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25 YEARS OF ECONOMIC LIBERALISATION

For this, it is useful to distinguish between


The 1991 Reforms the period up to 1980 and the period
between 1980 and 1990.
How Home-grown Were They?
1.1 Up to 1980
The period up to 1980 was one of uncrit-
Montek S Ahluwalia ical acceptance of the strategy for indus-
trialisation, fashioned in the 1950s and

T
Refuting the allegation that he 25th anniversary of the 1991 early 1960s, in which the state played a
the 1991 reforms were thrust reforms is an important occasion very active role with the public sector as
for reflection. There were reforms a major investor. The strategy was con-
upon an unwilling government
before 1991, but they were at best incre- ceptualised by P C Mahalanobis and drew
by the International Monetary mental, adding flexibility to the system heavily from the Soviet closed-economy
Fund and the World Bank in without changing the system itself. It thinking. Faster growth needed higher in-
return for financial assistance, was in 1991 that an effort was made for vestment, which in turn required capital
the first time to change the system of goods. In a closed economy this was only
it is argued instead that 1991
economic management, which was possible if there was sufficient domestic
was the logical culmination of dev ised in the 1950s and early 1960s, production of capital goods. This led to the
internal rethinking that took and had become quite unsuitable for policy conclusion that investment should
place well before the 1990 crisis. the times. not only be increased, but most of it
The story of how the reforms were should be directed towards the capital
The reforms would have stopped
conceived and implemented, whether goods sector rather than consumer goods,
within two years had they been they were well designed and appropri- as that would facilitate a rapid increase
only undertaken because of the ately paced and sequenced, how the in the rate of investment over time.
need for the IMF’s assistance. resistance to change was dealt with, This was the rationale for pushing the
and, most importantly, what went right public sector into these capital-intensive
Though admittedly slowly, their
and what did not, deserves to be ex- areas and also for controlling private
continuation has been evident plored in full detail. I am currently investment through industrial licensing
over successive governments. working on a book that hopes to do pre- to ensure that resources were not diverted
cisely that. This article deals with only for non-priority use. Critics at the time
one aspect of the story, and that is (for example, Hannan Ezekiel) did point
whether the reforms were home-grown out the alternative, that capital goods
or pushed by the International Monetary could have been imported and paid for
Fund (IMF) onto a helpless government by exports, which would have meant
as the price for financial assistance. directing investment towards export
The widely believed allegation that industries. This was ruled out by treating
the reforms were pushed by the IMF was the economy as a virtually closed eco-
a constant refrain when the reforms nomy, which in turn was justified on the
were unveiled. This completely ignores grounds of export pessimism that was
the fact that there was a home-grown popular at the time.1
process of rethinking on economic poli- Comprehensive import licensing was
cy that had been underway and pointed introduced in 1956–57 to deal with bal-
towards many changes. These changes ance-of-payments problems, but it be-
certainly formed part of the conditional- came a permanent feature of the system
ity of the IMF’s assistance, because the with damaging consequences. Control
IMF is expected to lend only in situations over imports was seen as necessary to
where the government has a credible ad- manage the balance of payments, and also
justment programme. The IMF obviously to allocate scarce imports to so-called
approved the reforms in that sense, but priority uses. This gave the bureaucracy
that is not the same thing as saying it enormous discretionary power, since
dictated the contents. imports were allowed only after clearance
from the “indigenous angle,” that is, there
1 Thinking on Economic Policy was no domestic substitute available,
Montek S Ahluwalia (monteksingh.ahluwalia@ The domestic pedigree of the 1991 reforms and also “essentiality,” that is, the
gmail.com) is former deputy chairman of the is best assessed by looking at the evolution imported item was “really needed.” Both
Planning Commission.
of thinking in the pre-reforms period. decisions were taken by officials, and,
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25 YEARS OF ECONOMIC LIBERALISATION

not surprisingly, domestic producers However, most of his heavyweight committee made a number of recommen-
typically lobbied hard to deny imports. political colleagues had very different dations to liberalise imports for exporters,
The economy performed reasonably views, including firebrand socialist George but it also took a broader view that
well under this strategy in the 1950s, when Fernandes, who famously ejected IBM and imports should not be viewed only as a
the growth rate averaged 3.6%, and even Coca Cola from India because they would negative item in the balance of payments
in the first half of the 1960s, when it not agree to dilute their equity to 40%. to be always controlled. Imports also had
averaged 4.9%. Growth was below the 5% There was also Gandhian–Lohiaite socia- a developmental role and import licens-
target, but was certainly much better than list Raj Narain, who favoured traditional ing needed to be progressively liberalised
in the pre-independence period. However, labour-intensive Indian industries, and to allow imports to play that role. In 1976,
performance deteriorated sharply there- there was Chaudhary Charan Singh whose a new window of imports under Open
after and the growth rate from the mid- main concern was agriculture. General Licensing (OGL) was created,
1960s through the 1970s averaged only The Janata government announced a whereby 79 capital goods items not pro-
3% per year, at a time when the population premature end to the Fourth Five Year duced in India could be freely imported.
