Neoliberal reforms

Indian neoliberalism: A toxic gift from global finance

Print edition : September 24, 2021

The Bombay Stock Exchange building in Mumbai. The outcomes of financial speculation, driven in the first instance by foreign finance, are being used as proof of neoliberal success. The most obvious is the barometer of stock market activity, the benchmark Sensex. Photo: Dhiraj Singh/Bloomberg

Outside the RBI headquarters to exchange old 500 and 1,000 rupee notes in Chennai on March 31, 2017. The evidence that neoliberalism had failed was concealed by a set of fortuitous developments that had their own effect on the growth process: the illogical and senseless demonetisation, the failed Goods and Services Tax regime and the COVID-19 pandemic. Photo: B. Jothi Ramalingam

The stock market, with the foreign institutional investor at the centre, has come to symbolise what neoliberalism has to offer. If at Independence freedom from foreign capital was the objective and a marker of success, today it is the recognition of foreign investors as being an attractive playfield for speculation that is seen as a sign of arrival.

India’s tryst with neoliberalism—the economic framework that preaches market fundamentalism but uses the state to engineer a redistribution of income and assets in favour of finance capital and big business—is routinely traced to 1991. That was the year when, following a balance of payments crisis, the Indian state openly declared its embrace of neoliberal ideology. Despite its adoption in the wake of a crisis, that shift was presented as a swift transition to a superior policy regime wherein state intervention that distorts markets, suppresses private initiative, represses finance, and limits growth was to be abjured. Indian capitalism was to be uncaged, the animal spirits of capitalists unleashed, the inflow of foreign capital enhanced, exports success ensured, and growth accelerated. All other positive outcomes, such as improvements in the well-being of Indians mired in poverty and social deprivation, were to follow automatically.

However, though the 1991 crisis provided those in power the justification to openly embrace neoliberalism, on the grounds that support from the International Monetary Fund (IMF) would not be forthcoming without that transition, the shift had been initiated earlier in the 1980s, especially in the second half of that decade. But during that decade, political circumstances, including a strong opposition (which spoke up against the 1981 IMF loan and the associated neoliberal conditionalities), ensured that the turn was slow and halting.

Lessons from the 1980s

Even if one disregards the creeping liberalisation of the 1980s, the three decades over which the neoliberal regime in India has been in place is sufficient time to generate a credible scorecard to assess its consequences. The most touted metric of the success of neoliberalism is growth in gross domestic product (GDP), assessing which is the prime intent here. But there is another reason why developments during the 1980s should not be ignored. By the late 1960s, it was clear that the post-Independence import-substitution strategy had run out of steam for reasons among which were (i) the failure to address asset and income inequality that precluded the consolidation of a domestic market for mass consumption goods; and (ii) the state’s inability to mobilise through taxation the surpluses needed to finance its expenditures that were crucial to driving demand and growth. The second of these failures resulted in reliance on inflationary financing, which was unsustainable because of supply side constraints, especially in agriculture. Though these factors had by the mid-1960s brought to an end the high growth of the first 15 years of planned development, even the partial transition away from the state-led interventionist trajectory to the neoliberal regime had to wait until the middle of the 1980s.

This delay was because, even if the Indian elite wanted to experiment with such a transition, international conditions were not favourable. A crucial element of neoliberal transition is external liberalisation that does away with quantitative restrictions and reduces tariffs on imports and dilutes regulation on the cross-border movements of capital, facilitating, in particular, financial capital flows. When trade is liberalised, often with the intention of using international competition as a means of restructuring domestic capacity to make it globally competitive, imports rise immediately because of the release of the pent-up demand for imported goods that had been suppressed by a protectionist trade policy. Income inequality ensures that such demand, coming from the well heeled, was substantial. On the other hand, even if liberalisation leads to export success, that will take time, since it requires new investment and building confidence and goodwill in markets. So, in the interim, while the import bill increases, export revenues do not, requiring foreign capital inflows to finance trade and current account deficits. The absence of adequate capital inflows sets off a balance of payments crisis.

What changed

Before the late 1970s, the volume of foreign capital flows to developing countries, consisting largely of foreign direct investment by global firms and foreign aid (grants and loans) from official bilateral and multilateral sources, was determined largely from the supply side and shaped by the objectives of foreign investors and governments. The private international financial system played only a limited role in recycling financial surpluses to developing countries.

