Ashok Desai on the 1991 Economic Reforms in India

Thirty years ago, India embarked on a massive program to reform its economy amid a grave balance-of-payments crisis that led New Delhi to secure loans from outside against the country’s gold reserves. The reform program soon became wide-ranging and opened up the Indian economy to the world, setting India on course to become the world’s sixth largest economy in nominal terms three decades later. The reform program – controversial at the time – in turn secured New Delhi geopolitical heft as key industrialized nations found a growing and extremely large middle-class market for their goods and an ideologically-congruent counterweight to communist China. India’s exports soon included advanced information technology (IT) services, earning the country the sobriquet of an IT powerhouse. The economic and social impacts of the reform program were far-reaching: It lifted millions of Indians out of poverty; its middle class became outward looking; and India looked poised to become part of the “political West,” some analysts argued.

Three decades later, between the COVID-19 pandemic as well as poor policy choices, India’s economy once again finds itself in troubled waters with its growth trajectory uncertain and key sectors – such as manufacturing – in disarray. More troubling, Prime Minister Narendra Modi’s commitment to the overall tone of the reforms program initiated 30 years ago remains uncertain and prospects of deeper reforms of the factor markets look dim and politically expensive.

Economist Dr. Ashok Desai was a key figure in the early days of the reform program, as New Delhi took dramatic measures to prevent the Indian economy from falling off a cliff. As chief consultant to the Indian Finance Ministry between December 1991 and September 1993 – a position equivalent to that of the chief economic adviser – he worked closely with then-Finance Minister Manmohan Singh (widely seen as the architect of India’s economic liberalization, and later prime minister for a decade) to push through key measures to open the Indian economy. Desai, who also served in Prime Minister Atal Bihari Vajpayee’s council of economic advisers, spoke frankly with The Diplomat over email about India’s economic liberalization: the choices the country made, the ones it didn’t, and how the past may no longer hold the key to the future.

For readers unfamiliar with India’s economic history, could you please recap the circumstances that led New Delhi to embark on the path of economic liberalization 30 years ago? Can you tell us a bit about India’s traditional approach to its economy before 1991?

India was Britain’s biggest colony and was drawn into World War II by its masters in 1939; its government introduced severe controls on balance of payments and industrial production. When India became independent in 1947, it inherited the controls. Its new rulers from the Congress had spent years in agitations and jails and had no experience of running government. They were led by Jawaharlal Nehru, who had picked up a penchant for socialism during his youth in England. He retained the controls and turned them into an instrument to discriminate against capitalists – home-grown as well as foreign – and promoted state-led industrialization.

These policies led to one balance of payments crisis after another. Each crisis led to more restrictive import policies and raised domestic prices even further and made exports uncompetitive. The last came in 1989. Yashwant Sinha, then finance minister serving the Janata Dal party, took one loan after another. Finally, India’s external position became so dire that international institutions refused any further loans unless the rupee was devalued, and controls dismantled. He did not; whether he was against it or was prevented by the Congress party on whose support the government survived, is disputed. The Congress formed the next government under P.V. Narasimha Rao in 1991 and accepted International Monetary Fund (IMF)-World Bank conditions, which were the foundation of liberalization.

What steps did New Delhi take over the course of 1991 and 1992 to open the Indian economy?

P. Chidambaram, the new commerce minister, introduced “eximscrips” -- saleable import licenses issued to exporters against 30 percent of exports; they substantially replaced import licenses. Duty-free imports of inputs against exports were made easier. Imports were allowed (within certain limits) even if competing goods were being produced within the country; domestic industry was thus made to face some competition from abroad. Exporters were allowed to open bank accounts in foreign exchange to give flexibility in their payments for imports. State import monopolies were pared down. Technology imports no longer required official approval if royalty was below 5 percent on domestic sales and 8 percent on exports.

To what extent was the reform program forced on to India due to contingencies arising out of the Gulf War? Even before the balance of payment crisis struck India, were there any advocates for economic liberalization – or, at the very least, significant reforms – within the Indian government?