was expanding by about 2.2%. This was a Plan and a switch to annual plans, but The Alexander committee recommended
period when Southeast Asian countries no serious steps were taken to restruc- that the scope of imports through the
grew much more rapidly, driven by strong ture economic policy. They did set up the OGL window be widened. It also recom-
export performance tapping expanding Committee on Controls and Subsidies mended that, over time, import licensing
markets in industrialised countries. under Vadilal Dagli, the then editor of be replaced by tariffs and the level of
India’s industrial sector, dominated the well-known business weekly Com- duties also reduced.
by heavy industry, was ill suited to ex- merce. Its report was submitted in 1979, The Janata experiment ended in 1980
ploit export prospects in simple consum- which was too late for any action since when the general election was convinc-
er goods. The private sector could have Desai had resigned in July 1979 to be ingly won by Indira Gandhi, who once
exploited these possibilities, but restric- replaced by Chaudhary Charan Singh, again became Prime Minister in 1980.
tions placed on private sector investment who resigned six months later in Janu-
getting into “non-priority areas,” includ- ary 1980. 1.2 After 1980
ing the reservation of many of the items Bibek Debroy (2004) has called the The new government initiated some im-
for the small-scale industry, made this Dagli Committee a forerunner of the portant changes. One change was quali-
difficult. In any case, pervasive domestic 1991 reforms. But, in my view, it is a pro- tative; controls under industrial licensing
protection raised the cost of production foundly disappointing document. This is and the Monopolies and Restrictive Trade
in India, making Indian producers hope- because it fully recognised the dysfunc- Practices Act, 1969 (MRTP) remained in
lessly uncompetitive. tionality of the control system, but failed place, but they were administered more
These weaknesses were clearly brought to make specific recommendations for flexibly. The earlier bias against the
out by Jagdish Bhagwati and Padma change. The committee noted that the private sector was greatly moderated, and
Desai (1970), but this did not lead to any control system had become dysfunctional. it was recognised that Indian industry
reconsideration of policy. In fact, policy Controls had proliferated, vesting consi- needed to modernise and upgrade tech-
in the mid-1970s seemed to accept lower derable discretionary powers on the con- nology. Industrial licences were granted
growth as unavoidable, and called for trol authorities and generating corrup- for capacities that were closer to economic
greater emphasis on programmes aimed tion and delays.2 However, when it came scale. The year 1982 was declared the
at directly benefiting the poor. The Fifth to recommendations, it pronounced that year of productivity and some steps were
Five Year Plan for the period 1974–75 to each set of controls—industrial licensing taken to introduce flexibility. Automatic
1978–79 stipulated a lower growth target control, MRTP control,3 import control, expansion of licensed capacity was allo-
of 4.4% and emphasised self-reliance to price control, capital issues control, etc— wed up to 25% over a five-year period. The
deal with balance-of-payments problems. were all justifiable, but they needed to be concept of “broad banding” was intro-
A natural opportunity to restructure reviewed by the ministries concerned to be duced, which allowed automobile produc-
policies arose when Indira Gandhi sure they were indeed serving the purpose ers of four-wheeled vehicles to switch
ended the Emergency in 1977, and called intended, were exercised with transpar- from producing cars to producing any
a general election. She was roundly ency, and that multiple points of control other four-wheeled vehicle.
defeated and a Janata Party govern- were avoided, etc. Leaving these issues to The Abid Hussain Committee on Trade
ment, under Prime Minister Morarji be decided by the ministries administer- Policies submitted its report in 1984. As
Desai, took office in 1977. Morarji Desai ing the controls was a guarantee that only expected, the committee recommended
was generally regarded as pro-business marginal improvements would emerge. more liberal procedures for exporters to
and it might have been thought that he A more useful initiative of the Janata access imports, along with a three-year
could have tilted policies to make them a government was the establishment of the validity of the policy for giving assurance
little more market friendly, with a greater Committee on Import–Export Policies and of certainty. It also recognised the impor-
role for the private sector, operating in a Procedures under P C Alexander, then tance of exchange rate policy in promoting
competitive environment. the commerce secretary. The Alexander exports and recommended that the real
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25 YEARS OF ECONOMIC LIBERALISATION

effective exchange rate (REER) should It suggested specific changes including, in the preceding period. There are
not be allowed to appreciate and should (i) delicensing of industries on the basis different views on how much of the
be maintained at an appropriate level. It of certain criteria, although subject to acceleration can be attributed to actual
repeated the earlier recommendations existing controls on foreign direct in- liberalisation, and how much to the
of the Alexander committee for progres- vestment (FDI) and MRTP; (ii) shifting more pro-business attitude of the gov-
sively replacing import licences with tar- controls on import of capital goods from ernment in operating the control sys-
iffs and phasing down the level of pro- quantitative controls via licensing to tar- tem. J Bradford DeLong (2001) has
tection. However, it cautioned that this iffs, along with an outline plan on how argued that the latter was the dominant
could only be a long-term aim, and given to do it; (iii) raising the limit for MRTP factor, but a good case can be made that
the pressures on the balance of payments, controls from `20 crore in terms of total the reforms, incremental though they
import licensing could not be abandoned investment to `75 crore; and (iv) estab- were, did make a difference (see, for
in the near future. lishing a quasi-statutory securities and example, Panagariya 2004)
By the mid-1980s it was clear that exchange board to oversee the function-
deeper policy changes would be needed. ing of the stock exchanges (although 2 1990: The M Document
Isher Judge Ahluwalia (1985) examined regulatory control was to be retained in The next step documenting the internal
the many different arguments advanced the finance ministry). rethinking on policy was a paper I wrote
to explain the slow growth of Indian Unfortunately, the Narasimham com- in June 1990. I apologise to readers if
industry, including the slowdown in mittee made no recommendations regard- this seems like unseemly self projection,
agricultural growth, or in import substi- ing the extensive import control on items but it is relevant to the issue of how
tution, or public investment. She found other than capital goods. much of the thinking behind the reforms
that although lower investment in infra- Several steps were taken to liberalise was home-grown.
