The Rise of Goliath

by AK Bhattacharya

  The visit of Finance Secretary Sriranga Purushottam Shukla to Washington in April 1991 was one such move that had been okayed by Chandra. Shukla had the RBI Governor S. Venkitaramanan as his company and both were in Washington on 28 April to attend the annual spring meeting of the IMF and World Bank. They had a tough time facing up to the officials of the two Bretton Woods institutions, who were extremely unhappy with India for its failure to honour the promise of reforms because of political uncertainties caused by the sudden fall of the government. Venkitaramanan and Shukla stomached those words of admonition and broached gingerly the idea of the Aid India Consortium, a group of developed donor countries, including the US, Japan, Germany, the UK, France and the Netherlands, the IMF and the World Bank, to consider extending temporary loans of about $700 million to help India meet its emerging international payments obligations. Finance Minister Yashwant Sinha also visited Tokyo to seek Japan’s financial assistance. Foreign Secretary Muchkund Dubey was in Washington at around the same time to persuade the US to lean on Japan and Germany to accommodate India’s request for financial help. Their efforts did not go entirely in vain. A few days later, Japan sanctioned to India a soft loan of $150 million and a further commitment of $350 million, Germany granted a loan of about $400 million and the Netherlands too agreed to offer India $30 million as a soft loan.7

  These loan amounts were small compared to the overall need for the Indian economy to bail itself out of that balance-of-payments crisis. But they were useful to prevent an escalation and, more importantly, showed the commitment of even a caretaker government to honour its international payments obligations, instead of seeking recourse to the option of a default, like some Latin American countries chose to do, and a course that was advocated in a section of the Indian political class.

  The loans kept the country’s foreign-exchange reserves above the critical level of about $1 billion and the caretaker government, led by Prime Minister Chandra Shekhar and Finance Minister Yashwant Sinha, with able assistance from Cabinet Secretary Naresh Chandra and RBI Governor S. Venkitaramanan, took a series of belt-tightening measures. Thus, a squeeze on imports was enforced, inconveniencing no end Indian traders and industrialists. In addition, the State Trading Corporation and MMTC, the government’s two biggest trading arms, started cancelling import orders to prevent any fresh payment liability accumulating on them. This was also partly in response to many foreign suppliers refusing to honour letters of credit issued by Indian banks, unless they were guaranteed or confirmed by internationally reputed banks. This raised import costs and taken together with the measures taken by the RBI to tighten the money supply, it was a tough time to do business in India.

  On 3 May, the RBI introduced a cash-reserve ratio for banks at 10 per cent of their net demand and time liabilities, which effectively meant a total CRR requirement of 25 per cent. CRR is that share of the commercial banks’ total deposit that must be kept with the RBI in the form of liquid cash and this is done in a bid to regulate the total lendable resources that the banks have and to keep inflation under control. With the resultant tightening of the money market, call rates shot up to 30 to 40 per cent. A week later, the government came out with another round of measures to tighten money supply by imposing a 25 per cent surcharge on bank credit for import finance. Within weeks after these extremely tight measures to choke money supply and raise the cost of imports, the government realized that there was now no recourse left to it other than approaching the IMF for an emergency loan.

  On 13 May, a two-member team left for Washington. Its members included Chief Economic Adviser Deepak Nayyar and RBI Deputy Governor Chakravarthi Rangarajan. On its agenda was a proposal for seeking a bridge loan of $700 million from the IMF to help India avert a payments default. It was one of the most serious situations the Indian economy had faced since it became an independent country. Almost all senior political leaders of different parties agreed that the country had little option other than seeking an IMF loan and the leaders who supported the Chandra Shekhar government’s move then included Rajiv Gandhi, Lal Kishan Advani and Vishwanath Pratap Singh. This was also an early indication of the political mood that would envelop the country in the next few months, where all political parties irrespective of their political ideologies would either remain neutral or support the dramatic but path-breaking steps needed to rescue the economy from its crisis.

