Second Gen Reforms

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India’s Economic ReformsC h a l l e n g e s a n d P r o s p e c t s

The remarkable growth transformation since 1980s was made possible bygradual unshackling of the economy and liberalising many sectors of theeconomy. The policies of centralised planning, state intervention and tradeprotection were gradually replaced by liberalisation of trade, industrial de-licensing, rationalisation of taxes, current account convertibility of the rupee andthe easing of foreign investment norms. The process of reforms gainedmomentum in the 1990s in response to the balance of payment crisis thatsurfaced in 1990-91. The economic reforms in 1990s had a significant impact on the Indian economy.

At a generic level, the reforms played a facilitative role and created acompetitive environment for Indian' companies. Industrial de-licensing providedflexibility to firms in investment decisions. This led to a surge in privateinvestment. The share of private investment in total industrial investment went upfrom 56 per cent in the 1980's to almost 75 per cent by the end of 1990's. Tradereforms lowered tariffs and removed barriers on imports. This increased importcompetition for traded goods and also allowed firms to rationalise their inputdecisions. This enhanced the productivity of Indian manufacturing and permittedthem t o not only stay competitive in the new environment but also becomeglobally competitive. Many sectors were also opened up for Foreign DirectInvestment (FDI) and higher equity participation. The Indian firms were permitted

to access international capital markets. Capital market reforms, together with theremoval of restrictions on firms to tap capital markets, brought down entrybarriers. Telecom sector benefited from the entry of private players and improvedaccess to capital. Challenges Most of the reforms implemented did not require legislative changes and couldbe carried out through administrative fiat. These reforms, as we have seen,made India competitive and notched up the GDP growth rates. But the highgrowth achieved in the mid nineties could not be sustained, as the momentum of

reforms petered out. The `Second Generation Reforms' would involve crucialstructural, legislative and administrative changes in major sectors and requirewider consensus building, particularly due to coalition governments. The major second generation reforms are listed below:

• Power sector reforms. Implementation of the Electricity Act, 2003.

http://www.isasnus.org/jan28conference/papers/Paper%20-%20S%20Narayan%20-%20India's%20Economic%20Reforms.doc







• Providing flexibility of entry and exit to firms. This would involveamendment of the labour laws.

• De-reservation of the small-scale sector. This will permit the exploitation of scale economies.

• Fiscal consolidation - keeping the deficits and debt under check.

Encouraging FDI flows

• Reducing tariff barriers to the international level

• Reducing unemployment and alleviating poverty

• Bringing up human development, etc. Infrastructure Bottlenecks

Successive Indian governments have put considerable emphasis oninfrastructure; there-is a considerable gap between demand and availablesupply. India not only lags behind the developed countries but also itsdeveloping country peers with respect to infrastructure supply. The reforms thatIndia has had so far, by and large, failed to address the critical issue of improving the supply and lowering the costs of non-tradable inputs likeinfrastructure which cannot be procured from just anywhere. All the infrastructuresectors need sufficient funds for expansion and maintenance of existing facilities.According to the tenth five-year plan the cumulative investment requirementduring 2001-02 to 2005-06 has been estimated at Rs. 7500 billion. Of this, 40 per

cent of the investment is required in the power sector, 11 per cent in telecom andaround 14 per cent in roads and railways. With Rs. 1819.4 billion alreadyinvested during 2001-02 to 2002-03, there still exists a target of Rs. 5680.6 billionto be met in the next three years.

