An overview


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ECONOMIC growth is the principal yardstick of macroeconomic performance. By this standard, the two decades since 1980/81 have been easily the best in the last half-century of India’s economic performance. After averaging the so-called ‘Hindu rate’ of 3.6% per year in the 30 years between 1950/51 and 1980/81, GDP growth accelerated to 5.6% in the ’80s and averaged even higher at 5.8% in the final decade up to 2000/01. Indeed, if the crisis-affected year of 1991/92 is omitted, as it reasonably should be, GDP growth in the past nine years (1992/93-2000/01) averaged an unprecedented 6.3%.1

Furthermore, the growth performance of the ’80s was bedevilled by the emergence of unsustainable fiscal deficits and increasing strains in the external accounts, which triggered the crisis of 1991. In the last nine years, although the fiscal imbalances have waned and waxed, the external sector has been far more manageable. Clearly, this has been a golden decade (almost) of growth for India. The trend in decadal growth rates looks even better when we look at per capita GDP growth, which accelerated from 0.8% in the ’70s to 4.4% in the last nine years. If we think of per capita GDP as a rough proxy for average living standards of India’s population, the last two decades have shown welcome improvement.

India’s growth performance in the last two decades of the 20th century also looks good in international perspective. Virmani (1999) ranks India sixth in the world growth league after China, Korea, Thailand, Singapore and Vietnam. This is certainly a far cry from the conventional image of the Indian economy as a lumbering, shackled giant trailing far behind most significant emerging market economies in the growth race. Even more heartening is Virmani’s finding that India retains sixth position, even when the ranking is redone in terms of per capita GDP growth.

A closer look at the last decade raises several interesting points. First, comparing performance in the last nine years to the pre-crisis decade, it is interesting that the acceleration in GDP growth (from 5.6 to 6.3%) is entirely attributable to the services sector where growth surged to 8.1% from an already high 6.7% in the ’80s. Indeed, the growth of both agriculture and industry averages a little slower in the post-crisis nine years compared to the pre-crisis decade. Second, focusing now on the post-crisis quinquennium, the acceleration of GDP growth to 6.7% from the pre-crisis decadal average of 5.6% is quite remarkable. Clearly, economic policy (including macro policy) was getting some things right! Third, it is noteworthy that in the post-crisis quinquennium all the major sectors (agriculture, industry, services) grew noticeably faster than in the pre-crisis decade. Fourth, in both the pre-crisis decade and the post-crisis quinquennium, the sectors of industry and services grew at almost identical rates.



The good news ends when we look at the average growth performance in the four most recent years. Overall GDP growth drops to 5.8%. Much more disquieting is the collapse of agricultural growth to 1.4% (from over three times the rate in the Eighth Plan period) and the significant fall in industrial growth down to 4.9%. Indeed, the drop in GDP growth in these four years would have been much steeper but for the extraordinary buoyancy of services which averaged growth of 8.8%. This growth in services was much faster than industry, a pattern that is quite different and novel compared to our past experience and, at the very least, raises questions of sustainability.

In both the pre-crisis decade and the post-crisis quinquennium services accounted for a little under half of GDP growth. For the full nine years, post-crisis, the growth-contributing role of services was almost 60%. Even more remarkably, the proportion rose to 70% in the last four years. Without wishing to be labelled as a commodity-fetishist, such numbers surely raise genuine issues of both plausibility and sustainability.



A part of the services sector growth in the last four years was ‘spurious’ in the sense that it simply reflected the revaluation of the value added in the sub sector ‘Public Administration and Defence’ because of higher pay scales resulting from decisions on the Fifth Pay Commission. It is a peculiarity of national income accounting conventions that value added in non-marketed services is estimated on the basis of cost. These Pay Commission effects (including knock-on effects in states) were spread mainly over three years, 1997/98, 1998/99 and 1999/2000, when ‘real’ growth of ‘Public Administration and Defence’ soared to 14.5%, 10.3% and 13.2%, respectively, compared to an average growth in the previous five years of less than 4%.

