Sebi begins repayment process in Sahara case

In the high profile Sahara case involving over Rs 24,000 crore raised through “various illegalities”, market regulator Securities and Exchange Board of India (SEBI) has begun the process of refund to individual investors who have been verified by it.

The money is being refunded only in those cases where SEBI has not found any multiplicity during its verification process. Refund for others will have to wait till the next direction from the Supreme Court, which is likely to hear the case on 17 July.

The refunds are being made from Rs 5,120 crore that has been deposited by the Sahara group, which claims to have already returned close to Rs 20,000 crore to the bondholders of two Sahara firms directly.

This claim of direct refunds, which Sahara says were made before the Supreme Court order of 31 August 2012, is yet to be verified independently, sources said.

Even among the lists of investors submitted by Sahara to SEBI  after being directed by the apex court to do so, the regulator has come across numerous multiplicities and other anomalies, sources said.

There are numerous instances of one investor being named at hundreds of places, while there are also cases of multiple addresses for one single investor and hundreds of investors sharing the same address, sources said.

However, the largest number of anomalies suspected by SEBI involves untraceable addresses and other investor details.

Sources said the refunds are being made to the genuine investors whose credentials have been verified, although the number of such cases is so far very small when compared to initial claims of about 3 crore bondholders from whom two Sahara firms had raised over Rs 24,000 crore.

something to learn from china in economic reforms

The Chinese advance to be watched these days is not only across the international border high up in the Himalayas. They are pushing ahead with economic reforms as well.

A statement this week from its state council, the main administrative agency in the country, said that China will make it easier for capital to flow in and out of its economy. This follows a statement in March by the state council that China would soon begin to ease controls on domestic interest rates and the exchange rate of the yuan. The Chinese government also said it wants to change the household registration system that constricts labour movement across the country.

These reforms come at a time when the Chinese economy is slowing. Wages are rising. There is pressure on China to rebalance its economy by encouraging consumer spending to replace the current overemphasis on investment.

China first tried to deal with the post-Lehman downturn with a massive $550 billion stimulus that propped up growth for some time but did little to address the structural challenges in the economy. The strategy now seems to have shifted from stimulus to economic reforms.

There are lessons here for India. To be sure, India does not have to pursue the same individual policies. For example, it has limited scope to open its capital account further at a time when the massive fiscal and current account deficits threatens economic stability. The bigger lesson is the importance of economic reforms when countries are in the midst of structural rather than cyclical slowdowns, as in both India and China.

There has been some policy action after P. Chidambaram returned to the finance ministry in August, but the moves to attract foreign capital in certain sectors or setting up a cabinet committee to clear investment projects will be more effective in addressing immediate economic problems. The more important changes required in areas such as labour laws, land acquisition, taxation or the financial sector are still stuck.

The 2009 stimulus in India at best gave a temporary boost to economic activity. Its long-term costs are now being borne through high inflation and a decline in national savings. What India needs now is economic reforms, but it has a government that has showed very little commitment to do so since 2004.

India, Tajikistan working on an easy route for trade

"We are going to further increase trade. There is a great scope for micro, small and medium industries where Indian expertise and experience can come in handy. There are specific areas where trade can be furthered. The problem everywhere is one of connectivity. 

"The present approach route for trade are complex, time- consuming and difficult. These are something to which we have to live with till something better comes up," the Vice President told the accompanying media on board a special aircraft while returning here from a four-day visit to Tajikistan. 

The two countries agreed on opening up of a trans-Afghan corridor to facilitate easy access to trade to and from the land-locked country. The proposed trade route will come via Afghanistan and Pakistan, said an External Ministry official. 

Tajikistan has its borders with China (520-km), Afghanistan (1,420 km) and the Afghan-Wakhan corridor (16-km), which is the least distance between Tajikistan and Pakistan-occupied Kashmir. 

Ansari termed his visit and talks with Tajikistan leadership as "very productive". 

Cooperation on security issues, cross- border terrorism and energy security were the main focus of Ansari's talks with top Tajik leadership. 

Both the countries also agreed to strengthen their relations in mining, Information Technology-enabled services and medical sectors among others. 

"Last two and half days have been extremely productive in terms of the substance of discussions and the general ambience and atmosphere in which they were conducted... A number of things were agreed upon for cooperation in different areas," Ansari said. PTI The two countries discussed regional security issues especially with regard to Afghanistan. 

"We have a common interest in checking cross-border terrorism. They also have cross-border terrorism, we also have cross-border terrorism," the Vice President said adding both the countries were sharing counter-terror information regularly. 

Ansari is the first Vice President to have visited Tajikistan. 

Former Prime Minister Atal Bihari Vajpayee had visited Tajikistan in 2003. Former President Pratibha Patil had paid a visit to the central Asian nation in September 2009. 

Tajikistan President Emomali Rahmon has been a frequent visitor to India. He has visited India five times -- 1995, 1999, 2001, 2006 and in September 2012. 

During Tajik President's last visit to India, both the countries had elevated their bilateral relationship to the level of strategic partnership.

The Trading World of the Indian Ocean

The population of Asia in 1500 was five times as big as that of Western Europe (284 million compared with 57 million), and the ratio was about the same in 1600. It was a very large market with a network of Asian traders operating between East Africa and India, and from Eastern India to Indonesia. East of the straits of Malacca, trade was dominated by China. Indian ships were not sturdy enough to withstand the typhoons of the China sea, and not adequately armed to deal with pirate activity off the China coast (see Chaudhuri, 1982, p. 410).

The Portuguese displaced Asian traders who had supplied spices to Red Sea and Persian Gulf ports for onward sale to Venetian, Genoese and Catalan traders. But this was only a fraction, perhaps a quarter, of Asian trade in one group of commodities. In addition there was trade within Asian waters in textiles, porcelain, precious metals, carpets, perfume, jewellery, horses, timber, salt, raw silk, gold, silver, medicinal herbs and many other commodities.

Hence, the spice trade was not the only trading opportunity for the Portuguese, or for the other later European traders (Dutch, British, French and others) who followed. Silk and porcelain played an increased role, and in the seventeenth and eighteenth centuries, cotton textiles and tea became very important. There were possibilities of participating in intra–Asian trade as well. In the 1550s to the 1630s this kind of trade between China and Japan was a particularly profitable source of income for Portugal.

Asian merchants were familiar with the seasonal wind patterns and problems of the Indian Ocean, there were experienced pilots, scientific works on astronomy and navigation, and navigational instruments not greatly inferior to those of the Portuguese.

From East Africa to Malacca (on the narrow straits between Sumatra and Malaya), Asian trade was conducted by merchant communities which operated without armed vessels or significant interference from governments. Although Southern India, where the Portuguese started their Asian trade, was ruled by the Empire of Vijayanagar, conditions in coastal trade were set by rulers of much smaller political units, who derived income by offering protection and marketing opportunities to traders. The income of the rulers of Vijayanagar and later the Moghul Empire was derived from land taxes, and they had no significant financial interest in foreign trade activities. In China and Japan the situation was different.

Asian merchants operated in mutually interactive community networks with ethnic, religious, family or linguistic ties and an opportunistic concentration on profit. In this respect their trading habits were not very different from those of Venetians or of Jewish traders in the Arab world of the Mediterranean. In Western Asia and the Middle East merchants were generally Arabs and Muslims, but further east they included “Gujarati vaniyas, Tamil and Telugu Chettis, Syrian Christians from Southwestern India, Chinese from Fukien and neighbouring provinces”. If they paid for protection and market access, they found that they were free to trade. If the protection became too expensive they usually had some leeway for moving elsewhere.

The Portuguese trading network was different in two respects. It consisted of a string of strongly fortified bases linked by a fleet of armed ships, so market forces were modified by coercion. Unlike the Asian trading communities or in the European trading companies which penetrated Asia at a later date, Portugal was involved in religious evangelism.

