Indian Economy in the Shadow of Documentation

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Indian Economy in the Shadow of Globalisation*

Sunanda Sen

Introduction: Globalisation in India had its impact in terms of a regime change in economic policies since the beginning of 1991. While the immediate factors which had been responsible for a change-over to a liberalised regime in July 1991 included a severe balance of payments constraint and a change of leadership at the Centre, one can trace the beginning of the change to the mideighties since when trade as well as industrial policies have been liberalised to a considerable degree. Economic reforms during the 1990s encompassed the entire economy, covering the external sector, industry, agriculture, services, monetary and fiscal policy and finally, labour policy. Behind these moves was an undercurrent of an uncritical reliance on the ‘efficient market’ hypothesis of mainstream neo-classical economics, which today is subscribed by advanced countries as well as most international financial and trading institutions. Critics denouncing the universal virtues of a free-market regime have often been pointing at the limitations of the neo-liberal agenda. This , as pointed out, especially relates to the developing countries which are yet to strengthen the domestic economic base, not just to achieve higher growth but also to cater to the teeming millions of people who lack even the bare minimum of subsistence. Instead of enhancing growth via efficiency gains, these policies, as is claimed by the critics, may stall growth in these economies and be responsible for increasing income inequality and social unrest. Countries as above would, as a consequence, be more dependent on the vicissitudes of the global economy, a process which generally contributes to an added degree of vulnerability and instability in their respective domestic economies. The present paper makes an attempt to evaluate the impact of economic reforms on the Indian economy. We find little evidence of a steady improvement in the growth performance and/or developmental indicators (e.g, an improvement in the quality of life and reduction in poverty as a consequence of the implementation of these economic reforms in the country. Instead

2 we have observed that these economies have been exposed to an added degree of vulnerability , both actual and potential, since the beginning of the period when reforms were implemented. The paper will refer to the major heads of economic reforms in the implemented in India since 1991. It aims to provide an account of the major changes as are observed in the post-reform economy, drawing attention to the positive aspects as well as the problems in the economy as can be related to the implementation of these reforms. Aspects covered by reforms include external trade and services, exchange rate, fiscal –monetary policies, de-regulation of the financial market (including the banking as well as the capital market and the state of labour, agriculture as well as industry in the economy. Policies have by and large been guided by internationally accepted directives as are implicit in the drive towards globalisation. Much of it can be attributed to the misplaced priorities as are placed by the indoctrinated policy makers on facilitating the entry of foreign capital, commodities as well as services. In order not to transgress too vast a terrain, we have concentrated on (a) trade, exchange rate and capital account management on the one hand and (b) the fiscal-monetary and financial reforms. In order to have a complete picture, we do, however, pay some attention to the related scenario in the economy, especially

in terms of growth of output , employment, and the social

indicators relating to poverty. The paper concludes with observations relating to the underlying alliances between the national elite in the developing countries on the one hand, and the international power brokers on the other, in the currently prevailing state of dependent development in the world economy. Open economy Concerns in the Indian Economy We first look into the reforms in the area of trade and then assess the performance of this sector, especially in the light of the expected beneficial impact of the new policy regime. In India the major changes in trade policy as have come about started earlier than the formal launching of reforms in 1991. Thus by mid-1980s it was evident that the country already was on a path of trade liberalisation, especially in terms of the de-licensing of

imports. Proposals for import

liberalisation, which was, strongly advocated by an official committee on trade policy in 1978 were followed up, in quick succession, by two more official committees, in the respective years 1982 and 1984. While the 1982 Committee strongly recommended a package of measures for export promotion the 1984 Committee suggested trade reforms for achieving both improved trade balance as well as efficiency in resource use. Stress was laid on export promotion, import

