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Economic problems:Give a critical review of the First Generation Reforms

Economic Problems and Politics

Give a critical review of the First Generation Reforms. Also, discuss the main features of the Second Generation Reforms.


Review of First Generation Reforms

(1) Fiscal Discipline: The most serious problem facing the country today is the high level of fiscal deficit. A high fiscal deficit is synonymous with high government borrowing which keeps the rates of interest high and is detrimental to the much, needed private investment in the economy.                      In 1991, when India embarked upon the economic reforms, the Central government’s fiscal deficit had reached 8.3 percent of the GDP-this was seen as the root cause of the crisis. This gave a sense of urgency for the need for fiscal correction and the country was able to reduce the fiscal deficit to around 6 percent of the GDP in the first year. In 1993, the finance ministry announced that the medium-term objective was to reduce the fiscal deficit to around 3 percent by 1996-97. However, this target still eludes India. The actual fiscal deficit was 5.2 percent in 1996-97; it deteriorated to 6 percent in 1997-98 and remained at a high level of 5.1 percent in 1998-99.

Meanwhile, the fiscal position of the states has also deteriorated significantly. Unlike the Centre, the states are not allowed to borrow freely and this puts a limit on their fiscal deficit. However, the financial Weaknesses of the states are reflected in the uncontrolled growth in non-plan expenditure and losses in economic services (electricity, water, transport) offered by them. The scale of the problem can be judged from the fact that in 1997-98, the losses of all the state electricity boards (SEBs) amounted to about Rs. 11,000 crore, losses of State Road Transport Corporation (SRTC) were about Rs. 1,000 crore and losses on account of irrigation were Rs. 2,000 crore.

‘In order to reduce poverty, it is crucial to have a faster agricultural growth and rural development. This requires investment in wide-ranging areas-irrigation, land development, soil and moisture conservation, agricultural research and development, development of agricultural marketing and expansion and maintenance of rural roads to improve connectivity. Huge investments are also needed in health and education sectors to bring our social development indicators at a level comparable with other developing countries.

In infrastructure sectors such as ports, telecom, airports, power generation and distribution, private investment must be encouraged, but public investment will continue to be important.

Therefore, it is essential to reduce the fiscal deficit in order to release resources for crucial development activities. The finance minister has recently said that we must bring down the Centre’s fiscal deficit to two per cent of the GDP in the next three years. This would imply that the combined fiscal deficit of the Centre and states should be reduced to, say, 4.5 per cent of the GDP. In order to achieve this, action will be required on various fronts.

(i) Reducing subsidies: The total level of direct and indirect subsidies in our system has risen to unsustainable levels. The major direct subsidies by the Central government are on fertilizer; food and sugar, and these amounted to Rs. 24,000 crore according to Budget Estimates for 1999-2000.

In addition, there are large implicit subsidies such as massive undercharging for higher education, hospital services, postal services, railway travel, etc. The subsidy on kerosene is around Rs. 8,000 crore and on LPG around Rs. 4,000 crore. These subsidies are not technically borne by the budget but are covered by overcharging for petroleum and aviation turbine fuel. This cross-subsidy, however, results in a loss of potential tax revenue. Moreover, the subsidies are not specifically targeted at the poor. The burden of huge subsidies prevents the government from spending on programs that would otherwise stimulate broad-based growth that would have a large beneficial effect.

(ii) Improving tax administration to raise larger revenues: The Indian tax system suffers from complex and cumbersome procedures, the multiplicity of rates, numerous exemptions, and large areas of discretion which all lead to large-scale tax evasion. The system also lends itself to corruption at all levels which results in relatively low levels of tax realization. The experience of other countries shows that tax reform that brings about a change in the system could generate additional revenues of 3 percent of the GDP without increasing the tax rates. In other words, half the fiscal adjustment needed could come from the effective implementation of tax reform. There is a need to not only improve tax administration but also widen the tax to include services and agricultural incomes.

(iii) Downsizing the government: Resources can also be saved by downsizing the government departments such as railways and posts which have been long overmanned. Also, there are too many ministries and departments that are not required in a liberalized economy. The Fifth Pay Commission has estimated that a 30 percent reduction in government staff should be achieved over time. The efforts at downsizing the government are often met with resistance because it is perceived that unemployment is a serious problem and the government helps to meet the demand for jobs. But it is not realized that resources redirected from paying surplus manpower can be used to build much-needed economic and social infrastructure which will create many jobs for the economy.

(iv) Disinvestment and privatization: This is another area where resources so generated can be utilized in the creation of socially more useful assets such as schools, hospitals and rural infrastructure. The changing role of the government requires it to disengage itself from activities such as production of goods and services which can be equally if not better provided by the private sector.

