Dr. Bimal Jalan - Governor, Reserve Bank of India     


“The Politics of India’s Reforms”
- The Financial Times, London, July 15, 2005

Two facts stand out about economic reform in India. The first is that it is a mixed bag. In some areas, reforms have been successful. But in others, progress has been negligible or non-existent.

The second striking fact is that once a policy reform has been put in place, it has not been reversed. In the past 15 years, India has had governments of all hues. Several have come and gone within a year or less. All have been coalitions. However, policies that are in the country's interest have not been given up. This is a triumph of India's open, participative democracy.

An important area where reforms have been far-reaching is the management of the external sector. From 1956 to 1991, India was perennially in balance of payments crises with high levels of protective tariffs, severe import restrictions, fixed exchange rates and low reserves. After one of the worst crises in 1991, reforms were introduced. These included a reduction in external tariffs, the introduction of a flexible exchange rate and the substantial liberalisation of all transactions in foreign exchange. Today, India has one of the strongest balance of payments positions in the world, including large reserves and low external debt.

Another area where reforms have had a highly positive effect on growth and competitiveness is the removal of industrial licensing and price controls. The system of industrial licensing was introduced in the 1950s to discourage consumption of so-called "non-priority" items (such as synthetic fibres) and to encourage investment in heavy industries (such as steel). Both the maximum output of a company and the number of companies in an industry were controlled by government. The process of liberalisation in this area began in the early 1980s, after a long period of slow growth (of only 3.5 per cent annually). Licensing was eliminated in 1991. India also undertook substantial tax reforms. The highest marginal rate of tax on personal income was 97.5 per cent in the early 1970s. This was a big cause of tax evasion and growth of the black economy. The rate has been gradually reduced to globally comparable levels of 35 per cent.

In these areas, reforms have been impressive. There is an equally impressive list of policy areas where reforms have been conspicuous by their absence or limited in their scope. These include privatisation or disinvestments in public sector undertakings (despite high fiscal deficits), reform of the power sector, rigid labour laws and the multi-layered administrative system (which is a major cause of corruption and delays). The lack of reform in these and similar areas leads to the inefficient use of resources.

There is a line that divides what can be reformed and what cannot. This line is politically determined and controls the direction and pace of reforms irrespective of the parties in power. If the beneficiaries of a restrictive policy belong to a coalition of special interests - such as labour unions, civil servants, government ministers and large farm owners - that policy is likely to continue. Privatisation of public enterprises or reduction in farm subsidies adversely affect one or more such groups. Strong reforms in these areas are, therefore, politically unacceptable.

What about the future? My hunch is that the compulsions of current coalition politics are likely to prevail over economic objectives. In addition to the Congress party, the present coalition consists of several regional parties. These parties are powerful in their own states. However, in several states, the Congress, with whom they are allied in the central government, is the main opposition. There are also bitter disputes among some of them at the state level, even though their leaders are members of the central government's cabinet. Furthermore, the government is dependent on the support of the Communist Party Marxist (CPM), Communist Party of India (CPI) and some smaller parties on the left. These parties are ideologically opposed to dis-investment or privatisation in public sector enterprises, liberalization of foreign investments, reduction in fiscal subsidies and outsourcing of public services.

As a result of earlier reforms and other factors, India's economy is also doing quite well. Inflation is moderate, growth is good, external flows are strong and stock markets are generally buoyant. India is one of the fastest growing economies in the world with growth of more than 6 per cent annually. The political will for pressing ahead with reforms in the face of opposition is therefore weak. India is likely to continue on its present path - with a bit of reform here and there. We are not likely to see any big reforms in crucial areas. This is a pity. India has the opportunity to lift its growth to 8 per cent or more. It can also reduce poverty at a faster pace, and improve the efficiency and delivery of public services. However, a political consensus to achieve these objectives through reform is not yet in sight.

Thank you.

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