As I said in the reply to the first question, it was “forced” upon India because a good deal of it formed the precondition for getting more loans from the IMF and the World Bank, and the loans were necessary because of the unfavorable balance of payments. The Gulf War was the [proximate] trigger; the fundamental reason was that the Indian government was unwilling to rethink its external economic policies, especially import controls. There may be claims of reformers having been [there] in pre-Narasimha Rao governments, but if there were any, they hid themselves very well. Montek Singh Ahluwalia [a senior Indian civil servant] comes to mind; but he kept his private thoughts – whatever they were – well concealed. He was a stayer in power, before and after reforms. So, he was effectively anti-reform before reforms and pro-reform after reforms. So was Manmohan Singh.

What was the role of the IMF and other Bretton Woods institutions in India’s economic liberalization program? Can you please tell us a little bit about domestic opinion at that time about these institutions across the political spectrum, but also within the then ruling coalition?

IMF’s role was crucial. When I was taken into government in 1992, I found a list of its demands on the table if we wanted more loans from it. I found it acceptable; I supported it, and Finance Minister Manmohan Singh implemented it. Its recommendations were perfectly reasonable economics; any non-socialist economist would have thought of them. There was a leftist lobby, within as well as outside government, which considered the IMF and the [World] Bank devilish agents of the U.S. government. It must have had representatives in Narasimha Rao’s cabinet, for after we resolved the payments crisis, Manmohan Singh was dead against reforms. Whenever I suggested one – removing [the] ban on gold imports for example – he would say, “I am not sure; it is too risky.” Incidentally, the biggest reform – removal of industrial licensing – was made by Narasimha Rao; he [also] held the industry portfolio [in the cabinet]. Chidambaram’s reforms, which I have listed above, were the next biggest. Public opinion was limited in those days: Private television did not exist, and the press tried to keep the government happy since government advertisements brought a substantial proportion of its revenue and displeasing it could have dire consequences.

In hindsight, what further steps do you think should have been taken as India moved to dismantle the “license-permit raj” in 1991? What could have been done differently?

I would have reformed the financial system, which remained unreformed because the finance minister appointed governors of Reserve Bank [of India] out of minions who put loyalty to Delhi above good economics. Until 1988, the capital market was controlled directly by the finance ministry; a joint secretary attended the meetings of stock exchange boards and gave whatever arbitrary instructions the ministry felt like giving. The Securities and Exchange Board of India  (SEBI) was created in 1988, but the finance ministry enjoyed its power over the capital market too much to pass it on to SEBI. After I joined the ministry, we legislated to make SEBI a statutory body, and transferred the ministry’s power to it. We were following the precedent of countries with active capital markets such as the U.S. and the United Kingdom; but our regulator turned out to be very different. It created a huge bureaucracy, complicated rules, and killed off the capital market. It has been one of the basic causes of the primitiveness of the Indian corporate sector.

The other, related, failure was in introducing private capital and competition in the financial sector. Competition in the capital market is an important component of competition in markets for goods and services; it is largely lacking in India. As a result, the financial system is unreformed to this day. It is dominated by bankrupt banks unwilling to lend to productive activities, a virtually dead capital market, and little competition. This is the biggest obstacle to efficient growth in India.

Is the 1991 consensus around liberal economic regimes in India fraying, as Prime Minister Narendra Modi speaks of a self-reliant India? Are dramatic factor market reforms politically unsellable today?

There never was a consensus; vested interests could always be found to support controls and restrictions. This government has found them, and milked them; three-quarters of private donations to political parties go to the [ruling] Bharatiya Janata Party. Self-reliant India is precisely Nehru’s idea where there would be systematic discrimination against competition from abroad in goods, services, and financial markets. The idea has been brought back because it is politically profitable. Economic reforms require economic understanding and courage: both are lacking in this government. The consequence is evident in poor growth and profits.