Why did India reform?

A few weeks ago the Global Development Network of international development scholars held their annual conference (in Delhi) on the theme of 'Understanding Reform' (worldwide).

Predictably, Manmohan Singh was slated to address a plenary session on India's economic reforms. A few days before the event he withdrew because of political commitments and the conference organisers roped me in to field as substitute. They also asked me to avoid the well-worn story of the 1991 crisis, the ensuing reform programme and its impact on the Indian economy.

Instead, they wanted me to address the question of why economic reforms were successfully initiated, implemented and sustained (without serious rollbacks), paying special heed to political, institutional and external factors of the times. Having put some thoughts together for the conference session, I thought I would share them with the readers.

Looking back, it's pretty clear that political ideology (of the Markets versus State variety) did not play a significant part in sparking the reforms. The general elections of June 1991 were not fought and won under the banner of economic liberalisation. Economic liberalism had never been a serious part of the Congress credo and it wasn't in 1991.

That's not to say that politics played no part in the reform story of the early nineties. The fact that the new Congress government (initially a minority one) stayed in power for a full five-year term, 1991-96, was very important for sustaining the reform thrust and avoiding serious rollbacks.

The fact that the Prime Minister and Finance Minister remained unchanged for the full term assured an important degree of continuity and coherence in economic policies.

If the political ideology of economic liberalism did not launch the ship of Indian reforms, what did? (I can almost hear my fellow columnist Surjit Bhalla muttering "it sure wasn't Helen of Troy"!) The conventional wisdom accords prime importance to the external payments crisis of 1991 and the pressures it generated for serious reorientation of the economic policies and paradigms of the previous four decades.

By this account, the situation confronting the new Congress government was one of rapidly depleting confidence, plummeting forex reserves (despite a savage squeeze on imports), fleeing non-resident deposits, rising inflation, declining production and a serious likelihood of an unprecedented external payments default by India.

In this grim scenario, the freshly mandated Narasimha Rao turned to an experienced and highly respected technocrat, Manmohan Singh, gave him the finance portfolio and, for a while, support and a free hand with economic policy to get the country out of crisis. So, if necessity is the mother of invention, then the external payments crisis was the mother of reforms!

Broadly speaking, this conventional wisdom is correct. But it does not quite answer some nagging questions? Why did the reforms take the form they did, marking such a radical change with past policies? Why did the implementation of the new policies proceed fairly smoothly? What led to their success in quickly generating good economic outcomes? Why were rollbacks rare?

To answer these questions we have to marshal some other factors, which played a significant role in India's successful reforms.

First, although economic liberalism (plus prudent fiscal management) was not part of contemporary political ideology in India, most elements of the reform agenda had been around in influential sections of India's 'technocracy' for some years.

The partial success with the limited liberalisations of import and industrial controls in the mid-1980s had also enhanced the spread and commitment to these ideas in the technocracy. All this facilitated quick articulation of a coherent reform programme when crisis created the opportunity for change.

Incidentally, contrary to some left-wing fiction, the reform programme was very much 'home grown'. The major international financial institutions (IMF, World Bank, ADB) only played a supportive and constructive role of providing emergency balance of payments financing and bolstering external confidence in the Indian economy.

Second, a key institutional feature, which facilitated the design and implementation of the reforms of the early 1990s was the close coordination between the Prime Minister's Office, the Finance Ministry, the Reserve Bank of India and the Commerce Ministry.

This, in turn, was helped by the Prime Minister's clear and strong mandate, Manmohan Singh's long and distinguished technocratic service (he had earlier served as RBI Governor, Planning Commission head, Economic Affairs Secretary, Chief Economic Adviser) and consequent ability to command respect and cooperation of the civil service, plus his deliberate programme to build a strong and durable team of economic managers in the Finance Ministry and the RBI. Such durability was important for successful implementation of reforms and for maintaining a consistent 'reform message'.

Third, in the spectrum between 'big bang' and 'gradualism' India's initial reforms are best described as 'medium bang'. This (initially) systemic approach was very important for quickly restoring confidence and for triggering early fruits of reform.

The systemic or 'medium bang' nature may be gauged from the fact that within a few months the following steps had been taken: virtual abolition of industrial licensing; rupee devaluation by 20 per cent; the complex import licensing replaced by a system (EXIMSCRIPS) of tradable, import entitlements earned through exports (later replaced by a dual, and then, market-determined exchange rate); phased reduction of customs duties; fiscal deficit cut by 2 per cent of GDP; foreign investment opened up; banking reforms launched; capital market reforms initiated; initial divestment of public enterprises announced and major tax reforms outlined.

It certainly helped that most of these early reforms could be implemented by government orders and notifications and did not require legislative enactment.

The initial burst of reforms (with emphasis on deregulation and market orientation) was the key to swift revival of domestic confidence (hence the investment boom of 1993-96) and external confidence (hence the quick rise in foreign investment, external remittances and non-resident deposits).

Other good things followed swiftly, helped by the nature of the reforms, the economy's underlying resilience, and a buoyant world economy.

GDP growth recovered quickly and strongly to average over 6.5 per cent in the first four post-reform years with strong growth in all major sectors, exports surged by 20 per cent annually in 1993-96, savings and investment were buoyant, forex reserves quickly climbed from about $ 2 billion to $ 20 billion by early 1995, and the external debt situation improved quickly.

This swift turnaround in major economic indicators was important for sustaining the reform momentum, winning converts and preventing serious rollbacks. Thus the 'early harvest' itself became an ingredient of success with the reforms.

Finally, we should not underestimate the personal factor. The external payments crisis of 1991 certainly generated the pressures and created the opportunity for undertaking long-overdue reforms. But the opportunity had to be seized and held. And for that, India's citizens will forever be in debt to the courage, wisdom and vision of Manmohan Singh. He was the right man in the right place at the right time.

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