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India’s Economic Reforms
Challenges and Prospects

The remarkable growth transformation since 1980s was made possible by

gradual unshackling of the economy and liberalising many sectors of the
economy. The policies of centralised planning, state intervention and trade
protection were gradually replaced by liberalisation of trade, industrial de-
licensing, rationalisation of taxes, current account convertibility of the rupee and
the easing of foreign investment norms. The process of reforms gained
momentum in the 1990s in response to the balance of payment crisis that
surfaced in 1990-91.

The economic reforms in 1990s had a significant impact on the Indian economy.
At a generic level, the reforms played a facilitative role and created a
competitive environment for Indian' companies. Industrial de-licensing provided
flexibility to firms in investment decisions. This led to a surge in private
investment. The share of private investment in total industrial investment went up
from 56 per cent in the 1980's to almost 75 per cent by the end of 1990's. Trade
reforms lowered tariffs and removed barriers on imports. This increased import
competition for traded goods and also allowed firms to rationalise their input
decisions. This enhanced the productivity of Indian manufacturing and permitted
them t o not only stay competitive in the new environment but also become
globally competitive. Many sectors were also opened up for Foreign Direct
Investment (FDI) and higher equity participation. The Indian firms were permitted
to access international capital markets. Capital market reforms, together with the
removal of restrictions on firms to tap capital markets, brought down entry
barriers. Telecom sector benefited from the entry of private players and improved
access to capital.

Challenges

Most of the reforms implemented did not require legislative changes and could
be carried out through administrative fiat. These reforms, as we have seen,
made India competitive and notched up the GDP growth rates. But the high
growth achieved in the mid nineties could not be sustained, as the momentum of
reforms petered out. The `Second Generation Reforms' would involve crucial
structural, legislative and administrative changes in major sectors and require
wider consensus building, particularly due to coalition governments. The major
second generation reforms are listed below:

• Power sector reforms. Implementation of the Electricity Act, 2003.

• Providing flexibility of entry and exit to firms. This would involve
amendment of the labour laws.

• De-reservation of the small-scale sector. This will permit the exploitation of

scale economies.

• Fiscal consolidation - keeping the deficits and debt under check.

Encouraging FDI flows

• Reducing tariff barriers to the international level

• Reducing unemployment and alleviating poverty

• Bringing up human development, etc.

Infrastructure Bottlenecks

Successive Indian governments have put considerable emphasis on

infrastructure; there-is a considerable gap between demand and available
supply. India not only lags behind the developed countries but also its
developing country peers with respect to infrastructure supply. The reforms that
India has had so far, by and large, failed to address the critical issue of
improving the supply and lowering the costs of non-tradable inputs like
infrastructure which cannot be procured from just anywhere. All the infrastructure
sectors need sufficient funds for expansion and maintenance of existing facilities.
According to the tenth five-year plan the cumulative investment requirement
during 2001-02 to 2005-06 has been estimated at Rs. 7500 billion. Of this, 40 per
cent of the investment is required in the power sector, 11 per cent in telecom and
around 14 per cent in roads and railways. With Rs. 1819.4 billion already
invested during 2001-02 to 2002-03, there still exists a target of Rs. 5680.6 billion
to be met in the next three years.

Power

There is a virtual consensus on the fact that the power situation in the country is
not very sound. It would be no exaggeration to say that Indian industries pay
inordinately high prices (when they do) for inordinately low quality power (when
they receive it). This immediately imposes a severe constraint on production and
would inevitably affect the investment decisions of new entrepreneurs. Despite a
rapid expansion of generation (from 1300 megawatts in 1947 to 112,000
megawatts in 2003) and simultaneous growth in transmission and distribution,
the sector has not been able to keep pace with the growth in demand, resulting in
chronic shortage. Under-investment in the sector has stemmed largely from the
poor financial health of the state electricity boards (SEBs) that have traditionally
played the key role in generating and supplying power. This in turn, is due to un-
economic tariffs for the agricultural sector, lower slabs for domestic consumption
,
and high transmission and distribution (T&D) losses that are often due to theft
and poor billing and collection efficiency.

