Implosion: India’s Tryst with Reality

by John Elliott

  Ahluwalia says that the paper was specially significant because it pulled together a comprehensive approach for tackling India’s economic problems and set out a five-year plan with firm objectives – though it acknowledged it was bound to create more controversy. ‘Even if you do things gradually, you must emphasize the end result – that is needed for any reforms,’ says Ahluwalia,12 citing initiatives in recent years on energy pricing as an example. He says it was also significant because it linked the reduction in import tariffs with reduction in the rupee exchange rate so that increased imports could be balanced by a growth in exports.

  The paper began by setting the scene: ‘Our ability to compete is likely to be significantly impaired if our industry continues to operate in an environment which is much more restricted, and less amenable to various types of international linkages than our competitors.’ It covered five areas: ‘achievement of macro-economic balance with high investment levels; reform and redefi nition of the role of public sector; reducing and restructuring domestic controls over production and investment licensing; reducing the degree of protection to Indian industry; opening up to foreign investment’. There were detailed proposals for tackling the country’s mounting fiscal crisis, followed by plans for public sector reforms (but not privatisation), drastically reducing industrial licensing and trade protection, and opening the country up to foreign investment. The need for financial and labour reforms were mentioned without any details.

  Another policy document had been prepared at the industries ministry during V.P. Singh’s time by Amar Nath Verma, the industry secretary (the ministry’s top civil servant), and Rakesh Mohan, then the ministry’s economic adviser and later the finance secretary and a deputy governor of the RBI. The industry minister at the time (later aviation minister from December 2011) was Ajit Singh, who was new to politics. He had returned to India in 1981 with plans to set up his own company after 17 years in the US working as a software systems trouble-shooter with IBM, Xerox and others. His father, Chaudhary Charan Singh, a prominent farmers’ leader in Uttar Pradesh and briefly prime minister in 1979–80, died in 1987 and this swept Ajit into politics to inherit a mass-base legacy. Accustomed to life in America, he was impatient for reforms and was appalled by the huge number of approvals and files that crossed his desk. ‘The industries minister was the most powerful in the government – I had seven secretaries handling licensing for everything,’ he told me.13 In January 1990, V.P. Singh (no relation) told him to go to the World Economic Forum in Davos, which was just beginning to grow into an annual Swiss alpine jamboree for world leaders and businessmen, and talk about how India could be changed by reforms. ‘We had to brief him on policy and that was the trigger for putting together a presentation on what had to be done,’ says Mohan,14 adding: ‘That gave me the opportunity to see the whole picture on control mechanisms that were in place including industrial licensing, phased manufacturing, monopolies regulations, controlling capital issues and export-import controls.’ But a day or two before Ajit Singh was due to fly to Davos, V.P. Singh decided to send someone else who did not have an industries’ brief.

  The ideas continued to be developed and, in the middle of 1990, Ajit Singh placed a new industries policy in the Rajya Sabha. This included measures that appeared in the ‘M’ document and proposed, perhaps most controversially, raising the permissible level of heavily restricted foreign direct investment (FDI) to 51 per cent of a company’s equity, and opening some public sector industries to the private sector. It also proposed relaxing controls on monopolies and industrial production, and changing the way that import and export trade classifications were listed. There was widespread opposition, and the ideas had not progressed by the time the V.P. Singh government fell in November. Next came a coalition government led by Chandrashekhar (his second name was Singh but he was always known by this one name), a respected veteran socialist politician with a broad enough base to be chosen as leader of a fractured coalition. India was heading into a deep financial crisis and there was some interest in reforms, but there was strong resistance from politicians, bureaucrats and the private sector, who regarded the ideas as too controversial, so nothing was done. Eventually, the Chandrashekhar government collapsed in June 1991 after just seven months in office, triggering the election of Rao’s administration.

