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April 27, 2002 | 1645 IST
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Ten years of Indian reforms: The unfinished agenda

Nirupam Bajpai

Nirupam BajpaiIt has been a decade since India launched a programme of economic policy reforms. The programme consisting of stabilisation-cum-structural adjustment measures was put in place with a view to attaining macroeconomic stability and higher rates of economic growth.

Some rethinking on economic policy had begun in the early 1980s, by when the limitations of the earlier strategy based upon import substitution, public sector dominance and extensive government control over private sector activity had become evident, but the policy response was limited only to liberalising particular aspects of the control system.

By contrast, the reforms in the 1990s in the industrial, trade, and financial sectors, among others, were much wider and deeper.

As a consequence, they have contributed more meaningfully in attaining higher rates of growth. India has gone through the first decade of her reform process.

Hence, an assessment of what remains on the reform agenda is in order.

Reforms have gone on despite change in governmentsFour different governments were in office during the 1990s - the Congress government which initiated the reforms in 1991, the United Front coalition (1996-98) which continued the process, the BJP-led coalition which took office in March 1998 and then again the BJP-led National Democratic Alliance in October 1999 till date.

In short, it seems that India's political system is more than ever in consensus over the basic direction of reforms.

Undoubtedly, fiscal consolidation is the first order of business.

Considering the excessive pre-emption of the community's savings by the government, the potential for crowding out the requirements of the enterprise sector, the pressure on interest rates, and rising interest payments on government debt, it is essential to reduce the fiscal deficit substantially, and more aggressively, mainly by lowering the revenue deficit.

In the absence of significant fiscal adjustment, neither will the government be able to maintain low inflation, nor will India achieve a path of sustainable high growth. India's overall government spending (Centre and states), currently around 33 per cent of the gross domestic product, needs to be brought down substantially as a proportion of national product in order for India to achieve its reform goals of macroeconomic stability and long-term rapid growth.

Large and persistent fiscal deficits in India are a serious cause for concern. There are several risks with high fiscal deficits.

First, budget deficits could once again spill over into macroeconomic instability.

Second, the budget deficits imperil national saving rates, thereby reducing overall aggregate investment, and jeopardising the sustainability of high growth. The effects of low investment rates on overall GDP growth are not hard to see.

Most directly, low levels of public investment have rendered India's physical infrastructure incompatible with large increases in national product. Without an increase in the scale and rate of growth of infrastructure investment, growth rates in India are bound to remain moderate at best.

Third, the continuing large budget deficits, even if they do not spill over into macroeconomic instability in the short run, will require higher taxes in the long term, to cover the heavy burden of internal debt. High tax rates will place India at a significant disadvantage relative to other fast-growing countries.

Expenditure reform in India is critical in view of the fact that India's government dissavings and overall level of government spending remains very high.

There is probably little room to cut capital expenditures as they have already been squeezed significantly.

Of course, in the future, it should be the private sector rather than the government to meet most of the enormous infrastructure needs of a growing economy. Still it is hard to imagine that rapid growth can be accomplished with public investment spending by government of less than the current rate relative to GDP.

Inadequate public investment in the post-reform period had an adverse impact on the economy. It led to serious under-investment in critical infrastructure sectors such as power generation, roads, railways and ports. For example, the addition to power generation capacity in the public sector during the Eight Plan was only a little over half the target.

India needs to boost infrastructure spending There were similar shortfalls in capacity creation in roads and ports. These shortfalls would not have mattered if capacity in the private sector had expanded, but this did not happen either.

The end result was that total investment in infrastructure development was less than it should have been, leading to large infrastructure gaps.

The economy was able to achieve higher economic growth in the post-reform years despite inadequate investment in infrastructure because there was some slack in the system, but there can be no doubt that rapid growth will be difficult to sustain in future unless investment in infrastructure can be greatly expanded.

In order to analyse India's global competitiveness, we look at the results of the Global Competitiveness Report 2001-02.

The GCR carried a survey of business leaders in 75 countries of the world, to explore the comparative business environments of the major economies.

The report focuses on two distinct, but complementary, approaches.

The first one is a growth competitiveness index, which focuses on global competitiveness as "the set of institutions and economic policies supportive of high rates of economic growth in the medium term."

The second one is a current competitiveness index, which focuses on microeconomic indicators to measure the "set of institutions, market structures and economic policies supportive of high current levels of prosperity," referring mainly to an economy's effective utilisation of its current stock of resources.

The survey results are combined with other quantitative data (e.g. objective measures of infrastructure, saving rates, financial market depth, educational attainment, etc.) to produce an overall assessment of international competitiveness, which the study defines as the ability to achieve rapid growth over the medium term.

In the 2001 GCR, India ranks a relatively disappointing 57th out of 75 countries in growth competitiveness, slipping below from the rank of 48th in the 2000 report.