3 liberalisation as well as on greater access to technology from abroad, presumably by means of an easier access to foreign equity participation in India. The claim was made that a freer flow of foreign direct investment would contribute to higher exports, ushering in technological innovations in the export sector. The annual and the long term import and export policy announcements of the Ministry of Commerce incorporated most of the recommendations for trade reform recommended by the earlier committees. In 1991 the formal change-over to a liberalised regime in 1991 was followed by a renewed emphasis on import liberalisation (especially by shifting imports of capital goods and raw materials to the OGL list ) and market –oriented export incentives. The official sources claimed that the reduction of import tariff would work towards export promotion and also attract FDI flows to India. Import liberalisation during the earlier years of the post-reform period, however, was subject to short-term interruptions as were due not only to sudden crises in the external payments front but also intermittent pressures from domestic industry which for the first time was facing stiffer competition from overseas merchandise and capital. A major plank in India’s trade policy during the earlier years of the 1990s included the grant, on a concessional basis, of import licenses (on non-OGL list of capital goods, raw materials and components) and even restricted items of imports, on a concessional basis, as incentives to exporters. Transferability of these licenses (especially the EXIM scrips) added the incentive value of the device to exporters as long as foreign exchange was scarce. However, the steady pace of delicensing and the reduction of average customs tariff on imports soon reduced the effectiveness of the import-linked export incentives. This was evident in the sharp reductions in the market premium of the EXIM scrips , from 40-50% in November 1990 to 16-20% in February 1992.as reported in newspapers. The steady pace of import liberalisation in India which started in the early 1990s was selfevident by mid 1990s in at least three aspects. These included, first, declines in the gap between the value of actual imports and imports under licensing; second, increases in the list of items under the OGL list along with expansion in the absolute value of limits set against licenses; and finally the removal of the ‘actual user’ condition from both the OGL and the Exim scrips. (The last mentioned change implied that imports were no longer linked to specific production requirements.) With these changes, the market for intermediates as well as consumables were virtually left open to imported products, which affected both the capacity utilisation as well as the import cost component of the Indian producers. With depreciating exchange rates costs were

4 subject to upward revision in terms of rupees, especially in producing units where import dependence was high and rising. Import liberalisation in the country led to increases in the volume of imports over the 1990s. Value of imports, as a proportion of the GDP, rose even more sharply, from 8.31% in 1990-91 to more than 12% by 1995-6 and to 13% in 2000-01. The macro-economic implications of the rising import share on the economy will be dealt with later in this paper. Economic reforms in India in the area of trade aimed to achieve a fast-track growth in exports, with a competitive trade regime in terms of the availability of imported inputs at international prices, cost-efficiency in exporting units as a result of the wide-ranging economic reforms and with changes in the real effective exchange rate (RER) of rupee which would promote exports. In reality, however, export growth was far from an impressive one. As for the exchange rate movements, the nominal rate of the rupee depreciated considerably since 1991, the movements in the RER were not always in the same direction. In fact the there has recently been some degree of appreciation in the RER in recent years ( largely with subdued inflation in the country) a development which might have had an adverse effect on the trade balance. A closer look at the determinants of India’s trade, however, reveals that the price variables like the RER and the customs duty reductions have not worked to influence India’s trade balance In a simple econometric testing of the structural links between the value of exports, imports and other variables including the RER and the GDP over 1973-74 to 1995-96 reveal that imports in India tend to have a positive contribution on GDP, largely as a supply response in a liberalised economy. As for exports these also can be viewed as indirect inputs towards GDP, by providing the foreign currency as can be used to meet the cost of imported inputs. The above result can be interpreted by the tendencies of a greater degree of reliance on imports as inputs for production in a liberalised economy. As a supportive evidence one comes across the sharp increases in import /GDP ratio, mentioned above, which has moved up sharply since the middle of the 1990s. The econometric testing of data also reveals that during these years RER had been rather insignificant as an explanation of changes in either exports or imports of commodities. In contrast domestic output (GDP) had been a major variable to explain the variations in imports. One notices the recent contractions in the annual percentage growth in imports which in large part is due to similar

5 deteriorations in domestic output. ( GDP growth in India has faltered , in recent years, from its peak at 8.2% in 1995-96 to 4.2% in 2000-01). As for exports the external economic environment had a major role to play. The continuing recession in the OECD and the multiple devices of non-tariff trade barriers in these countries have worked to dampen India’s exports, thus dampening the expected benefits of economic reforms. While the year-to-year changes in the value of exports indicate shifting fortunes, the annual percentage changes in the dollar value of exports ranging between 20-21% to negative rates at around 2-5% over 1990-91 to 2001-02, a more consistent picture can be obtained from the compound growth rates. Contrasting the higher compound growth rate at 10.42% over the three decades as a whole between 1970-71 to 2000-01, export growth was lower at 9.39% between 1990-91 to 2000-01. However, comparing the decade wise growth patterns, the data for the 1980s decade records a percentage growth at 4.08% which was even lower as compared to the 1990s decade at 9.39%. The year to year percentage changes indicate a much more uneven pattern, with spurts in export values followed by dips, as happened, e.g, in 1998-99 and more recently in the year 2000-01. It is thus not appropriate to arrive at a conclusion regarding a definite improvement in the export performance of the country during the post reform period, and especially, to attribute those to the market-induced changes in the exchange rate and the trade policy reforms. As for imports, we have already mentioned the sharp increases in import intensity by the mid-1990s, as measured by the import- share in GDP. This was also reflected in the rise in the compound growth rate, both of non-oil as well as aggregate imports during the post-reform period of 1991-92 to 2000-01. Aggregate imports grew at 4.26% over the years 1980-81 to 1990-91 and at 10.23% between 1991-92 to 2000-01. The above had been a direct consequence of import liberalisation in the economy, as mentioned above. However, the absolute changes in imports, which are largely dependent on similar changes in domestic output, had been rather moderate. This has been the direct consequence of the halting pace of output growth in the economy, especially during the recent years. While most of the licensed categories of imports have been shifted to the OGL list in recent years, a monitoring committee was set up to watch the responses for a select group of ‘sensitive items’ which is a mixed bag of essential consumer goods (milk, fruits & vegetables, poultry, food-grains, edible oils), luxuries ( automobiles, alcoholic beverages)and manufactures ( cotton and silk). The annual percentage growth in these products, at less than 3% during 2000-01 and the next year were far from impressive. It is thus rather revealing that these