The headquarters of the Portuguese trading empire was established in 1510 at the captured Arab port of Goa, an island harbour halfway up the west Indian coast which was a Portuguese colony for nearly 460 years. It was the residence of the Portuguese Viceroy, and from 1542 it was the headquarters of the Jesuit order for all its operations in Asia. Malacca, the port which controlled trade and shipping from India to Indonesia and China, was captured in 1511 and kept until 1641 when it was taken by the Dutch. A base was established at Jaffna in Sri Lanka for trade in cinnamon. Most Portuguese shipments of pepper and ginger originated from the Malabar coast of India, but for higher value spices they obtained a base at Ternate in the Moluccas (between Celebes and New Guinea) for trade in cloves, nutmeg and mace.

The West and the Rest in the International Economic Order

In 1962, we usually divided the world into three regions. The advanced capitalist group was then known as the developed world. The second was the “Sino-Soviet bloc”. Countries “in course of development” were the third world. The China-USSR split occurred in the early 1960s; most of the communist regimes collapsed around 1990, and the hostility of the cold war has largely faded away. The income gap between the former communist countries and the advanced capitalist group has become very much wider than it was. For this reason, a tripartite division of the world economy is no longer appropriate.

For rough comparisons, it is now useful to divide the world in two and compare developments in the advanced capitalist group with the aggregate for lower-income countries – designated as the “West” and the “Rest” in our tables. On average, the West increased its income per head fourfold from 1950 to 2001 – a growth rate of 2.8% a year. In the rest of the world there was a threefold increase – a growth rate of 2.2%. In both cases this was much better than earlier performance. From 1820 to 1950, income grew 1.3% a year in the West and 0.6% in the Rest. Though the gap in income level was still increasing, the acceleration in performance was bigger in the Rest.

Population of the West rose by half from 1950 to 2001 (0.8% a year), about the same pace as in 1820-1950. In the Rest, the situation was very different. Population grew by 2.0%, compared with 0.6% in the earlier period. This reflected a major improvement in welfare as mortality declined and life expectation rose from 44 to 65 years in 2001 – much faster than in the West. In the past two decades birth rates have fallen rapidly – a demographic transition which happened earlier in the West.

The West is now a relatively homogeneous group in terms of living standards, growth performance, economic institutions and modes of governance. Over the past five decades there has also been significant convergence in most of these respects. This is not true of the Rest. There are more than 180 countries in this group. They have nearly all increased their income levels significantly since 1950, but the degree of success has varied enormously. Most of Asia is experiencing fast per capita income growth. Most African countries are fairly stagnant. Most Latin American countries found it very difficult to keep a steady trajectory of advance in the 1980s and 1990s. Population growth is fastest in Africa, a good deal slower in Latin America and slower still in Asia. Life expectation and levels of education are lowest in Africa, better in Latin America, and better still in Asia.

Between 1950 and 2001, the Asian group increased per capita income fivefold and narrowed the relative gap between their incomes and the West. In other regions there was no convergence. Latin American income rose more than twofold, in the former command economies of Eastern Europe and the USSR less than twofold and in Africa about two thirds.

The divergence was even more striking in 1990-2001. In this period the Western group increased their income by a fifth, the Asian group by half, Latin America by a sixth, Africa stagnated and in the former communist countries per capita income fell by a quarter.

American policy since 1973 has been much more successful than that of Western Europe and Japan in realising potential for income growth. The incidence of unemployment is now about half of that in Western Europe, whereas in 1950–1973 it was usually double the European rate. Labour force participation increased, with employment expanding from 41% of the population in 1973 to 49% in 1998, compared with an average European rise from 42 to 44%. The percentage drop in working hours per person was half of that in Western Europe. These high levels of activity were achieved with a rate of inflation which was generally more modest than in Western Europe.

US policymakers have been less inhibited in operating at high levels of demand than their European counterparts. Having the world's major reserve currency, and long used to freedom of international capital movements, they generally treated exchange rate fluctuations with benign neglect. The Reagan administration made major tax cuts, and carried out significant measures of deregulation in the expectation that they would provoke a positive supply response that would outweigh potential inflationary consequences. The US operated with more flexible labour markets. Its capital market was better equipped to supply venture funds to innovators. Its economy was as big as Western Europe but much more closely integrated. Demand buoyancy was sustained by a stock market boom in the 1990s.

The United States was a major gainer from the globalisation of international capital markets. In the postwar period until 1988, US foreign assets always exceeded liabilities, but thereafter its net foreign asset position moved from around zero to minus $1.5 trillion (more than 20% of GDP). Thus the rest of the world helped to sustain the long American boom and financed the large US payments deficit.

Future prospects

The table provides a quantification of growth performance of eight major regions of the world economy and some very tentative projections for development up to the year 2015.

The demographic projections are those of the United Nations Population Division, and indicate a continuing decline in the rate of population growth in virtually all parts of the world. Nevertheless there will still be a very striking difference between the advanced capitalist group and Africa. At 0.33% a year it would take 210 years to double population in the first group. In Africa it is likely to happen within 32 years.

In making per capita GDP projections, I assumed a continuance of 1990-2001 rates of performance in Western Europe and Japan and a mild slowdown in the USA, where the information technology bubble of the 1990s has burst, and where the capital inflow which financed its trade deficit seems likely to slacken substantially. Aggregate per capita growth in the “West” seems unlikely to slow down very significantly, but combined with the demographic slowdown, it means that aggregate GDP growth would be about 2% a year. This pace would be similar to that in 1913-1950. Growth momentum transmitted by the “West” is likely to be more modest than in 1870-1913 and 1973-2001.

Asia (excluding Japan)

The most buoyant part of the world economy since the early 1970s has been Asia (excluding Japan). These economies have grown faster than those of the West and their buoyancy has been sustained in great part by their own policies. Their weight in the world economy is much larger than any other non-Western region. I assumed that their per capita growth 2001-2015 will be at the same pace as in 1990-2001.

These economies are catching up with the West and are still at a level of development where “opportunities of backwardness” are unlikely to erode. The combination of high investment rates and rapid GDP growth means that their physical capital stock has been growing more rapidly than in other parts of the world. The East Asian economies also have a high ratio of employment to population. This is due to falling fertility and a rising share of population of working age, but also reflects the traditionally high labour mobilisation of multi-cropping rice economies. In all cases which are documented they had high rates of improvement in education and the quality of human capital. Equally striking were the rapid growth of exports, the high ratio of exports to GDP, and a willingness to attract foreign direct investment as a vehicle for assimilation of foreign technology. These characteristics of China, South Korea and Chinese-Taipei have made for super-growth, but there is a second tier of countries whose growth is accelerating rapidly. The most notable case is India which has the potential to join the super-growth club. There are other economies where prospects are more problematic, but these are only a sixth of the Asian total. The projections assume no substantial change in their performance.

Latin America

Latin America is the second largest non-Western region with about 8% of world product and a slightly bigger share of world population. Until the 1970s, economic policy was different from that in the advanced capitalist group. Most countries never seriously tried to observe the fixed rate discipline of Bretton Woods. National currencies were repeatedly devalued, IMF advocacy of fiscal and monetary rectitude was frequently rebuffed, high rates of inflation became endemic. Most countries reacted with insouciance to the worldwide explosion of prices, and governments felt that they could accommodate high rates of inflation. They were able to borrow on a large scale at negative real interest rates to cover external deficits incurred as a result of expansionary policies.

However, the basic parameters had changed by the early 1980s. By then, the OECD countries were pushing anti–inflationary policy very vigorously. The change to restrictive monetary policy initiated by the US Federal Reserve pushed up interest rates suddenly and sharply. Between 1973 and 1982, external debt increased sevenfold and the credit worthiness of Latin America as a whole was grievously damaged by Mexico's debt delinquency in 1982. The flow of voluntary private lending stopped abruptly, and created a massive need for retrenchment in economies teetering on the edge of hyperinflation and fiscal crisis. In most countries resource allocation was distorted by subsidies, controls, widespread commitments to government enterprise and detailed interventionism. Most of them also had serious social tension, and several had unsavoury political regimes.

In the 1930s, most Latin American countries resorted to debt default, but it was not a very attractive option in the 1980s. World trade had not collapsed, international private lending continued on a large scale. The IMF and World Bank had substantial facilities to mitigate the situation, and leverage to pressure Western banks to make involuntary loans and legitimate a substantial degree of delinquency.

