Home >News >India >1991 reforms aimed at more than just BoP crisis

An economist of international renown, Montek Singh Ahluwalia has been a key figure in India’s economic reforms journey from the 1980s. As commerce secretary and then finance secretary when P.V. Narasimha Rao was prime minister, Ahluwalia was part of the team that ‘liberalized’ India’s economy. He’d been an adviser to former prime minister V.P. Singh, and took on this position again in prime minister A.B. Vajpayee’s office. During the 10 years of the Manmohan Singh-led government, he was deputy chairman of erstwhile Planning Commission. Ahluwalia, the author of Backstage: The Story Behind India’s High Growth Years, tells Mint how a team of economists, politicians and bureaucrats worked together to bring the 1991 crisis under control, cracking open a political space to reverse the interventionist economic policies of the first four decades after Independence.

How did the 1991 reforms come about?

The reforms of 1991 are often seen as a response to the balance of payments (BOP) crisis of that year but in fact they were a response to two distinct challenges. One was an immediate crisis in the BOP and the other was the challenge of overcoming the persistent problem of slow growth in India compared with other countries in East Asia.

The BOP problems began to surface in the last years of the Rajiv Gandhi government when fiscal expansion led to a widening current account deficit. Since an election was due in 1989, it was felt that corrective action could be taken after the election. The coalition government headed by V.P. Singh that took over after the election was preoccupied with other issues, and no corrective action was taken.

The situation turned into a crisis when Saddam Hussein invaded Kuwait in August 1990, sending crude oil prices through the roof. This happened at a time when V.P. Singh had announced reservations for OBCs (other backward classes), provoking student protests and causing a break with the BJP (Bharatiya Janata Party). Markets lost confidence in the ability of the government to handle the situation. Foreign banks stopped extending new loans while insisting on repayment of old ones. NRI inflows turned negative. V.P. Singh resigned in November 1990. The next government under Chandrashekhar (started negotiating with) the IMF (International Monetary Fund). But the IMF lends only to countries willing to take the difficult decisions needed to bring the BOP into equilibrium. The Chandrashekhar government was too weak to commit to such action. It fell in March 1991 and a general election was called.

A Congress-led coalition under P.V. Narasimha Rao was sworn in and its first priority was to deal with the BOP crisis. Foreign exchange reserves were at rock bottom and there were fears India would default on its debt obligations. The new government, with Manmohan Singh as finance minister, continued negotiations with the IMF to get loans that would tide over the immediate problem. It took strong action, including devaluation and reducing the fiscal deficit, but did not limit itself to dealing with the BOP. It also took up the other challenge of slow growth.

This challenge had been discussed through the 1980s and a consensus had evolved that our system of control was too restrictive and was preventing India from becoming a competitive economy. The BOP crisis was used as an opportunity to undertake deeper structural reforms which would unleash the growth potential of the economy.

We were criticized at the time that all this was being done to satisfy the IMF. There is no doubt that the IMF would have insisted on action to restore equilibrium in the BOP, notably a reduction in the fiscal deficit and a devaluation. But what we did in 1991 was much more.

What were the structural reforms?

It began with a devaluation of the rupee in two stages, on 1 July and 3 July 1991. This was accompanied by a major liberalization of trade policy. We had one of the most restrictive import policies in the world... Consumer goods imports were banned. The new policy did not liberalize imports of consumer goods. However, almost all intermediate and capital goods, which earlier needed an import licence, were allowed to be freely imported against Exim scrips issued to exporters at 30-40% of export earnings. The Exim scrips were freely tradable and the premium on them was an additional incentive for exporters. This introduced a market mechanism for limiting imports to a sustainable level. In less than a year, the Exim scrip system was replaced by a dual exchange rate applicable to all foreign exchange earnings. By March 1993, we were able to unify the exchange rate.

An important feature was the coordination of reforms in different areas to ensure internal consistency and mutual supportiveness. Import liberalization was essential for industrial liberalization to be meaningful. However, we also needed a mechanism for situations where the demand for imports might exceed the foreign exchange available. The freely floating exchange rate provided such a mechanism since excess demand for imports would lead to a depreciation which would help equate demand for imports with available foreign exchange. Tax reforms covering both direct and indirect taxes laid out by the Chelliah committee were implemented over three years. Foreign capital inflows in the form of portfolio flows were liberalized in steps.