Subtracting the trend growth from the exceptionally high reported growth rates gives a measure of the ‘spurious’ (or Pay Commission effected) growth in these years, which we also subtract from overall GDP growth in the relevant years. This adjustment reduces GDP growth by 0.5% in 1997/98 and 1999/2000 and by 0.4% in 1998/99. The adjusted (net of Pay Commission effect) GDP growth becomes 4.3% in 1997/98, 6.2% in 1998/99 and 5.9% in 1999/2000. As a result of these adjustments, the average GDP growth in the last four years 1997/98 to 2000/01 drops to 5.4%, which is below the 5.6% average for the pre-crisis decade and substantially lower than the 6.7% achieved in the post-crisis quinquennium.2

A serious investigation of the determinants of growth in the last decade is far beyond the scope of this paper. But we can essay a brief heuristic story. GDP growth collapsed to 1.3% in 1991-92 as the balance of payments crisis of 1991 took its toll. The stabilization and structural reform measures of 1991-93 restored macro-economic stability and fuelled one of the swiftest recoveries of economic dynamism seen anywhere in the world in recent decades (see Acharya 1995, 1999). GDP growth recovered to nearly 6% in 1993/94 and exceeded 7% in each of the next three years.



Manufacturing recorded average real growth of 11.3% in the four years 1993/94 to 1996/97. Export growth in dollar terms averaged 20% in the three years 1993/94-1995/96 and the rates of aggregate savings and investment in the economy peaked in 1995/96. Real fixed investment rose by nearly 40% between 1993/94 and 1995/96, led by a more than 50% increase in industrial investment. It was, manifestly, boom time for the Indian economy.

The year 1997 was a watershed which rang in the end of the economic party. In particular, three marker events occurred within a six-month period to check the momentum of growth. In March, the instability inherent in coalition governments became manifest in the political crisis which ended the Deve Gowda government and ushered in the Gujral version of the United Front government. In July, the Thai financial crisis raised the curtain on the Asian crisis saga, which dominated the international economic arena for next 18 months. Finally, in September, the Gujral government announced its decisions on the Fifth Pay Commission report, decisions that were to prove costly for both the fiscal and economic health of the country.



Economic growth fell to 4.8% in 1997/98, 4.3% if the ‘Pay Commission effect’ is netted out. Agriculture recorded negative growth in value added, while the growth of manufacturing slumped to 1.5% from 9.7% in the previous year. Only services boomed at 9.8%. Although industrial expansion remained subdued, GDP growth recovered smartly in 1998/99 thanks to a strong rebound in agriculture and continued buoyancy in services. Growth was sustained in 1999/2000 by a temporary recovery in industry. In 2000/01, renewed industrial deceleration and virtual stagnation in agriculture pulled GDP growth down to 5.2%.

The marker events of 1997 are by no means the only reasons for the deceleration in India’s economic growth after 1996/97. Others included the petering out of productivity gains from economic reforms, which clearly slowed after 1994. Although reforms continued throughout the decade, they never regained the breadth and depth of the early ’90s. Key reforms in the financial sector, infrastructure, labour laws, trade and industrial policy, bankruptcy provisions and privatization remained unfinished or undone.

Real investment in industry, which had risen fast until 1995/96, plateaued thereafter for several reasons, including the political instability associated with three general elections and a succession of coalition governments, rising fiscal deficits after 1996/97 that kept real interest rates high, and the loss of momentum in reforms. Third, despite good intentions, the bottlenecks in infrastructure became worse over time, especially in power, railways and water supply, reflecting slow progress in reforms of pricing, ownership and the regulatory framework.

Fourth, the low quality and quantity of investment in rural infrastructure combined with distorted pricing of some key agricultural inputs and outputs to damp the growth of agriculture. Fifth, the continuing decline in governance and financial discipline in (especially, but by no means exclusively) the populous states of the Gangetic plain constrained growth prospects for over 30% of India’s population. Finally, aside from the Asian crisis of 1997/98, the economic sanctions of 1998/99 and the rebound of international oil prices in the last two years have together made the international economic environment less supportive than in the Eighth Plan period.