In the 1980s, the attempts to resolve these problems brought major changes in economic policy. But in most countries, changes were made reluctantly. After experiments with heterodox policy options in Argentina and Brazil, most countries eventually embraced the neoliberal policy mix pioneered by Chile. They moved towards greater openness to international markets, reduced government intervention, trade liberalisation, less distorted exchange rates, better fiscal equilibrium and establishment of more democratic political systems.

The cost of this transition was a decade of falling per capita income in the 1980s. After 1990, economic growth revived substantially but the process was interrupted by contagious episodes of capital flight.

My projections for Latin America assume some modest improvement in per capita performance in 2001-2015.

Africa

Africa has nearly 13% of world population, but only 3% of world GDP. It is the world's poorest region. Its population is growing seven times as fast as in Western Europe. Per capita income in 2001 was below its 1980 peak. African economies are more volatile than most others because export earnings are concentrated on a few primary commodities, and extremes of weather (droughts and floods) are more severe and have a heavy impact.

As a result of rapid growth, little more than half the population is of working age. Almost half are illiterate. They have had a high incidence of infectious and parasitic disease (malaria, sleeping sickness, hookworm, river blindness, yellow fever). Over two thirds of HIV-infected people live in Africa. As a result the quantity and quality of labour input per head of population is much lower than in other parts of the world.

European powers became interested in grabbing Africa in the 1880s. Twenty-two countries eventually emerged from French colonisation, 21 from British, 5 from Portuguese, 3 from Belgian, 2 from Spanish. Germany lost its colonies after the First World War, Italy after the Second. The colonialists created boundaries to suit their own convenience, with little regard to local traditions or ethnicity. European law and property rights were introduced with little regard to traditional forms of land allocation. Hence European colonists often got the best land and most of the benefits from exploitation of mineral rights and plantation agriculture. African incomes were kept low by forced labour or apartheid practices. Little was done to build a transport infrastructure or to cater for popular education.

Colonisation ended between 1956 and 1974. In South Africa, the mass of the population did not get political rights until 1994. Independence brought many serious challenges. The political leadership had to try to create elements of national solidarity and stability more or less from scratch. The new national entities were in most cases a creation of colonial rule. There was great ethnic diversity with no tradition or indigenous institutions of nationhood. The linguistic vehicle of administration and education was generally French, English or Portuguese rather than the languages most used by the mass of the population. Africa became a focus of international rivalry during the cold war. China, the USSR, Cuba and East European countries supplied economic and military aid to new countries viewed as proxies in a worldwide conflict of interest. Western countries, Israel and Chinese-Taipei were more generous in supplying aid and less fastidious in its allocation than they might otherwise have been. As a result, Africa accumulated large external debts which had a meagre developmental pay-off.

There was a great scarcity of people with education or administrative experience. Suddenly these countries had to create a political elite, staff a national bureaucracy, establish a judiciary, create a police force and armed forces, send out dozens of diplomats. The first big wave of job opportunities strengthened the role of patronage and rent-seeking, and reduced the attractions of entrepreneurship. The existing stock of graduates was too thin to meet the demands and there was heavy dependence on foreign personnel.

The process of state creation involved armed struggle in many cases. Many countries have suffered from civil wars and bloody dictators. These wars were a major impediment to development.

In many African states, rulers have sought to keep their positions for life. In most states, rulers relied for support on a narrow group who shared the spoils of office. Corruption became widespread, property rights insecure, business decisions risky.

A major factor in the slowdown since 1980 has been external debt. As the cold war faded from the mid-1980s, foreign aid levelled off, and net lending to Africa fell. Although the flow of foreign direct investment has risen it has not offset the fall in other financial flows

The challenges to development in Africa are greater than in any other continent, the deficiencies in health, education and nutrition the most extreme. It is the continent with the greatest need for financial aid and technical assistance. The per capita GDP projections assume that these kinds of aid will be increased and that per capita growth will be positive. However, it is unlikely that African countries will, by 2015, be able to establish a trajectory of rapid catch-up such as Asian economies have achieved.

Eastern Europe

In Eastern Europe, the economic system was similar to that in the USSR from 1948 to the end of the 1980s, and so was economic performance. In 1950-1973, per capita growth more or less kept pace with that of Western Europe, but faltered badly as the economic and political system began to crumble. From 1973-1990, it grew at 0.5% a year compared with 1.9% in Western Europe.

The transition from a command to a market economy was difficult in all of the countries. The easiest part was freeing prices and opening of trade with the West. This ended shortages and queuing, improved the quality of goods and services and increased consumer welfare. However, much of the old capital stock became junk; the labour force needed to acquire new skills and work habits; the legal and administrative systems and the tax/social benefit structure had to be transformed; the distributive and banking networks to be rebuilt from scratch. The travails of transition led to a fall in average per capita income for the group from 1990 to 1993, but it rose by over 3% a year from then to 2001. My projection assumes that this pace of advance can be maintained at least until 2015. In fact, these countries can probably do better than this if they can be integrated into the European Union with better access to its goods, labour, and capital markets, its regional and other subsidies, than they have thus far enjoyed. Present real income levels are only a third of those in Western Europe. Wages are also much lower, but the disparity in skills is much less. The Eastern economies are therefore capable of mounting a catch-up dynamic similar to that of Asia if the integration takes place.

Successor states of former USSR

Fifteen successor states emerged from the collapse of the Soviet Union in 1991. In all of them, there was already a very marked deceleration of economic growth in 1973-1990. There was colossal inefficiency in resource allocation, a very heavy burden of military expenditure and associated spending, depletion and destruction of natural resources.

Capital/output ratios were higher than in capitalist countries. Materials were used wastefully. Shortages created a chronic tendency to hoard inventories. The steel consumption/GDP ratio was four times as high as in the US. The average industrial firm had 814 workers in 1987 compared with 30 in Germany and the UK. Transfer of technology from the West was hindered by trade restrictions, lack of foreign direct investment and very restricted access to foreign technicians and scholars. Work incentives were meagre, malingering on the job was commonplace.

The quality of consumer goods was poor. Retail outlets and service industries were few. Prices bore little relation to cost. Consumers wasted time queuing, bartering or sometimes bribing their way to the goods and services they wanted. There was an active black market, and special shops for the nomenklatura. There was increasing cynicism, frustration, growing alcoholism and a decline in life expectation.

Soviet spending on its military and space effort was around 15% of GDP in the 1970s and 1980s, nearly three times the US ratio and five times as high as in Western Europe. There were significant associated commitments to Afghanistan, Cuba, Mongolia, North Korea, Vietnam and Soviet client states in Africa.

In the 1950s a good deal of agricultural expansion was in virgin soil areas, whose fertility was quickly exhausted. Most of the Aral sea was transformed into a salty desert. Exploitation of mineral and energy resources in Siberia and Central Asia required bigger infrastructure costs than in European Russia. The Chernobyl nuclear accident had a disastrously polluting effect on a large area of the Ukraine.

In 1985-1991 Gorbachev established a remarkable degree of political freedom and liberated Eastern Europe but had no coherent economic policy. From then to end 1999, Yeltsin broke up the Soviet Union, destroyed its economic and political system and moved towards a “market” economy. The economic outcome was a downward spiral of real income for the mass of the population. On average, GDP was nearly 30% lower in 2002 in the 15 republics than in 1990. Fixed investment and military spending fell dramatically, so the drop in private consumption was milder. There were very big changes in income distribution. Under the old system, basic necessities (bread, housing, education, health, crèches and social services) had been highly subsidised by the government or provided free by state enterprises to their workers. These all became relatively more expensive, the real value of wages and pensions was reduced by hyperinflation, and the value of popular savings was destroyed. There were major gains in the income of a new oligarchy.

The new “market” economy is grossly inefficient and unfair in allocating resources. There has been legislation to establish Western style property rights, but in practice accountancy is opaque and government interpretation of property rights is arbitrary. Many businesses are subject to criminal pressure. Property owners such as shareholders or investors are uncertain whether their rights will be honoured. Workers are not sure their wages will be paid.

