Handling a modern economy

The government should have less to do with the management of the economy and concentrate on macro-economic stability and the improved efficiency of infrastructure and social services.

I CAME into government for the first time in 1971 and, within one year, moved to the Ministry of Finance. The (Indira Gandhi) Government had come to power with the promise to eradicate poverty. But as always, politics is the art of the possible. We were soon facing the twin spectacles of a drought and the crisis created by the increase in oil prices. By the end of 1973, the country was in the midst of an unprecedented inflationary crisis. That was when Mrs. Gandhi asked me whether I could devise a plan to combat inflation.

Essentially, we followed a strategy of demand compression. A number of subsidies were cut and fiscal and monetary policies were tightened. We launched the programme in the middle of 1974, and the country responded significantly to the policy initiatives.

Poverty cannot be removed in one go. Inflation is a worse tax on the poor. The income distribution consequences of inflation are also very regressive. Faced with a strong macroeconomic imbalance, no government could have done anything but restore a sense of balance to the economy.

Another significant thing at that time was that we had to increase exports substantially to absorb the impact of oil prices. Fortunately, after the initial impact, our exports did very well, both because of domestic demand management and because of the secondary effects of increased economic activity in the oil exporting countries of West Asia.

When the second oil price shock came in 1979, it again coincided with a drought and a phase of political instability. We still managed to bring inflation under control, but in a more gradual fashion.

IT was after the second oil shock that we went to the IMF. This was an idea which I mooted from the Planning Commission, because I wanted to have a safety net for the Sixth Five Year Plan. We had seen earlier that India's Plans could be disrupted by an unforeseen balance of payments crisis. At that time, Finance Minister R. Venkataraman was not very keen. But money was available at relatively low conditionality and I thought it was worth buying an insurance. The fact that our domestic oil production also started increasing at the same time was a fortunate circumstance. Although we did not utilise the whole of the IMF's advances, the growth targets of the Sixth and Seventh Plans were met.

If you look at the 1980s as a whole, India's growth performance of close to 5.5 per cent looks very respectable. Africa was down into negative growth rates, Latin America was down. That was the first decade in which India's long-term rate of growth went beyond the 3.5 per cent level, which Prof. Raj Krishna used to call the "Hindu rate of growth". Consequently, there was a sharp decline in the proportion of people below the poverty line.

There was a deterioration in the external current account. One reason was that the atmosphere for concessional aid flows worsened very sharply in the 1980s. The Americans brought China into the International Development Association in 1980, which reduced our share of funds. We started borrowing in international financial markets. And this burden became oppressive since these were essentially short to medium-term loans that were vulnerable to the kind of crisis of confidence that came in 1991. We had an unstable Government and another disruption of the economy in the form of oil prices. Foreign banks stopped lending and we were again in an international liquidity crisis.

ON the whole, liberalisation since 1991 has been extremely successful. Liberalisation has two aspects - the first is domestic deregulation and the removal of endless industrial restrictions. When an economy becomes very complex, it is a bit unrealistic to assume that planners have the best idea of who should invest and where. The whole system becomes too difficult to administer and it breeds corruption and inefficiency.

The second aspect is that we had an import regime that gave Indian industry infinite protection and really hurt its growth. Our industrial structure could not absorb modern technology, militated against exports, promoted excessive capital intensity, and was hence crisis prone. We wanted to remove these biases.

Unfortunately, in the first year of the reforms, we had to combine reforms with fiscal stabilisation. Since we had to cut expenditure to reduce the fiscal deficit, a certain deflationary bias was imparted. Superimposed over this in 1991 was the disappearance of the Soviet Union, which was responsible for about 20 per cent of our exports. So in the first year, our growth was very poor, industrial production did not expand, exports did not grow. But I think, after about 18 months, the beneficial effects of liberalisation became visible.

India has had one of the most successful structural adjustment programmes in the Third World. Nowhere else have we seen an economy bouncing back so fast from the initial contractionary effects of adjustment. Except for 1991-92, when the growth rate of the economy was less than 2 per cent, growth has been respectable every other year.