Also read: Neoliberalism: An era of growth sans justice

Flows of private financial capital to developing countries in the form of loans or investments in equity and bond markets were limited or absent. This meant developing countries could not access foreign finance on demand. If they liberalised trade, and the trade and current account deficits widened to a degree where they could not be covered with the available foreign capital inflow, a balance of payments crisis that aborted the effort at growth through liberalisation was inevitable. During those years, liberalisation was not a viable alternative for most countries.

The scenario changed in the late 1970s and 1980s because of a huge build-up of liquidity in the global financial system. With the formation of OPEC (Organisation of the Petroleum Exporting Countries) and the sharp spike in oil prices in the 1970s, oil-exporting countries recorded large surpluses on their balance of payments. These oil surpluses were held mostly as deposits with the international banking system based in and controlled by the developed world, making the private financial system a powerful agent for recycling surpluses. There was an explosion of global flows of financial capital, especially in the form of credit.

Simultaneously, one other factor contributed to the increase in international liquidity during the 1970s and 1980s. The confidence in the dollar stemming from the immediate post-War hegemony of the United States, which made it ‘as good as gold’, allowed it to ignore national budget constraints on its international spending. The U.S. built up large international liabilities during the Bretton Woods years, including those resulting from expenditures on the Vietnam War and its policing efforts elsewhere in the world.

Global finance plays a role

With the global financial system awash with liquidity, it began searching for new targets to lend to and invest in and discovered developing country “emerging markets”, whose exposure to foreign private finance was then low or nil. They had meanwhile opened their doors wider to cross-border inflows of foreign capital. India was one such country, which in the 1980s decided to exploit the new access to foreign finance. Between 1980 and 1991, India’s outstanding exposure to international debt rose from around $21 billion to close to $85 billion. Relying on this foreign finance, which could be used to import whatever was needed to relax domestic supply constraints, India on the one hand relaxed restrictions on trade, which widened trade and current account deficits, and on the other ramped up domestic spending by the government, leading to a sharp rise in the deficit on the government’s budget. Large foreign borrowing was accompanied by substantially enhanced domestic borrowing. It was this elevated spending that resulted in an improvement in India’s growth performance, with annual GDP growth rates rising from 3.5 per cent during the 1964-65 to 1979-80 period to 5.5 per cent during 1980-81 to 1990-91. Growth was riding on a spike in public debt.

The demand stimulated by public spending was serviced by the domestic industry with the help of imported capital goods, intermediates and raw materials, access to which was liberalised. This essentially meant that the import intensity of domestic production rose. But such growth was not foreign exchange constrained because of increased access to foreign loans. It was when international creditors chose to shut off such credit at the end of the 1980s that India ran into the balance of payments crisis of 1990-91, which provided the grounds for advocates of neoliberal reform to push through an IMF-style stabilisation and adjustment strategy.

Three elements highlighted by the 1980s experience are noteworthy. The first is that the turn to neoliberalism was possible only when India could access large sums of foreign finance. The second is that such access permitted the pursuit of strategies that allowed the resolution of a GDP growth impasse, even though that growth was accompanied by increased inequality and social deprivation. And the third is that the reliance on foreign finance increased external vulnerability and led to the balance of payments crisis of 1991 that set the stage for the open embrace of neoliberal ideology by the Indian state. In a bizarre turn, the crisis precipitated by the initial experiments with neoliberalism provided the justification for the shift from embryonic to full-blown neoliberalism.

At that time, it appeared that India was set for another period of prolonged slow growth. Foreign creditors who had walked out on India at the end of the 1980s were unlikely to return in the immediate future. And India’s turn to the IMF meant it had to agree to keep in place a lenient tax regime and not notch up large fiscal deficits. With such ‘austerity’, a return to the growth strategy of the 1980s appeared to be ruled out. That assessment, while not altogether wrong, missed out on several features of the global and domestic conjuncture. To start with, the international financial system was still flush with funds and needed to include as many countries as possible in its investment portfolio. Second, while India did experience a balance of payments crisis, it was no basket case and its external debt to GDP ratio was well below that of many other countries. Third, as part of the financial liberalisation that accompanied the 1991 shift to neoliberalism, India opened up its equity and bond markets, including its hitherto marginally active stock exchanges, to foreign investors. It also created new opportunities for financial investments by relaxing caps on stakes that could be held by foreign investors in domestic firms. Even if international banks were reticent to lend, there were opportunities for non-debt creating foreign capital inflows. Finally, realising that it could manage without the IMF and could release itself from the conservative fiscal stance the latter sought to impose, India walked out of its arrangement with the Fund without utilising in full all instalments of the standby line of credit it had negotiated in 1991.