  1991: Ten Hours to a New Policy

  After Narasimha Rao had told Manmohan Singh to go and assemble reform policies, he prepared for a television address that he made to the nation at 9.45 the next evening, 22 June. He returned to his cobwebs theme and said there was ‘no time to lose’ because the government and the country could ‘not keep living beyond their means’. With ‘no soft options left... this government is committed to removing the cobwebs that come in the way of rapid industrialisation’.15 Major announcements were planned for Singh’s Budget speech on 21 July, but the schedule was suddenly upset on the morning of 3 July when it became clear that a second devaluation would be needed by the end of that day. Singh rang Ahluwalia, who was secretary for commerce, to say that he should brief Chidambaram, the commerce minister, on the need to announce, simultaneously with the devaluation, that expensive export incentives would be abolished. (Called the cash compensatory scheme, these incentives, which gave exporters arbitrarily, and potentially corruptly, authorized tax rebates, would no longer be necessary because the devaluation would give exporters sufficient incentive without compensation.)16

  That phone call triggered one of the most rapid exercises ever seen in policy development and implementation, with major policy restructuring being written and approved by two ministries, as well as the prime minister, in just ten hours. Ahluwalia suggested to Chidambaram that grumbles from exporters about losing the rebates could be offset if a new liberalized trade policy, which the ministry was working on, was also announced at the same time.17 Chidambaram was new to economic policy making but, as a lawyer and one of the best brains in government, he quickly bought the idea.18 He and Ahluwalia said the policy could be ready in a few hours and suggested to Singh that it should be announced that evening. Singh agreed, overruling objections from top officials who were against the reforms.

  ‘We returned to the Commerce Ministry and worked feverishly to outline the proposals,’ says Ahluwalia. Late in the afternoon, the papers were taken to the prime minister, who signed the file without the customary scrutiny by his office staff. Jairam Ramesh, who was posted in the PMO and was involved in drafting the policies, was ‘asked to ensure it received wide publicity’. That evening, Singh announced the second devaluation, and the new trade policy was launched by Chidambaram, who eulogistically told the media, ‘We have always had wings, but suffered a fear of flying. We should now soar in the high skies of trade.’ He said he wanted to achieve full convertibility of the rupee on the trade account in three to five years – it was done in two years.

  After the trade reforms, industrial licensing was tackled in the new industrial policy on Singh’s first Budget Day. The moves were so dramatic and extensive that they sent out a strong reform message, even though they had been opposed behind the scenes by some cabinet members, as well as senior civil servants. Chidambaram says the opponents ‘shot them down as a betrayal’ of the Congress party’s early leaders. He overcame that opposition with some neat drafting that confounded the critics by harking back to the origins of independent India. He says he inserted a tribute to Nehru’s original goals in the first lines of the policy document, and wrote that the new policy was ‘inspired by these very concerns, and represents a renewed initiative towards consolidating the gains of national reconstruction at this crucial stage’.19 Another key factor was that Narasimha Rao himself held the industry minister’s portfolio, so he did not have to persuade another, possibly reluctant, politician to give up a host of discretionary powers.

  All but 18 nationally important and sensitive industries (such as defence, coal, pharmaceuticals, railways and sugar) were freed from industrial licensing, and the number of cor
e industries reserved for the public sector was reduced to eight, including railways, defence equipment, atomic energy and coal.20 Rules that limited foreign investment primarily to technology projects were abolished, and automatic approval was announced for foreign equity stakes up to 51 per cent (up from a 40 per cent basic limit) in 35 industries, with faster approval-vetting above that level, and 24 per cent stakes in small-scale industries.21 Transfer of technology was eased, and revision of mergers and monopolies legislation was announced along with plans for a new foreign investment promotion board. Also removed were restrictions on the location of industry and price controls in various sectors such as steel and aluminium. Foreign companies were allowed into some infrastructure areas (up to 100 per cent ownership in power projects), and the financial services’ primary and secondary markets. Foreign stock brokers’ activities were boosted by Indian companies gaining access to global capital markets. Other major decisions taken with or shortly after the New Industrial Policy included allowing the use of foreign brand names, and the abolition of the finance ministry’s Controller of Capital Issue who presided over stock market affairs.

