Three decades ago, India embarked on a new economic adventure when Manmohan Singh, then Minister of Finance, introduced the reform bill and echoed Victor Hugo: “No power on earth can can stop an idea whose time has come. “ in Parliament. Since then, the crisis-stricken economy has come a long way and marked its firm presence in the global platform.
In the early 1990s, India was reeling from double-digit inflation, gross budget deficits above 7.5% of GDP, domestic debt close to 54% of GDP, and foreign exchange reserves were sufficient to sustain it. hardly cover the fifteen-day import invoices. In addition, there was a new government at the Center.
With an imminent economic crisis and political confidence on the verge of collapse, the economy was at its nadir. It was a “TINA” (there is no alternative) situation for Singh, to turn the crisis into an opportunity and to undertake long overdue structural reforms.
Liberalization began with a dose of devaluation and was followed by a series of policies which together have been called LPG (Liberalization, Privatization and Globalization) reforms. As always, the change was not welcomed by everyone. There was political resistance inside and outside the ruling party as many were not optimistic about its success.
Thirty years later, from a GDP of $ 512.92 billion in 1991, India had grown to $ 2.70 trillion (in constant 2010 dollars) by 2020. In addition, the average annual growth rates of GDP, after the 1990s, were around 6.25% against 4.18% for the three decades preceding the reforms.
Thanks to the increase in the share of services relative to the erratic agricultural sector, post-reform growth rates have been less volatile than in previous years. The coefficient of variation of annual GDP growth rates fell from 80% in the period 1961-1990 to 30% in 1991-2020. Inflation and public deficits have also become favorable.
Average annual inflation rates during the post-reform period were well below around 5 percent and the gross budget deficit below 4.80 percent of GDP. While limiting the automatic monetization of deficits and strong monetary policies helped lower inflation, it was divestment through privatization and budget cuts in the form of lower subsidies that halted the deficits.
On the external front, the reforms have also had a significant impact. First, India’s trade openness fell from a meager 13% in 1990-91 to 42% in 2020. Exports, driven by the devaluation of the rupee in 1991 and further depreciation in the following years, rose from $ 17.96 billion in 1990 to $ 324.43 billion in 2019.
Abolition of the permitraj and the reduction in excessive regulation has been rewarded in terms of better foreign investment. From 236.69 million dollars in 1991, net FDI inflows amounted to 50.61 billion dollars in 2020. With the entry of more and more foreign firms in India, domestic consumers have benefited from ‘healthy competition in the market. For Indian manufacturing, foreign collaborations meant access to technology and, therefore, efficient production. In addition, there has been a significant improvement in foreign exchange reserves, which are now sufficient to cover 15 months of imports.
The openness of the economy also makes it vulnerable to external shocks. A few years after the reforms, India’s first challenge came from its East Asian neighbors in 1997. Within three years, the global economy was hit by the dot-com bubble, and the Third challenge came in the form of the global financial crisis in 2008. It was prudent economic policies and disciplined financial markets that helped the Indian economy resist and recover quickly from the three crises.
The reforms have also had a revealing impact on the socio-economic fabric of India. From about 45% of the population below the national poverty line in 1994, rates fell to 21.9% in 2011. There have also been improvements in literacy rates, gross enrollment rates and life expectancy, among others.
However, a major criticism of the reforms was that they widened the gap between the rich and the poor. World Bank estimates show that the Gini index, a measure of income inequality, deteriorated slightly, from 31.7 in 1993 to 35.7 in 2011.
According to the ONSS consumption surveys, while the poorest 20 percent of the population contributed 9.20 percent of consumption expenditure in 1993-94, their contribution decreased to 8.10 percent in 2011-12. In addition, the share of the richest 20 percent of the population fell from 39.70 percent to 44.70 percent over the same period.
The heterogeneity of the Indian population, which leads to variable adjustment capacities, is one of the main reasons for the increase in inequalities. Inequalities can also arise from structural changes induced by reforms. While increasing the share of the service sector in GDP has its benefits, it has also resulted in a reduction in the share of agricultural income in total GDP. With almost 42 percent of the labor force employed in agriculture, a reduction in the income share would imply a larger gap between the respective income.
Turning the crisis into an opportunity is riskier than it looks. In the current scenario, India must act quickly to avoid a looming crisis. If left unresolved, the growing NPA problem can exacerbate banking sector balance sheet imbalances. This would require reforms to make the banking and financial sector more transparent and accountable.
While Covid-19 was a blow, the economy was already showing signs of deteriorating growth even in the periods leading up to the pandemic. This would require immediate intervention to tackle the problems of unemployment, poverty and other social problems. The pandemic has also raised concerns about existing health infrastructure and the future of education. The government must invest more in these sectors.
Gopakumar is part of the Faculty of Economics, SSSIHL, and Rajendra is part of the Faculty of Economics and Finance, IIT Patna