1980s redux?

The turnaround in foreign capital inflows that followed, though not startling, was significant. From levels in the range of $100-300 million in the first three years of the 1990s, the combined inflows of foreign direct and portfolio investments rose to $5 billion or more a year in all years between 1994-95 and 1999-2000, except for 1998-99, the year following the Southeast Asian financial crisis. This allowed the government to muddle through with a strategy similar to what was experienced during the 1980s. Liberalised imports of technology, capital equipment and intermediates allowed the domestic production of a range of manufactured consumption goods that could not be imported. The release of hitherto pent-up demand for such commodities spurred growth in selected sectors. And the imports needed for the purpose could be financed through the inflow of capital. India’s total external debt stocks rose at a slower pace than in the 1980s, from $85 billion in 1991 to $100 billion in 2001, but the stock of private non-guaranteed debt that could be accessed in the liberalised environment grew from $1.6 billion to $17 billion. There was one other difference. Financial liberalisation meant that “innovative financing” methods adopted by the banking system were allowing it to expand its credit provision levels, supplementing debt financed public expenditures with some expansion in debt financed private spending. GDP growth remained reasonable, with the average annual rate during 1991-92 to 2000-01 touching 6.3 per cent—a tad higher than the 5.3 per cent of the 1980s. The average was higher, but yearly rates were volatile, with high growth in the mid-1990s.

Supply-side surge in foreign finance

The foreign capital-facilitated acceleration in growth did not stop there. When the surge in financial investments facilitated by easy money policies in developed countries occurred after 2003, India was a major beneficiary. Total foreign direct investment and portfolio flows rose from around $6.5 billion between 2000-01 and 2002-03 to $15.7 billion in 2003-04, $29.8 billion in 2006-07 and $62.2 billion in 2007-08, just before the global financial crisis. After a hiccup in the crisis year, investment flows revived and were in the $40-70 billion range in most years.

Also read: ‘A corporate-communal nexus has emerged’: Sitaram Yechury

As footloose capital of this kind came flooding in, the possibility of a sudden exit of large volumes of foreign finance increased. So did the pressure on the government, both to keep taxation lenient and to adopt a conservative fiscal stance with limited fiscal deficits and public borrowing. Such conservatism is a prime demand of global finance which fears that deficit spending will spur inflation and erode the value of financial assets, besides encouraging enhanced taxation in future to meet debt service commitments. To remain attractive and please finance, the government decided in 2003 to tie its hands legislatively with a defined pathway for deficit reduction. It enacted the Fiscal Responsibility and Budget Management (FRBM) Act. Its fallout was curtailed spending and limits on the ability of the state to drive growth as it did in the 1980s, for example.

However, this did not show up in the growth figures because a set of developments spurred debt financed private spending as a substitute for debt financed public spending, as is typical of all neoliberal environments. Following the rise of global finance, it was not just that the global financial system was flush with funds, but the flows from there ensured that the Indian financial system too was awash with liquidity. In both cases, underlying the unusual financial build-up, were the easy money policies followed by the central banks of developed countries. Those “unconventional monetary policies” involving large injections of liquidity into the system and extremely low interest rates were adopted in the run-up to the 2008 Global Financial Crisis (which was partly the result of those policies), as a response to the Great Recession that the financial crisis set off, and more recently, as a response to the COVID-19 induced economic crisis. In the event, the Indian financial system experienced a prolonged era when it was burdened with excess liquidity, which was reflected in a surge in the deposit base of the commercial banking system from 36 per cent of the GDP in the mid-1990s to close to 70 per cent by 2016-17. And, as happened in developed countries, that excess liquidity set off a credit boom and a flood of speculative financial investments in asset markets—equity and debt markets, housing and commercial real estate.

Tellingly, the ratio of outstanding advances of the scheduled commercial banks to the economy’s GDP rose sharply from around 20 per cent on average in the late 1990s and touched almost 60 per cent by 2013-14 before it began to decline marginally. The lending surge was mediated by a complex and diversified financial system created by financial liberalisation, populated with banks, non-bank financial companies, microfinance institutions and mutual funds. Retail loans for purposes varying from housing investments, automobile purchases, educational investments and day-to-day consumption swelled, and large corporate loans to individual firms or business groups financed capital-intensive investments, including in infrastructure, which banks relying on short-run deposits for capital had abjured in the past because of long lending cycles and illiquidity.