The above discussion omits the important issue of the evolution of potential GDP over time and the gaps between potential and actual GDP. Some interesting work has been done by RBI analysts Donde and Saggar (1999) showing much lower differences between potential and actual growth in the post-1991 period as compared to the previous four decades. Although the study is not conclusive, it does suggest that macroeconomic policy has had greater success in attaining the economy’s output potential in the last decade than in any previous period.



If growth is the key measure of macroeconomic performance, inflation (or rather its absence) is the generally preferred indicator of macroeconomic stability. The 1950s was the best decade in the last half century as far as inflation is concerned; the ’70s had the worst record, with annual inflation averaging in double digits. This is mainly because the decade straddled the two oil shocks of 1973/74 and 1979/80. In both the decades since 1980/81 inflation has averaged in the 7 to 8% range: the average annual rate was 7.2% in the ten years upto 1990/91 and 7.8% in the 10 years since. If the crisis year of 1991/92 is omitted, the average rate of inflation in the last nine years was 7.1%.



How does India’s inflation record stack up in international perspective? In the ’80s India’s average inflation rate of 7.2% was close to the average rate for Asian Developing Countries as a group (7.1%), a little above the average rate for the ‘Advanced Economies’ (5.6%) and much lower than the average for all Developing Countries (39.0%), which was driven high by Latin American inflation (145.4%).

In the most recent decade a similar pattern is repeated except for the conspicuous difference that inflation in Advanced Economies is very low at 2.6%, or one-third the average rate for India. Two other points are noteworthy. First, although the average inflation recorded by Asian Developing Countries is marginally higher than India’s for the decade, the Asian group does better than India in the two most recent years. Second, Latin American inflation has dropped to single digits in the last three years.

All of this suggests that in the closing years of the 20th century the inflation dragon had been slayed in most parts of the world. This was both a boon to India (in helping contain price increases of freely traded commodities) and a challenge to keep inflation low or suffer the penalties in competitiveness and exchange rate volatility.

As with economic growth, inflation is a multi-causal phenomenon, which defies simple explanations. A short heuristic story would run as follows.

The balance of payments crisis of 1991 and attendant severe restrictions on imports disrupted industrial production. Coupled with a bad year in agriculture these supply problems propelled inflation to nearly 14% in 1991/92. Inflation moderated in the next two years as the stabilization programme took hold and confidence in macromanagement was restored. By the second half of 1993/94 the restoration of confidence and liberalization of foreign investment policies had triggered a temporary surge in foreign capital inflow, which added over US$ 12 billion to foreign exchange reserves between September 1993 and October 1994.



As a result, reserve money shot up by 25% in 1993/94 and by over 22% in 1994/95, fuelling broad money growth of over 18% in 1993/94 and 22% in 1994/95.3 This surge in liquidity pushed inflation back up to 12.5% in 1994/95. By the following year monetary growth had been curbed and the simultaneous boom in industry and imports ensured an easy supply situation, resulting in moderation of inflation down to 8%.

In 1996/97 aggregate demand cooled as both investment and exports levelled off after the boom in the preceding three years. The supply situation remained easy with strong growth in agriculture and industry. More significant for the medium-term, the cumulative impact of import liberalization and customs tariff reductions combined with low world inflation in manufactures to bring down the increase in the wholesale price index for manufactures, WPI(MP), to 2.1% in 1996/97. As a result, the increase in the overall WPI dropped to 4.6% in 1996/97.

From 1996/97 onwards inflation in India has remained low, powerfully influenced by the prevalence of very low inflation in industrialized countries and (therefore) internationally traded manufactures, combined with an increasingly open trade regime in India. Core inflation, measured by WPI(MP), stayed around 3%, except for a blip up to 4.4% in 1998/99.

Since manufactures have a weight of about 64% in the WPI, low increases in WPI(MP) have translated into low inflation in the WPI. In two years there were sharp spikes in the indices for ‘primary articles’ and ‘fuel, power, light’, which temporarily raised the rate of WPI inflation. In 1998/99 the spike was due to the flare up in prices of a handful of agricultural commodities, especially onions and potatoes. In 2000/01 the major increases in petroleum prices were the main culprit.

