The Rise of Goliath

by AK Bhattacharya

  That was just the beginning. The changes brought about by the industrial policy liberalization on that day would set off a series of policy changes in other sectors of the Indian economy. Their impact would be felt for several decades later.

  CHAPTER 15

  AN ANATOMY OF THE CRISIS

  What led to the first set of disruptions that caused India’s fiscal indiscipline to reach an unsustainably high level and the balance of payments deteriorate to a precarious situation? The root cause of the problems was the pace of growth that was pursued by the Rajiv Gandhi government between 1985 and 1989. Gandhi had finalized an ambitious plan for investments to boost growth. Aiming at an annual growth target of 5 per cent, the Seventh Five-Year Plan (1985–90) had hugely relied on borrowing to fund the requisite investments. While the five years of the plan indeed saw the growth rate at 6 per cent per annum, exceeding the target by a clear margin of one percentage point, pressures on the government’s fiscal situation and on the balance of payments were becoming too obvious to be ignored. By 1988–89, the Union government’s fiscal deficit had deteriorated to over 7 per cent of the GDP. The current account deficit, too, widened to 2.7 per cent of GDP. With no recourse to any support from the capital account (foreign investment flows those days were almost negligible, and foreign institutional investors were not allowed to invest in India’s stock markets), even that level of current account gap became difficult to meet without drawing down foreign-exchange reserves. Not surprisingly, the economy had hit a major roadblock as it faced difficulty in meeting its import needs and honouring its past international payment obligations.

  Three factors could be identified as the cause of this disruption. One was a borrowing-led pursuit of growth. Two, political uncertainty that got deeper with the V.P. Singh government falling less than a year after its formation and then the Chandra Shekhar government falling in just four months. And three, the emergency measures that were needed to prevent further deterioration of the economy. If Rajiv Gandhi was responsible for the first two disruptions, then Chandra Shekhar was the key force behind the third disruption. Qualitatively, these three disruptions are of different types, although there are strong causal connections between them.

  Gandhi, of course, has been accused of having led an economic policy in the 1980s which relied on borrowings to boost growth and contributed to the economic crisis in 1991. The World Bank in a report in 1991 observed: ‘In this environment, the shift in the stance of macro-policy from the conservative management of aggregate demand in the 1960s and 1970s to the fiscal expansionism of 1980s resulted in large and potentially unsustainable accumulations of domestic and foreign debt.’1 Imagine a situation where Gandhi had been less ambitious about his growth projections and had ensured adequate availability of resources for investment without relying excessively on borrowing, or had preceded that investment-led growth drive with basic reforms by at least partially opening up the economy to foreign investment and by liberalizing trade and industrial policies! The consequences for the economy would certainly have been far less severe. Indeed, that phase of policymaking has left an indelible impact on all governments that followed it.

  The idea of a fiscal deficit had not yet made its debut in media discussions or even in a national debate. It was only after the economic reforms of 1991 that the concept of a fiscal deficit came into vogue. Till then, what constituted Budget deficit was broadly equivalent to net credit from the RBI. By its very nature, there was no check on such deficit financing as the government was not made adequately responsible for its borrowing excesses. After the concept of the fiscal deficit was introduced, the next big reform in this area was when over a period of three years starting from 1994 and ending in 1997, the government’s recourse to the issuance of ad hoc treasury bills to finance its deficit was completely stopped. These bills were issued by the government to raise resources to meet its budget deficit. An agreement between the RBI and the government was signed on 9 September 1994 that stipulated that ad hoc treasury bills would be discontinued from 1 April 1997. In order to help the government meet its temporary mismatches in its receipts and payments, the RBI introduced a scheme of Ways and Means Advances (WMA). The new scheme of WMA helped the government obtain necessary cash at a mutually agreed interest rate to meet its temporary payment needs. Any cash withdrawal by the government from the RBI in excess of the WMA limit was allowed only for ten consecutive days. The day the government used up 75 per cent of this limit, the RBI would start floatation of a fresh round of government securities. With the discontinuation of ad hoc treasury bills and the introduction of WMA, the idea of the government’s budget deficit became irrelevant and the practice of gross fiscal deficit, capturing the government’s total borrowing requirements in a year, became the key indicator of the deficit or the gap between the government’s total revenues and expenditure.2

  The excesses committed by the Gandhi government between 1985 and 1989 proved to be so costly that they led to a new awakening in the minds of India’s economic administrators to introduce durable fiscal reforms for the Union government enforcing, thereby, curbs on the government’s borrowings. It is quite ironical that Finance Minister S.B. Chavan said with unconcealed pride in his 1989–90 Budget speech that the Seventh Five-Year Plan would be spending an amount that was 150 per cent more than what was envisaged. The outlay target was exceeded, but at the cost of the government’s financial discipline. Finance Minister Madhu Dandavate, who presented the next Budget—for 1990–91—did not mince his words when he described the state of the economy as his government had inherited from Gandhi in these words:

  Let me, at the outset, deal with the economic situation that we inherited from the previous Government. I do so not in a spirit of acrimony, but with a view to revealing to the House the ground realities. The Central government’s Budgetary deficit was Rs 13,790 crore as on 1st December 1989, a level nearly double the deficit projected for the whole year in the 1989–90 Budget. Wholesale prices had risen by 6.6 per cent since the beginning of the financial year. The balance of payment was under strain and the foreign-exchange reserves (excluding gold and Special Drawing Rights) were down to around Rs 5,000 crore. Stocks of food grains had fallen to 11 million tonnes.