  Other changes followed, but the pace slowed when the approach of a general election due in 1996 led Rao to decide that reforms were not good electoral politics. There were, however, some more gradual changes such as the opening up of telecom and aviation to the private sector, trade and electricity reforms and licensing of private sector banks and these have continued, haltingly, through successive governments.

  From 1996, when the Rao government was defeated, India had a series of coalitions and it became difficult for the leading party to obtain agreement from its often more populist regional partners. The Bharatiya Janata Party-led National Democratic Alliance (NDA) coalitions from 1998 to 2004 did continue with reforms, but parliamentary oppositions became increasingly irresponsible and negative. Arun Shourie, the NDA’s minister for disinvestment, put it neatly when he told me in 2001 that his government’s implementation problems stemmed from ‘a fractured electorate that leads to a fractured legislature’ and an opposition that had a ‘perverse concept of what it means to be out of office’.22 This was a reference to the Congress-led opposition that was disrupting parliament over rows ranging from corruption on defence contracts and the collapse of the country’s largest unit trust to controversial anti-terrorism legislation. As a result, there was a backlog of more than 40 bills.

  ‘Everyone has enough power to block everything and no one has enough power to see anything through,’ said Shourie, highlighting a failing of India’s parliamentary democracy which became even more true with the 2009–2014 UPA coalition. During those years, the BJP and other opposition parties behaved even more irresponsibly in parliament than Congress had done earlier. It wasted weeks of parliamentary time and impeded urgently needed legislation such as land ownership compensation, banking and insurance regulations and labour laws, while the government dithered on opening up the defence industry and other areas.

  The opposition also played havoc with overhyped plans to allow foreign investment into supermarkets and other parts of the retail business, which Manmohan Singh and his commerce minister, Anand Sharma, unwisely allowed to become a litmus test of reform success.23 This was a typical example of the government avoiding diffi cult basic issues and policy debate with headline-grabbing reforms. Singh and Sharma hoped that foreign companies would invest in supermarket supply chains and would then force through state-level reforms in public sector-dominated and inefficient marketing arrangements for farm produce. Instead, the policy foundered and foreign supermarket companies were put off partly by muddled and complex regulations and ministerial hubris, and partly by entrenched opposition from vested interests in the distribution system, supported by populist and anti-Congress regional political parties.

  Gandhi Sops, Not Growth

  The main blockage to reforms between 2009 and 2014 came from divided government leadership. It was caused by Sonia and Rahul Gandhi favouring the provision of expensive and wasteful sops and aid schemes for the poor rather than pushing growth-oriented reforms favoured by Manmohan Singh. I heard in London in June 2012 that Rahul had told a friend on a recent visit that the way for Congress to stay in power and win elections was through the aid scheme route, not reforms.24 ‘Has the domination of economic policy by Sonia and Rahul Gandhi, together with regional members of the governing coalition... become so established that there is now no room for reformers to be heard? Is the government so much under the spell of these forces that India’s leadership has gone back to the 1970s when the private sector profit was frowned on [except when it lines the pockets of politicians]?’ I asked on my blog in August 2012.25

  Raghuram Rajan, who became governor of the Reserve Bank of India in 2013, criticized the Gandhis’ favourite aid project, the National Rural Employment Guarantee Scheme (NREGS, renamed the Mahatma Gandhi National Rural Employment Guarantee Act, MNREGA, in 2009). The scheme guaranteed at least 100 days’ employment a year to those volunteering for unskilled manual work. In a 2010 interview, he said it was ‘a short-term insurance fix’ for dealing with problems of the poor, but added: ‘If it comes in the way of creating long-term capabilities, and if we think NREGS is the answer to the problem of rural stagnation, we have a problem’.26 The scheme helped to boost rural wages in many (though not all) states, but was inefficiently and corruptly run, with money being siphoned off on the way down to villages. It also frequently involved unproductive projects. In April 2013, the Comptroller and Auditor General (CAG) condemned extensive misuse of funds and incomplete projects.27