* This article is an adapted extract from Angus Maddison’s chapter, “The West and the Rest in the International Economic Order”, in Development is Back, OECD Development Centre, 2002.

LATE NOTE: Angus Maddison passed away on 24 April 2010. See tribute.

References

Visit www.theworldeconomy.org/

IMF (2002), World Economic Outlook, Washington DC.

Maddison, A. (2001), The World Economy: A Millennial Perspective, OECD Development Centre, Paris.

OECD (2001), Agricultural Policies in OECD Countries: Monitoring and Evaluation, Paris.

Stiglitz, J. E. (2002), Globalization and its Discontents, Norton, New York.

World Bank (2002), Global Development Finance, Washington, DC.

encountering the safety deposit schemes in India

Stuart Rutherford in his famous book, The Poor and Their Money, narrates the story of Jyothi, a deposit collector in the slums of Vijayawada, as follows: Jyothi gives her clients, mostly poor women in the slums, a card divided in 220 boxes (20 columns and 11 rows). She visits her clients’ at their homes every day at a specified time. The client has the option to save a fixed amount every day. This saving is purely voluntary depending on the financial liquidity of the client on a particular day. Assuming that the client is able to save Rs5 every day, after 220 days she has saved Rs1,100. The question arises as to how much Jyothi should give back to her clients? A popular answer would be obviously not less than Rs1,100, or even higher, as the fund would surely attract some interest.

But surprisingly, as documented by Rutherford, Jyothi returns only Rs1,000 and keeps Rs100 as her fee for providing a safe place to save. As money is fungible unless the option for savings with Jyothi is available, the poor slum women would have spent Rs5 per day for some or the other purpose.

Now let us look at the operation of another savings mechanism called the Rotating Savings and Credit Association (Rosca), believed to be the root of the microfinance movement. Under Rosca, a few people, usually from same socioeconomic setting, come together to save a certain amount of money at regular intervals. Assume that 20 people agree to save Rs100 per week for 20 weeks and start a Rosca. In a simple Rosca scheme, a weekly collection of Rs2,000 is collected by one of the members on a mutually agreed basis. This is to develop a group corpus and for self-lending. But the most prominent form of Rosca is where members bid to get the fund. A member with an urgent need for the money would bid the highest. In this case, say in the first week two members bid, one for Rs200 and another for Rs300, the member who has quoted Rs300 will receive Rs1,700 and the remaining Rs300 will be distributed among the other members. The process continues for 19 more weeks till other 19 members receive their weekly collection. Rosca is very popular in western states in India, Bangladesh and in several African countries.

Both these savings mechanisms have been functioning well for times innumerable. The reasons may be as follows: In the first case, as Jyothi had not promised to pay any top-up amount over the principle, there was no need for her to invest the collected sum in any business venture. Keeping the money in a safe vault or regularly depositing the money in a savings account of a bank would be good enough for her to meet the obligation of the clients on time. The success of the second mechanism may be attributed to the governance structure of Rosca. Governance is ensured through self-selection of the members as well as by holding intimate knowledge of the activities of the other members.

The recent Saradha Group fiasco in West Bengal points to a failure on both fronts. First, Saradha Group’s promise to pay a high interest on deposit may have pushed the firm to invest in risky ventures but without it having the expertise to handle these. The second failure is of governance, as the depositors were kept in the dark and were clueless as to how Saradha Group would keep its promises.

The government as well as regulatory bodies such as the Reserve Bank of India that have a dominant role to play in preventing such market failure woke up to the crisis only after it shot up to its highest level.

The West Bengal government has proposed a fund of Rs500 crore to make up the losses of the duped depositors, safe-guarding their interest with taxpayers’ money. While this may bring some short-term relief to the depositors, the move is likely to have an adverse effect on the financial market in the long term as people will expect the government to bail them out for any of their irrational decisions. The state’s move, rather than forcing people to become cautious and making informed investment decisions, will only make investors more careless while investing in high-return deposit schemes.

While timely government intervention is essential to curb such market failure, the common man too should be careful while investing in deposit schemes as high returns can’t be without risk.

highlights of budget 2013-2014

before reading the budget you must be familiar with some financial jargon. to know ,click me 

you can download the highlights of the budget,to download click me, click me

Handbook of Statistics on Indian Economy

CLICK ME TO GET UR COPY
A READY GUIDE FOR INDIAN ECONOMY  

ECONOMIC REFORMS IN INDIA- REPORT CASE

India's Economic Reforms

The past three years have seen major changes in India's economic policies marking a new phase in India's development strategy. The broad thrust of the new policies is not very different from the changes being implemented in other developing countries and also all over the erstwhile socialist world. They aim at reducing the extent of Government controls over various aspects of the domestic economy, increasing the role of the private sector, redirecting scarce public sector resources to areas where the private sector is unlikely to enter, and opening up the economy to trade and foreign investment.

These changes have been accompanied by a lively debate in India and have also attracted interest abroad. International opinion has typically welcomed the reforms and generally urged a much faster pace of implementation, especially in view of changes taking place in other countries. Within India, opinion has been more varied. There are some who question the very direction of reform, but this is definitely a minority opinion. More generally, the broad direction of reform has met with wide approval, but there are differences of view on what should be the pace and sequencing of reforms. While there is widespread support for the elimination of bureaucratic controls over domestic producers, there are differences on such issues as the speed at which protection to domestic industry should be reduced, the extent to which domestic industry can be subjected to foreign competition without being freed from the currently prevalent rigidities in the domestic labour market; the extent to which privatisation should be pursued etc. These are obviously critical issues in designing a reform programme. They become particularly important when all the elements of an optimal package cannot be fully implemented simultaneously owing to social or political constraints. This confronts reformers with typical "second best" problems since the infeasibility of one element of the package could make pursuit of other elements anfractuous even counter- productive. The recently developed literature on the sequencing of reform in developing countries provides some guidance in making these difficult choices though it is far from being conclusive.

This paper presents an overview of what has been achieved in India's current reforms. It indicates some of the compulsions affecting the sequencing and pace of reforms and attempts to evaluate the internal consistency of the resulting package. The paper also presents a tentative assessment of the results achieved at the end of the third year.

I. A Gradualist Approach

An important feature of India's reform programme, when compared with reforms underway in many other countries, is that it has emphasised gradualism and evolutionary transition rather than rapid restructuring or "shock therapy". This gradualism has often been the subject of unfavourable comment by the more impatient advocates of reform both inside and outside the country. Before considering the contents and design of the Indian reform programme, it is useful to review some of the main reasons why India's reforms have followed a gradualist path.

One reason for gradualism is simply that the reforms were not introduced in the background of a prolonged economic crisis or system collapse of the type which would have created a widespread desire for, and willingness to accept, radical restructuring. The reforms were introduced in June 1991 in the wake a balance of payments crisis which was certainly severe. However, it was not a prolonged crisis with a long period of non-performance. On the contrary, the crisis erupted suddenly at the end of a period of apparently healthy growth in the 1980s, when the Indian economy grew at about 5.5% per year on average. This may appear modest by East Asian standards, but it was much better than India's previous experience of 3.5 to 4% growth and was also better than the average growth rate of all developing countries taken together in the same period.

Not only did economic performance improve in the eighties, this improvement was itself perceived to be the result of a process of evolutionary reform. By the beginning of the decade of the eighties it began to be recognised that the system of controls, with a heavy dependence on the public sector and a highly protected inward oriented type of industrialisation, could not deliver rapid growth in an increasingly competitive world environment. The sustained superior performance of East Asian countries was evident to all by the mid-eighties, and this helped create a perception that India could and should do better, but the approach remained one of evolutionary change. Several initiatives were taken in the second half of eighties to mitigate the rigours of the control regime, lower direct tax rates, expand the role of the private sector, and liberalise licensing controls on both trade and foreign investment. However, these changes were marginal rather than fundamental in nature amounting more to loosening controls and operating them more flexibly rather than a comprehensive shift away from a regime of controls. Since the economy was seen to have responded well to these initiatives, with an acceleration in growth in the 1980s, it created a strong presumption in favour of evolutionary change.