6 imports also have not shown an up-trend. Imports have thus not picked up as fast as was expected, despite, on the one hand ,the rise in the import-intensity of output on an average. With the generally slackened export growth rate on the other, there has resulted in a narrowing of the trade deficit in recent years. In an economy , which is, both supply and demand constrained, import can play a double role. On the one hand, inflow of the inputs and raw materials can be output- expanding, especially in an import-dependent liberalised economy. At the same time imports as leakages to income stream can have a dampening effect on demand, especially

with demand-constraints in the

economy. The last mentioned possibility limits the pace of output growth when imports are liberalised, with each unit of import subject to an additional import requirements. We provide below a diagram to conceptually depict the argument.

With actual imports of a country subject to the constraints of exchange earnings ( as available from exports and net capital inflows from abroad), a rise in desired imports, as results from import liberalisation can have a contractionary effect on output growth. Since the country has to restrain its actual demand for imports, to a level which is permissible in terms of the available exchange earnings, each such rise in desired imports would proportionately cut back the level of output as is achievable. We point out here that the process is related to the supply constraint in an economy which gets intensified in a liberalised import regime. The above is different from a demand constraint, with lack of demand operating as a bottleneck to capacity utilisation. Arguments as above help to interpret the tendencies in India’s trade performance. While exports did not respond much to the exchange rate depreciation, the contracted external market, both with the sustained use of non-tariff barriers and the on-going recession in the OECD, provided little opportunities of a surge in exports, thus ruling out the expected expansions during the post-reform period. The cost efficiency in production, as expected from the availability of inputs at international prices was thus rather inoperative in terms of export expansion. With imports, the unimpressive growth record, despite the steady pace of liberalisation with the rising import share in GDP, is explained by the economic stagnation in the domestic economy, which has been rather prominent during the last few years. However, import liberalisation has been responsible for the rise in the import propensity, with consequences which may turn out as

7 contractionary in terms of domestic output, with effects which include enhanced

supply

bottlenecks and contractions of domestic demand for import substitutes. We characterise the effect in terms of the supply bottleneck as an import-led GDP compression. Changes in invisible earnings during the post-reform period however, indicate a favourable scenario, both with marked improvements in remittances and the spurts in software exports from India, thanks to the continuing growth in world demand from India which still remains as one of the cheaper sources of these products. As for remittances, with an annual average value at around $30.0bn during 1996-97 to 2001-02, the flow was more than 10-times the investment income liabilities which averaged $2.26bn over the same period. Net value of services as recorded in India’s external accounts recorded a positive sum of $3.35bn on an average, thus considerably reducing the size of the current account deficit during these years. While remittances from nonresident Indians working abroad was in large measure a fall out of the emigration to the oil-rich countries in Middle East, the export performance of the software industry was more related to the IT revolution at a global level and also a consequence of the developments in the industry under economic reforms. It is interesting to observe that exports of services, which so far are less bound by the WTO have been doing relatively better as compared to the duty bound exports of goods! Looking at the performance of the capital account in the post-reform period, expectations of a major boom in FDI inflows have been belied. A moderate to high growth is observed instead in portfolio capital inflows, of which Foreign Institutional Investments (FIIs) remain the major component with their marked volatility which is rather normal. Short-term capital inflows , however, have tapered off in recent years, as can be seen from the $5.04bn stock of short-term debt at end of 1997-98, which in turn fell to $1.07bn at end of 2001-02. Commercial borrowings , both on a long-term and a short-term basis, increased at a slower pace as compared to other forms of private capital inflows, especially the FDIs and portfolio varieties. One thus does not get a clear picture as to whether India has been able to tap the private sources of capital more successfully during the post-reform period. While annual liabilities on the declining stock of external debt are naturally not growing as fast as before, other investment income outflows, as are related to the non-debt creating liabilities abroad, have continued to swell. These have reduced the net inflow of capital to the economy, thus dampening the prospects of augmenting investments by supplementing the domestic sources of savings. Observing the sharp declines in the net flow of capital to the country in recent years one arrives at the conclusion that