Power

There is a virtual consensus on the fact that the power situation in the country isnot very sound. It would be no exaggeration to say that Indian industries payinordinately high prices (when they do) for inordinately low quality power (whenthey receive it). This immediately imposes a severe constraint on production and

would inevitably affect the investment decisions of new entrepreneurs. Despite arapid expansion of generation (from 1300 megawatts in 1947 to 112,000megawatts in 2003) and simultaneous growth in transmission and distribution,the sector has not been able to keep pace with the growth in demand, resulting inchronic shortage. Under-investment in the sector has stemmed largely from thepoor financial health of the state electricity boards (SEBs) that have traditionallyplayed the key role in generating and supplying power. This in turn, is due to un-economic tariffs, for the agricultural sector, lower slabs for domestic consumption



and high transmission and distribution (T&D) losses that are often due to theftand poor billing and collection efficiency. Transport

The transport is another sector, which is not only relatively expensive by anymode but also because of infrastructural constraints hugely unpredictable interms of transit time. One of the critical problems in Indian railways has been thedecline in share of its internal resources, which has deteriorated its financialposition. This decline is due to the loss of its freight market share to roadtransport, and the relatively higher freight rates in order to subsidise ordinarypassenger segments. Besides this, there is a large speed differential betweenfreight and passenger services that reduces the traffic throughput in the system.Also there is an urgent need for better port connectivity and better infrastructurefor handling larger vessels. Focus on providing hinterland connection to variousports through railways and roads will reduce congestion levels at many ports.

Though the average turnaround time for ships has improved, it is still lower compared to international standard. Rural road infrastructure is also very poor because of bad connectivity, which in turn takes longer time to travel, and marketagricultural products across the country. Labour Laws and Labour Market Rigidities The Indian labour market does not seem to function with a reasonable degree of efficiency. Subject to the constraints that all employees have certain rights thatmust be protected, market efficiency implies that workers will be hired or retrenched as the demand for their particular skills expands or contracts.

However, in the present scenario an employer, employing more than 100workers, has to seek permission to lay off workers-from the state government.This effectively means permanent employment. For practical purposes, once aworker is hired his costs have to be borne by the employer whether he iscontributing to revenues or not. In a risky business and uncertain marketenvironment, and there is no question that the policy changes have allcontributed to enhancing business risk, this is a huge deterrent to hiring andgrowth of firms beyond the limit. Labour market rigidities constrain large industrialinvestments and therefore preserving the extreme fragmentation of the industryand limiting its growth potential. The new government has explicitly ruled out therelaxation of job security regulations that would make the market more flexible.Elimination of job security regulations for the industrial sector would significantlyimpact the effective cost of labour which would make all labour-intensivemanufacturing far more competitive. Reservation for Small Scale Industry (SSI) The policy of reservation of commodities for production by the small-scale sector is another area. It supports and sustains weak and inefficient producers, it



hinders the assimilation of technology, it perpetuates sub-optimal scales of production. Reservation of small scale production constrains large industrialinvestments and therefore preserving the extreme fragmentation of the industryand limiting its growth potential. Though exemptions based on export obligationswhich are by all accounts hardly monitored are one way in which back-door entry

by large producers into the manufacture of reserved products is effected, thisback door entry is less competitive than any front door entry. Despite many persuasive arguments to the contrary, particularly the fact thatmost of the commodities, which are reserved, are freely importable, thegovernment has not been able to terminate this policy. Though there is someback-door liberalization, with a few products being de-reserved every now andthen, for many products, this is a binding constraint on scale of operations, whichtypically means lower quality, use of inferior materials and localized marketing.De-reservation would allow producers of these to build up to scales for nationaland global competitiveness, which would give a huge boost to the manufacturing

sector as a whole, because of linkages. Fiscal Consolidation Government finances remain an area of major weakness. Some reforms in thisarea has already been initiated, however, results are awaited. The government isfacing a severe resource constraint, which prevents it from making the kinds of investments - both in physical and social infrastructure - that are consistent withits growth and human development objectives. This has resulted in a legislativemandate to curb government consumption expenditure, the Fiscal Responsibilityand Budget Management Act of 2002, which should compel the government to

