India’s economic reforms

Before its independence in 1947, there was hardly any discernible economic growth in India. Per capita income was stagnant perhaps declining over that whole long period. After independence, annual per capita growth was in the range of 1 to 1. 5% for about 30 years or so until around 1980. After 1980 it increased to about 3-4%. The full blown economic crisis at the end of the 1980s (the balance of payments came under severe pressure; a realistic threat of sovereign default loomed over us; fiscal deficits had increased significantly) made the Indian leaders to think in terms of strategy for future economic policy.

Consequently, a whole reform process got unleashed in 1991. Wide range of macro reforms were undertaken along with corresponding microeconomic and sectoral reforms. The macro reforms can be divided into (a) fiscal policy, (b) monetary policy, (c) trade policy, and (d) exchange rate management. Without any claim of exhaustiveness, the exposition aims at setting the context. To reduce the complexity of tax laws and to tax evasion, both personal income tax and corporate tax rates have been gradually brought down to 30% along with considerable simplification.

The rates in case of customs duties have been brought down from an average of 110 per cent in 1991 (with highs over 400 percent) to a non agricultural peak of 12. 5 per cent in 2006. Before 1980, monetary policy as we know it now had become almost non-existent. It had different interest rates for different purposes; automatic monetization of fiscal deficits; and financial repression through pre-emption of banks’ resources.

As part of the reforms independence of monetary policy and central bank has been restored. As part of the external sector reforms, the government let market to determine the exchange rate though it still manages to some extent. The trade regime has undergone massive change with the removal of quantitative restrictions along with rationalization of the tariff structure. Massive deregulation of the industrial sector, in fact, constituted the first major package of reforms in July 1991.

The obsolete system of capacity licensing of industries was discontinued; the existing legislative restrictions on the expansion of large companies were removed; phased manufacturing programs were terminated; and the reservation of many basic industries for investment only by the public sector was removed. At the same time restrictions that existed on the import of foreign technology were withdrawn, and a new regime welcoming foreign direct investment, hitherto discouraged with limits on foreign ownership, was introduced.

Several industrial sectors were deregulated and several public sector companies were disinvested. Financial sector reforms allowed the FDI into banking and insurance triggering explosive growth in those sectors. The only sector that was not affected much by these reforms is the agricultural industry. India and China: Comparative Analysis All projections under the realistic scenario made by the World Bank (and several other national and International organizations) reveal that India is all set to emerge as the third largest economy in the world in PPP terms by 2020 next only to the USA and China (see Exhibit 2).

As two of the leading most Asian economic powers, China and India will be major driving forces for stimulating world economic growth in the next twenty-five years and beyond. While India’s performance has been substantial, China’s has been truly dramatic. China and India have taken different development paths, but each moved ahead with a strategy that made sense given its economic fundamentals. China probably wouldn’t have grown as fast had it sought to become a services powerhouse. It would have stumbled on language and cultural barriers.

Similarly, emphasizing goods probably wouldn’t have worked well in India, especially if it meant competing with China for export markets. Economies advance as they shift from low-productivity agriculture to higher-valued productive resources in industry and services. China and India are building viable alternatives to farming in low-end goods and services production (see Exhibit 3). But both maintain agriculture sectors that are larger than other countries with similar per capita incomes, a sign they still have far to go.