Finally, gradualism was the inevitable outcome of India's democratic and highly pluralistic polity in which economic reforms can be implemented only if they are based on a sufficiently wide popular consensus. The favourable experience of liberalisation in the 1980s had created an intellectual climate for continuing in the same direction, and the crisis of 1991 certainly "concentrated the mind" in favour of bolder reforms, but the pace of reforms had to be calibrated to what would be acceptable in a democratic polity.[2] This consideration was all the more important in June 1991 since the new Government did not at that time have a majority in Parliament.

II. The Scope and Coverage of the Reforms

The reform programme initiated in June 1991, though gradualist in its approach, was nevertheless very different from the incremental approach to reforms of the 1980s. As far as objectives are concerned, the current reforms are based on a much clearer recognition of the need to integrate with the global economy through trade, investment and technology flows and for this purpose to create conditions which would give Indian entrepreneurs an environment broadly comparable to that in other developing countries, and to do this within the space of four to five years. As far as instruments are concerned, there is clear recognition that the reforms cannot be limited to piecemeal adjustments in one or other aspect of policy but must bring about system changes affecting several sectors of the economy. The comprehensiveness of the reforms was not perhaps fully evident at the very beginning, when the primary focus was on restoring macro-economic stability, but as the reforms proceeded the scope and coverage of the reform effort was more clearly outlined. The main elements of the reform are summarised in this section, which also indicates differences in the pace and sequencing of individual elements in the package.

i) Fiscal Stabilisation

If the recent literature on sequencing of reforms yields one firm conclusion it is that fiscal stabilisation is an essential precondition for the success of economic reforms. The design of India's reform programme was fully in line with this conclusion and fiscal stabilisation was given the highest priority, especially in the initial phase of crisis management when the current account deficit was high and inflation in double digits.

The Central Government fiscal deficit had expanded steadily during the eighties and had reached a peak level of 8.4% of GDP in 1990-91. Allowing for deficits of the State Governments, this meant an overall Government fiscal deficit of around 10% which is high by any standard. A reduction in the Central Government's fiscal deficit was therefore critical for the reforms to take off. The first year of the reforms saw a substantial reduction in the Central Government fiscal deficit from 8.4% of the GDP in 1990-91 to 5.9% in 1991-92 and further to 5.7% in 1992-93. Some of the reduction in the fiscal deficit in the first two years was achieved by systemic improvements which permanently strengthened the fiscal situation, such as for example the abolition of export subsidies in 1991-92 and the partial restructuring of fertiliser subsidy in 1992-93. Another important systems change was the announcement that budget support to loss making public sector units in the form of Government loans to cover their losses would be progressively phased out. However part of the fiscal adjustment in the first two years was also achieved by restricting development expenditure, including expenditure on social and economic infrastructure. Despite this limitation, the success achieved in fiscal consolidation in the first two years was commendable, with the fiscal deficit being reduced by 2.7 percentage points of GDP. In this respect the management of reforms in the first two years was entirely in line with the prevailing consensus on sequencing.

The process of fiscal consolidation was to continue into the third year of the reform with the fiscal deficit expected to be reduced to 4.6% of GDP in 1993-94. In the event, there was a substantial slippage from this target and the fiscal deficit in 1993-94 is estimated at 7.3% of GDP. Part of the slippage (about 1 percentage point of GDP) was due to a shortfall in tax revenues compared to Budget targets. Customs revenues were substantially below the target because imports were much lower than expected, despite significant reductions in customs duty rates and liberalisation of imports implemented as part of the structural reform (see below). Excise duty collections also fell short because industrial production did not recover as rapidly as expected. The rest of the slippage (about 1.7 percentage points of GDP) was due to expenditures exceeding targets. Delays in adjusting food prices in the public distribution system led to higher food subsidy and expenditures on development were higher than projected partly because of larger flows of resources to support development expenditure of the States. To some extent the overshooting of expenditures reflects pent up pressures, which had built up over two years of fiscal consolidation and were difficult to resist.

It is also true that the overshooting of expenditure in 1993-94 was to some extent tolerated in 1993-94 because the economy was suffering from underutilisation of capacity. Public sector investment, especially by the States, was held back by fiscal constraints and private sector investment was also restrained as the corporate sector re-adjusted its investment plans in line with the new, much more competitive economic environment. The prevalence of excess capacity in parts of the economy, combined with a surprisingly easy external payments position, and a sharp reduction in inflation to less than 6% in mid-1993 led to a willingness to accept a more expansionary fiscal policy.

The unexpected increase in the fiscal deficit in 1993- 94 is understandably a cause of considerable concern among observers of the reform programme. Experience in many developing countries provides several examples of reform efforts which have been aborted by premature easing of fiscal control. The Government has recognised this problem and has indicated that the deviation from the path of fiscal consolidation in 1993-94 was a temporary phenomenon and will be reversed in 1994-95. Accordingly, the target for the fiscal deficit in 1994-95 has been set at 6 per cent of GDP, which is a significant improvement over the actual performance in 1993-94.

An important new initiative in the 1994-95 Budget is the announcement that there will be a pre-determined cap on the extent of monetisation of the Government deficit which did not exist earlier since the Government could borrow from the Reserve Bank without limit. It is now proposed to operate a ceiling on Government borrowing from the Reserve Bank by authorising the Reserve Bank to auction Treasury Bills at market rates whenever the pre-determined ceiling is breached for more than a specified period.

ii) Industrial Policy and Foreign Investment

Perhaps the most radical changes implemented in the reform package have been in the area of Industrial Policy removing several barriers to entry in the earlier environment. The system of pervasive industrial licensing prevalent earlier, which required Government permission for new investments as well as for substantial expansion of existing capacity, has been virtually abolished. Licensing is now needed only for a small list of industries, most of which remain subject to licensing primarily because of environmental and pollution considerations. The parallel but separate controls over investment and expansion by large industrial houses through the Monopolies and Restrictive Trade Practices (MRTP) Act have also been eliminated. The many inefficiencies of this system - carefully documented by Bhagwati and Desai as early as 1970 - are now truly a part of history as far as the Central Government is concerned. A comprehensive restructuring of the Companies Act is also underway which aims at simplifying and modernising this aspect of the legal framework governing the corporate sector.

One area where licensing controls remain in place relates to the list of industries reserved for the small scale sector. Doubts are often expressed on whether reservation, which prevents larger units from entering the reserved areas to compete with small scale industries, is a desirable instrument for promoting the small scale sector. However the Government has indicated that the general policy of reserving certain items for the small scale sector will continue for social reasons. This restriction may not be very significant in practice since the areas reserved in this way are actually quite small. The major problem really arises in certain product areas which are reserved for the small scale sector but which also have a substantial export potential such as for example toys and "garments. In order to introduce a measure of flexibility in such cases, the Government has modified policy to allow medium scale units to enter such areas provided they export at least 50% of production.

The list of industries reserved for the public sector has been drastically pruned and many critical areas have been opened up to private sector participation. Electric power generation has been opened up for private investment, including foreign investment, and several State Governments are actively negotiating with various foreign investors for establishing private sector power plants. The hydrocarbon sector, covering petroleum exploration, production and refining has also been opened up to the private sector including foreign investment and has attracted significant investor interest. Air transport, which until recently was a public sector monopoly, has been opened up to the private sector and some new entrants have begun operations. The Telecommunication sector has also been opened up for certain services such as cellular telephones, though the modalities for inducting private sector participants have yet to be worked out.

The liberalisation of controls over domestic investors has been accompanied by a radical restructuring of the policy towards foreign investment. Earlier, India's policy towards foreign investment was selective and was widely perceived by foreign investors as being unfriendly. The percentage of equity allowed to foreign investors was generally restricted to a maximum of 40%, except in certain high technology areas, and foreign investment was generally discouraged in the consumer goods sector unless accompanied by strong export commitments. The new policy is much more actively supportive of foreign investment in a wide range of activities. Permission is automatically granted for foreign equity investment upto 51% in a large list of 34 industries. For proposals involving foreign equity beyond 51%, or for investments in industries outside the list, applications are processed by a high level Foreign Investment Promotion Board. The Board has established a record of speedy clearance of applications and the total volume of foreign equity approved in the first 24 months amounts to $3 billion. This compares with annual levels of approvals of only about $150 million only a few years earlier. Various restrictions earlier applied on the operation of companies with foreign equity of 40% or more have been eliminated by amendment of the Foreign Exchange Regulation Act and all companies incorporated in India are now treated alike, irrespective of the level of foreign equity.