(v) Re-prioritize Plan Schemes: The post-evaluation studies of various Plan schemes show that though well-intention, many do not achieve their stated objectives or do so only to a limited degree, making the schemes cost-ineffective. This is due to a combination of poor design of the schemes and inadequate administrative capability. It is necessary to reprioritize Plan expenditure to eliminate schemes that are of doubtful value. Such schemes continue to remain in operation, absorbing resources that could be deployed in other areas. The system also suffers from a multiplicity of schemes resulting in overlap and poor targeting. The schemes should be organized in a comprehensive manner for better targeting and eliminating ‘double costs.

(2) Industrial DE-regulation: As a part of the first generation reforms, industrial licensing was abolished in all but six items on account of environment, safety, and strategic considerations. The MRTP Act has also been amended so that firms no longer require approval from the government for investment in the delicensed industries. The role of the public sector has been diluted drastically. The number of industries reserved for the public sector has now come down to only four from 17 in the Pre-reform period. A new foreign investment policy was launched in 1991. This has been continuously liberalized to attract foreign direct investment in the economy.

Most of these reforms have progressed well at the Central level. However, investors still face a lot of hurdles in implementing projects at the state level. This is an area of second-generation reforms which need to be implemented soon.

(3) Opening the Economy to Trade: Opening up the economy to foreign trade was an important part of the first generation reforms, and reforms in this area are more or less complete. Many goods can now be imported on an ‘open general license’ i.e., without a license. There is now partial convertibility on the current account.

The removal of quantitative restrictions (QRs) on imports will be Completed by April 2003. The average level of tariffs has been reduced to 30 percent in the Budget 2000-2001 as compared to 250 percent earlier. To fulfill India’s obligations to the WTO, QRs have to be reduced further. The government should announce a time frame for this so that industries get sufficient time to adjust. (For instance, if tariffs have to be reduced from the present 30 percent to 15 percent in three years, this Would imply a reduction of 5 percent per year-a a figure easily absorbed by Indian industry). Steps should also be taken to identify and eliminate tariff anomalies of the kind when tariffs on imports are reduced but those on exports remain high. India also needs to strengthen its anti-dumping mechanism to protect the domestic industry from unfair competition.

(4) Disinvestment and Privatization: Disinvestment is another first-generation, reform where the pace of reform needs to be accelerated. The government has declared its intention of limiting its share to 26 percent in most public sector enterprises (PSEs).                                                                                    The fiscal problem facing the country suggests that we should achieve disinvestment levels exceeding Rs. 10,000 budgeted for 2000-2001; only then will sufficient resources be released for creating socially more useful assets such as schools, hospitals, rural infrastructure, etc.

(5) Financial Sector Reforms: The financial sector is another area where first-generation reforms are well underway but the process needs to be accelerated.                                                                          The East Asian crisis has generated a fresh set of concerns about the extent to which problems in the financial sector can have a significant impact upon growth and macro stability. The Reserve Bank of India (RBI) has made commendable progress in upgrading prudential and regulatory standards in our banking system to meet the international standards laid down by the Basle Committee. Interest rates, have been partially freed. Private entry in banking has taken place. The public sector banks need to be made competitive enough to meet the performance of the private, especially foreign, banks. Competition in the banking system will be intensified by technological change, especially the introduction of information technology. To meet this challenge, the public sector banks need to reduce the high percentage of non-performing assets(NPAs), close down loss-making branches, and do away with surplus staff.                                                                                                                                      The capital markets also have undergone drastic changes in the form of electronic trading, a clearing corporation, and a depository which have resulted in not only increased volumes of trading but also the high speed of transactions.

(6) Private Investment in Infrastructure: Achieving rapid growth in today’s more open and competitive environment requires a much higher degree of international competitiveness. This in turn requires a very high quality of infrastructure. The country today not only suffers from inadequate infrastructural facilities but there also exists a severe deficiency in the quality infrastructure. Public investment will continue to play an important role but it needs to be supplemented by private investment.                                                                                                                                                  The power sector and telecommunications were opened up for private investment as part of the first-generation reforms, and this was extended to ports, airports, and roads. In the telecommunications sector, there has been a substantial investment in cellular phones and other value-added services. The development of telecommunications infrastructure is central to opportunities such as exports of knowledge-based services. India’s comparative advantage is higher in the services investment which also does not continue to be a hinterland for private investors as they are seen as unreliable paymasters.