The relatively low inflation in the second half of the decade also reflected two other factors: mostly moderate increases in money supply and, more worryingly, the apparent slack in autonomous investment demand.



The external sector of India’s economy was the focal stress point of the 1991 balance of payments crisis. Perhaps for that reason it saw the most far-reaching reforms and successful responses to reform initiatives. As I have dealt with these issues in some detail in a separate paper (Acharya 1999), I shall be relatively brief here.

The 1991 crisis had manifold roots, including a series of high fiscal deficits, excessive regulation of industry and trade and a weakening financial sector. Within the external sector itself the key contributory factors included an overvalued exchange rate (aggravated by real appreciation of the rupee in the first half of the 1980s), foreign trade and payments policies biased against exports and growing recourse to various forms of external borrowing to finance a series of large trade and current account deficits in the latter half of the ’80s.



The extent of anti-export bias in the trade and payments regime can be gauged by the fact that in 1985/86 merchandise exports accounted for only 4.1% of GDP, while imports were running more than 80% higher at 7.6% of GDP, entailing a trade deficit of 3.5% of GDP. Although an active policy of real exchange rate depreciation in the second half of the ’80s induced good export growth in the later years of the decade, it was a case of too little too late. Moreover, the growth of exports was offset substantially by a steady decline in net invisible earnings.

For the five-year period 1985-90, the trade deficit averaged 3% of GDP, while the current account deficit averaged 2.2% of GDP. These deficits were financed by growing recourse to various sources of external borrowing including external assistance, commercial borrowing and increasingly expensive NRI deposits. Foreign exchange reserves were also run down. Foreign investment was a negligible 0.1% of GDP. By 1990/91, the trade deficit of 3.0% of GDP was fully reflected in a peak current account deficit of 3.1% of GDP, since invisibles had turned marginally negative.

The growing recourse to external borrowing in the second half of the 1980s had led to a substantial deterioration in India’s external debt indicators. The debt service ratio rose to a peak of 35% in 1990/91. The external debt stock to GDP ratio peaked at 39% at the end of 1991/92, as did the debt to exports ratio at 563%. The proportion of short-term debt (by original maturity) in total external debt attained its highest level in March 1991 at 10.3%. As a ratio to foreign currency reserves, short-term debt soared to a dangerous 382%, signalling the heightened fragility of India’s external finances.



The Gulf War of 1991 and the associated oil price hike tipped India’s fragile external finances into a full-blown balance of payments crisis. To contain the crisis and restore economic health, the new Congress government of June 1991 initiated a wide-ranging programme of stabilization and structural reform. Without going into the details of the programme, the salient thrusts that directly relate to the external sector may be summarized:

* The exchange rate was devalued and the system transformed in less than two years from a discretionary, basket-pegged system, to a market-determined, unified exchange rate, following a short intermediate period of dual rates.

* The heavy anti-export bias in the trade and payments regime was reduced substantially by a phased reduction in the exceptionally high customs tariffs and a phased elimination of quantitative restrictions on imports.

* Policies were initiated to encourage both direct and portfolio foreign investment.

* Short-term debt was reduced and strict controls put in place to prevent future expansion. Medium-term borrowing from private commercial sources was made subject to annual caps and minimum maturity requirements.

* Growth of NRI deposits was moderated through reduction of incentives.

* Foreign exchange reserves were consciously accumulated to provide greater insurance against external sector stresses and uncertainties.

As a result of these measures and other reforms in industrial, fiscal and financial areas, the performance of the external sector over the last decade has generally been strong. The stabilization measures of 1991/92 reduced sharply imports, the trade deficit and the current account deficit. Import growth recovered and surged in the mid-’90s, but the current account deficit remained well below 2% of GDP because of the concomitant buoyancy of exports and the strong recovery of net invisible earnings. This surge in net invisibles to an average level of over 2% of GDP in the last five years may be attributed in part to the strength of the world economy, in part to the rational incentives embedded in a market determined exchange rate system and in part to the strong growth of software service exports.