structure did matter, the slowdown in the economy in the second half of the I had served as the special secretary to
industrial growth could not be explained 1980s under the prime ministership of Prime Minister Rajiv Gandhi, and I
by these factors. The main explanatory Rajiv Gandhi. A number of industries remained in that position when V P Singh
factor was a slowdown in total factor were freed from industrial licensing, as took over from him. In the course of a con-
productivity growth. This suggested that recommended by the Narasimham com- versation in May 1990, in which V P Singh
the policy framework, including especially mittee, and, by 1990, 30 industries had commented on the performance of
controls on investment and open-ended been delicensed. The MRTP limit was Southeast Asian countries, he asked me
protection, needed to be reviewed. raised from `20 crore to `100 crore. Cap- why these countries had done so much
The first official recognition of the need ital goods imports were liberalised, along better than India. I responded that it is
to rethink the system of controls can be with an increase in duty, as recommended because they had been much bolder in
traced to the appointment in 1984 of the by the Narasimham committee. The OGL undertaking structural reforms. He
Committee to Examine the Principles of window, which had begun with 79 capital asked me to prepare a paper on what
a Possible Shift from Physical to Financial goods items in 1976, had widened to cover we should do. I prepared a note on
Controls under the chairmanship of 1,170 capital goods items and 949 items “Restructuring India’s Industrial and
M Narasimham (GoI 1985). The committee of raw materials and other intermedi- Trade Policies.” The note put together
acknowledged that the system of controls ates by 1988 (Pursell 1992; Panagariya ideas we had planned to submit to Rajiv
had produced a diversified industrial 2004). Though, it is worth noting that Gandhi if he was re-elected. V P Singh
sector, but it was a high-cost structure these were mainly items not produced in instructed that it should be discussed in
with insufficient attention to quality. India. Items produced in India remained the Committee of Secretaries chaired
This was due to the way the strategy of subject to licensing, although the system by the cabinet secretary. The note was
import substitution was implemented, was administered more liberally, with discussed in two meetings of the Com-
with internal competition discouraged greater recognition that imports were mittee of Secretaries.
by controls on investment and production. often justifiable to ensure the quality of The press soon got hold of a copy and
As a result, domestic production. it was printed in the Financial Express.
the rate of industrial growth has been adversely
The Securities and Exchange Board of Although the authorship of the paper
affected and employment opportunities in India (SEBI) was established as a non-stat- was never acknowledged, it was widely
the industrial sector have not expanded suf- utory body to begin with, to work on the known that it was authored by me, and it
ficiently. India could not also take advantage outlines of a regulatory system for the came to be referred to in the press as the
of the tremendous expansion which took stock exchanges and capital issues, but M Document. The specific proposals in
place in world trade which took place in the with the intention of transferring these the M Document were never approved
Sixties (GoI 1985: 2).
functions out of the finance ministry as government policy. But the fact that it
Unlike the Dagli committee, the Nara- and in due course. was sent by the Prime Minister to the
simham committee stated unambiguously India’s economic performance improved Committee of Secretaries for discussion
that the moves towards liberalisation in in the 1980s with GDP growth averaging establishes that the proposals were
recent years needed to be carried further. 5.6% over the decade, much higher than being considered internally, well before
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25 YEARS OF ECONOMIC LIBERALISATION

any IMF arrangement was contemplated, a strong public sector, but some changes increased; and (iv) the import limits
and indeed even before the crisis were needed to achieve it. To this end, it should also be progressively relaxed.