re-orient both the tax and expenditure systems towards growth and income-enhancing activities. Lower FDI flow India has experienced lower FDI inflows in relation to the size of the economy.This contrast is sharp in comparison to China and other East Asian economies.The key deterrents to FDI in India are bureaucratic bottlenecks, slow reformsand poor infrastructure. But market size and potential, labour force skills, andcompetitive wages are the key advantages that India has. However, India hasnot been able to leverage its competitive advantage, due to a lack of concertedeffort. The challenge is that India has to remove the above impediments in order to attract more FDI in the country. Tariff Barriers India earlier had one of the most restrictive trade regimes. Not only were therephysical barriers to trade ('through quotas), tariff rates also were very high. As aresult of tariff reforms, import-weighted average tariff came down from a high of



around 56 per cent in 1990 to around 28 per cent in 2001 for all products puttogether. According to World Development Indicators, the reduction in tariffs for manufactured products was much sharper from about 71 per cent in 1990 to 29per cent in 2001. Despite these reductions, India's tariff rates are among thehighest in the South and East Asian countries.

Unemployment and Poverty Currently around 60 per cent of the workforce is employed in agriculture, about17 per cent in industry and while the rest in services. It is difficult to expectservices to absorb such a large overhang from agriculture - industry must alsocontribute. The government has drastically reduced its intake of people, theprivate sector just does not seem inclined to take up the slack for the reasonsmentioned earlier. The slow growth in employment and the rising number of young people looking for jobs is another critical issue for any government wishingto be re-elected. Reforms in labour markets that promote employment and the

development of social security systems will allow the economy to significantlyincrease its utilization of its most abundant resource - unskilled and semiskilledlabour. Reduction of poverty is another area of challenge. There is a considerablecontroversy about the impact of growth and reforms on poverty and incomedistribution. According to official household surveys, the proportion of populationbelow the poverty line fell from around 51 per cent in 1978 to 36 per cent in 1994and further to around 26 per cent in 2000. However, various researchers haveadjusted and corrected the methods to show either greater or lesser povertyreduction. Though the last decade has seen a substantial reduction in the

absolute incidence of poverty but India has to go a long way to alleviate poverty. Human Development There has been a continuous improvement in the Human Development Indexsince 1980s. At the national level, the index has improved by nearly 26 per centin the eighties and by another 24 per cent in the nineties. Despite improvement inhuman development parameters in the past two decades, India ranks 127th in theworld, compares very unfavourably with other countries. Political Instability From an economic policy perspective, despite the many changes in thecomposition of the government, the overall direction of these reforms did notchange fundamentally. Apprehensions were expressed that the reforms processof the present UPA government would be derailed because of the fragility of thenew coalition (UPA), with Congress at the helm of affairs being criticallydependent on outside support by Left. Though the underlying reformisttendencies of the economic administrators are still active and their agenda is



being pursued, the pace of reforms has slowed down compared to the early1990's. Public opposition from the Left is a regular phenomenon and one of thereasons for the slow pace of reforms. There are persistent demands for obtaining consensus on economic reforms, particularly those which are likely toimpose high short-term costs on entrenched political interests. Public sector jobs,

subsidies on various commodities and services-

and so on are prominentexamples of the pressures that any government has to contend with. This is insharp contrast to China, where the issue of consensus-building does not ariseand the state is able to push reforms in the desired direction at a faster pace. India - A Diversified Global Manufacturing Hub? In comparison with its Asian peers, manufacturing in India makes a relativelylower contribution to the GDP. The contrast is particularly sharp in relation toChina where the share of the manufacturing sector in overall GDP was around36 per cent in 2002, compared with a mere 16 per cent in India.

It is general understanding that the major barriers to India's emergence as adiversified global manufacturing centre, a role, which is entirely compatible withits varied resource endowments - labour, natural resources and agriculturalproducts - are in the policy realm. The two most important of these areinfrastructure and labour market inflexibility. Power is a sector that impacts on theprospects of virtually all manufacturing activity, so the likelihood that India willdevelop as a global manufacturing hub, depends critically on the growth of thepower sector. Dealing with both these issues may not in and of itself unleash aboom in manufacturing activity; however, it is unlikely that anything will happen inthis sector unless these two problems are squarely dealt with.