Merchandise exports grew at about 20% a year in dollar terms for three successive years between 1993/94 and 1995/96 and then decelerated to negative growth in 1998/99 before recovering again to record 20% growth in 2000/01. Despite the sluggish performance of exports between 1996/97 and 1998/99, the trade deficit remained below 4% of GDP thanks to the equally subdued growth of imports, especially non-oil imports. The continuing deceleration in non-oil import growth largely reflects the slow growth of industry in recent years.

Portfolio foreign investment responded smartly to new initiatives and climbed quickly to a peak of $ 3.8 billion in 1994/95. Direct foreign investment rose more slowly but steadily to a peak of $ 3.6 billion in 1997/98, before falling off significantly thereafter. Taken together, foreign investment peaked at $ 6.2 billion 1996/97 or just 1.6% of GDP, which compares quite unfavourably with the record of a number of East Asian and Latin American countries, including China and Brazil, where FDI has attained 5% of GDP in recent years.



Comparing the latest decade to the late ’80s, three sources of foreign borrowing have clearly declined in significance: external assistance, NRI deposits and IMF financing. On the other hand, net external commercial borrowings have fluctuated, reaching peak levels in 1998/99 and 2000/01 because of exceptional recourse to Resurgent India Bonds and India Millennium Deposits, respectively.

Taking the constituent elements together, it is noteworthy that the capital account surplus reached its peak in 1993/94 (at 3.5% of GDP) and has been well below that level in all subsequent years. Nevertheless, except for 1995/96, the capital account surplus has been large enough in relation to the corresponding current account deficit in each of the last 10 years, to ensure accretion to foreign exchange reserves. Such reserves have increased from $ 5.8 billion in March 1991, representing 2.5 months of import cover to $ 42.6 billion 10 years later, amounting to more than eight months of import cover.

We noted earlier how external debt indicators clearly signalled in 1991 the fragility of India’s external finances. However, a sustained and remarkable improvement in these indicators over the decade, reflecting the success of India’s external sector policies in general, and prudent approach to external debt in particular, can be noted. By March 2000 the debt service ratio had more than halved (from its peak) down to 16%. The external debt to GDP ratio had fallen to 22%. The proportion of short-term debt (by original maturity) was at a comfortable level of 4.1%. Perhaps most telling, the ratio of short-term debt to foreign currency assets had plunged from its perilous height of 382% in March 1991 to a sanguine 11.5% in March 2000.



A critical instrument in bringing about healthy outcomes in the external sector has been exchange rate policy. The transition from the prevailing (undisclosed) basket-pegged system in June 1991 to a unified, market determined system was accomplished in a phased manner and with considerable finesse. By August 1994 India had committed to current account convertibility under Article VIII of the IMF. Following the unification of the exchange rate in March 1993, the authorities (especially the RBI) operated the ‘managed float’ of the rupee with the twin objectives of fostering India’s international competitiveness while containing day-to-day market volatility. The instruments deployed by RBI to manage the float have included exchange market intervention, occasional administrative measures and monetary policy.

However, these indices fail to capture possible deterioration in India’s competitiveness in major markets relative to a number of East Asian competitors (notably, Thailand, Malaysia, Philippines and Indonesia) whose nominal exchange rates underwent substantial depreciation during the East Asian crisis of 1997-98 (see Krueger and Chinoy, 2001). If this dimension is factored in, it is quite possible that the rupee’s prevailing exchange rate in the closing years of the decade has been somewhat overvalued from the vantage point of India’s export competitiveness.

On the other hand, India’s exchange rate policy has achieved considerable success in damping volatility in nominal rates, especially during periods of international currency market turbulence and contagion that prevailed in 1997 and 1998.



Growth, inflation and external balance are the main ultimate targets of macroeconomic policy. These are the aggregate variables by which an economy’s macro performance is most commonly evaluated. However, there is almost as much interest in a set of intermediate target variables that lie at the heart of macroeconomic policy, namely fiscal deficits, savings and investment. Each of these, especially fiscal deficits, warrant some commentary.