  The crisis was aggravated with another tragedy—this time it was the dastardly manner in which Rajiv Gandhi was killed in a bomb attack at Sriperumbudur near Chennai. That was on 21 May. The election schedule was upset. This added to the uncertainty over an early conclusion of an economic rescue package. The election calendar for the remaining phase had to be rescheduled and it became clear that a new government to take the necessary decisions on the economy would not be in place before the third week of June. A big relief came in the form of statements from the World Bank and the IMF, reiterating their support to India. But these statements also made it clear that they would not sanction any fresh loans before a new government was in place.

  By then, the country’s foreign-exchange reserves had dipped below $1 billion, sending out alarm signals to the markets and the managers of the economy. It was at that point in time that the Chandra Shekhar government took perhaps the boldest step that any caretaker government can take—it decided to mortgage 20 tonnes of confiscated gold, kept with the SBI, to UBS in Zurich with the option of buying it back after six months.

  All it got in return was a loan amount of $240 million. Something was better than nothing. The entire operation of shipping the gold was conducted in complete secrecy and the shipment was completed by 30 May. The news of the sale of the confiscated gold was out only about a week later. Of course, the political reaction was on expected lines. After Yashwant Sinha made it public, most political reaction was adverse and the narrative was that the government had sold its gold as it failed to manage the economy. Even Congress leader Pranab Mukherjee criticized the move.8

  International markets, however, continued to punish India. Rating agencies like Standard & Poor’s downgraded India’s long-term rating to the speculative category. It had reasoned in its rating statement that the dangers of India defaulting on its international payments obligations had not receded. Indeed, such a statement actually halted the government’s fresh moves on sending another consignment of gold abroad for securing fresh foreign exchange to repay its loan liabilities becoming due in the next few weeks.9 There was a view that any such move might downgrade India’s rating further. Cabinet Secretary Naresh Chandra convened a meeting of secretaries on 6 June to review the economic situation and the meeting pointed to yet another risk that the Indian economy was exposed to. It was reckoned that non-resident Indians (NRI) had parked an estimated Rs 20,000 crore by way of deposits in India and if another round of gold sale was resorted to, there was a fear of a flight of such NRI deposits out of the country. And this could have further worsened the balance-of-payments situation. A day after that meeting, the finance minister and RBI Deputy Governor Chakravarthi Rangarajan issued a public statement assuring the nation that there would be no further pledging or sale of gold. As subsequent events showed, that statement was nothing but a balm to soothe the market sentiment; India did dispatch a few more rounds of gold shipments abroad, but only after a new government was in place.

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  On 21 June 1991, P.V. Narasimha Rao took oath as the prime minister of a new minority government after the Congress won 232 out of the 521 seats in the lower house, for which elections were held then. No other political party in that house was in a mood to challenge the formation of the Congress government, given the state of the economy and the need to have a government in place at the earliest opportunity. The Bharatiya Janata Party had won the second largest number of seats at 120, but its stance was no different.

  Thus, the Rao government started its innings as a minority government, putting an end to what turns out to be the longest rule by a caretaker
government in independent India’s history. The Chandra Shekhar government fell on 6 March, but President R. Venkataraman asked it to function as a caretaker government till the elections were completed and a new government was in place. In these three months and a couple of weeks, the Chandra Shekhar government took some of the most dramatic decisions to prevent the country’s economic crisis from getting worse. But more dramatic decisions were to follow in the next few weeks as Rao took charge as prime minister and held his first Cabinet meeting on the very same day he and his colleagues had been sworn in. At that Cabinet meeting, Rao asked Manmohan Singh to take charge of the finance ministry and take the necessary steps to shore up the economy. Singh was the only minister that day who knew of his portfolio, as the full list of ministers with their portfolios came out only after a day.10