Transport

The transport is another sector, which is not only relatively expensive by any
mode but also because of infrastructural constraints hugely unpredictable in
terms of transit time. One of the critical problems in Indian railways has been the
decline in share of its internal resources, which has deteriorated its financial
position. This decline is due to the loss of its freight market share to road
transport, and the relatively higher freight rates in order to subsidise ordinary
passenger segments. Besides this, there is a large speed differential between
freight and passenger services that reduces the traffic throughput in the system.
Also there is an urgent need for better port connectivity and better infrastructure
for handling larger vessels. Focus on providing hinterland connection to various
ports through railways and roads will reduce congestion levels at many ports.
Though the average turnaround time for ships has improved, it is still lower
compared to international standard. Rural road infrastructure is also very poor
because of bad connectivity, which in turn takes longer time to travel, and market
agricultural products across the country.

Labour Laws and Labour Market Rigidities

The Indian labour market does not seem to function with a reasonable degree of
efficiency. Subject to the constraints that all employees have certain rights that
must be protected, market efficiency implies that workers will be hired or
retrenched as the demand for their particular skills expands or contracts.
However, in the present scenario an employer, employing more than 100
workers, has to seek permission to lay off workers-from the state government.
This effectively means permanent employment. For practical purposes, once a
worker is hired his costs have to be borne by the employer whether he is
contributing to revenues or not. In a risky business and uncertain market
environment, and there is no question that the policy changes have all
contributed to enhancing business risk, this is a huge deterrent to hiring and
growth of firms beyond the limit. Labour market rigidities constrain large industrial
investments and therefore preserving the extreme fragmentation of the industry
and limiting its growth potential. The new government has explicitly ruled out the
relaxation of job security regulations that would make the market more flexible.
Elimination of job security regulations for the industrial sector would significantly
impact the effective cost of labour which would make all labour-intensive
manufacturing far more competitive.

Reservation for Small Scale Industry (SSI)

The policy of reservation of commodities for production by the small-scale sector

is another area. It supports and sustains weak and inefficient producers, it
hinders the assimilation of technology, it perpetuates sub-optimal scales of
production. Reservation of small scale production constrains large industrial
investments and therefore preserving the extreme fragmentation of the industry
and limiting its growth potential. Though exemptions based on export obligations
which are by all accounts hardly monitored are one way in which back-door entry
by large producers into the manufacture of reserved products is effected, this
back door entry is less competitive than any front door entry.

Despite many persuasive arguments to the contrary, particularly the fact that
most of the commodities, which are reserved, are freely importable, the
government has not been able to terminate this policy. Though there is some
back-door liberalization, with a few products being de-reserved every now and
then, for many products, this is a binding constraint on scale of operations, which
typically means lower quality, use of inferior materials and localized marketing.
De-reservation would allow producers of these to build up to scales for national
and global competitiveness, which would give a huge boost to the manufacturing
sector as a whole, because of linkages.

Fiscal Consolidation

Government finances remain an area of major weakness. Some reforms in this

area has already been initiated, however, results are awaited. The government is
facing a severe resource constraint, which prevents it from making the kinds of
investments - both in physical and social infrastructure - that are consistent with
its growth and human development objectives. This has resulted in a legislative
mandate to curb government consumption expenditure, the Fiscal Responsibility
and Budget Management Act of 2002, which should compel the government to
re-orient both the tax and expenditure systems towards growth and income-
enhancing activities.

Lower FDI flow

India has experienced lower FDI inflows in relation to the size of the economy.
This contrast is sharp in comparison to China and other East Asian economies.
The key deterrents to FDI in India are bureaucratic bottlenecks, slow reforms
and poor infrastructure. But market size and potential, labour force skills, and
competitive wages are the key advantages that India has. However, India has
not been able to leverage its competitive advantage, due to a lack of concerted
effort. The challenge is that India has to remove the above impediments in order
to attract more FDI in the country.