My main point is that the 1991 reforms aimed at much more than dealing with the BOP crisis. They have been criticized for being too gradual but gradualism had the advantage that the changes were accepted widely, and a consensus evolved in favour of change. This acceptance was reflected in the fact that subsequent governments of differing political hues, ranging from the United Front government, which included the Communist Party of India, to the BJP-led government under Vajpayee, all continued in the broad direction of the 1991 reforms.

Commentators argue that the burst of reforms in 1991 was unique. Was this because of personalities involved or the strategy itself?

Personalities are always important and in Manmohan Singh we had a finance minister who was respected and trusted across political parties. He understood the workings of the economy and the role of persuasion in making reforms politically saleable. He had the full backing of Rao. The strategy was also unique. There had been considerable discussion in the 1980s inside government of the need for change and many top civil servants were convinced we were falling behind other countries by not changing.

It was the multipronged action, focusing on policy change, that made the 1991 reforms unique. Most budget speeches identify objectives and announce new government programmes to achieve those objectives... Singh’s 1991 speech was different because it talked mainly of policies.

True, we have not had a comparable burst of coordinated reforms since then. However, it must be admitted that the first burst of reforms was much easier to conceptualize because the Indian economy was so constrained that it had become a no-brainer that we needed to change. Subsequent stages of reforms are more difficult and require building of institutions which takes time.

We now see considerable disenchantment with the thinking that guided reforms since 1991. There is criticism about the system not delivering for all Indians and the growth of crony capitalism...

There is a lot of rethinking globally on various aspects of economic policy and the limits of market-oriented economies and we are no exception. One line of criticism is that the reforms and reformers have become excessively focused on GDP growth as the sole objective of economic policy, which ignores environmental impacts. These are relevant considerations, but it is wrong to say that we viewed growth as the sole objective of policy. In all our plan documents, we emphasized that GDP growth is only one measure of progress and there are others that are equally important such as poverty reduction, reduced regional differences, progress in child nutrition, educational achievements, health indicators...

It is important to recognize that we cannot assume that progress in each indicator can be achieved without rapid growth in GDP. India moved out of the category of low-income developing countries in 2010 but it only entered the bottom of the middle-income category. We need much higher levels of per-capita income to improve the living standards of the bulk of our people and for that we must aim at growth rates between 7% and 8 %, while also ensuring that the growth is as inclusive and sustainable as possible.

The growth of crony capitalism is indeed a serious problem, not just in India but in all developing countries. The solution lies not in rejecting freer markets or becoming suspicious of any large Indian company but in ensuring that all such companies operate in a genuinely competitive environment, and that government does not act to grant favours to preferred companies.

Some believe the thinking that led to trade reforms was flawed and, so, the reversal of trade policy by the current government is justified.

It is true that we have seen a series of increases in import duties in the past three years... This is sometimes presented as a consequence of the policy of Atmanirbhar Bharat. We need greater clarity on what is meant by atmanirbhar. The prime minister has said the government wants to integrate India into global supply chains. The message of integrating is the right approach but it is not clear that the specific actions we are taking will promote that objective. High tariffs, combined with a message that reducing imports is a virtue in itself, is not consistent with integrating into global supply chains. Such integration requires items to be imported from wherever they can be produced cheaply, worked on in the country for some part of the production process, and re-exported. High tariffs will make us unattractive for integration into global supply chains.

The import duty increases of the past three years have been implemented because segments of Indian industry have expressed concern that they cannot compete against imports. Industry does have genuine concerns about aspects of our policies that make Indian producers uncompetitive. These are low-quality infrastructure, our labour skills are not what they should be, our labour markets are not flexible enough, we score poorly on logistics and also on ease of doing business. However, the solution to these problems lies in redoubling our effort to close these gaps, not raising import duties.

Raising duties may make some producers more competitive against imports, but it does nothing to help exporters who suffer from the same disadvantages. In fact, it perpetuates our competitive disadvantage in world markets. These are not just my views. Arvind Panagariya, a distinguished trade economist, who was appointed the first vice-chairman of NITI Aayog, argued strongly that we should lower our tariffs and reduce disparities across categories. Unfortunately, policy has moved in the opposite direction.

Another unfortunate development is India’s decision to stay out of RCEP (Regional Comprehensive Economic Partnership). I think this is contrary to the Act East policy enunciated by the prime minister. I hope the government will reconsider.

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