Prospects Future prospects for the Indian economy depend on a number of factors rangingfrom the pace of economic reforms to the performance of the global economy.India has a number of inherent advantages, and reforms can translate theseadvantages into high growth rates in the long run. Population and incomedemographics play a critical role in the production process as well as from theconsumption side. Rising Level of Per Capita Income Over the past decade, per capita incomes have risen at the faster pace in thecountry's history due to higher GDP growth and falling birth rates. With theincome growth fast outpacing population growth, nominal per capita income hasgrown by 3.6 times between 1990-91 and 2002-03. The present level of per capita income may still be a very low level by international standards, but it is animpressive change and this has had very interesting effects on consumer behaviour.



Growing Middle Class The latest survey by National Council of Applied Economic Research (NCAER)shows that middle class segment has grown by 2.5 times between 1995-96 and

2001-02. This survey also mentions that the middle class is expected to show asignificant bulge in future. The middle class is defined as households with incomebetween Rs 2,00,000 and 10,000,00. Bulging middle class together with risingincome will give a thrust to consumption in future. Larger Number of Working Population and Reducing Dependency The age dependency ratio in India is expected to show a significant decline.Dependency ratio is defined as the ratio of non-working population (< 15 yearsand > 64 years) to working population (15-64) years. India will have anadvantage of lowest dependency ratio. Low dependency ratios promote

consumption of goods and services, due to lower burden of caring for the agedand bringing up children. Higher population in the working age group impliesgreater supply of labour, and an increasing concentration of population in higher income group translates into higher consumption levels. India's current share of working population in total population low, but the size of population puts India in the second spot after China in terms of number of people in the working age. Among comparator countries, the share of workingpopulation to total population will decline in China, Thailand, Brazil and Russia.India, Malaysia and Philippines will have larger and increasing share of workingpopulation in the years to come. India, with a faster rate of increase, will emerge

as a major source of labour supply, due to the sheer size of its population. The rising share of working population is both an opportunity as well as achallenge. The opportunity is in terms of availability of human capital andchallenge is in provision of productive employment to the bulging workingpopulation. Alpo, much will depend upon the education levels and skill sets of theworking population. Availability of Qualified Manpower There has been a steady improvement in the literacy rate from around 52 per cent in 1991 to around 65 per cent in 2001. A very significant advantage thatIndia has is the high pool of educated and technical staff together with low wagerates. As India's 60 per cent of the labour force is in agriculture, India will alsoremain a key supplier of low skill labour in times to come. In terms of skill sets and availability of qualified labour, India is quite well placed.India ranks very high in terms of availability of skilled labour in general andengineers in particular. This fact is brought out by the Global Competitiveness



Report's finding, which puts India in the third place in the availability of scientistsand engineers. India, however, does not rank very high in the quality of education system. It ranks 36 in terms of quality of overall education among the102 countries surveyed in the Global Competitiveness Report.

Certain Niche Areas where India can make Competitive Advantage Economic liberalization and increased globalization has effectively changed theIndian industrial landscape. Increased opportunities, greater access to resourcesand knowledge and the forces of competition have transformed the Indianindustrial landscape quite dramatically. India currently is a service hub of theworld where it enjoys dominant position in a variety of service and knowledge-based activities.

There is no question that India has potential comparative advantage in manymanufacturing activities. First there is the substantial natural resource

endowment. Secondly there is the oft-repeated abundance of relatively low-costlabour, much of which are endowed with craft skills emerging from the tradition of occupational castes. India has a competitive advantage in some sectors likepharma; auto and auto ancillaries, textiles, gems and jewellery, etc. Conclusions Although India's growth performance does not match that of other fast growingEast Asian countries and China, in recent years India has emerged as one of thefastest growing economies not only in the region but also in the world. It isexpected that India would be a high performer in the years to come.

