The 1991 Budget, in hindsight

On July 24, 1991, Manmohan Singh presented the first Budget of the PV Narsimha Rao government, a Budget that would change the face of the Indian economy. While the intellectual argument for reforms had been gaining momentum for a long time before 1991, it took an economic crisis and deft politics, both within and outside his party, by Rao — he was heading a minority government at the time — to actually see them through. The reforms triggered a sharp debate when they happened, but they have come to enjoy a rare bipartisan consensus in the last 30 years and survived many regimes.

At a time when the Indian economy is trying to come out of its largest ever contraction, the nature of economic challenges is very different from what they were 30 years ago. The 30th anniversary of Manmohan Singh’s first Budget is an opportune moment to look at the 1991 Budget in hindsight, retrace the journey, and, perhaps, ask the right questions.

How serious was the immediate crisis before 1991 Budget?

Manmohan Singh’s 1991 Budget speech made no attempt to hide the extent of the economic crisis prevailing then.

“The new Government, which assumed office barely a month ago, inherited an economy in deep crisis. The balance of payments situation is precarious...We have been at the edge of precipice since December 1990 and more so since April 1991...The people of India have to face double digit inflation which hurts most the poorer sections of our society. In sum, the crisis in our economy is both acute and deep. We have not experienced anything similar in the history of independent India.”

How bad was the foreign exchange and inflation situation at the time?

A look at inflation and foreign exchange reserve and trade numbers suggests that the balance of payment crisis was much bigger than the inflation crisis.

We have inflation data going back to 1961-62 under the Consumer Price Index for Industrial Workers or CPI (IW) series. CPI (IW) had been in double digits from October 1990 onwards when Singh presented his Budget in July 1991. It would stay above the 10% mark until September 1992.

Annual growth in CPI (IW) was 11.2% and 13.48% in 1990-91 and 1991-92. The country had seen worse or comparable inflationary episodes before. The oil-shock years of the 1970s were the worst. CPI (IW) grew at 20.59% and 26.75% in 1973-74 and 1974-75. 1966-67 and 1967-68 had seen inflation to the tune of 12.11% and 12.36%. 1980-81 and 1981-82 were also consecutive double-digit inflation years. (See Chart 1)

“The current level of foreign exchange reserves, in the range of ₹2,500 crore, would suffice to finance imports for a mere fortnight,” Manmohan Singh said in his Budget speech.

This particular statistic went on to become the biggest artefact associated with the pre-reform economic crisis in 1991. Because India does not have monthly trade and foreign exchange figures before 1990, it is difficult to ascertain whether the foreign exchange crisis in 1991 was the most severe the country ever faced. However, monthly average calculations based on annual import and foreign exchange reserve numbers since 1970-71 do show that the pre-reform crisis was indeed the most severe. Arguments over the roots of this crisis triggered a sharp debate among various economists back then, and the basic tenets of this continue to be relevant today. ( See Chart 2)

‘An idea whose time has come’: The 1991 Budget’s case for economic liberalisation

The Indian economy had its share of fiscal, inflationary and balance of payments crisis even before 1991. Where the 1991 Budget differed was in its firmness to unleash wholesale policy reform. The speech articulated this unequivocally.

“Macroeconomic stabilisation and fiscal adjustment alone cannot suffice. They must be supported by essential reforms in economic policy and economic management, as an integral part of the adjustment process, reforms which would help to eliminate waste and inefficiency and impart a new element of dynamism to growth processes in our economy. The thrust of the reform process would be to increase the efficiency and international competitiveness of industrial production to utilise for this purpose foreign investment and foreign technology to a much greater degree than we have done in the past, to increase the productivity of investment, to ensure that India’s financial sector is rapidly modernised, and to improve the performance of the public sector, so that key sectors of our economy are enabled to attain an adequate technological and competitive edge in a fast changing global economy.”

The real liberalisation push came not in the Budget but via drastic changes in industrial and export-import policy which were announced with the Budget. In his essay The Road to the 1991 Industrial Policy Reforms and Beyond published in the collection India Transformed: 25 Years of Economic Reforms, former Reserve Bank of India deputy governor Rakesh Mohan (who was then working in the industry ministry) provides an account of Singh’s firm resolve to push the reform process.