exploded. The specific points made in made some recommendations: (i) The
the M Document are summarised below. policy of reserving certain areas for the 2.5 MRTP Act
(Readers can access a copy of the M docu- public sector needs to be changed. Res- The M Document argued against sub-
ment at www.epw.in/system/files/The% ervation could continue in areas where jecting proposals from MRTP houses to
20M%20Document%201990%20%281% security is involved, but in other areas separate scrutiny, in order to prevent
29.pdf.) the private sector should be allowed to monopoly or avoid concentration of eco-
compete; (ii) The system of price and nomic power. Prevention of monopoly
2.1 Broad Approach purchase preferences, whereby public was better achieved by increasing com-
The M Document argued that the process of sector units gave preference to other petition by delicensing investment in the
liberalisation that had been underway public sector units in purchases, should area and also by freeing imports. It also
needed to be taken further. Most develop- be given up; (iii) Public sector units that pointed out that preventing the emer-
ing countries had already gone further are demonstrably unviable have to be gence of large Indian companies would
than we had, and even the Eastern Euro- closed down and while it may not be hurt our ability to compete internation-
pean countries were replacing state and practical to close down all of them, we ally, since world markets were dominated
bureaucratic controls with market econo- should make a start with closing down by large companies. It did not suggest an
my mechanisms. India’s competitive ability some; (iv) It also recommended partial abolition of the MRTP Act, but it suggested
would suffer if our industry continued to privatisation to bring in new capital and that (i) the asset limit for MRTP, which
operate in a restricted environment. inject a new management culture (ITDC was fixed in 1985 at `100 crore, should
It also pointed out a weakness in our and Air India were specifically mentioned be raised to “say Rs 300 or Rs 500 crores;”
approach, arising from the fact that our in this context); and (v) Legal changes and (ii) various other flexibilities should
liberalisation initiatives consisted of ad should be made which ensure that the be introduced for companies covered.
hoc steps in a particular direction. They public sector is not equated with the
were not conceived as part of an explicitly state under Article 12 of the Constitution, 2.6 Reducing Protection
stated medium-term strategy, in which an interpretation that greatly limits com- The proposals in this area were in some
the end point is clearly identified, and mercial flexibility. ways the most important proposals in the
the specific policy initiatives needed to document. It repeated the standard
get where we want are then identified 2.4 Industrial Licensing arguments against high levels of protec-
and appropriately sequenced and coor- The note said the economy had become tion, namely, making the protected
dinated across ministries to ensure imple- too complex to continue with the system domestic market much more attractive
mentation of the whole package. It then of licensing control as it had operated in than the highly competitive export market
went on to identify a reform programme in the past. The specific recommendations and raising the domestic cost structure,
five interrelated areas discussed briefly on industrial licensing were conditioned making our products uncompetitive.
below. The note explicitly excluded two by the fact that the government had only While this was offset to some extent
important sectors—agriculture and in- a few days earlier announced a new (and through export incentive schemes, such
frastructure—which needed to be con- somewhat limited) liberalisation of policy, as tax rebates, subsidies, and access to
sidered separately. whereby projects below `25 crore (`75 duty free imports, these arrangements
crore in backward areas) in a defined list could never offset the full impact. It,
2.2 Macroeconomic Balance of industries (to be announced later) therefore, recommended reducing duty
The M Document emphasised the need to would be exempted from industrial protection to 30%–40% by 1994–95,
bring the fiscal deficit under control over a licensing, subject to the conditions that that is, by more than 50%–60% from
three-year period. The measures suggested imported capital goods were not more their existing levels. Earlier reports had
were conventional measures to restrain than 30% of the value of the investment talked in general terms about reducing
defence expenditure, subsidies, etc. It also and imports of raw materials, and duties, but had not suggested a specific
noted that ministries were overstaffed, components were below 30% of the target for reduction.
especially if we intended to follow a strat- value of production. It also recommended a shift from
egy of reducing controls. It suggested that The M Document recommended steps import licensing to tariff-based protection.
a group under the cabinet secretary should to increase the scope of delicensing, Consumer goods imports could continue
advise on abolition of certain departments within the framework of the policy to be banned, but all capital goods,
and mergers of other departments. recently announced, namely, (i) the list intermediates, raw materials, etc, should
of industries to be delicensed should be be freely importable subject only to duty
2.3 Public Sector Reform extensive; (ii) the list once announced protection.4 Replacing licensing with
It noted, but did not endorse, the enthu- should be expanded over time; (iii) the tariffs would call for some increases in
siasm for privatisation in the world. value limit of the investment exempted tariffs initially, but these tariffs would
Instead, it took the view that India needed from licensing should be progressively come down over time as a part of phased
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duty reduction. However, it was also they would not destabilise the balance the proposals. Many were broadly sup-
urged that duties on imports of inputs of payments. portive, although some demurred.