Tariff Barriers

India earlier had one of the most restrictive trade regimes. Not only were there
physical barriers to trade ('through quotas), tariff rates also were very high. As a
result of tariff reforms, import-weighted average tariff came down from a high of
around 56 per cent in 1990 to around 28 per cent in 2001 for all products put
together. According to World Development Indicators, the reduction in tariffs for
manufactured products was much sharper from about 71 per cent in 1990 to 29
per cent in 2001. Despite these reductions, India's tariff rates are among the
highest in the South and East Asian countries.

Unemployment and Poverty

Currently around 60 per cent of the workforce is employed in agriculture, about

17 per cent in industry and while the rest in services. It is difficult to expect
services to absorb such a large overhang from agriculture - industry must also
contribute. The government has drastically reduced its intake of people, the
private sector just does not seem inclined to take up the slack for the reasons
mentioned earlier. The slow growth in employment and the rising number of
young people looking for jobs is another critical issue for any government wishing
to be re-elected. Reforms in labour markets that promote employment and the
development of social security systems will allow the economy to significantly
increase its utilization of its most abundant resource - unskilled and semiskilled
labour.

Reduction of poverty is another area of challenge. There is a considerable

controversy about the impact of growth and reforms on poverty and income
distribution. According to official household surveys, the proportion of population
below the poverty line fell from around 51 per cent in 1978 to 36 per cent in 1994
and further to around 26 per cent in 2000. However, various researchers have
adjusted and corrected the methods to show either greater or lesser poverty
reduction. Though the last decade has seen a substantial reduction in the
absolute incidence of poverty but India has to go a long way to alleviate poverty.

Human Development

There has been a continuous improvement in the Human Development Index

since 1980s. At the national level, the index has improved by nearly 26 per cent
in the eighties and by another 24 per cent in the nineties. Despite improvement in
human development parameters in the past two decades, India ranks 127 in the
th

world, compares very unfavourably with other countries.

Political Instability

From an economic policy perspective, despite the many changes in the

composition of the government, the overall direction of these reforms did not
change fundamentally. Apprehensions were expressed that the reforms process
of the present UPA government would be derailed because of the fragility of the
new coalition (UPA), with Congress at the helm of affairs being critically
dependent on outside support by Left. Though the underlying reformist
tendencies of the economic administrators are still active and their agenda is
being pursued, the pace of reforms has slowed down compared to the early
1990's. Public opposition from the Left is a regular phenomenon and one of the
reasons for the slow pace of reforms. There are persistent demands for
obtaining consensus on economic reforms, particularly those which are likely to
impose high short-term costs on entrenched political interests. Public sector jobs,
subsidies on various commodities and services and so on are prominent
-

examples of the pressures that any government has to contend with. This is in
sharp contrast to China, where the issue of consensus-building does not arise
and the state is able to push reforms in the desired direction at a faster pace.

India - A Diversified Global Manufacturing Hub?

In comparison with its Asian peers, manufacturing in India makes a relatively

lower contribution to the GDP. The contrast is particularly sharp in relation to
China where the share of the manufacturing sector in overall GDP was around
36 per cent in 2002, compared with a mere 16 per cent in India.

It is general understanding that the major barriers to India's emergence as a

diversified global manufacturing centre, a role, which is entirely compatible with
its varied resource endowments - labour, natural resources and agricultural
products - are in the policy realm. The two most important of these are
infrastructure and labour market inflexibility. Power is a sector that impacts on the
prospects of virtually all manufacturing activity, so the likelihood that India will
develop as a global manufacturing hub, depends critically on the growth of the
power sector. Dealing with both these issues may not in and of itself unleash a
boom in manufacturing activity; however, it is unlikely that anything will happen in
this sector unless these two problems are squarely dealt with.