“Within a few days of his appointment (as finance minister), Manmohan Singh called a meeting of all the secretaries of the major economic ministries and the chief economic adviser... Manmohan Singh outlined the full economic reform programme that was to be followed over the next five years — and more importantly, over the next six weeks. The latter included immediate action to be taken on industry policy. He said quite clearly that he had the full mandate of the Prime Minister to do whatever had to be done to solve the crisis... Since he knew that some of the mandarins present were not on board with the kind of liberalising economic reforms envisaged, he added: “If any of you have any difficulty with the proposed reform programme, we can find other things for you to do!” This was perhaps the most firm and forceful that I ever saw Dr Manmohan Singh.”

The unfulfilled promise of 1991 industrial policy reform and continuing quest for a new industrial policy

The 1991 Industrial Policy document looked at five major areas: industrial licensing, foreign investment, foreign technology agreements, public sector and The Monopoly and Restrictive Trade Practices (MRTP) Act of 1969. In all these areas, the policy thrust was towards removing restrictions on entry of capital, both foreign and domestic. Industrial licensing was abolished in all sectors except 18 industries where it was preserved on account of security and strategic concerns. The policy also said that the “portfolio of public sector investments will be reviewed with a view to focus the public sector on strategic, high-tech and essential infrastructure”. This was the first signal of withdrawal of government from business — a policy that would gain further momentum with the disinvestment of public sector enterprises, a process which continues to unfold even today.

While private industry has made significant achievements in India in the three decades of economic reforms, the cherished goals of the 1991 industrial policy are still unrealised to a large extent, especially when they are seen from a macroeconomic lens. The share of manufacturing in GDP has not increased much. It was 14.5% in 1991-92, and stood at just 17.1% in 2019-20, the year before the pandemic disrupted economic activity. The stagnant share of manufacturing even after three decades of reforms is the biggest proof that there are other structural impediments to an industrial revolution in India.

That India has not been able to realise the objective of increasing the efficiency and international competitiveness of its industrial production can be seen from the composition of its exports. The World Integrated Trade Solution (WITS) database of the World Bank uses a 2000 paper by economist Sanjaya Lall to classify exports by their level of technological sophistication. There are five mutually exclusive categories in this classification: primary (rice, tea, petroleum, etc.), resource-based (vegetable oils, cement, etc.) low technology (textile fabrics, jewellery, etc.), medium technology (passenger vehicles, industrial machinery, etc.) and high technology (turbines, pharmaceuticals, etc.) products.

The share of high technology exports in India’s export basket has barely increased; from 2% in 1991 to 6% in 2019, the latest period for which this data is available. For China, this share increased from 9% in 1992 to 35% in 2019. (See Chart 3)

While India did enjoy some success in exporting medium technology goods, whose share increased from 11% to 21%, this has not been an unambiguous blessing. This year’s Economic Survey made this point in the most effective manner when it attributed Bangladesh’s export success to its prioritisation of labour-intensive commodities unlike India. While Bangladesh’s export basket is in keeping with its labour abundant reality — textiles, footwear and apparel constitute 90% of its exports — around 40% of India’s exports is capital or technology intensive, the survey pointed out. Using the Bangladesh export example, the survey asked the country’s exporters to learn from this and specialise in products in which India is competitive. As India continues to experiment with various kinds of policy tools to promote industry, be it the Make in India programme or the latest Production Linked Incentive (PLI) scheme, the question of an effective industrial policy is as relevant and perhaps elusive as it was in 1991.

To be sure, economic reforms did play a critical role in the rise of IT industry in India. According to NAASCOM, the industry association of India’s IT industry, the IT sector is a $194 billion industry which employs 4.47 million professionals and contributes around 8% of India’s GDP. The IT sector also generates significant export earnings for the country; $128.6 billion in 2019-20, according to data from RBI.

The rise of India’s IT industry would not have been possible if the pre-reform restrictions on imports and foreign currency use had not been lifted, which led to the absurd situations such as IT companies having to keep waiting for approvals to import computers. Writing in the collection India Transformed: 25 Years of Economic Reforms Infosys founder Narayana Murthy also talks about two critical reforms which were critical in the growth of the IT industry in India. The first was a removal of condition of multinational companies necessarily diluting equity holding in their Indian subsidiaries to 40%. This encouraged global IT giants to set up entities in India and generated significant positive spill over effects for the domestic players. The second was the abolition of the office of Controller of Capital Issues (CCI) which had a mandate to decide on the pricing of Initial Public Offerings of companies. The officer did not have the necessary skill-set to evaluate business prospects of evolving sectors such as IT. The CCI had valued Infosys shares at ₹11 in 1990. The company finally got listed in 1993 at ₹95 per share, after it could work with specialised investment bankers before listing, once the office of CCI was abolished.