should also be reduced, so that negative Excess demand for imports would
protection is avoided. lead to a higher premium on the licences, 3 Crisis of 1990: A Brief Recap
The M Document recognised that which would incentivise exports and The internal rethinking summarised
reduction in protective duty would be a also serve as a guide to how far the above predated the crisis. However, the
shock to producers, and suggested that exchange rate was out of line. It is a matter reforms when they were actually intro-
this should be cushioned by depreciation of record that a year later, the trade duced were against the backdrop of a
of the rupee. Earlier committees, which reforms in 1991 adopted precisely this balance-of-payments crisis of exceptional
had recommended a phased reduction approach, with the replenishment licences severity. A brief recap of the crisis itself is
in duties over time, had not drawn renamed EXIM Scrips. perhaps in order to give a sense of the
attention to the need for parallel action urgency of implementing the reforms.
on the exchange rate. For modest duty 2.7 Foreign Direct Investment It is frequently said that the crisis of
reductions one can expect that produc- The M Document also proposed that the 1990 was triggered by the sharp increase
tivity increases could offset the shock, prevailing restrictive approach to FDI in oil prices in August 1990 because of
but when duties are to be reduced from needed to be liberalised. It suggested a the Gulf War following Saddam Hussein’s
around 100% to, say, 30% or even 40%, positive list of industries where foreign invasion of Kuwait. However, the oil
the productivity increase needed would investment up to 40% should be wel- price was not the only cause. If it had
be very large. The M Document argued comed, and there should be another high- been, normalcy would have returned
that that a real depreciation of 20% over priority list where investment up to 51% very quickly, because oil prices fell back
a five-year period would enable substan- would be allowed. This had been allowed to normal by February 1991. There were
tial duty reduction to take place over the recently for hotels, and it was proposed two other factors that were important.
same period without shocking the system. that it should be extended to manufac- One, the macroeconomic imbalance,
Reduction in duties would also have turing also. It also proposed a proactive in the form of high fiscal deficits inherited
an adverse effect on revenue, and the approach towards good quality foreign from the late 1980s, had generated excess
M Document argued that this needed investors by encouraging some of our aggregate demand. This spilt over into a
to be offset by an increase in domestic large public sector organisations and large current account deficit, which in turn
tax revenues. Earlier recommendations private corporations to seek out foreign was financed by an increase in external
favouring a phased reduction in tariffs investors as partners. borrowing, mainly in the form of NRI
had ignored the revenue impact, although The reaction within the government, deposits, and a steady erosion of foreign
this would be a major concern of the when the M Document was discussed in exchange reserves. This was clearly not a
finance ministry. the Committee of Secretaries, was mixed. sustainable situation. Corrective action
Finally, the M document recognised Secretary for industrial development, should have been taken in 1989 and the
that there may be hesitation in embarking the late Amarnath Verma, who played a need for such action was discussed inter-
on import liberalisation for fear of the critical role in steering the reforms in nally. But, an election was due towards the
consequences for the balance of pay- 1991 as the principal secretary to the end of 1989, and it was felt that the adjust-
ments. It, therefore, suggested a transi- Prime Minister, was strongly supportive. ment programme could be postponed until
tional mechanism of keeping import He had only a month earlier persuaded after the election. This was not an un-
licensing in place, but linking import the industry minister, Ajit Singh, to push reasonable decision at the time since there
liberalisation to tradable replenishment a more aggressive industrial policy was no reason to fear an oil price shock.
licences given to exporters. through the cabinet, but it was opposed As it happened, Rajiv Gandhi lost
The system included replenishment by the finance ministry. Finance Minister the election of 1989 and a new govern-
licences that were given to exporters at Madhu Dandavate clearly had very ment was formed under Prime Minister
different rates to meet their need for different views. V P Singh. The V P Singh government
imported inputs. It was suggested that The Planning Commission was espe- lasted only 11 months, but this was time
the rates at which tradable replenish- cially critical because it had just pre- enough to take corrective action. V P Singh
ment licences were issued could be pared an approach paper for the Eighth was certainly aware of the problem, but
increased to 30% of the export value for Five Year Plan to be circulated to the it was ignored because political preoccu-
all products over a two-year period, and National Development Council, which pations took centre stage. V P Singh had
anyone wishing to import any restricted took a very different approach emphasis- campaigned on the promise of empower-
item that would otherwise require a ing traditional labour-intensive industries ing the backward classes by implement-
licence could do so against a replenish- rather than modernisation of industry. ing the Mandal commission recommen-
ment licence purchased from exporters. The press had a field day reporting that dations, extending reservation of seats
Since the volume of imports resulting some parts of the government were think- in educational institutions and govern-
from this particular liberalisation ing differently from others. Several articles ment jobs to the Other Backward Classes.