India has joined the Multilateral Investment Guarantee Agency (MIGA) and has recently concluded a bilateral Investment Protection Agreement with the United Kingdom. Similar bilateral agreements are being negotiated with other major investing countries.

iii) Trade and Exchange Rate Policy

In keeping with the objective of greater openness and outward orientation, trade policy has been very substantially liberalised for all except final consumer goods. The complex import control regime earlier applicable to imports of raw materials, other inputs into production and capital goods has been virtually dismantled. Today, all raw materials, other inputs and capital goods, can be freely imported except for a relatively small negative list. Imports of consumer goods remain restricted except for the limited windows of permissible imports of such items by returning Indians and a limited facility for imports of some consumer goods allowed against special import licenses which are given to certain categories of exporters as an incentive. The exclusion of consumer goods from trade liberalisation is an important restrictive element in trade policy - and the Government has indicated that this too will be gradually liberalised - but for all other sectors quantitative restrictions on imports have been largely eliminated.

The removal of quantitative restrictions on imports has been accompanied by a gradual lowering of customs duties. India's customs duties before the reforms were very high, with the average rate of duty being as high as 100% and very substantial variations around this average. The Government has made a series of downward adjustments in customs duties in each of the four Budgets since 1991. The peak rate of customs duty applicable to several items was over 200% in 1991. It has been lowered to 65% in 1994. Other customs duty rates below the peak have also been lowered, especially the duties on capital goods. The rate of customs duty on capital goods used to be as high as 90-100% in 1991 with concessional duty imports of capital goods available only to 100% export oriented units. The duties on capital goods have now been lowered to a range from 20% to 40%. Even with these reductions, India's customs duty rates are still too high and the Government has indicated that it will continue the process of lowering tariffs over the next two years to reach levels comparable with other developing countries.

Exchange rate policy has gone through a series of transitional regimes since 1991, leading to a total transformation at the end of three years. The reforms began with a devaluation of about 24% in July 1991 in a situation in which extensive trade restrictions were still in place. The devaluation was accompanied by an abolition of export subsidies to help the fiscal position, and an offsetting increase in export incentives in the form of special incentive licenses (Eximscrips) given to exporters which could be used to import items which were otherwise restricted. These licenses were freely tradeable and commanded a premium in the market depending upon the excess demand for restricted imports. The system was modified in March 1992 by the introduction of an explicit dual exchange rate system simultaneously with the dismantling of licensing restrictions on import of raw materials, other inputs into production and capital goods. These items were made freely importable against foreign exchange obtained from the market at a market determined floating exchange rate. Imports of certain critical item's such as petroleum, essential drugs, fertiliser and defence related imports were paid for by foreign exchange made available at the fixed official rate, and the demand for foreign exchange at the official rate to pay for these imports was met by requiring exporters to surrender 40% of their export earnings at the official rate. The remaining 60% of export earnings was available to finance all other imports, all other current transactions and debt service payments, at the market rate. This dual exchange rate system was again a shortlived transitional arrangement to a unified floating rate which was announced in March 1993. After a year's experience with the unified rate the Government, in March 1994, announced further liberalisation of payment restrictions on current transactions and stated its intention of moving to current account convertibility. Capital controls however remain in place.

Thus in the short space of two and a half years the trade and payments system has moved from a fixed and typically overvalued, exchange rate operating in a framework of substantial trade restrictions and export subsidies, to a market determined exchange rate within a framework of considerable liberalisation on the trade account and the elimination of current restrictions. The transition is by no means complete, since consumer goods remain subject to quantitative restriction and tariffs are still high, but the changes made thus far are certainly substantial. The fact that they have been successfully managed has created the confidence necessary for an easy transition through the remaining stages.

The continuation of controls on the capital account is broadly in line with the current consensus in the literature on sequencing which holds that liberalisation of the current account and an effective management of such a liberalised system should precede libralisation of the capital account.

iv) Tax Reform

Reform of the tax system has been an important element in the Government's reform programme with major changes contemplated in both direct and indirect taxes. The broad directions of tax reform have been spelt out in the Report of the Taxation Reforms Committee (Chelliah Committee). The Committee has recommended a move towards a simpler system of direct taxation with moderate rates and fewer exemptions, a progressive reduction in the level as well as the range of variation of customs duties and a rationalisation of the domestic excise taxes on industrial production with a switch from specific to ad valorem rates, fewer duty rates and a drastic reduction if not elimination of exemptions. Substantial progress has been made in these directions in the four Budgets that have been presented since the reforms began and this is best seen by considering the cumulative changes that have taken place in each of the major areas of taxation:

·               The maximum marginal rate of personal income tax was 56% in June 1991. This has now been reduced to 40%.

·               The incentive structure for savings in the form of financial assets has been strengthened. The Wealth Tax, which was earlier applicable to all personal assets, has been modified to exempt all productive assets including financial assets such as bank deposits, shares and other securities.

·               The rates of corporate income tax, which were 51.75% for a publicly listed company and 57.5% for a closely held company have been unified and reduced to 46%. All these rates are inclusive of a 15% surcharge. Without the 15% surcharge the rate of corporate tax would be 40% which is the same as the maximum marginal rate on personal taxation.

·               Customs duties, as noted above, have been significantly reduced over the past three years and the Government has indicated that further reductions are expected to be implemented in phases to bring the rates in line with those prevailing in other developing countries.

·               Excise duties on domestic manufactured goods were charged at varying rates on different commodities, with most of the duties being specific rather than ad valorem. There were also a large number of exemptions. A system of tax credit for taxes paid on inputs called Modified Value Added Tax or MODVAT was in force but excluded important sectors such as textiles and petroleum. Duty credit was also not available on excise duty paid on capital goods at the time of investment. The Budget presented in February 1994 has greatly simplified the system, with the bulk of the taxes shifted to an ad valorem basis and the number of exemptions greatly reduced. The coverage of the tax credit for taxes paid on inputs has been extended to include petroleum and capital goods. The number of excise duty rates has been reduced from 21 to 10. A start has also been made in extending indirect taxation to a few services by imposing a 5% tax on telephone bills, premium payments for general insurance and stock brokers' commissions. The longer term objective of the Government is to move to a Value Added Tax, but this is still a distant prospect since it involves integration of the taxes on production, which under the Constitution are levied by the Central Government, with taxes on sales which are levied by State Governments.

These reforms in the tax system go a long way towards the objective of creating a system which avoids economic distortions, and ensures adequate buoyancy of revenues to support the task of fiscal consolidation. The changes in tax structure will have to be accompanied by major improvements in tax administration to realise the full potential of reforms in this sector. The Government has indicated that this is high on its agenda.

v) Public Sector Policy

Reform of the public sector is a critical element in structural adjustment programmes all over the world and is also included on India's reform agenda. However, this is an area where changes are being implemented slowly. Unlike the case in many other countries, where public sector reform has involved explicit programmes of outright privatisation of public sector units combined with closures of unviable units, the approach adopted in the Indian reform programme is more limited.

Instead of outright privatisation the Government has initiated a limited process of disinvestment of Government equity in public sector companies, with Government retaining 51% of the equity and also management control. The disinvestment helps provide non-inflationary resources for the Government Budget, without adding to the fiscal deficit. However this is not the only objective. The emergence of private shareholders in public sector units and trading of public sector shares in the stock markets are both expected to make public sector managements more sensitive to commercial profitability. This is especially so since the Government has decided not to use budgetary resources to finance public sector investment in industry. Public sector companies have been given a clear signal that in future their investment plans must be financed either by internal resource generation or by resources raised from the capital markets - both alternatives being bound to encourage and reward efficiency and commercial orientation. A number of public sector units have resorted to the capital markets to raise resources to finance their investment plans and this trend is certain to accelerate in future.