Main Features of Second Generation Reforms

(1) Extending Reforms to the States: The reforms in the central government need to be, extended to the state government level. This is because states are responsible for health, education, agricultural extension, and agriculture-related services, irrigation power distribution rural state and district roads, municipal services in urban areas-which directly affect the life of the people. Some states have recognized the need for reforms in particular sectors such as power and have initiated some steps in this regard. This is a welcome development but more states should identify the areas for reform and involve themselves in the process. The poor financial health of the states is a major hindrance; however, this is not the only problem. The efficiency levels in the government system have deteriorated in many states. Administrative reforms designed to improve performance and increase accountability are essential if resources are to be translated into effective development work.

Though steps have been taken to encourage private investment at the Central level, small businesses still face lengthy clearance procedures at the state level which become an occasion for harassment and corruption. A serious effort should be made by the states to create an investor-friendly environment and reduce the rigors of the “inspection raj”.

(2) Labor Legislation: An area that has not been touched by reforms so far relates to the reforms in the labor market. India’s labor laws deny firms the flexibility needed to operate successfully in highly competitive markets. PSUs do not have the freedom to retrench labor or close down a particular unit in the company in response to changing market conditions without government permission. Labor laws also specify the “service rules” which govern employment and which cannot be changed easily. This makes it difficult even to re-deploy workers to different activities when needed. The liberalized market-oriented set-up of today requires industry to be flexible enough to deal with new and Competitive situations- to be able to downsize when needed, restructure, and re-organized businesses through sale, acquisition, and mergers.

The provisions relating to contract labor also need to be amended. Greater flexibility in this area would lead to a profusion of smaller businesses that provide services to existing firms which are not willing to increase their own labor force. This will not only lead to increased employment generation but even enterprise development.

Labor laws should be amended to bring them in line with the practices in other countries. The existing laws only apply to the organized Sector which constitutes only 8 percent of the labor force. Ninety-two percent of the labor population derives no benefit from these laws. In fact, labor laws discourage the growth of high-quality employment. Simultaneously, the laws also need to be amended to ensure a particular level of labor protection and welfare measures the effectiveness of measures relating to social security, occupational health and safety, minimum wages, and linkage of wages with productivity and the safeguards and facilities required for women and handicapped persons in employment.

(3) Legal System: In the present scenario when India is fast integrating with the world economy and there are large inflows of foreign investment, there is an urgent need to update our laws, scrap the obsolete ones and re-draft the ones vulnerable to multiple interpretations to improve clarity. The legal procedures in India are enormously time-consuming. They seem to be designed to help those seeking postponements. There are presently more than 2000 cases pending per judge. Therefore, there is a need how courts work and redrafting of fossilized legislation. Reform of our legal system is vital for economic progress as well as social justice.

(4) IPR Regime: India needs to establish a good intellectual property rights (IPR) regime to open up possibilities of huge rewards for innovation. We also need to create a database of our traditional wealth of knowledge to safeguard it from being pirated by other countries.

(5) Education: Human resource is the most crucial resource for furthering the economic growth of a country. The new age of knowledge industries requires an educated population. The country needs to expand both the quantity and quality of educational services in the country. This requires not only universal and compulsory primary education as a first step but also empowerment of parents and local governments such as panchayats for effective results. Primary education is critical and its importance cannot be over-emphasized. But for running a technology-driven economy, we need to go beyond primary education and build institutions for higher education. The recent experiences have shown that a few high-quality engineers and managers have made a strong impact in various industries and on the economy as a whole. The splendid achievements of our software engineers, both in India and in Silicon Valley, have won appreciation all over the world. However, the institutions of higher education in the country today face enormous constraints in terms of finance and operational autonomy. The student intake is pitifully small when compared to the size of India’s economy. There is a need to not only increase the number of such institutions but also bring them at par with international standards to have a powerful impact upon our economic growth.

(6) Social Security Nets: India needs to consolidate various anti-poverty measures into a coherent targeted safety net for the poor. There is also the challenge of fulfilling social obligations towards the huge middle class which has been hit hard with inflation and mass unemployment among the educated. The increase in life expectancy, the breakdown of the joint family system, and the desire for modern medical care have created several problems for the aged. We need to set up a system for old age income security. The present system of provident funds (PFs), even for those few who have that facility, is grossly inadequate largely because of early withdrawals and a low rate of returns. A system based on empowering people through a lifetime of saving is preferable to one that provides doles in old age.

To meet all these obligations, the government should withdraw from most areas of commercial activity and restrict itself to overall governance and social responsibilities.

(7) Environment Sustainability: Economic growth along with environmental degradation does not increase social welfare. We need to institute effective policies to preserve and regenerate environmental resources. A combination of economic incentives, liability laws, and an awareness campaign can help clean up air and water. Policies need to be put in place to control industrial, vehicular, and household emissions. The use of dirty bio-fuels leads to half a million premature deaths each year. There is also a need for developing a large and efficient public transport system and stipulating stricter emission standards for private as well as new vehicles.

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