It is generally agreed (though not unanimously) that a series of large fiscal and revenue deficits is inimical to macroeconomic performance.4 Such deficits tend to crowd out private investment, increase inflationary potential, weaken the balance of payments, render financial sector reform more difficult and impose a serious burden of adjustment on future generations. The series of high fiscal deficits in the late ’80s were clearly a major cause of the 1991 economic crisis in India. Let us look at the trends since then.

The following trends are noteworthy regarding the consolidated picture:

* The gross fiscal deficit increased significantly from an average of 7.2% in the 5 years 1980-85 to 8.9% in the next quinqennium, 1985-90, and even further to 9.4% in 1990/91.

* There was a reduction of over 2% of GDP in the gross fiscal deficit in 1991/92, brought about essentially by the Central budget of that year and in the context of an IMF loan programme initiated to help cope with the balance of payments crisis of 1991.

* This correction was largely negated by a very large Central government fiscal slippage (relative to budget targets) in 1993/94, timed, perhaps not coincidentally, with the end of the IMF programme in spring 1993.

* The lost ground was quickly recovered and further consolidated in the next three years, with the lowest consolidated fiscal deficit for the decade of 6.4% of GDP recorded in 1996/97. This coincided with and was largely a result of the Centre’s achieving its lowest deficit in the decade (indeed in 20 years) of 4.1% of GDP.

Before leaving the subject of fiscal deficits, a quick glance at international comparisons of fiscal deficits reveals that India’s deficit is emphatically on the high side. Out of 74 countries with population more than 10 million for which the IMF has fiscal data, only seven recorded a general government deficit higher than 7% of GDP in 2000. India is one of this ‘magnificent seven’. And of these seven, only two countries, Turkey and Zimbabwe had a higher deficit than India. The warning bells are ringing loud and clear!



As we would expect, the trends in the overall fiscal position, especially in revenue deficits, find reflection in India’s public savings performance. Public savings in the ’90s reached its peak of 2.0% of GDP in 1995/96, the year when the consolidated revenue deficit was at its lowest mark in the decade. Subsequently, as the consolidated revenue deficit nearly doubled to 6.2% of GDP in 1999/2000, an increase of 3% points of GDP, public savings fell by almost the same percentage of GDP, becoming a negative 1.2% of GDP by 1999/2000.

This sharp decline in public savings between 1995/96 and 1999/2000 fully explained the drop in the ratio of gross domestic savings from its peak of 25.1% of GDP in 1995/96 to 22.3% in 1999/2000. Private savings was at its highest in the decade in 1999/2000 at 23.5% of GDP; indeed it was a little higher than in 1995/96. Furthermore, this was achieved essentially through continued buoyancy of house-hold savings and despite some reduction in corporate savings.

Not surprisingly, the gross investment ratio mirrors the trend in the savings ratio, attaining a peak level of 26.8% of GDP in 1995/96 and then dropping by 3.5% points of GDP to 23.3% in 1999/2000. It is quite uncanny how the deterioration of 3% points of GDP in the consolidated revenue deficit between 1995/96 and 1999/2000 is reflected almost exactly in the worsening of aggregate savings and investment ratios over the period. It would be hard to find more telling presumptive evidence of the adverse impact of fiscal deficits on savings and investment. Another way to look at this is that if the fiscal deterioration since 1995/96 had not occurred, savings and investment might well have been higher by at least 3% points of GDP in 1999/2000. Indeed the beneficial impact might well have been greater because of the effect of lower real interest rates on the buoyancy of private, especially corporate, investment and savings.



The ’90s have ended but macroeconomic challenges continue. I discuss briefly some of the main problems that confront macroeconomic policy today and are likely to pose continuing challenges in the years ahead.