The policy towards loss making public sector units is also cautious. The Government has announced that budgetary support to finance losses will be phased out over three years and this has had a salutary effect in confronting public sector units with a hard budget constraint. This needs to be supplemented with a policy for active restructuring of these units wherever it is possible to make them economically viable, and with closure combined with adequate compensation for labour where it is not. The Government has not ordered any closures on its own initiative, but an objective process for determining whether a unit should be closed or not has been initiated by amending the Sick Industrial Companies Act (SICA) to bring sick public sector companies under the purview of the Board for Industrial and Financial Reconstruction (BIFR) in the same way as private sector companies are covered. Sick public sector companies (defined under the law as companies which have completely eroded their net worth) are now automatically referred to the BIFR which will then consider whether a consensus can be evolved among the existing management (i.e. Government, creditors and labour) for a viable restructuring package which may involve some voluntary burden sharing by all parties - banks may offer to reschedule loans, workers to accept partial retrenchment or wage freezes, Government may have to give up taxes due etc. The Board can also consider revival packages involving induction of new managers, with a fresh injection of capital. If no consensus can be evolved for a revival package the BIFR is authorised to order closure of the unit and liquidation of its assets. This is a lengthy process but it does provide an objective means of exploring ways of reviving sick public sector units, with closure as a credible ultimate threat in extreme cases.

vi) Financial Sector Reform

The reforms in the real sector aim at creating a new set of incentives which will encourage reallocation of resources towards more efficient uses. This process needs to be underpinned by a parallel process of financial sector reform which will enable the financial sector to mobilise savings and allocate them in a manner which supports the process of restructuring in the real economy. Several initiatives have been taken in these areas covering both the banking system and the capital markets.

As far as banking system reform is concerned, the Government has announced a package of reforms to be implemented over a three year period based on the report of the Committee on the Financial System (Narasimham Committee). The high reserve requirements applicable to banks in the form of the statutory liquidity ratio (SLR) and the cash reserve ratio (CRR) were essentially designed to support Government borrowing at below market rates of interest and constituted a hidden tax on financial intermediation. The Government has announced that these high reserve requirements will be progressively reduced, and the process has already begun. Parallel with the reduction in the requirements for compulsory investments by banks in Government securities, the interest rates on Government securities are increasingly market determined. Interest rate regulation in the banking system is also being reduced and rationalised. Earlier the Reserve Bank of India prescribed a number of different interest rates on deposits of different maturities and also a large number of prescribed lending rates for different sectors and classes of borrowers. Deposit rates for different maturities have now been freed subject only to a single ceiling. The proportion of deposits which banks can accept in the form of Certificates of Deposits, which are completely free from interest rate regulation, has been increased. On the lending side the number of prescribed interest rates for different types of borrowers has been reduced from six to three and it is proposed to move to an even simpler system with only one concessional rate and a single floor rate for all other loans.

Prudential norms relating to income recognition, provisioning and capital adequacy applicable to banks, have been brought in line with Basle Committee standards and these norms are being phased in gradually to be fully in force by March 1996. Combined with improved accounting practices and management information systems in the banks, this is expected to yield a much better picture of the true financial condition of the banks. This in turn will improve the quality of lending and generate pressures for greater efficiency among borrowing units. The absence of such pressures from the banking system in the past has been one of the reasons for pervasive inefficiency in many sectors of the economy.

The new norms reveal that the nationalised banks, which account for about 90% of total deposits, have a much higher proportion of non-performing assets than was earlier supposed. Full provisioning for these assets will inevitably lead to substantial impairment of capital and this means the nationalised banks will require extensive injection of fresh capital to meet the new capital adequacy norms. The Government has announced a programme of contributing fresh capital to the nationalised banks which involves a substantial burden on the Budget. This is unavoidable, reflecting the real cost of past banking inadequacies. However, in order to mitigate the impact on the Budget it is envisaged that the relatively stronger nationalised banks with good balance sheets will mobilise additional capital from the market by issuing new equity to the public. This will dilute the present 100% Government ownership of these banks by bringing in new private shareholders though Government equity will remain at least 51%. It is expected that the induction of private shareholders will create an environment in which these banks will pay much greater attention to the commercial viability of their operations.

The banking system is also being opened up to competition from new private banks and several new banking licenses have been granted. Branches of foreign banks have also been expanded to increase competition. All these policy changes will be supported by improved supervision by the Reserve Bank of India and strengthening of the management systems within the nationalised banks. The Government has also set up special Debt Recovery Tribunal to help facilitate recovery by banks from defaulting borrowers. The end result of these initiatives should be a much more efficient banking system which would support greater efficiency in the real sector.

Parallel with efforts to reform the banking system the Government has also embarked on a major reform of the capital market. During the eighties the capital market grew remarkably in size, with a sharp increase in the volume of resources being raised by the corporate sector in the form of corporate debt and new equity. The size of the investing public also expanded considerably especially in the form of subscribers to mutual funds. This quantitative expansion was not however matched by necessary qualitative improvements. India's stock exchanges have shown considerable dynamism, but they remained inadequately regulated and suffered from lack of transparency in trading practices. Supervision was not up to the level required to ensure investor protection.

Several important initiatives have been taken in the past two years to remedy these deficiencies and raise standards to those prevailing in countries with well functioning efficient capital markets. The requirement of Government permission for companies issuing capital, as well as the system of Government control over the pricing of new issues of equity by private companies, has been abolished with the repeal of the Capital Issues Control Act in May 1992. Firms are now free to issue capital and price new issues according to market conditions subject only to guidelines aimed at effective disclosure of information necessary for investor protection. The Securities and Exchange Board of India (SEBI) has been established as an independent statutory authority for regulating the stock exchanges and supervising the major players in the capital markets (brokers, underwriters, merchant bankers, mutual funds, etc). The focus is not on control and Government intervention but on establishing a framework of regulation to ensure transparency of trading practices, speedy settlement procedures, enforcement of prudential norms and full disclosure for investor protection.

An important initiative taken as part of the reforms is the opening up of the capital market for portfolio investments. Indian companies have been allowed to access international capital markets by issuing equity abroad through the mechanism of Global Depository Receipts. Foreign institutional investors managing pension funds or other broad based institutional funds have been allowed to invest directly in the Indian capital markets. Favourable tax treatment has been granted to such investments to encourage capital inflows through these routes. These initiatives have come at a time when international fund managers are diversifying their portfolios by investing in "emerging capital markets" and India has benefited from this trend along with other developing countries. It is estimated that inflows from international equity issues by Indian companies in 1993-94 amounts to about $2.5 billion, while foreign institutional investors have invested about $1.5 billion in the domestic capital markets.

vii) Reforms and the Agricultural Sector

With over 70 per cent of the population in rural areas, and most of them dependent on agriculture, it follows that the strategy for economic reforms must address the constraints on efficiency and production in the agricultural sector. Much of what needs to be done in this area consists of effective implementation of the basic strategy for agricultural development that has worked well in many parts of the country and needs to be extended to other parts. This calls for substantial investments in land and water management, supply of improved seeds, an effective system for delivery of rural credit and of course security of tenure. Many of these elements fall within the area of responsibility of State Governments.

A disturbing feature of recent trends in the agricultural sector is that real investment in agriculture, both public and private, has been stagnant. There is need for substantial increase in public investment in agriculture and irrigation but this can only happen if resources available for investment with the State Governments can be increased. Unfortunately, investible resources with State Governments have been seriously eroded because of large increases in unproductive current expenditure and the heavy burden of losses on the provision of basic economic services in rural areas such as electric power and irrigation. Top priority must be given to reducing these implicit subsidies through rational pricing of both water and electricity and also better management. The resources thus saved should be devoted to increased investment in agriculture and related rural infrastructure.