8 opening up the economy has not helped in terms of the availability of a larger inflow of investible surpluses to the country. There has been a similar pattern in a large number of other developing countries, as is reflected in the negative financial flow to this area (measured by the magnitude of net capital flows less investment income payments) in recent years. We now turn to reforms and their impact in the realm of monetary and fiscal policy during the post liberalisation period. As it can be expected, these changes also explain the trade performance, especially in terms of imports. The agenda of economic reforms included, from the very beginning, the goal of a reduced fiscal deficit, as defined by the difference between aggregate expenditure and capital receipts other than borrowing. Discarding the pre-reform practice of financing the budget through deficit finance (which amounted to borrowings from the Central bank against Treasury Bills monetised automatically by printing notes), the new practice was to bridge the uncovered fiscal deficit by marketised borrowings. The growing internal debt proved a source of liabilities with interest payments as a fixed charge in the fiscal balance. As a consequence the pressures to reduce the fiscal deficit reduced , more than proportionately, the primary deficit which was the fiscal deficit less interest liabilities. There has taken place, in the post-reform period, some

reductions in the fiscal deficit, and much faster cuts in the primary

deficit.(Comparing 1990-91 when fiscal deficit and the primary deficit stood respectively at 6.8% and 2.8% of GDP, in 2000-01 the respective ratios are found at 5.9% and 1.4%). Primary deficit, which was responsible for financing defence expenditure, subsidies (including expenditure on social heads) and capital expenditure, thus suffered as a consequence. It can be expected that the last two of the above mentioned items had less priority in terms of allocation of expenditure which is determined by political exigencies. The major consequence of the cuts in the primary deficit include the dismantling of the activities of the state which so long had been supporting, to some extent, the marginalized income groups. Examples include the cuts in official expenditure on health, primary education, transport, water, power, public distribution of food, housing etc all of which affect the economic status of the poor. Facilities offered by private agencies, which have taken over often, prove too expensive to these sections, which per force accept a cut in their already depressed real income. Cuts in the fiscal deficit also downsize, as mentioned above, capital expenditure on part of the state. The above can be witnessed in the declining share of public capital expenditure in GDP, which fell from 1.4%in 1990-91 to (-)0.4% in 2000-01. Compensatory increases in investments

9 from private sources, domestic or foreign, are yet to materialise , especially in the area of infrastructure. It can be observed that despite the generous incentives offered, FDI has shown little interest in entering the much-needed infrastrucure projects, excluding, of course the power sector, which has a different context. On the whole, the much advocated reductions in the fiscal deficit, while proving difficult to achieve on political grounds, has been successful to squeeze the primary deficit, with untoward consequences in terms of the social sector and the potentials of capital formation and employment. While fiscal policy of a country under globalisation is subject to the political and economic pressures from the powerful global lobbies, both formally (as with conditional loans from the IMF) or informally, monetary policy in an open economy can never be free from external constraints. These include the pressing need to keep a tab on the movements in the exchange rate, especially with convertibility of the domestic currency. It also includes the management of the money as well as the capital market, keeping in view the much needed balance between the internal and external targets. Thus fixing the interest rate needs to fulfil, to the extent possible, the dual target of encouraging domestic activity and attracting foreign capital inflows. It is not difficult to observe that the two goals may pull the interest rate in opposite directions. There has been, in India, monetary targeting during the initial years of economic reforms. This has been to curb inflation by controlling money supply and also by raising the rate of interest. Simultaneously, cash reserve ratio maintained by commercial banks with the Reserve Bank of India has been adjusted upwards during these years, along with sale of government bonds in the market, largely to mop up excess liquidity in the market. The regime of tight money, along with the constrained fiscal budget were instrumental in curbing demand in the economy, which was partly responsible for initiating the recession since the last few years of the 1990s. The fiscal norms to use market borrowings in place of deficit finance made monetary policy responsive to the moods of the market, and to pitch the interest rate at a level, which can make the fixed rate bonds attractive. As we have mentioned above, the rising interest cost made fiscal management harder and at the cost of the primary deficit. Of late the RBI has been following a soft money policy, with interest rates bottoming out to a low of 6% which is one of the lowest. Cash reserve ratio maintained by commercial banks with the RBI has also been cut, apparently to instil liquidity in the credit market and to help out the ailing the banking industry. These moves can be interpreted by the following: First, the need to