On current competitiveness, India ranks 36th in 2001, little change from the rank of 37th in the 2000 report.

Notable competitive advantages for India include large availability of scientists and engineers, strong potential for 'catch-up' growth, easy access to credit, low exchange rate premium, strong IT training and education, local availability of information technology services, government success in promotion of information and communication technologies, and quality of management schools, among others.

There are, however, many more competitive disadvantages. Notable among these are: lack of access to foreign capital markets, high average tariff rate, stringent hiring and firing practices, high government deficit, extensive distortive government subsidies, permits and time taken to start a firm, large-scale irregular payments in tax collection and government procurement, etc.

The areas of weakness point implicitly to the most urgent points of the reform agenda.

  • First, despite the importance of the stock exchange, India's financial markets are deficient. The overall sophistication of the financial system is low. Venture capital, which is key to the start-up of new industries, is particularly weak.
  • Second, administrative regulations have strongly constrained business activities (the License Raj continues); state subsidies have inappropriately been protecting old industries; the civil service is unduly politicised; and tax evasion is rampant.
  • Third, and perhaps most striking, is the quality of infrastructure, which is abysmal. This is true in all areas: roads, ports, power, and telecom. For instance, India ranked 69th out of the 75 countries ranked on telephone lines per 100 inhabitants; 73rd on road quality outside of major cities; 57th on port facilities and inland waterways; and 47th on the quality of air transport infrastructure.
  • Fourth, the research and development nexus is very weak, with little collaboration between business and academia, and little success in commercialising or adopting new technologies. This poor outcome is ironic in view of the praise for India's science and engineering prowess.
  • Fifth, labour markets are ineffective, perhaps the most ineffective in the world. Put briefly, India shows the advantages of a vast labour force with a skilled engineering and scientific community.

It also shows, however, deficiency in both the hard infrastructure, such as roads, ports, and power, as well as the soft infrastructure of public administration, labour market practices, and financial market depth.

With the opening up of the Indian economy, the country's information technology industry has been the biggest beneficiary.

Between 1995 and 2000, the Indian IT Industry recorded a compound annual growth rate of more than 42.4 per cent.

Software continues to contribute a major portion of the Indian IT industry's revenues. India's exports of computer software beat global recession in 2001-2002 (April-March) to grow by a healthy 31.4 per cent.

In absolute terms, software and services exports went up to $7.8 billion in 2001-02 as against $5.9 billion in 2000-01. This represents 13.3 per cent of India's manufacturing exports.

Software forms a major portion of India's exportsThe steady growth in exports of software is the combined effect of software giants setting up bases in India to meet their global software requirements in the aftermath of September 11, gradual market penetration that India is making in the non-traditional markets like the EU, Australia, Japan and China, and the increased receivables from IT enabled services like back office operations.

India's exports of electronics hardware grew by 13.6 per cent in 2001-02 to $1.183 million from $1.041 million in 2000-01. The IT manufacturing industry has over 150 major hardware players supported by over 800 ancillary units and small time vendors engaged in sub-assemblies and equipment manufacturing.

The combined export of software and services, and electronics hardware registered a growth of 28.7 per cent in 2001-02.

In absolute terms, India's overall IT exports grew to $9.04 billion in 2001-02 from $7.0 billion in 2000-01. In 1999-00, more than 185 of the Fortune 500 companies outsourced their software requirements to Indian software houses.

India's software industry shows the clustering of the software companies in three distinct areas: the southern states specifically Tamil Nadu (Chennai, Madurai, Coimbatore and Trichy), Karnataka (essentially confined to Bangalore), and Andhra Pradesh (essentially confined to Hyderabad), in the west, Maharshtra (Mumbai and Pune), and in the north, Delhi, Noida and Gurgaon.

Software companies located in these regions account for almost the entire software and services exports of the country, highest number of firms and employment in the sector.

The government could do more for this industry, not through direct subsidies necessarily, but actually through liberalisation of telecom, allowing for lower priced telecommunication services, by allowing new entry of major international players in telecom.

These companies could lay down a tremendous fibre optic network in India and increase the bandwidth available for Indian business and put India even closer to the international scene.

The government should allocate larger resources to support basic science and R&D in this sector to some extent because India has world-class engineers and scientists that have already brought India up in an important way in this sector and could keep India in the very forefront of this new technology.

It is necessary to move swiftly to complete many of the reforms, which are now underway, such as reduction in protection levels, reforms in banking, sector, product de-reservation for the small-scale industry, decontrol of prices, such as petroleum, reform of the power sector and so on.

Among other things, sustaining higher rates of economic growth would require a more vigorous pursuit of economic reforms at both the federal and state levels.

Part-II: 'India needs to open up economy further for sustained growth'

Nirupam Bajpai is a Development Advisor at the Center for International Development, Kennedy School of Government at Harvard University and the Director of the Harvard India Programme.

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