would be linked to export earnings, appeared in newspapers commenting on This was announced in early August 1990
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25 YEARS OF ECONOMIC LIBERALISATION

and it triggered an explosion of student to improve efficiency and growth. On the (iv) On foreign trade control, he said
protests, especially in North India. This fiscal deficit, the address was conven- that the acute balance of payments diffi-
was just about the time when the invasion tional, focusing on the need to contain culties meant that import restrictions
of Kuwait sent oil prices skyrocketing, current expenditure and reduce subsi- could not be dispensed with immediately,
creating uncertainty about our exports to dies. The difficulty in reducing subsidies, but this should not become an excuse to
the region as well as remittances from it. especially food subsidies, was recognised, perpetuate the regime of quantitative
The second cause of the crisis was but it was suggested that the ends could import controls. Full participation in the
domestic political instability, which in- be better met by other means. Export emerging global economy necessitated
tensified very quickly. The BJP with- subsidies could be replaced by a more ag- progressive liberalisation of import con-
drew support from the government and gressive use of the exchange rate, which trols and exchange controls. He called for
V P Singh was replaced by a minority is exactly what happened. Fertiliser sub- a well-thought-out plan to make the
government led by Chandra Shekhar, sup- sidies could be reduced by raising ferti- rupee a convertible currency in a reason-
ported from the outside by the Congress liser prices, without affecting fertiliser use, able period of time, in any case before
party. No one believed that the govern- provided procurement prices were raised. the end of the decade.
ment would last, and there was a pre- The address also dealt with tax reforms
dictable loss of market confidence. Foreign to generate the revenue needed for rural 5 The 1991 Reforms
banks withdrew lines of credit, and NRI infrastructure and universalising access When the new Congress government
deposits, which had become a substantial to basic social services, like health and headed by P V Narasimha Rao was sworn
source of financing for the balance of education. It called for “a broad-based, in on 21 June 1991, it was clear that it faced
payments, turned negative from October moderately progressive and elastic tax a desperate situation. Foreign exchange
1990 onwards. As expected, the Chandra system, so that tax revenues can increase reserves had dropped continuously to
Shekhar government lasted only a few faster than national income growth even reach a low of $1.1 billion, only enough
months. The Congress withdrew its sup- without frequent revision of tax rates.” for two weeks’ imports. There was spec-
port in early March 1991, triggering a The tax structure should also have “built ulation that a default on payments might
general election. in incentives to promote savings and re- be imminent. Prime Minister Rao was ad-
Rajiv Gandhi campaigned vigorously ward risk-bearing activities” (Singh 1991). vised that he get a technocrat as finance
for the May election in the hope of form- On structural reforms, it recommended minister, and preferably one who was well
ing a Congress government. Tragically, a number of innovative approaches: regarded in international financial circles.
in the last stage of the campaign, he was (i) On the role of the public sector, he Manmohan Singh fit the bill perfectly.
assassinated by a suicide bomber, who boldly called for a reconsideration of the Manmohan Singh had very little time to
blew herself up as she bent to touch his Industrial Policy Resolution 1956, which send out signals that would restore con-
feet. When the votes were counted, the reserved certain industries exclusively fidence. Within a few days of the govern-
Congress was in a position to form the for the public sector. Public enterprises ment taking office, the rupee was devalued
government, and elected P V Narasimha operating in competition with other pri- by about 20% in a two-step operation.
Rao as the leader. vate sector enterprises would have greater This was actually an essential aspect of
incentives to perform well and it would any serious adjustment programme, but
4 Manmohan Singh’s Address at also be easier to judge their performance. it was also highly sensitive politically.
IIM Bangalore (ii) Privatisation was ruled out, but he There is no doubt that the government’s
Before moving to what was actually done urged that we think of ways to increase willingness to act firmly on this matter
by the new government, it is important to autonomy and accountability. Loss-making helped create credibility in markets.
note that just before the election, in April public sector undertakings (PSUs) that are Shortly thereafter, an unprecedented
1991, Manmohan Singh delivered the patently unviable needed to be closed, series of reforms in many different areas
convocation address at the IIM Bangalore. but in a manner which protected the were rolled out, and the rationale for
He knew at the time that the country was interest of labour, including through the reforms was outlined in Manmohan
facing a crisis, and his remarks were, provision of a social safety net, so that Singh’s budget speech of 24 July 1991.
therefore, made in the context of a crisis. the cost of adjustment is not borne The reforms could be broadly described
What he did not know was that two exclusively by labour. as proceeding on two tracks: (i) reducing
months later he would be directly in (iii) On industrial licensing and MRTP the fiscal deficit with a view to containing
charge of handling the crisis. The address control, the address was crystal clear. It excess aggregate demand which would
outlined a course of action proposed by said firms must be free to expand and otherwise spill over into the balance of
someone speaking at the time as a tech- diversify in the light of their perception payments; and (ii) implementing struc-
nocrat, and it is important because it is a of market opportunities. The objective of tural reforms, aimed at improving effi-
reflection of what he thought was the discouraging investment flowing to “low ciency and thereby stimulating growth.