Prospects

Future prospects for the Indian economy depend on a number of factors ranging
from the pace of economic reforms to the performance of the global economy.
India has a number of inherent advantages, and reforms can translate these
advantages into high growth rates in the long run. Population and income
demographics play a critical role in the production process as well as from the
consumption side.

Rising Level of Per Capita Income

Over the past decade, per capita incomes have risen at the faster pace in the
country's history due to higher GDP growth and falling birth rates. With the
income growth fast outpacing population growth, nominal per capita income has
grown by 3.6 times between 1990-91 and 2002-03. The present level of per
capita income may still be a very low level by international standards, but it is an
impressive change and this has had very interesting effects on consumer
behaviour.
Growing Middle Class

The latest survey by National Council of Applied Economic Research (NCAER)

shows that middle class segment has grown by 2.5 times between 1995-96 and
2001-02. This survey also mentions that the middle class is expected to show a
significant bulge in future. The middle class is defined as households with income
between Rs 2,00,000 and 10,000,00. Bulging middle class together with rising
income will give a thrust to consumption in future.

Larger Number of Working Population and Reducing Dependency

The age dependency ratio in India is expected to show a significant decline.

Dependency ratio is defined as the ratio of non-working population (< 15 years
and > 64 years) to working population (15-64) years. India will have an
advantage of lowest dependency ratio. Low dependency ratios promote
consumption of goods and services, due to lower burden of caring for the aged
and bringing up children. Higher population in the working age group implies
greater supply of labour, and an increasing concentration of population in higher
income group translates into higher consumption levels.

India's current share of working population in total population low, but the size of
population puts India in the second spot after China in terms of number of
people in the working age. Among comparator countries, the share of working
population to total population will decline in China, Thailand, Brazil and Russia.
India, Malaysia and Philippines will have larger and increasing share of working
population in the years to come. India, with a faster rate of increase, will emerge
as a major source of labour supply, due to the sheer size of its population.

The rising share of working population is both an opportunity as well as a

challenge. The opportunity is in terms of availability of human capital and
challenge is in provision of productive employment to the bulging working
population. Alpo, much will depend upon the education levels and skill sets of the
working population.

Availability of Qualified Manpower

There has been a steady improvement in the literacy rate from around 52 per
cent in 1991 to around 65 per cent in 2001. A very significant advantage that
India has is the high pool of educated and technical staff together with low wage
rates. As India's 60 per cent of the labour force is in agriculture, India will also
remain a key supplier of low skill labour in times to come.

In terms of skill sets and availability of qualified labour, India is quite well placed.
India ranks very high in terms of availability of skilled labour in general and
engineers in particular. This fact is brought out by the Global Competitiveness
Report's finding, which puts India in the third place in the availability of scientists
and engineers. India, however, does not rank very high in the quality of
education system. It ranks 36 in terms of quality of overall education among the
102 countries surveyed in the Global Competitiveness Report.

Certain Niche Areas where India can make Competitive Advantage

Economic liberalization and increased globalization has effectively changed the

Indian industrial landscape. Increased opportunities, greater access to resources
and knowledge and the forces of competition have transformed the Indian
industrial landscape quite dramatically. India currently is a service hub of the
world where it enjoys dominant position in a variety of service and knowledge-
based activities.

There is no question that India has potential comparative advantage in many

manufacturing activities. First there is the substantial natural resource
endowment. Secondly there is the oft-repeated abundance of relatively low-cost
labour, much of which are endowed with craft skills emerging from the tradition of
occupational castes. India has a competitive advantage in some sectors like
pharma; auto and auto ancillaries, textiles, gems and jewellery, etc.

Conclusions

Although India's growth performance does not match that of other fast growing
East Asian countries and China, in recent years India has emerged as one of the
fastest growing economies not only in the region but also in the world. It is
expected that India would be a high performer in the years to come.

