonomy and accountability for public enterprises.2.4.3 Industrial Sector1. Virtual abolition of industrial licensing: The licensing requirements for domesticproduction and imports have been largely abolished.2. Abolition of separate permission needed by MRTP houses.3. Sharp reduction of industries reserved for the public sector.4. Freer access to foreign technology.2.4.4 Financial Sector1. Autonomy of the Reserve Bank of India (RBI); the practice of automaticmonetisation of the fiscal deficit through the issue of short-term treasury billsto the RBI discontinued; the volume of RBI credit to the government is to bedetermined by the bank; the government now falls back on its marketborrowings to balance its budget.2. Reduction of reserve requirements for banks, notably the cash reserve ratio(CRR) and the statutory liquidity ratio (SLR).3. Gradual freeing up of interest rates; interest rate to be determined by the marketforces and no attempt to be made to deliberately keep them at a low level.4. Setting up and legislative empowerment of the Securities and Exchange Boardof India (SEBI) and establishment of National Stock Exchange (NSE) in order to(a) provide more transparency to the transaction, (b) ensure that the agents in thestock market do not indulge in unfair practices, (c) allow mutual funds to enterthe market so that small investors could enter the market without going throughbrokers and middlemen and (d) allow foreign institutional investors to enterthese markets.5. Abolition of government control over capital issues.2.4.5 External Sector1. Devaluation and transition to a market-determined exchange rate.2. The foreign exchange rate regime shifted from the practice of pegging to abasket of currencies to a managed float in 1993, the RBI started regulating themarket by the purchase and sale of foreign exchange and the government alsomoved to convertibility for transactions in the current account.14 2 Review of Economic Policies and Growth Performance
  7. 7. 3. Phased reduction of import licensing: The government started lifting quantitativerestriction (QRs) on imports from the mid-1980s and substituting themwith tariffs; QRs were largely abolished and tariff rates were brought downsignificantly during the 1990s.4. Phased reduction of peak custom duties.5. Policies to encourage direct and portfolio foreign investment.6. Monitoring and controls over external borrowing, especially short term.7. Build-up of foreign exchange reserves.8. Amendment of the Foreign Exchange Regulation Act (FERA) to reducerestrictions on firms.2.4.6 Agricultural SectorThe comprehensive economic reforms have focused mainly on industrial, financialand trade policies. The agricultural sector, which still contributes about 15% of theGDP and provides livelihood to about 52% of the population, has witnessed modestchanges in policies. The process of reforms in agriculture actually began from1994–1995 when India became a part of the multilateral trading system under theWorld Trade Organization (WTO). The policy reforms in agriculture may beclassified into two categories: (1) the policy reforms liberalising the externaltrade in agricultural commodities, advancing thereby the openness and integrationof the agricultural sector to the world economy, and (2) the measures to reforminternal (domestic) trade and agricultural policies.Efforts have been made to change external trade policies in line with theprovisions laid under the WTO. Tariff rates (TRs) and nontariff barriers (NTBs)have been reduced for several commodities, and provisions have been made torevise them keeping in view of the movements of world commodity prices, increasein imports and concerns for food security and self-sufficiency. Measures for pro-motion of export of agricultural commodities have been initiated through removalof restrictions on licensing, minimum export price, etc. Besides, the reduction ofprotection to industry and the consequent depreciation in the exchange rate arelikely to help agricultural exports by changing the relative prices in favour ofagriculture.There have been a number of policy reforms liberalising the restrictions oninternal trade in agricultural commodities. Some of these include (a) removal ofrestraints on interstate movement of food grains, (b) restructuring of the publicdistribution system, (c) relaxation of restrictions under the Essential CommoditiesAct, (d) introduction of forward trading in most agricultural commodities and (e)removal of some marketing restriction of crop produce. For details of the internaland external trade policies and agricultural sector reforms, see Athukorala (2005)and Bathla (2006).While agriculture has benefited from the changes in external and internal tradeand other farm policies, it has suffered from the decline in public investment in2.4 Economic Reforms Since 1991 15
  8. 8. areas of critical importance for agricultural growth, such as irrigation and drainage,soil conservation and water management systems and rural infrastructure. Thedecline in public investment in agriculture actually began much before the reforms,and this was sharper in the 1980s than in the 1990s (Gulati and Bathla 2001).Although this decline was more than offset by a rise in private investment inagriculture, which accelerated after the reforms, there is nothing denying that publicinvestment in agricultural infrastructure has to be increased for achieving higherproductivity, and agriculture needs much more focused attention in order to revivethe stagnating agricultural economy (Mohan 2006).The economy recorded a mixed performance during the post-reform period.During 1991–2001, the growth performance of the agricultural sector was relativelypoor with an average growth rate of 2.7%, much lower than the rate in the previousperiod. Industrial sector recorded an average growth rate of 5.7%, down from thegrowth rate of 7.1% in the previous period. The performance of the services sectorduring this period was better than in the previous period, as the growth rateregistered an increase from 6.8 to 7.6%. The performance of the economy wasmore or less stable, as the growth rate of GDP (5.6%) and per capita GDP (3.5%)during 1991–2001 remained almost same as in the previous period. The economywitnessed an improvement in the growth performance during 2001/2002–2008/2009, as GDP grew at the rate of 7.6%, net domestic product (NDP) at the rate of7.5% and per capita NDP at the rate of 5.9%. Agriculture, industry and servicesgrew at the rate of 2.8, 7.1 and 9.6%, respectively.ReferencesAcharya, S., et al. (2006). Economic growth in India 1950–2000. In K. S. Parikh (Ed.), Explaininggrowth in South Asia. New Delhi: Oxford University Press.Ahuja, S., et al. (2006). Economic reform in India: Task force report. Chicago: The Harris Schoolof Public Policy/University of Chicago.Athukorala, P.-C. (2005). Agricultural trade policy reforms in India. South Asia EconomicJournal, 6(1), 23–36.Bathla, S. (2006). Trade policy reforms and openness of Indian agriculture: Analysis at thecommodity level. South Asia Economic Journal, 7(1), 20–53.Bhattacharya, B. B., & Kar, S. (2007). Macroeconomic reforms, growth and stability. New Delhi:Oxford University Press. Chapter 2.Gulati, A., & Bathla, S. (2001). Capital formation in Indian agriculture: Revisiting the debate.Economic and Political Weekly, 36(20), 1697–1708.Mohan, R. (2006, November 10). Economic reforms in India: Where are we and where do we go?In Lecture delivered at a public seminar organised by Institute of South Asia Studies,Singapore.Panagariya, A. (2005, November 7). The triumph of India’s market reforms: The record of the1980s and 1990s (Policy analysis, No. 554). Washington, D.C.: CATO Institute.16 2 Review of Economic Policies and Growth Performance