professionally correct thing to do. priority activities,” was better met by It was made clear that stabilisation alone
The address called for action on both having a short negative list of industries could not be the objective. The real
the fiscal deficit and on structural reforms where capacity creation is discouraged. challenge was to put the economy on a
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higher growth path in which benefits sick PSUs could be subjected to the same was suggested in the M Document and
would flow to all. discipline regarding closure as the private also the convocation address. The restric-
There was general agreement that sector. Both steps were in line with what tive condition regarding balancing divi-
belt-tightening was necessary, though of had been said in the M Document and dend payments with export earnings
course there were different views on ex- later at the convocation address. was removed within a year.
actly how the belt should be tightened, The extent of import licensing was The convocation address had spoken
and who should feel the greatest pinch. drastically cut down by making imports of tax reforms. The Tax Reforms Com-
The real controversies, however, related earlier allowed on OGL or on import mittee under Raja Chelliah was appoint-
to the proposals for structural reform. licences freely importable against EXIM ed to recommend reforms in taxation
These reforms represented a significant Scrips issued to exporters at 30% of the (both direct and indirect taxes), and the
departure from the past, giving much value of exports (or 40% in some cases). recommendations of this committee
greater play for market forces, reducing This was fully in line with the transitional guided tax policy reforms for the next
the role of the public sector, and opening arrangement recommended in the M Doc- several years. Similarly, the Narasim-
the economy to foreign trade and for- ument. At the time the EXIM Scrip idea ham Committee guided reforms in the
eign investment. To many, they seemed was announced, it was also announced financial sector.
completely contrary to long held percep- that the government would move to full
tions on India’s economic strategy, and it convertibility of the rupee on the current 6 Reforms and After
was perhaps natural for opponents to account in three to five years. This was a The 1991 reforms were generally well re-
claim that they were forced upon the much shorter time span than the time- ceived by the press as signalling a
government by the IMF. line of a decade suggested in the convo- resolve to deal firmly and innovatively
However, a comparison of what was cation address. with the crisis. But, of course, there were
actually done, with the process of internal In fact, we moved even more rapidly reservations from some quarters. The
policy rethinking documented above, by replacing the EXIM Scrips with a dual left were profoundly suspicious of the
demonstrates that the reforms had a exchange rate in March 1992, whereby scaling down of the role of the public
strong domestic pedigree. exporters of goods and services (EXIM sector, the weakening of control over
A key feature of the reforms was the Scrips did not apply to services) would large houses, greater reliance upon
delicensing of all except 18 industries, surrender 40% of their earnings at the market forces, and especially external
where licensing control was retained for official rate and retain 60% of their liberalisation. This, despite the fact that
security and environmental reasons. This earnings to be sold freely in the open Deng Xiaoping in China had been press-
was in the direction proposed by the market to be used for imports and ser- ing in this direction since 1978, giving
Narasimham Committee and also the M vice payments. Within one year, that is, China a head start of more than a decade
Document, though the action taken was on 1 March 1993, the exchange rate was over India. They were also unaffected by
much bolder, and fully in line with the unified and became a floating rate. All the collapse of statist models in East
convocation address at IIM Bangalore. the planning for the introduction of the Europe, soon to be followed by the
The reforms also abolished the sepa- EXIM Scrip and the transition to a unified collapse of the Soviet Union itself a few
rate approval process under the MRTP floating rate was home-grown and not months after the 1991 reforms.
Act that was required for the so-called even pushed by the IMF, though they Indian industry had a mixed reaction.
large houses. This was again in the supported it after it was announced. The They welcomed the removal of controls
direction proposed earlier, but much pace of the transition was also much on domestic investment, but they were
bolder and in line with the IIM Bangalore faster than the IMF imagined was possible. ambivalent about the external competi-
convocation address. The rules regarding foreign invest- tion via imports, and especially the
The list of items reserved exclusively ment were liberalised in several ways. liberalisation for FDI. A group of indus-
for the public sector was reduced from 17 Foreign equity, which hitherto had been trialists, described by the press as the
to eight, consisting of industries with a restricted to 40%, was automatically Bombay Club, argued that Indian industry
security aspect. This was in line with the allowed up to 51% in a range of priority needed time before they could make
M Document and the convocation address. industries. Equity above 51% was per- themselves ready to face competition.