One dimension in which agriculture will be helped by the new policies is the expected general eguilibrium impact of reduced protection to industry, which should reduce the anti-agriculture bias of the earlier high protection regime. The new regime not only makes agricultural exports more competitive at the new exchange rate, it also stimulates the growth of the agro-processing industry, with strong backward linkage to agriculture. A logical extension of the current programme of reforms is the elimination of all restrictions on movement of agricultural commodities both domestically (across States) and also for exports. This has been accepted as an element of the economic reforms. All Central Government restrictions on domestic trade have been removed though some State Governments restrictions remain. Restrictions on agricultural exports have also been reduced significantly though not as yet fully eliminated. Some of the remaining restrictions, such as for example the restriction on exports of pulses and coarse grains are not really binding in practice but have been continued with an eye to avoiding any psychological pressure on prices.

A major area where policy reforms can help agriculture is in the area of rural credit. Poor banking practices, including especially laxness regarding loan recovery, has greatly weakened the cooperative credit system and has also weakened rural lending by the commercial banking system. The financial sector reforms currently underway will address this problem through a combination of rationalisation of interest rates to reduce the disincentive of unviable lending rates which discourage rural lending, recapitalisation of banks and restructuring of cooperative credit institutions.

viii) Labour Market Reforms

A commonly heard complaint from domestic as well as foreign investors is that labour markets are unduly rigid. Indian labour laws provide a high degree of protection to labour with retrenchment of labour and closure of an unviable unit requiring prior permission of the State Government for units employing more than 100 workers. Such permission is not always granted and this leads to the complaint that Indian firms lack the flexibility they need to adapt to changed economic circumstances. Spokesmen of domestic industry, and also foreign investors, make the point that firms must have the ability to retrench labour and to close down unviable units if necessary or else they will not be able to compete effectively with the rest of the world in a more open economy. This flexibility is also relevant if old firms, with a hangover of excess labour, have to compete with new firms without this burden.

One of the lessons from the literature on sequencing is that if some markets take longer to adjust than others, it is important to begin with reforms in the markets which adjust slowest. On this basis, reforms in the labour markets should have top priority since labour market typically take longer to adjust. However it is also important to recognise that reform of labour laws is a politically sensitive issue. Any weakening of the labour laws is likely to evoke fears of widespread unemployment and this is especially the case at the early stages of the reforms when the beneficial effect of the new policies in terms of more rapid growth of output and employment has yet to gain momentum. There is recognition, even in official circles, that excessive rigidity in the Labour Laws may not be in the interest of employment creation, but a consensus on how to tackle this problem has yet to emerge.

In any case, reform of labour laws must come after the creation of credible safety nets to deal with the problems of displaced labour. A first step in this direction has been taken by the creation of a National Renewal Fund which will finance compensation payments to labour rendered redundant in the course of public sector restructuring and closure of unviable units. It will also finance retraining programmes to help redeploy such labour. Financing for the fund is being provided from the Central Budget and resources have been obtained from multilateral and bilateral aid donors in support of this activity. Approximately 20,000 workers were laid off and paid compensation from the NRF in 1992-93 and a similar number again in 1993-94. As the process of restructuring public sector firms gains momentum the NRF will play a larger role in years to come.

III. A Tentative Assessment

The reforms described in the previous section clearly go beyond piecemeal adjustments of one or other aspect of policy. The reforms are far reaching and cover several sectors of the economy in a mutually re-inforcing fashion. It is however too early to attempt a definitive assessment of their impact on the economy. In some areas, such as for example in the financial sector, the reforms are still in the initial stages of implementation. Even where progress has been rapid, as for example in industrial deregulation and trade liberalisation, there are unavoidable lags before the economy can respond, especially where the total response depends upon investment and the resulting creation of new capacity. Nevertheless, it is useful to assess the results achieved in terms of economic performance in the first three years.

The success in managing the short term crisis and stabilising the economy are impressive. Inflation has been reduced from a peak of 17% in August 1991 to about 8.5% within two and a half years. Foreign exchange reserves have increased from $1.2 billion in June 1991 to over $15 billion in March 1994. Exports have responded well to the new trade policy and the exchange rate regime, and exports (measured in US dollars) have grown by about 21% in the first ten months of 1993-94. International confidence has been restored and there is an upsurge of investor interest in India both for direct foreign investments and also for portfolio investment.

The results in terms of the medium term objectives of stimulating growth and investment are less dramatic at this stage, but this is not altogether surprising. Many countries going through structural adjustment have experienced sluggish, and indeed even negative, growth in the early years. India's experience of structural adjustment has been much less painful. GDP growth dropped to 1.1% in 1991-92, which was the first year of the reform, but it recovered to about 4% in 1992-93 and is expected to continue at about the same rate in 1993-94. Growth has not collapsed, but it is also true that the economy has not yet recovered to its previous trend performance of 5.5% growth in the 1980s. Even the growth achieved in 1992-93 and 1993-94 is largely on account of a good performance in agriculture and the tertiary sector.

Industrial growth, which is the main target of industrial and trade reforms, remained sluggish at 1.8% in 1992-93 and is unlikely to exceed 3.5% in 1993-94. A slowdown in industrial growth in the initial phase of economic reform was not unexpected as Indian industry adjusted to the new competitive environment. However, the success of the reforms will inevitably be measured by how quickly the system returns to the earlier levels of 7 to 8% growth in industry. In fact the medium term objective should be to accelerate quickly beyond this level. If the aim of the reforms is to enable the economy to achieve growth rates of GDP of 6 to 7% in a sustainable manner this can only be achieved if the industrial sector grows by about 10%.

The transition to a higher and growth path for the economy, and one which is sustainable from the balance of payments point of view, requires a revival in total investment. The first two years of the reforms saw a slight decline in the rate of investment (Gross Fixed Capital Formation as a per cent of GDP) from 22.8% in 1990-91 to 21.3% in 1992-93. National accounts data for 1993-94 are not yet available, but the rate of investment is unlikely to have increased. Public investment has been low because of severe resource constraints affecting State Governments. Private investment has also been depressed as the corporate sector re-orients its investment strategy to the new economic environment with greater domestic competition and lower protection. Such reductions in the rate of investment have occurred in other countries going through structural adjustment. To some extent the lower rate of investment may be offset by greater efficiency in capital use, and indeed this is a critical objective of much of the structural reforms. However a revival of economic growth to levels above the 5.5% achieved in the 1980s will definitely call for higher rates of investment in the years ahead.

There is evidence that private investment activity is beginning to revive and the new investment will be more efficient. Corporate strategies are being re-oriented to enable companies to perform effectively in the emerging, more competitive environment. Firms are paying much more attention to modernisation of existing plants than to creation of new capacity in greenfield sites, and this is a desirable development since such investments are more cost effective. Several companies are also undertaking labour rationalisation through voluntary retirement schemes to ready themselves for stiffer competition. Financial sector reforms, including especially the efforts being made to strengthen capital markets, are creating an environment in which firms with a good track record and market appeal are able to raise substantial volumes of capital both domestically and internationally to finance modernisation and expansion. Increased interest by foreign investors looking for joint venture partners is also helping to stimulate investment optimism on the part of domestic firms through tie ups with global partners.

The revival of private investment will also need to be supported by higher level of public investment in critical infrastructure areas such as power, railways, roads, ports and irrigation. The new policies allow, and indeed encourage, private investment in critical areas such as power and petroleum exploration, and a limited beginning is also being made to induct private investment in roads and ports. Telecommunication is another area where new initiation are under consideration. However the quantitative significance of private investment in these areas is bound to be modest initially and can only supplement the public sector effort. The ability of the public sector to undertake the large investments needed in the medium term is therefore critical for the success of the reforms. This will in turn depend upon improved financial performance of major public sector organisations such as the State Electricity Boards and also an improvement in the fiscal position of both the Central and State Governments.

Improvement in the fiscal position of the Central and State Government is important not only to bring about a revival of investment in infrastructural but more generally for creating a favourable macro-economic environment in which the reforms can operate. Successful management of a liberalised and more open economy, with increasing liberalisation of the financial sector, depends crucially upon the fiscal deficit being reduced substantially from present levels. This is a key element of the current strategy and as long as progress in this dimension continues, there is good reason to expect that the reforms launched in 1991 will succeed in shifting the Indian economy on to a higher growth path.

-Montek S Ahluwalia*