In a democracy we cannot impose burdens on the population beyond a certain point. But we could not go on investing on the basis of an ever-increasing fiscal deficit. In real terms, a country cannot spend more than it earns. Investment cannot exceed what we have as domestic savings plus whatever we can have as balance of payments deficit. The limited amount we can have as balance of payments deficit depends on what foreigners are willing to lend.

In the short run, if we want to cut expenditure, it is difficult to cut consumption. Those who are above the poverty line would respond by reducing their saving. The only people who have no option are the poor, who will have to reduce consumption.

IN the short run it is probably true that the burden of adjustment falls more on the poor. Although this is regrettable, we made the decision that the only way we could have an adjustment is to make it as brief as possible.

If you look at 1993-94, the proportion of people below the poverty line was lower than in 1987-88, when the data was last available. After 1993-94 we increased the outlays on anti-poverty programmes very substantially and the public distribution system was expanded. When later data becomes available, I think they will show a further decrease in poverty.

I am willing to concede, however, that in the first two years or so, there may have been a temporary increase in the incidence of poverty. But the combined impact of accelerated growth, export improvement and increased outlays in the social sectors, has reduced poverty.

I would be the last to suggest that you can move mountains on the poverty front in a period of five years, of which two were spent in crisis management. But I am not persuaded that the incidence of poverty increased as a result of the reforms. We should avoid the tendency, as my teacher at Cambridge, Prof. Joan Robinson, used to say, of comparing the principles of Christianity with the practice of Islam. We must compare them like for like. Those who say that things were better before the reforms have an obligation to show whether what was happening in 1991 could have been sustained for much longer.

You cannot remove poverty in this country without strong and broad-based economic growth. Further, this growth must be labour-intensive and must permeate agriculture. Our growth until 1980 and even afterwards was highly capital intensive. In the 1980s, India's industrial production grew at the rate of 8 per cent. Yet private industry did not create new jobs because of the implicit policy bias against labour-intensive production.

To realise the potential over the next few years, we have to handle our fiscal adjustment well. The fiscal deficit at the Centre has declined, but it is still high at the State level. On a sustained basis, we cannot bring interest rates down if we do not have fiscal correction. The task is to bring the fiscal deficit down without cutting public sector investment. For that, we have to tackle subsidies and other consumption expenditures. So much depends upon politics - a national consensus has to be built up. And I am worried that many of these subsidies are going up rather than down.

We also face an infrastructural crisis. Until now, the bulk of our infrastructure investment has been in the public sector. Over time, the public sector has become a more inefficient provider. For instance, if public sector electricity was better managed, there would be less need to rely on private enterprise. I think the private sector should come in at the margin in all these sectors, but there is no way that the public sector can wish away its role.

ANOTHER crisis area is human resources development. There I think India has not performed well at all. Growth is necessary, but I do not think that growth will automatically trickle down, particularly with regard to the Scheduled Castes and Tribes and Other Backward Classes. If we are serious about giving them access to the benefits of economic growth, then we should pay special attention to their educational needs. Of special concern should be the needs of first generation learners - children from families with no tradition of learning. Our school system does not make that distinction. We need more pre-primary day care centres and classes that will pay special attention to these children. This calls for a large-scale, decentralised initiative.

Indian democracy is now entering a new phase. Power is passing into the hands of people who have no experience in handling a modern economy. That is perhaps inevitable. The whole process of democratisation will bring new sections into political leadership. But those in power do not think it wrong to use their power to influence decision-making for personal advancement - the award of contracts, for instance. This makes it all the more necessary for the depoliticisation of economic policy to be carried further. If politics is going to be played the way it is, then it is necessary that the government should have less to do with the management of the economy and concentrate on macro-economic stability and improved efficiency of infrastructure and social services. The economy should not be allowed to suffer till such time as India evolves a new and coherent politics.

As told to Sukumar Muralidharan in New Delhi.