The question of fiscal consolidation

One of the biggest milestones of India’s post-reform phase was the adoption of the Fiscal Responsibility and Budgetary Management (FRBM) Act in 2003. The FRBM Act gives a legal mandate to the Union government to keep its budgetary deficit under check. The original Act called for an elimination of revenue deficit and bringing down the fiscal deficit to 3% of GDP by 2008. The fiscal glide path, the term used for bringing down the deficit as prescribed under the Act has since been adjusted owing to the adverse economic developments. The 1991 Budget made the first noise about the need for fiscal consolidation.

“In the macro-management of the economy, over the medium term, it should be our objective to progressively reduce the fiscal deficit of the Central Government, to move towards a significant reduction of the revenue deficit, and to reduce the current account deficit in the balance of payments,” Singh said in his Budget speech. Fiscal deficits, while they have come down compared to where they were in 1991, have not stabilised to the levels envisaged in the FRBM Act. The pandemic’s shock is likely to administer a long-term shock to fiscal consolidation.

The issue of fiscal conservatism or prudence has always been a polarising one among economists. Even Singh tried to pre-empt some of this criticism while arguing for fiscal prudence in his 1991 speech. “During the period of transition (to a low deficit phase), it shall be our endeavour to minimise the burden of adjustment on the poor. We are committed to adjustment with a human face. It will also be our endeavour that the adjustment process does not adversely affect the underlying growth impulses in our economy,” he said.

The economic virtue of fiscal intervention gained popularity after British economist John Maynard Keynes gave his idea of government investment acting as a multiplier of growth in a recession affected economy during the Great Depression of the 1930s. Keynesian ideas held sway after the Second World War until the 1970s, often referred to as the Golden Age of capitalism. A neoliberal economic revolution after the Oil Shocks brought fiscal conservatism and deregulation of finance back in favour.

Questions have been raised about the purported virtue of fiscal prudence, especially during an economic downturn by many economists across the world. The view found a reflection when the FRBM Review Committee under the chairmanship of NK Singh submitted its report in 2017.

“One disadvantage of headline fiscal balance rules is that they do not have counter-cyclical properties. For example, when growth – and therefore revenues – is above potential, policymakers should ideally be reducing fiscal deficits, and thereby creating fiscal space that can be used in downturns. However, adhering to a fiscal deficit target necessarily results in those extra revenues being spent. Similarly, during downturns, as automatic stabilizers work, one would want the fiscal deficit to expand, but that is precluded by adherence to a headline deficit rule, thereby making fiscal policy pro-cyclical. There is widespread evidence that fiscal policy in emerging markets tends to be pro-cyclical rather than counter-cyclical, in part because of political incentives to run large deficits in good times when financing is available.”

The question of fiscal prudence bringing a pro-cyclical element to economic policy — as was pointed out by the NK Singh Committee — is extremely relevant given the fact that India’s fiscal stimulus to deal with the pandemic’s economic shock has been among the smallest among major economies. (See Chart 4)

The nature of tax burden and the question of tax evasion

There is one area where the vision set in the 1991 Budget has seen a reversal: the objective of raising the share of direct taxes in overall tax revenue. “The revenue from direct taxes, both as a proportion of GDP and as a percentage of total tax revenues, has registered a steady decline over time. This trend has to be reversed, so as to restore equity in, and balance to our fiscal system,” Singh said in his Budget speech.

According to the Centre for Monitoring Indian Economy (CMIE) database, share of direct taxes in total tax revenue of Centre and states fell from 18.3% in 1981-82 to 16.3% in 1990-91. This share would increase consistently in the post-reform period to reach a peak of 43.2% in 2009-10. It has since then fallen steadily. It fell to 36.1% in 2015-16 before rising marginally to 38.9% in 2019-20. Recent numbers are likely to be even lower, thanks to the corporation tax cuts in 2019, fall in direct taxes due to the pandemic and the increased reliance on petrol-diesel taxes in the post-pandemic phase. The goal of reversing this decline in the share of direct taxes is still worth pursing.