  Similar criticisms were made of food security legislation28 that was passed at the insistence of Sonia Gandhi, who led the final debate in parliament despite opposition from senior government ministers and the Reserve Bank of India.29 Aimed at providing five kilograms of subsidized rice per family, wheat and other food grains every month to tackle widespread hunger among the poor, it ranged far wider and was gifted to a total of 810m people (75 per cent of the rural population and 50 per cent in urban areas). This brought the total cost of subsidized food aid to $21bn a year, which could not be afforded when the country was facing a growing current account deficit. Surjit Bhalla, an economics commentator, put the cost at 3 per cent of GDP.30 There would inevitably be massive waste as funds leaked and food was diverted or rotted in India’s inefficient food distribution system; experts also argued that the balance of protein was inadequate. But such concerns were not a priority for Sonia Gandhi, who regarded the scheme as a potential vote winner at the 2014 general election. Incredibly, Gandhi insisted on going ahead with the scheme and announcing it on Rajiv Gandhi’s birth anniversary, even though the country was in the middle of a financial crisis with a mounting current account deficit and a plunging rupee.31 Later, in order to keep the scheme running, the government even disrupted World Trade Organisation negotiations on an international food security agreement that was supported by other developing nations.32

  The Gandhi family had however shelved some of their ambivalence about reforms by the end of 2012 and publicly backed various measures when India faced a run on the rupee and a sharp decline in its international image as an investment destination. They allowed Chidambaram, reappointed as finance minister in 2012, to try to revive the economy, to move ahead on various measures including foreign investment in supermarkets and airlines, and de-regulation of fuel prices which continued into 2013.33

  Manmohan’s Over-stated Role

  The role of Manmohan Singh in the early 1990s is often overstated. As has been seen in this chapter, he was certainly not the ‘architect’ of the 1991 reforms – an easy but inaccurate tag that is often used by foreign journalists and others. Nor was he even the primary implementer, though he did have a public role in pulling together and extolling the various reforms that emerged, and in painting a favourable picture internationally of a new and open India. He worked in particular with Chidambaram on the trade reforms and then had to sell them to
colleagues and the country. The fourth person who played an essential and central role along with Rao, Singh and Chidambaram was A.N. Verma, Rao’s principal secretary. An experienced senior bureaucrat, he understood what was required because he had been involved, as industry secretary, with Ajit Singh and Rakesh Mohan during the V.P. Singh government. He steered the implementation of the 1991 policy through the government with daily and weekly committee meetings on specific areas such as economic reforms and foreign investment, operating with the full authority of the prime minister.

  Rao was an unlikely leader and reformer. A politician of considerable intellect but little charisma, he was Indira Gandhi’s downtrodden foreign minister when I first saw him in the summer of 1983. He was being ignored by a bunch of braying Indian businessmen as they pressed forward around Gandhi, anxious to be seen bidding her goodbye as she left an investment conference in a Swiss alpine village. The businessmen were fleeing India’s heat and had gone to the conference (some with girlfriends, at least two of whom had been flown in from London to the retreat) to be seen by Gandhi before moving on to weeks of leisure in the UK and the US. Rao was standing in the doorway of the chalet hotel, unnoticed and alone, when Gandhi left.

  He was on the verge of retirement when Rajiv Gandhi was assassinated and the Congress won the general election in 1991, but was picked as a safe interim prime minister after Sonia Gandhi resisted sycophantic pressure to take the job. No one expected him to tackle the financial crisis or anything else with the focus and determination that he showed. Maybe, at his age and at the end of his career, he felt he had nothing to lose by challenging those who resisted change. He certainly had the intellect to recognize the depths of the crisis and to realize it could be a turning point in history. There is a nice story he told a colleague: that he had picked Singh as finance minister because he reckoned that he (Rao) would get the credit if the reforms succeeded, while ex-bureaucrat Singh could be blamed if they failed. As it turned out, Rao’s calculation was wrong because the reforms were a success and Singh got the credit.34