From 1991, the lessons for the India of 2021

The 30th anniversary of the 1991 reforms deserves commemoration. They dismantled a dysfunctional system of controls, which tied down the private sector and closed the economy to trade and investment.

The reforms were opposed by both the Left and the Right. The Left feared they would hurt the poor and lead to unnecessary imports, perpetuating balance of payments (BoP) problems. The Right feared foreign investors would take over the economy, in a replay of the East India Company phenomenon.

Both fears were unwarranted. The results took time because policy changes were gradual, delaying the benefits. However, by the first decade of the 21st century, India began to be seen as one of the fastest growing emerging markets. Far from poverty increasing, for the first time, there was a substantial reduction in it.

This looks enviable at a time when India is reeling from the impact of the Covid-19 pandemic, with Gross Domestic Product (GDP) having fallen by 7.3% in 2020-21, and an even sharper decline in per capita GDP because the population has continued to grow. Not surprisingly, unemployment and poverty have both increased.

The best way to commemorate the 1991 reforms is to consider what we can learn from them in dealing with the current crisis. The 1991 strategy had two components — reducing the fiscal deficit and implementing structural reforms. Both are relevant today, but with differences.

Reducing the fiscal deficit was essential in 1991 because the crisis was caused by excess domestic demand sucking in imports and widening the current account deficit (CAD). A loss of confidence triggered an outflow of funds and financing CAD forced a sharp drawdown in reserves. Reducing the fiscal deficit was an obvious way of containing demand.

The crisis today is not caused by excess demand. It has been triggered by a collapse in production following the disruption caused by the pandemic, which, in turn, has caused a fall in demand. Those who lost incomes had to cut consumption. Even those who have not lost income, face uncertainity and have postponed expenditure. Investment, a key source of aggregate demand, has also slowed because of unutilised capacity and uncertainty about growth.

Faced with a collapse in demand, it is appropriate to increase the fiscal deficit. The government rightly allowed the fiscal deficit to expand to 9.6% last year, though some of this was statistical, reflecting the inclusion of off-budget items. The question is whether the BE deficit of 6.8 % for 2021-22 is appropriate.

Many have called for a stronger stimulus. Is this justified? The budget projection assumed GDP would grow by 11.3%. Those who want a stronger stimulus are not saying 11.3% is not good enough. They are saying that GDP growth will be much lower and, therefore, a stronger stimulus is needed. Most independent analysts say that growth will be much lower than 11.3%.

If growth is going to be much lower than projected, there will be shortfalls in both tax and non-tax revenues. If we still try to stick to the 6.8% target, we will have to cut expenditure. This would be unduly contractionary. We should definitely maintain expenditure at the levels budgeted, and let the fiscal deficit rise if it has to. The is also a strong case for providing more funds for vaccination, which is key to reviving growth, and also to cover expanded demand for the Mahatma Gandhi National Rural Employment Guarantee Scheme, which is proving to be a valuable safety net.

The government would be well advised to undertake a mid-year review of budget prospects in September, and come up with a revised growth forecast and establish new fiscal targets. We need not fear a loss of international confidence as long as we undertake a credible path for deficit reduction over the next three years. Revising revenue targets to more realistic levels will also have the advantage of not pushing tax officers to achieve unrealistic targets, which only leads to unreasonable assessments.

Another important lesson from 1991 is that we need to move away from a “long list of reforms” approach towards a more strategic approach, focussing on the most critical reforms needed immediately.

The 1991 reforms succeeded because they were structured around a core package of mutually supportive reforms. The need for mutually supportive reforms was not adequately recognised at the time even by the private sector. Representaives of the private sector asked for elimination of government controls over investment, but did not recognise that this by itself would only mean that investors would have to queue up in the commerce ministry to get licences to import capital goods. Genuine liberalisation required parallel delicensing of capital goods imports, but that could only be done if we had some way of managing the BOP. The obvious solution was to shift to a market-determined exchange rate. All these steps were carefully coordinated and implemented over a very short period.

What would a similar priority list look like today?

I would put banking sector reforms right at the top. Our banking system is heavily dominated by public sector banks (PSBs) and genuine reform in this area is not in sight. Mergers may help reduce branches, and perhaps monetise excess real estate to boost capital, but it is not a systemic reform. Giving the Reserve Bank of India (RBI) the same regulatory control over PSBs that it has over private sector banks would qualify as a real reform. It is time to take the plunge on this. Vesting the government’s equity in PSBs into a holding corporation run by a board of independent professionals, which then appoints the top management, would also be a serious reform. It was recommended by the PJ Nayak committee in 2015. Implementing it would send a strong signal.

The Insolvency and Bankruptcy Code (IBC) is a key reform, but its operation was temporarily put on hold because of the pandemic. While the process will hopefully resume, promoters may try to interrupt it through action taken in the courts. The government can play an important role in signalling to the courts that IBC is a flagship reform that should not be undermined.

Another example of implementing mutually supportive reforms is the inter-relationship between moderating the fiscal deficit over the medium-term with the creation of an efficient financial sector. At present, the combined deficit of the Centre and the states exceeds the net savings of the household sector. The combined deficit is effectively financed by the net inflow of foreign capital. Preempting net savings to this extent leaves little scope for financing expansion in private investment, unless it is expected to happen through a further increase in net capital flows, which would only increase the system’s vulnerability.

The crowding out of private investment may not be relevant today because investment sentiment is depressed but, in the long-run, making room for expanded private sentiment is essential. This calls for fiscal consolidation for next year onwards, which will require greater buoyancy in tax revenues.

The need for buoyancy in tax revenues calls for a second look at the Goods and Services Tax (GST) regime. GST is a major reform and it was expected to generate greater tax buoyancy. It has not done so. Its rate structure and exclusions need to be reviewed. An important lesson from 1991 is that tax reforms are best evolved by an expert group outside government. Such a group should be set up and asked to review the experience so far, and make proposals for reform which could be discussed in the GST Council. This cannot be left to the revenue department.

The 1991 reforms helped the economy stave off a crisis and then bloom. It is time to outline a credible new reform agenda that will not just bring GDP back to pre-crisis levels, but also ensure growth rates higher than it had when it entered the pandemic.

Montek Singh Ahluwalia has served as deputy chairperson of the Planning Commission and finance secretary. He was among the architects of the 1991 reforms. He is currently distinguished fellow, Centre for Social and Economic Progress

The views expressed are personal