  There was yet another consequence of the disruption caused by the political uncertainty in the years before India’s economic crisis blew up in 1991. Both the fall of the National Front government, led by Vishwanath Pratap Singh, in November 1990 and the collapse of the Chandra Shekhar government just four months later in March 1991 were caused largely due to political adventurism of a few leaders. The sixty-nine Lok Sabha members of the Janata Dal who defected to form a new party, brought about the fall of the Singh government and formed a new government with the outside support of the Congress were as guilty of such adventurism for political gains as Rajiv Gandhi, who decided to withdraw his party’s support to Chandra Shekhar, once again in the hope of securing some political gains.

  The collateral damage of such political adventurism for the Indian economy was huge. The disruption that those two incidents caused has taught such a long-term and enduring lesson for India’s political class for the next few decades that such narrow, opportunistic political adventurism has never been used so brazenly by any political party after the 1990s, particularly when it is perceived that such actions would entail heavy damage for the economy. Thus, no elections were forced on the nation at the end of the thirteen-day government of Atal Bihari Vajpayee in 1996, and instead, regional opposition parties got together and formed a coalition government that ran for about two years. And when elections had to be called after the sudden fall of the BJP government in 1998, all opposition political parties got together and agreed to first pass the Budget before the Lok Sabha could be dissolved. Similarly, governments that did not enjoy full majority were not usually disallowed from passing economic laws that by common consensus would benefit the economy. While there would be opposition to laws such as opening up foreign direct investment in
insurance sector or retail outlets, eventually they would receive the green signal of Parliament with some modifications in the original proposal, after some political give and take. But economic laws would not always be a casualty of political gamesmanship. This certainly is one of the big consequences of the disruption that Rajiv Gandhi’s decision had caused in 1991.

  Chandra Shekhar, too, qualifies as a disrupter in 1991. He assumed charge as prime minister in November 1990 knowing full well the grim economic situation facing the country. The nature of the policy prescription that his government, under advice from his finance minister, Yashwant Sinha, had outlined, was not very different from what was eventually adopted by the P.V. Narasimha Rao government a few months later after the general elections. Sinha was ready to present his Budget that would outline a series of economic reforms to help the country bail itself out of that crisis on a sustainable basis. However, with Rajiv Gandhi withdrawing support to the government, all that Sinha could do was to present an interim Budget without any of the taxation proposals that he wanted to introduce. The decision to sell 20 tonnes of confiscated gold to UBS, impose curbs on the easy availability of credit for imports and initiate discussions with the IMF for loans were among the many steps that contributed in the long run to the disruption in the Indian economy. It was, of course, a disruption that had a positive intent of preventing further disorder and even chaos in the economy. More importantly, it was a disruption aimed at conveying a larger message to the international community—that India as a nation would not consider default as a credible option to get out of the crisis and instead submit itself to the rigours of hard policy reforms to be recognized as a responsible nation in the world. That intent of the disruptive measures taken by Chandra Shekhar was no less important.

  Rebuilding the Economy

  The duo of P.V. Narasimha Rao and Manmohan Singh would perhaps stand out as the most effective disrupter in this phase of the Indian economy. Rao’s disruption was to bring in an economic administrator like Manmohan Singh to be the finance minister in his minority government. Rao could have easily followed the trodden path of giving the usually coveted job of the finance minister to a veteran politician, who would have then been a little more cautious with his steps, mindful of the political implications and consequences. If Rao had chosen a politician to be his finance minister, the story of India’s economic reforms would have been substantially different. But Rao decided to embark on a completely new path— no prime minister ever chose a finance minister who was not a politician. Initially, Rao had thought of offering the finance minister’s portfolio to former RBI Governor I.G. Patel, who was not interested in the job. But later Manmohan Singh’s name cropped up as an alternative. Rao’s preference for a technocrat, instead of a politician, to be the finance minister only shows how serious and complicated the economic challenges before the country were in 1991.

  That is also why Rao treated his finance minister like few other prime ministers did or would do after him. As prime minister, he gave his finance minister the freedom to devise the measures to rescue the economy out of a crisis. And when it required some political management to ensure the acceptance of the tough measures that the finance minister was proposing, Rao would step in to find a way out. Singh’s decision to hike fertilizer prices by a steep margin of 40 per cent in his first Budget of July 1991 came under intense attack from all quarters including even the CPP, which targeted Singh so viciously that the finance minister offered his resignation to the prime minister. Rao was reported to have asked Singh: ‘Are you going to desert me at this lonely hour?’3 Singh did not press for his resignation and the next day went back to Parliament and announced a rollback of the fertilizer price increase by 10 percentage points. In other words, deft political management of the fertilizer price hike issue allowed the Rao–Singh duo to effect a 30 per cent increase—which was the highest increase in such a politically sensitive input for farmers in many years. That was the other face of the modus operandi of the disruption caused by the Rao–Singh duo.