It needs to be understood that this objective cannot be pursed without rationalising the tax structure and plugging various loopholes which existed 30 years ago and continue to, today. The absurdities of India’s tax system in 1991 are best captured by this exemption Singh abolished in his speech.

“Over the years, those with an instinct for gambling have increasingly patronised the races. I propose to withdraw the income-tax exemption of ₹5000 (India’s per capita GDP at factor cost was ₹7167.28 in 1991-92) in respect of earnings from races, including horse races. I am sure that persons who place bets will now also have the added pleasure of sharing their earnings with the government.”

The problems facing India’s tax system are far from over. This is best seen from the fact that amount of taxes raised, but not realised by the Union government stood at ₹12.98 lakh crore at the end of 2019-20 (latest available data). To put this number in context, the gross tax revenue of the Union government was ₹20.1 lakh crore in 2019-10.

Of the ₹12.98 lakh crore of revenues not realised, ₹10.42 lakh crore was under dispute, while the rest was on account of lack of assets or the assessee not being traceable. The fact that amount worth almost half of the Centre’s gross tax revenue is mired in dispute raises serious questions about the transparency and simplicity (or lack of it) of India’s tax system. The fact that Goods and Services Tax, which is the biggest indirect tax reform in independent India, had serious teething troubles when it was launched in 2017 and continues to suffer from multiplicity of slabs only underlines the importance of simplifying India’s tax regime.

While the current government’s tax policy has its share of blames, especially on the question of tax burden becoming regressive, the United Progressive Alliance government, where Singh was the Prime Minister, also did not do justice to the ideals of a simple transparent tax system, by decisions such as retrospective taxation. (See Chart 5)

The moral dilemma of conspicuous consumption in a poor economy which also runs a trade deficit

There is practically no rationale against the removal of arbitrary, often stifling, regulations on private enterprise which existed in India before the 1991 Budget. However, there is merit in engaging with the line of argument which was given by many left-leaning economists. This critiques the liberalisation of trade, which had begun in a piecemeal manner before the 1991 reforms and has increased significantly in the last three decades. The logic which was given was that it was the rich who had contributed to the rise in current account deficit by spending scarce foreign exchange on items of luxury consumption.

“There is no time to lose. Neither the government nor the economy can live beyond its means year after year,” Singh said in his Budget speech referring to the high fiscal deficit and current account deficit along with a shortage of foreign exchange.

Ashok Mitra, one of India’s most original Marxist economists, and also a cheeky polemicist, attacked Singh’s logic in his column Calcutta Diary in the July 27, 1991 issue of the Economic and Political Weekly. “It is simply not true that the nation as a whole has been living beyond its means. It is only a minor segment of the nation, the top-most decile, which has lived it up since that egregious doctrine of borrow and spend , borrow again and spend again, became official policy in the eighties,” Mitra wrote.

Singh himself had tried to pre-empt the attack on this front in his Budget speech. “In highlighting the significance of reform, my purpose is not to give to fillip to mindless and heartless consumerism we have borrowed from affluent societies of the West. My objection to the consumerist phenomenon is two-fold. First, we cannot afford it. In a society where we lack drinking water, education, health, shelter and other basic necessities, it would be tragic if our productive resources were to be devoted largely to the satisfaction of the needs of a small minority...Our approach to development has to combine efficiency with austerity. Austerity not in the sense of negation of life or a dry, arid creed that casts a baleful eye on joy and laughter. To my mind, austerity is a way of holding our society together in pursuit of the noble goal of banishing poverty, hunger and disease from this ancient land of ours.”

Singh’s Budget speech also referred to the Congress manifesto’s promise of “measures to curb conspicuous consumption” while increasing excise duty on refrigerators, air-conditioners, motor cars, etc.

Conspicuous consumption has increased by leaps and bounds in the three decades since Singh’s warning in 1991, even as millions of Indians continue to live in penury. The richest Indians can enjoy almost all the pleasures money can buy inside and outside the country. Sure, India does not face a foreign exchange crisis today like it did in 1991, even though we continue to run a large trade deficit. Capital inflows and remittance incomes have helped on this front. The possibility of a capital-flight driven balance of payment crisis is remote, if not non-existent today. However, the question of forcing some sort of austerity on the rich to pursue the goal of providing relief to the poor continues to be as relevant and it is politically difficult.