  Singh realized at the very start of his innings as finance minister that the tasks for him were formidable. His team in the ministry, with S.P. Shukla and Deepak Nayyar, finance secretary and chief economic adviser respectively, had already helped the Chandra Shekhar government take a series of steps to prevent further deterioration in the economic situation. Singh did not enjoy a great equation with either Shukla or Nayyar, but he made no immediate changes in his team in North Block. Instead, he widened his consultation process to arrive at the package of measures that needed to be taken to tackle the imminent crisis. Apart from his officers in the finance ministry, he roped in senior secretaries and economic advisers in different ministries for consultation, including Montek Singh Ahluwalia, who was then the commerce secretary, and Rakesh Mohan, who was then in the industry ministry as its economic adviser. There was general concurrence on the need for taking urgent remedial steps that would reassure the international business community and institutions that India meant business and was keen on bailing itself out of its crisis. The prime minister played a stellar role by offering his full support to the finance minister for the steps he thought were necessary.

  About a week later, Singh decided to go in for a steep correction in the value of the Indian rupee by depreciating it by more than 20 per cent. Barring a few voices of mild dissent, there was a general view that the proposed depreciation was a credible path to take. The only debate was on whether the correction should be brought in two phases or in a single round. The RBI was in favour of a single-stroke depreciation of 20 per cent. Clearly, that was a view of a technocrat, but the awareness of the political implications of such a sharp correction in the value of the currency influenced Singh and other bureaucrats in the government to go in for a two-stage depreciation. The logic was that a two-stage correction would allow businesses, trade and the people absorb the shock. The counter-argument was that a two-stage depreciation could build political pressure within the ruling party. After the first round of depreciation, there could be pressure on the finance minister to go soft and avoid the second round of depreciation. And that is exactly what happened. It is a different matter that Singh’s deft handling of the situation saved the day.

  On 2 July, a depreciation of 9.5 per cent in the value of the rupee against the US dollar was announced and the official explanation was that it was a routine adjustment in the currency value. To prevent any political mobilization against the next round, Singh even issued a public statement to quell rumours that the government might be buckling under the pressure of the IMF for securing loans. He said: ‘We will not do anything under pressure and which is not consistent with our national interest.’ Indian industry’s response was unusually positive. The Confederation of Engineering Industry, as CII was known then and which by then had become the most influential industry voice in the country, welcomed the move, but Lalit Mohan Thapar, chairman of the Thapar group and an influential member of the Bombay Club that had serious doubts on the efficacy and need for opening up the economy, issued a guarded statement: ‘More steps should follow towards liberalization and other long overdue measures.’ Backchannel communication from the government was also in full swing. Commerce Minister Palaniappan Chidambaram held a meeting with senior media representatives to put the entire depreciation move in the context of the prevailing economic and political situation. Chidambaram had also taken the media leaders into confidence on the contours of the big structural economic policy changes the government wished to initiate in the coming days.

  While this helped the government to get media on its side, political forces against depreciation were not adequately reined in. On 3 July, the RBI had prepared to go in for the second round of depreciation—by about 12 per cent. This would have meant the Indian rupee’s value against the US dollar would go down from about Rs 21.09 to Rs 25.95 in just about two days—a fall of over 23 per cent. Just when the second round was going to be announced, Singh got a call from his prime minister, P.V. Narasimha Rao, who had by now been approached by several senior politicians. These leaders wanted the prime minister to rein in Singh on effecting these changes so rapidly and with such sharp consequences. Rao asked Singh if the second round of depreciation could be held back. Singh paused and told him what was not entirely accurate, yet he could not be faulted for telling a lie. He explained to the prime minister that the depreciation process had already been effected, and it would be difficult to roll it back at that stage. It was after all a two-stage depreciation and the process, Singh referred to in his reply to Rao, had begun on 2 July. Rao had no option. In the meanwhile, Singh allowed the deputy governor of the RBI, Chakravarthi Rangarajan, to go ahead with the depreciation.