First and foremost is the enduring problem of the fiscal deficit. As we saw earlier, with a consolidated general government deficit of around 10% of GDP India has the dubious privilege of being in the top three countries in worldwide fiscal deficit rankings. The ratio of central and state government debt to GDP also stands impressively high at about 70%. Our own economic history and that of many other countries points to the unsustainability of such high ratios and to the enormous economic toll they exact.5



Furthermore, the problem of debt sustainability is likely to become more pressing if the present slowdown in economic growth continues. The sooner there is significant and enduring progress in fiscal consolidation the better it will be for overall macroeconomic performance, the health of the financial sector and the economy’s capacity for coping with unforeseen external or internal shocks. The best medium term hope in this regard is the Fiscal Responsibility and Budget Management Bill tabled in Parliament in December 2000. Much will depend on its legislative fortunes.

In the short run there is no substitute for determined efforts at expenditure containment, better cost recovery and revenue mobilization at all levels of government. In any case, even if the FRBM Bill is enacted in its present form, meeting its targets will require the same set of coordinated and comprehensive policies for fiscal consolidation.

Second, recent months have brought home the high economic costs that can emanate from a weak and inefficient financial sector. It is a drag on overall economic performance, generates periodic and large claims (through bail-outs of foundering financial institutions) on an already weak fisc, weakens significantly the competitiveness of Indian firms and can profoundly cloud the climate for business investment.

Prescriptions for necessary financial sector reform have been around for a long time, for example the ‘second’ Narasimham Committee report on banking sector reforms (GOI, 1998) and the report on restructuring weak public sector banks brought out by the RBI (Reserve Bank, 1999). The challenge is to move forward with implementing the key prescriptions in the face of political and administrative opposition.6 Indeed in some areas the time may have come to go further than some of the recommendations in these reports.



Third, the challenge of a sluggish industrial economy continues. To a substantial extent, real progress with fiscal consolidation and financial sector reform will enhance the climate for industrial investment and improve the availability and terms of financing. This will certainly help the industrial sector. But some of the solutions to the problem lie outside the realm of macro policy. For example, successful reform of rigid labour laws, small-scale reservation policy and ill-functioning infrastructure sectors is crucial for improving industrial productivity and investment. Unless these problems are seriously tackled the best macro policy will only have limited impact on boosting industrial growth.

Nor does the oft-touted solution of ‘pump priming’ have much credibility when fiscal deficits are already so dangerously high. And sector-specific tax sops (often advocated by industry associations) could set back seriously the genuine progress achieved in tax reform without accomplishing any lasting favourable impact on overall industrial growth. Indeed, a continuing challenge for economic policy will be to avoid inappropriate and ill-conceived solutions to the very real problem of growth slowdown.



In the external sector some disquieting signs have emerged in recent years. Export growth in dollars has slowed to average below 10% in the last five years and the outlook for 2001/2002 and beyond is clouded by the slowing world economy and our weakening international competitiveness. Foreign investment has fallen substantially from the peak level of 1996/97. The future debt service profile has to navigate the redemption humps of RIBs and IMDs. Until now the continued buoyancy of inward remittances and software exports and the sluggishness of non-oil import growth have outweighed these weaknesses.

But the tide could turn, especially if exports of both goods and services are seriously hurt by the global slowdown that began in the second half of 2000. In the short run this will pose a challenge for appropriately flexible exchange rate management. In the medium term, there is no alternative to improving the underlying productivity and competitiveness of the economy through the wide range of structural reforms indicated earlier.

Policies will also have to contend with tensions between the priorities for stabilization on the one hand and structural reform on the other. An important example of this is in tax policy. To enhance our competitiveness and reduce the policy bias against exports it is important to reduce our still exceptionally high customs tariffs. But with customs revenue still accounting for about 30% of the central government’s gross tax revenues, reductions in customs tariffs will have to be carefully managed to avoid missing fiscal deficit targets. The solution to this dilemma is to increase the proportion of tax revenues coming from direct taxes and domestic commodity/service taxes, notably central excise. It is relatively simple to state the necessary direction of change, much harder to carry it out in practical policy.

