A balance sheet of the 1990s |
ASHOK V DESAI
Copyright (c) Business Standard
The state of the Indian economy appears to be embarrassingly sound. It is now two years after the nuclear ceremony, which brought universal condemnation and sanctions upon India; just the month before last President Clinton christened our subcontinent the most dangerous spot in the world, thereby telling American business not to invest in India. Despite this confrontation with the capitalist world, India's balance of payments remains surprisingly strong; through hail and high water, the reserves keep rising.
And that is not because of foreign investment. Foreign direct investment is distinctly down after the coming of the BJP governments. Portfolio investment is not, but it is a fickle bird of fancy. It has been down and up. It is here today and may be gone tomorrow. In any case, capital inflows are not responsible for the rising reserves. One cannot avoid the conclusion that the external fundamentals are strong.
And more surprisingly, inflation is down. The level of inflation showed a distinct fall from 1996 onwards; in the past year it has come down to levels that have not been seen since the days before socialism and the grand follies. Something has changed; we are no longer in the boom-and-bust mode of the 1960s, 1970s or 1980s.
What has changed? Five things in particular. First, industry is no longer in a position to pass on cost increases. Domestic competition has increased, and now there is some competition from abroad as well. This accounts for much of the fall in inflation. For this, the credit must go to the Fund and the Bank, which forced us to abolish industrial licensing in 1991, and to Narasimha Rao who had the sense to yield to force. If the Fund and the Bank had any strategic sense, they would be advertising their success in India instead of drawing comfort from Cte d'Ivoire and El Salvador.
Second, the illegal balance of payments has collapsed. The hawala premium has disappeared, and billions of dollars that used to be siphoned off into illegal foreign exchange transactions. For this, credit again goes to the Fund and the Bank they forced us to devalue in 1991, begin to dismantle import licensing in 1992, and start reducing tariffs in 1993 and to Manmohan Singh at the finance ministry and P Chidambaram at the commerce ministry who carried out these changes. But I would now give greater credit to Chidambaram. For when Manmohan Singh liberalised gold imports through NRIs without releasing foreign exchange for them, he in effect legalised smuggling; most of the gold came to be brought in by couriers of big Dubai smugglers. When Chidambaram allowed a few banks to import and sell gold in 1996, he dug the grave of gold smuggling. We see the effects of this single measure today in the death-throes of hawala. The rise in the reserves is due to the fall in the demand for gold and smuggled goods, and in foreign exchange balances illegally held abroad.
The third change is something Manmohan Singh did in a moment of righteousness. He felt it was unfair that the government should take away people's savings without a by-your-leave through the loans it compulsorily sold to the banks. So he resolved in 1992, without anyone asking him, that the central government and its institutions would no longer resort to the Statutory Liquidity Ratio. On the face of it, it changed nothing; even now the Reserve Bank sells thousands of crores of central securities to the banks. But the absorption is no longer automatic; the Reserve Bank has to cajole, threaten, twist arms, and even then it sometimes cannot sell the loans. It has had to raise interest rates; the cost to the government has gone up. IDBI and ICICI have had to raise money from retail investors at high interest rates. The change is working its way through the system. When Yashwant Sinha inveighs against the fiscal deficit, he is not being a reformer; he is just reflecting the consequences of Manmohan Singh's decision.
The fourth change is in taxation. Manmohan Singh brought down the income tax rates. If I write that revenue has increased as a result, S S Bagai will immediately write back showing that it has not as a proportion of non-agricultural income. But I would still claim that that in a country where tax evasion is so rife, all taxation is unfair to honest taxpayers; the reduction in taxes has evened the scales slightly in their favour. It is not just the tax reduction; there are two further fiscal changes. One is that the rate of corporate tax and the peak personal rate of tax are about the same, so the gains from declaring personal expenses as corporate expenses have declined, and so have the advantages of controlling companies for that purpose. And Yashwant Sinha abolished the tax on dividends in the hands of shareholders, and thereby reduced the double taxation of dividends (as against the single taxation of undistributed profits). This too reduced the advantage of controlling companies. With these two changes, a promoter no longer has to control a company to be able to live off its profits; he can hand it over to competent managers and live comfortably as a shareholder. A handful of promoters have done so already; many more have hired more competent CEOs than themselves.
The last change is not very clear to me: something has happened in the foodgrain market. In the 1970s, the Green Revolution created a flood of wheat; to save Punjabi farmers from distress, the central government turned the rationing scheme into a scheme to subsidise foodgrains and increase their consumption. But there are always many claimants for a subsidy: farmers, who would like higher prices, consumers, who would like lower prices, and the officials of Food Corporation, who would like fat margins to blow up on themselves. The farmers have politically been the most powerful, and have won an annual support price increase of 10-15 per cent year after year. That is what raised the rate of inflation from an average 7 per cent in the 1950s and 1960s to 11 per cent in the 1980s, even though the growth rate of foodgrain output rose. In the 1990s, somehow, the political advantage of pushing up support prices petered out. The first sign came in the eight state elections of 1994-95, of which the Congress lost six. Manmohan Singh connected this to Balram Jakhar's pushing up of support prices by 60 per cent in three years. He applied all brakes and brought down inflation to an incredible 4 per cent by the general election of 1996; but the Congress still lost it. The present government is, if anything, even more beholden to Punjabi farmers; but it has been more circumspect in raising support prices. The urban supporters of the BJP have at last found a voice. So inflation has come down, and I think the fall may last.
These five changes have buttressed the economy and opened up great opportunities. In the next article I shall suggest how the momentum imparted by these reforms can be maintained.