10 induce activities in the otherwise slackening economy which in terms of the budgetary norms can not be helped via the fiscal route. The cut in the interest rate also aimed to revamp the ailing capital market, by pushing up stock prices .Second, with foreign exchange reserves at around $70bn which can finance more than a year’s imports, the need to attract foreign funds by raising interest rates is considered as temporarily absent. Additions to the official exchange reserves, from around $1bn in 1990-91 to nearly $70bn today, is considered to be one of the biggest achievements of economic reform in the country. The rise has been made possible by factors, which include (a) the improved trade and current account balances, (thanks to the slump in import demand due to the on-going recession),with the current account even recording a surplus of $1.6bn in the last financial year of 2002-3. (b) Second, the inflows of portfolio capital, in particular the FIIs, have been rising , while subject to the fluctuations as are typical with these flows. (c) Sale of official bonds to non-resident Indians at rate of returns, which were rather high as compared to the market rate. The large reserves have provided a cushion to the exchange rate in the market, the effectiveness of which, however, can only be judged by future exigencies. One can only make the point that for country with a rather vulnerable capital account and with a trade balance narrowed down by GDP compression rather than export expansions, it may be an imprudent decision to try full capital account convertibility of the rupee. Incidentally, rupee convertibility in the current account has been introduced since 1993, thus permitting foreign exchange through market channels to meet all current account liabilities including payments of investment income. In the capital account the earlier restraints, in the form of controls or monitoring of FDI or other capital flows have also been discontinued at stages. It only remains for the resident Indians to go through official channels to move capital from the country. Experiences of countries struggling with capital flights by residents indicate the potential dangers underlying a relaxation of these controls. Monetary policy in India has also been conditioned by the need to manage the floating exchange rate of the rupee. It has been a conscious effort of the Reserve Bank to prevent appreciation of the exchange rate, which with low inflation rate as at present, pushes up the Real Effective Exchange rate (REER) , which is considered to be a major determinant of export competitiveness. This has led the RBI to purchase the inflows of exchange , which adds to exchange reserves. To avoid an expansionary impact on domestic money supply as is expected from the rise in reserves and the High-powered money (in terms of the money multiplier), the

11 government has been resorting to open market sale of bonds, which also conforms to the currently accepted norms of fiscal management . There have also been times when the rupee had been subject to market pressures in the downward direction. Excluding the special situations when the RBI stopped further downtrend in the rupee by selling foreign exchange from its reserves, there has usually been a tendency to ‘lean with the wind’ by permitting limited depreciations in both the nominal and the real exchange rate of the rupee. The above is reflected in the steady downtrend of the nominal value of the rupee in terms of dollar since it started floating in 1973. Changes in monetary policy as was impacted by economic reforms also include wideranging liberalisation in the financial sector. These included an end to the regime of directed and subsidised credit. The change did adversely affect not only the major beneficiaries in agriculture and the export sector but also small and unorganised industrial units which had little access the organised credit market. It has been observed that the ‘exclusion’ of these creditors from the market for loans has been responsible for further reductions in output and employment with second round contractions as can be expected. The change also affects the social fabric with increased inequality and poverty. The above brings us to a close with some comments on the employment growth and the level of poverty and well being of the poor in the country. As for employment, aggregate statistics on the annual percentage change in unemployment ( as registered through employment exchanges) indicate a 4.74% increase over 1993-94 to 1999-2000, which is a sharp rise over the negative change in unemployment at (-)0.08% on an average during 1983-93. The rise has been even steeper in the rural areas. Considering the inadequacy of official statistics on the registered record of unemployment, it will not be surprising if the actual figures turn out to be much more . As for poverty, while one agrees with the fact that poverty cannot be quantitatively measured, statistics offered from official and unofficial sources reveal the large mass of population under what is described as the poverty line. Official statistics , which has been contested, claims a so-called reduction in the percentage of people below the poverty line, from 54.9%in 1973-74 to 36.0% in 1999-00. With the rank of the country in terms of Human Development Index at 124 in the year 2000 and more than a third of population at abject poverty, it does not require much introspection to accept that much needs to be done, not only for growth but also for development and social justice. Policies implemented under economic reforms have clearly failed to achieve such goals.

12 References: Economic Survey, Government of India. Various issues __________________________