  The same evening Commerce Minister Chidambaram announced a series of trade policy changes. He abolished the system of export subsidies in the form of providing cash compensatory support, removed supplementary licences, aimed at helping exporters with import facilities, and decanalized the import of a host of goods. Decanalization removed the monopoly of the state-owned companies in sourcing these goods from foreign countries and allowed any Indian company, be it in the private or the public sector, to import them freely through their own channels of trade. He also announced a plan for transitioning to a new system of offering import benefits to exporters. In the system prevailing then, exporters used to get replenishment licences against their shipments. These licences gave exporters the benefit of duty-free imports. Abandoning that system, Chidambaram introduced exim scrips to be issued to exporters and these could be traded in the markets. Within a few weeks, there was a new trade policy and a time table was outlined for making the rupee convertible on the current account. By March 1992, the government announced the Liberalized Exchange Rate Management System or LERMS, which essentially introduced a dual exchange-rate system. Exporters could convert 60 per cent of the dollars they earned at a market rate and the remaining at the official exchange rate. By March 1993, a unified exchange rate, linked to the markets, was in place and exporters could convert their entire dollar earnings at that market-linked exchange rate. This paved the way for the country’s biggest exchange rate policy reform in the country and ended the incentive for sustaining what was till then a thriving illegal market for converting dollars into rupees or hawala.

  The crisis that Singh was dealing with on the macroeconomic front in July, however, was far from over. The foreign-exchange reserves had dipped just below $1 billion and Singh went in for three more rounds of pledging of gold kept with the RBI. The pledging was done with the Bank of England and required the physical movement of a part of the RBI’s gold reserves. On 6 July, 25 tonnes of gold was air-freighted to London, to be kept with the Bank of England as security against which the government obtained a loan of $200 million. Two more such gold shipments—of 9.8 tonnes a week later and 12 tonnes on 18 July—took place as a result of which India could borrow up to a total amount of $400 million. A week later, on 24 July, Singh presented his first Budget that outlined a road map for the economic reforms that would be needed in the coming years. More important than the Budget was the laying on the table of Parliament the government’s decision to liberalize industrial policy, changes that would unshack
le Indian industry from licensing controls of the previous forty years and help, in the words of Singh, release the ‘animal spirits’ of Indian business leaders.

  Each of the industrial policy changes announced on 24 July would fundamentally alter the way Indian business would operate in the coming years and indeed decades. The asset limit for companies governed by the MRTP Act was scrapped in one stroke. This meant virtually unlimited freedom for Indian industries to grow without worrying about breaching the ceiling on their assets, initially set at Rs 20 crore in 1969. It had been relaxed twice in the past—to Rs 50 crore in 1980 and to Rs 100 crore in 1985, but now it was scrapped. Even bolder was the decision to abolish industrial licensing for all sectors except eighteen specified groups. Giving a big boost to the private sector’s freedom to operate in new areas, Singh allowed private enterprises to enter as many as ten new areas, which till then were reserved exclusively for the public sector. A few of the sectors, which were reserved for the public sector and now thrown open to the private sector, were iron and steel, heavy electrical plants, aircraft manufacturing, air transportation, ship-building, telephones, telephone cables and power generation as well as distribution. Automatic approval for foreign equity participation up to 51 per cent in thirty-four selected industries was permitted and companies entering into foreign technology agreements were freed from the requirement of obtaining the government’s permission. Such approvals for a host of technology agreements, often a bone of contention and a cause for delay, were made automatic. In a big relief to the private sector, Singh also scrapped the clause that allowed conversion of loans into equity for new projects. This clause would earlier result in financial institutions being saddled with equity shares of many companies just because they had given loans to them. In another major move, Singh also allowed the process of state-owned enterprises to shed their stake in the market with the twin intention of raising revenues for the government through the sale of stakes in the PSUs and consequently subjecting these enterprises to greater market discipline.