Instead of privatisation, there was to be mitted subject to clearance by a newly We know in retrospect that these fears
partial “disinvestment” of government established Foreign Investment Promo- were overdone. Indian industry did get a
equity to financial institutions and mutual tion Board, which was expected to adopt lot of time. Large parts of the industrial
funds in order to raise non-inflationary a proactive approach in attracting invest- sector, such as the entire consumer
finance for the government and to create ment. Equity beyond 51% was initially goods range, were not opened to imports
a culture of working that would encourage subjected to the condition that foreign until 2002, 11 years after the reforms
efficiency. It was also announced that exchange outflow on dividend payments began! FDI also did not flow in very
the Sick Industrial Companies (Special on the additional equity above 40% be quickly, although many foreign compa-
Provisions) Act, 1985 would be amended balanced by export earnings. These pro- nies began to express interest. On the
to bring PSUs under its purview, so that posals were broadly in line with what whole, those domestic companies that
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25 YEARS OF ECONOMIC LIBERALISATION

adapted to the new environment and 7.7%, much higher than that achieved in which it is the business of the opposition
opportunities came out stronger. the pre-reform period. Furthermore, to oppose. Claiming a consensus on
Although an assessment of the full contrary to the fears that opening the reforms when introducing them runs
impact of the reforms is well beyond the economy would increase our vulnerabil- the risk of an immediate denial by the
scope of this article, one aspect of the ity, we have not needed to go to the IMF political opposition, whose function is to
post-reforms performance is worth men- in this period, despite two external oppose. This often worries investors, but
tioning. The post-reforms performance shocks, the financial crisis in 2008 and they need to separate the noise from the
certainly belied the fears of those who the Eurozone crisis in 2011. This is also a signal, and in India the noise to signal
had warned of a negative impact on period when poverty fell much faster ratio is typically high. What is really
growth, but it is also true that the growth from 2004–05 to 2011–12 (the latest important is that there should be no
rate in the first 10 years or so after the period for which data are available) sudden disruptive reversals in policy just
reforms was not markedly higher than than in the earlier periods. because governments change. Indian
the growth rate in the 1980s. This led policymaking since 1991 has survived
Dani Rodrik and Arvind Subramanian 7 Conclusions that test thus far.
(2004) to pursue the argument of J Brad- The limited purpose of this article was to
ford DeLong that the shift to a more pro- show that the 1991 reforms were a logical notes
business attitude in the 1980s was the culmination of a home-grown process of 1 The fact that the models actually used in the
Planning Commission allowed for both exports
real break in the trend, and the deeper rethinking. In fact, the policy response and imports does not negate this criticism, since
reforms of the 1990s, including external in the area of both trade and exchange exports in these models were typically fi xed
exogenously and served only to determine the
liberalisation, though much applauded, rate policy went well beyond what the maximum value of imports the economy could
were perhaps not as important. IMF and the World Bank had thought sustain.
This is an important point and I would possible. Equally, the conscious exclusion 2 Delays are integrally connected with corruption,
since they become the instrument for extract-
like to list the reasons why I disagree. of privatisation made the Indian reform ing bribes.
First, the high growth of the 1980s was programme very different from what the 3 Controls under the Monopolies and Restrictive
Trade Practices Act, 1969 (MRTP).
partly due to the expansionary fiscal IMF and the World Bank would have liked. 4 Conceding continuation of a ban on consumer
policy that was followed in the second Two other points are relevant to estab- goods imports was primarily on political
grounds. These items were typically produced
half of the 1980s, and, to that extent, lish that the reforms were not imposed by smaller producers and it was logical to first
part of the growth in the 1980s could be from outside. First, the IMF programme get the prices of basic intermediates, produced
by much larger producers, in line with world
called unsustainable. ended within two years, and we did not prices before opening this sector to competition.
Second, retaining a restrictive set of need to make subsequent drawings under
controls but operating them liberally is the Enhanced Structural Adjustment Facil- REFERENCES
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and Trade Policies since 1951, Delhi: Oxford
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which is what the reforms of 1991 did. for IMF funding, it could have reversed DeLong, J Bradford (2001): “India since Independ-
ence: An Analytical Growth Narrative,” Modern
Third, opening the economy was critical course from 1994 onwards; it did not. Economic Growth: Analytical Country Studies,
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There can be little doubt that we would reforms went beyond the Congress gov- Debroy, Bibek (2004): India: Redeeming the Economic
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Panagariya, Arvind (2004): “India in the 1980s and
forms had not been undertaken. Rodrik same track. So did the National Demo- 1990s: A Triumph of Reforms,” IMF Working
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Monetary Fund, Washington DC.
Finally, the most important point Prime Minister Atal Bihari Vajpayee. Poli- Pursell, Garry (1992): “Trade Policy in India,”
about the post-reforms performance is ticians vociferously criticised the policy National Trade Policies, Dominick Salvatore
(ed), New York: Greenwood Press, pp 423–58.
that, because of gradualism, the impact initiatives when they were in the oppo- Rodrik, Dani and Arvind Subramanian (2004):
of the deeper reforms of the 1990s took sition, but this did not prevent them “From Hindu Growth to Productivity Surge:
The Mystery of the Indian Growth Transition,”
time to materialise. On this view, the from continuing the very same policies IMF Working Paper No WP/04/77, May, Wash-
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Singh, Manmohan (1991): “Challenges on the
started in 1991 but continued over subse- strengthening them. Economic Front Today,” excerpts from the 16th
quent years is best reflected in the fact There are important lessons here. Annual Convocation Address at IIM Bangalore,
Indian Institue of Management Bangalore, 15
that the growth rate of the economy in Democracy is not a consensual form of April, viewed on 7 July 2016, http://www.iimb.
the 13 years 2003–04 to 2015–16 averaged government. It is an adversarial form in ernet.in/node/264.

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