It was this debt-financed private spending that underlay the shift to a higher growth trajectory, capturing which is difficult because of the methodological changes starting in 2011-12 that made comparison of GDP figures difficult. However, based on the series with 2004-05 as base, GDP growth that averaged 5.9 per cent during 1994-95 to 2004-05 rose to 8.1 per cent during 2004-05 to 2011-12. The rate of investment rose from 28 per cent in 2002 to 36 per cent in 2007. Though it declined subsequently, it was close to 34 per cent until 2011, before falling sharply to 27 per cent in 2020. Those were the years of the great Indian neoliberal celebration. A propagandist government and an intoxicated elite declared India’s arrival on the global stage as the next Asian growth leader.

Bust of a bubble

But what the obsession with GDP growth missed was a brewing crisis in the form of a credit bubble rather than a boom. Accompanying the credit surge was a rise in bad debt, euphemistically labelled “non-performing loans”, with debtors unable to meet their debt service payments. Interestingly, for years, the government, the central bank and the banking system chose to conceal this canker in the system by restructuring the terms of debt in the hope that failed or failing investments would turn around. Most did not. As it became clear that the volume of bad debt being treated as standard had attained crisis proportions, the central bank had to issue a mandate to banks to recognise these non-performing assets for what they are. In the books, the official figure of the ratio of bad debt to gross advances rose from 5 per cent in 2014-15 to 15 per cent in 2017-18. Much of these loans were in the hands of a few large corporates. An almost conspiratorial nexus between the state, a largely state-run banking system and Indian big business had kept hidden a secret that showed that Indian neoliberalism was not a success, but just plain broken.

With the bad debt burden huge and too big for the government to help write off, the bubble went bust and bank losses rose. In time, the boom in credit showed itself to be what it was—unsustainable. The fuel that lubricated the short-lived neoliberal boom was less easy to come by. Growth decelerated significantly, even going by the inflated new series of national income with 2011-12 as base. But this evidence that neoliberalism had failed was concealed by a set of fortuitous developments that had their own effect on the growth process: the illogical and senseless demonetisation, the failed Goods and Services Tax regime and the COVID-19 pandemic. These alternative short-term explanations for the growth slowdown were and are used by advocates of neoliberal reform to divert attention from the end of the era of growth riding on a credit bubble.

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Meanwhile, the outcomes of financial speculation, driven in the first instance by foreign finance, are being used as proof of neoliberal success. The most obvious is the barometer of stock market activity, the benchmark Sensex. Close to 1,300 in July 1991 when accelerated liberalisation and neoliberal reform were announced, that index, after having displayed some volatility, rose to just above 5,000 at the end of 1999, only to lose momentum and fall to 3,500 by mid-2003. Then the speculative winds set in, and the Sensex rose to 20,000 by end-2007, only to fall to a half that value by end-2008 as the effects of the global financial crisis began to be felt in India’s financial markets. But by mid-2009, as central banks poured money into the global economy, the trend was reversed, the Sensex returned to its 20,000 level by September 2010, fluctuated in that neighbourhood until 2014, and then, as real economy growth began to slip, displayed much volatility but touched 25,000 by mid-2014, 30,000 in April 2017, 40,000 in late 2019 and 50,000 by February 2021. At the time of writing, it had touched 57,000. For those who knew how to ride the waves of speculation, there were many riches to be made. Those who did not, burnt their fingers.

The volatility and the danger of a financial collapse triggered by foreign investor exit notwithstanding, for many the stock market with the foreign institutional investor at the centre has come to symbolise what neoliberalism has to offer. If at Independence freedom from foreign capital was the objective and a marker of success, today it is the recognition of foreign investors as being an attractive playfield for speculation that is seen as a sign of arrival. It brings with it other speculative fortunes including those of the billionaires who built companies, often with no clear revenue models, to sell them to the speculator at mind-boggling valuations. Those fortunes often become the newer venture funds spurring on speculation. But skim off that cream and what we have is a failed growth experiment that rode on a bubble, which much of India’s working and unemployed poor have watched float above them. Unfortunately, they did not get to prick it.