In the decades ahead, there is likely to be a growing need to coordinate the central government’s budget policy with that of the states. Already we have seen the rising share of state deficits in consolidated deficits of the centre and states. This has had serious implications for the management of overall fiscal policy. Coming to grips with this problem will necessarily require changes in the existing pattern of inter-government fiscal relationships, a difficult task in the best of circumstances.



The recent injection of some conditionality in central financial assistance to states (linked to medium-term fiscal reform at the state level) may have to be strengthened. The key objective has to be the reversal of the recent deterioration in the states’ fiscal positions. Without such improvement both macroeconomic stability and development momentum will remain exposed to substantial risks.

Finally, there is urgent need to recapture the growth momentum of the mid-90s, not only in industry but also in all sectors of the economy. Most of the policy initiatives necessary to achieve this overarching objective are of a sectoral or structural nature. They entail reforms in agriculture, health and education, infrastructure, energy sector, industrial policy, labour laws, public enterprises and the financial sector. Some of the reforms have already been announced and await implementation. Others have been identified but not yet decided upon.7



At the level of macro policy, the key elements for restoring the growth momentum are successful fiscal consolidation, the evolution of a more flexible, market-responsive exchange rate policy and a supportive monetary policy. Without a decisive and sustained resurrection of the economy’s growth momentum, the prospects for rapid increase in gainful employment and quick reduction of India’s poverty will become distant.



* Extracted from ‘India’s Macroeconomic Management in the Nineties’, ICRIER, 2001.

1. Some commentators believe that the growth in the crisis year of 1991/92 should be included in the earlier, ‘pre-crisis’ period (which would pull down that average to 5.3%) on the grounds that the crisis was a direct result of the policies and trends in the ’80s. Others, such as Williamson, feel that 1991/92 growth belongs in the latter period because of ‘slack built up during the crisis.’ My preferred option of omitting 1991/92 from both periods would seem to be a reasonable compromise.

2. It could be argued that, for strict comparability, similar adjustments should be made to the growth in previous periods following previous Pay Commission decisions. However, the scale of the pay increases following the FPC is of a different order.

3. To some extent both the acceleration in monetary growth in 1994/95 and the deceleration in 1995/96 were exaggerated by there being 27 reporting fortnights for banks in 1994/95, with the last of them ending on 31 March 1995 and coinciding with the closing day for banks’ accounts ‘thereby giving rise to the phenomenon of year-end bulge in aggregate deposits and credit’ (Reserve Bank, 1995, p. 47).

4. Rakshit (2000) is one of the few proponents of the minority view.

5. These ratios are understatements since they exclude various extra-budgetary accounts (like the Oil Pool Account) and various explicit and implicit contingent liabilities at all levels of government.

6. Financial sector reform straddles the broad areas of both macroeconomic policy and structural reforms. To keep this paper manageable, I have deliberately kept away from this very important subject.

7. A recent, semi-official inventory of desirable, growth-promoting policies is contained in the Planning Commission’s Employment Task Force Report (Government of India, 2001).



Shankar Acharya (1995), The Economic Consequences of Economic Reforms. Sir Puroshottamdas Thakurdas Memorial Lecture, Mumbai, November 1995; reprinted in Indian Economy: Update, Volume I, edited by Raj and Uma Kapila, Academic Foundation, Delhi, 1996.

Shankar Acharya (1999), Managing External Economic Challenges in the Nineties: Lessons for the Future. 18th Anniversary Lecture of the Centre for Banking Studies, Central Bank of Sri Lanka, Occasional Paper No. 33, September; also available at

K. Donde and M. Saggar (1999), Potential Output and Output Gap: A Review. Reserve Bank of India Occassional Papers, Winter.

Government of India (1998), Report of the Committee on Banking Sector Reforms, April.

Anne O. Krueger and Sajjid Z. Chinoy (2001), Indian Exchange Rate Policy. Paper delivered at the Conference on Indian Economic Policy at the Centre for Research on Economic Development and Policy Reform, Stanford University, June.

Mihir K. Rakshit (2000), On Correcting Fiscal Balances in the Indian Economy, ICRA Bulletin, Money and Finance, July- September.

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