  Similarly, the process followed by Rao and Singh while framing the new industrial policy showed how conscious they were of the need to effectively manage the political fallout of their proposal. The new industrial policy statement made generous references to Nehru and the government’s commitment to upholding the values espoused by India’s first prime minister. And when the proposed changes, which would actually rewrite almost every aspect of Nehru’s Industrial Policy Resolution of 1956, came up for debate in the Cabinet and expectedly met with stiff resistance, Rao chose the noisiest among the opponents of the change, Makhan Lal Fotedar, a long-time Nehru–Gandhi family loyalist, to chair a committee to review the policy before it could be considered again by the Cabinet. The policy was reviewed by the committee. Marginal changes were introduced, while keeping the overall thrust of the policy intact. Rao made sure that the industrial policy changes got the endorsement from Fotedar, who was the sharpest critic of the proposed liberalization. A revised document was presented to the Cabinet a day before the Budget was to be presented on 24 July.

  It is important to remember that at the Cabinet level, Rao had kept with himself the portfolio of the industry ministry. This was yet another move of Rao to take charge of the reforms that he wanted to implement. The reforms of 1991 were largely seen in the areas of fiscal policy, trade policy and industrial policy. For trade policy, he had P. Chidambaram, a committed reformer, and he delivered on trade policy changes as the commerce minister. For fiscal policy, he had Manmohan Singh. And for industrial policy, he kept the portfolio with himself at the Cabinet level, a point that is not often recognized. But on the day of the Budget, he decided that instead of reading out the new industrial policy, the document should be simply tabled. And the task of tabling that document in Parliament was, ironically, given to the minister of state for industry, P.J. Kurien, who was not really convinced of the need to bring about such radical changes in industrial policy, doing away controls, removing public-sector monopoly in many areas and allowing a liberalized automatic foreign investment rules in several sectors of the economy.

  The disruption that the Rao–Singh duo caused to the Indian economy is also a lesson on how to sequence those disruptive steps. Both of them were aware that the industrial policy changes would hit the vested interests in domestic industry and the political class opposed to such deregulation. In retrospect, thus, the tabling of the industrial policy document in Parliament on the same day as the Budget was a carefully planned strategy. The first Budget of a new government was always expected to elicit special attention from all quarters—trade, industry, political parties and the people in general. In that excitement, the industrial policy statement, which had a greater disruptive impact on economic policymaking, received relatively far less attention. Indeed, the media and the newspapers the next morning, with notable exceptions, talked more about the Budget and less about the liberalized industrial policy.

  If the industrial policy deregulated the economy, the Budget struck the right notes as far as politics was concerned. The Budget could be seen as one that soaked the rich. It raised duties on all items that were consumed by the upper-middle-class Indians. The income-tax rates at the lowest income slabs remained unchanged. Barring customs duty cuts in certain goods, Manmohan Singh’s first Budget raised taxes on cigarettes and the consumerist India. Was that a political act? Presenting a Budget that was largely popular to bolster the government’s revenues and drawing all attention there, so much so that the industrial policy statement deregulating India Inc. remained below the radar? The execution of what caused the biggest disruption to India Inc. was carefully planned to minimize its political consequences.

  The durability of the disruptive moves initiated through the reforms of 1991 in fiscal policy, trade policy and industrial policy has been the most robust. If the policy shift from 1950, the Industrial Policy Resolution of 1956 and the Second Five-Year Plan started a new phase in India’s economic policies, the policies o
f 1991 gave those policies a different direction and the changes they brought about have been enduring. The continuation of the policies introduced in 1950 lasted for forty years and that was largely possible because the Congress ruled at the Centre for much of this period. But almost three decades have passed after the reforms of 1991 and there have been different political parties with commitment to different ideologies, but the overall direction of the economic policies have remained the same. There may be differences in minor details of the economic policies framed and followed by the United Front government in 1996–97, the BJP-led coalitions from 1998 to 2004, the Congress for ten years between 2004 and 2014 and the BJP-led government from 2014. But the trend and direction of economic policymaking in these years since 1991 have remained unchanged even though its pace and quality may have undergone some variation.

  This is perhaps the biggest tribute to the kind of disruptions that the Rao–Singh duo introduced to India’s governance. Not surprisingly, therefore, Rao stood by Singh when the latter faced political attacks because of his economic reforms, and Singh recognized the role Rao played and the support he gave him. In spite of Rao becoming a virtual persona non grata for the Gandhi family, Singh continued to pay Rao the respect that he deserved. Singh was among the very few senior Congress leaders who attended Rao’s funeral in Hyderabad and he recognizes the role Rao played in bringing about the most durable disruptions in the Indian economy, for which the history books will never forget either Rao or Singh.