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 Second generation reform soon, says Sinha
PRESS TRUST OF INDIA
NEW DELHI, APRIL 29: The government will soon unveil the second generation reform
programme to provide a "road map" for economic development during the next 10 to 15
years, Finance Minister Yashwant Sinha said here today.

The main thrust of the second generation reforms would be to sequence the unfinished
economic agenda and deal with sensitive issues such as subsidies, as the first phase of
liberalisation process has been "ad hoc and not well-planned", Sinha told the CII annual
session here.

A comprehensive paper on the second generation reform would be released "shortly" to

elicit opinion from all sections of the society including the peasantry and trade and
industry, before implementation, he said.

Sinha later told reporters that the comprehensive paper on second generation economic
reforms was being given final touches by the government and would soon be unveiled.
He, however, did not divulge the exact period of release of the paper.

The finance minister told the gathering that the reform wouldalso encompass on revenue
and fiscal deficit and Plan and non-Plan expenditure. He said the division between Plan
and non-Plan expenditure had led to artificial distinction that led to distortion in the
budget that caused harm to the economy.

Sinha expressed concern over the delay in passage of legislations such as the Insurance
Regulatory Authority Bill, the Foreign Exchange Management Act and the Companies
Act.

This will have to wait until the Lok Sabha is convened again after elections, he said
adding ``it is a temporary set-back.'' ``Though it is possible for the government to pass
ordinances to put in effect some legislations, it is still a grey area,'' he said. Sinha said the
government was keen to clear the IRA Bill during the last session of Parliament and had
listed it in the business.
He said the distinction between Plan and non-Plan expenditure had led to problems of
provisions for assets created in the country through budgetary allocations. ``This has led
to destruction along with theconstruction of assets,'' he said.

Buildings were built of which some have collapsed and similarly roads and bridges were
made but could not be properly maintained due to lack of provisions, he said adding this
distinction between Plan and non-Plan would have to be re-looked in a careful manner.

The government was also keen to go ahead with zero-budgeting by making it necessary
for the implementing agencies in the country to provide quarterly results of the amount
spent on projects and not rushing in the figure before the end of financial year, he said.
``If any organisation (responsible for implementing of the projects) does not do so we
will consider asking them to surrender the funds,'' he said.

Sinha said he was unhappy that the budget was passed without discussion as discussions
would have enabled him to introduce some amendments in accordance with post-budget
representations received from various quarters. He blamed the opposition for it.

Sinha said the fractured mandate received by the partiesduring the last elections had led
to political uncertainty. He said there were no differences on economic policies within the
BJP as was vindicated at the recently held BJP national executive at Goa. ``There are also
no differences between the BJP and its allies on the economic issues,'' he asserted.

``It will be our endeavour to ensure in the coming months the implementation of the
budgetary proposals," he said adding ``there will be no let-up, no relaxation, no lethargy
as far as various provisions of the budget are concerned." Sinha said all efforts would be
made to contain the revenue deficit and the fiscal deficit to two per cent of GDP as has
been targeted. Sinha reiterated there were no differences between the RBI governor and
him on interest rates and other issues.

He said the future reforms would also look into the aspect of making the RBI a purely
custodian of the monetary polices and doing away with its equities in the banks. He said
the government would deal with the problems of non-performingassets besides looking
into the agricultural pricing and agriculture produce trading and putting in place the land
reforms.

Sinha said the government was committed to going ahead with all the policies that had
been cleared before the losing of the confidence motion, including the disinvestment of
some public sector undertakings.

Later speaking to reporters, Sinha said the question of lowering of interest rates would
have to be dealt by the Reserve Bank of India. ``The RBI has already brought down the
bank rate soon after the budget and it is for it to decide on this aspect,'' he said. He
refused to comment on the rupee-dollar exchange value.

Copyright © 1999 Indian Express Newspapers (Bombay) Ltd.