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Second generation reform soon, says Sinha

PRESS TRUST OF INDIA

NEW DELHI, APRIL 29: The government will soon unveil the second generation reform

programme to provide a "road map" for economic development during the next 10 to 15

years, Finance Minister Yashwant Sinha said here today.

The main thrust of the second generation reforms would be to sequence the unfinishedeconomic agenda and deal with sensitive issues such as subsidies, as the first phase of

liberalisation process has been "ad hoc and not well-planned", Sinha told the CII annual

session here.

A comprehensive paper on the second generation reform would be released "shortly" to

elicit opinion from all sections of the society including the peasantry and trade and

industry, before implementation, he said.

Sinha later told reporters that the comprehensive paper on second generation economic

reforms was being given final touches by the government and would soon be unveiled.He, however, did not divulge the exact period of release of the paper.

The finance minister told the gathering that the reform wouldalso encompass on revenue

and fiscal deficit and Plan and non-Plan expenditure. He said the division between Planand non-Plan expenditure had led to artificial distinction that led to distortion in the

budget that caused harm to the economy.

Sinha expressed concern over the delay in passage of legislations such as the Insurance

Regulatory Authority Bill, the Foreign Exchange Management Act and the CompaniesAct.

This will have to wait until the Lok Sabha is convened again after elections, he said

adding ``it is a temporary set-back.'' ``Though it is possible for the government to pass

ordinances to put in effect some legislations, it is still a grey area,'' he said. Sinha said thegovernment was keen to clear the IRA Bill during the last session of Parliament and had

listed it in the business.



He said the distinction between Plan and non-Plan expenditure had led to problems of

provisions for assets created in the country through budgetary allocations. ``This has led

to destruction along with theconstruction of assets,'' he said.

Buildings were built of which some have collapsed and similarly roads and bridges were

made but could not be properly maintained due to lack of provisions, he said adding thisdistinction between Plan and non-Plan would have to be re-looked in a careful manner.

The government was also keen to go ahead with zero-budgeting by making it necessaryfor the implementing agencies in the country to provide quarterly results of the amount

spent on projects and not rushing in the figure before the end of financial year, he said.

``If any organisation (responsible for implementing of the projects) does not do so we

will consider asking them to surrender the funds,'' he said.

Sinha said he was unhappy that the budget was passed without discussion as discussions

would have enabled him to introduce some amendments in accordance with post-budget

representations received from various quarters. He blamed the opposition for it.

Sinha said the fractured mandate received by the partiesduring the last elections had ledto political uncertainty. He said there were no differences on economic policies within the

BJP as was vindicated at the recently held BJP national executive at Goa. ``There are also

no differences between the BJP and its allies on the economic issues,'' he asserted.

``It will be our endeavour to ensure in the coming months the implementation of the budgetary proposals," he said adding ``there will be no let-up, no relaxation, no lethargy

as far as various provisions of the budget are concerned." Sinha said all efforts would be

made to contain the revenue deficit and the fiscal deficit to two per cent of GDP as has

been targeted. Sinha reiterated there were no differences between the RBI governor andhim on interest rates and other issues.

He said the future reforms would also look into the aspect of making the RBI a purely

custodian of the monetary polices and doing away with its equities in the banks. He saidthe government would deal with the problems of non-performingassets besides looking

into the agricultural pricing and agriculture produce trading and putting in place the land

reforms.

Sinha said the government was committed to going ahead with all the policies that had been cleared before the losing of the confidence motion, including the disinvestment of

some public sector undertakings.

Later speaking to reporters, Sinha said the question of lowering of interest rates would

have to be dealt by the Reserve Bank of India. ``The RBI has already brought down the bank rate soon after the budget and it is for it to decide on this aspect,'' he said. He

refused to comment on the rupee-dollar exchange value.

Copyright © 1999 Indian Express Newspapers (Bombay) Ltd.

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